Taxation issues for foreign investors in Saudi Arabia. INTAX Conference Dubai March 2016

Transcription

1 Taxation issues for foreign investors in Saudi Arabia INTAX Conference Dubai March 2016

2 Topics covered 1. Investment environment 2. Basics of taxation 3. Withholding tax rules 4. International tax treaties 5. Tax treaty application procedure 6. Cross-border services 7. Dividends and branch remittances 8. Capital gains 9. Permanent establishment 10. Cross-border leasing 11. Derivatives and guarantees 12. Anti-avoidance rules and transfer pricing 13. Dealing with DZIT 14. Introduction of VAT Page 2

3 Economic features Saudi Arabia is the largest economy in MENA Political stability A member of G20, and the world s most strategically important energy provider Ranked 49th in the world out of 189 nations in the World Bank s 2015 ease of doing business report Economic growth 2.8% during 2015, compared with 3.5% growth in 2014 King Salman s reordering of the country s line of succession and reshuffling of the main cabinet positions indicates leadership with its sights firmly set on the future The drive for economic diversification continues, with non-oil exports growing faster than oil exports in recent years With low oil prices and the Government s commitment to maintaining spending levels, the country ran a fiscal deficit in Page 3

4 Economic features The Saudi riyal peg to the US dollar has continued to serve as an effective platform to minimize the risk of currency speculation and contain exchange rate volatility In December 2015, the GCC countries confirmed that provisions of VAT framework agreement has been decided with likely introduction in 2016 with an 18 month lead time for businesses to become compliant Key high-growth sectors attracting foreign investments include: Energy power and water, mining and petrochemicals Health and life sciences pharmaceuticals and medical devices Transportation and logistics Telecommunication Education Page 4

5 Investment environment: forms of business Joint-stock company (open or closed) Limited Liability Company (100% foreign owned) most common for foreign investors. Joint venture Branch full commercial registration - (CR) Temporary commercial registration (TCR) «Tax PE» - permanent establishment for tax purposes without commercial registration Unincorporated Joint Venture (partnership) Commercial agencies registered by MoCI TSSO technical scientific office Others (less widely used) Page 5

6 Investment environment: regulations SAGIA deals with procedures for setting up for foreign businesses Commercial regulations for FDI gradually relaxing Foreign Investment license (FIL) issued by SAGIA + CR (MoCI) 100% foreign ownership permitted with exceptions In certain sectors FDI prohibited or restricted (SAGIA publishes negative lists) Off limits: Oil exploration, real estate brokerage, education, pilgrim services, recruitment, public transport, military sector etc. Foreign ownership restricted: banking, insurance, professional services, telecommunications, distribution and sales, etc. Foreign real estate ownership allowed (for residents) Tadawul (stock exchange) opened to foreign investors Member of WTO since GCC Economic Cooperation Agreement: national regime for GCC citizens Free repatriation of earnings Protection from confiscation Free transfers of shares Page 6

7 Investment environment: regulations Commercial and tax registration required to: Sponsoring employees Participation in public tenders Visa / residence permits Legislation & practices: Shari ah (principles and pronouncements) Legislation (subordinate to Shari ah): Royal Orders, Royal Decrees, Resolutions of the Council of Minsters, Ministerial resolutions, Ministerial Circulars Official language: Arabic Page 7

8 Tax system Two-layer tax system: 1. Corporate Income Tax Payers (CIT rate 20%): Resident capital companies (on profits attributable to shares owned by non-saudi or non-gcc [GCC] A PE of a non-resident WHT on passive income 2. Zakat payers Resident capital companies (on profits attributable to shares owned by non-saudi or non-gcc [GCC] 3. No Individual income tax Page 8

9 Zakat Companies owned by Saudi or GCC nationals are subject to zakat Zakat rate is 2.5% of the Saudi or GCC shareholder s share of net assessable funds or share of adjusted profits, whichever is higher The zakat base generally comprises of share capital, statutory reserves, retained earnings, provisions, shareholders credit current account balances, term and shareholder loans less net book value of long term assets plus the adjusted profit for the year Page 9

10 An overview of the Saudi tax / zakat regulations Summary: Corporate income tax, WHT and zakat Who is liable? Corporate income tax Withholding tax Zakat Resident company in respect of non-gcc share of profit Resident non-gcc natural person with business activities in the Kingdom Non-resident with a branch/pe in the Kingdom A non-resident not having a PE in Saudi Arabia, in respect of income earned from a source in the Kingdom Companies incorporated in Saudi Arabia with respect to share owned by Saudi or GCC nationals/companies owned by GCC nationals Rate 20% capital companies, branch and PE 30% to 85% companies engaged in the field of natural gas investment 5% to 20% depending on the nature of payment Dividends subject to 5% WHT 2.5% of the Saudi/GCC shareholder s share of net assessable funds or share of adjusted profits, whichever is higher 85% companies engaged in production of oil and other hydrocarbons Basis of calculation Gross income less allowable deductions (net adjusted profit) Gross amount paid to non-resident regardless of any costs incurred by the non-resident 'Net assessable funds' comprises capital employed and long-term financing, less fixed assets, allowable long-term investments and deferred costs, plus/minus net adjusted profit/loss for the year Page 10

11 Withholding tax overview Relevant provisions found in ITL (Art. 5, 68) and By-Laws (Art. 5, 6, 63, 68 etc.) Complex sourcing rules apply to various types of payments, sometimes application of WHT rates drived by practice (e.g. DZIT letters, BoG decisions) Examples of some of types of income of non-residents from sources in KSA are subject to WHT: Nature of payment WHT rates (%) Loan fees (interest) 5 Rents 5 Air tickets 5 Air freight or marine shipping 5 Technical and consulting services 5 International telecommunications services 5 Dividend payment, profit remitted to head office 5 Insurance and reinsurance premiums 5 Royalties 15 Payments for services (i.e., technical services, international telecommunications, etc.) made to the head office or a non-resident related party (50% or more ownership) 15 Management fees 20 Any other payments 15 Page 11

12 Recent developments: tax treaties Tax treaties Legal status: tax treaties override domestic law unless situations of abuse (art. 35 Income Tax Law) Most tax treaties are based on UN Model Convention 2001 (or 2011), not OECD MC (hence reference to OECD Model Commentary disputable) Status of tax treaties 2016: Status Effective Signed but not effective Under negotiation Number of treaties Appendix A B C Shipping and Aviation Taxation treaties (SATAs): US, India Bilaternal investment protection treaties: Luxembourg, the Netherlands Special (not based on UN / OECD MCs): Tax & Inheritance treaty with France 1982 Page 12

13 2.1 Overview of KSA existing and new treaties France (1981) Poland (2013) China (2007) Syria (2011) Austria (2008) Romania (2013) India (2007) Uzbekistan (2011) Spain (2009) Ukraine (2013) Pakistan (2007) Bangladesh (2012) Italy (2010) Malta (2014) Malaysia (2008) Japan (2012) UK (2010) Czech Republic (2014) South Korea (2009) Singapore (2012) Belarus (2010) Luxembourg (2015) Turkey (2010) Vietnam (2012) Greece (2010) Azerbaijan (2016) Russia (2011) Tajikistan (2016) Netherlands (2011) Hungary (2016) Ireland (2013) South Africa (2009) Tunisia (2014) Page 13

14 New tax treaties signed but not effective Macedonia Signed 15 December 2014 Morocco Signed 14 April 2015 Portugal Signed 8 April 2015 Algeria Signed 19 December 2013 Bosnia & Herzegovina Initialed Ethiopia Signed 28 February 2013 Georgia Initialed Egypt Initialed Croatia Under negotiation Jordan Initialed Guernsey Under negotiation Sudan Initialed Jersey Under negotiation Botswana Under negotiation Switzerland Under negotiation Gabon Under negotiation Kazakhstan Signed 7 June 2011 Venezuela Signed 11 November 2015 Sri Lanka Initialed Mexico Initialed Mauritius Under negotiation Barbados Under negotiation New Zealand Under negotiation Taiwan Under negotiation Page 14

15 Application of tax treaties Tax treaty application procedures: Two alternative tax treaty procedures exist: Pay and reclaim (DZIT Circular Nr. 3228/19) risk with beneficiary Upfront exemption from WHT (DZIT Circular Nr. 3227/19) risk with paying party FIlings for advance exemption: Form Q7B form must be completed by the non-resident and certified by foreign tax authority Form Q7C Undertaking by local Saudi entity Foreign-issued tax residence certificates (e.g. US form 6166) not accepted by DZIT DZIT Letter: Shipping companies (e.g. in case of Singapore DTT, the DZIT letter required form Q7B alongside with the Singaporean TRC confirming the «place of effective management» under Article 8 DTT) Practice: when applying tax treaty exemption an advance filing of a ruling request to DZIT to avoid late payment interest (before payment), should DZIT disagree Page 15

16 Cross- border services Technical or consulting services (T&C) are generally subject to WHT: 5% if unrelated parties 15% if related parties 15% if a branch (PE) pays to its HO company or a related party for any services Taxable in KSA at source even if physically rendered outside KSA Controvercial questions arise e.g. in relation to offshore repairs outside KSA Tax treaty exemption usually claimed by most non-residents under article tax treaties (Article 7) (non-resident claims that no PE arises in KSA) DZIT practice: trying to attribute income from services to a «virtual service PE» if tax treaty exemption is claimed under article 7 DTT. Taxpayers are «forced» into a «tax PE» situation: most register a PE with DZIT under deemed profit filing basis (5-6% effective taxation of the contract revenue) Practice: when applying tax treaty exemption an advance filing of a ruling request to DZIT to avoid late payment interest (before payment) Page 16

17 Dividends and branch remittances Dividends and branch remittances of profits payable to non-resident shareholders/ HOs subject to WHT at 5% Most Saudi DTTs do not reduce DWHT to less than 5% (0% in tax treaties with Spain, Syria, France) DWHT applies both to GCC and non-gcc shareholders regardless of Tax/Zakat status Branch remittance tax applies to cash distributions of profits to HOs No DTT exemption generally available for branch remittance tax Page 17

18 Taxation of Capital gains Article 5(3) ITL: non-resident capital gains from disposal of shares taxable at 20% at source (unless DTT exemption available) Real estate gains (ITL 5(3)): «directly or indirectly», so shares in real estate companies may be taxed at any level of the corporate chain of ownership Taxable person: seller but buyer jointly liable Reportable within 60 days (change in AOA and CR) Zakat vs. Tax implications on change of ownership Valuation issues (Art. 16(7) By-Laws) Tax exemptions under Article 13 of most KSA DTTs for ownership LESS than 25% (exception: Article 13 Netherlands DTT exemption if more than 10% ownership percentage) Watch out anti-avoidance rules of Art. 63 ITL for «stepped» transactions and income splitting, as well as transfer pricing Page 18

19 Permanent Establishment Art. 4 ITL: definition of a PE, broadly similar to OECD/ UN Model Conventions «Negative catalogue» of activities not subject to a PE physical PE agency PE (also defined Art. 4 By-Laws) service PE no domestic law definition but based on DZIT practice «contract manufacturing» PE (if processed goods are supplied to domestic market) Income attribution rules to PEs: Accounts basis Deemed profit filing basis (deemed profit rate of 25-80%) subject to 20% tax OECD Authorized approach explicitly not accepted (ref. UN MC Commentary) Page 19

20 Permanent Establishment (continued) Formulae apportionment rule of By-Laws 16(6): 10% deemed profit for each component of a combined contract including supply of goods, works and services (if PE is not reported) «Virtual» Service PE recent trend of DZIT practice requiring non-resident service providers that perform consulting, survey etc. Projects in KSA to register a PE if the duration of the activity is more than 6 months (akin to UN MC 5.3(b) «service PE») The DZIT threshold test is based on the duration of the contract, rather than the duration of physical presence of consultants in KSA working on a project Some DTT protocol provisions (e.g. UK, NL etc. explicitly state that income from activities performed outside KSA should not be taxable in KSA) Page 20

21 Cross-border leasing income Equipment rentals subject to WHT of 5% if equipment is used in the Kingdom But what is a ship/aircraft is used entirely on international routes and not generally operate in Saudi territorial waters / airspace? DTT classification: business profits or royalties (watch out article 12 UN MC) DTT Ireland, Singapore, Malta: Article 8 applies to bareboat and time-charters (dry and wet leases) Malaysia DTT: treatment of technical services as royalties Equipment (e.g. dredging vessel) operated by crue under a wet lease creates a PE under DZIT practice / Q&A, but some DTTs may provide exemption under Art 8 (analysis required) SATA (Shipping and Aviation Tax Agreement) exemption could be claimed for dry/wet aircraft leases in specific circumstances, but generally complex tax analysis required (US, India) Page 21

22 Derivatives and guarantees Certain payments under financial instruents cause controversy with DZIT e.g.: Payment for a parent company guarantee Payment under an interest-rate SWAP (IRS) DZIT approach: 5% WHT either under «insurance» or «loan fee» classification. Taxpayers tend to disagree and claim no WHT even under domestic tax law Tax treaty classification (for both guarantee and IRS) quite complex: No taxation in KSA if «Business profits» or «other income» article applicable Taxation at source allowed in classifid as «insurance» under some DTTs Detailed review of all contract provisions required MAP procedure strongly recommented for clients Page 22

23 Anti-avoidance rules Under Article 63 of the ITL DZIT has powers to: disregard any transaction with no tax effect re-arrange transactions whose form does not reflect their substance and put them in their real form. DZIT may re-allocate revenues and expenses in transactions among related parties as to reflect the returns that would have resulted if the parties were independent and unrelated. Page 23

24 Transfer pricing Transfer pricing: Currently, no specific regulations/guidelines for TP DZIT is empowered to issue rules for related party transactions (MR 1776/2014). Formal TP rules is expected (during 2016) Arm s length principle: transactions between related parties (Article 64) are to be conducted at arm s length and documentation is to be presented to the DZIT when requested for scrutiny (Article 61), to support the precise determination of tax payable by the taxpayer (Article 58) Global TP policy accepted by a foreign MNC if evidence proves that this was appropriately recorded in the books of the recipient entity DZIT is currently in the process of developing detailed TP guidelines, and has now issued a draft transfer pricing manual DZIT to introduce explicit Transfer Pricing documentation laws (in line with BEPS Action point 13) in the subsequent financial years. Page 24

25 Dealing with DZIT Official communications (written applications, appeals) only in Arabic Good and constructuive relationships highly recommended Sometimes verbal communication / explanation of a submitted written application helps resolving issues Electronic filing system Taxpayers electronic (re)-registration Page 25

26 Recent tax experience: DZIT tries to adopt an income classification under DTT to apply a higher WHT rate and to deny the DTT exemption, e.g.: Fees for technical services vs. Royalties (see e.g. Malaysia DTT) (higher 8% WHT rate for royalties) Equipment rentals vs. Royalties (most DTTs under article 12). (WHT rates for royalties under DTTs are higher than 5%) Business profits vs. «other income» article (see e.g. DTTs India, South Africa) Payments under IRS/guarantee classificed by DZIT as «insurance» hence DTT protection disallowed Taxpayer unsuccessfully challenged DZIT for them treating web-design services as «other payments» rather than «technical or consulting services» (case currently in BoG) Taxpayer challenged DZIT on a «virtual service PE» issue under the UK and the Netherlands DTTs (case currently in HAC) DZIT imputed a deemed profit where imported materials per Customs records was higher than in the company s purchase accounts Where the purchase price exceeded the customs value upon import, DZIT has disallowed the cost deduction of the excess amount Page 26

27 Recent tax experience (continued): Taxpayer challenged DZIT on non-application of US SATA to dry lease payments (MAP awaited) DZIT challenged taxpayer on an EPC contract where all on-shore works were subcontracted to a local subsidiary entity (DZIT insisted on that the non-resident creates a PE because they undertake a contract in KSA as a prime contractor regardless of sub-contracting the on-shore works) DZIT applied an «aggregation» approach to classify technical services (offshore remote help-desk IT services) as «royalties» on the basis that they must be «bundled» with royalties charged under the same agreement despite being mentioned as a separate category of works DZIT challenged taxpayer in a «triangular» structure claiming that the DTT with the HO company cannot apply because payment is made to a branch in a third country DZIT challenged taxpayer claiming DTT (France, Austria, UK etc.) exemption from 15% WHT on payments for services made by the branch to the HQ entity for offshore services claiming that «Business profits» article does not apply DZIT challenged taxpayer claiming a reduced WHT rate for royalties under the KSA- Netherlands DTT based on that the royalty recipient entity was not «benenficial onwer» of income being a sub-licensor (rather than a legal owner of the underlyaing trademark) Page 27

28 Introduction of VAT Timeline GCC members representative restarted discussions on the specifics of the potential GCC VAT regime in March and May 2015 Proposed implementation of VAT in the KSA The introduction of VAT at a GCC level has been considered for some time Proposed introduction of VAT in UAE, Oman and the KSA Page 28

29 Introduction of VAT (continued) The introduction of VAT in the GCC region represents a major change in fiscal policy and will require tax administrations in the region to significantly beef up their staff resources and begin engagement with the business community The GCC VAT framework is now expected to be finalized and formally announced by mid The provisions of the GCC Framework Agreement will be transposed into domestic tax law in each of the GCC States prior to the effective date The GCC States have agreed to implement their VAT regimes in Most countries will be working to implement by 1 January 2018 to avoid distortions arising from intra- GCC trade where one country has implemented VAT and another country does not have mechanisms to deal with charging VAT from business to business and onwards to the consumer. All GCC States will need to have implemented VAT by the end of 2018 Page 29 With the ratification of the GCC VAT Framework Agreement by mid-year, the GCC countries will be on a tight timeline of 18 months to prepare for VAT readiness by 1 January 2018, the target date to be achieved. However a number of GCC countries have already made substantial progress on preparing their tax administration systems for VAT and from July 2016 onwards the focus will likely shift to preparing the business community for VAT.