In recent years, the United Arab Emirates has been making efforts to create a transparent business environment by aligning its tax framework with global tax standards. The introduction of Economic Substance Regulations is an important initiative taken in this regard as it reflects the UAE’s dedication to combat harmful tax practices, and promote a competitive environment for businesses in the UAE. The regulations require UAE businesses to ensure that the relevant activities they are engaged in have genuine economic presence within the UAE which is necessary to tackle tax avoidance.
The UAE’s Commitment to Global Tax Standards
The United Arab Emirates introduced Economic Substance Regulations on 30 April 2019 as testament to its commitment to global tax standards. Following are the reasons which depict UAE’s commitment to global tax standards in regards to ESR:
- International Cooperation: The Economic Substance Regulations were implemented in the UAE to collaborate with the Organization for Economic Co-operation and Development (OECD) Inclusive Framework on Base erosion and profit shifting (BEPS). Moreover, the UAE issued Economic Substance Regulations to address the concerns raised by the European Union Code of Conduct Group on UAE’s tax framework. The introduction of ESR in UAE showcases its dedication to international cooperation and commitment to Global Tax Standards.
- Transparency and Information Exchange: The Economic Substance Regulations demonstrates the UAE’s compliance with global tax standards by enhancing transparency and information exchange with other countries. These regulations demonstrates a proactive approach to combat tax evasion and erosion of the tax base and ensures that businesses carrying out the relevant activities contribute their fair share to the economic development of UAE.
- Base Erosion and Profit Shifting: The Economic Substance Regulations align with the OECD’s Base Erosion and Profit Shifting (BEPS) initiative. Base erosion involves tax planning strategies to reduce income tax in high-tax countries by deducting payments such as interest or royalties whereas, profit shifting involves manipulating profits by shifting the profits to low or no-tax locations. In both scenarios, the aim is to legally avoid income tax by allocating income and expenses strategically across borders. This can lead to a reduction in tax revenue for high-tax countries and potentially create an uneven playing field for international business. To ensure their dedication to OECD Inclusive Framework on BEPS, the UAE implemented Economic Substance Regulations to tackle tax avoidance through base erosion and profit shifting to create a sustainable business environment in the country.
- Assessment of Economic Substance: The International Tax Rules defines that countries are required to ensure that profits are taxed where economic activities generating the profits are performed and where value is created. For this purpose the members of OECD Inclusive Framework are establishing a modern international tax framework to ensure profits are taxed where economic activity and value creation occur. The implementation of Economic Substance Regulations in the UAE play a pivotal role in this regard as it obliges the businesses carrying out the relevant activities to have substantial economic presence in the UAE. This means that the business carrying out a relevant activity conducts necessary core income generating activities in the UAE, are directed and managed in the UAE and has adequate employees, operating expenditures and assets in the UAE.
- Double Taxation Relief: The Economic Substance Regulations play a pivotal role in in implementing double taxation as defined under International tax rules. Generally, the purpose is to reduce the risk of financial burden by ensuring that the income of business is taxed once rather than multiple times by multiple jurisdictions, which is referred as double taxation. ESR undermines the fairness and integrity of tax systems thus, breaks the barrier to cross-border investment.
- Enhanced Reputation: The UAE has gained significant worldwide reputation in the dynamic business market as a result of introducing the Economic Substance Regulations that align with the global tax standards. Introduction of ESR has attracted international investors and expatriates who are looking to set up business in UAE by promoting transparency and accountability in the global business landscape.
Impact on Businesses in the UAE
Businesses operating in the UAE are required to ensure compliance with the Economic Substance Regulations. For this the businesses are required to conduct core activities in relation to their relevant activities in the UAE and have to showcase their responsibility for setting the strategic decisions and supervising their day-to-day operations. Moreover, businesses in the UAE have to ensure that they are investing in local talent and making significant contributions to the UAE’s economic development. By aligning with global tax standards, the purpose of ESR is to create UAE an attractive destination for international business.
The businesses operating in the UAE are advised to avail the services of trusted ESR consultants in UAE to effectively determine their relevant activities in compliance with the Economic Substance Regulations and thus, contribute their share to establish a fair and transparent international tax regime.