The role of economic substance in the UAE’s taxation system

  1.  Economic substance is not a criterion of tax residence. In other words, it is required more to secure substance than tax residence. In most jurisdictions, residents are entities registered in such jurisdictions, including those that are not present there.
  2. Countries are required to grant tax benefits only to those of their residents who have passed the economic substance test in such countries. Otherwise, they grant tax relief for profit earned in other regions. This violates the principles of international tax law order established at the level of the OECD and G20.
  3. A company’s place of effective management (POEM) may be relevant for determining its tax residence. The place of management and operating control is also checked within the scope of the economic substance test.
  4. With a certain combination of facts, results of the economic substance test can be used for determining residence from the perspective of POEM. However, this is not the case under different circumstances. In substance test, the place of management and operating control of the core income generation operations within the scope of a specific type of activity. In the residency test, POEM stands for the management and control of the whole company with all its activities.
  5. 4.If double residence is threatened, the countries involved may factor in both the POEM and the place of economic substance to determine of which country a company is a tax resident.







Within the scope of the OECD and G20's efforts to address BEPS, an action plan was devised in 2013. Action 5 of the plan was implementation of an economic substance requirement to be used for the purposes of applying any tax benefits.

Within the scope of such implementation, a report was prepared in
 A standard (technical guidance) was set out in the report and subsequent reports of the OECD Forum on Harmful Tax Practices (FHTP) for applying the factor. These list the following:

- relevant (‘geographically mobile') activities;

- twoThe criterion of management and operating control is missing.
 out of three elements have been determined of the modern economic substance test,

- examples have been given of transactions that are of key importance for generating income from relevant activities.

In accordance with the FHTP standards that were devised, the UAE's Cabinet of Ministers issued, on 30 April 2019, a decision concerning the regulation of economic substance. By Decision No. 57 of 10 August 2020, the Cabinet of Ministers has approved a revised version of economic sub­stance rules. These rules are being applied to this very day.

The FHTP continually monitors whether economic substance rules are in place and are applied in no-tax or only nominal tax jurisdictions. The UAE is subject to such monitoring. As at January 2023, the FHTP acknowledges that the necessary rules have been implemented in UAE legislation and that no drawbacks have been identified in such rules or in how they are applied.The criterion of management and operating control is missing.


The general economic substance rules in the UAE

At the federal level, rules have been introduced in the UAE which impose an obligation to:


  • meet economic substance requirements (ESR) in the UAE. In other words, a physical pres­ence in the UEA is mandatory for companies that have been registered in its territory;
  • file annual notifications and reports to confirm compliance with the ESR.

These rules are confined to the list of relevant types of business (‘activities'). These include:


  • 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.


The types of activities that have not been included in the list are not be covered by the ESR.




The UAE's tax provisions relating to economic substance

The requirement to ensure economic substance for taxation purposes appeared in article 18(1)(a) of the Corporate Tax Law.Decree Law No. 47 of 2022 on the Taxation of Corporations and Businesses
 It stipulates that taxpayers in the UAE's free zonesThe list of such free zones for Corporate Tax purposes is to me released by the Cabinet (Art. 1 of the Corporate Tax Law).
 and “maintain adequate substance” in the UAE may apply a 0% tax rate to the qualifying income.Maintenance adequate economic substance in the state.

Interestingly, to apply a 0% tax rate, an adequate substance must be maintained in the country (the UAE) and not necessarily within a free zone. The literal application of this provision suggests that a substance test also covers those resources and transactions that are performed outside a relevant free zone (on the mainland).

Example 1.

Company A is registered in the Khalifa Port Free Trade Zone. The Company has an office and warehouses there. The Company purchases products from the group com­panies and subsequently ships them from the UAE to buyers from the Middle East and Africa.

A subsidiary that is located on the UAE mainland outside the free trade zone collects bids from buyers.

A hefty portion of operating costs is attributed to promoting the products. Company A compensates such costs to independent providers that carry out their business in the UAE mainland.

In that case, the activity of providers from the mainland also counts for the purposes of compliance with the condition of there being adequate substance in the UAE.

Article 17(1)(a) of Corporate Tax Law uses the term ‘adequate substance' rather than ‘economic substance' or ‘adequate economic substance'. That there is no mention of an ‘economic' nature of the substance does not rule out the application of the criteria which have been devised for economic substance. The content of the term ‘substance' must be determined based on the general principle of priority of substance over form. Sometimes, references are made to ‘economic' substance and ‘legal' form, sometimes not. The essence of the point stands.




The correlation between economic substance rules and tax provisions

Article 18(1)(a) of the Corporate Tax Law makes the application of a 0% tax rate by companies within the free trade zone conditional on maintaining adequate substance in the UAE.“Maintenance adequate economic substance in the state”.
 If the condition was formulated as ‘compliance with the requirements' for maintaining economic sub­stance in the UAE, it would have been clear that the condition only applied to the nine (relevant) types of activity stated above. However, the prerequisite for a 0% tax rate stipulates adequate sub­stance in the UAE rather than compliance with economic substance requirements.

Hence, the question arises of whether it is required to maintain adequate substance for the pur­poses of applying a 0% tax rate with regard to irrelevant types of activity?

Example 2.

A company provides advisory services to independent persons (an irrelevant type of activity) and intra-group services (relevant activity).

Both the report and the notification must be submitted only with regard to intra­group services. Is it required to maintain adequate substance with regard to advi­sory services as well?

The following routes can be suggested for how practice may develop in this regard:


  • a broad interpretation when all types of activity will be tested in terms of economic sub­stance. In that case, the rules established for relevant types of activity will be applied to other types of activity by analogy;
  • a narrow interpretation when it is decided that it is not required to comply with the ade­quate substance prerequisite with regard to irrelevant types of activity.


In turn, a broad interpretation may also have options:


  • if interpreted literally, non-compliance with the adequate substance requirement with re­gard to at least one type of activity will deprive a taxpayer of the right to apply a 0% tax rate with regard to remaining types of activity where such a prerequisite has been met;
  • under a more liberal interpretation, a taxpayer does not lose the status of a qualified partici­pant of a free trade zone in terms of the profit generated from the type of activity with re­gard to which adequate substance has been secured.


It is still unclear which interpretation may prevail. Before the Corporate Tax Law was adopted, clause 3.27 of the Public Consultation Document (PCD) proposed that a 0% tax rate should be granted to those persons that “maintain adequate substance and comply with all regulatory re­quirements”. This wording is to the greatest extent in line with the broad interpretation. The Cab­inet at that moment thought of adequate substance in addition (“and”) to the compliance with the requirements (which already cover substance but for relevant activities only). “Comply with all regulatory requirements, including maintaining economic substance” or another similar phrase would make a case for the narrow interpretation.

! Non-compliance with the economic substance prerequisite under the broad interpreta­tion is costly. If no adequate substance is secured in the UAE with regard to any type of activity, a company will not be eligible for a 0% tax rate with regard to all types of activity, including those for which the economic substance test has been passed. The Law does not provide for the status of a Qualified Participant of a Free Zone to be par­tially lost.

Therefore, taxpayers to which this issue is relevant are advised to have recourse to FTA for clari­fications. Such an opportunity has been offered to them by Art. 59 of the Corporate Tax Law.




The economic substance test

There are no special rules for the economic substance test for taxation purposes. However, the general rules of such test are set out in article 6(1) of the Cabinet's Decision No. 56. To pass the test, a company must meet the following criteria:

  1. the company should perform in the UAE key business operations which generate its in­come from the corresponding type of activity;
  2. the relevant activity should be managed and directed in the UAE;
  3. having regard to the scale at which the activity is performed, the company should:
  • engage in such activity full-time employees who are physically present in the UAE;
  • assume adequate operating costs in the UAE;
  • use tangible assets for such activity that are located in the UAE.


Please find below our review of each of the elements.


The place of core income-generating activity (CIGA)

CIGA comprises such transactions that ‘are of central importance' for generating income.Clause 4.2(a) of Decision No. 100 of the UAE's Ministry of Finance.

An indicative list of such transactions for each of the nine types of activity has been determined in article 3(2) of Decision No. 56. For instance, for the headquarters businessArticle 3(2)(f) of the Cabinet's Decision No. 56.
 these are:


taking relevant management decisions1These are decisions on the substantive functions and significant risks for group companies, such as decisions on purchases, sales and marketing strategies, product development, business process standardization, etc. (clause 25 of the Relevant Activities Guide)., or


coordinating group activitiesSuch coordinating is aimed at ensuring that activities such as marketing, HR, IT, finance, tax, etc., are coordinated and arranged in a way that produces the best outcome for the group as a whole as opposed to individual group com­panies (Ibid).
, or

incurring operating expenditures on behalf of group entities.Such expenditures are incurred for the benefit of the group and are allocated among its members (Ibid).


Insofar as the list is a tentative list it is not necessarily compatible with the nature of income or methods for generating same in a particular situation. Then one's own positions rather than the above tentative three positions should be applied.

! While using the tentative list, it is not required that all three types of activity of a head­quarters are being pursued.Clause 4.2(a) of Decision No. 100 of the UAE's Ministry of Finance.
 However, if all three activities are performed, these should be performed in the UAE.Ibid.
 If most of the transactions relating to CIGA are performed in the UAE, while a lesser portion of such transactions is performed outside, the test is not passed. However, on the other hand, transactions in which several persons are en­gaged that are located in different countries are deemed to have been performed in the UAE if the majority of such persons performed such transactions in the UAE.

Example 3.

Making business decisions has been included in the headquarters business within the scope of CIGA. Clause 2.5 of the Ministry of Finance's Decision No. 100 (2020) clarifies that such decisions are deemed to have been made in the UAE if the major­ity of persons who make a decision should be physically present in the UAE. The correct determination of such transactions is relevant for answering the question of which transactions must necessarily be performed in the UAE and which must not. By determining the scope of CIGA incorrectly, a taxpayer may take those transactions that comprise CIGA outside the UAE. And nor will it pass the test.

Example 4.

A company granted an intra-group loan to another company. The conditions and ma­turity date of the loan have been determined by the group treasury, which was lo­cated in another country. The loan was made on such conditions.

In the case at hand, the only asset that yields profit from the loan is the money provided. However, a transaction that involves such an asset being provided consists not only of the physical transfer of the asset but also determining the conditions and maturity of the loan.Clause 2.4 of the Relevant Activities Guide.

Clause 4.3.2 of the Relevant Activities Guide allows for a back office, IT, accounting and legal department to be excluded from CIGA. If outside providers are engaged for such functions to be performed or for relevant advice to be obtained they also may perform such work abroad.

! In general, exploring the CIGA parameter is reminiscent of a functional analysis in the sphere of transfer pricing under which place is determined where functions are per­formed. In other words, CIGA and TP have a common subject of research. Therefore, it is logical to assume that a tax authority will use facts established during a CIGA test when the tax authority checks for compliance with the arm's length rule, and vice-versa. Hence, taxpayers are advised to avoid discrepancies in the functional analysis conducted in the TP documentation and economic substance reports.

! The significance of a functional analysis for taxation purposes should not be underesti­mated. Traditionally, it has been boiled down to determining the price. We have found out that a functional analysis affects CIGA. However, there is more to it than that. A functional analysis, in essence, means determining economically relevant facts, i.e. facts on which taxation rests. Therefore, a mismatch between persons that actually received income and persons that performed key business transactions which generated such in­come might be also relevant for determining the jurisdiction that may lay claim to levy­ing taxes on a portion of this income.

Example 5.

In Example 4, tax authorities of the country of the borrower may divide income into two parts.

The part of income (interest) attributable to the treasury's activities which are associ­ated with the loan being granted is subject to withholding tax under a double taxation treaty between the country of the borrower and the country of the treasury.

The remaining part is subject to withholding tax according to the rules of the double taxation treaty between the country of the borrower and the country of the lender.




Element 2. Place of management and operating control

The place of management and operating control of the corresponding activity must be in the UAE.

Clause 4.2(b) of Resolution No. 100 of the Ministry of Finance states that an adequate number of

meetings of members of the Board of Directors[ were held in the UAE and they attended it. The required number is determined based on the scale and other specifics of the operations carried out by the taxpayer. They use the provisions of corporate legislation and the provisions of the constit­uent documents regulating this issue.

The meeting is ‘qualified' if:


  • minutes of the meeting were prepared;
  • these minutes of the meeting are stored in the UAE;
  • all strategic resolutions passed at the meeting are listed in these minutes of the meeting;
  • the minutes of the meetings have been signed by the members of the board attending the meeting in person in the UAE;
  • the quorum of the meeting provided for by law or constituent documents has been reached, and those who attended it were in the UAE;
  • the members of the Board of Directors have the necessary knowledge and experience to perform their duties, and do not just formalise with their presence a resolution made for them by someone else outside the UAE.


The Ministry of Finance emphasises that members of the Board of Directors do not necessarily have to be residents of the UAE. It is enough that they are “physically present in the UAE when taking strategic decisions”.

As we can see, these criterions are fairly formal. This is surprising, since the test is just being conducted in order to see if the form corresponds to the substance. But, in order to check this, methods are used that are quite simple to formalise or formally execute. Attendance in person at a meeting held in the UAE, of course, requires this fact to really exist. But, a trip that is not condi­tioned by anything other than the desire to fulfil a formal condition at the venue of the meeting is

formal in itself. The same elements as preparation of the minutes of the meeting, their storage

location, etc. - this is a pure formality. It turns out that whether the form confirms to the content is checked at the expense of the other form.

However, this is not the mere specifics of the UAE. This happens almost everywhere in accordance with the recommendations of the OECD. In other words, it is rather a defect of urgent recommen­dations executed literally without the adjustments being meaningful.

The actual verification of the content includes an indication that the members of the board of di­rectors should meet in order to pass a resolution, and not in order to formalise a resolution previ­ously made by them (or someone else). The informal one can also include the criterion of physical presence in the UAE at the time of the passing (actual passing, not signing) of the resolution. These two requirements can be left in the test.

Example 6.

On 1 August the meeting of the Board of Directors was held and a strategic resolution was passed. But throughout the whole of July the members of the Board of Directors were involved in discussing it. Having all disagreements resolved, the date of the meet­ing was set.

In this case, the period for which presence should be checked is not only the first of August, but also July.

Example 7.

The duties of a member of the Board of Directors are assigned to a person who does not take a real part in the development of this resolution. According to the group's policies and procedures, this person's official duties include signing resolutions ap­proved by other responsible departments and persons.

The presence of this member of the Board is not taken into account in the test.

It is clear how the “management and operational control” criterion works for the purposes of draft­ing reports and notifications about economic substance. They take into account the management of only the activities of the Company for which it is necessary to report (banking, distribution, service centre, IP activities, etc.). For other types of activities, there is no need to conduct either a test or this stage of it.

However, there is no such restriction on the recognition of a Qualified Participant of a Free Zone for Corporate Tax purposes. Article 18(1)(a) of the Law No. 47 requires an adequate level of sub­stance to be maintained, rather than the requirements to be fulfilled for the level of economic sub­stance established by the legislation of the UAE.

This problem is somewhat made less concerns by the fact that, in the UAE, the combination of relevant activities with other activities in one entity is not allowed in a large number of cases.




Element 3 of the test. People, assets, expenses.

The singling out of this element of the test as a separate item does not seem entirely justified. People, assets and expenses are just a tool with which the first item is checked, i.e. it is established where the income-generating transactions were actually carried out. In other words, at the first stage, the range of transactions related to CIGA was identified. At the third stage:


  • ‘scales' and other parameters of CIGA are determined
  • then they are compared with the amount of resources spent on them in the UAE (labour, tangible assets and expenses).



Outsourcing when the third element of the test is performed

All income-generating transactions or a part of them can be outsourced, i.e. conducted through outsourcing providersClause 4.3 of the Relevant Activities Guide.
. In these cases, testing for compliance with the level of relevant activity is carried out based on the resources involved in the UAE: employees, operating expenses and tan­gible assets. If the CIGA is distributed between the contractors and the taxpayer, then the corre­sponding figures of the contractors and the taxpayer are added together.

At the same time, double counting in outsourcing is not allowed. If an outsourcing provider from the UAE provides services to one or more clients, then the time spent by the provider's employees and the time during which the provider used the asset “cannot be counted for more than one Li­censee at any given time”.

The following example is provided in Clause 4.3 of the Relevant Activities Guide: “if an employee of an Outsourcing Provider spends an hour performing CIGAs for a Licensee, the same employee cannot spend the same hour performing CIGA for a different Licensee”. It is a pity that the same example has not been considered with an asset. Let us say that at the same hour, an employee used a computer to do this work. Using the same logic of reasoning, we get that the computer can be taken into account by several clients when determining the level of economic substance, because it was used for them at different times (at different hours of the same day). Therefore, the time­sheets mentioned in the Guide (or an extract from them, certificates, etc.) should be required from the provider not only for people, but also for tangible assets.

When employees are counted, the test rules allow only those who are hired on full-time terms to be used. How these rules can concert with example above where employee definitely does not work for one client only? With outsourcing, full-time rule will not mean that an employee works a full day for the same client taxpayer, but that the provider hires this employee full-time.

An outsourcing provider can be either an affiliate or an independent company.

The activities of the outsourcing provider will not be counted as part of the taxpayer's activities if the latter does not control (supervise) this activity of the provider.

The obligation to confirm the substance remains with the taxpayer. Therefore, it is recommended to include provisions in the contract with the provider that oblige the provider to disclose and document the relevant data.




The specifics of the economic substance test in terms of holding structures

The activities of holding companies are included in the types of activities for which it is necessary to confirm economic substance in the UAE. However, it stands apart from the other 8 activities.

Even in the OECD report on clause 5 of the BEPS plan, it was indicated that to perform the func­tions of buying and holding shares and similar rights in other companies, to receive dividends and income from the increase in the value of shares, the same level of substance is not required as for other relevant activities. The main problem of holding structures was identified when they were used to conceal ultimate beneficial owners (clause 87 of the

Therefore, it was proposed to limit the substance test to compliance with the requirements for the transparency of transactions and the presence of a minimum of employees and premises that would allow the functions of ownership of other companies. This will make sure that such a holding company is a real entity, and not a “letter box” (“brass plate”) company (clause 88 of the Report).

The substance test is considered passed if the holding company:


  • provides all the necessary documents that the law requires it to submit to the regulatory authorityFor a holding company, this is the Ministry of Economy on the mainland or the corresponding body in the free economic zone (article 4(1)(g) of the Cabinet's Decision No. 57).
  • has the employees and premises necessary to carry out its holding company businessArticle 6(5) of the Cabinet's Decision No. 57.


On the one hand, article 6(5) of the Cabinet's Decision No. 57 contains no requirement that these employees and premises must be located in the UAE. On the other hand, in the form of an eco­nomic substance
 in the "Declaration" section (box 2 (b), specially designed for holding activities), it is required to reflect the number of employees and premises located specifically in the UAE. Reports and reviews from FHTP also indicate whether employees and companies are tied to the testing jurisdiction.

In order to pass the substance test, a holding company is not required to comply with the condi­tions that:


  • key income-generating operations are carried out in the UAE;
  • management and operational control of activity was located in the UAE;
  • expenses corresponding to this type of activity and its scale are carried by the company in the UAE.


There is no requirement for employees to be employed full time. The "General Information" sec­tion of the economic substance report of holding activities contains information on full-time em­ployees in the UAE and on the costs of local providersBoxes 3 and 4.
. However, in the "Declaration" section, where it is required to confirm employees, property and expenses in the reporting period, it is indicated that it is not filled in by companies engaged in holding activities.

The composition of the necessary property is limited by the requirements for there to be prem­ises.

At the same time, holding activity includes a limited scope of operations. This is an activity that:


  • has as its sole function the acquisition and ownership of shares or equivalent membership interests in other companies; and
  • only earns dividends and capital gains from its equitable interests.


If, in addition, the company conducts other activities, makes investments in another form or owns assets in another form, then this company is not recognised as a holding company. If this other activity is not relevant, then the company will not confirm its economic substance at all.

Example 7.

The company owns shares of other group companies and real estate, leasing the latter to the group's enterprises.

Such a company is not recognised as a holding company for the purposes of confirming its economic substance. Since the company does not carry out other types of relevant activity. It does not need to submit a notification and an economic substance report. Example 8.

DEF LLC produces food and owns shares in another company (GHI LLC), which car­ries out the restaurant business.

Despite the fact that DEF LLC owns shares of GHI LLC and receives dividends from it, DEF LLC is not considered as a holding company, since its main business is food production.

Food production and the restaurant business are not included in the list of relevant activities. Therefore, there is no need to submit a report and notification of economic substanceThe example is provided in clause 2.7 of the Relevant Activities Guide.

However, we should not forget that confirmation of economic substance in all these cases may still be still the case for the purposes of applying the 0% Corporate Tax Rate. Until there are other rules from the Cabinet, the Minister of Finance or the Federal Tax Au­thority, “adequate substance” for any qualified income should be maintained in the UAE for these purposes.

If there is another relevant activity, then the economic substance must be confirmed according to the rules established for this activity (there is no need to confirm the substance for holding activ­ity).

Example 9.

A company owns shares of other companies of the group and intangible assets (patents, trademarks, etc.), granting rights to use them to other companies of the group.

Such a company is not also recognised as a holding company for the purposes of con­firming its economic substance. But IP activities are classified as relevant activities. And it is necessary to provide a notification and an economic substance report in the UAE.

Example 10.

The holding company owns shares of the group's enterprises and receives dividends in relation to this activity. In addition, it granted a loan to some companies of the group, receiving interest income on it.

In this case, the company must confirm its economic substance only by the activity of “Leasing and Financing”.

As we may see, “adequate substance” required for 0% tax rate is much tricky issue when general application of economic substance rules (ESR). Easy way to alleviate the burden is to tie up zero percent rate with compliance with existent ESR, i.e. to replace requirement to “maintain adequate substance” with “comply with economic substance regulation”. We'll see if legislator, Cabinet, MoF or FTA take this way to change the rule or interpret it.



Last News


Case Study. VAT on providing advertising space in social media platforms

In this study, we delve into VAT issues related to e-advertisements, using social media ad platforms to demonstrate the case. The focus is on applying the place of use and

Read more

PGP Tax Consultancy has celebrated its first anniversary in Dubai

  On 16 May, we held an evening function in Dubai to commemorate the first anniversary of the official launch of PGP Tax Consultancy. Senior Partner Andrey Nikonov and Partner

Read more

We'd love to hear from you!

Whether you have a question, need advice, or are ready to explore tax solutions for your business, don't hesitate to reach out