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“Payments received for use of or the right to use intellectual rights, including, but not limited to, copyright, patents, designs, industrial secrets, trademarks and trade names, know-how, trade secrets, business, goodwill, and payments received against the use of information related to industrial, commercial, or scientific expertise, or against granting the right to exploit natural and mineral resources.”
IMPORTS AND SUPPLY CONTRACTS
Saudi tax law provides that no profit will be considered to arise from a contract for the supply of goods to Saudi Arabia, provided delivery of the goods is either free on board (FOB) or cost, insurance, and freight (CIF) to a Saudi port. However, should the contract provide for the delivery and/or installation of materials at a point inside Saudi Arabia, the supplier may be considered to be carrying on business within Saudi Arabia, and, as a consequence, the contract may be subject to Saudi income taxation as follows:
● If the material cost was identified in the supply contract separately from the cost of work performed in Saudi Arabia, then, in the absence of a PE, a WHT on the work that will be performed in Saudi Arabia may be assessed, based on the type of services. However, if the contract qualifies the supplier to have a PE in Saudi Arabia, then income tax will be applied according to the Saudi tax regulations as for a normal taxpayer.
● If the supply contract indicates a total cost without segregation in the value of supply and the value of the other activities in Saudi Arabia, then the work performed in Saudi Arabia will be assigned a value equal to 10 % of the contract value for each type of activity.
FOREIGN INCOME
The gross income derived by a capital company resident in Saudi Arabia from its operations and of its branches inside and outside Saudi Arabia is subject to tax in Saudi Arabia. However, in order to avoid double taxation on the same income, the following exceptions and clarifications are to be considered:
● With respect to the income realised from investments in other resident capital companies and foreign capital companies (foreign dividends applicable from 1 January 2018) and in order to avoid double taxation, such income is to be excluded from being subject to tax under the following conditions:
○ The percentage of ownership in the company invested in is not less than 10 %.
○ The period of ownership of shares is not less than one year.
Previously (up to 31 December 2017), foreign dividends were taxable unless a DTT provided relief.
There are no restrictions on repatriation of profits, fees, capital, salaries, or other monies.
CORPORATE – DEDUCTIONS
All expenses that are necessary and normal to the business, paid or accrued, are allowable deductions, provided the expense meets the following conditions:
● It is an actual expense, supported by a verifiable document or other qualifying evidence.
● It is related to the generation of taxable income.
● It is related to the subject tax year.
● It is of a non-capital nature.
DEPRECIATION
A depreciation deduction is allowed under the following limitations as stipulated by the law:
● The asset is not intended for resale and is to be used, in full or in part, for the entity’s purposes.
● The asset is of a depreciable nature that loses value because of use or because of wear and tear and obsolescence and has a value extending beyond the end of the taxable year.
● The asset is owned by the business, as per the ownership document for buildings and contracts and invoices for other assets.
● The asset depreciation is allowed even if the asset becomes inactive during the tax year.
Depreciation for tax purposes is calculated as follows, based on the following five categories of depreciable tangible or intangible assets, other than land:
The declining-balance method of depreciation, according to the above rates, should be followed for tax purposes. However, straight-line depreciation is allowed for Zakat payers as per Zakat regulations.
There are also rules for depreciation relating to assets either acquired or disposed of. Essentially, 50 % of the allowable acquisition price or disposal proceeds is added to or subtracted from the asset pool in the first year, and the remaining 50 % in the following year.
From 1 January 2018, the cost base of assets transferred or distributed between companies that are part of the same group should be set at the net book value.
Assets under build, own, and transfer (BOT) and build, own, operate, and transfer (BOOT) are allowed to be depreciated over the contract period. This presumes, although it is not clear, that assets under the BOT and BOOT schemes actually will have a separate grouping in addition to the above prescribed groups.
START-UP EXPENSES
Tax treatment of start-up expenses depend on how they were treated under Saudi generally accepted accounting principles (GAAP). Generally, they can be fully expensed in the first financial year or can be capitalised and amortised.
LOAN CHARGES (INTEREST EXPENSES)
An interest deduction is limited to the lower of the loan charge incurred during the tax year, if related to income that is subject to tax, or the result of the following formula, whichever is less.
The taxpayer’s total income from loan charges, plus 50 % of (A minus B) as below:
A = income subject to tax other than income from loan charges.
B = expenses allowed under the law other than loan charge expenses.
Note that banks are not subject to this formula.
BAD DEBT
Bad debts are deductible, provided they meet all of the following conditions:
● The bad debt was previously declared in the appropriate year’s income.
● The debt resulted from sale of goods or services.
● The company holds a certificate from the taxpayer’s certified public accountant (CPA) certifying that the debt has been written off in the taxpayer’s books and records, based on a decision by the taxpayer at the appropriate management level.
● Serious efforts have been exerted by the taxpayer to collect the debt with no success and the inability of the debtor to pay has been proved based on a judicial ruling or bankruptcy.
● The debt is not from a related party.
● There is a commitment by the taxpayer to reinstate, as income, any written-off debt whenever collected.
CHARITABLE CONTRIBUTIONS
In determining the tax base of each taxpayer, a deduction is allowed for donations paid during the taxable year to public agencies or philanthropic societies licensed in Saudi Arabia, which are non-profit organisations and are allowed to receive donations.
ALLOCATIONS AND RESERVES
Allocations and reserves formed during the year are deductible as follows:
● Bank allocations to a reserve fund for doubtful debts are allowable deductions. However, a bank must submit a certificate from the SAMA stating the amount of doubtful debts and the amount of doubtful debts collected during the year that should be reinstated in the tax base of the year of collection.
● Insurance/reinsurance companies may deduct, based on industry standards, a reserve for unearned premiums and for unexpired risks, provided that it is reported in the tax base of the following year. A reserve for unearned premiums means a part of premium amounts collected or stated in books that covers risks related to the future tax year(s). A reserve for unexpired risks mean the amount of compensation claimed or reported, but for which the payment process falls short of completion during the tax year.
● A taxpayer may reduce its book profit by the amount of reserves used during the year that had been readjusted when made to increase income or decrease expenses in the year of formation. Examples of such reserves are end-of-service awards, doubtful debt, and drops in prices. Such amounts are deductible, provided the following conditions are met:
○ The used amount was paid or accrued during the year, and it is supported by documentation.
○ The reserve had been adjusted in the year of formation to increase the tax base.
SCHOOL FEES
School fees paid by taxpayers for their employees’ children are deductible expenses, provided they meet the following conditions:
● They are paid to a local licensed school.
● This benefit is stated in the employment contract.
PENSION FUND
Employers’ contributions to employees’ pension funds or savings funds established under Saudi Arabia’s rules and regulations are deductible, provided that such contribution, one payment or in aggregate, is not in excess of 25 % of the employee’s income before the employer’s contributions and that the fund meets the following criteria:
● The fund is established according to special provisions that clearly stipulate conditions of subscription and rights of subscribers.
● Such obligation is stated in the employment contract or in the Articles of Association of the establishment.
● The fund has a character independent of the establishment and has separate accounts audited by an independent CPA.
A capital company is allowed to deduct its contribution to a retirement fund, a social insurance fund, or any other fund established for the purpose of settling employee end-of-service benefits or to meet staff medical expenses, provided they meet certain conditions. It should be noted that there is a notification requirement to the GAZT in order to claim any deduction of the contribution.
RESEARCH AND DEVELOPMENT (R&D)
A deduction is allowed for R&D expenditure incurred during the tax year in connection with the generation of income that is subject to tax. Such expenditure relates to technical, scientific, and engineering experiments; computer systems; or similar research. This provision does not apply to the acquisition of land and facilities, or to equipment used for research. Such facilities and equipment are subject to depreciation under the law.
FINES AND PENALTIES
Fines and penalties related to income tax, paid or payable in Saudi Arabia or to other countries, are not deductible.
Financial fines or penalties paid or payable to any party in Saudi Arabia, such as traffic fines or fines for causing damage to public utilities, are also not deductible.
Fines or penalties paid for breach of contractual obligations, such as fines on delayed or defaulted completion of contracts, are deductible, provided they are documented by the contracting party and the income from such penalties is reported in the year of recovery.
TAXES
Income taxes are not deductible.
NON-DEDUCTIBLE EXPENSES
The following expenses are non-deductible:
● Wages, salaries, and whatever is so deemed, in cash or in kind, paid to an owner, partner, or shareholder, or to a member of their families, being a parent, spouse, sons/daughters, and siblings (this provision does not apply to stockholders in a stock company).
● Compensation in cash or in kind paid to a partner, shareholder, or to a family member, including a parent, spouse, sons/daughters, and siblings, for a property or service to the extent that the compensation is higher than the fair market value of such property or service at time of transaction.
● Entertainment expenses incurred for events such as parties, sports competitions, entertainment trips and activities, etc.
● Expenses of a natural person for personal consumption, such as personal withdrawals, dependants’ cost of living, or education.
● Any bribe or similar payment, which is considered an illegal practice in Saudi Arabia, even if paid abroad.
● Insurance commission in excess of 3 % of total premiums collected in Saudi Arabia through an agent or others and regardless of whether or not the agent is a partner.
NET OPERATING LOSSES
A taxpayer may carry forward operational losses, as adjusted, to the years following the loss year until the cumulative loss is fully offset. The maximum profit percentage of any year that could be used to offset cumulative losses should not exceed 25 % of the year’s taxable profit as reported in the taxpayer’s return. Carryback of losses is not allowed.
PAYMENTS TO FOREIGN AFFILIATES
Payments made to head offices located abroad by local branches are not deductible. Such payments include:
● royalties or commissions
● loan charges (interest expense) or any other financial fees (except loan charges paid by branches of foreign banks in Saudi Arabia to their non-resident head offices, which are considered as tax deductible expenses), and
● indirect administrative and general expenses allocated on an estimated basis.
The value of goods or services delivered to the taxpayer by related parties is not deductible to the extent that it is in excess of an arm’s-length value.
CORPORATE – GROUP TAXATION
The income tax rules in Saudi Arabia do not allow for consolidation or grouping of taxpayers. For Zakat purposes, the concept of consolidation is acceptable, and relief may be obtained for wholly owned subsidiaries by Saudi/GCC companies that are subject to Zakat.
Note that an entity operating in Saudi Arabia that has undertaken more than one project under the same commercial registration is required to consolidate the results of such projects into the financial statements of that entity and subject them to taxation as a single operation.
TRANSFER PRICING
On 15 February 2019, the GAZT published the Transfer Pricing By-Laws (the By-Laws) in final form as well as an accompanying frequently asked questions (FAQs) document.
The By-Laws are effective from their date of publication in the official gazette. It has also been clarified in the FAQs (in question 8) that the By-Laws will apply to the reporting year ended 31 December 2018 and all subsequent reporting years.
The By-Laws and the FAQs refer to the GAZT’s own Guidelines in many places. Whilst none have yet been published, we expect that these Guidelines will be issued in due course to provide further practical guidance to help businesses comply with the procedural aspects of the By-Laws.
Persons subject to the By-Laws
Article 2 confirms that, notwithstanding any provision to the contrary, the By-Laws shall apply to all taxable persons under the Law. The ‘Law’ means the Income Tax Law issued by Royal Decree No. (M/1) dated 15/1/1425H and its amendments. This is the Corporate Income Tax Law in the Kingdom of Saudi Arabia.
The By-Laws will therefore apply to entities that are subject to tax only, and to mixed ownership entities that are subject to both Zakat and tax, and this is stated in the FAQs (question 3). Generally, therefore, the By-Laws do not apply to entities that are subject to Zakat only.
However, Article 2 now includes additional wording to confirm that whilst the By-Laws generally apply to taxpayers (and mixed ownership entities subject to Zakat and tax), it does not prevent the country-by-country (CbC) reporting requirements as prescribed in Article 18 from applying to Zakat payers.
Scope of the By-Laws: Domestic transactions
