Economic substance regulations – Distribution Business
What is “Distribution Business”
If the Licensee purchases goods from a FOREIGN CONNECTED PERSON and import those goods into the UAE and distribute those goods outside UAE. The trigger point is Foreign Connected Person.
Foreign Connected Person is a natural or judicial person not a resident of UAE, who is related to one or more natural or judicial person(s) through direct or indirect ownership or control, or common control.
Distribution Business shall comprise of following but not limited to Core-income Generating Activities:
- Transporting and storing component parts, materials, or goods ready for sale
- Managing inventories i.e. storing goods in the warehouses based in UAE
- Taking orders
- Inventory controls and checks including physical verification and stock audits.
There could be Three cases under Distribution Business:
- Purchases from China, import in UAE through customs and then store in the warehouse and then finally export to Africa.
- Purchases from China, no imports i.e. goods are not touched to the territorial waters of UAE, rather it shipped directly from China port to Africa Port i.e High Seas Sales.
- Purchases from China, import in UAE through customs, store in the warehouse and then finally sell in the UAE Market itself.
In all the above cases, purchases are made from “Foreign Connected Person”
Analysis of Cases
Case I: As per Cabinet of Ministers Resolution No. 31 of 2019 Concerning Economic Substance Regulations (ESR), Economic Substance Regulations shall be applicable.
Case II: As per Cabinet of Ministers Resolution No. 31 of 2019 Concerning Economic Substance Regulations (ESR) AND as per FAQ given by Hamriyah Free Zone Authority, the licensees activities should not be considered as a distribution business under ESR as the goods being traded were never imported into UAE. In such a case, the licensee is not required to comply with ESR tests. Although, the licensee is required to submit the notification for ESR.
However, as per the guide published by Ministry of Finance, ESR shall be applicable which states that A Licensee is considered engaged in a “Distribution Business” if the Licensee purchases raw materials or finished products from a Foreign Connected Person, and distributes those raw materials or finished goods. (The words “imports the goods into the UAE” and “distribute those goods outside the UAE” has been mislaid in the guide).
Case III: As per Cabinet of Ministers Resolution No. 31 of 2019 Concerning Economic Substance Regulations (ESR) AND as per FAQ given by Hamriyah Free Zone Authority, the licensees activities should not be considered as a distribution business under ESR as the goods were not exported. In such a case, the licensee is not required to comply with ESR tests. Although, the licensee is required to submit the notification for ESR.
However, as per the guide published by Ministry of Finance, ESR shall be applicable which states that A Licensee is considered engaged in a “Distribution Business” if the Licensee purchases raw materials or finished products from a Foreign Connected Person, and distributes those raw materials or finished goods. (The words “imports the goods into the UAE” and “distribute those goods outside the UAE” has been mislaid in the guide).
Public clarification in the form of notification should come from other Relevant Authorities as well to solve further ambiguities with respect to “Distribution Business”.
Companies that earn income from a relevant Activity “Distribution Business” during the financial period must submit the return with the Relevant Authority within 12 months from the end of the relevant financial period. For reporting purposes, Companies in UAE must start preparing standalone financial statements for the income generated from relevant activities. Statement of Comprehensive Income and Balance Sheet should be prepared with respect to Distribution Business Relevant Activity. The biggest challenge is to track the inventory purchased from Foreign Connected Person and compute the profits related to the relevant activity only i.e Relevant Income generated. It requires proper recording of operating expenditure, sales, purchases, and all other financial transactions for the relevant activity conducted during the reportable period.
