Managing ESR Compliance in the UAE After 2024 Legal Amendments

The 2024 amendments exempt UAE businesses from Economic Substance Regulations (ESR) compliance for financial periods beginning after January 1, 2023. However, businesses must ensure compliance for the ESR Period (Jan 1, 2019 – Dec 31, 2022) by submitting Economic Substance (ES) notifications, annual reports, and demonstrating adequate substance within the UAE. These records should be retained for at least six years, during which the Federal Tax Authority may review and verify Licensee compliance with the ES Test for each reportable period.

By Melissa Cyrill

In 2024, the UAE introduced notable changes to its Economic Substance Regulations (ESR) via Cabinet Decision No. (98) of 2024, amending and replacing aspects of the prior Decision No. (57) of 2020. These amendments, aimed at aligning ESR compliance with the UAE’s new Federal Corporate Tax (CT) Law, exempt many businesses from ESR obligations after the financial year starting January 1, 2023. This article explores the scope of these amendments, their implications for businesses, and key compliance considerations to navigate this evolving regulatory landscape.

Key changes in UAE ESR compliance regime

The 2024 amendments primarily exempt businesses from ongoing ESR compliance obligations for financial periods starting after January 1, 2023. This regulatory shift is significant for entities across the UAE as it reduces reporting obligations for most companies while still maintaining specific compliance requirements for prior years.

The revised framework clarifies that compliance requirements now apply only to the “ESR Period” covering financial years from January 1, 2019, to December 31, 2022. Businesses categorized as “Licensees” under the previous regulations must meet certain obligations for this period, which include submitting Economic Substance (ES) notifications, annual reports, and demonstrating adequate substance in the UAE.

For companies with financial years beginning after January 1, 2023, there are no ESR reporting obligations, marking a substantial reduction in administrative duties. Here are some scenarios that illustrate the applicability of the regulatory amendments:

• Example 1 (January 1, 2023 – December 31, 2023): A company with a financial period in this range is exempt from filing ES notifications or reports.
• Example 2 (July 1, 2022 – June 30, 2023): Since the financial year ends after the ESR period, this company need not submit any ESR-related filings for this timeframe.
• Example 3 (January 1, 2022 – December 31, 2022): The company must complete all ESR filing and substance requirements, as this period falls within the ESR timeframe.

Practical compliance considerations and financial relief

The amendments bring much-needed relief to UAE businesses by reducing the scope of compliance while still necessitating strict adherence for financial years within the ESR Period. To ensure that companies meet compliance standards effectively, it is important to address the following key considerations:

1. Retention of documentation and portal access

The Federal Tax Authority (FTA) has up to six years to review and verify if Licensees have met the Economic Substance Test for each reportable period. For instance, the assessment period for the year ending December 31, 2019, extends to December 31, 2025, while the period for December 31, 2020, continues until December 31, 2026. Consequently, Licensees are expected to retain relevant documentation, including access to the ESR portal, for at least six years following the end of each reportable period.

Maintaining accurate records ensures businesses can address any future compliance checks and avoid potential fines or penalties if discrepancies arise during the FTA’s review process. This long-term documentation requirement underscores the importance of thorough record-keeping for companies that operated within the ESR Period.

2. Administrative penalty refunds

A significant relief measure under the 2024 amendment is the cancellation of administrative penalties previously imposed for non-compliance outside the designated ESR Period. Entities facing such penalties may be eligible for refunds, which they can request through the UAE Ministry of Finance’s e-refund portal. This policy aims to mitigate financial strain for businesses by waiving penalties for ESR non-compliance after the mandated ESR Period, allowing companies to reclaim previously paid fines.

3. Addressing retrospective filings and documentation

Entities should ensure that all required ES notifications and annual reports for the ESR Period (2019-2022) have been submitted in compliance with the regulations. Licensees must also ensure they maintain relevant documents to support compliance claims during the ESR Period, given the FTA’s authority to conduct audits retroactively for up to six years after each financial period.

Fulfilling these retrospective requirements is crucial to avoid penalties in case of an audit. Businesses are advised to revisit past filings, correct any discrepancies, and retain documentation evidencing adequate substance for each reportable period, where applicable.

4. Anticipated audit activity

With a limited timeframe available to assess ESR compliance, businesses can expect an increase in audit scrutiny from the FTA, especially focusing on the 2019–2022 periods. This uptick in audits could entail detailed evaluations to confirm whether companies met the Economic Substance Test during applicable years. Licensees should ensure their documentation is in order and that they can substantiate compliance with ESR mandates, particularly regarding “adequate substance” requirements for relevant years.

ESR’s intersection with UAE corporate tax regime

Although the ESR compliance requirements are relaxed for years starting January 1, 2023, companies operating within UAE Free Zones, known as Free Zone Persons, must still demonstrate adequate substance to benefit from the 0 percent Corporate Tax rate under UAE Federal Corporate Tax regulations.

Qualifying Free Zone Persons can access the 0 percent corporate tax rate if they fulfill specific criteria, including the performance of core income-generating activities within the Free Zone, the maintenance of adequate assets, employment of qualified personnel, and incurrence of appropriate operational expenses.

The requirements for “adequate substance” vary depending on a business’s nature and size. Consequently, companies should conduct detailed evaluations of their operational structure to ensure they meet UAE Federal Corporate Tax requirements. Adhering to these regulations can help qualifying entities preserve tax benefits while minimizing the risk of non-compliance.

Strategic next steps for ESR compliance in the UAE

With the 2024 amendments, UAE entities should proactively manage their ESR compliance obligations. Here are some steps to help companies navigate the updated ESR landscape effectively:

• Finalize ESR filings for 2019-2022: Businesses must ensure all ES notifications and reports for applicable years within the ESR Period are accurately submitted and maintained as per regulations.
• Review free zone substance requirements: Free Zone entities should evaluate their structure to verify alignment with UAE corporate tax standards to qualify for the 0 percent CT rate, where applicable. This may involve adjustments to staffing, asset allocation, or operational expenditures to meet adequate substance requirements.
• Verify eligibility for administrative penalty waivers: Entities should assess their eligibility for administrative penalty waivers and initiate the refund process through the Ministry of Finance’s portal if applicable.
• Monitor further guidance from authorities: Staying updated on any new guidelines or clarifications from UAE authorities is essential, especially regarding ongoing ESR compliance requirements and the applicability of penalty waivers. Further information may provide clarity on how businesses can best comply with both ESR and CT obligations.

Key takeaways for UAE businesses

The 2024 amendments to the UAE’s ESR framework have significantly streamlined compliance obligations by limiting requirements to the financial years from January 1, 2019, to December 31, 2022. As a result, companies with financial periods beginning on or after January 1, 2023, are exempt from ESR filings, providing a welcome reduction in administrative responsibilities.

However, the ESR amendments also emphasize the importance of diligent record-keeping and compliance for Free Zone entities that aim to benefit from the 0 percent corporate tax rate. These companies must maintain adequate substance within their operations, adhering to Federal Corporate Tax standards to secure the tax benefits associated with Free Zone status.

Businesses operating in the UAE should take time to review how the recent ESR amendments impact their operations, ensuring they meet all required obligations for the ESR Period while maintaining compliance under the evolving UAE corporate tax landscape. By taking a proactive approach, companies can effectively manage ESR compliance, avoid penalties, and benefit from corporate tax advantages offered within the UAE regulatory environment.

Conclusion

The UAE’s ESR amendments offer a streamlined approach to economic substance compliance, reflecting the country’s ongoing commitment to maintaining a competitive and business-friendly environment. By reducing ESR requirements for recent financial years, these changes alleviate the compliance burden on UAE businesses while clarifying obligations for past reporting periods.

For businesses, these amendments underscore the importance of staying vigilant with compliance for specific financial years, retaining adequate documentation, and ensuring that Free Zone operations meet the UAE’s corporate tax standards. By doing so, companies can leverage the regulatory advantages and optimize their strategic positioning within the UAE market.

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