What Is ESR Compliance and What Does an ESR Report Include?

For UAE businesses that carry out Relevant Activities, ESR compliance goes beyond simply filing a notification. These entities must also submit a detailed ESR report that demonstrates they meet the economic substance requirements. This guide explains what ESR compliance means in practice and walks you through the contents of an ESR report.

What Is ESR Compliance?

ESR compliance means that your entity meets all the obligations set out under UAE Cabinet Resolution No. 57 of 2020. These obligations include:

1. Filing the annual ESR notification within six months of your financial year end.
2. Filing the annual ESR report (if you carry out Relevant Activities) within twelve months of your financial year end.
3. Meeting the economic substance test by demonstrating that you have adequate employees, expenditure, physical assets, and Core Income-Generating Activities (CIGAs) in the UAE.
4. Maintaining supporting documentation that can be provided to the regulatory authority upon request.

The Economic Substance Test

The heart of ESR compliance is the economic substance test. To pass this test, your entity must demonstrate that it has:

1. Adequate Employees

Your entity must have a sufficient number of qualified full-time employees in the UAE who are involved in carrying out the Relevant Activity. “Adequate” depends on the nature and scale of your activity. A holding company that only manages equity participations will need fewer employees than a distribution centre handling physical goods.

Outsourced employees can count, provided they are based in the UAE and the entity can demonstrate direction and control over their activities.

2. Adequate Operating Expenditure

Your entity must incur a level of operating expenditure in the UAE that is proportionate to the Relevant Activity. This includes salaries, rent, utilities, professional fees, and other operational costs. The expenditure should be genuine and directly related to carrying out the Relevant Activity.

3. Adequate Physical Assets

Your entity must have physical assets in the UAE — such as office space, equipment, technology infrastructure, and other tangible assets — that are appropriate for the Relevant Activity. A serviced office or flexi-desk may be sufficient for a holding company, but a distribution centre would typically require warehouse facilities.

4. Core Income-Generating Activities (CIGAs)

This is often the most important element of the substance test. CIGAs are the key activities that directly generate income for the entity. These activities must be conducted in the UAE. The specific CIGAs vary by Relevant Activity. For example:

• Holding company: Making decisions on acquisitions and disposals, bearing and managing risk, reviewing and approving operational decisions.
• Distribution and service centre: Transporting and storing goods, managing stock, taking orders, providing consulting or administrative services.
• Headquarters: Setting strategic direction, managing risk, providing advisory services to group entities.
• IP business: Research and development, brand management, product enhancement and protection, strategic decisions relating to IP assets.

5. Direction and Management

Your entity’s board of directors (or equivalent management body) must make key strategic decisions in the UAE. Board meetings should be held in the UAE with adequate frequency, a quorum of directors should be physically present in the UAE during meetings, and the minutes of these meetings should be maintained in the UAE.

What Does the ESR Report Include?

The ESR report is a detailed filing that typically requires the following information:

Entity Information

• Legal name, licence number, and registration details
• Financial year covered by the report
• Type of Relevant Activity or activities carried out
• Gross and net income from each Relevant Activity

Employee Details

• Total number of full-time employees in the UAE
• Number of employees involved in carrying out the Relevant Activity
• Qualifications and roles of key employees
• Details of any outsourced personnel

Expenditure Information

• Total operating expenditure incurred in the UAE
• Breakdown of key expenditure categories (salaries, rent, professional fees, etc.)
• Expenditure specifically attributable to the Relevant Activity

Asset Information

• Description of physical assets located in the UAE
• Value of assets used in carrying out the Relevant Activity
• Details of office premises, equipment, and technology

CIGA Details

• Description of the Core Income-Generating Activities performed in the UAE
• Whether any CIGAs are outsourced and, if so, details of the arrangements
• Evidence that the entity directs and controls any outsourced CIGAs

Board Meeting Information

• Number of board meetings held during the period
• Location of each board meeting
• Attendance of directors at each meeting
• Key decisions made at each meeting

Preparing for Your ESR Report

Good preparation makes the ESR report much easier to compile. Throughout the year, maintain:

• Board meeting minutes: Document all meetings, including location, attendees, and decisions.
• Employee records: Keep up-to-date records of employees, their roles, and their involvement in Relevant Activities.
• Financial records: Ensure your accounting records clearly separate income and expenditure related to Relevant Activities from other business activities.
• Asset registers: Maintain a register of physical assets in the UAE.
• Outsourcing agreements: If you outsource any CIGAs, keep the agreements and evidence of direction and control.

Common Pitfalls

• Insufficient documentation: Having substance is not enough; you must be able to prove it with documentation.
• Board meetings held outside the UAE: If key decisions are made abroad, you may fail the substance test.
• Over-reliance on outsourcing: Outsourcing CIGAs is permitted, but the entity must demonstrate direction and control over the outsourced activities.
• Inconsistent financial records: Your ESR report figures must be consistent with your audited financial statements.

Conclusion

ESR compliance is an ongoing obligation that requires proper planning and record-keeping throughout the year. The ESR report is a comprehensive document that demonstrates your entity has genuine economic substance in the UAE. By maintaining proper documentation, holding regular board meetings in the UAE, and ensuring your operations are adequately resourced, you can meet the substance test and file your ESR report with confidence.