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Taxation Laws for Citizens in Saudi Arabia

Introduction

In the contemporary globalized world, many businesses are established by the citizens of one state but operate in the other, which creates an issue of double taxation. If the states were to tax the income from each company regardless of the residency and specifics of where it received its income, businesses would either engage in tax evasion or avoid establishing branches in different counties altogether. However, Saudi Arabia’s government, similarly to the governments of other states, developed tax policies and signed agreements that allow businesses that are permanent residents (PE) to avoid double taxation. The OECD’s Tax Model is a prominent example of such a bilateral agreement. Hence, this paper will discuss the definition of PE, tax law, and bilateral double taxation treaties concluded by Saudi Arabia. Additionally, this paper will examine the specifics of the permanent residents’ taxation in Saudi Arabia. Saudi Arabia has implemented PE tax policies that allow businesses to be taxed efficiently based on their net income derived from their operations on the territory of this Kingdom.

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General Characteristics

Taxation is a process of imposing a financial obligation on an individual or an organization by a government(Hayes, 2020). Different states apply varied taxation models and approaches, but generally, companies are required to pay a specific share of their income to the state’s government. Saudi Arabia, however, differs from the Western countries in its taxation laws since apart from the standardized regulations, it also incorporates the Islamic laws under which the permanent residents are taxed.

Definition of a Permanent Establishment

A permanent establishment (PE) is defined as a type of legal framework applicable to companies whose head office is located in the Kingdom, and that was created following the Saudi Arabian regulation for companies. The specifics of the Saudi Arabian taxation system, when compared to others, is Zakat, which is an Islamic taxation system. It is applicable only to the citizens of Saudi Arabia and its permanent residents. Moreover, if a portion of a company is owned by a Saudi citizen, while the other is attributed to a non-resident, the taxation will be differentiated based on the percentage of ownership, and the company will adhere to both Zakat and standard taxation regulations.

In order for a person or entity to be considered a PE of the Kingdom, one of the two criteria must be met. This entity should have a place of permanent residence within the Kingdom for a period of no less than 30 days per taxable year. Alternatively, a person should spend at least 183 days in Saudi Arabia per tax year (PWC, 2020b). If one condition is met, the entity should pay taxes to the Saudi government under the Saudi Income Tax Law.

Notably, there is a difference in the tax rates for PEs, foreign businesses, and companies owned by Saudi citizens. The taxation rates under Zakat are substantially lower when compared to the standard taxation policies. For example, the income tax on net adjusted profits is 20%, and companies working in the oil and gas industries are changed between 50% to 80% of their profits (PWC, 2020b). Zakat taxation requires the business owners to calculate the net worth of their company and pay 2.5% of this sum (PWC, 2020b). Considering this, the PEs still pay a higher rate when compared to the Saudi nationals. However, they can avoid having to pay the tax in their home state. Hence, there is a significant variation in the taxation rules for PEs, residents, and non-residents under the Saudi laws.

To be a permanent establishment in Saudi Arabia, a company must meet specific conditions. According to PWC (2020a), a PE is an organization that was established by a non-resident of Saudi Arabia that operates in a state either directly or through an agent. For instance, a fixed location where a non-Saudi resident carries out their business activities is a PE (PWC, 2020a). However, PE policies outline the types of activities that do not qualify a business for PE regulation. For example, entities that store and display goods belonging to a non-resident are not PE (PWC, 2020a). Other instances are purchases of goods for the purpose of collecting them, supplementary services, any technical or legal services needed to prepare documents for signature, and storing items that will be processed by another entity. Hence, to be considered a PE, a non-resident must perform direct business activities, such as sell goods and provide services within Saudi Arabia.

Another important factor to consider for PEs is the legal process required to establish a company. According to OECD (n.d.), the current laws in Saudi Arabia outline two criteria under which it may be considered a state’s resident and therefore has to pay taxes. The first factor is that this organization has been formed following the Companies Law, which means that it was created and operates legally and following all the requirements outlined in this policy. The second factor is that the businesses’ central management must be in the Kingdom. Although the law set out two criteria, a business is considered to be a resident if it meets any one of these two.

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Taxation of Foreign Business Activity

As becomes evident from the definition of permanent establishment and the application of Islamic laws towards defining the taxes for these companies, the Saudi laws use a different model of tax for foreign companies. Considering this, the foreign business, even if managed as a PE, are still at a disadvantage when compared to local organizations. However, there are other benefits. In general, the concept of PE is linked to international laws and is needed to attract foreign investment into a country.

The importance of PE, in comparison to companies that do not have this legal status, is the amount of tax that has to be paid. According to Santander (n.d.), “a non-resident carrying out activities in Saudi Arabia through a permanent establishment is taxed on income arising from or related to the permanent establishment” (para. 1). Hence, this foreign business will owe the Saudi government the amount of tax calculated based on the income that is received within the Saudi borders. However, if this business also sells the same product in a Western country, they will not have to pay the taxes to this state as well if the two have signed a bilateral agreement.

When examining PE laws and taxation, one should consider the concept of the force of attraction. This rule is an international law principle under which requires a business to be taxed by the laws of the state where it is located unless this organization has a PE in a different country (Damania & Varaiya, 2020). In the cases when businesses have a PE, the source county has an extended force to impose taxes on the incomes of these enterprises. The force of attraction and PE tax rules are a part of several international treaties that will be discussed below.

Currently, a non-resident company that has a PE in Saudi Arabia is required to pay 20% of income tax (EY Global, 2021). Moreover, this rule, under the force of attraction principle, applies to PEs that sell goods or services within Saudi Arabia but are operated from different states. For example, if a company sells computers through a website that is operated in another country, this business could be taxed in Saudi Arabia (EY Global, 2021). Hence, PE is applicable to companies that want to operate within the Saudi borders.

Since PE implies the ability of a foreign business to avoid being taxed twice, both in Saudi Arabia and another country, the Kingdom’s government has to sign treaties with other states to enable this cooperation. Currently, Saudi Arabia has fourteen treaties with the government of “Azerbaijan, Bangladesh, Ethiopia, Georgia, Jordan, Kazakhstan, Mexico, Macedonia, Tunisia, Ukraine, United Arab Emirates, Uzbekistan, Venezuela and Vietnam” that allow the residents of these states who have businesses in Saudi Arabia to be taxed under the PE taxation laws (EY Global, 2021, para. 6). The profits and applicable tax, in this case, are determined by the Income Tax Law.

Treaties

Similar to other states, Saudi Arabia’s government has signed several bilateral taxation treaties to ensure that the companies operating within its borders are subjected to tax in other states if they are owned by non-Saudi citizens. Bilateral tax agreements are created to help companies that operate in more than one state ensure that they do not have to pay income tax in each of these countries (Hayes, 2020). There are multiple benefits of these agreements, both for the businesses and for the governments, since they promote international business activity, encourage foreign investment, and prevent tax evasion and fraud.

The Gulf Cooperation Council (GCC) has set up multiple treaties and agreements to ensure that the business activities within the region are regulated through similar laws. However, GCC consists of Islamic states, and there are not many differences in the way the taxations laws are set up since most of these states use Zakat as well. However, Gooi (2019) states that foreign businesses should be aware of the tax laws changes that were recently introduced by many GCC states. The issue is that GCC depends on the taxes derived from the oil industry and natural resources, and the governments of GCC declared their strategy to diversify their taxation systems to decrease this dependence. Hence, “evolving tax regimes of the GCC countries pose a challenge to foreign investors who are either seeking to establish a presence in the GCC or sell, divest or acquire businesses in the GCC” (Gooi, 2019, para. 2). Hence, these states will continue to introduce new forms of taxes, both for local companies and for PEs to address their new strategy.

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The organization for Economic Cooperation and Development (OECD) is the primary international establishment, which sets the frameworks for bilateral taxation. For tax-related purposes, recording the domicile of the individual or a business is essential to determine which state would receive the income tax. According to Hayes (2020), in most European countries, an entity or a person is considered a resident if they spend over 183 days within its borders, and as was previously mentioned, the same rules are outlined in the Saudi legislation.

OECD Model Convention is a document that is a reference form for countries that want to create a bilateral tax agreement. According to OECD (2019), this convention is a “model for countries concluding bilateral tax conventions, plays a crucial role in removing tax-related barriers to cross border trade and investment” (para. 1). This model serves as the basis created to help states when they negotiate their bilateral tax agreements. Additionally, it helps prevent some of the most common double taxation problems by outlining them and setting a framework for resolution. Notably, Hayes (2020) states that these treaties usually have a “saving clause” needed to ensure that the businesses do not avoid paying tax at all. Hence, the OECD’s convention is a helpful tool for states such as Saudi Arabia in their efforts to ensure that businesses pay taxes but are not forced to do this in more than one state.

Saudi Arabia’s taxation agreements show the state’s willingness to cooperate with other countries and support businesses that want to work within the Saudi borders. The Kingdom is a part of OCED’s agreement and follows its policies on bilateral taxation. According to the commentary on this model convention, its early versions did not include clauses related to the PEs and only considered the companies-residents (“Commentary in the articles of the model tax convention,” n.d.). The issue of residency has become important and highlighted by the OCED since previous agreements would also apply to persons staying in the country, meaning that they could be subjected to tax. Residency, however, is clearly defined and has a set of criteria, as was discussed earlier, making it easier to tailor the agreement to the needs of PEs. For example, “the terms “resident” and “permanent establishment” are defined in Articles 4 and 5 respectively, while the interpretation of certain terms appearing in the Articles on special categories of income” (“Commentary in the articles of the model tax convention,” n.d., p. 78). Thus, based on this model convention, a PE registered in Saudi Arabia can pay income tax based on the profits derived from its operations in this country and avoid being taxed twice in another state.

Conclusion

Overall, this paper addresses the question of taxation laws for permanent residents in Saudi Arabia. The Saudi taxation laws make a distinction between the resident businesses and PEs, and the former are taxed under Zakat, while the latter is subjected to standard income tax. PE allows companies to avoid double taxation, which is beneficial for encouraging foreign investment and business activity. Hence, companies pay a 20% tax to the Saudi government based on the income they received from this PE and do not have to pay taxes derived from the businesses’ operations in other countries. The OECD Tax Model Convection is among the treaties that Saudi Arabia adheres to when determining the PE’s tax policies. Thus, Saudi Arabia’s PE laws and bilateral treaties support businesses that operate within its borders by allowing them to pay taxes fairly and avoid double taxation of their net profits. Currently, the state has bilateral agreements with multiple countries in Asia, Middle East, and Europe.

References

Commentary in the articles of the model tax convention. (n.d.). Web.

Damania & Varaiya. (2020). India: Concept of ‘force of attraction’ rule in international transactions under tax treaties. Mondaq. Web.

EY Global. (2021). Saudi Arabia clarifies permanent establishment force of attraction rules. Web.

Gooi, G. (2019). Taxes in the CGC. Lexology. Web.

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Hayes, A. (2020). Bilateral tax agreement. Web.

OECD. (n.d.). Saudi Arabia residency. Web.

OECD. (2019). Model ax Convention on income and on capital 2017 (Full Version). Web.

PWC. (2020a). Corporate – Corporate residence. Web.

PWC. (2020b). Corporate – Taxes on corporate income. Web.

Santander. (n.d.). Tax system. Web.

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StudyCorgi. (2023, January 18). Taxation Laws for Citizens in Saudi Arabia. Retrieved from https://studycorgi.com/taxation-laws-for-citizens-in-saudi-arabia/

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