Introduction:

The UAE applies Economic Substance Regulations (ESR) to Holding companies located in the country, including businesses in free zones and those engaged in any of the defined ‘relevant activities.’
Regulations hence require these holding companies to maintain and demonstrate an adequate “economic presence” in the UAE relative to the activities they undertake i.e., “Holding Company Business”.
In simple terms, if an entity wanted to declare its revenue in a country, they need to demonstrate sufficient “substance,” i.e. business actions that fit ESR’s relevant activities, taking place in the country. Entities can no longer book any revenue in any jurisdiction for tax benefits when there is no real activity taking place in that jurisdiction. The ESR law for holding companies, along with other licensed companies, was adopted in 2019 to ensure transparency and prevent financial manipulation. Holding companies in the UAE must adhere to these regulations and file the Economic Substance Return as per the law.

Definition of a Holding Company under ESR:

In the context of ESR, a holding company in the UAE is defined by meeting the following criteria:

1. The company holds equity interests in other juridical persons.
2. It earns income solely from dividends and capital gains derived from its equity investments.

A company that holds assets and has income from sources other than dividends and equity investments would not be considered a holding company under ESR.

Compliance Requirements for Holding Companies:

Holding companies must comply with the regulations set by the licensing authority, maintain an adequate number of employees and physical assets, and do not necessarily need to be directed and managed in the UAE.
Furthermore, they are not required to disclose adequate expenditures in the UAE. Holding companies can be mainland or free zone companies, such as Abu Dhabi Global Market (ADGM), Dubai Multi Commodities Centres (DMCC), MASDAR, 2454, etc. as long as they do not engage in any commercial activity within the UAE.

Core Income-Generating Activities (CIGA) for Holding Companies:

Section 3 of the Relevant Activities guide outlines that the CIGA of a holding company involves acquiring and holding equity interests in one or more companies. The income generated by the holding company primarily stems from its equity interests and dividends derived from those equity investments.

Reduced Economic Substance Test:

To qualify as a holding company, an entity must pass the Reduced Economic Substance Test. This test is designed for companies engaged in pure equity holding activities.

Penalties for Non-Compliance:

Non-compliance with ESR can result in various penalties, including fines. These include AED 50,000 for failing to conduct tests and submit a report in the first year, AED 400,000 for non-submission of reports and tests repeatedly in the second year, AED 50,000 for providing inaccurate information, and AED 20,000 for failure to submit a notification.

Importance of a Professional Service Provider for ESR Filing:

Engaging professional team for ESR filing offers several benefits:

1. Accurate tracking and monitoring of economic activities to ensure compliance with ESR regulations.
2. Expert guidance in identifying and distinguishing relevant activities under the scope of ESR.
3. Timely and accurate reporting and notification to regulatory authorities.
4. Review actual business operations/activities undertaken by the licensee (substance over form approach)
5. Provision of consultancy services to evaluate and structure operating models and corporate governance.
6. Avoidance of conflicts of interest through the involvement of unbiased third-party professionals.
7. Recommend remedial actions/measures to comply with Economic Substance Regulation

Conclusion:

Compliance with ESR is essential for holding companies operating in the UAE. By engaging ESR consultants or professional accounting services, companies can ensure accurate identification of relevant activities, timely filing of notifications, and avoidance of penalties. If you require further information or assistance in preventing penalties related to ESR notification failure, it is advisable to reach out to expert accounting firms or service providers in the UAE.