ESR Explained in UAE
Muhammad Akmal Zia
Senior Accountant | Accounts Payble Specialist | 6 + Years Experience Accoss UAE and Pakistan | SAP & QuickBooks Expert | Specialized in Hospitality & Manufacturing | Seeking Oppurtunites
ESR in the context of the United Arab Emirates (UAE) typically refers to the "Economic Substance Regulations." These regulations were introduced to ensure that businesses operating in the UAE are engaging in substantial economic activities and are not just using the country for tax benefits without significant local operations.
What is ESR?
The Economic Substance Regulations (ESR) were introduced to align with international standards set by the OECD and the EU, addressing concerns about base erosion and profit shifting (BEPS). These regulations require that income reported by UAE entities is attributable to actual economic activities conducted within the UAE.
Key Points of ESR in the UAE:
1. Purpose:
- To comply with international standards set by the OECD and the EU regarding Base Erosion and Profit Shifting (BEPS).
- To ensure that income generated in the UAE is related to real economic activities undertaken in the UAE.
2. Scope:
- Applies to entities carrying out "Relevant Activities," including:
- Banking
- Insurance
- Investment Fund Management
- Lease-Finance
- Headquarters
- Shipping
- Holding Company
- Intellectual Property (IP)
- Distribution and Service Center
3. Requirements:
- Entities must meet the "Economic Substance Test," which includes:
- Conducting core income-generating activities (CIGAs) in the UAE.
- Being directed and managed in the UAE.
- Having adequate employees, expenditure, and physical presence in the UAE.
4. Reporting:
- Entities must file an Economic Substance Report annually with the relevant regulatory authority in the UAE.
- The report should demonstrate how the entity meets the Economic Substance Test.
5. Penalties:
- Non-compliance can result in penalties, including fines, exchange of information with foreign authorities, and potentially license suspension or cancellation.
Implementation and Compliance:
The ESR was introduced through Cabinet of Ministers Resolution No. 31 of 2019 and has undergone several updates and amendments to provide clearer guidance and more comprehensive regulations. Businesses operating in the UAE must regularly review these regulations to ensure compliance, as failure to do so can result in significant legal and financial consequences.
Entities must also maintain detailed records of their economic activities, including minutes of board meetings, records of expenditures, and evidence of employees and physical assets in the UAE.
If you have a specific question about ESR or need details on compliance for a particular type of business, please let me know!
### OECD (Organisation for Economic Co-operation and Development)
The OECD is an international organization that works to build better policies for better lives. It provides a platform for governments to work together to share experiences and seek solutions to common problems. The OECD:
1. Promotes Policies:
- Aimed at improving the economic and social well-being of people around the world.
2. Sets International Standards:
- In areas like tax, trade, labor, education, and environment.
3. Base Erosion and Profit Shifting (BEPS):
- An initiative aimed at addressing tax avoidance strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations.
- The OECD's BEPS Action Plan includes 15 actions to equip governments with the domestic and international instruments needed to tackle BEPS.
### CIGAs (Core Income-Generating Activities)
In the context of the UAE's Economic Substance Regulations (ESR), CIGAs refer to activities that are essential and substantial to the income generation of an entity. For an entity to meet the Economic Substance Test, it must conduct CIGAs in the UAE. Each relevant activity has its specific CIGAs. Here's an overview of CIGAs for some relevant activities:
1. Banking:
- Raising funds, managing risk including credit, currency and interest risk.
- Taking hedging positions.
- Providing loans, credit or other financial services to customers.
- Managing capital and preparing regulatory reports.
2. Insurance:
- Predicting and calculating risk.
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- Insuring or re-insuring against risk and providing insurance business services to clients.
- Underwriting insurance and reinsurance.
3. Investment Fund Management:
- Taking decisions on the holding and selling of investments.
- Calculating risks and reserves.
- Taking decisions on currency or interest fluctuations and hedging positions.
- Preparing relevant regulatory or other reports for government authorities and investors.
4. Lease-Finance:
- Agreeing funding terms.
- Identifying and acquiring assets to be leased (in the case of leasing).
- Setting the terms and duration of any financing or leasing.
- Monitoring and revising agreements and managing any risks.
5. Headquarters:
- Taking relevant management decisions.
- Incurring expenditures on behalf of group entities.
- Coordinating group activities.
6. Shipping:
- Managing crew (including hiring, paying, and overseeing crew members).
- Overhauling and maintaining ships.
- Overseeing and tracking deliveries.
- Determining what goods to order and when to deliver them, organizing and overseeing voyages.
7. Holding Company:
- All activities related to that of a Holding Company as defined in the regulations.
- Complying with all relevant corporate law and filing requirements.
8. Intellectual Property (IP):
- Conducting research and development.
- Marketing, branding, and distribution of IP.
- Managing and enhancing the IP rights.
9. Distribution and Service Center:
- Transporting and storing goods.
- Managing inventories.
- Taking orders and providing consulting or other administrative services.
Entities must not only perform these CIGAs but also demonstrate adequate levels of employees, physical presence, and expenditure proportionate to these activities in the UAE. This ensures that profits are aligned with substantial economic activity within the UAE, adhering to the standards set by the OECD's BEPS Action Plan.
Where ESR Does Not Apply
How to Apply ESR TEST ON Company in UAE?
Applying the Economic Substance Regulations (ESR) test to any company in the UAE involves several steps to ensure compliance with the regulations. Here's a step-by-step guide:
Step 1: Determine Applicability
Step 2: Understand Core Requirements
Step 3: Conduct Internal Review
Step 4: Prepare Economic Substance Report
Step 5: Submit Economic Substance Report
Step 6: Maintain Compliance
By following these steps, a company in the UAE can effectively apply the Economic Substance Regulations (ESR) test and demonstrate compliance with the regulatory requirements.