Saudi Arabia announces new Income Tax Law for Public Consultation

Background

On 25 October 2023, the Saudi Arabia’s Zakat, Tax and Customs Authority (ZATCA) published a draft Income Tax Law (ITL) and opened the same for Public Consultation. The Public Consultation is open for comments until 25 December 2023.

A closer look at the draft ITL reveals ZATCA’s goal of modernising the law and aligning with international tax standards, whilst making it more robust by targeting perceived (tax) abusive situations.

Although the draft ITL includes many changes compared to the existing tax regime, our below observations primarily focus on international and cross-border tax aspects, in line with our firm’s tax practice. As such, the below observations are neither exhaustive, nor comprehensive. It should also be noted that the published draft ITL may be subject to further changes as a result of the ongoing Public Consultation process.

Saudi Sourced Income

The draft ITL includes an article which stipulates that income derived from an indirect disposal of shares in a resident company is considered as Saudi sourced income. As such, this appears to codify the taxation of capital gains realized on indirect share transfers, which is a long-standing practice in Saudi Arabia but seemingly constitutes a deviation from the current law.

Also included in the Saudi source income article is income which is derived from services rendered remotely through technical or electronic means that facilitate the deriving of income. This emphasizes the trend where the KSA wishes to bring foreign service providers within the taxation scope where the recipients of those services are Saudi residents.

Permanent Establishment

Besides the relatively standard provisions on Permanent Establishment (PE), the draft ITL includes a new Services PE concept for non-resident companies performing services in the KSA, where the services continue for more than 30 days within any twelve-month (12) period. Whilst the ZATCA has been quite active in recent years on different PE positions, the related taxing rights are definitely not unlimited under the Double Tax Treaties (DTTs) entered into by the KSA.

Anti-avoidance

A new anti-tax avoidance article introduces a Principal Purpose Test (PPT), whereby a tax benefit will be denied if the obtaining of such benefit was the principal, or one of the principal, purpose(s) of an arrangement or transaction that resulted in the benefit. A PPT for cross-border arrangements and transactions has in recent years been included in many DTTs as part of the multi-lateral instrument. The experience of international tax practitioners working on this topic will be key in navigating these provisions in a domestic context.

The same article introduces the concept of a special tax treatment for transactions with parties that are based in a jurisdiction that applies a Preferential Tax Regime (PTR). Such special tax treatment may affect a Saudi taxpayer’s deductibility of expenses and depreciation and the applicable rate of withholding tax, among others.

The tax regime applicable in a jurisdiction is considered a PTR if (i) the statutory income tax rate is less than 15%, (ii) there is no agreement for the exchange of information between the KSA and the relevant jurisdiction, or (iii) tax benefits are given to the non-resident company, without having to carry out actual economic activities in that jurisdiction. A list with jurisdictions that are considered to apply a PTR will be published (and updated) at least once a year.

Participation Exemption

A welcome development is the draft ITL’s introduction of a comprehensive Participation Exemption regime, exempting qualifying dividend income, capital gains and liquidation proceeds from taxation at KSA shareholder level.

In order to qualify, the shareholder must own 10% or more of the subsidiary’s shares, for at least one year (uninterrupted). The draft ITL states that a shareholding will not qualify for the Participation Exemption if, among others, it is exempt from tax in its jurisdiction of residence or benefits from a PTR in that jurisdiction.

Interest Deductibility

In line with the OECD BEPS initiative’s Action 4 on excessive interest deduction, the new draft ITL stipulates that net interest expenses (i.e., interest expenses minus interest income) are tax deductible only up to 30% of the taxpayer’s adjusted earnings.

Reinvestment reserve

A reinvestment reserve is introduced enabling a taxpayer that realizes a gain on a disposal of a tangible or intangible asset, to postpone taxation on such gain. The gain would be allocated to the reinvestment reserve for a maximum of two years and deducted from the reserve upon acquisition of similar tangible or intangible asset within that period.

Anti-hybrid Rules

The draft ITL introduces anti-hybrid rules for cross-border financial instruments between related parties. This means that if the instrument is treated differently from a tax perspective in the KSA, compared to the other jurisdiction, this can have tax implications, such as the denial of the deduction of interest expenses on such instrument.

Withholding Tax

From a Withholding Tax (WHT) perspective, the draft ITL keeps certain rates unchanged, such as the 5% for dividends and interest payments, among others. A 10% WHT rate is included for payments for services which, without further speciation of the specific type(s) of services, might be covering a wide range of services. Presumably, the implementing regulations to a new ITL will provide further details in this regard.

Importantly, the draft ITL stipulates that the applicable WHT rate on interest, dividend, royalty, rental and services payments will be increased to 20% if the recipient is based in a jurisdiction that applies a PTR. Where the recipient is based in a jurisdiction that concluded a DTT with the KSA, it will be relevant to analyse such DTT to determine if, and to which extent, the KSA may exercise its taxing right. 

The draft ITL includes many proposed changes which may be relevant for KSA taxpayers and international businesses alike. Apart from providing input to the Public Consultation for the draft ITL, we will monitor the developments and will keep informing our client on these important changes. 

Conclusion

Saudi Arabia's draft Income Tax Law marks a significant step towards modernizing the nation’s tax regime and aligning with international standards. International businesses and investors doing business in the Kingdom will need to carefully consider the impact of the upcoming tax reform on their Saudi business operations. With potential changes following public consultation, this evolving framework presents both challenges and opportunities for Saudi taxpayers and international enterprises.