Some businesses in the Kingdom of Saudi Arabia (KSA) may have been structured to circumvent the Kingdom’s foreign ownership restrictions in order to benefit from the more favourable tax treatment that is available under the Zakat tax regime rather than the Corporate Income Tax (CIT) levied on profit.
But given increased transparency and international exchange of information, such corporate structures are now much more likely to be successfully challenged by the General Authority of Zakat and Tax (GAZT) if they do not reflect the economic reality or the intention of the KSA’s tax laws and regulations.
Generally, non-Saudi investors are liable for CIT in Saudi Arabia. In most cases, Saudi citizen investors (and Gulf Cooperation Council (GCC) nationals, who are considered to be Saudi citizens for Saudi tax purposes) are liable for Zakat, an Islamic assessment. Where a company is owned by both Saudi and non-Saudi interests, the portion of taxable income attributable to the non-Saudi interest is subject to income tax, and the Saudi share goes into the basis on which Zakat is assessed.
The rate of income tax is 20% of the net adjusted profits, whereas. Zakat is charged on the company’s Zakat base at 2.5%. Zakat base represents the net worth of the entity as calculated for Zakat purposes.
In order to optimise the overall tax liability of an operational company in KSA, it was common to set up a foreign holding company to hold the shares. Typically, the majority or all of the holding company shares were held by GCC nationals on behalf of the foreign investor, with ‘side agreements’ in place under which they would waive all economic and legal rights to receive dividends, exercise votes or receive any proceeds of the sale of the shares.
GAZT recently announced that any such arrangements for the purpose of reducing the CIT or Zakat liability of a company might qualify as tax evasion if they had the effect of lowering the overall tax liability of a company in KSA. Under this classification, GAZT would then have 10 years to issue or amend an assessment. It could also impose penalties up to 25% of any unpaid tax.
In 2014, the G20 countries, which include the KSA, mandated the Organisation for Economic Co-operation and Development (OECD) to set up the Base Erosion and Profit Shifting [BEPS] project to combat tax avoidance by multi-national groups. Currently, the BEPS Inclusive Framework has more than 135 member countries.
The BEPS projects led to significant changes in the Model Tax Convention and, in order to apply these changes to already existing double tax treaties, the OECD developed the Multilateral Instrument (MLI). When signing the MLI, countries can select to which of its existing double tax treaties it wants to apply the BEPS adjustments. Saudi Arabia has listed all its current 55 double tax treaties to be covered by the MLI.
In the current environment, where the tax affairs of corporations are in the spotlight and tax administrations are actively engaged in curtailing perceived abuses, it is more important than ever that corporations have proper tax risk management in place and ensure that all tax planning is well founded in the law. With increasing detection risks and awareness at GAZT, we highly recommend that any taxpayers that have put in place tax arrangements in the KSA of the kind outlined above should revisit these structures to mitigate their risks.