Are the intercompany activities taken into consideration in relation to economic substance regulation? Are they counted as a part of the necessary volume of activity and employment?


  • QUESTION POSTED BY: Student
  • TOPIC: Residency & Treaties
  • PROGRAMME: Postgraduate Diploma in International Taxation
  • TOPIC: Introduction to Treaties (WEEK 18)
  • LECTURER: Renier van Rensburg

FULL WRITTEN ANSWER

Yes, intercompany activities are taken into consideration under the Economic Substance Regulations (ESR). The ESR requires entities conducting relevant activities in certain jurisdictions (like the UAE, for instance) to have substantial economic presence and substance in that jurisdiction. This includes having an adequate level of activity, employment, and physical presence.

Intercompany Transactions and Economic Substance

Intercompany transactions are relevant when assessing whether an entity meets the economic substance requirements. These transactions can be counted as part of the necessary volume of activity provided they are genuine and have a legitimate commercial purpose.

Necessary Volume of Activity

The “necessary volume of activity” refers to the actual economic activities the entity is engaged in within the jurisdiction. This includes generating income and undertaking operations that are core to the business. Intercompany activities, such as providing services or financing within a group, can contribute to this volume if they are substantial and not merely artificial arrangements aimed at meeting the requirements.

Employment and Economic Substance

For employment, the ESR typically requires an adequate number of qualified employees to be physically present in the jurisdiction. Intercompany activities that require staff and involve employees working within the jurisdiction can also count toward this requirement.

However, it is crucial that these intercompany activities reflect real economic substance rather than being set up purely to meet regulatory requirements without any actual business purpose.

Compliance and Documentation

Entities involved in intercompany transactions should maintain proper documentation and demonstrate that these activities are conducted on arm’s length terms and have genuine economic substance. This ensures compliance with ESR and reduces the risk of penalties or adverse assessments by regulatory authorities.