UAE introduces Economic Substance legislation with aim of EU blacklist removal
In response to the EU blacklisting of the UAE, the UAE has recently published its Economic Substance legislation (Cabinet Resolution 31 of 2019). The legislation entered into force as from 30 April 2019 and was expected for some time. The anticipated removal of the UAE from the EU's blacklist will be welcomed by international investors and financial institutions alike.
The reason why the UAE was blacklisted - as a non-cooperative jurisdiction - is that the EU perceived it as a jurisdiction facilitating offshore structures or arrangements aimed at attracting (overseas) profits which do not reflect real economic activity in the jurisdiction (so-called Criterion 2.2). In a Scoping Paper published by the EU Code of Conduct Group on Business Taxation in 2018, specific substance requirements were provided for companies performing geographically mobile activities. The economic substance legislation which has now been introduced by the UAE is broadly in line with the Scoping Paper.
UAE substance requirements
The legislation prescribes mandatory levels of substance for UAE corporates, including companies, branches and representative offices (including those based in any of the free zones) performing the following activities (the Relevant Activities):
Finance and leasing
Holding company business
Intellectual property holding
The legislation's substance requirements prescribe for corporates in the UAE performing the Relevant Activities to: (i) conduct certain core business activities within the UAE (eg incurring operating expenses and taking relevant management decisions), (ii) have its director(s) and management in the UAE, (iii) have an appropriate number of qualified staff to perform its activities physically present in the UAE, (iv) incur sufficient expenses in relation to outsourcing activities to third parties in the UAE, (v) have sufficient physical assets or an adequate expense level in the UAE, and (vi) control the execution of activities which have been outsourced to third parties.
In order to satisfy the requirement that direction and management of the corporate takes place in the UAE, corporates must ensure that:
the board of directors have quorate meetings in the UAE on frequent occasions;
the meetings are minuted and signed by all attendees;
the directors have the necessary knowledge and experience to carry out the functions of the board; and
the records of all meetings of the board and records of the company are kept within the UAE.
For legal entities such as branches, representative offices and other companies which do not have a board and whose management is carried out by a single manager/director, that manager/director must be physically present in the UAE when making the main decisions concerning administration and operation of that entity. Holding companies are subject to less extensive requirements and will satisfy the economic substance requirements if they fulfil the requirements for the submission of data and information to the competent authority, and if they have sufficient staff and premises to carry out the work of a holding company. Companies which carry out intellectual property Related Activities are subject to additional obligations.
The legislation envisages that further guidance will be issued to assist corporates in meeting the economic substance requirements, and in particular to help interpret phrases such as 'appropriate' and 'adequate' which are used throughout the legislation.
Outsourcing to third party service providers
The legislation does envisage that corporates will be able to appoint a third party to fulfill certain of their economic substance requirements, but in doing so the corporate must be able to show that it has full control over the activity designated to the third party.
Reporting and fines
Corporates that fall within the remit of the new legislation will need to prepare and submit to the competent authority a report no later than twelve months after the end of the corporate's financial year. This reporting requirement will apply annually and the report must be prepared in accordance with the form to be issued by the competent authority. With the rules having come into effect per 30 April 2019, first reports for existing corporates should be done in 2020. The report will contain mandatory information which includes:
the value and type of income related to the Relevant Activity;
the location of the activity and the manufacturer, property or equipment used to conduct the Relevant Activity;
the number of employees, their qualifications and the number of people responsible for conducting the Relevant Activity; and
a disclosure stating that the corporate has met the economic substance requirements.
There will be fines of up to AED 50,000 applicable for non- or late reporting and up to AED 300,000 for corporates not meeting the mandatory economic substance requirements. Non-compliance may eventually also result in commercial licence suspension, withdrawal or non-renewal. The legislation also permits information sharing between the Ministry of Finance and foreign authorities.
Impact for corporates
For many UAE-headquartered corporates and overseas multinationals that undertake genuine business activities within the UAE, the new legislation will have a limited impact, save for imposing additional reporting requirements for which they should await supplementary guidance with regards to the form, content and timing of reporting. Corporates who have operations (and conduct Relevant Activities) within the UAE but which are managed from outside of the UAE should closely review their governance structures to ensure that management is conducted in accordance with the requirements of the legislation. Companies without sufficient operations and management in the UAE to meet the new standards of economic substance should consider conducting core activities within the UAE whilst moving operating assets and/or expenses into the UAE to ensure compliance going forward.
Removal from EU blacklist
The economic substance legislation will already have been submitted to the EU for their review and the UAE's subsequent removal from the EU blacklist. It remains to be seen if the currently introduced legislation suffices in light of the criteria included in the Scoping Paper. As Dominica was removed from the blacklist last week, after Aruba, the BVI and Barbados in May, the UAE's removal could follow very quickly, assuming that the EU indeed accepts its new legislation.