Saudi Arabia’s economic reforms have allowed the economy to grow rapidly in the recent years.
Saudi Arabia’s economic reforms have allowed the economy to grow rapidly in the recent years. Saudi Arabia has implemented various programs to improve the business environment, provide comprehensive service to investors and foster investment opportunities in key sectors of the economy. This is helping the country attract foreign investment and encouraging mergers and acquisitions (M&A).
Among the key recent developments, Saudi Arabia is:
Saudi Arabia issued a Ministerial Resolution (MR) No. 1727 dated 10 February 2018 (25/05/1439H) amending certain provisions of the Income Tax Law promulgated in 2004.
The key aspects of these amendments are summarized below.
Oil and hydrocarbon producing companies and investee companies
The following amendments are specific to oil and hydrocarbon producing companies.
Group relief for asset transfers
The tax authorities issued formal zakat regulations in 2017, which consolidate existing zakat practices and Ministerial Resolutions and override all previous zakat circulars, resolutions and instructions. The zakat regulations are applicable as of their date of issuance 28 February 2017 (1/6/1438H).
Saudi Arabia’s foreign investment regulations permit foreign ownership of capital and shares in a Saudi company, provided a foreign capital investment license is obtained.
The Saudi Companies Regulations provides for mergers in which:
Acquisitions can also be effected by buying shares in a company, subject to foreign investment regulations.
Purchase of assets
The cost base of an asset purchased, produced, manufactured or constructed by the taxpayer is the amount paid or incurred by the taxpayer in cash or in kind in respect of the acquisition of the asset.
Goodwill paid on the acquisition of shares in a company is considered as part of the base cost and is deductible for determining any gain arising on disposal. The buyer may pay for goodwill in acquiring a business as a going concern. Such goodwill is tax-deductible and can be amortized at a rate of 10 percent on a declining-balance basis for tax purposes.
No gain or loss arises on the disposal of an asset that is depreciable under Saudi tax law. The result of disposal of such assets is dealt with under the depreciation method stipulated by the law.
Tax in Saudi Arabia consists primarily of corporate income tax, withholding tax (WHT) and zakat. For local companies, corporate income tax is assessed on the share of the profit of the foreign partner in the local company. The corporate income tax rate is 20 percent.
Zakat is a religious levy imposed on Saudi and Gulf Cooperation Council (GCC) nationals and on companies to the extent owned by Saudi or GCC nationals through a GCC-based chain of ownership. The zakat rate of 2.5 percent is applied on the higher of Saudi/GCC share in the zakat base and the Saudi/ GCC share in taxable profits of the entity.
Although no specific rules in the corporate income tax and zakat regulations address M&A, any capital gains arising as a result of a sale or transfer of assets (including the entire business) are treated as normal business income and taxed at the normal corporate income tax rates.
Value added tax
The acquisition of a business or part thereof may be considered as a transaction outside the scope of VAT, provided the assets (and liabilities) can be operated as a business unit in their own right (transfer of an economic activity) and certain conditions are met.
Purchase of shares
In a purchase of shares, the purchase price is the cost base for the purposes of determining capital gains tax payable on the shares’ later sale. The tax authority may not consider the value of bonus shares as part of the base cost for calculating the taxable gain, as this remains an area of dispute. In some cases, the assessing officers have imposed a 5 percent WHT on the amount of after-tax capital gain by treating the net gain as a distribution of profits (akin to dividend). However, this treatment is contestable at the appellate level.
In certain circumstances, the seller may prefer to realize part of the value of their investment as income by means of a pre-sale dividend. Such dividend should be subject to a 5 percent WHT and should reduce the amount of sale proceeds and thus the capital gain, which would otherwise be taxed at 20 percent.
Value added tax
The acquisition of shares should be considered as a VAT- exempt transaction.
There is currently no stamp duty on the acquisition of shares or assets.
In Saudi Arabia, foreign investors are not permitted to operate or acquire businesses without first obtaining an investment license from the Saudi General Investment Authority (SAGIA). Foreign investors with a license from SAGIA may directly acquire a Saudi operating company.
The Saudi Arabian foreign investment regulations impose restrictions on available areas of investment through the so- called ‘negative list’. The following forms of business entity can be used in Saudi Arabia:
Foreigners generally can carry on businesses through an LLC, branch or joint stock company. International companies may establish representative offices in Saudi Arabia. A representative office should not engage in any commercial activities.
Local holding company
Under Saudi Companies Regulations, a joint stock company or LLC may be established as a holding company if the main purpose of the entity is to participate in joint stock companies or LLCs that are associated with it and with a percentage shareholding enabling it to dominate, control and support them. The holding company’s name should include the company type coupled with the word ‘holding’.
Foreign parent company
An investor may operate in Saudi Arabia by setting up an LLC. Under the Foreign Capital Investment Law in Saudi Arabia, an LLC can be established with 100 percent foreign ownership. There are minimum capital requirements. In addition, the foreign investor would need to obtain a license from SAGIA and a Commercial Registration Certificate from the Ministry of Commerce and Investment. Under the Companies Regulations, it is possible to establish single-member LLCs. An LLC must transfer 10 percent of its net profit each year to a statutory reserve until this amount equals 30 percent of the LLC’s share capital. The entity must withhold tax on dividends and other payments to the non-resident foreign partner, depending on the nature of the payment.
An entity is subject to corporate tax of 20 percent on its taxable profits. Actual expenses incurred specifically
and necessarily for generating income are generally tax- deductible.
A company can merge with another company of the same or of a different kind. However, a cooperative company cannot merge with a company of a different kind.
A foreign investor may operate in Saudi Arabia through a branch. A branch in Saudi Arabia has a share capital of its own and the minimum invested capital requirement would depend on the nature of activities. In addition, a license from SAGIA and a Commercial Registration Certificate from the Ministry of Commerce and Investment would be required.
A branch has no legal reserve requirements. However, it is required to withhold tax from remittances and profits transferred to the head office. Actual expenses incurred specifically and necessarily for generating gross income are generally tax-deductible. For branches of foreign companies, certain limitations apply to restrict the tax-deductibility of expenses.
Foreign investors may establish an LLC or joint stock company with a Saudi partner. The corporate tax is assessed on the foreign shareholder’s share of the entity’s taxable income.
Saudi tax law also permits unincorporated joint ventures, which are considered as partnerships for tax purposes.
The investment may be financed on either the local or foreign market. No limitations apply to local financing.
It is possible to finance an acquisition through a share capital contribution and/or with debt. There are no specific rules under the corporate income tax law regarding thin capitalization, although SAGIA imposes minimum capital requirements.
There are WHT implications for payments of interest or dividends to non-resident shareholders in a Saudi company. Interest expenses also are subject to certain limitations under Saudi tax law.
Companies may finance their operations through bank loans or the issuance of capital market debt instruments, but there are some restrictions on issuing debt securities.
Deductibility of interest
Under Saudi tax law, deductions for interest expense are restricted to the lesser of interest expense incurred during the tax year and the result of the following formula:
The taxpayer’s total income from loan charges (interest), plus 50 percent of (a) minus (b) where:
a = income subject to tax other than income from loan charges
b = expenses allowed under the law other than loan charge expenses.
Withholding tax on debt
According to the Saudi tax law, WHT at a rate of 5 percent is payable on the gross amount of actual interest paid or settled to a non-resident lender.
Under Saudi tax law, ‘interest’ is defined as any amount paid for the use of money. This includes income realized from loan transactions of any type, whether secured with guarantees or with rights to participate in the borrower’s profits. Interest also includes income realized from government and non- government bonds.
According to the Saudi Companies Regulations, LLCs must fully pay their capital and retain it in a local bank account until the company’s regulatory requirements are met.
Unlike LLCs, joint stock companies may raise capital by issuing shares. The shares must be nominal shares and may not be issued at a value higher than their nominal value, unless such a premium is stated in the company‘s articles of association and agreed by the shareholders. The share premium is then added to the company’s statutory reserve.
Concerns of the seller
The tax position of the seller can be expected to have a significant influence on any transaction. In certain
circumstances, the seller may prefer to realize part of the value of their investment as income by means of a pre-sale dividend. In this case, the dividend may be subject to 5 percent WHT but reduces the proceeds of the sale and thus the gain on the sale, which may be subject to 20 percent capital gains tax.
Company law and accounting
All business entities are required to maintain a journal, general ledger and inventory book in Saudi Arabia in Arabic.
In addition, all original supporting documentation for all entries recorded in the accounting books must be maintained locally to enable the government authorities to request and review them at any time. According to the Saudi Accounting Regulations and in practice, all books and records usually must be retained for at least 10 years.
Audit of financial statements
Currently, an LLC/branch is required to prepare financial statements and have them audited by a locally licensed accountant. Financial statements should conform to the standards of the Saudi Organization for Certified Public Accountants.
Saudi Arabia has converted to International Financial Reporting Standards) (IFRS). Listed entities were required to adopt IFRS from 1 January 2017, and unlisted entities from 1 January 2018.
Transfer pricing and anti-avoidance
Saudi Arabia has no specific transfer pricing rules. However, the tax law provides for certain measures against tax avoidance. In determining the tax liability, the tax authorities have the right to:
Under Saudi tax law, companies are considered related if they are 50 percent or more owned or controlled by the same person, whether directly or indirectly. For capital companies, ‘control’ is defined as ownership of the voting power or value in the company held directly or indirectly through one or more subsidiary of any type of company.
In addition to the above and based on the Ministerial Resolution (No. 1776) dated 19 March 2014, the tax authorities would issue guidelines/regulations on transfer pricing of transactions between related parties in accordance with the internationally accepted standards. At the time of writing, detailed transfer pricing guidelines were expected to be issued in the next few months.
Relevant regulations and rulings
The tax authorities have not yet issued any transfer pricing regulations or rulings.
OECD transfer pricing guidelines
Saudi Arabia is not a member of the Organisation for Economic Co-operation and Development (OECD). The OECD transfer pricing guidelines are not binding on the Saudi Arabian tax authority, but the tax authorities do expect transactions between related parties to be on an arm’s length basis. KPMG in Saudi Arabia believes that the principles set out in the OECD guidelines should be accepted by the tax authorities, as most tax treaties signed by Saudi Arabia are based on the OECD guidelines.
No specific transfer pricing methods are prescribed in the tax law, so there is no hierarchy or priority to govern which transfer pricing methods should be applied. If a taxpayer in
Saudi Arabia adopts and properly implements a global transfer pricing policy that is based on the commonly accepted transfer pricing methods set out in the OECD guidelines, then the tax authorities may accept that methodology.
Transfer pricing penalties
There is currently no specific transfer pricing penalty prescribed under the law. However, penalties prescribed under the general provisions of the Saudi tax law would apply on any assessed differences.
No penalty relief is currently available under the Saudi tax law.
There is currently no requirement for taxpayers in Saudi Arabia to prepare contemporaneous transfer pricing documentation or for documentation to be submitted to the tax authorities together with the filing of tax declaration. Nonetheless, the taxpayer should maintain adequate documents to support their transactions.
Statute of limitations on transfer pricing assessments
There is no specific statute of limitations set out in the Saudi tax law for transfer pricing assessments. The general statute of limitation under the tax law is 5 years, and 10 years where the tax return was not filed or if filed, was found to be incomplete or incorrect with the intent of tax evasion.
Return disclosures/related-party disclosures
The tax law does not require taxpayers to submit an information return to disclose related-party transactions. However, the online filing system (ERAD) introduced by the tax authorities and the system’s unified declaration requires entities to disclose the movement of the related-party balances.
Specific transfer pricing returns
Separate tax returns are currently not required for related- party transactions.
Tax audit frequency and transfer pricing scrutiny
Transactions involving related parties are reviewed in depth by the tax authorities to verify whether the transactions were made on an arm’s length basis.
The concept of dual residency is not relevant in Saudi law. However, for Saudi tax purposes, a company is a resident company if either:
Foreign investments of a local target company
The following rules apply on the treatment of investments in foreign entities for zakat purposes in Saudi Arabia.
Holding companies and their wholly owned subsidiaries are required to submit consolidated financial statements that include the holding company and its subsidiaries, whether the subsidiaries are registered inside or outside Saudi Arabia. The zakat assessment is on a consolidated basis as one unit and one zakat base.
Additionally, investments in entities outside Saudi Arabia — joint ventures — are deducted from the zakat-payer, provided either:
If the zakat-payer fails to comply with these requirements, the investments may not be deducted from their zakat base.
Finally, any investment — local or abroad — in forward transactions or in sukuks representing a debt are not deductible from the zakat base, regardless of the issuer’s location and the period of the investment.
Developments affecting Saudi holding companies
Income realized by a resident company from investments in other Saudi-resident companies is not taxable for the investor company, provided that:
Further, income from investments and operations outside Saudi Arabia is taxed in the country unless a tax treaty in force between Saudi Arabia and the country of the investee states otherwise.
Advantages of asset purchases
Disadvantages of asset purchases
Advantages of share purchases
Disadvantages of share purchases
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