Any High Risk Intellectual Property (IP) Licensee is, by default, deemed to have failed the ESR test, resulting in the Competent Authority exchanging information on the High Risk IP Licensee with the relevant Foreign Competent Authorities (where the Parent Company, Ultimate Parent Company and the Ultimate Beneficial Owner of the High Risk IP Licensee are resident).
Important points to be noted:
Note: This information is based on my personal interpretation, from references used. This content is for informational & knowledge sharing purposes only, and is not intended to provide, and should not be relied on for compliance or accounting advice.
Article (1) Definitions
“High Risk IP Licensee” is a Licensee which carries on an Intellectual Property Business and in respect of which any of the following two conditions apply:
(a) the Licensee–
i. did not create the intellectual property in an intellectual property asset which it holds for the purposes of its business.
ii. acquired the intellectual property asset either from-
(a) a Connected Person.
(b) in consideration for funding research and development by another person situated in a country other than thin e State.
iii. licences the intellectual property asset to one or more Connected Persons or otherwise generates income from the asset in consequence of activities performed by Foreign Connected Persons.
(b) the Licensee does not carry out research and development, or branding, marketing and distribution as part of its State Core Income-Generating Activity.
Income : in respect of an intellectual property asset includes any of the following:
(b) income from a franchise agreement.
(c) income from licensing the intangible asset.
(d) income from capital gains and other income derived from the sale of an Intellectual Property Asset.
Article 4 (Section (a) point 8) - Meaning of Relevant Activity and Regulatory Authority
“Intellectual Property Businesses” as licensed in the State, including Intellectual Property Businesses licensed in a Free Zone or a Financial Free Zone.
Article 5 “State Core Income-Generating Activities”
(8) in respect of Intellectual Property Business:
(a) where the Intellectual Property Asset is a –
i. patent or an asset that is similar to a patent, research and development.
ii. non-trade intangible (including a trademark), branding, marketing and distribution.
(b) if the Relevant Activity is conducted by a Licensee that is regarded as a High Risk IP Licensee, the State Core Income-Generating Activity must include any of the following additional activities:
i. taking strategic decisions and managing (as well as bearing) the principal risks related to development and subsequent exploitation of the intangible asset generating income.
ii. taking the strategic decisions and managing (as well as bearing) the principal risks relating to acquisition by third parties and subsequent exploitation and protection of the intangible asset.
iii. carrying on the ancillary trading activities through which the intangible assets are exploited leading to the generation of income from third parties.
Article 7 Assessment of whether Economic Substance Test is met
Clause 1 - The Regulatory Authority may determine that a Licensee has not met the Economic Substance Test during any Financial Year of the Licensee, provided that such determination is made no later than six (6) years after the end of the Financial Year to which the determination relates.
Clause 3 - In relation to a High Risk IP Licensee, for the purposes of Clause 1 of this Article, the Regulatory Authority must determine that the Economic Substance Test is not met during a Financial Year unless the Licensee provides sufficient information to satisfy the Regulatory Authority that the Test is met.
Article 8 Requirement to provide information
Clause 4(h) - in the case of a Relevant Activity being an Intellectual Property Business, a declaration as to whether or not it is a high risk intellectual property business. If the Licensee declares that it is a high risk intellectual property business, the Licensee shall provide the information under paragraph (i) to refute a determination made by the Regulatory under Clause 3 of Article 7 of this Resolution.
Clause 4(i) - in the case of a Licensee that is carrying on a high risk intellectual property business the following additional information must be provided:
i. Information demonstrating that the Licensee does and historically has exercised a high degree of control over the development, exploitation, maintenance, enhancement and protection of the intellectual property asset by an adequate number of full-time employees, with the necessary qualifications, who permanently reside and perform their activities in the State.
ii. business plan showing the reasons for holding the ownership in the Intellectual Property Asset in the State.
iii. employee information , including level of experience, type of contracts, qualifications and duration of employment with the Licensee.
iv. evidence that decision making is taking place within the State.
Article 5: Sector Specific Guidance / Clause 5.3 High Risk Intellectual Property Activity
The ESR identifies certain activities in relation to intellectual Property Business as high risk and sets out additional conditions that must be satisfied by a licensee carrying out any of such activities.
Income derived from intellectual property assets activity poses a greater risk of artificial profit shifting as opposed to income derived from non-IP related activity. In anticipation of this higher risk, the ESR presumes that a licensee who carries out such activity is not complying with the Economic Substance Test.
A licensee shall be considered a High Risk IP Licensee if such licensee carries on an intellectual property business and in respect of which any of the two conditions set out in Article (1) of the ESR applies.
The Regulatory authority shall presume that a High Risk IP Licensee has not met the Economic Substance Test during the financial year. Such an assumption can be rebutted by a licensee provided that the licensee submits, inter alia, sufficient information demonstrating that the licensee does and historically has exercised a high degree of control over the development, exploitation, maintenance, enhancement and protection of the intellectual property asset by an adequate number of full-time employees, with the necessary qualifications, who permanently reside and perform their activities in the UAE.
A High Risk IP Licensee must further show sufficient evidence that decision making is taking place with the UAE by meeting the following criteria:
(a) Taking strategic decisions and managing (as well as bearing) the principle risks related to development and subsequent exploitation of the intangible assets generating income.
(b) Taking the strategic decisions and managing (as well as bearing) the principle risk relating to acquisition of third parties and subsequent exploitation and protection of the intangible assets.
(c) Carrying on the ancillary trading activities through which the intangible assets are exploited leading to the generation of income from third parties.
Periodic decisions by non-resident directors on board member would not be sufficient to satisfy the Economic Substance Test in respect of High Risk IP Licensee.
Section 3.8 Intellectual Property Business
A UAE business is regarded as carrying on an Intellectual Property Business if it holds, exploits, or receives gross income from “Intellectual Property Assets”.
An Intellectual Property Asset is defined as any intellectual property right in intangible assets, such as copyrights, patents, trademarks, brands, and technical know-how, from which the Licensee earns separately identifiable income in the form of royalties, license fees, franchise fees, capital gains and any other income from the sale or exploitation of the Intellectual Property Asset.
Most UAE businesses will own some form of Intellectual Property Asset (e.g. their trademark, technical know-how relating to their processes, copyright in their works etc.), but not earn separately identifiable income from such assets. Instead, the Intellectual Property Assets contribute to, or protect the value of, the good or services these UAE businesses provide. The ownership of such Intellectual Property Asset would not be considered as carrying on an Intellectual Property Business as the Intellectual Property Asset is merely auxiliary to the main business of the UAE business.
If there is any indication that a Licensee has manipulated its gross income to avoid being subject to the economic substance requirements as an Intellectual Property Business, for example, by disguising royalties as part of sales income, the Regulatory Authority shall take the necessary action to ensure compliance with the Regulations.
Core Income-Generating Activities of an Intellectual Property Business
The Regulations set out certain CIGAs for an Intellectual Property Business. The CIGA required to be undertaken in the UAE will depend on the nature of the asset being exploited and how that asset is being used to generate gross income for the Licensee.
Patents and similar assets (e.g. that share the same features of a patent including copyrighted software, technical know-how and other similar novel, useful and protected assets): ‘Research and development’.
This CIGA includes planning and documentation of new products, processes or services, prototyping, demonstrating, piloting, testing and validation of new or improved technologies, addressing known scientific or technological obstacles, applying research findings or other knowledge for producing or introducing new or improved materials, devices, products, processes, systems, technologies or services, etc.
Marketing intangibles (an intangible that relates to marketing activities, aids in the commercial exploitation of a product or service, and/or has an important promotional value for the product concerned such as trademarks, brands, customer lists and relationships): ‘Branding, marketing and distribution’.
Marketing and branding includes advertising, seeking endorsements, artistic design, developing consumer awareness and developing customer loyalty.
Distribution includes distribution of the marketing intangible through various mediums such as on demand services, business to business sectors, integration into IT systems, creating dealership networks and distribution channels and maintaining relationships to aid in the distribution of the marketing intangible.
In demonstrating economic substance in the UAE for an Intellectual Property Business, periodic decisions made by non-resident directors would not be sufficient to satisfy the economic substance test. Therefore, it would require more than local staff passively holding intangible assets whose creation and exploitation is a function of decisions made and activities performed outside of the jurisdiction.
1. LicenseCo holds a brand, the rights for which are licensed to others in return for a royalty. LicenseCo is within the scope of an Intellectual Property Business.
2. ChocolateCo has a trademarked range of chocolates, which it manufactures and sells to unrelated third parties. ChocolateCo is not an Intellectual Property Business as its gross income is derived from the sale of finished goods to third parties, not the exploitation of an Intellectual Property Asset (i.e. the value of the trademark is intrinsically linked to the value of the chocolates and is not separately distinguishable making the use of the trademark incidental).
3. SoftwareCo has developed a unique IT software platform for accepting, processing and tracking online orders that it holds and uses within its own business of online marketing. SoftwareCo also licences the IP software platform to others to use within their online marketing businesses. The users pay SoftwareCo a licence fee in order to use the IT software platform. SoftwareCo is within the scope of an Intellectual Property Business.
High Risk IP Licensee
Where a Licensee is carrying on an Intellectual Property Business, it will also have to consider if it is a High Risk IP Licensee. A High Risk IP Licensee is defined under Article 1 of the Economic Substance Regulations as a Licensee which carries on an Intellectual Property Business, and under condition (a) of the definition meets all of the following three requirements:
1. The Licensee did not create the Intellectual Property Asset which it holds for the purpose of its business, and
2. The Licensee acquired the IP Asset from either;
a. A group company, or
b. In consideration for funding research and development by another person situated in foreign jurisdiction, and
3. The Licensee licenses or has sold the IP Asset to one or more group companies, or otherwise earns separately identifiable gross income (e.g. royalties, licence fees) from a foreign group company in respect of the use or exploitation of the IP asset.
Any High Risk IP Licensee is, by default, deemed to have failed the economic substance test, resulting in the Competent Authority exchanging information on the High Risk IP Licensee with the relevant Foreign Competent Authorities (where the Parent Company, Ultimate Parent Company and the Ultimate Beneficial Owner of the High Risk IP Licensee are resident).
A High Risk IP Licensee would nevertheless be required to meet the economic substance test to avoid being subject to penalties, by providing sufficient evidence supporting that it has, and has historically had, a high degree of control over the development, enhancement, maintenance, protection and exploitation (the so-called “DEMPE functions”) of the Intellectual Property Asset.
The Licensee is required to have an adequate number of full-time employees, with the necessary qualifications, who permanently reside and perform their activities in the UAE, and would need to provide the following information:
· A business plan showing the reasons for holding the ownership in the Intellectual Property Asset in the UAE;
· Employee information, including;
o level of experience;
o type of contracts;
o qualifications; and
o duration of employment of the Licensee;
· The above information would have to prove that in the UAE there is more than local staff passively holding intangible assets whose creation and exploitation is a function of decisions made and activities performed outside of the jurisdiction. As such, the business would need to evidence that decision making is taking place in the UAE (note: periodic decisions made by non- resident directors or board of members would not be sufficient).
PharmaCorp LLC, a UAE resident company earns gross income from licensing its patent for a new medicine to its group companies located in Egypt and KSA.
PharmaCorp did not create the patent, the rights were acquired from a group company (R&D Co in the UK).
PharmaCorp is a High Risk IP Licensee and would
(i) be subject to the exchange of information provisions of Article 9.3, and
(j) be required to provide additional information to evidence its economic substance in the UAE.
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