Updated legislation guides zakat and taxpayers in navigating Saudi Arabia's regulatory framework

Corporate income tax rules are governed by the Income Tax Law (Tax Law), which came into force in 2004. The Tax Law is supplemented by implementing regulations (by-laws). The Ministry of Finance issues ministerial resolutions concerning aspects of tax and zakat, a payment under Islamic law that is used for charitable or religious purposes. The General Authority of Zakat and Tax (GAZT) regularly issues circulars and responses to frequently asked questions containing its interpretation or position on regulations. The GAZT generally takes a substanceover-form approach in dealing with tax matters as it normally suits them more. The GAZT often scrutinises transactions and challenges taxpayers if they view transactions as being motivated by non-commercial tax reasons. In some cases the GAZT may base their judgement on the documentation alone; for example, the virtual permanent establishment (PE) concept.

Taxation System

Saudi Arabia’s direct taxation system includes corporate income tax, withholding tax and zakat. Corporate income tax is assessed on the share of profits of the foreign partner in the local company and a non-resident who conducts business in Saudi Arabia through a PE.

The corporate tax rate is 20%, apart from activities related to oil and hydrocarbons production, where the tax rate ranges from 50% to 85%. Non-residents providing services in Saudi Arabia without having a PE or branch are subject to withholding tax ranging from 5% to 20% depending on the nature of services.

Zakat is a religious levy on Saudi/GCC nationals and Saudi companies that are wholly owned by Saudi/GCC nationals. The zakat rate is 2.5% and applicable on the higher of the adjusted taxable profits or the zakat base which comprises equity, loans and provisions reduced by deductible investments and fixed assets.

Value-Added Tax

Since January 2018 value-added tax (VAT) has been in place at a single rate of 5% on the majority of goods and services. The GAZT continues to develop its capacity to administer taxes, which is crucial to ensure the key principles of taxation are adhered to and support the Vision 2030 goal of economic diversification. The Kingdom now boasts 140,000 VAT taxpayers and an additional 150,000 would have likely registered by January 2019. VAT has raised over SR49bn ($13.1bn) in 2018, exceeding the original target by over 60%.

The introduction of VAT followed the implementation of excise in June 2017, followed by the introduction of transfer pricing in February 2019 and new zakat regulations in March 2019. The Kingdom is rapidly moving towards a fully taxed economy.

The VAT system in the Kingdom is based on the GCC Agreement, Saudi VAT Law and the Saudi implementing regulations. These documents outline the legal basis for determining, inter alia, the nature, location, timing and value of supplies.

Certain supplies of goods and services are zero rated and exempted from VAT to provide some relief to consumers. Examples include: the leasing of residential real estate, the supply of medicines and medical goods, educational services to nationals, etc. Similarly to other VAT jurisdictions worldwide, taxpayers that make exempt supplies are restricted in their ability to deduct tax incurred on purchases.

Mostly, the compliance requirements for VAT taxpayers have been kept relatively straightforward with the obligation to file monthly returns, or quarterly if the turnover is below SR40m ($10.7m), by end of the following month of the tax period. The returns contain summary-level numbers of turnover and VAT on output and input transactions.

That said, taxpayers that operate in complex industries – for example, banking, asset management, insurance and telecommunications – can find reporting requirements extremely challenging.

To address this concern, the GAZT has published a number of guides on topics such as financial services, health care, the digital economy, economic activity and real estate. Rulings have also been issued to taxpayers that have applied for clarifications. The GAZT is very active in terms of conducting audits, issuing assessments for contraventions and questioning approaches adopted by taxpayers in terms of specific transactions leading to an increased number of disputes with the GAZT.

February 2019 marked the beginning of VAT compliance for this year. To ensure accurate compliance for the new year, taxpayers must consider the legislative provisions taking effect in 2019 such as:

• Transitional provisions: Relief provided to taxpayers to zero-rate domestic supplies made in 2018 (subject to specific conditions), where the contract was entered before May 30, 2017, has now been withdrawn. From January 2019, such supplies are now subject to VAT at 5%.

• Outstanding payments to vendors: The legislation imposes a condition on the taxpayers who have deducted input VAT to make a payment to the vendor within 12 months from the date of the supply in order to retain this deducted input VAT. If the payment remains outstanding, the taxpayer is obliged to reduce the input VAT deduction claimed earlier to the extent the consideration has not been paid to the vendor.

Bad Debts

VAT legislation provides relief to taxpayers to reduce output tax to the extent consideration is not received for a taxable supply previously made. Taxpayers are eligible for relief 12 months from the date the supply was made.

According to the Tax Law, a foreign partner’s (shareholder’s) share in a resident capital company and a non-resident who does business in the Kingdom through a PE are subject to corporate income tax in the Kingdom at a flat rate of 20%. According to Article 3 of the Tax Law, a company will be considered a resident company if it is formed under the Saudi companies’ regulations, or if its central management is situated within the Kingdom.

Companies which are wholly owned by Saudi nationals are subject to zakat instead of income tax. Companies owned by Saudi and non-Saudi (and non-GCC) nationals pay tax on the portion of income attributable to non-Saudis (and non-GCC) and zakat on the portion of income attributable to Saudi nationals. Residents from countries belonging to the GCC (Bahrain, Kuwait, Oman, Qatar and the UAE) and companies from these countries doing business in Saudi Arabia are subject to zakat and not income tax. In determining the tax/zakat profile, the Saudi tax authorities apply a look-through approach to determine whether the upstream shareholding structure at any point exists outside of the GCC. As per the amendment to the by-laws vide Ministerial Resolution No. 1727 on February 10, 2018, in determining indirect ownership the GAZT can look through the structure up to the second level. However, based on discussion with the GAZT and their practices, they may not restrict the look through up to the second level. If at any point the shareholding structure exits the GCC, they will consider that for tax purposes.

Personal Taxes

Saudi Arabia does not impose personal income taxes on wages and salaries. From a corporate tax point of view, salaries, wages or any benefits paid to a shareholder or any of their relatives, a partner is not a deductible expense for tax purposes.

Tax Residents

A natural person is considered a Saudi resident if one of the following conditions is met:

• He/she has a permanent place of residence in Saudi Arabia and resides in Saudi Arabia for at least 30 days in a tax year; or

• He/she resides in Saudi Arabia for at least 183 days in a tax year without having a permanent place of residence. A company is considered resident in Saudi Arabia if one of the following conditions is met:

• It is formed in accordance with Saudi Arabia’s Companies Regulations; or

• Its central management is located in Saudi Arabia.

Income Subject to Tax

Income subject to tax is gross income and includes income, profits, gains of any type and any form of payment arising from carrying out activity. Gross income includes capital gains and incidental income but excludes certain exempt income. The Tax Law provides that income derived from the following types of activities and sources is considered taxable in Saudi Arabia:

• Any activity carried out in Saudi Arabia;

• Immovable property or lease of immovable property located in Saudi Arabia including capitals gains from the disposal of shares or similar interest in such property;

• Capital gains from the disposal of shares held or partnership in resident company;

• Sale or licence for use of industrial or intellectual property or software;

• Dividends, management and directors’ fee paid by resident company;

• Any payments made by a resident company to its head office or to an affiliated company in respect of services;

• Amounts paid by a resident against services performed in Saudi Arabia completely or partially;

• Exploitation of natural resources;

• Income derived by a PE connected with Saudi Arabia;

• Interest charge and insurance/re-insurance premium with certain conditions; and

• Income from technical or consultancy services rendered to a resident person in the Kingdom or such services are related to an activity carried out in Saudi Arabia.

Corporate Tax Rates

Corporate income tax on resident taxpayers are charged a flat rate of 20% including the income that originates from natural gas investment activities. However, income tax rate on hydrocarbons products ranges from 50% to 85% depending on the amount of capital that is invested.

Non-residents providing services in Saudi Arabia without having a PE or branch are subject to withholding tax ranging from 5% to 20% depending on the nature of services.

Zakat

Zakat is an obligatory payment required from Muslims according to sharia law and forms one of the five pillars of Islam. In most Muslim countries the payment of zakat has been left to the individuals, whereas in Saudi Arabia, the collection of zakat is governed by regulations. Zakat in the Kingdom is assessed on Saudi and GCC nationals and on companies wholly owned by those nationals or their equity interest in companies with foreign (non-Saudi/GCC) participation.

Zakat Base

Zakat is assessed on the basis of earnings and holdings. All earnings from business, industry, personal work, salaries, property, monetary acquisitions of whatever kind or description, including commercial or financial transactions, dividends and generally all income on which sharia law has levied a zakat, is subject to zakat. All holdings that are intended for sale are also subject to zakat. Holdings not intended for sale are not subject to zakat.

There are certain rules that apply to the method of calculating the zakat liability. In general, zakat is levied at a fixed rate of 2.5% on the higher of the adjusted zakatable profits or the zakat base – which generally comprises equity, loans and provisions reduced by deductible investments and fixed assets.

On March 14, 2019 the Ministry of Finance issued new zakat regulations replacing previous zakat regulations. The new regulations are effective for fiscal years beginning on or after January 1, 2019. Some of the key observations include the following:

• Specific article on definitions has been included, such as the definitions of zakat payer, assessments and resident.

• The zakat rate of 2.5% is applicable on the Hijri calendar year (i.e., lunar year, 354 days), however, if a zakat payer is following Gregorian calendar year (365 days) they will be required to pay zakat based on the number of days which would result in an increased zakat rate proportionately.

• Zakat will be payable on the higher of the zakat base or zakatable profits.

• The introduction of concept of a PE for zakat purposes also, which was previously tax subject only.

Accordingly, a PE of a non-resident Saudi or GCC national would be subject to zakat if any two of the three conditions laid down in the regulations are met, i.e., board of directors holds regular meetings in Saudi Arabia; or executive decisions are made in Saudi Arabia; or non-resident PE earns more than 50% of its revenue from Saudi Arabia.

• Listed companies are subject to zakat, except for the founding shareholders.

• Appeal procedures have also been updated requiring zakat payers to pay the zakat liability on the undisputed amounts and in addition, for an appeal to be accepted in form, a zakat payer is required to pay a minimum of 10% to a maximum of 25% of the assessed zakat liability or provide a bank guarantee equal to 50% of the assessed zakat liability.

• Limited relief has been granted to real estate and insurance/re-insurance businesses in the form of deduction of long-term projects under development (certain conditions apply) and statutory deposits.

• Addition to zakat base of long-term loans and similar balances has been restricted to long-term assets deductible for zakat purposes.

• Lower of accumulated brought forward losses as per audited financial statements or the GAZT’s assessment is allowed.

• Net book value of fixed assets as per audited financial statements will be allowed as a deduction from the zakat base.

• An adjustment to the value of transactions between related parties would be made if the transaction is not at arm’s length.

Advance Tax

Taxpayers are required to make an advance payment of corporate income tax for the year in three instalments, i.e., by the end of the sixth, ninth and 12th month. Each instalment of advance payment of tax is equal to 25% of tax liability of the prior period reduced by the withholding tax deducted at the source during the prior period. However, the taxpayer is not required to pay advance taxes if the instalment calculated is less than SR500,000 ($133,000).

If a taxpayer foresees that the current year taxable income (gross revenue) will be lower than the previous year by at least 30%, the taxpayer may request the GAZT to reduce the advance tax due under the second and third instalments proportionally.

Withholding Tax

The Tax Law imposes direct withholding tax on payments for services from an in-Kingdom source to non-resident parties.

In accordance with Article 68 of the Tax Law and Article 63 of its by-laws, a taxpayer has to withhold and pay to the GAZT withholding tax on payments made to non-residents. The taxpayer is required to file a monthly withholding tax return (WTR) online within 10 days of the end of the month in which the payment was made to the non-resident. Failure to settle the withholding tax would result in a delay fine of 1% for every 30-day delay in payment.

For transactions with related parties, the date of recording the transaction is construed as the date of payment if transactions are settled through an account rather than making payments.

Withholding tax is computed at flat rates ranging from 5% to 20% (depending on the nature of services) on payments made to non-residents. For example, for a payment of SR100 ($26.66) at a flat rate of 5%, the withholding tax would be SR100 ($26.66) x 5% = SR5 ($1.33).

In addition, a taxpayer is required to file an annual WTR within 120 days from the end of the fiscal year. For proprietorships, the annual WTR should be submitted within 60 days of the end of the fiscal year.

The GAZT may request information relating to payments made to non-residents at the time of assessment. The records such as copies of the contracts, etc., as well as supporting documents with respect to withholding tax should be maintained for a minimum of 10 years after payment. If the subject is still under the review of the department or the competent authorities, maintenance of such records should be continued until the finalisation of such review or the issuance of a final decision by the Appeal Committee.

Capital Gains Tax

The capital gains tax (CGT) applies on disposal of certain assets in Saudi Arabia. According to Article (1)(2b) of By-laws to the Income Tax Law (BITL), capital gains realised by a non-resident partner from disposal of share or part thereof in a Saudi resident capital company is subject to tax as the disposal is considered a Saudi source of income under Article 5(3) of the Income Tax Law. The non-resident seller is required to file the CGT return and pay due tax at the rate of 20% on the realised capital gains (unless the sale relates to listed securities that qualify for exemption). Any capital gains realised from the sale of shares by a Saudi resident company is subject to tax/zakat, on the basis of year-end results.

Article 16 of BITL provides that the disposing partner should inform the GAZT of the sale transaction and pay the due tax on the resulting capital gains within 60 days of the sale transaction date. The seller is primarily responsible for paying CGT, however, in case of failure, the seller and purchaser are jointly liable with the seller to pay any amount that is due to the GAZT as a result of a sale transaction. Delay in settling the required CGT will result in late filing penalties and delay fines.

Capital gains realised by a resident taxpayer is added to the tax base and subject to tax on the overall position for the year. Further, in an amendment made to the tax laws, a disposal of assets (the definition of asset includes shares) between wholly-owned group companies (directly or indirectly owned by same parent company) is disregarded for tax purposes provided the assets remain within the group for at least two years after the transfer. Where this relief is claimed, the transfer is considered as made at book value for tax purposes. The language employed in the law is broad enough to take a view that it may cover all wholly owned groups and not just groups or entities within Saudi Arabia.

Exempt Income

Based on the amendments to Saudi Tax Laws dated September 20, 2017, tax exempt income includes:

• Capital gains realised from the disposal of securities traded on the stock markets inside and outside of Saudi Arabia, if such securities are traded on the Saudi Stock Exchange, regardless of whether the disposal was executed through a stock market inside or outside Saudi Arabia or through any other means; subject to the conditions set out below:

• Sale transaction is performed in accordance with the Capital Market Law in the Kingdom; or

• If the investment disposed of did not exist before July 30, 2014. Cash or in-kind dividend due on investments made by a Saudi Arabian resident capital company in a Saudi Arabian resident company or a non-resident company is also not taxable, provided that:

• The ownership in the investee company is 10% or more; and

• The period of ownership is one year or more.

Loss Carry Forward

Loss-making capital companies are allowed to carry forward tax losses indefinitely. However, an adjustment of maximum 25% of the current year’s taxable profits can be utilised in a given tax year.

Based on the amendments made to the Tax Law on September 20, 2017, the capital companies are now allowed to carry forward their losses regardless of a change in the ownership or control, provided they continue to undertake the same activity. The amendment is effective from January 1, 2018.

Return Filings

Resident zakat/taxpayers including PEs are required to file annual tax/zakat declaration in Arabic within 120 days of the end of the financial year of the company. In case of a foreign shareholding, tax return is also required to be certified by a Saudi-certified public accountant. Under the current Tax Law, no extensions are granted.

A tax return is required to be supported by audited financial statements, the social insurance payment certificate, break-up of purchases made during the period, annual withholding tax and other detailed account of affairs.

The GAZT implemented the online electronic filing system (ERAD) in 2016. As per the ERAD system, it is mandatory for all zakat/taxpayers, including mixed companies (companies owned by Saudi and foreign shareholders) and fully owned foreign companies to submit their tax/zakat returns electronically. The online filing system requires all types of zakat/ taxpayers to submit their annual corporate tax returns, zakat returns, withholding tax returns and other statutory declarations through ERAD.

Tax Form

Recently, the GAZT updated the tax form thereby reducing the disclosure requirements applicable to the taxpayers, e.g., removal of vendor-wise disclosure of property rentals required in the previous form, which is now replaced by a requirement to disclose the total amount of rental expense only.

Additionally, Transfer Pricing By-laws (TP By-laws) have been introduced in Saudi Arabia effective for tax periods ended December 31, 2018 and onwards. These by-laws require a Disclosure Form for Controlled Transaction (DFCT) to be submitted along with the annual tax return. The DFCT has been incorporated in the GAZT portal as part of the tax return. The form requires a taxpayer to disclose inter alia the details of controlled transactions entered into by a taxpayer during the year and the transfer pricing method adopted by taxpayers to determine the value of such transactions.

Delay Fines & Penalties

The GAZT imposes delay fines if there is a delay in submitting the tax declaration and late settlement of income tax beyond the prescribed deadline as well as penalties where there is a tax evasion.

Failure to file a tax return or pay the due amount on time results in a fine amounting to the greater of:

• 1% of the gross revenue to a maximum penalty of SR20,000 ($5330) or according to the following rates:

• 5% of the underpayment of tax if the delay is for up to 30 days after the due date;

• 10% of the underpayment of tax if the delay is more than 30 days and no more than 90 days after the due date;

• 20% of the underpayment of tax if the delay is more than 90 days and no more than 365 days; or

• 25% of the underpayment of tax if the delay is more than 365 days after the due date. In addition to the penalties mentioned above, 1% of underpayment of tax for each 30 days of the delay is added in the following cases:

• Delay in payment of tax payable per the return; or

• Delay in payment of tax payable per the GAZT assessment. A penalty for tax evasion is imposed at a flat rate of 25% on the additional tax assessed if a taxpayer intentionally conceals facts or information from the GAZT that would have resulted in an increase in the tax liability.

Assessment & Statue of Limitation

A final assessment is raised by the GAZT after a full and thorough review of the declaration submitted to the GAZT. This review may result in further details being requested by the GAZT before raising a final assessment.

The Tax Law, however, provides that a declaration will be considered as finalised/accepted as filed by the taxpayer in the case that five years have elapsed, from the date of filing the declaration, without the GAZT requesting any additional information or raising an assessment. The Tax Law empowers the GAZT to:

• Raise an additional tax assessment within five years of the statutory filing deadline to rectify errors in the application of regulations;

• Raise an additional tax assessment within 10 years of the statutory filing deadline correcting material errors in the declaration or the assessment; and

• Raise an additional assessment at any time with the taxpayer’s consent.

Resolution Committees

Article 66 and 67 of the Income Tax Law provides for the constitution, jurisdiction and functions of appeal committees. In July 2017 Royal Decree No. M/113 was issued to amend Article 67 regarding such appeal committees. As per the amendment, new appeal committees consist of two levels, i.e., preliminary level and high level, where a higher level appeal of a committee’s decision would be considered final without having further right to appeal. Accordingly, zakat/taxpayers will not have the option to file an appeal before the Board of Grievances (BoG). Further, there is a risk that any pending cases with BoG may no longer be heard by the BoG.

Following the changes to the law, the GAZT issued a circular subsequently to clarify that until the formation of new appeal committees, original procedures provided in Article 66 and 67 shall remain effective. After the formation of new appeal committees, a time limit to file an appeal against the assessment or revised assessment raised by the GAZT would be reduced from 60 days to 30 days.

The new appeal committees were recently formed, however, they are still not functional and going through the set-up stage. The GAZT has sent all pending objections to the new committees. Further, the new committees also approached tax/zakat payers and requested them to file through emails available copies of the appeal documents in some cases.

Additionally, the Ministry of Finance has issued Ministerial Resolution No. 2753, dated April 30, 2018, announcing the formation of Dispute Resolution Committees (DRC) which is in effect from the date of issue. DRCs are composed of six members including the chairman who are competent in the field of tax and zakat. The purpose of the DRC is to resolve disputes resulting from an assessment or revised assessment raised by the GAZT. The aggrieved taxpayer may request the DRC to require the GAZT to present their case before the DRC.

The DRC shall review and notify the taxpayer of acceptance or rejection of the taxpayer’s case within 30 days of request. In response to the request, the GAZT may opt to offer a settlement to the taxpayer or move the DRC to present their case. After the acceptance of case, the DRC shall decide the case within 60 days of acceptance, extendable to a further 60 days with the taxpayer’s consent.

In case the DRC rejects the case or fails to render recommendations within the stipulated timeframe or if the taxpayer disagrees with the DRC’s decision, the appeal case shall be considered pending and the appeal procedures shall continue.

Permanent Establishments

A PE is defined as a permanent place of the non-resident’s activity through which it carries out business, in full or in part, including business carried out through an agent. The following are considered a PE:

• Construction sites, assembly facilities, and the exercise of supervisory activities connected therewith;

• Installations, sites used for surveying natural resources, drilling equipment, ships used for surveying for natural resources as well as the exercise of supervisory activities connected therewith;

• A fixed base where a non-resident natural person carries out business;

• A branch of a non-resident company licensed to carry out business in the Kingdom;

• A dependent agent mentioned above is defined in the by-laws as someone who has any of the following powers:

• To negotiate on behalf of non-resident;

• To conclude contracts on behalf of non-resident;

• Maintains stock of goods owned by the non-resident on hand in Saudi Arabia to supply customers on behalf of non-resident;

• An insurance/re-insurance agent (with or without powers to negotiate); or

• A place from which a non-resident carries out insurance and/or reinsurance activity in the Kingdom through an agent is considered a PE of the non-resident even though the agent is not authorised to negotiate and conclude contracts on behalf of the non-resident. A place is not considered a PE of a non-resident in Saudi Arabia if used in the Kingdom only for the following:

• Storing, displaying or delivering goods or products belonging to the non-resident;

• Keeping a stock of goods or products belonging to the non-resident for the purpose of processing by another person;

• Purchasing goods or products for the sole purpose of collection of information for the non-resident; or

• Carrying out other activities of preparatory or auxiliary nature for the interests of the non-resident. The Tax Law and the by-laws do not provide any period or threshold of onshore presence that would result in activities of a non-resident entity to qualify as a PE in Saudi Arabia.

However, the GAZT has recently begun applying the concept of a virtual PE where offshore services are provided even without the physical presence of a non-resident in Saudi Arabia.

Force of Attraction

The force of attraction rule envisages that when an enterprise is said to have a PE in another country, it exposes itself to taxation of income that it earns from carrying on activities in that other country, whether or not through that PE. The reason for this contention is that the Tax Law states that income is from a source in the Kingdom if it is attributable to a PE of a non-resident located in the Kingdom, including income attributable to sales in the Kingdom of goods of the same or similar kind as those sold through such a PE, and income arising from the rendering of services or the performance of other activity in the Kingdom of the same or similar nature as activity performed via such a PE.

Tax Treaties

Saudi Arabia has double tax treaties currently in force with Algeria, Austria, Azerbaijan, Bangladesh, Belarus, China, the Czech Republic, Egypt, Ethiopia, France, Greece, Hong Kong, Hungary, India, Ireland, Italy, Japan, Jordan, Kazakhstan, Kyrgyzstan, Luxembourg, Malaysia, Malta, Mexico, the Netherlands, North Macedonia, Pakistan, Poland, Portugal, Romania, Russia, Singapore, South Africa, South Korea, Spain, Syria, Sweden, Tajikistan, Tunisia, Turkey, Turkmenistan, Ukraine, the UK, Uzbekistan, Vietnam and Venezuela. The treaty with the UAE will be effective after completion of necessary ratification procedures. Other treaties have also been concluded with Morocco and Switzerland, but await ratification. The expansion of Saudi Arabia’s tax treaty network (especially over the past years) is indicative of the Kingdom’s desire to increase bilateral trade with its major trading partners.

Multilateral Instrument

The OECD has taken an initiative to prevent base erosion and profit sharing, i.e., international tax planning with the intention of shifting profits to low-tax or no-tax jurisdictions. Saudi Arabia has recently signed this convention becoming the 84th country to be part of the convention to encounter tax evasion.

Withholding Tax Refund

After the accession to the World Trade Organisation, the Saudi tax treaty network grew rapidly. In order to curb any misuse of treaty benefits for withholding taxes purposes, the GAZT issued Circular No. 3228/19, dated 23-Rabi al-thani 1431H (corresponding to May 23, 2010), which provided for the payment of withholding tax at the rates prescribed in Saudi tax regulations first and claiming the refund of overpaid taxes based on the provisions of tax treaties later. However, the GAZT subsequently issued Circular No. 5068/16/1434, dated 30-Rajab 1434H (corresponding to June 9, 2013), advising certain amendments in the procedure of claiming tax treaties’ benefits as provided in the GAZT’s previous Circular No. 3228/19.

Based on the GAZT’s circular later, the Saudi Arabian entity making taxable payment to a non-resident service provider can apply the provisions of effective tax treaties (i.e., not settle withholding tax on payment to non-resident parties from a treaty country or apply a reduced rate) if it complies with the following requirements:

• Reporting of all payments to non-resident parties (including those payments which are either not subject to withholding tax or subject to withholding tax at a lower rate as per the provisions of effective tax treaties) in the monthly withholding tax returns (on a prescribed format);

• Submission of a tax residency certificate issued by the tax authorities in the country where the beneficiary is residing. Such tax residency certificate should confirm that the beneficiary is resident in that country in accordance with the provisions of Article 4 of the treaty and the amount paid is subject to tax in that country. Such forms should be in the prescribed format (Form Q7/B). The aforementioned document should be attested by the Saudi Embassy in the country of non-resident and the Ministry of Foreign Affairs in Saudi Arabia; and

• Submission of an undertaking from the Saudi entity that it would bear and pay any tax or fine due on non-resident payees due to an error of submitted information or a computational error or misinterpretation of the provisions of tax treaty (Form Q7/C), attested by the Chamber of Commerce.

The aforementioned Circular No. 5068/16/1434 also specified that the Saudi Arabian entities who cannot comply with the aforementioned requirements may follow the procedure provided in the previous circular, i.e., Circular No. 3228/19.

Saudi tax laws provide that the taxpayer is entitled to a refund of any overpayment made under the provisions of the Tax Law within five years of the year for which the overpayment was made.

Interest Expense Limitation

The Tax Law does not provide any limitation to debt-equity ratio and an entity can be formed with minimum required capital and funded by debts. However, interest expense is limited to the lower level of the actual expense or a resultant of the following formulae interest income plus 50% of taxable income before an interest income and interest expense. Any disallowed interest as a result of this limitation is a permanent loss and does not form part of the accumulated losses. Interest expense limitation is not applicable to banks. Interest paid by a branch to its head office is not considered a deductible expense, except in the case of a branch of a bank.

Contract Reporting

Under the Income Tax Law, all persons (natural or legal) and government agencies are required to provide the GAZT with information pertaining to contracts with a value exceeding SR100,000 ($26,700) that they entered into with the private sector.

A zakat/taxpayer is required to report all the contracts it concludes with the private sector of SR100,000 ($26,700) or more within three months of the signing of the contract. The GAZT also reserves the right to obtain data on any other contracts of less than SR100,000 ($26,700) or any other information relevant to tax.

Based on the amendments to the Tax Law dated September 20, 2017, the GAZT’s right to receive information now extends to the provisions of international agreements.

Social Insurance

Social insurance contribution is collected by the General Organisation for Social Insurance (GOSI). The social insurance is levied on salaries within the following rates: the minimum and maximum amounts used to calculate GOSI are SR1250 ($333) and SR45,000 ($12,000).

Wage Protection System

The Ministry of Labour (MoL) has implemented a wage protection system (WPS) in Saudi Arabia. Under the WPS, entities are required to disburse salaries to their employees using a standard wages or payroll electronic file provided by the MoL. Each entity is required to submit a completed wages or electronic payroll file to its bank in Saudi Arabia for the disbursement of salaries to its employees. A copy of the electronic file provided to banks in Saudi Arabia is also required to be filed with the MoL.

Annual Financial Statements

Effective 2018, all businesses are required to prepare annual financial statements under the International Financial Reporting Standards (IFRS), as adopted by the Saudi Organisation for Certified Public Accountants (SOCPA). Saudi banks and insurance companies have already been preparing their financial statements under IFRS.

Arabic Books

According to Income Tax Laws and by-laws, all zakat/taxpayers are required to maintain necessary commercial books and accounting records locally inside Saudi Arabia in Arabic to support their tax declarations.

The GAZT re-emphasises the need to keep necessary books of accounts in Arabic inside Saudi Arabia by all companies, branches of foreign companies and individuals, with the exception of filers under deemed profit method. The GAZT may not accept any return from any company, branch or individual that does not keep books of accounts in Arabic.

Furthermore, the GAZT is reluctant to receive any responses to their queries if the response includes extracts from the ledger or journal vouchers in a language other than Arabic.

The Ministry of Commerce and Investment (MCI) has issued a circular to the SOCPA to re-emphasise that auditors should comply with the requirement of issuing a limited review report certifying that an audit client is maintaining the books and records in Arabic.

Special Zones

Saudi Arabia has announced the establishment of new special integrated logistics zones. The first such zone will be situated at King Khalid International Airport in Riyadh. Other similar zones would be established after approval by the Council of Economic and Development Affairs. The zones intend to provide preferential tax treatment for specified activities to be carried out in the zones.

Key features of the preferential tax treatment include:

• Non-residents conducting activities directly related to specified goods inside the zone shall not be treated as having a PE in the Kingdom;

• Goods situated inside the zone will be under Customs suspension – therefore Customs duties and VAT should not apply while goods remain in the zone;

• VAT will not be charged on the supply of goods in the zone; and

• Temporary transfer of goods between the mainland and the zone for the purposes of repair and maintenance shall not be subject to VAT. Specified activities what would enjoy preferential tax treatment include:

• Repair maintenance or routine processing, etc. of goods;

• Sorting, repackaging and similar actions in relation to goods, including simple manufacturing processes;

• Import, export and re-export;

• Logistics and after-sales services; and

• Certain recycling activities.

Customs & Excise Taxes

World Customs Organisation has adopted the SAFE Framework of Standards to Secure and Facilitate Global Trade since 2005 to act as a deterrent to international terrorism, secure revenue and promote trade facilitation worldwide. One of the main features of this framework is the Authorised Economic Operator (AEO) programme, under which Customs authorities can accredit businesses that have high-quality internal processes to prevent the tampering of goods in international transport.

As Saudi trade with the rest of the world is growing rapidly, it has developed its own AEO programme to facilitate stakeholders involved in the import and export of goods. The Saudi AEO programme lists certain requirements for a business to be part of AEO such as the existence of a robust electronic record keeping system, financial solvency, effective policies and procedures related to the safety of goods, staff training, etc. A business recognised by AEO has various advantages over non-recognised businesses, which include a dedicated fast lane in Customs clearance, priority over non-AEO shippers, reduced physical inspection, use of AEO logo and a dedicated Saudi Customs account manager. This list of requirements and advantages is not exhaustive.

Further to the government’s vision to transform Saudi Arabia into an international logistics hub, Saudi Customs is implementing an audit after clearance initiative programme. The aim of this programme is to ensure that importers comply with Customs regulatory requirements. The Customs audit focuses on a wide range of issues including examining the transaction value, bank statements, sales contracts, inventory papers, financial statements, non-financial records, payment terms, total imports, tariff headings and Customs duty payments. In case of non-compliance, Customs authorities may impose penalty up to twice the amount of Customs duty due on an imported consignment.

Excise

Excise Tax was introduced into the Kingdom in June 2017, based on the GCC Unified Agreement for Excise Taxes. The law states that businesses which undertake any of the following activities must register for excise tax purposes: 1. Import of excisable goods;

2. Production of excisable goods; and/or 3. Acquisition of excisable goods under a duty suspension arrangement. The Excise Tax Executive Regulations, published in June 2017, provide additional guidance regarding the application of the law and taxpayers’ responsibilities in terms of registration and compliance. The excise duty rate is 50% on soft drinks and 100% on energy drinks and tobacco products. Excise taxes on goods released for home consumption are calculated based on the retail prices of the released goods, listed per warehouse, less any eligible deductions (e.g., excise tax paid on the importation of excisable raw materials). As of the first quarter of 2019, the GAZT is reviewing the excise regime with a view to expanding the tax to additional products.

Transfer Pricing

In December 2018 the GAZT issued the draft Transfer Pricing (TP) By-laws. On February 15, 2019 the GAZT formally released the final version of its TP By-laws. On its website, the GAZT has also posted various frequently asked questions and their respective answers. In early March 2019 TP guidelines were released through the GAZT. The TP guidelines have a wider approach and represent the GAZT’s view on how it wants to apply the TP By-laws in the Kingdom. Notably, the GAZT has become increasingly active in the field of TP.

Effective Date

In the final version of the TP By-laws, there is no specific mention of any reporting in respect of the year ended December 31, 2018, which was still the case in the draft version. However, the GAZT addresses this question as part of their frequently asked questions. TP documentation requirements are applicable to the reporting year ended on December 31, 2018 and all subsequent reporting years. The answer further clarifies that the GAZT also retains the right to seek documentation with respect to the transactions that are undertaken during the years prior to 2018. However, in all cases, the taxpayer would be allowed at least 30 days in order to submit the requisite information and documentation.

Persons Subject to Tp Regulations

The TP By-laws are applicable on all taxable persons, as defined in the Income Tax Law. This includes entities that are jointly owned by GCC and foreign (non-GCC) shareholders (mixed entities). Companies that are owned 100% by GCC nationals, and are subject only to zakat, are not subject to TP documentation requirements relating to Master File, Local File and DFCT. Such entities are subject to requirements relating to the filing of a country-by-country report (CbCR), provided they meet the threshold requirement for global gross revenues being in excess of SR3.2bn ($853.1m).

TRANSACTIONS SUBJECT TO TP REGULATIONS: From a Saudi perspective, all controlled transactions should be documented. A controlled transaction is any transaction between related parties or parties under common control. Individuals are considered related parties if they are relatives (up to the fourth degree) or partners in a partnership.

To determine if an individual is related to a juridical person, the GAZT uses the concept of control. If the individual is able to control the juridical person, they should be considered as related.

Two juridical persons are related for Saudi TP purposes if one person has effective control over the other, or a third person has effective control over both juridical persons. The GAZT provides a long list of examples of how effective control could be established between persons. Ultimately, the GAZT concludes that effective control can be established by governance, funding or business.

This approach is extremely wide and is not fully aligned with the OECD guidelines. Under the GAZT approach, any exclusivity agreement will lead to the conclusion of a related party scenario and potential TP documentation requirements. Another important aspect is that the TP regulations also include domestic transactions.

TP Methods

In Article 7 of the TP By-laws, the GAZT list the approved methods, which are identical with the five OECD TP methods. The GAZT highlights the fact that there is no hierarchy that the taxpayer should follow when applying a TP method. Taxpayers may even use a non-approved method if they can demonstrate that the non-approved method delivers better results than the traditional TP methods.

Documentation Requirements

Documentation requirements vary with the tax status. While taxpayers or mixed companies are subject to documentation obligations as defined by the new OECD approach, zakat payers are subject to CbCR reporting obligations only.

The DFCT is required to be filed along with tax returns for the year ended December 31, 2018. This is on the basis that the filing requirement – a procedural matter – arises after the issuance of the TP By-laws. The GAZT retains a right to seek additional information in support of a tax return.

Within the DFCT the following detailed information needs to be submitted:

• Details of all controlled transactions undertaken for or without monetary consideration, such as barter arrangements;

• A list of all shareholders. For listed entities, information of all shareholders directly owning more than 5% of shares would need to be disclosed; and

• Where there has been an internal reallocation of functions, assets and risks within a group, the same needs to be reported as part of the DFCT for the reporting year relevant to the change. The DFCT shall form part of an annual tax declaration and be submitted electronically by every person engaged in controlled transactions, irrespective of their value. Along with DFCT, taxpayers would also be required to produce an auditor’s certificate confirming that the TP policy of a multinational enterprise (MNE) has been consistently applied by and in relation to the taxpayer.

TP Documentation

The GAZT has adopted the new OECD three-tier approach for preparing TP documentation. Taxpayers need to prepare: (i) master file; (ii) local file; and (iii) CbCR, if applicable.

The master file should contain information on the global business operations and TP policies of the MNE group to which the taxable person belongs. In respect of any intangibles, the master file should provide for identity of legal and de facto owners of intangibles.

The local file should contain detailed information on all controlled transactions of the taxable person and should also contain information in respect of any business restructuring – transfers of risks, functions or tangible or intangible assets directly or indirectly impacting the taxpayer in Saudi Arabia – in the current year or in the preceding year.

The requirement to maintain a master file and local file is not necessary for the following:

• Natural persons; and

• Small-sized enterprises, which are entities with an arm’s-length value of controlled transactions not exceeding SR6m ($1.6m) in a 12-month period.

Country-by-country Reporting

The CbCR and the notification need to be submitted by members of an MNE group with consolidated group revenue exceeding SR3.2bn ($853.1m) as per consolidated financial statements of the MNE group.

Where CbCR is being filed in another country that has signed the multilateral instrument and the qualifying competent authority agreements, the filing of the notification to the GAZT should suffice. However, if the foreign country systematically fails to provide a copy of CbCR to the GAZT, then the local constituent entity is required to provide a copy of the CbCR submitted in the foreign jurisdiction.

Deadlines

The DFCT needs to be filed together with the annual tax declaration not later than 120 days after the end of the financial year.

The GAZT may seek a taxpayer to provide a copy of their master file or local file or any part thereof at any time by issuing a notice of not less than 30 days. As mentioned above, only in respect of the financial year ended 2018, taxpayers will be given an additional extension of 60 days for providing a master file or local file or any part thereof.

For controlled transactions undertaken during the years prior to 2018, the GAZT may also require any information or documentation.

Foreign Account Tax Compliance Act

In line with its efforts to improve international tax compliance and transparency, the Kingdom signed several exchange of tax information agreements. The Foreign Account Tax Compliance Act Intergovernmental Agreement Model 1 (IGA) with the US to exchange information on US accounts and the OECD’s Multilateral Convention on Mutual Administrative Assistance in Tax Matters (Multilateral Convention), which covers various means of exchanges including the Common Reporting Standard Multilateral Competent Authority Agreement (CRS MCAA).

Under the Model 1 IGA, Saudi Arabia would annually exchange information on financial accounts held by US specified persons and maintained by Saudi financial institutions. This agreement is non-reciprocal, i.e., the US will not exchange similar information with Saudi Arabia.

Contrary to the signed IGA, under the CRS MCAA, Saudi Arabia has concluded a wide range of reciprocal exchange agreements. For the 2018 tax year, 62 countries will receive information from Saudi Arabia on financial account holders who are tax residents in those countries and have bank accounts maintained by Saudi financial institutions, while 86 countries will send the same information to Saudi Arabia on Saudi tax residents that have financial accounts outside the Kingdom. Under the CRS, tax residency – not nationality – matters, as a person, individual or entity can have more than one tax residency.

Information Reported

For individual Saudi tax residents, the Kingdom will receive the name, address, tax identification number (TIN), date and place of birth, account number, name of financial institutions where the account is held and the balance or value of the accounts.

For entity Saudi tax residents, the Kingdom will receive the name, address, TIN, account number, name of financial institutions where the account is held and the balance or value of the accounts. In case this entity is a passive entity and controlled by a reportable person, the Kingdom will receive, in addition to the above-mentioned entity details, the name, TIN, and date and place of birth for each controlling person. A controlling person is determined as per the local anti-money laundering rules.

In each of these cases, income such as gross interest, gross dividends or other income, gross proceeds and full or partial surrenders that are paid to the corresponding accounts will be exchanged.

OBG would like to thank KPMG for its contribution to THE REPORT Saudi Arabia 2019

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The Report: Saudi Arabia 2019

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