The United Arab Emirates (UAE) was removed from the European Union's blacklist by the Code of Conduct Group on Business Taxation on October 10, 2019 following the introduction of Economic Substance Regulations in the UAE and the specific Guidance on those regulations (Ministerial Decision 2015 of 2019) issued by the UAE Ministry of Finance. The removal from the European Union's (EU) blacklist will be welcomed by international investors and financial institutions alike. At the same time, however, the Economic Substance Regulations introduce additional compliance and substance requirements for certain UAE entities. See our prior alert on the UAE substance requirements.
The UAE was initially blacklisted in December 2017 by the EU - as a non-cooperative jurisdiction - because it was perceived as facilitating offshore structures or arrangements aimed at attracting (overseas) profits which do not reflect real economic activity in the jurisdiction. The removal of the UAE from the blacklist is a reflection of the UAE's commitment to the international standards set by the OECD and the EU. This puts the UAE in a comparable position with some other countries, notably the Cayman Islands, Jersey, Guernsey, Bahrain and the BVI (all who were removed earlier from the EU's blacklist after they introduced economic substance legislation before the end of 2018).
Economic Substance Regulations and Guidance
The Economic Substance Regulations (ES Regs) prescribe mandatory levels of substance for UAE entities, including companies, branches and rep offices (including those based in any of the UAE's Free Zones) that perform any of the following geographically mobile activities (or, Relevant Activities):
- Fund administration
- Finance and leasing
- Holding company business
- Intellectual property business
- Distribution centres
From 2020, all UAE entities with a license to carry out activities in the UAE will need to provide the Regulatory Authority with a notification (Notification) whether they perform any of the Relevant Activities in the UAE, and whether part of their income is subject to tax outside the UAE. Those entities performing Relevant Activities in the UAE will be required to submit an Economic Substance Report (ES Report) to the Regulatory Authority. The ES Report provides specific information in relation to its compliance with the Economic Substance Tests (ES Tests).
Penalties and potential exchange of information (EOI) may apply as a result of non-compliance with the ES Regs. The penalties for failing to provide the Notification, or for providing inaccurate information, are between AED10,000 and AED50,000. Similar penalties apply to entities that fail to comply with the ES Tests for first time failures, and penalties of up to AED300,000 may apply to subsequent failures. Continuing failures to meet the ES Tests may eventually lead to the suspension of the entity's business license. In case of non-compliance with the ES Tests, the UAE Ministry of Finance may exchange information to that effect with the competent authorities of the jurisdiction where the entity's parent company, ultimate parent company and/or ultimate beneficial owner are resident.
According to the Guidance on the ES Tests, the relevant UAE entity will need to satisfy the following requirements:
- Conduct the core income generating activities (CIGA) within the UAE;
- Be appropriately directed and managed in the UAE;
- Have an adequate number of qualified full-time employees who are physically present in the UAE;
- Incur an adequate amount of operating expenditure (OPEX) in the UAE;
- Have adequate physical assets in the UAE; and
- In case of outsourcing, have control over the execution of the activities outsourced to third parties.
Although the ES Regs do not provide further details on what will be considered 'adequate' in relation to employees, OPEX and physical assets, the Guidance clarifies that "…what is adequate or appropriate for each entity will be dependent on the nature and level of the Relevant Activity being carried out". Thus, the entity needs to ensure it maintains sufficient records to demonstrate the adequacy and appropriateness of the resources utilized and expenditures incurred.
The ES Tests will have different implications for different types of entities. For example, holding companies are subject to fewer requirements, and will satisfy the ES Test if they meet 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. In contrast, Intellectual Property (IP) companies (which carry out so-called High Risk IP Relevant Activities) are subject to additional obligations such as: (i) information on the historic control over development, exploitation, maintenance, protection and enhancement (DEMPE) of the IP, (ii) business plans, and (iii) detailed employee information.
Many multinational groups have entities and structures in jurisdictions which have introduced Economic Substance rules, such as the UAE. We are aware of an increased focus with these rules, in particular in relation to the UAE, but also in respect of similar developments in the Cayman Islands and BVI. In general, multinational groups should determine if, and to what extent, their entities' current levels of substance in those jurisdictions are sufficient. Where there is insufficient substance, consideration should be given to a number of options, such as to: (i) increase substance in entities, (ii) liquidate non-compliant entities, (iii) centralizing / concentrate substance into one entity, (iv) reorganize or, (v) redomiciliation (to jurisdictions where the group does have substance). In this context, the UAE's substantial and efficient business infrastructure, as well as an extensive network of more than 100 double tax treaties, greatly facilitates multinationals to establish and host entities with adequate substance in the UAE.
The removal of the UAE from the EU's blacklist may also have other positive benefits, such as the fact that the domestic laws of EU countries that impose more stringent conditions on entities in non-cooperative jurisdictions, would no longer apply to entities in the UAE. The UAE may also use this development as leverage so as to be removed from domestic blacklisting in countries outside of the EU and in tax treaty negotiations.