Interplay of Economic Substance Regulations with Corporate Tax Law in UAE

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Introduction

The interaction between the UAE Economic Substance Regulations (ESR) and the Corporate Tax law is crucial for businesses operating in the region. The UAE introduced ESR in 2019 to align its tax framework with international standards and combat harmful tax practices. Under ESR, entities conducting “relevant activities 1 ” must demonstrate substantial activities in the UAE, ensuring that they have a substantial presence and economic impact.

In this write-up, we have analyzed the plausible interaction of the ESR with the Corporate Tax Law which is effective from 1 June 2023.

Expanse

ESR is applicable to all entities operating in the UAE, including those in free zones or offshore jurisdictions, if they are engaged in “relevant activities” (also known as Licensees). In the absence of any minimum threshold under ESR, it has a wide coverage. There is no change proposed in the ESR subsequent to the implementation of the corporate tax law. It is likely that in the near future, entities covered under the 9% tax rate may be exempted from ESR.

Impact on tax residence

ESR emphasizes on “substance over form” to prevent base erosion and profit shifting (BEPS). Aligning operations of an existing entity with ESR may impact the tax residence status of a company/entity as well as its key management personnel operating in the UAE.

Interplay with Free Zone Regulations

Tax benefits and exemptions offered in free zones may conflict with the substance requirements of ESR. Balancing these aspects while ensuring compliance with both sets of regulations can be challenging. Free zone entities may need to make adjustments to their operations (for instance, employee visa, income streams, assets utilised etc.) to align with ESR without compromising the advantages provided by the free zone. The Cabinet Decision 100 of 2023 requires that a Qualifying Free Zone must have adequate assets, an adequate number of qualified full-time employees and incur an adequate amount of operating expenditures, in relation to each activity. ESR may be useful to

These activities include banking, shipping, insurance, holding company, fund management, intellectual property, lease financing, distribution and service center's and headquarters. understand the meaning of adequate number of assets, employees and expenditure.

Interplay with transfer pricing regulations

All entities covered under ESR may not be subject to transfer pricing under the Corporate Tax law and vice versa. For instance, a controlled transaction between related parties may be subject to transfer pricing but may not be covered under ESR unless the entity is engaged in a relevant activity. Further, assuming a transaction is covered both under ESR and transfer pricing regulations, ESR reporting may be limited whereas under transfer pricing, controlled transactions must be documented in adequate detail to ensure adherence to the arm’s length principle.

Documentation and reporting

Due to multiplicity of regulations, as in any other jurisdiction, any entity in the UAE must maintain different set of documents and records under different regulations. Separate returns and forms are also required under each of these regulations, viz. ESR, corporate tax and transfer pricing regulations, if applicable.

Conclusion

Multinational companies operating in different jurisdictions may need to make adjustments to their operations and structures to align with the substance requirements mandated by ESR while also considering the implications for corporate tax planning. Seeking professional advice is advisable to navigate these complexities and ensure compliance with both ESR and corporate tax regulations in the UAE.

Disclaimer : The content on this website is provided for general informational purposes only. It is not intended as professional advice and should not be construed as such. The information is based on the knowledge and experience available at the time of writing and is subject to change.