Saudi Arabia - Taxation of cross-border M&A | KPMG | GLOBAL

Saudi Arabia - Taxation of cross-border mergers and acquisitions

Saudi Arabia - Taxation of cross-border M&A

Saudi Arabia’s economic reforms have allowed the economy to grow rapidly in the recent years.

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Introduction

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:

  • moving away from an oil-based economy
  • introducing new revenue measures in the form of a value added tax (VAT) and excise duty
  • amending its current corporate income tax laws and Zakat regulations.

Recent developments: corporate income tax

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.

  • The scope of taxable persons has been expanded to include resident capital companies with respect to shares owned directly or indirectly by persons engaged in the production of oil and hydrocarbons.
  • The tax base of a company that produces oil and hydrocarbons is calculated after deducting expenses and allowances in accordance with the tax law.
  • The amendment will result in a change in tax profile of companies having shares owned, whether directly or indirectly, by Saudi Arabian oil and hydrocarbon producing companies that were previously subject to Zakat on shareholdings attributable to oil and hydrocarbon producing companies. As a result, any income of a Saudi company that is attributable to shares owned, directly or indirectly, by oil and hydrocarbon companies will be subject to corporate income tax (and not to Zakat).

Exempt income

  • The scope of tax exemption on gains arising from the disposal of listed securities has been expanded to include securities listed on foreign stock exchanges, providedthe shares are also listed on the Saudi stock exchange (Tadawul). This would apply to sales made through the stock exchange or outside of the stock exchange.
  • Franked investment income relief has been introduced for local and foreign-sourced dividends. Saudi taxable entities can claim a tax exemption on dividend income in cash or kind (bonus shares) provided the ownership in the investee company is at least 10 percent for at least 1 year before it receives dividends.

Tax losses

  • Previously, a company would lose its right to carry forward tax losses on a change in 50 percent or more in the ownership or control of the company. As a result of the recent amendments, a company can now carry forward its tax losses regardless of any change in theownership or control, provided it keeps on carrying on the same activity.
  • It has also been clarified that the transfer of assets between companies would not be considered as a change in ownership or control.
  • Losses can be carried forward without time limit by the entity that incurred the loss. However, the maximum deductible accumulated losses in any taxable year should not exceed 25 percent of taxable income for that year.
  • The remaining losses can be carried forward to be offset against taxable income of the following years.
  • Accordingly, an acquisition of shares in a company does not cause the acquired company to lose the potential benefit of carrying forward losses, provided the acquired company continues carrying on the same business.

Group relief for asset transfers

  • A disposal of assets between wholly-owned group companies (directly or indirectly by capital company) is now disregarded for tax purposes provided the assets remain within the group for at least 2 years after the transfer. Where this relief is claimed, the transfer is considered as made at book value for tax purposes.
  • Similarly, when calculating depreciation, the transfer of assets is recognized at book value in both companies.

Recent developments: Zakat regulations

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).

Recent developments: value added tax

  • VAT was implemented as of 1 January 2018 in Saudi Arabia. The VAT applies at a standard rate of 5 percent. Exempt supplies include margin (interest)-based financial services, life insurance and reinsurance services and lease of residential property.
  • Zero-rated supplies include international transportation of goods and passengers and ancillary services, exports of goods and services, medicines and certain medical equipment and supplies of qualifying investment metals.
  • VAT registration is required for persons having an annual taxable turnover of 375,000 Saudi Arabian riyal (SAR; about 100,000 US dollars — US$), while the threshold for voluntary registration is annual turnover of SAR187,500 (about US$50,000).
  • All businesses having annual turnover of more than SAR1 million (US$266,667) were required to register for VAT by 20 December 2017. Businesses with turnover below SAR1 million but above the mandatory registration threshold may register for VAT by 31 December 2018.
  • VAT group registration is possible, subject to certain requirements.
  • A VAT return must be filed electronically with the tax authorities by the last day of the month following the end of the tax period to which the tax return relates.
  • A VAT return is required to be submitted monthly or quarterly, depending on the annual taxable turnover of the registered entity.
  • As a general rule (with some exceptions), tax is due on the earliest of the following:
    • making goods or services available to the customer
    • issuing a tax invoice
    • receiving partial or full consideration (within the limit of the amount received).
  • Special rules apply for continuous supplies, sales on an instalment basis, supplies of oil, gas, water and electricity, and deemed supplies.
  • When claiming a deduction for input VAT, a registered person must have a valid tax invoice issued by the supplier.
  • A deduction for input VAT is not allowed for certain procurement.
  • Specific rules apply to input VAT paid to procure capital assets.

Recent developments: excise duty

  • During 2017, Saudi Arabia also introduced excise tax.
  • Excise tax is chargeable on the importation or production of excisable goods released for consumption in Saudi Arabia on or after 11 June 2017.
  • Currently, excisable goods broadly include soft carbonated drinks (50 percent rate), energy drinks (100 percent rate) and tobacco products (100 percent rate).
  • Excise tax registration is required for anyone intending to import, produce or hold (under a suspension arrangement) any excise goods in Saudi Arabia.

Recent developments: land tax regulations

  • The Council of Ministers issued the White Land Tax Law and implementing regulations in June 2016, imposing an annual 2.5 percent tax on the market value of urban white land. This tax applies to empty plots of land allocated for residential or commercial use inside cities’ urban zones and owned by individuals and non- governmental legal entities.
  • Tax revenues are to be deposited into a special account with the Saudi Arabian Monetary Agency (i.e. Central Bank) and are used to finance housing projects and access to public utilities and services.

Asset purchase or share purchase

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:

  • the companies involved are liquidated and their assets and liabilities are contributed to a newly incorporated company; the shareholders of the liquidated companies receive shares in the new company in exchange for their shares in the liquidated companies
  • one or more companies are absorbed by an existing company; the shareholders of the absorbed companies receive new shares in the absorbing company.

Acquisitions can also be effected by buying shares in a company, subject to foreign investment regulations.

Purchase of assets

Purchase price

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

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.

Depreciation

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 attributes

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.

Pre-sale dividend

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.

Transfer taxes

There is currently no stamp duty on the acquisition of shares or assets.

Choice of acquisition vehicle

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:

  • companies with variable capital
  • cooperative companies
  • corporations
  • general partnerships
  • joint ventures
  • limited liability companies (LLC)
  • limited partnerships
  • partnerships limited by shares.

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.

Local branch

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.

Joint ventures

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.

Choice of acquisition funding

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.

Debt

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.

Equity

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.

Other considerations

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:

  • disregard a transaction that has no tax effect
  • reclassify a transaction whose form does not reflect its substance according to its reality
  • raise an arbitrary assessment on a taxpayer according to the relevant facts and circumstances where a taxpayer fails to make timely filing of its declaration, does not maintain accurate accounts and records, or fails to maintain accounts and records in the required form and manner
  • allocate income or deductions between related persons or persons under common control as necessary to reflect the income that would have resulted from a transaction between independent persons (arm’s length principle)
  • adjust tax assessable profits if an individual taxpayer attempts to split income (as defined in the law) with another taxpayer to reduce the tax liability.

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.

Priorities/pricing methods

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.

Penalty relief

No penalty relief is currently available under the Saudi tax law.

Documentation requirements

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.

Dual residency

The concept of dual residency is not relevant in Saudi law. However, for Saudi tax purposes, a company is a resident company if either:

  • it is formed under the Companies Regulations
  • its place of central control and management is situated within Saudi Arabia.

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:

  • the zakat-payer submits financial statements audited by a certified public accountant authorized in the investee country for the purpose of calculating the zakat dueon such investments and pays the zakat due to the department
  • the zakat-payer submits proof of zakat payment in the country of the investee and then deducts the investments from the zakat base of the Saudi investing company to avoid duplication of zakat in these companies.

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:

  • the underlying income has been subject to Saudi tax
  • the shareholding percentage owned by the investor company in the investee company is at least 10 percent
  • the shares in the investee company are held for at least 1 year.

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.

Comparison of asset and share purchases

Advantages of asset purchases

  • The purchase price (or a proportion) can be depreciated or amortized for tax purposes (including goodwill), a step-up may be achieved.
  • Possible to acquire only part of a business.
  • For GCC shareholders, the value of fixed assets may be deducted from the company’s zakat base.
  • The company is not required to carry any risk of unsettled tax and Zakat liabilities relating to investee company for pre-acquisition years.

Disadvantages of asset purchases

  • Possible need to renegotiate supply, employment, technology and other agreements.
  • 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.
  • Capital gains on disposals of certain assets (including shares in an unlisted Saudi company) are determined according to the sale value and cost price at the time of the transaction. Certain specific rules apply to asset sale transactions.

Advantages of share purchases

  • A capital gain realized on a sale of securities traded on Saudi Arabia’s stock market is tax-exempt if the securities are sold in accordance with Saudi stock market regulations and the securities did not exist before 31 July 2004.
  • The holding structure may be optimized, especially for a foreign investor.

Disadvantages of share purchases

  • Capital gains arising to a non-resident from the sale of shares in a local company are subject to tax at a rate of 20 percent.

KPMG in Saudi Arabia

Kashif Jahangiri
Level 9, Tower B
Zahran Business Centre Prince Sultan Street
P.O. Box 55078 Jeddah 21534
Kingdom of Saudi Arabia

T: +966 12 698 9595
E: kashifjahangiri@kpmg.com

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