The UAE Economic Substance Regulations (ESR) were introduced in 2019 in response to the OECD's Base Erosion and Profit Shifting (BEPS) framework and the EU's concerns about preferential tax regimes in UAE jurisdictions. Since their introduction, the ESR have been amended several times and their practical scope has narrowed following the introduction of UAE Corporate Tax. This guide sets out what the ESR require and what DIFC companies need to know.
Background: Why Were the ESR Introduced?
The UAE Economic Substance Regulations were introduced by Cabinet Resolution No. 31 of 2019, subsequently amended by Cabinet Resolution No. 57 of 2020. The regulations were designed to ensure that UAE entities deriving income from certain activities maintain genuine economic substance in the UAE, rather than using the jurisdiction solely as a low-tax holding location.
The ESR were introduced in response to the EU's listing of the UAE as a non-cooperative jurisdiction for tax purposes. By implementing the ESR, the UAE sought to demonstrate that entities benefiting from its tax environment were genuinely operating and economically active within the country.
Which Entities Were Affected?
The ESR applied to UAE onshore and free zone entities, including DIFC entities, that carried on one or more of the following Relevant Activities:
- Banking business
- Insurance business
- Investment fund management business
- Lease-finance business
- Headquarters business
- Shipping business
- Holding company business
- Intellectual property business
- Distribution and service centre business
Entities carrying on a Relevant Activity and deriving income from that activity were required to meet the economic substance test and file an ESR notification and report each year.
The Economic Substance Test
To satisfy the economic substance test, an entity carrying on a Relevant Activity was required to:
- Conduct its core income-generating activities (CIGAs) in the UAE
- Be directed and managed in the UAE
- Have adequate employees, expenditure and physical assets in the UAE relative to the level of activity
The specific requirements varied by Relevant Activity, with higher thresholds applying to more complex activities such as banking and IP business.
ESR and UAE Corporate Tax: What Changed?
The UAE Corporate Tax Law, which came into effect for financial years beginning on or after 1 June 2023, has significantly reduced the practical scope of the ESR for most entities.
ESR Notification and Reporting
For financial years beginning on or after 1 June 2023, entities that are subject to UAE Corporate Tax are generally no longer required to file ESR notifications or reports in respect of those financial years. The Ministry of Finance has confirmed that the ESR filing obligation is effectively suspended for corporate tax-registered entities for periods after the corporate tax effective date.
Earlier Financial Periods
Entities may still have outstanding ESR obligations for financial years prior to their UAE Corporate Tax registration date. It is important to confirm whether any ESR notifications or reports remain outstanding for earlier periods and to file any outstanding returns before the relevant deadlines.
Holding Company Business
Entities carrying on Holding Company Business under the ESR had reduced substance requirements. For DIFC Prescribed Companies and similar holding vehicles, holding company ESR obligations have generally been straightforward, but confirmation of historic filings remains important.
What DIFC Companies Should Do
DIFC companies should take the following steps to ensure their ESR position is up to date:
- Confirm historic filing status: Review whether ESR notifications and reports have been filed for all relevant financial periods prior to the UAE Corporate Tax effective date
- File any outstanding returns: Engage with a qualified adviser to prepare and file any outstanding ESR notifications or reports before penalties are applied
- Assess corporate tax implications: Confirm the entity's UAE Corporate Tax registration status and Qualifying Free Zone Person eligibility
- Review the substance position: Ensure the entity's substance arrangements in the DIFC remain appropriate for UAE Corporate Tax purposes, which has its own substance-related requirements for Qualifying Free Zone Persons
Penalties for Non-Compliance
Failure to file ESR notifications and reports or to meet the economic substance test can result in significant administrative penalties under the UAE ESR framework. Penalties for non-filing start at AED 20,000 and can escalate substantially for repeat or sustained non-compliance.
How Atlas Can Help
Atlas Corporate Services provides compliance and economic substance advisory services for DIFC-registered entities. Our team assists with ESR historic filings, corporate tax registration, substance assessments and ongoing compliance support. Contact the Atlas team to discuss your ESR and corporate tax compliance requirements.