UAE Corporate Tax and Economic Substance Regulations (ESR): A Comprehensive Guide for Free Zones

The United Arab Emirates (UAE) has been at the forefront of enhancing its regulatory landscape to promote economic transparency and adhere to international tax standards. Two key regulations that have been significant in this regard are the UAE Corporate Tax Law and the Economic Substance Regulations (ESR). The Cabinet Decision No. 55 of 2023, issued on 30 May 2023, brings these regulations into focus, specifically concerning businesses registered and operating in UAE free zones.

Background of UAE Economic Substance Regulations (ESR)

The UAE introduced the Economic Substance Regulations (ESR) in April 2019, which aimed to address concerns raised by the European Union about economic substance in the UAE. These regulations were later repealed by Cabinet Resolution No. 57 of 2020 in August 2020, incorporating more comprehensive provisions and clarifications.

The ESR requires certain juridical persons and unincorporated partnerships engaged in “Relevant Activities” within the UAE to maintain adequate economic presence in the country relative to their activities. The Relevant Activities encompass core income-generating activities such as banking, insurance, fund management, leasing, headquarters, shipping, holding company, intellectual property, and distribution and service centers.

Scope of Application and Compliance Requirements

The scope of the ESR applies to both mainland companies and businesses registered in UAE free zones. Free zones play a crucial role in attracting foreign investments and fostering trade in the UAE. However, to maintain fairness and transparency, the Cabinet Decision No. 55 of 2023 now requires businesses in free zones to meet the same economic substance requirements as mainland companies.

UAE Licensees, which include entities with separate legal personality and branches, must fulfill two main filing requirements under the ESR:

Economic Substance (ES) Notification: All UAE Licensees, regardless of whether they undertake Relevant Activities or generate relevant income, must submit an ES Notification through the Ministry of Finance (MoF) online portal within six months of their financial year-end.

ES Annual Report: UAE Licensees engaged in Relevant Activities and generating relevant income must also submit an ES Annual Report through the MoF portal within twelve months of their financial year-end. This report requires detailed information on the Licensee’s activities, core income-generating activities, income, operating expenses, and more.

Exemption Claims for Economic Substance

Certain UAE Licensees may be eligible to claim an exemption from demonstrating economic substance in the UAE if they meet specific conditions. The exemption criteria include:

Investment Funds: Licensees functioning as investment funds are exempt from the economic substance requirements.

Branches of Foreign Entities: If a foreign entity’s branch’s relevant income is subject to taxation in a jurisdiction other than the UAE, it may claim exemption.

Entities Tax Resident Outside the UAE: Licensees that are tax residents in a jurisdiction other than the UAE are eligible for exemption.

Entities Wholly Owned by UAE Residents: Licensees wholly owned by one or more residents in the UAE, not part of a Multinational Enterprise (MNE) Group, and exclusively conducting business in the UAE may claim exemption.

It is essential to note that the acceptance of an exemption claim lies at the discretion of the UAE authorities. Additionally, if a Licensee meets the exemption criteria, it must still file a claim for each financial period to maintain its exemption status.

Interaction with UAE Corporate Tax Law in Free Zones

The UAE Corporate Tax Law governs taxation for corporations and businesses, offering a 0% rate on “Qualifying Free Zone Persons” income under specific conditions. To qualify as a “Qualifying Free Zone Person,” a business must maintain adequate substance, derive “Qualifying Income,” comply with transfer pricing requirements, and meet other conditions prescribed by the UAE Minister.

“Qualifying Free Zone Persons” are also required to maintain adequate substance in the free zone, undertake core income-generating activities (CIGAs) within the zone, and have sufficient qualified employees, assets, and operating expenditures in line with their CIGAs.

Consequences of Non-Compliance

Failure to comply with the economic substance requirements may result in the loss of “Qualifying Free Zone Person” status, leading to the applicability of the UAE Corporate Tax rate of 9% on non-qualifying income.

Conclusion

The UAE’s commitment to adhering to international tax standards and promoting economic transparency is evident through its Economic Substance Regulations (ESR) and the UAE Corporate Tax Law. With the introduction of Cabinet Decision No. 55 of 2023, businesses operating in UAE free zones must now ensure adequate substance to meet the “Qualifying Free Zone Person” definition and fulfill economic substance requirements. Complying with these regulations is crucial to avoid penalties and maintain a strong presence in the UAE’s thriving business landscape. UAE Licensees in free zones should carefully assess their operations, conduct the necessary filings, and seek professional advice to ensure full compliance with the evolving regulatory framework. By doing so, businesses can thrive and contribute to the continued growth and success of the UAE’s economy.