Readiness of ESR Audit

March 26, 2024 |
Issued on August 10, 2020, Cabinet Resolution No. 57 of 2020 concerning Economic Substance Requirements (“Regulations”) appointed the Federal Tax Authority (the “FTA”) as the ‘National Assessing Authority’. The FTA’s functions include, without limitation:
  • undertaking assessments to determine whether a licensee has met the ‘Economic Substance Test’;
  • imposing administrative penalties where applicable; and
  • hearing and deciding on appeals.
The FTA has recently begun audits of UAE businesses to verify compliance with Economic Substance Regulation (“ESR”). The UAE released the Economic Substance Regulations as part of its commitment to the Organization for Economic Co-operation and Development's (OECD) inclusive framework and in response to the European Union Code of Conduct Group on business taxation's review of the UAE's tax system. As a result, it became necessary for businesses to engage in several pertinent operations to maintain a sufficient ‘Economic Presence’ in the UAE about the activities they carry out. The objective is to prohibit unfair tax tactics and the influx of profits from specific mobile activities into low-tax jurisdictions without sufficient equivalent economic activity. The major goal of the Regulations is to ensure that UAE businesses report actual profits. The entities will need to assess whether they perform any relevant activities mentioned in the Regulations. Businesses operating in the UAE are required to adopt a ‘substance over form’ approach when determining whether they engage in a ‘Relevant Activity’ and, thus, fall under the coverage of the Regulations. To make this decision, the UAE business would need to examine well beyond the information on their commercial licence and the actions carried out throughout the course of a financial period. Beginning with the 2019 fiscal year, the FTA will start conducting ESR audits, clarifications, and assessments. As the ‘National Assessing Authority’, FTA has the authority to audit any licensee to check for adherence to the Regulations. They want to check the substance to verify if the licensee can show that:
  • In the UAE, the licensee and the ‘Relevant Activity’ are overseen and managed;
  • In the UAE, the pertinent Core Income Generating Activities (CIGAs) are being carried out; and
  • The licensee has sufficient personnel, facilities, and expenses in the UAE.
The companies subject to the requirements under the Regulations must keep the necessary documents to demonstrate the presence of economic substances in the UAE for this purpose, and they must give this information to the FTA within five days of the FTA's request for it. To ensure their availability to supply the information if necessary by the Regulatory authority or the FTA, entities are expected to retain pertinent papers showing enough economic substance in the UAE for a lookback period of six years. Although the Regulations make no mention of adequate content, FTA may still contest it. Achieving compliance is not as straightforward as it may seem. Typically, authorities demand a hefty bundle of documents, leaving a mere 5-day window for submission. Postponing any response until the official audit notification is received indicates potential complications ahead; by then, it is often too late, disrupting business operations. Thus, proactive readiness before the audit request is paramount.   Process: ESR Compliance Procedure: The majority of UAE businesses are not fully aware of their obligations concerning compliance under the Regulations. It could lead to a multitude of complications. The following is a list of the fundamental actions or procedures that any organisation must do to comply with Regulations:
  • First Stage: Notification of ESR
  • Second Stage: Filing annual ESR return
The penalties for non-compliance under the Regulations are as follows:
  • Failure to file a notification - AED 20,000
  • Non-submission of a report or required documentation - AED 50,000
  • Not meeting the economic substance test - AED 50,000
  • Provision of inaccurate information - AED 50,000
  • Failing ESR audit by FTA two years in a row - AED 400,000
The company may incur administrative fines for failing to comply with the Regulations or providing false information. It is pertinent to note that if the fines levied by the FTA are not paid by the entity, then the licensing authorities may potentially suspend or refuse to renew the entities commercial licence. MBG Expertise: MBG excels in providing comprehensive expertise in conducting ESR audits. Our focus is on preparing and guiding you through the intricacies of the ESR audit, ensuring compliance with regulatory standards and optimizing your readiness for a successful audit experience in the following manner:
  • We examine past ESR submissions to judge the quality of the material presented;
  • We assist in collation of documents under the FTA audit requirement list;
  • We assist in verification of documents to be in compliance with the FTA audit standards;
  • We assist in draft appropriate responses to FTA's audit questions, and help with submissions on the portal; and
  • In case of a penalty, we provide our assistance in review and aid in preparing an appeal and support processes to waive aid in comprehending discussions with FTA and developing solutions.
  MBG is available to provide guidance on ESR audit requirements and ensure complete compliance. Our ESR assessment and diagnostic analysis help you understand the compliance requirements specific to your company and address any identified gaps. In the event of an ESR audit, our team can support you in comprehending the technical aspects of the information requested by the FTA and provide guidance throughout the audit process.
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