Economic Substance Test in Dubai
The Economic Substance Test is a crucial procedure for companies operating in Dubai and the United Arab Emirates (UAE). This test serves to ensure that companies, especially those benefiting from the tax advantages and free zones in the UAE, are actually carrying out substantial economic activities in their country of operation. The aim is to prevent tax avoidance and abuse.
What is the economic substance test?
The economic substance test assesses the actual activities carried out by a company in relation to the tax requirements applicable there. In the UAE, companies must prove that they actually carry out certain business activities and not just exist as a „naked shell“ to take advantage of tax benefits.
Relevant aspects of the test
- Physical presence: Companies must have office space or operating facilities that support business operations.
- Adequate staff: Sufficiently qualified employees are required to carry out the business activities.
- Monitoring and control mechanisms: Companies must demonstrate that they have effective control mechanisms in place to direct actual business activities.
- Proportionality of activities: The activities carried out must be proportionate to the above factors.
Who is affected?
The economic substance test mainly affects companies operating in certain sectors, including
- Banks and financial service providers
- Insurance companies
- Hedge funds and investment companies
- Companies with certain types of intangible assets
The importance of the economic substance test
Carrying out an economic substance test is of great importance, as companies that do not fulfil the requirements can expect considerable legal and financial consequences. These can range from fines to the loss of tax benefits.
How is the test carried out?
The test is usually carried out by the Dubai Land Department (DLD) or other competent tax authorities. Companies must provide relevant documents and evidence to prove that they are actually carrying out the specified economic activities.
Questions and answers:
What happens if a company fails the test?
Companies that fail the economic substance test may be fined and may lose their entitlement to tax relief. It is therefore important to fulfil the requirements carefully.
How can a company ensure that it passes the test?
Companies should keep comprehensive documentation of their physical presence, employees and business activities and seek legal or tax advice if necessary.
Illustrative example on the topic: Economic substance test
Imagine a company offering offshore services is based in one of the many tax-favoured zones in Dubai. In order to benefit from the advantages, the company has rented an office, but only has a manager there who is occasionally present. Most of the business is conducted from another country. When conducting the economic substance test, the tax authority determines that the company’s activities do not correspond to the actual level of business and that there are not enough substantial economic activities in Dubai. Consequently, the company is forced to return the tax benefits and receives a substantial fine for non-compliance. A scenario that shows how important it is to maintain economic substance in Dubai.
Conclusion
The economic substance test is an indispensable part of corporate governance in Dubai. Companies must ensure that they comply with the necessary legal requirements to maintain their tax advantages and avoid legal issues. A good understanding of the test and its requirements is therefore essential for anyone wishing to do business in the UAE.
