UAE removed from EU blacklist after issuing Economic Substance Rules

The United Arab Emirates (UAE) issued Ministerial Decision No. 215 of 2019 on 11 September, containing guidance for businesses on compliance with the Economic Substance Regulations (ESR), enacted on 30 April in Resolution No. 31 of 2019. As a result, the European Union’s Code of Conduct Group on Business Taxation announced that it had removed the UAE from its blacklist of non-cooperative jurisdictions on 10 October.

The EU initially blacklisted the UAE in December 2017 because it was perceived as facilitating offshore structures or arrangements aimed at attracting overseas profits that did not reflect real economic activity in the jurisdiction.

The removal of the UAE from the blacklist is a reflection of the UAE’s commitment to the international standards set by the EU and the OECD. It puts the UAE in a comparable position with other countries and territories – notably the Cayman Islands, Jersey, Guernsey, Bahrain and the BVI – which were previously removed from the EU’s blacklist after introducing economic substance legislation before the end of 2018.

The UAE’s removal from the EU blacklist will be welcomed by international investors and financial institutions, although the ESR introduce additional compliance and substance requirements for certain UAE entities.

Any natural or juridical person licensed by a competent licensing authority in the UAE that carries out any relevant activity is subject to the ESR. Relevant activities are banking, insurance, investment fund management, shipping, lease-finance, distribution and service centres, headquarters and intellectual property (IP) activities.

A licence includes a commercial licence, certificate of incorporation, or other form of permit that is required prior to carrying out an activity in the UAE. Only companies deriving income from the relevant activities in the UAE must meet the requirements in the ESR.

The guidance clarifies that the licensee will, with effect from 1 January 2020, submit the notification to the relevant authorities. The specific deadline, form and manner in which the notification must be submitted are yet to be determined.

An adequate number of board meetings must be held and attended in the UAE to meet requirements in the ESR. The adequate number depends on the level of the relevant activity being carried out by the licensee. It is expected that at least one meeting should be held in the UAE per financial year. These meetings must be recorded in written minutes, signed by attendees physically present in the UAE and kept in the country. If an individual manages the licensee, these requirements apply to such individual.

The UAE guidance further states that what is adequate or appropriate for each licensee depends on the nature and level of the relevant activities. The guidance indicates that the ESR is not intended to impose requirements that businesses engage more employees or incur more expenditures than what is needed. Instead, a licensee should maintain sufficient records to demonstrate the adequacy and appropriateness of the resources utilised and expenditures incurred.

The guidance clarifies that a licensee may outsource core income generating activity (CIGA) to a related party in the UAE. A licensee must be able to demonstrate that outsourcing to third-party or related-party service providers is not being done to circumvent compliance with the ESR. The guidance states that the resources of a third-party service provider in the UAE will be taken into consideration to determine the adequacy of a licensee’s resources, but there must be no double counting if the service is provided to more than one licensee carrying out a relevant activity in the UAE.

Companies whose activities are limited to holding equity participation are not required to carry out CIGA in the UAE. Holding companies that undertake a relevant activity other than solely receiving income from equity interests (i.e., dividends and capital gains) do not benefit from the reduced ESR. A licensee must meet the full substance requirements associated with the relevant activities it carries out.

An entity carrying out headquarter activities is tested based on the activities it performs, and not on its position within the group structure.

In general, multinational groups should determine if, and to what extent, their entities’ current levels of substance in the UAE are sufficient. If there is insufficient substance, consideration should be given to increasing substance to meet the requirements or restructuring to a jurisdiction where the group does have substance. In this context, the UAE’s substantial and efficient business infrastructure, as well as an extensive network of more than 100 double tax treaties, greatly facilitates multinationals to establish and host entities with adequate substance in the UAE.