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͵羺 Taxes: Your queries on Economic Substance Regulations (ESR) answered! Image Credit: iStock

Highlights

A weekly column where readers get their queries answered on Value Added Tax (VAT), Economic Substance Regulations (ESR), Customs and other GCC taxes. This week, queries relating to ESR are answered.

Question #1: My company has already submitted the ESR notification in June 2020 after a thorough review. Is this week’s Q&A on ESR relevant for me?

The short answer is ‘Yes’, essentially for the following three reasons:

a) Since the submission of the ESR notifications in June this year, the scope of the ESR has been significantly revised in August 2020. Companies are required to examine whether they are still, or are now, covered under the amended ESR and ensure if their business is compliant.

b) The Ministry of Finance will launch an online portal to facilitate the electronic filing of the ESR notification. Companies are required to resubmit the ESR notification on the online portal even if the notification was earlier submitted in June 2020.

c) If a company is still covered, or is now covered, under the amended ESR, the company would also be required to submit the ESR Report (as per the recently introduced template) on the online portal.

(The online portal is yet to go-live, however, the MoF has recently issued the templates of the ESR notification and the ESR Report on the public domain or website, which gives insights into ESR compliance on the required data and records.)

What is ESR, what does it mean to have ‘economic substance’ in the ͵羺?
Economic Substance Regulations (ESR) is a compliance requirement to determine that the ͵羺 companies (in mainland or in free zones) undertaking specific ‘relevant activities’ have adequate ‘economic substance’ in the ͵羺.

Presence of ‘economic substance’ requires companies to be directed and supervised in the ͵羺, and have adequate assets, resources and qualified people, thereby proving the businesses have substantial economic purpose.

Further, as per ESR norms, the indicative Core Income Generating Activities (CIGAs) corresponding to each ‘relevant activity’ should be undertaken in the ͵羺.

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Question #2: My company’s trade license does not list any of the ‘relevant activities’ covered under the ESR, should I still be concerned?

It is not enough to review the activities listed in the trade license to determine the applicability of the ESR. A ‘substance over form’ approach should be adopted to determine whether a company is conducting any of the ‘relevant activities’ covered under the ESR.

What is a ‘substance over form’ approach? ‘Substance over form’ is a subjective test whereby the actual essence or nature of a transaction is considered instead of the form or name given to such transaction.

What are ‘relevant activities’?
Nine activities are covered as ‘relevant activities’ under the ESR namely, (1) Distribution & Service Centre Business (2) Headquarters Business; (3) Lease Finance Business; (4) Insurance Business; (5) Investment Fund Management Business; (6) Banking Business; (7) Shipping Business; (8) Intellectual Property Business; and (9) Holding Company Business. The scope of each ‘relevant activity’ is explained in detail in the ESR laws and guidance.

Question #3: My ͵羺-based company (let’s call it ‘Company X’) purchases goods from group companies in Belgium and Germany. To save on the logistics costs, the group companies dispatches the goods directly to the end-customers in the US. Are the transactions of ‘Company X’ covered under the scope of the amended ESR?

Among other changes in the scope of ‘relevant activities’, Distribution & Service Centre (D&SC) business now covers purchasing of goods from a foreign connected person and reselling of such goods. Under the earlier ESR, coverage under the D&SC business required (a) purchasing of goods from a foreign connected person; (b) importing and storing the goods in ͵羺; and (c) reselling the goods outside ͵羺

With the removal of condition (b) and (c), purchasing of goods from foreign connected persons for international distribution typically referred to as “Bill To-Ship To” transactions, or for local distribution within ͵羺, could trigger the ESR compliance.

What is a ‘Foreign Connected Person’?
Two or more entities are treated as ‘Connected Persons’ if they are related through ownership, like companies within the same group, trusts and trustees, companies and their shareholders, partners and their families. A ‘Foreign Connected Person’ means a connected person that is not tax resident in the ͵羺.

Question #4: Does my company need to pay additional taxes if my firm falls under ESR purview? Should the company stop the ‘relevant activity’ henceforth to remain outside the scope of the ESR?

Through international cooperation by over 135 countries, the ESR is aimed to curb tax evasion. However, applicability of the ESR in itself does not involve any additional tax obligation.

If the ESR is applicable on a company then the company needs to demonstrate that the ‘economic substance’ is present in the ͵羺. Only in the absence of ‘economic substance’ in the ͵羺, stringent penal consequences are applicable. The penalties for non-compliance could range from Dh20,000 to Dh50,000, further increasing to Dh400,00 and possible cancellation/suspension of trade license in the future years.

Did you know?
The Federal Tax Authority (FTA) has now been appointed as the ‘National Assessing Authority’ for the ESR. In addition to VAT and Excise Tax, FTA will undertake assessments to determine compliance with ‘economic substance’ tests by the companies. As per the recent ESR notification template , the companies are required to report if they are registered for VAT or not.

Question #5: My company (let’s call it ‘Company D’) was incorporated on July 1, 2018 with its financial year ending June 30, 2019. What would be the first reportable period under the ESR?

ESR is applicable in relation to financial years commencing on or after January 1, 2019. Accordingly, the financial year of ‘Company D’ from July 1, 2018 to June 30, 2019 would not be covered under the ESR. The first reportable period for ‘Company D’ would be from July 1, 2019 to June 30, 2020.

What are the compliance timelines under the ESR?
For the financial year starting on or after January 1, 2019, a company is required to submit ESR Notification within 6 months from the end of the relevant financial year and the ESR report, if applicable, within 12 months from the end of the relevant financial year. The above timelines could vary depending on the go-live status of the online portal by MoF.

Question #6: My company (let’s call it ‘Company Local’) is a mainland company involved in a local grocery shop business. A ͵羺 national and myself are the only two shareholders of Company Local. Is the company still required to comply with the ESR?

The amended ESR has introduced a category of ‘exempt licensees’ which covers (a) Investment Funds, (b) Licensee that is a tax resident in a foreign jurisdiction, (c) a ͵羺 branch of a foreign entity (if taxed in a foreign jurisdiction); and (d) entities that carry out business in the ͵羺 which are wholly owned by ͵羺 residents/nationals and are not part of a multinational group.

Company Local should be covered under category (d) above and would be required to submit only the ESR notification along with certain prescribed documents on a yearly basis. Based on the category of the ‘exempt licensee’, the prescribed documents could include tax residency certificate of the foreign jurisdiction, details and tax residency certificate of the Head Office (Foreign Company), details of the shareholders of the companies and/or financial statements.

Selected queries on a particular topic are being answered by a team from AskPankaj Tax Consultants. You can send your tax queries on YourMoney@gulfnews.com. The answers are for general guidance and does not constitute as legal advice.

Pankaj S. Jain

Pankaj S. Jain, is the Managing Director of AskPankaj Tax Consultants and Tax Agency.