The United Arab Emirates introduced in April 2019 a legislation named as Economic Substance Regulations [ESR]. For many Years UAE has been considered as a Tax Haven by the many entities due to its lack of direct and indirect taxes.

Recently, however, the United Arab Emirates has introduced legislation to tax supplies in its jurisdiction termed as a Value Added Tax [VAT]. The introduction of Economic Substance Regulations [ESR] is one of the many ways in which the United Arab Emirates has aligned its policies with that of the Organization for Economic Cooperation and Development [OECD]. The directives issued by the Organization for Economic Cooperation and Development [OECD] for BEPS [Base Erosion Profit Shifting] are a direct precursor of Economic Substance Regulations [ESR] directives.

Base Erosion Profit Shifting directives are regulations issued by the Organization for Economic Cooperation and Development [OECD] to combat corporate policies for Tax Planning which would shift the profits of companies from low tax rate jurisdictions to high tax jurisdictions. Thus “eroding” the tax base in high tax jurisdictions.

Commitment to the Organization for Economic Cooperation and Development [OECD] requirements and being a member country of the same body, UAE has introduced the ESR. The issuance of ESR has also helped the UAE to comply with the assessment of UAE Tax Frameworks made by the European Union.

The purpose of the ESR is to bring specific requirements for businesses to demonstrate actual activity in the UAE. With the introduction of ESR, UAE has been removed from the blacklist of tax havens.

The ESR adopted by the UAE is roughly similar to the regulations of the Organization for Economic Cooperation and Development [OECD] member countries which have a similar tax structure as the United Arab Emirates.

The Economic Substance Regulations [ESR] require all UAE entities, whether they are onshore, free zone, branch or representative offices that undertake one or more “Relevant Activity” for Financial Year commencing on or after January 2019.

It should be noted that Entities that direct or indirect ownership amounting to 51% of its total shares is exempted from the compliance requirements of ESR. All UAE Entities need to whether and which of their activities fall within the scope of the Economic Substance Regulations, as well as ensuring that they meet the requirements in respect in each relevant activity. This is in essence both a qualitative and quantitative assessment that would involve consideration of operational, financial, tax/transfer pricing, legal, and governance matters.

What are the relevant activities for Economic Substance Regulations [ESR] Compliance Requirements?

The regulations will apply to companies and other business forms which are registered within the UAE mainland, Free Zones, and Financial Free Zones, that carry out the following activities:

It should be noted with clarity that there is a requirement for a business to use the “Substance over Form” approach when evaluating whether they undertake a relevant activity or not.

This means that companies will not only be evaluated on what activities are stated on their commercial license but their activities will be evaluated and ESR applied accordingly. It is not a requirement that a UAE entity is directly engaged in the performance of a relevant activity directly. If an entity is earning income passively from a relevant activity, it will be sufficient for the application of Economic Substance Regulations [ESR].

What are the requirements for UAE Entities for Economic Substance Regulations [ESR]:

All Entities which assess that they are involved in the performance of a Relevant Activity will carry out the Economic Substance Test for Economic Substance Regulations [ESR]. The Economic Substance is composed of two parts:

  1. The Direct and Managed Test:
    1. The Entity needs to be directed and managed in the UAE with regards to the relevant activity carried out in the Emirates.
  2. The Core Income Generated Activities Test [CIGA]:
    1. The Entity that performs the relevant activities for the purpose of application of Economic Substance Regulations [ESR], need to demonstrate that the CIGA’s are undertaken in the UAE.
    2. The activity which constitutes as a CIGA varies with the activity being performed.

Below is a list of CIGA activities for each relevant activity, however, the list is for illustrative purposes and is not exhaustive.

Relevant ActivitiesExamples of CIGA
 

 

Banking

§  Raising Funds

§  Managing Risks

§  Taking Hedge Positions

§  Providing Loans, credit and other financial services

§  Managing Capital and preparing reports to investors.

 

 

 

Insurance

§  Predicting and Calculating Risk

§  Insuring and Re-insuring against the risk

§  Providing Insurance business services

§  Underwriting Insurance and Re-insurance

 

 

 

Investment Fund Management

§  Taking Decision on holding and selling of investments

§  Calculating risk and reserves

§  Taking decision on currency or interest fluctuations

§  Preparing report for Investors

 

 

Lease Finance

§  Agreeing Funding Terms

§  Identifying and acquiring assets to be leased.

§  Setting terms and duration of any leasing

§  Monitoring and revising agreements

§  Managing risks

 

Headquarters

§  Taking relevant management decisions

§  Incurring operating expenditures

§  Co-ordinating Group Activities

Holding Company§  All activities related to the business that derives income from dividends and capital gains from equity interest
 

 

Shipping Company

§  Managing crew

§  Overhauling and Maintenance of ships

§  Overseeing and Tracking Shipping

§  Determining what goods to order and when to deliver.

§  Organizing and overseeing voyages.

 

 

Intellectual Property

§  Taking a strategic decision and managing principal risks related to the development and subsequent exploitation of intangible assets generating income. Acquisition by third parties and subsequent exploitation and protection of the intangible assets.
 

 

Distribution and Service Center

§  Transportation and storing component parts.

§  Material and goods ready for Sale

§  Managing Inventories

§  Taking Orders

§  Providing Consulting and Other Administrative Services

 

What are Economic Substance Regulations [ESR] Reporting Requirements?

The Entities which exist in the United Arab Emirates and carry out relevant activities within its jurisdiction need to follow certainly and comply with certain reporting requirements.

The entities will be required to submit an annual notice to their Regulatory Authority indicating that they are carrying out a Relevant Activity in the preceding Financial Year and whether there has been any Income from the Relevant activity that has been subject to Taxation outside the United Arab Emirates.

It should be noted that UAE entities that qualify for an exemption from the Economic Substance Regulations, or those that did not earn any income from their Relevant Activities will still be required to file a notification with the Relevant Authority.

UAE Entities which qualify for submission of notification and those that earned any income from the same will also be required to file an Annual Economic Substance Return. The purpose of the Return will be to make an assessment of the requirements of economic substance regulations are met, the income earned, qualifications of the staff involved, and information about the premises and other assets used in carrying out the relevant activity.

What are compliance timelines for [ESR]?

The question arises as to when the entities which are required to comply with Economic Substance Regulations [ESR]. For understanding this, we can divide the requirements into two categories:

These entities must comply with the requirements of the regulations from the beginning of their financial year commencing on or after the 1st of January 2019. The first Return for these entities will be due 12 months after the financial year ends in 2020. For entities engaged in relevant activities with a calendar year ending by the year 31 December, the first notification and return need to be submitted by 31st of December 2020.

 

New Entities that are engaged in carrying out the relevant activities must comply with the regulations from the commencement of the Financial Year. The first return due will be after their Financial year-end [could be in the year 2020 or later]

 

What are the Penalties for Non-Compliance of [ESR]?

In addition to an exchange of information by the UAE with countries which are a member of Organization for Economic Cooperation and Development [OECD] to remove the possibility of Base Erosion and Profit Shifting, failure to comply will cause the levy of administrative penalties not less than 10,000 AED and not more than 50,000 AED for failure to comply for the first year. In case of failure to comply with ESR, the minimum amount of penalty will be increased to 50,000 AED and the maximum amount to 300,000 AED.

In addition to this, additional penalties, such as suspending, revocation of UAE Trade License may also be levied.

 

Summary for Economic Substance Regulations [ESR] Compliance:

For better understanding, the following flow chart will better explain the application of Economic Substance Regulations [ESR].

of Economic Substance Regulations

Internal audit is an independent, objective assurance and consulting activity designed to feature value and improve an organization’s operations. It helps a company accomplish its objectives by bringing a scientific, disciplined approach to appraise and improve the effectiveness of risk management, control, and governance processes.

Why Do Organizations Have Internal Audit?

When the Sarbanes-Oxley Act of 2002 was passed, it made executives of publicly traded companies legally liable for the accuracy of its financial statements and also the internal controls over financial reporting. Internal Audit functions play a critical role in helping executives to achieve their conclusions. Also, Internal Audit efforts to detect breakdowns in internal controls helps safeguard against potential fraud, waste or abuse, and ensure compliance with laws and regulations.

Why it’s important

Types of Internal Audits

Internal auditing has historically been synonymous with the performance of financial audits, which seek to confirm a company is using generally accepted accounting procedures (GAAP)/ International Accounting Standard (IAS) to make and manage financial information through the review of financial statements. Businesses also recognize the necessity for other varieties of auditing that look beyond ledgers and balance sheets with relevance to legal compliance, IT security, environmental, operational, and performance oversight objectives:

Compliance Audits are accustomed to evaluate an organization’s compliance with applicable laws, regulations, policies, and procedures.

Environmental Audits identify the impact of a company’s activities on the environment and determine whether the corporate is complying with environmental laws and regulations.

Information Technology Audits to judge the systems they are in situ to protect an organization’s information. Specifically, information audits are accustomed to evaluate the organization’s ability to guard their information assets and to accurately communicate information to authorized parties.

Performance Audits assess whether a company is meeting the goals and objectives set forth by the board of directors. If the organization isn’t meeting its stated goals, the internal auditor will identify process shortfalls and make suggestions for improvement to the board of directors.

Operational Audits measure the overall effectiveness and consistency of an organization’s control mechanisms. A necessary component of operational auditing is that the objective review of the way a company allocates resources. If resources don’t seem to be being employed efficiently, the internal auditor will report these findings accompanying recommendations on a way to reduce wasteful or inefficient resource allocation.

What do internal auditors do?

Internal auditors have a knowledgeable duty to deliver an unbiased and objective view. They need to be independent of the operations they evaluate and report back to the uppermost level in an organization: senior managers and governors. Typically, this is often the board of directors or the board of trustees, the accounting officer, or the audit committee.

To be effective, the internal audit activity must have qualified, skilled and experienced folks that can add accordance with the Code of Ethics and also the International Standards.

What activities internal audit conducts?

The role of the internal auditor has expanded in recent years as internal auditors seek to oversee all aspects (not just accounting) of organizations and add value to their employers. The work of the internal auditor remains prescribed by management, but it’s going to cover the subsequent broad areas.

  1. Review of the accounting and control systems. The establishment of adequate accounting and control systems may be a responsibility of management and also the directors. Internal audit is usually assigned specific responsibility for the subsequent tasks.
    1. Reviewing the plan of the systems
    2. Monitoring the effectiveness of the operation of the systems by risk assessment and detailed testing
  1. Examination of financial and operating information. This might include a review of the means accustomed to identify, measure, classify, and report such information and specific inquiry into individual items including detailed testing of transactions, balances, and procedures.
  2. Review of the economy, efficiency, and effectiveness of operations.
  3. Review of compliance with laws, regulations, and other external requirements, with internal policies and directives, and with other requirements including appropriate authorization of transactions.
  4. Review of the safeguarding of assets. Are valuable, portable items like computers or cash secured, is authorization needed for dealing in investments?
  5. Review of the implementation of corporate objectives. This includes a review of the effectiveness of arrangement, the relevance of standards and policies, the organization’s corporate governance procedures, and also the operation of specific procedures like communication of data.
  6. Identification of important business and financial risks, monitoring the organization’s overall risk management policy to confirm it operates effectively and monitoring the risk management strategies to confirm they remain to operate effectively.
  7. Special investigations into particular areas, for instance, suspected fraud.

How Long Does an Internal Audit Take?

Internal Audit may take up to some weeks, dependent on the scope of the audit and also the size of the corporate, or department, being assessed. Before it’s concluded, an audit includes a consultation with the director or board that hired them to deliberate how their suggestions for improvement can best be implemented.

Quality control and internal auditing

Whatever the criteria accustomed judge effectiveness; quality control procedures are required to observe the professional standards of internal audit. Internal audit departments should establish and monitor quality control policies and procedures designed to make sure that each one audits are conducted in accordance with internal standards.

They should communicate those policies and procedures to their personnel in an exceeding manner designed to deliver reasonable assurance that the policies and procedures are understood and implemented. Quality control policies will vary counting on factors like the following. x the nature and size of the department x Organisation x Geographic dispersion x Cost-benefit considerations Policies and procedures and related documentation will, therefore, vary from company to company.

The Institute of Internal Auditors has suggested that a proper system of quality assurance should be implemented within the internal audit department. This could cover the department’s compliance with appropriate standards, encompassing quality, independence, the scope of work, the performance of audit work, and the management of the internal audit department.

Annual review of internal audit

The board or audit committee should conduct an annual review of the internal auditors’ work

Quality of internal audit report

What’s The difference between internal and external audit?

While sharing some characteristics, internal and external audits have very different objectives. These are explained within the table below:

External auditInternal audit
Reports toShareholders or members who are outside the organization’s governance structure.The board and senior management are within the organization’s governance structure.
ObjectivesAdd credibility and reliability to financial reports from the organization to its stakeholders by giving an opinion on the reportEvaluate and improve the effectiveness of governance, risk management, and control processes.  This provides members of the boards and senior management with assurance that helps them fulfill their duties to the organization and its stakeholders.
CoverageFinancial reports, financial reporting risks.All categories of risk, their management, including reporting on them.
Responsibility for improvementNone, however, there’s an obligation to report problems.Improvement is key to the aim of internal auditing. But it’s done by advising, coaching, and facilitating so as to not undermine the responsibility of management.

 

Advantages of Internal Audits

  1. The major advantage of internal audit is that it’ll result in the discovery of errors and thus when the external audit has completed those errors which were discovered during internal audit would have been rectified by then.
  2. Internal audit reduces the probabilities of frauds because top management cannot look after all things and lots of times top management isn’t competent enough to appear into minute details of accounts whereas internal audit is dole out by professionals and that they are able to learn quickly where are the loopholes in company’s accounts and policies.
  3. As an internal audit is a constant procedure where records are checked regularly it ensures that the accounting staff of an organization keep the records up so far and are always vigilant.

Disadvantages of Internal Audits

  1. Internal audits aren’t full proof within the sense that it cannot eliminate or catch all the frauds and thus some chances of fraud happening even after an internal audit is completed are usually there.
  2. Since the internal audit is performed by the professionals who are outsiders’ likelihood is, they have little or zero attachment towards the corporate and hence they’re going do copulate the work for money instead for betterment of the company.
  3. Internal audit reports aren’t accepted by shareholders and thus it’s for only management use and the company should conduct external audit no matter fact whether it regulates internal audit or not, therefore it ends up in additional costs for the corporate for hiring internal auditors.

Outsourcing the internal audit function

In common with other areas of a company’s operations, the administrators may consider that outsourcing the internal audit function represents better value than an in-house provision. Company management and employees are under particular pressure to make sure that every service represent ‘best value’ and this might prompt them to choose to adopt a competitive tender approach

Advantages of outsourcing


  • Accounting and bookkeeping

    We offer our professional services from large sized clients to small size entrepreneur.

    Our services can help:
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    • Correct period-end technical adjustments
    • Accurate business decisions
    VAT services

    We offer complete outsourcing to manage VAT affairs correctly and timely.

    Our services can help:
    • Platform for information sharing, reminders and file transfer
    • Expert opinions on technical matters
    • Providing training to the employees
    VAT Software

    A reliable accounting software is essential to support the business strategies.

    Our services can help:
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    Professional advisory that can lead an organization on a right track of business success.

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Corporate Advice

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Accounting Software

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Taxation (VAT)

  • VAT registration
  • Filing of VAT returns
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  • VAT evaluation and Planning
  • VAT dispute resolution
  • Representation before Authorities
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Accounting

  • Maintenance of general ledgers, subsidiary ledgers
  • Controlling trial balance
  • Preparation of annual, half yearly, quarterly and monthly financial statements
  • Preparation of management reports
  • Accounting advice & technical opinion
  • Preparation & review of accounting manual


Outsourcing

  • Accounting services
  • Day to day bookkeeping
  • VAT compliance services
  • Payroll and salary administration
  • Management of accounts receivables/customer invoices/payments
  • Management of accounts payable/disbursement/supplier invoices


Consultancy

  • Standard Operating Procedure (SOP)
  • Project Management
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  • Financial Projections
  • Business Evaluation
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  • System and Operations Review
  • Evaluation of Internal Controls


Information Technology

  • ERP Implementation
  • Information System Review
  • Development of IT Strategy
  • Implementation of Off the Shelf ERP
  • Alignment of IT requirements
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Business Advisory

  • Operations and process improvement
  • Budgeting and Forecasting
  • Merger and Acquisition
  • Joint Venture and Business Sales
  • Physical Verification of Assets
  • Cost Management and Reduction


Human Resource (HR)

  • Recruitment of staff
  • HR Policies and Job Descriptions
  • Payroll Services
  • Employees Benefits Plans
  • Succession Planning