Economic Substance Regulations – Relevant Activities Examples

Continuing our series on Economic Substance Regulations (ESR) and its Relevant Activities, the following section discusses examples of scenarios where a Licensee may, or may not be, subject to the ESR Regulations, based on its activities. The examples in this Relevant Activities Guide are meant as general guidance in the context of the specific Relevant Activity being discussed in the earlier blog posts on each Relevant Activities. UAE businesses should consider whether the activities described under any of the examples could constitute another Relevant Activity.

Recently, UAE MOF announced the updated Economic Substance Regulations, replacing those announced in April 2019. The updated regulations are meant to be enforced retrospectively, on all licensees in the UAE from 1 January 2019 onwards. The amended regulations introduced important changes to the economic substance regime. Businesses operating in UAE should be aware of the changes and re-assess whether their earlier economic substance analysis is still valid under the Updated ESR and align them in the light of updated regulations.

The ESR Regulations apply to UAE entities that carry out any Relevant Activity; and are expected to use a ‘substance over form’ approach to determine whether or not they undertake a Relevant Activity and, as a result, are within the scope of the ESR Regulations. This determination would require the UAE business to look beyond what is stated on their commercial license to the activities actually undertaken during a financial period. It is not required that a UAE business is actively engaged in any of the relevant business categories for it to be considered as carrying on a Relevant Activity.

All UAE entities, which are falling within the scope of the Updated Economic Substance Regulations, are required to re-submit an economic substance notification and Economic Substance Report on the Ministry of Finance portal.

“Although a business may determine that it does not carry on a Relevant Activity and is therefore not within scope of the ESR Regulations, the Regulatory Authority in that jurisdiction may request information from the business to demonstrate that position”.

Banking Business – Examples:

ABC Bank (UK) offers current accounts, savings accounts, loans, credit cards, and other products and services to individual and corporate customers through a number of branches in the UAE. ABC Bank clearly undertakes a Banking Business in the UAE and is subject to the ESR Regulations.
PQR is a UAE branch of the Investment Banking division of the STV Banking Group. The activities of PQR include underwriting new debt and equity securities, facilitating and advising buyers and sellers on mergers and acquisitions, and marketing financial products. Whilst permitted under its UAE investment banking license to accept deposits whose maturities are at least two years, PQR’s funding is limited to borrowings from its head office and from other banks. PQR would not be considered as carrying on a Banking Business and be subject to the ESR Regulations on this basis.
MNO is the UAE branch of the JKL Banking Group that provides retail and corporate banking services globally. The activities of MNO are limited to providing UAE and regional clients with assistance and advice regarding the JKL Banking Group’s products and services, including assistance in the process of opening accounts with JKL Banking Group entities that are based outside of the UAE. MNO LLC is not considered to undertake a Banking Business by virtue of being in the same corporate group, and assistance in the opening of bank accounts would not be considered as conducting deposit taking activities. MNO may, however, be considered as undertaking a “Distribution and Service Centre Business” and be within the scope of the ESR Regulations on this basis.

Insurance Business – Examples:

First Life LLC (UAE) provides life, health and car insurance in and from the UAE, and is regulated as an Insurer by the UAE Securities & Commodities Authority. First Life LLC clearly undertakes an Insurance Business and is subject to the substance requirements.
Intermediary Co LLC (UAE) is an insurance intermediary that assists and represents consumers in the placement and purchase of insurance, and provides services to insurance companies to facilitate and complement the insurance placement process. Intermediary Co is regulated as an insurance broker, but is not required to be regulated as an Insurer. Intermediary Co does not undertake an Insurance Business and is not subject to the ESR Regulations on this basis.

Investment Fund Management Business – Example:

Trinity Fund is an Investment Fund registered with the SCA. The fund is structured as a limited partnership with Trinity LLC (UAE) as its corporate General Partner. Trinity LLC has appointed Morpheus LLC (UAE) as the investment manager for the Trinity Fund, and has delegated to Morpheus LLC the day-to-day investment and divestment decision making responsibilities. The administration of the Investment Fund is handled by a third-party administrator established in the UAE, Neo LLC. Trinity Fund itself is not considered to undertake an Investment Fund Management Business.

Trinity LLC, on the basis that its activities are limited to being the General Partner of the Trinity Fund, with all discretionary investment management activities being delegated to Morpheus LLC, is not considered to undertake an Investment Fund Management Business. Morpheus LLC, as the investment manager of the Trinity Fund, is considered as carrying on an Investment Fund Management Business. Neo LLC does not provide discretionary investment management services and is therefore not considered an Investment Fund Management Business.

Lease Finance Business – Examples:

STU LLC (UAE) lends AED 1,000,000 to its subsidiary, VWX LLC, at a 10% interest rate per annum. In respect of the interest bearing shareholder loan made by STU LLC, it is considered engaged in a Lease-Finance Business (specifically, financing).
STU LLC subsequently assigns the AED 1,000,000 loan to YZ LLC (UAE), another group company. After the transfer, YZ LLC will be considered as carrying on a Lease-Finance Business. If the AED 1,000,000 loan was the only loan advanced by STU LLC, and STU LLC does not obtain an interest bearing loan receivable from YZ LLC in exchange for the transfer, STU LLC would cease to carry on a Lease-Finance Business once the transfer is effected.
TradeCo LLC (UAE) sells office supplies and allows its customers a 45-day payment term on invoices. If customers do not pay within 45 days, TradeCo charges late payment interest. This trade-credit arrangement is not a Lease-Finance Business, as the credit is not offered with the intention of generating interest, but rather to facilitate the trading business of Trade Co.
TreasuryCo LLC (UAE) is part of the JMR group and acts as the central treasury center for the group. TreasuryCo enters into external borrowing arrangements and on lends the borrowed funds to group companies at the same interest rate it is being charged by the external funders. Despite TreasuryCo not applying a mark-up on the interest it is being charged, it offers financing to group companies for consideration, and is thus considered to carry on a Lease-Finance Business.

Headquarters Business – Examples:

PLC LLC (UAE) is part of a multinational group with subsidiaries around the world. Each of the senior management team based in the UAE has responsibility for a different region, and regularly spend time at the subsidiaries with the local management teams providing strategic direction and helping manage material risks. In addition, PLC LLC supports the group in managing risk through the procurement of external advice centrally, and the associated costs are shared amongst the group. PLC LLC’s activities are within the scope of a Headquarter Business.
FGH LLC (UAE) is part of a UK headquartered group and has subsidiaries in the Kingdom of Saudi Arabia (“KSA”). Whilst the senior management of FGH LLC have regular contact with the management of the KSA subsidiaries on the performance of their business and to share insights from the group, and FGH LLC (in its capacity as shareholder) has certain rights and influence in respect of the management and operations of the KSA subsidiaries, the KSA subsidiaries follow the strategic direction and manage risks in line with the corporate policy set by the headquarters based in the UK. FGH LLC is not considered to be providing ‘headquarters services’ because the strategic direction for the group is set by the headquarters in the UK and not by FGH LLC, and FGH LLC is not responsible for the performance of the subsidiaries in KSA.

Shipping Business – Examples:

Water LLC owns a passenger ship and its business is to operate that ship in international traffic to carry passengers from the UAE to other Middle East countries. Water LLC is within the scope of a Shipping Business because it operates a ship in international traffic for the transport of passengers.
Sailor Corp LLC provides and manages the crew of Fourth Fleet LLC’s ship as part of its crew management business, but Sailor Corp LLC does not operate the ship. Sailor Corp LLC is not related to Fourth Fleet LLC. Sailor Corp LLC is not considered to carry on a Shipping Business because it does not operate the ships where its crew is being deployed. The mere provision of crew and ship management services is not considered as “operating a ship” for purposes of the ESR Regulations because Sailor Corp LLC is not related to Fourth Fleet LLC, Sailor Corp LLC.
Charter LLC owns a ship and charters it on a bareboat basis to Cargo LLC that uses and operates the ship to carry cargo from the UAE to other countries. Charter LLC does not operate the ship it has chartered to Cargo LLC, or any other ship, and is therefore not considered engaged in a Shipping Business. Cargo LLC, on the other hand, is considered as carrying on a Shipping Business because it operates the ship it has chartered for the international transportation of cargo. It is not relevant that Cargo LLC is not the owner of the ship.

Holding Company Business – Examples:

ABC LLC’s only activity is the holding of shares in four subsidiary companies, and ABC LLC is itself held by the regional holding company of the group headquartered in France. The only gross income earned by ABC LLC, are annual dividends from its subsidiaries. ABC LLC undertakes a Holding Company Business irrespective of its own shares being held by another holding company in the group.
DEF LLC manufactures food products, and holds the shares in another company (GHI LLC) which operates a restaurant. Despite DEF LLC holding the shares of GHI LLC and earning dividend income, DEF LLC is not considered a Holding Company Business because its business is food production. Because the manufacturing of food products and the operation of restaurants does not meet the definition of any of the other Relevant Activities, neither DEF LLC nor GHI LLC are subject to the ESR Regulations.
GHI LLC holds 100% of the shares in two subsidiary companies, and has provided an interest bearing shareholder loan to one of these companies. GHI LLC earns annual dividends and interest income. GHI LLC will be considered as engaged in a Lease-Finance Business only, and not also considered as carrying on a Holding Company Business.
Trustee LLC acts as trustee to a number of unconnected trusts, holding assets in its capacity as trustee. As Trustee LLC is in the business of providing trustee services and is not the beneficial owner of the assets, Trustee LLC will not be considered a Holding Company Business.

Intellectual Property Business – Examples:

License Co holds a brand, the rights for which are licensed to others in return for a royalty. License Co is within the scope of an Intellectual Property Business.
Chocolate Co has a trademarked range of chocolates, which it manufactures and sells to unrelated third parties. Chocolate Co is not an Intellectual Property Business as its gross income is derived from the sale of finished goods to third parties, not the exploitation of an Intellectual Property Asset (i.e. the value of the trademark is intrinsically linked to the value of the chocolates and is not separately distinguishable, making the use of the trademark incidental).
Software Co has developed a unique IT software platform for accepting, processing and tracking online orders that it holds and uses within its own business of online marketing. Software Co also licenses the IP software platform to others to use within their online marketing businesses. The users pay Software Co a license fee in order to use the IT software platform. Software Co is within the scope of an Intellectual Property Business.
Pharma Corp LLC, a UAE resident company earns gross income from licensing its patent for a new medicine to its group companies located in Egypt and KSA. Pharma Corp did not create the patent, the rights were acquired from a group company (R&D Co in the UK). Pharma Corp is a High Risk IP Licensee and would be subject to the exchange of information provisions of Article 9.3, and would be required to provide additional information to evidence its economic substance in the UAE.

Distribution and Service Centre Business – Examples:

XYZ LLC (UAE) buys furniture from a group company based in Lebanon, imports the furniture into the UAE, and then re-sells the furniture to other group companies and customers throughout the Middle East. XYZ LLC is considered as carrying on a Distribution and Service Centre Business.
The main business activity of TUV LLC (a company established in the Ajman Free Zone) is to provide HR and administrative support services to a group company based in Kuwait, which are recharged at cost. Despite TUV LLV not charging a mark-up on the relevant costs, TUV LLC is considered as engaged in a Distribution and Service Centre Business.
HIG LLC, the KSA subsidiary of ABC LLC (a company established in the United Kingdom), requires specialist IT support with the implementation of a new accounting system which will be used by HIG LLC in the provision of services to KSA based clients. QRS LLC (a subsidiary of HIG LLC established in the Abu Dhabi General Markets Financial Free Zone) provides audit and accountancy services to third party customers in the UAE, and agrees to second one of its IT support staff to HIG LLC for three months. QRS LLC recharges HIG LLC the relevant salary costs incurred. As QRS LLC is not in the business of providing IT services to foreign group companies, nor does it offer/solicit such services or maintain employees to provide such services to other group companies, and because it does not earn a margin on the costs recharged to HIG LLC, QRS LLC is not considered as carrying on a Distribution and Service Centre Business.

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