UAE to Discontinue Economic Substance Requirements

The economic substance requirements for companies in the United Arab Emirates will no longer apply to financial periods starting from 1 January 2023. 

Economic substance in the UAE

The “economic substance” rules were introduced in the UAE in 2019 to meet international standards for combating harmful tax practices. They are set out in the Cabinet Decision No. 57 of 2020. 

Under these rules, legal entities registered in the UAE (including free zones) and carrying on “relevant activities” must:

• maintain an adequate level of economic substance in the UAE and 
• report the required information to the regulatory authority.  

A “relevant activity” includes banking, insurance, investment fund management, shipping, lease and finance business, distribution and service centre business, headquarters, intellectual property and holding company business.

A company has economic substance in the UAE in relation to its relevant activity if the company:

• carries out core income-generating activity within the UAE;
• directs and manages the relevant activity in the UAE;
• has an adequate number of qualified full-time employees who are physically present in the UAE to conduct such activity;
• incurs adequate operating expenditure in the UAE;
• has adequate physical assets in the UAE. 

Cancellation of economic substance requirements in the UAE

The Cabinet Decision No. 98 of 2024 provides the following changes to the economic substance regime in the UAE.

• The economic substance requirements will apply until the financial year ending 31 December 2022. This means that companies will no longer be required to file economic substance notifications and reports for subsequent financial years. 
• All administrative penalties imposed for non-compliance with the relevant rules (including late reporting) for financial years ending after 31 December 2022 will be cancelled.
• Penalties imposed in respect of financial years ending after 31 December 2022 and already paid by companies are to be refunded. 

The introduction of comprehensive corporate taxation in the UAE made the abolition of economic substance requirements possible. As a result, the economic substance rules, primarily recommended for offshore and low-tax jurisdictions, are losing their relevance.  

The Report (par. 52) of the EU Code of Conduct Group (Business Taxation) dated 13 June 2024 states that the UAE is no longer a “no or only nominal tax jurisdiction” and it is no longer subject to monitoring under the criterion of economic substance. 

Impact on business    

The abolition of economic substance requirements will reduce the compliance burden on businesses in the Emirates. Companies will no longer have to ensure that the nature and scope of their activities within the UAE fully comply with regulatory requirements regarding economic substance. Furthermore, there is no longer a need to prepare and submit relevant notifications and reports and bear the risk of penalties for late reporting. 

However, this is not a reason to ignore matters of economic substance in a company’s operations. They will remain relevant for free zone companies entitled to a zero corporate tax rate.   

“Adequate substance” as a condition for zero tax in free zones

A company registered in a UAE free zone may apply zero tax if it is a qualifying free zone person (QFZP).

One of the requirements a company should meet to qualify as a QFZP is maintaining “adequate substance” in the UAE (Article 18(1) of the Federal Decree-Law No. 47 of 2022 on the Taxation of Corporations and Businesses). 

Other requirements include compliance with the transfer pricing rules, preparing audited financial statements, and an acceptable ratio of qualifying and non-qualifying income. To be a QFZP, a company must meet all the established requirements.

The “adequate substance” for tax purposes is not identical but generally similar to the “economic substance” mentioned above. According to Article 8 of the Cabinet Decision No. 100 of 2023, a company maintaining adequate substance in a free zone must:

1. Undertake its core income-generating activities in a free zone or a designated zone and, having regard to the level of activity:
2. Have adequate assets in a free zone or a designated zone;
3. Have an adequate number of qualified full-time employees in a free zone or a designated zone;
4. Incur adequate operating expenses. 

Therefore, to qualify for a zero-tax rate, a taxpayer must allocate its core income-generating activities in a free zone (outsourcing to another free zone person is also available) and be ready to confirm compliance with other requirements to the tax authority. 

Summary

• Companies in the UAE are no longer required to submit economic substance reporting for the years 2023, 2024 and beyond.
• Companies still have to comply with the economic substance requirements for all years in which they were in effect, including 2022. For these periods, companies must file reports, respond to tax authority inquiries and pay any penalties due.
• UAE free zone companies that qualify for zero-rate corporate tax as “qualifying free zone persons” must maintain adequate substance in the free zone under the tax laws.