Saudi Arabia - Taxation of cross-border mergers and acquisitions

Taxation of cross-border mergers and acquisitions for Saudi Arabia.

Taxation of cross-border mergers and acquisitions for Saudi Arabia.

Introduction

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

  • introduced tax revenue-generating measures such as the increase of the value-added tax (VAT) rate from 5 percent to 15 percent and the introduction of a real estate transaction tax (RETT);
  • made efforts to increase the clarity of the Zakat laws and regulations, income tax laws and VAT laws by publishing detailed guidelines;
  • introduced e-invoicing regulations; and
  • announced a strategy to make Riyadh one of the 10 largest city economies in the world.

Zakat and income tax regimes

Saudi resident companies, subject to certain exceptions, are subject to two different tax regimes, based on the nationality of their owners.

  • One hundred percent Saudi-/Gulf Cooperation Council (GCC)-owned: Resident companies that are directly or indirectly wholly owned by Saudi/GCC nationals (with no non-GCC entity in the ownership structure) are only subject to Zakat.
  • One hundred percent foreign-owned: Resident companies that are directly or indirectly owned by non-Saudi/GCC (foreign) nationals are subject to income tax.
  • Jointly owned: Resident companies that are jointly owned by Saudi/GCC and foreign nationals are subject to Zakat in proportion to the Saudi/GCC ownership and to income tax in proportion to the foreign ownership.

The exceptions include the following.

  • Resident companies listed on the Saudi Stock Exchange are subject to Zakat, except to the extent that they are owned by founding shareholders that are not GCC nationals.
  • Resident companies engaged in natural gas investment and oil and hydrocarbon production are only subject to income tax.
  • Resident companies are subject to income tax to the extent their shares are owned by persons engaged in oil and hydrocarbon production (with the exception of companies listed in the Saudi Stock Exchange and their subsidiaries, which will remain subject to Zakat).

All non-resident entities, regardless of their ownership structure, are subject to income tax.

Zakat is imposed at 2.5 percent on the higher of Zakat-adjusted income and the Zakat base.

The general income tax rate is 20 percent. However, income from oil and hydrocarbon production is subject to tax at rates ranging from 50 percent to 85 percent.

Recent developments: income tax

Tracing indirect ownership

As of 1 January 2020, the limit on tracing indirect ownership to the second level no longer applies in determining whether a Saudi resident company is subject to income tax.

M&A guidelines

On 15 June 2020, Saudi Arabia's General Authority of Zakat and Tax (GAZT) published guidelines related to corporate reorganization or restructuring events.

These guidelines provide additional clarity on the application of provisions included in the income tax law in relation to corporate reorganization and restructuring arrangements, including internal group restructuring and indirect disposal of shares. The guidelines also provide additional clarity on the application of the capital gains rules to:

  • sale or disposal of founders’ shares, bonus shares (stock dividends), and sale through a private deal in listed entities;
  • share splits; and
  • merger transactions.

Tax treaty related measures

On 1 May 2020, the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI) entered into force with respect to Saudi Arabia. The MLI implements tax treaty related measures to prevent BEPS.

The final list of key MLI measures adopted by Saudi Arabia are listed below:

  • Article 6 – additional wording in the preambles of its Covered Tax Agreements that they should not create opportunities for tax evasion or avoidance;
  • Article 7 – the application of a Principal Purpose Test to deny treaty benefits in the event of treaty abuse;
  • measures to address the artificial avoidance of permanent establishment (PE) status through:
    • Article 12 – commissionaire arrangements and similar strategies;
    • Article 13 – specific activity exemptions; and 
    • Article 14 – splitting contracts.
  • Article 15 – update of the definition of a person closely related to an enterprise;\
  • Article 16 – mutual agreement procedures to address disputes in relation to the application of Covered Tax Agreements; and
  • Article 17 – a requirement to make appropriate corresponding adjustments in transfer pricing cases.

Recent developments: Zakat regulations

Impact of transactions subject to RETT and VAT at zero rate

On 26 February 2021, the Ministry of Finance (MoF) has amended the rules for calculating the Zakat base under the estimated method.

The MoF decision allows taxpayers to take into account transactions subject to the RETT and VAT at the zero rate in addition to the VAT-exempt supplies while calculating the Zakat base using the estimated method. The decision also authorizes the GAZT to make necessary changes under the estimation method calculation if deemed to be a more accurate reflection of the facts. The GAZT is exempt from applying the rules of estimation method, provided that a report on these cases is submitted to the MoF annually.

The MoF decision is effective from 1 March 2021.

Resident companies whose shares are owned by persons involved in oil and hydrocarbon production

As of 1 January 2020, the direct and indirect investment of oil- and hydrocarbon-producing companies into Saudi Arabian-listed companies and subsidiaries of these listed companies shall be subject to Zakat.

Recent developments: VAT

Increase of standard rate to 15 percent

The standard rate of VAT in Saudi Arabia was increased from 5 percent to 15 percent with effect from 1 July 2020. This increase was a response to the unprecedented economic fallout from the impact of the COVID-19 pandemic.

Exemption for real estate transactions
On 1 October 2020, Royal Decree A84 was issued announcing a VAT exemption for all real estate transactions that take place after the issue of this new decree including:

  • transfer of ownership;
  • the sale of commercial, residential, or agricultural real estate; and
  • the sale of developed and undeveloped land.
  • Licensed real estate developers will be entitled to recover VAT incurred on purchases of goods and services.

Recent developments: RETT

On 1 October 2020, Royal Decree A84 was issued announcing the creation of a new RETT with a rate of 5 percent of the real estate supply.

This decision marks an effort to boost the real estate sector, which forms an integral part of the Kingdom’s Vision 2030. It also aims to support the Kingdom’s citizens and includes a commitment that the government will bear up to 1 million Saudi riyals (SAR) in tax for the purchase of the first home by Saudi nationals.

Recent developments: e-invoicing

GAZT issued the final regulation on 4 December 2020. The regulations were entered into force on the day of publication and must be applied within the next 12 months, i.e. by 4 December 2021.

E-invoicing regulations are integral and complementary to the VAT Implementing Regulations and apply to all taxpayers who are subject to VAT. The new regulations define the terms, requirements, and conditions related to e-invoices. For example, confirming the definition of an e-invoice to be a tax invoice issued electronically through electronic means, which excludes scans or copies of invoices.

Along with the regulations, GAZT has issued guidelines and answers to frequently asked questions (FAQs), which provide further detail on the application of e-invoicing. Further guidance on the specifications for issuing and maintaining invoices and debit notices, and on connecting billing and notification systems, will be published within 180 days from the date of publishing the regulations.

The move to e-invoicing is intended to improve the efficiency of the filing process for taxpayers.

The aim of the tax authority is also to increase compliance with tax laws and regulations and to improve the Kingdom’s alignment with, and adherence to, international standards.

Investment regulations

In Saudi Arabia, foreign investors are not permitted to operate or acquire businesses without first obtaining an investment license from the Saudi Arabian General Investment Authority (SAGIA). Foreign investors with a license from SAGIA may directly acquire shares in a Saudi company.

The Saudi Arabian foreign investment regulations impose restrictions on available areas of investment through the so-called ‘negative list’.

Purchase of assets

Cost base 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 with respect to the acquisition of the asset.

Goodwill

A purchaser may pay for goodwill on the acquisition of a business as going concern. Goodwill is deductible for income tax purposes at the rate of 10 percent on a declining-balance basis for income tax purposes.

Depreciation

Depreciable assets are depreciated on a pool basis. When a depreciable asset is sold, the sale proceeds are applied to reduce the tax written value of the relevant asset pool. A gain is made to the extent the sale proceeds exceed the tax written value of the pool.

VAT

The acquisition of a business or part thereof may be a transaction outside the scope of VAT if 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.

Transfer taxes

There are currently no transfer taxes (e.g. stamp duty) on the acquisition of assets.

Purchase of shares

Cost base of shares

The purchase price paid to acquire shares is included in the cost base of the shares for the purposes of determining capital gains or losses made on the later disposal of those shares. The tax authority may not consider the value of bonus shares as part of the base cost for calculating the taxable gain — this remains an area of dispute. In some cases, the assessing officers have imposed a 5 percent withholding tax (WHT) on the amount of an 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.

Tax losses

An acquisition of shares in a company will not cause the acquired company to lose the potential benefit of carried forward tax losses, provided:

  • there is not a 50 percent or more change in the underlying ownership or control of the company; or
  • the acquired company continues to carry on the same business.

Pre-sale dividend

In certain circumstances, it may be preferable for a seller to realize part of the value of their investment by means of a pre-sale dividend. Such a 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.

VAT

The acquisition of shares is a VAT- exempt transaction.

Transfer taxes

There are currently no transfer taxes (e.g. stamp duty) on the acquisition of shares

Mergers

The Saudi Companies Regulations provide 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; or
  • one or more companies are absorbed by an existing company; the shareholders of the absorbed companies receive new shares in the absorbing company.

Choice of acquisition vehicle

The main business structures in Saudi Arabia are:

  • General partnerships
  • Limited partnerships
  • Unincorporated joint ventures
  • Limited liability companies (LLCs)
  • Joint stock companies
  • Saudi Arabian branches.

General partnership

  • General partnerships do not have legal personality — legal relationships are entered by the partners, and they are jointly and severally liable for the debts of the partnership. 
  • General partnerships are transparent for income tax purposes. Income tax is imposed on the partners with respect to their shares of the partnership’s taxable income.
  • Non-Saudi resident partners in resident partnerships are deemed to have a PE in Saudi Arabia with respect to their interests in the partnerships.
    Limited liability partnership 
  • A limited liability partnership is comprised of general (at least one) and limited partners. 
  • The general partners are fully liable for partnership debts, while the limited partners are liable only to the extent of their capital contributions.
  • Limited liability partnerships are treated as capital companies for income tax purposes.

Unincorporated joint venture

  • Unincorporated joint ventures are co-operative arrangements between the joint venture participants. An unincorporated joint venture is defined by the agreements concluded by the joint venture participants. Unincorporated joint ventures do not have legal personality — legal relationships are entered by the joint venturers.
  • A foreign participant in an unincorporated joint venture may be subject to Saudi Arabian income tax where it results in the foreign participant carrying on business through a PE in Saudi Arabia. The profits attributable to the PE will be taxed in Saudi Arabia. Alternatively, if an unincorporated joint venture does not result in a PE for a foreign participant, income the foreign participant derives from providing services to customers in Saudi Arabia may be subject to WHT.

LLC

LLCs are the most common type of business structure in Saudi Arabia. The characteristics of an LLC include the following.

  • LLCs have a separate legal identity. 
  • An LLC must have at least one shareholder and the maximum number of shareholders is 50. 
  • A single shareholder LLC cannot own another single shareholder LLC. 
  • There are minimum capital requirements — generally, SAR500,000, but, for certain types of activities, specific minimum capital is prescribed.
  • The shareholders of an LLC are generally not liable for its debts, other than to the extent of their capital contribution. However, in certain circumstances, the limitation of liability may be pierced.
  • 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 capital.
  • An LLC is managed by either a manager or by a board of directors. If an LLC has more than 20 shareholders, it must have a supervisory board comprised of at least 3 members.
  • An LLC may not offer its shares for public subscription.
  • The sale of shares in an LLC is subject to a statutory pre-emptive right and should be approved by SAGIA and Ministry of Commerce and Industry.(MOCI).
  • Zakat is assessed on Saudi/GCC shareholder’s share of the higher of the Zakat base or Zakatable profit.
  • Income tax is assessed on the foreign shareholder’s share of an LLC’s taxable income at the rate of 20 percent.
  • Dividends paid by LLCs to foreign shareholders are liable to WHT at the rate of 5 percent, subject to the application of tax treaties.

Joint stock company

The characteristics of a joint stock company (JSC) include the following:

  • JSCs have a separate legal identity. 
  • A JSC generally must have at least two shareholders. However, a JSC may have only one shareholder if it has capital of at least SAR5,000,000.
  • The minimum capital is SAR5,000,000, except for single shareholder JSCs and JSCs carrying on certain activities for which a minimum amount of capital is required.
  • Twenty-five percent of a JSC’s capital must be paid up at the time of incorporation, and the balance must be paid up within 5 years. 
  • The liability of shareholders in a JSC is limited to their capital contribution.

Like an LLC, a JSC must transfer 10 percent of its net profit each year to a statutory reserve until this amount equals 30 percent of the JSC’s capital.

  • A JSC is managed by a board of directors. The minimum number of directors is 3 and the maximum is 11.
  • Shares in a JSC may be listed on the Saudi Stock Exchange. JSCs listed on the Saudi Stock Exchange are referred to as ‘public’ JSCs. Unlisted JSCs are referred to as ‘closed’ JSCs. 
  • Sale of shares in a JSC are not subject to a statutory pre-emptive right.
  • Public JSCs are generally only subject to Zakat (an exception relates to foreign-owned ‘founder’ shares) 
  • Open JSCs:
    • Zakat is assessed on Saudi/GCC shareholder’s share of the Zakat base or Zakatable profit.
    • Income tax is assessed on the foreign shareholder’s share of an LLC’s taxable income at the rate of 20 percent.
  • Dividends paid by JSC to foreign shareholders are liable to WHT at the rate of 5 percent, subject to the application of tax treaties.

Saudi Arabian branch

  •  A foreign investor can operate in Saudi Arabia through a branch, subject to obtaining the necessary approvals (e.g. a license from SAGIA and a Commercial Registration Certificate from the MOCI). 
  • There are minimum capital requirements — generally, SAR500,000, but, for certain types of activities, specific minimum capital is prescribed. 
  • Income tax is assessed on the taxable income of the Saudi Arabian branch at the rate of 20 percent. Certain limitations apply to restrict the tax-deductibility of expenses.
  • Profits transferred by a Saudi Arabian branch to its related parties are liable to WHT at the rate of 5 percent, subject to the application of tax treaties.

Choice of acquisition funding

An investment in Saudi Arabia may be funded by a mix of equity and debt, subject to satisfaction of the minimum capital and reserve requirements.

Deductibility of interest

Saudi income tax law provides deductions for interest expense incurred during a tax year cannot the taxpayer’s total income from loan charges (interest) plus 50 percent of (a) minus (b) where:

a is the amount of income subject to tax other than income from loan charges; and

b is the amount of expenses allowed under the law other than loan charge expenses.

WHT on interest payments

Interest paid by either a Saudi resident or a non-resident with respect to a PE in Saudi Arabia to a non-resident (not in relation to a business carried on by the non-resident payee through a PE in Saudi Arabia), from a source in Saudi Arabia, is liable to WHT at 5 percent.

Other considerations

Books and records
 

  • All business entities (except non-residents who do not carry on business through a PE in Saudi Arabia) are required to maintain the necessary books and records in Saudi Arabia in the Arabic language. Such book and records must include:
  • journal;
  • general ledger; and
  • inventory book.
  • 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.
  • Books and records must generally be retained for at least 10 years.

Audited financial statements
 

Partnerships, LLCs, JSCs and Saudi Arabian branches are 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.

Transfer pricing
 

On 15 February 2019, the GAZT formally released the final version of its Transfer Pricing (TP) Bylaws and Regulations. Early March 2019 saw the release of the TP Guidelines by GAZT. The TP Guidelines have a wider approach than the Organisation for Economic Co-operation and Development (OECD) Guidelines and represent the GAZT’s view on how it will apply the TP Bylaws and Regulations.

Effective date
 

The TP Bylaws are applicable to reporting years ending on 31 December 2018 and all subsequent reporting years.

Persons subject to transfer pricing requirements
 

The TP Bylaws and Regulations are applicable on all ‘Taxable Persons’, which includes entities that are wholly foreign-owned, or are jointly owned by GCC and foreign (non-GCC) shareholders (mixed entities). Companies that are owned 100 percent by Saudi/GCC nationals are subject only to Zakat and are not subject to TP documentation requirements relating to Master File, Local File and Disclosure Form for Controlled Transactions (DFCT). However, such entities are subject to country-by-country (CbyC) reporting requirements.

Transactions subject to TP regulations
 

The TP Bylaws apply to all ‘Controlled Transactions’. A ‘Controlled Transaction’ is a transaction between ‘Related Parties’ or ‘Parties under Common Control’.

TP methods
 

The TP Bylaws, the GAZT list the ‘approved methods’, which are identical with the five OECD TP methods. The GAZT highlight the fact that there is no hierarchy that the taxpayer should follow when applying a TP method. Taxpayers may even use a non-approved method, if they can demonstrate that the non-approved method delivers better results than the ‘traditional’ TP methods.

DFCT
 

The DFCT forms part of an annual tax declaration and must be submitted electronically by every person engaged in controlled transactions, irrespective of their value. Along with DFCT, taxpayers are required to produce an auditor’s certificate confirming that a Multinational Enterprise Group’s TP policy has been consistently applied in relation to the taxpayer.

TP documentation
 

The GAZT has adopted the OECD’s three-tier approach for preparing TP documentation:

  • master file
  • local file
  • CbyC reporting (if applicable to them).

Master file
 

The master file should contain information on the global business operations and TP policies of the Multinational Enterprise Group to which the taxable person belongs. With respect to any ‘intangibles’, the master file should provide identity of legal and de facto owners of intangibles.

Local file
 

The local file should contain detailed information on all Controlled Transactions of the taxable person and should also contain information with respect to any business restructures (transfers of risks, functions, tangible or intangible assets impacting directly or indirectly the taxpayer in Saudi Arabia) in the current year or in the preceding year.

CbyC reporting
 

The CbyC reporting and the related notification need to be submitted by members of the Multinational Enterprise Group with consolidated group revenue exceeding SAR3.2 billion as per consolidated financial statements of the Multinational Enterprise Group.

General anti-avoidance rule
 

Saudi income tax law contains a general anti-avoidance rule.  Under these provisions, assessing officers are empowered to re-characterize transactions that do not have any economic effect, have a legal form that does not reflecting its true economic substance, or were entered to obtain a tax benefit. 

KPMG in Saudi Arabia

Peter Bourke
Airport Road, Riyadh Front
P.O. Box 92876 Riyadh 11663
Kingdom of Saudi Arabia

T: +966 11 874 8500
E: peterbourke@kpmg.com
M: +966 56 087 0229

 

This country document does not include COVID-19 tax measures and government reliefes announced by the Saudi Arabian government. Please refer below to the KPMG link for referring jurisdictional tax measures and government reliefs in response to COVID-19

Click here — COVID-19 tax measures and government relief

This country document is updated as of 1 January 2021.