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Balanced Overview on UAE’s Economic Substance Regulations Update: Legal, Tax, and Economic Implication

The Economic Substance Regulations (ESR) have played a pivotal role in maintaining transparency and ensuring that businesses operating in low or no-tax jurisdictions, such as the UAE, meet international standards. With recent changes, particularly the issuance of Cabinet Decision No. 98 of 2024, the landscape surrounding ESR has evolved, creating new obligations and implications for businesses, particularly in the Abu Dhabi Global Market (ADGM). This article provides a balanced analysis of these changes, focusing on the legal, tax, and economic aspects.

The recent amendments have clarified and, in some respects, eased the compliance requirements for businesses in the UAE. Cabinet Decision 98 of 2024 has annulled ESR requirements for financial periods ending after 31 December 2022, which removes certain filing obligations for relevant entities, particularly those registered in ADGM. These changes simplify the compliance landscape for ADGM Licensed Persons, who are no longer required to file Economic Substance Reports for periods ending after the set date.

However, companies must remain cautious for periods between 1 January 2019 and 31 December 2022, as they are still required to submit Economic Substance Notifications and Reports for those periods. Additionally, the UAE’s Corporate Tax Law, introduced under Federal Decree-Law No. 47 of 2022, has incorporated ESR into its framework. This means that while separate ESR filings are no longer required, businesses must still demonstrate adequate economic substance in their operations to comply with the Corporate Tax Law.

The introduction of anti-avoidance provisions, such as the General Anti-Avoidance Rule (GAAR) within the Corporate Tax Law, adds another layer of complexity. This rule empowers the Tax Authority to disregard transactions structured solely for tax efficiency, potentially adjusting tax liabilities if the business lacks genuine economic activity. These provisions signify a shift toward stricter scrutiny of corporate activities, making it imperative for businesses to ensure their transactions are driven by legitimate business purposes.

From a tax perspective, the key change is that entities are no longer required to submit ESR filings for financial years ending after December 2022, providing relief from redundant compliance efforts. This aligns with the broader shift in the UAE toward the Corporate Tax regime, where ESR requirements are now embedded into the tax framework.

The UAE’s introduction of a Corporate Tax regime is also notable, as the ESR was initially designed to address concerns in tax havens with no corporate tax. Now that the UAE levies corporate tax, ESR compliance is embedded in the new tax framework, focusing on maintaining adequate substance, particularly for free zone persons and companies conducting cross-border transactions. Although the separate ESR regime is no longer active, businesses must be mindful of their corporate structures to ensure compliance with corporate tax regulations, especially to avoid triggering GAAR provisions.

Additionally, the annulment of penalties for rejected ESR appeals during financial periods post-December 2022 provides a fiscal benefit to companies that may have been impacted. This is particularly relevant for businesses that faced penalties under the previous regime but now stand to recover those amounts.

The economic implications of these updates are significant for businesses operating within the UAE, particularly those with international structures. The removal of ESR filing requirements for the post-2022 period alleviates a compliance burden, potentially reducing administrative costs and allowing businesses to refocus resources on operational growth.

For companies operating within free zones, the necessity to demonstrate substance remains critical under the Corporate Tax Law. This encourages companies to bolster their local presence and economic activity, which may drive increased investment and employment within the UAE. Onshore businesses, however, must continue to ensure that transactions are conducted for legitimate business purposes, with heightened scrutiny from tax authorities potentially affecting cross-border arrangements.

The overarching economic impact of these changes could lead to a more streamlined regulatory environment, fostering growth within the UAE’s business hubs like ADGM. By integrating ESR into the Corporate Tax framework, the UAE demonstrates its commitment to global tax standards while balancing the need to remain an attractive destination for international business.

To conclude, the change to the UAE’s Economic Substance Regulations, particularly the cessation of ESR filing obligations for periods after December 2022, offer a more simplified compliance framework for businesses. However, the embedded requirements within the UAE’s Corporate Tax Law, combined with the anti-avoidance provisions, mean that companies must still take care to demonstrate genuine economic activity and avoid purely tax-driven structures. These updates reflect the UAE’s evolving approach to corporate taxation, ensuring it remains compliant with international standards while fostering a business-friendly environment.

By:

Ahmed Ibrahim
Managing Partner

 

 

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