How to Know If Your Company Passes the ESR Substance Test in the UAE

The economic substance test is the core requirement of the UAE’s ESR framework. If your company carries out one or more Relevant Activities, you must demonstrate that you have adequate substance in the UAE to support those activities. But how do you know if your company actually passes the test? This guide provides a practical framework for self-assessment.

Understanding the Substance Test

The substance test requires you to demonstrate adequacy in five areas. The word “adequate” is important — there is no fixed number of employees, no minimum expenditure amount, and no specified office size that automatically means you pass. Instead, what is adequate depends on the nature and level of your Relevant Activity.

A holding company that holds shares in two subsidiaries and receives occasional dividends will have different substance requirements than a distribution centre that processes thousands of orders monthly.

The Five Elements of the Substance Test

1. Employees

Question to ask: Do we have enough qualified people in the UAE to carry out our Relevant Activity?

What to look for:

• Full-time employees on the UAE payroll who are directly involved in the Relevant Activity
• Employees with the qualifications and experience appropriate for their roles
• Sufficient headcount relative to the scale of the activity

Example: A headquarters entity providing strategic management to five group companies should have experienced senior managers in the UAE who can meaningfully direct the group’s strategy. Having only one part-time employee would likely be insufficient.

Outsourced staff: You can count outsourced personnel, provided they are based in the UAE and you can demonstrate that you direct and control their activities. You should have a written agreement clearly setting out the services provided and your right to direct how the work is performed.

2. Operating Expenditure

Question to ask: Is our UAE spending proportionate to the income we earn from the Relevant Activity?

What to look for:

• Salaries and wages paid to UAE-based employees
• Rent and facilities costs for UAE premises
• Technology and infrastructure costs
• Professional fees (legal, accounting, consulting)
• Other operational costs incurred in the UAE

Red flag: If your entity earns millions in revenue from a Relevant Activity but has minimal operating costs in the UAE, this signals a potential substance deficiency. The regulatory authority will question how you generated that income without proportionate investment in UAE operations.

3. Physical Assets

Question to ask: Do we have appropriate physical presence and assets in the UAE for our activity?

What to look for:

• Office space appropriate for the number of employees and the nature of the activity
• Equipment, technology, and tools needed to carry out the activity
• Warehouse or storage facilities (if applicable to the activity)

Note: The type of physical assets needed varies significantly by activity. An IP holding company may need only a small office with computers, while a distribution centre needs warehouse space and logistics infrastructure.

4. Core Income-Generating Activities (CIGAs)

Question to ask: Are the key activities that generate our income actually being performed in the UAE?

This is typically the most scrutinised element. For each Relevant Activity, there are specific CIGAs that the regulations expect to be performed in the UAE. Here are examples:

Key point: If decisions are actually being made by people in another country and the UAE entity is simply rubber-stamping them, you will likely fail the CIGA test.

5. Direction and Management

Question to ask: Are strategic decisions being made in the UAE by our board or management team?

What to look for:

• Regular board meetings held in the UAE (not just on paper)
• A quorum of directors physically present in the UAE during meetings
• Minutes that document substantive discussion and decision-making
• Directors who have the knowledge and authority to make genuine decisions

Red flag: Board meetings that are conducted entirely via phone or video conference with all directors located outside the UAE suggest that direction and management is not happening in the UAE.

Self-Assessment Checklist

Use this checklist to evaluate your company’s substance position:

1. Do we have full-time employees in the UAE who are involved in the Relevant Activity? Yes / No
2. Are our UAE employees qualified and experienced enough for their roles? Yes / No
3. Is our UAE operating expenditure proportionate to our income from the Relevant Activity? Yes / No
4. Do we have physical office space and assets in the UAE appropriate for our activity? Yes / No
5. Are the Core Income-Generating Activities for our Relevant Activity being performed in the UAE? Yes / No
6. Does our board hold regular meetings in the UAE with directors physically present? Yes / No
7. Do our board meeting minutes reflect genuine discussion and decision-making? Yes / No
8. If we outsource any CIGAs, can we demonstrate direction and control? Yes / No

If you answered “No” to any of these questions, you have a potential substance gap that should be addressed before filing your ESR report.

What to Do If You Have Gaps

If your self-assessment reveals substance gaps, you have several options:

• Hire or relocate employees: Bring in UAE-based staff with the right skills to carry out the Relevant Activity.
• Move decision-making to the UAE: Ensure board meetings are held in the UAE and that directors are present and making genuine decisions.
• Increase physical presence: Upgrade from a virtual office to a physical office if your current setup is inadequate.
• Restructure outsourcing arrangements: Ensure you have proper agreements with outsourced service providers and can demonstrate direction and control.
• Consider restructuring: In some cases, it may be more efficient to restructure your group to ensure that the entity carrying out the Relevant Activity is the one with the most substance in the UAE.

Conclusion

Passing the ESR substance test is not about meeting a fixed checklist of numbers — it is about demonstrating that your UAE entity has genuine operations proportionate to its activities and income. By regularly assessing your substance across the five key areas and addressing any gaps proactively, you can file your ESR report with confidence and avoid penalties.