Viewpoint: Wadih AbouNasr
Direct and indirect taxation have been used to increase non-oil revenues and provide services for citizens. Whether it is corporate, individual income, sales, excise or value-added tax (VAT) or custom duties, the main objective is typically to increase revenue and, in some instances, change the behaviour of citizens. Excise taxes on tobacco and sugary drinks are meant to reduce the consumption of unhealthy products, and as a result, improve quality of life and lower health care costs.
In recent years many developed countries shifted from direct to indirect taxes as they were considered to be more fair and straightforward. Major economies such as the US and the UK have lowered their corporate tax rates, while maintaining a high levels of individual taxes and increasing VAT. Reducing corporate tax rates is believed to stimulate the economy by creating more jobs and create an attractive investment climate.
Meanwhile, GCC nationals and residents operate in a tax-free environment in terms of income taxes, and only corporations were subject to taxation, whether in the form of corporate taxes, zakat – an obligatory payment originating from the rules of Islam – or a combination of the two. From a conceptual perspective, the amount of zakat paid by Muslims is based on their wealth, while corporate tax is based on business activity.
With the current push to diversify the economy as envisioned under Vision 2030, it is imperative to focus on taxation. In 2017 the GCC Framework Agreement on VAT let to the introduction of VAT and excise taxes in Saudi Arabia and the UAE in 2018, followed by Bahrain shortly after. The Kingdom has undergone several additional reforms and introduced measures in-line with international best practices. In 2019 Saudi Arabia was one of the 10 most-improved countries in the World Bank’s 2020 ease of doing business index, ranking 62nd out of 190 countries. Additionally, the country ranked 57th in terms of the ease of paying taxes. As part of its membership in the G20, Saudi Arabia has committed to implementing a tax system that stimulates the economy, pushes for higher growth rates, fights tax evasion and promotes transparency. The system also resists protectionism, encourages trade and removes fossil fuel subsidies, among other measures.
Currently, Saudi Arabia applies a two-tiered system dependent on whether the firm is GCC or non-GCC owned. Companies owned by GCC nationals are subject to zakat, with the rate based on the working capital and level of ownership. Non-GCC owners are subject to corporate tax based on their share of profits.
Saudi Arabia has long debated whether the zakat system currently in force – applicable to all companies with ownership based in the GCC – should be withdrawn or modified, and the corporate tax be universally applied instead. This is because there are several challenges related to the zakat system. It can cause discrimination and unfair competition, as the return on investment for shareholders is different if the tax burden varies. The zakat levy may be discriminatory in its structure, as it taxes highly capitalised entities more than lower-capitalised ones. It leaves open potential for tax evasion due to fronting arrangements between foreign shareholders and GCC owners, as well as causes increased compliance costs for mixed entities due to its complex filing system. Lastly, there is complexity in collection due to the need for more inspectors for different types of taxes. Zakat has, however, helped smaller businesses, as it yields a much more manageable tax burden on local small investors.
The current zakat law has not taken into consideration changes in the business environment. The recent changes to the zakat regulations for financial institutions are a clear indication that the current system will not help the Kingdom achieve its desired objectives. The government may consider moving away from this two-tiered system, but several amendments to the corporate tax system will need to be made to protect small-scale investors, deal with transitional rules, encourage investment and stimulate economic growth.
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