Economic Substance Regulations (ESR) are a set of rules introduced by the United Arab Emirates (UAE), to ensure that business have a genuine economic presence in the jurisdiction where they are tax resident. Compliance with these regulations is essential to avoid penalties and reputational damage. In this article, we will discuss strategies for demonstrating economic substance compliance under ESR.

Strategies for Demonstrating Economic Substance Compliance

Companies that are subject to the ESR can adopt the following strategies to demonstrate compliance:

1. Being Directed and Managed in the UAE

Companies must be directed and managed in the UAE to demonstrate economic substance compliance. This means that the entities must show that strategic management decisions are made in the UAE where they are tax resident. This can be achieved by holding board meetings in the UAE, with a quorum of directors physically present, and ensuring that minutes of meetings are kept in the jurisdiction. The directors must have the necessary knowledge and expertise to discharge their duties, and the entity must maintain adequate records to evidence its decision-making processes.

2. Have an Adequate Number of Qualified Full-Time Employees in the UAE

Companies must have an adequate number of qualified full-time employees in the UAE to demonstrate economic substance compliance. The number of employees required will depend on the nature and scale of the company’s operations. Companies can demonstrate that they have an adequate number of qualified full-time employees in the UAE by maintaining appropriate records and documentation, such as employment contracts and staff lists.

3. Have Adequate Operating Expenditure in the UAE

Companies must have adequate operating expenditure in the UAE to demonstrate economic substance compliance. Operating expenditure includes expenses related to the company’s operations in the UAE, such as rent, salaries, and utilities. Companies can demonstrate that they have adequate operating expenditure in the UAE by maintaining appropriate records and documentation, such as financial statements and invoices.

4. Have Adequate Physical Assets in the UAE

Companies must have adequate physical assets in the UAE to demonstrate economic substance compliance. Physical assets include property, plant, and equipment used in the company’s operations in the UAE. Companies can demonstrate that they have adequate physical assets in the UAE by maintaining appropriate records and documentation, such as lease agreements and asset registers.

5. Outsourcing to Third-Party Service Providers

Companies can outsource their CIGAs to third-party service providers in the UAE to demonstrate economic substance compliance. However, the company must be able to monitor, control, and demonstrate adequate supervision over the outsourced activities. Companies can demonstrate that they have outsourced their CIGAs to third-party service providers by maintaining appropriate records and documentation, such as service agreements and reports.

6. Prepare and submit annual notifications and reports

Entities within the scope of ESR must comply with annual notification requirements and submit annual reports to demonstrate compliance with the Economic Substance Test. This involves preparing financial statements, business plans, and other documentation to evidence the entity’s activities in the jurisdiction. Compliance with these reporting requirements is essential to avoid penalties and demonstrate economic substance.

7. Monitor and update compliance strategies

Economic substance regulations are subject to change, and entities must stay up to date with any developments that may affect their compliance status. This involves regularly reviewing and updating compliance strategies to ensure they remain effective and in line with any changes in the regulatory environment. By monitoring compliance on an ongoing basis, entities can identify any areas of risk and take appropriate action to mitigate them.

8. Engage with local stakeholders

Engaging with local stakeholders is an important strategy for demonstrating economic substance compliance. Building relationships with local partners, such as customers, suppliers, and regulatory bodies, can help to establish a business presence in the UAE and demonstrate a commitment to the local community. This can involve attending local events, sponsoring community initiatives, and forming partnerships with local businesses. By engaging with local stakeholders, entities can demonstrate that they are more than just a shell company and have a real presence in the UAE.

9. Invest in the local economy

Investing in the local economy is another effective strategy for demonstrating economic substance compliance. This can involve making capital investments in the UAE, such as buying property or equipment, or investing in local businesses or startups. By investing in the local economy, entities can create jobs, stimulate economic growth, and contribute to the development of the local community. This can help to establish a business presence in the UAE and demonstrate a commitment to the local economy.

Seeking Professional Assistance

To ensure compliance with Economic Substance Regulations, it is advisable to seek professional assistance from tax and legal experts who are familiar with the regulations in the relevant jurisdiction. These professionals can help identify potential exemptions or carve-outs that may simplify compliance, determine the applicable test, and assist in forming strategies to ensure ongoing compliance.

In conclusion, demonstrating economic substance compliance under Economic Substance Regulations requires a thorough understanding of the regulations and the development of effective strategies to meet the Economic Substance Test. By following the strategies outlined above and seeking professional assistance when needed, entities can ensure compliance with ESR and avoid penalties and reputational damage.