Upcoming ESR compliance and filing obligations

Reminder of ESR filing requirements

The United Arab Emirates (UAE) Economic Substance Regulations (ESR) require certain domestic and free zone legal entities that conduct one or more of nine relevant activities (RA) (referred to as “licensees”) to comply with annual filing requirements, as follows: 

• A notification must be submitted within 6 months from the end of the fiscal year (FY) declaring that the entity undertakes RA, irrespective of whether the licensee is exempt from the ESR or income was earned from RA.
• A report detailing certain business information must be submitted within 12 months from the end of the FY, but only if income was earned in the period from RA and the licensee was not exempt from the ESR. 

Upcoming deadlines for a selection of FY ends

The upcoming filing deadlines for a selection of FY ends are noted below:

All legal entities are encouraged to determine their upcoming ESR filing obligations as soon as possible for any completed FYs and take necessary steps to ensure filings are made within the applicable deadlines and all necessary supporting documentation is available at the time of the filing.

Penalties for noncompliance with the ESR include financial penalties for the failure to submit a notification (AED 20,000), submit a report (AED 50,000), provide accurate or complete information (AED 50,000), and demonstrate sufficient economic substance in the UAE (first failure is AED 50,000 and second consecutive instance of failure is AED 400,000). Nonfinancial penalties include information exchanges with certain foreign authorities. The Federal Tax Authority (FTA) has begun to initiate audits.

Businesses should note that access to the Ministry of Finance’s (MoF) portal for ESR submissions has changed such that it is now only possible through the ‘UAE PASS’ application. The UAE PASS is a secure digital identity for citizens, residents and visitors in UAE. Once the user has logged in with their UAE PASS, they would then be able to link their company account with their credentials.

Key ESR considerations before the end of the Financial Year

All legal entities should consider the following actions, where relevant, before the end of a FY to support compliance with the ESR:

• Assess whether the entity conducted and generated income from any of the nine RA during the period. This step is important to determine the entity's ESR compliance requirements for the FY.

• Review compliance with the applicable ESR tests (directed and managed test, core income generating activities (CIGA) test, and adequate test) if income was earned from RA during the FY.

• Take necessary steps to address any potential areas of noncompliance before the end of the FY to ensure compliance with all applicable ESR tests.

• Ensure control and supervision over any outsourcing arrangements can be demonstrated in the FY in relation to the CIGA test, e.g., through contractual agreements or correspondence.

• Collate relevant supporting documents relating to ESR compliance obligations and keep them on record in light of the Federal Tax Authority's (FTA) ESR audits. If selected for an audit, Licensees have a short turnaround period of 5 working days to provide the FTA with all requested documentation evidencing that the ESR tests are met.
  

The purpose of this guidance is to provide entities with an opportunity to take any necessary actions to comply with the ESR before it is too late. The Ministry of Finance (MoF) has a designated homepage for ESR, where entities can access legislation, guidance, notification and report templates, as well as a link to the ESR Portal.

Deloitte has developed an ESR guide to support UAE businesses with their reporting obligations. A sample version of the guide is available on the following link. Alternatively, if you would like to purchase a copy of the guide, please get in touch with us on the following email ID: Deloittetaxme@deloitte.com

Interaction between ESR and the Corporate Tax Law (Federal Decree-Law No. 47, issued December 2022)

• The application of corporate tax (CT) to Free Zones (“Free Zone CT Regime”) is a form of CT relief which allows free zone (FZ) businesses that are a ‘Qualifying Free Zone Person’ (QFZP) to benefit from a 0% CT rate on Qualifying Income.
• Critical to benefiting from the CT relief and qualifying as a QFZP is that the entity maintains an adequate level of substance in its FZ. 
• Specifically, Article 7 of Cabinet Decision. 55 of 2023 details that QFZPs must have and be able to demonstrate adequate substance in a FZ relative to the nature and level of its activities and the Qualifying Income it earns. This means that the QFZP must have adequate staff and assets and incur adequate operating expenditure in the relevant FZ or in any other FZ for the purposes of undertaking its CIGA.
• A QFZP can outsource its activities to related or unrelated persons in a FZ, provided it exercises control and supervision over the outsourced activities.
• A key difference between the requirements under the ESR and the Free Zone CT Regime is that the ESR allows entities to conduct CIGA anywhere in the UAE, whilst under the Free Zone CT Regime, QFZPs must conduct or at minimum control / supervise its relevant CIGA from in a FZ. 
• Noting the above, it is recommended that FZ businesses looking to benefit from the CT relief assess separately whether they would meet the enhanced substance requirements under the Free Zone CT Regime and identify whether any changes to the operating model are required to safeguard the CT relief / QFZP status. In particular, FZ businesses should ensure that control and supervision over any outsourcing arrangements can be demonstrated and evidenced going forwards. 
• Where a FZ entity fails to maintain an adequate level of substance under the Free Zone CT Regime, the entity may not be able to benefit from the CT relief / obtain QFZP status for 5 years (i.e., current year and the following 4 tax periods).

Further information on the transition from the ESR and new substance related reporting and compliance obligations for QFZPs will be provided in due course.