Significant purpose test: Companies must justify UAE footprint by today

MUMBAI: By end of Tuesday, hundreds of wealthy Indians and NRIs will have to regularise their outfits, subsidiaries, and paper companies that were set up in Dubai to escape tax and park undisclosed fund moved from Switzerland.

Under the United Arab Emirates (UAE) regulations, companies will have to justify their presence there — with evidence of employees and assets to demonstrate that there is genuine economic activity — and explain that profits booked are indeed generated from activities undertaken in the region.

The deadline to submit all documents for the ‘significant purpose test’ is June 30, 2020 – which many companies, either due to challenges posed by Covid-19 or their inability to produce adequate proof, will miss. Some have asked UAE authorities for more time.

Many businesses, which hire warehouses in Dubai, a trading hub, show profits generated in other jurisdictions in UAE to avoid income tax. Several use post office companies and their bank accounts (thanks to little exchange control) to hold funds after closing their Swiss bank accounts and eliminating paper trail.

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Tax and finance professionals ET spoke to spelt out the pitfalls for dodgy and profit-shifting entities.

“There are concerns due to the unanswered questions. Are UAE subsidiaries set up by Indian holding companies geared up to satisfy the significant purpose test? If not, will UAE authorities share such information with India? Does that pose a potential tax risk as permanent establishment or place of effective management of these entities is in India?” said Mitil Chokshi, senior partner at Chokshi & Chokshi.

Some of the companies are trying to hurriedly appoint local managers to pass the regulatory test. The economic substance regulation requires a company to show that an adequate number of qualified employees are physically present in the UAE; directed and managed in UAE; have reasonable level of operating expense, physical assets and premises in UAE, and conducts core income-generating activity in that country.

According to senior chartered accountant Dilip Lakhani, “The regulations, applicable to onshore and offshore companies operating in UAE, will ensure that profits that are not commensurate with economic substance are not artificially attracted. It will cover subsidiary or JV of Indian companies. Though their accounts will be consolidated with Indian parent, they will have to satisfy the test laid down by the regulation. If inquired they will have to satisfy the authorities as to how a large income is earned with little or no substance, and there is no leakage in the tax-paying jurisdiction.”

Will Indian tax offices stationed in UAE start probing into the taxability and functioning of such companies registered in UAE free zones and having ultimate owners as Indian entities? While UAE came out with the economic substance rule more than a year ago and introduced tighter KYC norms for banks, many have been slow in implementing them. Companies with genuine business activities have had sufficient time to put in place the basic elements. “But companies who were predominantly paper companies with PO addresses and created just to evade tax or for money laundering, may now find it very difficult to operate in Dubai (UAE). For others, ESR may not have a major impact but the cost of compliances may go up and related risks of non-compliance may cause some anxiety,” said Nirav Jogani of Lemon Consultech.

The regulation follows OECD’s Base Erosion Profit Shifting (BEPS) initiative and EU code on business taxation. The key test propagated: real activity, real presence, and real management. Among other objectives, it aims to minimize the practice of profit shifting from high-tax jurisdictions to low tax regimes. For instance, on case of branch and representative offices of foreign companies not having directors, the manager has to be physically present in the country when key decisions are taken.