INTAX Conference Dubai March 2016 · Saudi Arabia is the largest economy in MENA Political stability A member of G20, and the worlds most strategically important energy provider Ranked

Taxation issues for foreign investors in Saudi Arabia

INTAX Conference Dubai March 2016

Page 2 An Overview of Saudi tax regulations

Topics covered

1. Investment environment

2. Basics of taxation

3. Withholding tax rules

4. International tax treaties

5. Tax treaty application procedure

6. Cross-border services

7. Dividends and branch remittances

8. Capital gains

9. Permanent establishment

10. Cross-border leasing

11. Derivatives and guarantees

12. Anti-avoidance rules and transfer pricing

13. Dealing with DZIT

14. Introduction of VAT


Economic features

► Saudi Arabia is the largest economy in MENA

► Political stability

► A member of G20, and the world’s most strategically important energy

provider

► Ranked 49th in the world out of 189 nations in the World Bank’s 2015 ease of

doing business report

► Economic growth 2.8% during 2015, compared with 3.5% growth in 2014

► King Salman’s reordering of the country’s line of succession and reshuffling of

the main cabinet positions indicates leadership with its sights firmly set on the

future

► The drive for economic diversification continues, with non-oil exports growing

faster than oil exports in recent years

► With low oil prices and the Government’s commitment to maintaining

spending levels, the country ran a fiscal deficit in 2015.


Economic features

► The Saudi riyal peg to the US dollar has continued to serve as an effective

platform to minimize the risk of currency speculation and contain exchange rate

volatility

► In December 2015, the GCC countries confirmed that provisions of VAT

framework agreement has been decided with likely introduction in 2016 with an

18 month lead time for businesses to become compliant

► Key high-growth sectors attracting foreign investments include:

► Energy – power and water, mining and petrochemicals

► Health and life sciences – pharmaceuticals and medical devices

► Transportation and logistics

► Telecommunication

► Education


Investment environment: forms of business

► Joint-stock company (open or closed)

► Limited Liability Company (100% foreign owned) – most common for foreign

investors.

► Joint venture

► Branch – “full” commercial registration - (CR)

► Temporary commercial registration (TCR)

► «Tax PE» - permanent establishment for tax purposes without commercial

registration

► Unincorporated Joint Venture (partnership)

► Commercial agencies – registered by MoCI

► “TSSO” – technical scientific office

► Others (less widely used)


Investment environment: regulations

► SAGIA – deals with procedures for setting up for foreign businesses

► Commercial regulations for FDI gradually relaxing

► “Foreign Investment license (FIL) issued by SAGIA + CR (MoCI)

► 100% foreign ownership permitted with exceptions

► In certain sectors FDI prohibited or restricted (SAGIA publishes “negative” lists)

► Off limits: Oil exploration, real estate brokerage, education, pilgrim services, recruitment, public

transport, military sector etc.

► Foreign ownership restricted: banking, insurance, professional services, telecommunications,

distribution and sales, etc.

► Foreign real estate ownership allowed (for residents)

► Tadawul (stock exchange) opened to foreign investors

► Member of WTO since 2005

► 1982 GCC Economic Cooperation Agreement: national regime for GCC citizens

► Free repatriation of earnings

► Protection from confiscation

► Free transfers of shares


Investment environment: regulations

► Commercial and tax registration required to:

► Sponsoring employees

► Participation in public tenders

► Visa / residence permits

► Legislation & practices:

► Shari’ah (principles and pronouncements)

► Legislation (subordinate to Shari’ah): Royal Orders, Royal Decrees,

Resolutions of the Council of Minsters, Ministerial resolutions, Ministerial

Circulars

► Official language:

► Arabic


Tax system

► Two-layer tax system:

1. Corporate Income Tax Payers (CIT rate 20%):

► Resident capital companies (on profits attributable to shares owned by non-Saudi

or non-GCC [GCC]

► A PE of a non-resident

► WHT on passive income

2. Zakat payers

► Resident capital companies (on profits attributable to shares owned by non-Saudi

or non-GCC [GCC]

3. No Individual income tax


Zakat

► Companies owned by Saudi or GCC nationals are subject

to zakat

► Zakat rate is 2.5% of the Saudi or GCC shareholder’s

share of ‘net assessable funds’ or share of adjusted

profits, whichever is higher

The zakat base generally comprises of share capital, statutory reserves,

retained earnings, provisions, shareholders’ credit current account

balances, term and shareholder loans less net book value of long term

assets plus the adjusted profit for the year


Corporate income tax Withholding tax Zakat

Who is

liable?

► Resident company in respect

of non-GCC share of profit

► Resident non-GCC natural

person with business activities in

the Kingdom

► Non-resident with a branch/PE

in the Kingdom

► A non-resident not having

a PE in Saudi Arabia, in

respect of income earned

from a source in the Kingdom

► Companies incorporated

in Saudi Arabia with respect

to share owned by Saudi or

GCC nationals/companies

owned by GCC nationals

Rate ► 20% — capital companies,

branch and PE

► 30% to 85% — companies

engaged in the field of natural

gas investment

► 85% — companies engaged

in production of oil and other

hydrocarbons

► 5% to 20% depending

on the nature of payment

► Dividends subject to 5% WHT

► 2.5% of the Saudi/GCC

shareholder’s share of ‘net

assessable funds’ or share

of adjusted profits, whichever

is higher

Basis of

calculation

► Gross income less allowable

deductions (net adjusted profit)

► Gross amount paid

to non-resident regardless

of any costs incurred

by the non-resident

► 'Net assessable funds'

comprises capital employed

and long-term financing, less

fixed assets, allowable

long-term investments and

deferred costs, plus/minus net

adjusted profit/loss for the year

An overview of the Saudi tax / zakat regulations Summary: Corporate income tax, WHT and zakat


► Relevant provisions found in ITL (Art. 5, 68) and By-Laws (Art. 5, 6, 63, 68 etc.)

► Complex sourcing rules apply to various types of payments, sometimes application of WHT rates drived by practice

(e.g. DZIT letters, BoG decisions)

► Examples of some of types of income of non-residents from sources in KSA are subject to WHT:

Withholding tax overview

Nature of payment WHT rates (%)

Loan fees (interest) 5

Rents 5

Air tickets 5

Air freight or marine shipping 5

Technical and consulting services 5

International telecommunications services 5

Dividend payment, profit remitted to head office 5

Insurance and reinsurance premiums 5

Royalties 15

Payments for services (i.e., technical services, international telecommunications, etc.)

made to the head office or a non-resident related party (50% or more ownership) 15

Management fees 20

Any other payments 15


Recent developments: tax treaties

Tax treaties

► Legal status: tax treaties override domestic law unless situations of abuse (art. 35

Income Tax Law)

► Most tax treaties are based on UN Model Convention 2001 (or 2011), not OECD MC

(hence reference to OECD Model Commentary disputable)

► Status of tax treaties 2016:

► Shipping and Aviation Taxation treaties (SATAs): US, India

► Bilaternal investment protection treaties: Luxembourg, the Netherlands

► Special (not based on UN / OECD MCs): Tax & Inheritance treaty with France 1982

Status Effective Signed but not

effective

Under negotiation

Number of treaties 34 9 16

Appendix A B C


2.1 Overview of KSA existing and new treaties

France (1981) Poland (2013) China (2007) Syria (2011)

Austria (2008) Romania (2013) India (2007) Uzbekistan (2011)

Spain (2009) Ukraine (2013) Pakistan (2007) Bangladesh (2012)

Italy (2010) Malta (2014) Malaysia (2008) Japan (2012)

UK (2010) Czech Republic (2014) South Korea (2009) Singapore (2012)

Belarus (2010) Luxembourg (2015) Turkey (2010) Vietnam (2012)

Greece (2010) Azerbaijan (2016) Russia (2011) Tajikistan (2016)

Netherlands (2011) Hungary (2016)

Ireland (2013)

South Africa (2009)

Tunisia (2014)


New tax treaties signed but not effective

Macedonia Signed 15 December 2014 Morocco Signed 14 April 2015

Portugal Signed 8 April 2015 Algeria Signed 19 December 2013

Bosnia & Herzegovina Initialed Ethiopia Signed 28 February 2013

Georgia Initialed Egypt Initialed

Croatia Under negotiation Jordan Initialed

Guernsey Under negotiation Sudan Initialed

Jersey Under negotiation Botswana Under negotiation

Switzerland Under negotiation Gabon Under negotiation

Kazakhstan Signed 7 June 2011 Venezuela Signed 11 November 2015

Sri Lanka Initialed Mexico Initialed

Mauritius Under negotiation Barbados Under negotiation

New Zealand Under negotiation

Taiwan Under negotiation


Application of tax treaties

Tax treaty application procedures:

Two alternative tax treaty procedures exist:

► Pay and reclaim (DZIT Circular Nr. 3228/19) – risk with beneficiary

► Upfront exemption from WHT (DZIT Circular Nr. 3227/19) – risk with paying party

FIlings for advance exemption:

► Form Q7B form must be completed by the non-resident and certified by foreign tax

authority

► Form Q7C Undertaking by local Saudi entity

Foreign-issued tax residence certificates (e.g. US form 6166) not accepted by DZIT

DZIT Letter: Shipping companies (e.g. in case of Singapore DTT, the DZIT letter

required form Q7B alongside with the Singaporean TRC confirming the «place of

effective management» under Article 8 DTT)

Practice:

when applying tax treaty exemption an advance filing of a ruling request to DZIT to

avoid late payment interest (before payment), should DZIT disagree


Cross- border services

Technical or consulting services (T&C) are generally subject to WHT:

► 5% if unrelated parties

► 15% if related parties

► 15% if a branch (PE) pays to its HO company or a related party for any services

Taxable in KSA at source even if physically rendered outside KSA

Controvercial questions arise e.g. in relation to offshore repairs outside KSA

Tax treaty exemption usually claimed by most non-residents under article tax

treaties (Article 7) (non-resident claims that no PE arises in KSA)

DZIT practice: trying to attribute income from services to a «virtual service

PE» if tax treaty exemption is claimed under article 7 DTT. Taxpayers are

«forced» into a «tax PE» situation: most register a PE with DZIT under

deemed profit filing basis (5-6% effective taxation of the contract revenue)

Practice: when applying tax treaty exemption an advance filing of a ruling

request to DZIT to avoid late payment interest (before payment)


Dividends and branch remittances

Dividends and branch remittances of profits payable to non-resident

shareholders/ HOs subject to WHT at 5%

Most Saudi DTTs do not reduce DWHT to less than 5% (0% in tax treaties

with Spain, Syria, France)

DWHT applies both to GCC and non-GCC shareholders regardless of

Tax/Zakat status

Branch remittance tax applies to cash distributions of profits to HOs

No DTT exemption generally available for branch remittance tax


Taxation of Capital gains

Article 5(3) ITL: non-resident capital gains from disposal of shares

taxable at 20% at source (unless DTT exemption available)

Real estate gains (ITL 5(3)): «directly or indirectly», so shares in real

estate companies may be taxed at any level of the corporate chain of

ownership

Taxable person: seller but buyer jointly liable

Reportable within 60 days (change in AOA and CR)

Zakat vs. Tax implications on change of ownership

Valuation issues (Art. 16(7) By-Laws)

Tax exemptions under Article 13 of most KSA DTTs for ownership

LESS than 25% (exception: Article 13 Netherlands DTT – exemption if

more than 10% ownership percentage)

Watch out anti-avoidance rules of Art. 63 ITL for «stepped»

transactions and income splitting, as well as transfer pricing


Permanent Establishment

► Art. 4 ITL: definition of a PE, broadly similar to OECD/ UN Model Conventions

► «Negative catalogue» of activities not subject to a PE

► physical PE

► agency PE (also defined Art. 4 By-Laws)

► service PE – no domestic law definition but based on DZIT practice

► «contract manufacturing» PE (if processed goods are supplied to domestic

market)

► Income attribution rules to PEs:

► Accounts basis

► Deemed profit filing basis (deemed profit rate of 25-80%) subject to 20% tax

► OECD Authorized approach explicitly not accepted (ref. UN MC Commentary)


Permanent Establishment (continued)

► Formulae apportionment rule of By-Laws 16(6): 10% deemed profit for each

component of a combined contract including supply of goods, works and

services (if PE is not reported)

► «Virtual» Service PE – recent trend of DZIT practice requiring non-resident

service providers that perform consulting, survey etc. Projects in KSA to

register a PE if the duration of the activity is more than 6 months (akin to UN

MC 5.3(b) «service PE»)

► The DZIT threshold test is based on the duration of the contract, rather than

the duration of physical presence of consultants in KSA working on a project

► Some DTT protocol provisions (e.g. UK, NL etc. explicitly state that income

from activities performed outside KSA should not be taxable in KSA)


Cross-border leasing income

► Equipment rentals subject to WHT of 5% if equipment is used in the Kingdom

► But what is a ship/aircraft is used entirely on international routes and not

generally operate in Saudi territorial waters / airspace?

► DTT classification: business profits or royalties (watch out article 12 UN MC)

► DTT Ireland, Singapore, Malta: Article 8 applies to bareboat and time-charters

(dry and wet leases)

► Malaysia DTT: treatment of technical services as royalties

► Equipment (e.g. dredging vessel) operated by crue under a wet lease creates

a PE under DZIT practice / Q&A, but some DTTs may provide exemption

under Art 8 (analysis required)

► SATA (Shipping and Aviation Tax Agreement) exemption could be claimed for

dry/wet aircraft leases in specific circumstances, but generally complex tax

analysis required (US, India)


Derivatives and guarantees

Certain payments under financial instruents cause controversy with DZIT e.g.:

► Payment for a parent company guarantee

► Payment under an interest-rate SWAP (IRS)

DZIT approach: 5% WHT either under «insurance» or «loan fee» classification.

Taxpayers tend to disagree and claim no WHT even under domestic tax law

Tax treaty classification (for both guarantee and IRS) quite complex:

► No taxation in KSA if «Business profits» or «other income» article applicable

► Taxation at source allowed in classifid as «insurance» under some DTTs

► Detailed review of all contract provisions required

► MAP procedure strongly recommented for clients


Anti-avoidance rules

Under Article 63 of the ITL DZIT has powers to:

► disregard any transaction with no tax effect

► re-arrange transactions whose form does not reflect their substance and

put them in their real form.

► DZIT may re-allocate revenues and expenses in transactions among

related parties as to reflect the returns that would have resulted if the

parties were independent and unrelated.


Transfer pricing

Transfer pricing:

► Currently, no specific regulations/guidelines for TP

► DZIT is empowered to issue rules for related party transactions (MR 1776/2014).

Formal TP rules is expected (during 2016)

► Arm’s length principle: transactions between related parties (Article 64) are to be

conducted at arm’s length and documentation is to be presented to the DZIT when

requested for scrutiny (Article 61), to support the ‘precise determination of tax

payable’ by the taxpayer (Article 58)

► Global TP policy accepted by a foreign MNC if evidence proves that this was

appropriately recorded in the books of the recipient entity

► DZIT is currently in the process of developing detailed TP guidelines, and has now

issued a draft transfer pricing manual

► DZIT to introduce explicit Transfer Pricing documentation laws (in line with BEPS

Action point 13) in the subsequent financial years.


Dealing with DZIT

Official communications (written applications, appeals) only in Arabic

Good and constructuive relationships highly recommended

Sometimes verbal communication / explanation of a submitted written

application helps resolving issues

Electronic filing system

Taxpayers electronic (re)-registration


Recent tax experience:

DZIT tries to adopt an income classification under DTT to apply a

higher WHT rate and to deny the DTT exemption, e.g.:

► Fees for technical services vs. Royalties (see e.g. Malaysia DTT) (higher 8% WHT

rate for royalties)

► Equipment rentals vs. Royalties (most DTTs under article 12). (WHT rates for

royalties under DTTs are higher than 5%)

► Business profits vs. «other income» article (see e.g. DTTs India, South Africa)

► Payments under IRS/guarantee classificed by DZIT as «insurance» hence DTT

protection disallowed

► Taxpayer unsuccessfully challenged DZIT for them treating web-design services as

«other payments» rather than «technical or consulting services» (case currently in

BoG)

► Taxpayer challenged DZIT on a «virtual service PE» issue under the UK and the

Netherlands DTTs (case currently in HAC)

► DZIT imputed a deemed profit where imported materials per Customs records was

higher than in the company’s purchase accounts

► Where the purchase price exceeded the customs value upon import, DZIT has

disallowed the cost deduction of the excess amount


Recent tax experience (continued):

► Taxpayer challenged DZIT on non-application of US SATA to dry lease payments

(MAP awaited)

► DZIT challenged taxpayer on an EPC contract where all on-shore works were

subcontracted to a local subsidiary entity (DZIT insisted on that the non-resident

creates a PE because they undertake a contract in KSA as a prime contractor

regardless of sub-contracting the on-shore works)

► DZIT applied an «aggregation» approach to classify technical services (offshore

remote help-desk IT services) as «royalties» on the basis that they must be

«bundled» with royalties charged under the same agreement despite being

mentioned as a separate category of works

► DZIT challenged taxpayer in a «triangular» structure claiming that the DTT with the

HO company cannot apply because payment is made to a branch in a third country

► DZIT challenged taxpayer claiming DTT (France, Austria, UK etc.) exemption from

15% WHT on payments for services made by the branch to the HQ entity for offshore

services claiming that «Business profits» article does not apply

► DZIT challenged taxpayer claiming a reduced WHT rate for royalties under the KSA-

Netherlands DTT based on that the royalty recipient entity was not «benenficial

onwer» of income being a sub-licensor (rather than a legal owner of the underlyaing

trademark)


2018 2017 2014 2015 2016

GCC members representative

restarted discussions on the

specifics of the potential GCC VAT

regime in March and May 2015

The introduction of VAT at a GCC level

has been considered for some time

Proposed introduction of VAT in UAE, Oman and

the KSA

Proposed implementation of VAT in the KSA

Introduction of VAT Timeline


► The introduction of VAT in the GCC region represents a major change in fiscal policy

and will require tax administrations in the region to significantly beef up their staff

resources and begin engagement with the business community

► The GCC VAT framework is now expected to be finalized and formally announced by

mid-2016. The provisions of the GCC Framework Agreement will be transposed into

domestic tax law in each of the GCC States prior to the effective date

► The GCC States have agreed to implement their VAT regimes in 2018. Most countries

will be working to implement by 1 January 2018 to avoid distortions arising from intra-

GCC trade where one country has implemented VAT and another country does not

have mechanisms to deal with charging VAT from business to business and onwards to

the consumer. All GCC States will need to have implemented VAT by the end of 2018

► With the ratification of the GCC VAT Framework Agreement by mid-year, the GCC

countries will be on a tight timeline of 18 months to prepare for VAT readiness by 1

January 2018, the target date to be achieved. However a number of GCC countries

have already made substantial progress on preparing their tax administration systems

for VAT and from July 2016 onwards the focus will likely shift to preparing the business

community for VAT.

Introduction of VAT (continued)

Documents

INTAX Conference Dubai March 2016 · Saudi Arabia is the largest economy in MENA Political stability A member of G20, and the worlds most strategically important energy provider Ranked