UPDATE ON SAUDI INCOME TAX AND ZAKAT LAW - 2015 KPMG Al Fozan and Al Sadhan August 2015

UPDATE ON SAUDI INCOME TAX AND ZAKAT LAW - 2015

KPMG Al Fozan and Al Sadhan

August 2015

© 2015 KPMG Al Fozan & Al Sadhan, a partnership registered in Saudi Arabia and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved.

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Saudi Tax & Zakat Update – List of Topics

Shareholding and related party relationship

Cross Border Transactions – Tax Implications

Consortium Taxation

Capital Gains Tax

The DZIT Practice and Interpretations

Withholding Tax Update

Transfer Pricing and BEPS

Zakat Regulations

Accounting Records


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Saudi Tax & Zakat Update

The DZIT is getting more and more sophisticated in terms of personnel development, application of laws and procedures, deploying technology etc…

More pressure on the revenue due to;

• Decreasing Oil Prices

• Regional Conditions

• Increased budget spending

Over the last decade, the actual spending has consistently surpassed the budgeted spending.

Shareholding and Related Party Relationship


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Saudi Corporate Income Tax

Chargeability is based on ultimate non-Saudi/non- GCC shareholding

All non-resident persons, including branches of GCC companies, are subject to tax at 20%.

Zakat at 2.5% is applied on the higher of (a) Zakatable profit; and (b) net Zakat base

Non-GCC jurisdiction

Saudi Company

GCC Company

Saudi Company

GCC Company

Saudi Company

Income tax3

Zakat1

Saudi/GCC ShareholdersNon-Saudi/Non-GCC

ShareholdersSaudi/GCC Shareholders

Income tax2


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Related Party Relationship

Saudi Company(ABC KSA Ltd.)

USAParent Company(ABC USA Ltd.)

UK Company(ABC UK Ltd.)

UAE Company(ABC UAE Ltd.)

Related party relationship will be there for any direct / indirect / common shareholding of 50% or more than 50%.

75% holding by USA Co.

100% holding by USA Co.

70% holding by UK Co.

Related Parties

Related Parties

Related Parties

Bahraini Company(ABC Bh. Ltd.)

49% holding by UK Co.

Non- Related Parties

Cross Border Transactions – Tax Implications


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KSA has;

No law of precedent

Tax rulings and clarifications issued by the DZIT are not binding on assessing officers – persuasive only

Treaty relief can be claimed by the non-residents if PE has not been created in KSA.

WHY IMPORTANT IMPORTANT FACTORS TO CONSIDER

Withholding Tax Implications

Permanent Establishment (PE) Exposure

Nature/Type of Transactions

Duration of the contract/services

Onshore vs Offshore services/contracts

Transactions with treaty vs non-treaty countries

Relationship between the parties


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PE of the Non-Resident Service Providers

■ General DZIT criteria for PE determination:

– A fixed place of business in Saudi Arabia to conduct business activity;

– Providing onshore services (including supervision activities);

– Services (onshore) are continued for more than three months;

– Having an agency relationship with the contractor performing services in Saudi Arabia, including the holding of stock belonging to the non-resident.

Dealing with treaty vs non-treaty countries (Saudi tax law does not provide for a minimum period of activity to be performed inside Saudi Arabia that would create a PE, resultantly, a business activity for a single day could give rise to a PE – for non-treaty countries).


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PE of the Non-Resident Service Providers - contd…

■ In some recent cases the DZIT has rejected the taxpayers application claiming the treaty benefits for the non-resident service providers taking the position that PE of such non-residents has been created in Saudi Arabia (Virtual PE).

■ The DZIT has taken the above position taking into consideration the nature of the services required to be performed under the contract (whether onshore or offshore) and total duration of the contracts (both onshore and offshore).

■ The DZIT ruled that services performed outside Kingdom (offshore services) will create a PE of such non-resident in KSA if these services are performed for the benefit of a project in Saudi Arabia, the duration of which is more than the time period specified in the tax treaty (generally 6 months or 183 days).


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PE of the Non-Resident Service Providers - contd…

■ Preliminary Appeal Committee (PAC) has rejected the DZIT’s position. We understand that the DZIT has filed an appeal with the Higher Appeal Committee (HAC) against the PAC’s ruling.

■ If PE of non-resident is created in KSA, it has the same compliance requirements as of other residents entities (i.e. payment of taxes and filing of tax returns etc.).

Contract Information Form (CIF) Filing

■ CIF should be filed with DZIT to avoid any risk of assuming the liability of the non-resident service providers for the non-payment of applicable taxes.

■ Taxpayers are required to submit to the DZIT CIF for all contracts over SR 100,000 within 3 months from signing of the contract by the company and within one month of cessation of contract.

Un-Registered Joint Venture (UJV)


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Consortium Arrangements

Client

Contract(Consortium Agreement)

Company B Ltd.

Company A Ltd.


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Consortium Arrangements – Tax Obligations

■ A consortium is required to be registered with the DZIT and submit Information Tax Returns within 60 days of the year end;

■ Consortium is not required to pay tax/Zakat on its profits;

■ Respective Partners in the consortium needs to include the share of profit/loss in their Tax/Zakat return and pay tax/zakat accordingly;

■ The DZIT generally do not issue Tax Certificates to consortiums on the ground that these are not separate legal entities registered under Saudi regulations. The DZIT issues a Registration certificate and Facilitation Letter to a consortium to facilitate its business. A Consortium will also need to obtain No-Objection letter for release of the retention payments;

■ A non-resident partner in a consortium is considered to have a PE in Saudi Arabia because of its membership in the consortium.

Capital Gains Tax


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Capital Gain Tax

Capital gains tax is applicable on gain derived by a non-resident person on disposal of shares in a Saudi resident company.

DZIT’s Viewpoint;

In the case where non-resident investors (whether GCC or non-GCC) hold shares in a Saudi resident company from outside Saudi Arabia, any capital gains are included as part of total income and are subject to tax at the rate of 20%.


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Capital Gain Tax

A

B

C

GCC

Zakat

A

B

GCC

Zakat

Zakat

A

B

Non-GCC

A

B

C

Non-GCC

Zakat=2.5%

Tax Tax

TaxCGT = 20%

CIT = 20%


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Capital Gain Calculation Formula

Sale Value Cost Base Capital Gain- =

Capital Gain Tax (CGT) @ 20%


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Key Elements in CGT

Sales Value

The sale value for the purposes of capital gains will be the Higher of the following;

- The contractual sale value;- The market value of the shares; and- The book value of the shares per the company’s

records.


2020

The DZIT may consider the following as date of sale of shares:

The SPA date Approval and signing date of amended AOA; or Date on which SAGIA issued amended license

notification; or Date on which amendment to Commercial

Registration noted; or

Generally the DZIT consider the notarization of the amended AOA as the effective date for the sale of shares.

Key Elements in CGT

Date of Sale


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Key Elements in CGT

Usually, the DZIT require the following documents to be submitted with the return:

Sale Purchase Agreement Amended AOA Updated Share Registry Amended SAGIA License Audited FS as at effective date of change in

shareholding


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Key Elements in CGT

The disposing partner should inform the Department of the sale and pay due tax on the pre-sale period profits and on the resulted capital gains within 60 days of sale transaction.

The purchaser is jointly liable with the seller to pay any amounts that become due to the Department as a result of this transaction.

No re-organization relief for the capital gain taxes – No tax free re-structuring.

If change in shareholding is 50% or more than 50%, tax losses are not allowed to be carried forward.

THE DZIT PRACTICE AND INTERPRETATIONS


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The DZIT practice and interpretation

The current trends

Growing focus on field inspections, particularly if:

o No revenue in initial years

o Sustained losses for 3 or more years

o Erratic profit ratios

o Change in shareholding

o No assessment is conducted for last 4 to 5 years.

Seeking independent evidence

More focus on the “Substance” over “Form”

Commercial registration (CR) for every single branch to be mentioned in the financial statements


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Co-operation between the DZIT and other authorities

■ There is increasingly ongoing co-operation between the DZIT and various other departments.

■ The DZIT during the assessment proceedings starts comparing the information reported to various other departments by the taxpayers especially to Customs, GOSI and MOCI.

■ Resultantly, DZIT is requiring the taxpayers to provide the reconciliation for the below items as reported in the tax declaration;

1. Foreign purchases as reported in the Customs Bayan.

2. Salaries and GOSI expense as reported on the GOSI certificate.

3. Financial and other information reported with the MOCI.


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Bonus and other Awards (Employee Benefits) - Deductibility

■ The DZIT’s policy has been to disallow bonus and other awards if such items have not been included in the employment policy approved by the Ministry of Labor, or if these have not been reflected in the employment contracts; and

■ This practice of the DZIT has been upheld by HAC in its decisions.


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Transactions with related parties

■ DZIT paying more attention to related party transactions;

■ Original agreements, invoices and payment documents are generally required for such transactions, including international market value certification by external auditor;

■ In the case where the related parties are non-residents, supporting

documents for settlement of withholding tax also required; and

■ Transfer pricing focus.

WITHHOLDING TAX UPDATE


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Withholding taxes Update

Withholding Tax

■ Income derived by a non-resident from a Saudi source is subject to withholding tax;

■ Rate of withholding tax ranges from 5% to 20% depending on the nature of payment being made; and

■ Withholding tax deducted is considered as full & final discharge of tax liability of non-resident in respect of the source of income subjected to withholding tax (NO PE).


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Withholding Tax - Illustrated


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Withholding taxes Update - Withholding Tax - Rates

Services provided Saudi Sourced

Nature of payment and paid toRelated Parties

Non-Related Parties

Management fees 20% 20%

Royalty or license fees 15% 15%

Equipment Rental 5% 5%

Air tickets or air / marine freight 5% 5%

International telecommunications services 15% 5%

Dividends and Loan fees 5% 5%

Technical consulting services 15% 5%

Insurance or Reinsurance premiums 5% 5%

Payments for other services (Onshore) 15% 15%


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Withholding Tax – Triggering Point

■ Withholding tax required to be paid by10th day of the month following the month in which the payments are made. Non-payment of WHT attracts delay fine at one percent (1%) for every 30 days of delay.

■ Triggering point for withholding tax implications:

– Actual payment or adjustment/netting off of receivables/payables;

– Date of book entry – in case of related parties;

■ The Preliminary Appeal Committee (“PAC”) ruled that even in case of payments made to the related parties, WHT liability triggers at the time of payment of the expense and not when it is accrued. However, this decision has been reversed recently by the HAC, which has ruled in favor of the Department; and

■ We are aware that HAC has confirmed in some cases that WHT will trigger only at the time of actual payment or netting of balances between the Saudi resident and non-resident.


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Withholding Tax – Online filing of Monthly WHT statements

■ The DZIT has made online filing mandatory from 1 Muharram 1436H (corresponding to 25 October 2014);

■ Entities not registered for online filing must immediately register with the DZIT web site;

■ Once registered, withholding tax returns can be filed electronically using login details; and

■ After online submission of the withholding tax return, payment of withholding tax can only be made through SADDAD system against the system generated invoice number.

■ Taxpayers having NIL withholding tax liability during the year should also be registered with DZIT for online filing to file their annual withholding tax return.


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Treaty Relief

■ For the treaty countries, the treaty relief on withholding tax can be claimed by the non-residents.

■ Before granting treaty relief, the DZIT look for evidence to satisfy that a PE has not been created.

■ Upto June 2013, treaty relief can be claimed on “pay now claim later” basis.

■ Subsequently, the DZIT has issued a Circular No. 5068/16/1434 dated 30.7.1434H (corresponding to 9 June 2013) allowing for upfront tax treaty exemption benefit, provided certain documentary requirements are submitted, i.e. Form Q7B etc.; and

■ The DZIT might require for additional information e.g. copies of invoices, agreements, copies of passports etc….


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Withholding Tax – the DZIT practise

■ The DZIT is issuing letters to the listed companies to deduct the withholding on payment of dividend to GCC shareholders (non-residents) even if paid in their local bank accounts. GCC based entities/nationals are considered non-residents and payments made to them on account of dividend are subject to withholding tax at 5%;

■ The payment for online access to website is considered as payment for license and are subject to withholding tax at 15%;

■ The DZIT has confirmed that capital gain on sale of shares is not subject to withholding tax; and

■ Renting internet capacity in servers, cables and satellites is considered as rental of movable assets used in Saudi Arabia thus subject to withholding at 5% as a rent payment to a non-resident recipient.


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Withholding Tax – the DZIT practice

■ The DZIT has confirmed that payment to non-resident consultants for accommodation and travel expenses is subject to WHT.

■ Even though such expenses are billed separately from technical consultancy charges. Based on Article 63 (8) of the tax law, full amount paid to non resident is subject to WHT.

■ The HAC ruled no WHT on freight and insurance on import of leased equipment.

■ Freight and insurance paid on import of assets whether owned or leased should not constitute a Saudi source income.

Summary of Statutory Compliance Requirements


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Summary

Filing of annual audited financial statements - within MOCI 180 days from year end (online filing by the Auditors).

Filing of annual tax/zakat return with the DZIT - within 120 days from the year-end [within 60 days from the year-end in case of unregistered consortium)

Filing of monthly WHT return with the DZIT – wihtin10 days from the end of month in which payment was made

Filing of Annual WHT return with the DZIT – within 120 days from year end

Contract Information Form (CIF) - within 3 months of signing the contract or amendments to the contracts and within 1 month of suspension/termination of contract.

Filing of accelerated tax return with the DZIT - Pay advance income tax in 3 equal installments calculated at 25% of immediately preceding year’s tax liability, if due (tax liability is more than 2M) by 6th, 9th and 12th month of the year.

TRANSFER PRICING and BEPS


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Transfer Pricing

Transfer Pricing Regulations

■ A very significant development indicating the introduction of formal transfer pricing regulations, which would be in line with the international standards.

■ Transfer Pricing is gaining momentum in the region.

■ Transfer pricing is one of the top priorities for the DZIT in Saudi Arabia. The DZIT is currently in the process of developing detailed guidelines on transfer pricing.

■ However, the DZIT has not made any formal announcement on a timeline for implementation of formal TP guidelines/rules


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Transfer Pricing - Current Transfer Pricing position under Saudi Arabian Tax Law

■ Limited transfer pricing guidelines under the tax law and the current regime in Saudi Arabia is essentially an anti-avoidance regime;

■ The tax law empowers the tax authorities to challenge transactions between related parties as follows:

– Disregard any transaction that has no economic effect;

– Transactions are to be conducted at arm’s length basis;

– Substance vs form approach;

– Re-allocation of income and expenses between related parties to reflect the income that would have resulted from a transaction between independent and unrelated parties; and

– Estimate the appropriate tax base and impose penalties.

– Disallow the excess cost of materials supplied or services provided by related parties over the prices used by independent parties


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Transfer Pricing - Current Transfer Pricing position under Saudi Arabian Tax Law

From a practical perspective:

■ Taxpayers are already required to produce documentation to support related party transactions. The DZIT has the power to request documentation to support related party transactions (Article 61); and

■ Failure to produce documentation can lead to the disallowance of expenses (Article 58).

■ For goods supplied by related parties, Saudi companies are being requested to submit custom clearance documents. In some cases a certificate from the suppliers auditors has been requested confirming that the supply of goods was made at international market prices, prevailing at the date of dispatch; and

■ The DZIT has also raised questions around substance, beneficial ownership, and the nature of the services provided.


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Base Erosion and Profit Shifting (BEPS) – OECD Objectives


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Base Erosion and Profit Shifting (BEPS)

Base Erosion and Profit Shifting

■ In September 2014, the OECD released its BEPS action plan which is a key area of focus for tax authorities around the World.

■ Saudi Arabia as a member of the G20 is one of the main sponsors and therefore is committed to tackling BEPS. There is also broad commitment at a Middle East regional level to BEPS.

■ Applies to multinationals (current focus on corporate taxes).

■ Implementation by tax administrations is key to success, however, each country’s tax administration has its complications – sophisticated v unsophisticated tax administrations.


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What next for Saudi Arabia – Commitment to BEPS

Potential changes:

– Adoption of Country by Country Reporting;

– Changes to PE definition – impact on cross-border activity and FDI;

– Enforcement of treaty abuse recommendations;

– Restrictions on interest relief.

– Transformation of the international tax system.


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Key messages

■ Commence the transfer pricing lifecycle;

■ Review existing Transfer Pricing documentation and processes;

■ Country by Country (CbC) - entirely new reporting requirement;

■ Monitor developments on reporting requirements in the countries in which they operate;

■ “New world of Transfer Pricing compliance” where tax authority transparency and information sharing will be the norm:

– Country profitability and hence taxable income within an MNC will be compared;

– Increased tax authority scrutiny and tax audits;

– Robust TP documentation is a must; and

– Be prepared!

ZAKAT REGULATIONS UPDATE


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Zakat Regulations Update - Current Zakat Overview

Current Zakat Overview

■ Zakat is levied at a fixed rate of 2.5% on higher of adjusted taxable profits or the Zakat base. Zakat base is calculated as follows;

Additions Deductions

Current year adjusted profits Current year Adjusted losses

Share capital Net book value of fixed assets

Retained Earnings Approved accumulated losses brought forward

Reserves/ Provisions Long term investments in Saudi companies

Loans, Current accounts (credit balances) Dividends paid during the year


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Zakat Regulations Update - Current Zakat Overview

Loans, payables, over draft

■ Loans are added to zakat base if:

– One year has elapsed on these loans i.e. they are in the books of the borrower for one year even if the loans were used to finance working capital; and

– They have been utilized to finance the acquisition of fixed assets or zakat deductible assets even if one full year has not elapsed on these loans.

■ DZIT is relying on Fatwa No. 22665 (“Fatwa 22665”) for adding loans to zakat base;

■ DZIT is using the Fatwa 22665 to add to zakat base bank overdrafts, accruals and payables if one year elapses;

■ Revolving loans completed one year are added to Zakat base


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Zakat Regulations Update - Draft Zakat Regulations Highlights

The draft of the Zakat regulations was approved by the Shoura Council in June 2014, but still under consideration for ratification by the Council of Ministers.

Major changes has been introduced to the basis of zakat computation as compared to the current practice.

It is likely that it may be subject to further revisions and changes.


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■ Zakat rate is 2.5% on zakat base (based on hijri year) or 2.577% based on Gregorian year;

■ Zakat payers with capital of SR 500,000 or more to have their zakat returns attested by a public accountant licensed to practice in the Kingdom;

■ Immovable properties and real estate held for trading or leasing purposes, including vacant or developed lands whether owned by individuals or legal entities could be subject to zakat;

■ Charitable societies and non-profit organizations are exempted from zakat;

■ Closed investment funds could be regarded as companies for zakat purposes;


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■ Zakat payers registration with the DZIT before the end of the first financial year. Late penalties ranging from SR 100 to SR 10,000;

■ Zakat returns are due within 120 days from the end of fiscal year. Late filing penalties ranging from SR 100 to SR 25,000 might be imposed;

■ Penalties for zakat evasion migh be imposed – up to two times the amount of zakat sought to be evaded; and

■ Zakat payers could be allowed to pay up to 20% of their annual zakat to a registered charitable institution authorized to receive Zakat.


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Zakatable Assets (Additions) Zakat Deductible Liabilities (Deductions)

Cash and bank depositsLiabilities at the end of the year unless arising on account of non Zakatable assets, whether such liabilities are short-term or long-term including accrued salaries and expenses, payables etc. (The deductible liabilities will not include any kind of provisions, contingent liabilities, owner/partner/shareholder current account etc.)

Stock of goods and raw materials

Properties and land whether vacant, developed or under development

Investment in financial securities held for trading including shares, sukuk, and debt instruments

Units of mutual funds (if the funds are not already subject to zakat)

Receivables if resulted from cash lending, trading ,etc.

Non-trading investments in sukuk and debt securities

Non-trading investments in entities located inside or outside Saudi which are not subject to zakat

Accounting Record


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Regulatory and Statutory Requirements

Bookkeeping and Accounting Records

■ All business entities are required to maintain the following minimum books of account in Arabic and in Saudi Arabia:– A journal;– A general ledger; and – An inventory book.

■ All original supporting documentation for all entries recorded in the accounting books must be maintained locally, for a period of at least ten years;

■ Other Requirements:– Server must be located in Saudi Arabia; and– Original documents must be kept in Saudi Arabia.


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Regulatory and Statutory Requirements

Bookkeeping and Accounting Records

■ The financial statements are required to be filed online with MOCI by the Auditors.

■ Risk of non-compliance– Disregarding books and records; – Deemed profit assessment; and– Frequent DZIT field inspections.

QUESTIONS

THANK YOUQamar uz Zaman

[email protected]: +966 58 3888 901KPMG Al Fozan & Al SadhanAl Subaie Towers, 13th FloorKing Abdul Aziz Road,P.O. Box 4803, Al Khobar 31952Saudi ArabiaTel: +966 13 887 7241

Documents

UPDATE ON SAUDI INCOME TAX AND ZAKAT LAW - 2015 KPMG Al Fozan and Al Sadhan August 2015