UAE corporate tax: Do businesses still need economic substance reporting?

Legislation is rarely enacted in isolation. Typically, it builds on or over previous law.

Since 2019, those businesses with specified international operations began filing for Economic Substance Reporting – ESR to most of you. The objective is to prove that UAE entities are not being used to reduce liabilities that would, otherwise, be paid in other taxable jurisdictions.

Now that we, in the UAE, since June 1, 2023, have corporate tax, the question arises as to whether we still need such a reporting framework with all the onerous work it entails for those who need to report for it.

Yes, unfortunately, we do but it will now probably serve different purposes.

The question is about branding, and it is not a burning one. Will ESR be replaced by two of its constituent elements or, instead, elevate them to a known diffusion under the same marque? Why waste an established bureaucracy?

These two are in-country substance and transfer pricing.

Let us start with the in-country element. While most are conscious of it, it is oddly the most misunderstood of the two.

Your entity has an authority that issues trade licences. As is the case with a medieval baron, your business is supposed to serve within that locale, answerable to its overarching rules and regulations.

Trade should only be conducted under its bylaws. These differ depending on whether you are on or offshore. There could also be emirate-specific rules to consider.

To have substance, the entity must have its nexus within that defined space.

By nexus, I mean this to include an office. One that is staffed with sufficient and experienced personnel to deliver the goods and services to its customer base, wherever they are. Additionally, it should be large enough to house them.

Decision-making for the business – operational, tactical and strategic – should be formulated and executed in the same place. There should be a body of supporting documents that can be presented as proof of the same.

Board meetings that are held with all or at least a rolling majority in physical attendance are a good example. A workforce that delivers remotely from a beach or mountain will probably not cut it.

Covid-19 may have changed how we work but we await to see if the several pieces of pending tax legislation address the matter.

The ICP app, often part of the process of completing the Tax Residency Certificate application process, can be called upon by the relevant authorities to prove persons were in the UAE.

As I alluded to earlier, many make the mistake that the matter is all wrapped up in a documentary sliver that confirms where the entity is legally located. In matters of substance, it is not even a paperweight.

In the other corner, weighing in at 140 pages, the recent release by the Federal Tax Authority of its Transfer Pricing Guide ends the long wait by multinational companies for clarification on this critical element.

We typically think of MNC’s as only global-spanning leviathans. In tax terms, there is no such thing. The person who has moved from their home country but maintains their business there and opens up what is often a carbon copy in the UAE is equally bound by its rules.

Moreover, there are the familial ties, which I have touched upon in an earlier article. A person may set up a sales organisation in the UAE, providing a route to market for a sibling or cousin’s business in their home country. That is covered under transfer pricing.

Transfer pricing relates to the pricing of transactions, at a notional or actual monetary value, between parties that are either related or connected. In this, there is the potential that the existing relationship between the parties may allow the pricing of a transaction to be tempered to either party’s needs.

The ultimate loser would probably be the regime with the higher effective tax rate. Where one jurisdiction does not levy taxes, the temptation would be all the greater.

Thus, the Pillar 2 initiative championed by the International Organisation for Economic Co-operation and Development, which seeks a base corporate tax rate of 15 per cent for all countries and is aimed at MNCs, in particular. More than 130 countries have signed up, including the UAE.

The first task is to identify whether or not your business trades with any related or connected parties. The test is whether one side can influence the cost base of the other, upwards or downwards.

It is just not in the selling of goods or services. For example, loans have interest and can be structured in a tax-beneficial manner. If a commercial reason can be justified for this – and this is where the real work begins – it might pass review and be allowed by a relevant tax authority.

A transfer pricing pack will be required, a master file for the global group and a local file for the national entity. Will you be preparing one? Or many? Best get started. This is not a simple task.

David Daly is a partner at the Gulf Tax Accounting Group in the UAE