June 30: Deadline for ESR

ESR compliances are now mandatory for the UAE businesses to promote economic transparency

The Economic Substance Regulation (ESR) was introduced in the UAE in 2019 to ensure businesses incorporated in the mainland and freezones and engaged in the relevant activities under the regulations maintain an adequate economic presence in the UAE.

ESR compliance restricts businesses from incorporating their corporate structure to transfer activities to jurisdictions with a beneficial tax regime. Its key objective is to curb profit shift and promote economic inter-jurisdictional transparency. Businesses are obligated to notify their relevant licensing authorities if they fall under any of the relevant activities of the ESR or comply with filings, including businesses such as banking, insurance, investment fund management , lease-finance, shipping, headquarters, holding company, intellectual property, distribution — about foreign group company suppliers, service centre — provided to foreign group companies.

What needs to be submitted?

Businesses must submit an ESR notification, indicating their engagement in relevant activities within six months from the end of the financial year. However, other entities are also advised to notify to avoid queries from the UAE Ministry of Finance or the Federal Tax Authority (FTA). The ESR notification includes details about relevant activity, any exemptions applicable and whether any income has been earned.

Following the ESR notification, the entities, which have earned relevant income from the activity must submit an ESR report within 12 months from the end of the financial year. The ESR report must detail the financial information of the relevant activities and any other information satisfying the ESR testing parameters with supporting documents. Compliance is important with failure to submit leading to steep fines and penalties.

ESR audits by the UAE FTA

The UAE FTA, acting as the national assessing authority, has formally commenced the assessment of ESR reports and relevant supporting documents. Until now, most companies have completed two rounds of ESR notification filings since the implementation of the regulations in August 2020. For those companies whose financial year ended in December, the submission deadline for the ESR notification is just around the corner.

The FTA has released a list of information and relevant activity-specific documents required to support the ESR reports.

In general, the required documents are a detailed explanation of the nature of the ‘relevant activity’ of a company for that financial period, working papers for the calculation of the relevant income and full-time employees, board meetings minutes, board meetings agenda, evidence of the board meetings and full-time employees, CVs, passport copies of the board of directors and full-time employees, lease agreements for physical assets involved in the relevant activity, etc.

The ‘directed and managed’ test is an important metric of the economic substance test, which is a large part of the list.

The documents mentioned above are non-exhaustive and depending on the relevant activity, the FTA may request more documents accordingly. The supporting documents must be archived for at least six years from the submission of the ESR report.

If requested by the FTA, the relevant supporting documents must be submitted to the Ministry of Finance-ESR portal within five days from the time of request was made for such information.

— Sakina Dickenwala is associate partner, legal advisory and Jui Dongare is manager, legal advisory at MBG Corporate Services