Economic substance 2019

The term economic substance becomes very well-known by business owners from low tax jurisdictions, while many of them struggle to demonstrate such substance of their businesses.

Economic substance worries those who have their businesses registered in low or no tax jurisdictions (also known as NOONs – “no or only nominal tax” jurisdictions) and lacking “physical features” and economic reasons of having the business in such a jurisdiction.

Many of low tax jurisdictions issued new legislation, introducing higher substance requirements for the businesses. The legislation came as a reaction of including these countries into a Grey list, potentially turning into a black list if they fail to meet the new requirements of OECD. 

Such legislation came into force in January 2019 in BVI, Bermuda, Guernsey, Jersey, Seychelles, Bahamas, Isle of Man, Cayman Islands and Mauritius.

UAE has also issued its Economic Substance legislation in April 2019. 

Activities in the scope

Economic substance rules do not apply to all businesses in those jurisdictions. 

In the majority of them, the law concerns only the following “in scope” activities: 

• banking 
• fund management 
• shipping 
• insurance 
• headquarters 
• holding 
• financing and leasing 
• intangible property (intellectual property) 
• distribution centers 
• service centers 

Substance criteria 

So if a company is a resident in one of the listed NOONs and undertakes any of the mentioned activities, it needs to demonstrate the following 3 things:

Income generating activities could be outsourced to a 3-rd party service provider, but under the condition of constant control. So if a company’s activity is related to intellectual property, it has to perform research and development activity, headquarters must carry out the management and decision-making from the relevant jurisdiction office, etc. 

1. Companies have to be managed and directed in the relevant jurisdictions, having proof of such management, for example minutes of the meetings of the board of directors, physical presence of directors/managers, qualification of directors to carry out their duties.
2. Income generating activities should take place within the jurisdiction. The level of income should be adequate to the relevant activity.

   Income generating activities could be outsourced to a 3-rd party service provider, but under the condition of constant control. So if a company’s activity is related to intellectual property, it has to perform research and development activity, headquarters must carry out the management and decision-making from the relevant jurisdiction office, etc. 

3. Companies should be able to show their level of adequacy – adequate number of qualified employees, adequate office facility, adequate expenses and profits. 

To sum it up, any company performing one of the listed activities and being a tax resident of NOONs, will have to comply with substance requirements. 

If a company can prove that it is a tax resident elsewhere (by providing tax residency certificate), it will be exempted from substance requirements in its jurisdiction of incorporation. Most companies registered in NOONs are actually tax residents of NOONs too, which means they will have to comply. 

Of course, there are penalties for non complying companies, which start from financial fines and end up with striking off. 

Substance in UAE: are the requirements met?

Speaking about UAE, some licensing authorities already started streamlining their requirements to companies carrying out “relevant” business activities. Such requirements include:

• Having an executive office
• Producing audit reports annually
• Having staff under resident visas
• Having local phone number, web-site, e-mails
• Keeping company’s operational books in the local office
• Managing the company locally

UAE has several types of companies being formed in this country: offshore, free zone and mainland. Free Zone and mainland companies easily satisfy substance requirements, because these types of companies can and must have an office in the UAE, regardless of recent substance laws. 

Moreover, many Free Zones, especially in Dubai, have been always requiring audit reports and resident visa for company’s manager. This automatically satisfies substance requirements with no additional efforts. 

Offshore companies, on the contrary, may have difficulties because they are not allowed to have a UAE office or provide resident visas to the employees. At the same time they are non resident UAE companies and have more relaxed substance requirements overall. 

UAE - a substance paradise

Unlike many other jurisdictions which fall under new substance regulations, UAE is a country which can satisfy substance requirements for any type of business: small, medium or large. 
What makes UAE able to fit substance requirements:

1. You can rent a small office in a free zone for a reasonable cost. Such free zones as Ajman Free Zone, IFZA, Hamriyah, Dubai South and others offer various office solutions starting with flexi-desk or a 10 sq meters cubicle ending with executive offices. 
2. UAE Free Zones have no limitations on hiring labour. You can have staff under the visas or just as sub-contracted personnel. 
3. UAE is not a place where businesses are opened purely for tax reasons, even though the taxes are low. 

   First of all, it is more expensive than many low tax jurisdictions and opening a company here simply for tax reasons may not be attractive due to higher maintenance costs in comparison to tax havens.

   Secondly, it has a perfect location for many international trading or service companies - it is within 5-6 hours flight to Europe, Asia or Africa - literally in the middle of the world. It is very convenient for any type of global business. 

4. UAE is a country with real economy, which relies not only on its resources or tax free zones, but also real international investments, tourism and real estate, being a home to over 200 nationalities. 
5. UAE is making significant steps to comply with EU and OECD transparency policies, keeping its credible imagine in the global arena.

Summary

In conclusion, substance requirements and tests in the UAE are likely to be done on case-to-case basis, however the general outlines have to be met. 

The registration authorities will be responsible for making sure that the companies the onboard fit the substance criteria. 

Keep in mind, that UAE has over 40 authorities where the business can be registered. In each authority the regulations are likely to be slightly different, which gives more ways to create a business setup solution, which would comply with the new rules.