In the sections above, we have looked at the main characteristics of the ESR, the compliance and the potential penalties, and at first glance, this might give the impression that the ESR is a problem and a hindrance to business. However, it’s important to stress that although the ESR adds to the compliance burden, the overall impact of ESR is positive, and it brings benefits to the UAE and to the business community in the country. By introducing ESR, the UAE has demonstrated its commitment to the programs instigated by the OECD and others. In doing so, it has laid down a marker that it welcomes businesses that genuinely wish to contribute to the region rather than those that are merely aiming to take advantage of the UAE’s tax system. In turn, this benefits international businesses located in the UAE, as the business has the comfort of establishing in a jurisdiction that has credibility and is part of the global movement for good tax governance and visibility.
From our experience, there are three areas that it is especially important for international businesses to focus on when setting up. These are the ‘directed and managed’ test, the interpretation of the test around having sufficient resources in the UAE and the special rules for intellectual property businesses.
The ESR and the MOF website set out what is required to meet the directed and managed test. In summary, the requirement is that an adequate number of board meetings (for the business in question) need to be held in the UAE, with a quorum of adequately qualified directors physically present in the country. This, in itself, should not be an issue and is in line with normal good management and governance. However, we have seen some businesses that have fallen down simply because proper records of meetings have not been kept. This causes a problem because the business may not be able to demonstrate that the test has been met. The message, therefore, is to ensure that not only are the meetings held in the appropriate manner but that full minutes are taken and retained in the UAE.
With regards to the resources test, the licensee must show that it:
- Employs adequate full-time staff in the UAE
- Incurs adequate operating expenditure in the UAE
- Retains adequate physical assets in the UAE
The emphasis here is clearly that the resources must be ‘in the UAE’. However, many international businesses will use international shared service centres and outsourcing, and this can give rise to doubts as to whether the test can be met.
Fortunately, however, the ESR, and the MOF guidance, is reasonably practical on these matters, and once again, a bona fide UAE based business should be able to meet the requirements. Outsourcing is specifically dealt with, and the general rule is that the outsourcer itself should have adequate resources in the UAE. So, for example, using agency staff or external facilities to carry out any of the core income-generating activities will not be a problem, provided they are located in the UAE.
Evidence that the resources are located in the UAE is important, of course, and in some cases, it will be appropriate to obtain evidence from the outsourcer to ensure the business has all the evidence it will need in the event of an enquiry from the MOF.
International shared service centres can be a concern when considering the resources test, but it is important to remember that the resources test focuses on the CIGA, the core income-generating activities. This means that, for example, a shared service centre outside the UAE supporting the IT needs of the group as a whole – rather than the specific CIGA – should not be a problem. However, this is an area that deserves close attention.
The final area where we frequently see issues to be addressed is in connection with the special rules for intellectual property (IP). The special rules exist because this is an area where some international groups have sought to avoid tax in the past by moving IP to a low tax jurisdiction and then shifting group profits to that jurisdiction through intra-group licensing fees. The ESR, therefore, provides that a licensee that receives income from the holding of intellectual property will be considered a ‘high-risk IP business’ if:
- The Licensee did not create the Intellectual Property Asset which it holds for the purpose of its business, and
- The Licensee acquired the IP Asset from either a Connected Person or in consideration for funding research and development by another person situated in a foreign jurisdiction; and
- The Licensee licenses or has sold the IP Asset to one or more group companies or otherwise earns separately identifiable gross income (e.g. royalties, license fees) from a foreign group company in respect of the use or exploitation of the IP Asset. If a licensee falls into this category, it will be deemed to have automatically failed the ESR test unless it is able to produce evidence to refute the failure.
The evidence required to refute the failure is laid down in the ESR and is as follows:
- Employee information, including level of experience; type of contracts; qualifications; and duration of employment with the Licensee. The business must have an adequate number of full-time employees with the necessary qualifications who permanently reside and perform their activities in the UAE.
- A business plan showing the reasons for holding the ownership in the Intellectual Property Asset in the UAE
- Proof that relevant decision making for the IP business has and continues to take place in the UAE.
The above information would have to prove that in the UAE, there is more than local staff passively holding intangible assets whose creation and exploitation is a function of decisions made and activities performed outside of the jurisdiction. As such, the business would need to evidence that decision making is taking place in the UAE.
These tests and conditions are complex, but they will be very effective in preventing IP from being transferred to the UAE purely to avoid tax. Therefore, any international business that intends to hold IP in the UAE needs to study the rules very carefully and ensure that all the tests can be met.
Interestingly, whilst these rules are complex, they should not be seen as a barrier to genuine businesses holding IP in the UAE. In fact, the UAE, because of -its infrastructure and the skilled workforce it can provide, is an attractive location for research and development operations, and there are many sound, commercial reasons for developing and holding IP in the UAE. The introduction of similar ESR tests for IP in other countries around the world may give the UAE an advantage over jurisdictions that cannot offer the same levels of infrastructure and workforce.