One of the most important characteristics that must be present in any tax system is fairness and clarity. The more the tax is "general" and not limited to a specific group, and the amount of the taxpayer's liability is determined by the fulfillment of the conditions required for tax liability, and the tax rate is specified, the fairer and more reasonable the tax becomes.
As for the characteristic of clarity, practical and legal realities necessitate that the tax and the basis for the taxpayer's liability, as well as the system governing the tax authority and the taxpayers, be clear and defined, so that the taxpayer knows the obligations arising from it and the necessity of fulfilling those obligations on time as per the law, and the tax authority that carries out its work to ensure compliance with the taxpayers' obligations, and the existence of a competent authority to adjudicate disputes and objections between the taxpayer and the tax authority.
When the Kingdom of Saudi Arabia began implementing Value Added Tax (VAT) at the beginning of 2008, the characteristic of fairness was achieved in that the tax is general, the rate is specified, and it is realized by individuals and economic and non-profit sectors and government entities regarding the conditions that must be met for them to be subject to the VAT system in the Kingdom.
However, the important matter here is how clear the VAT is and understanding the application of the tax system on economic activities and defining products and understanding their commercial cycle to verify their liability for VAT at the basic rate. The implementing regulation is often detailed, showing the fundamentals of the system, methods of implementation, and identifying the specific entities responsible for adjudicating objections.
The implementation of VAT in the Kingdom was accompanied by the issuance of multiple guidance documents by the tax authority in the Kingdom, which is the General Authority of Zakat and Tax, detailing the general principles of the VAT system, such as the guide for economic activities, input tax deduction, capital assets, and the general guidance document, as well as specialized guidance documents detailing specific economic activities, such as the financial services sector, energy and minerals sector, transport, professional activities, and others. The advantage of these guidance documents lies in their clarity and comprehensibility, as economic activity and its continuity are not limited to existing economic entities, but extend to individuals who have future plans to engage in economic activity. The more individuals and new entities understand the tax systems and the principles of their calculation, as well as the rights and obligations of the taxpayer, the more it facilitates the taxpayer's understanding of these matters and preserves their financial and economic gains. The knowledge aspect in the VAT sector has not stopped, as the recent guidance documents related to zakat included a comprehensive and detailed explanation of the zakat collection system, providing specific guidance documents for banks due to their subjection to a specific zakat system, and others dedicated to the real estate, construction, health, communications sectors, and more.
One of the main taxes applied in the Kingdom of Saudi Arabia, which may cause a certain issue, is the withholding tax. The withholding tax does not have a separate implementing regulation; it is included in Article 63 of the Income Tax Regulation. Article 63 defined the taxpayer's liability as follows: a non-resident is subject to tax on any amount received from a source in the Kingdom, and the tax is withheld from the total amount according to the rates specified in the article.
I believe that the inclusion of withholding tax within income tax is due to its involvement in several main matters such as: residency and source of income. The conditions for residency are clearly defined; if met, the taxpayer is subject to income tax, and if not met, they are subject to withholding tax. The source of income, whether it has been realized for performing work from a source in the Kingdom or in exchange for services and activities outside the Kingdom, and the extent of its liability for tax or not.
What is the primary objective of withholding tax?
It is a source of revenue within the tax framework. The beneficiary of the services is the non-resident service provider, who is not obligated to employ Saudi competencies and employees within their field of work. They are subject to the laws of the state in which the company or non-resident individual is established. On the other hand, there are financial objectives that can be inferred from the design of the tax, which are currency and exchange rate. Money cannot be transferred in Saudi Riyals; all funds transferred to non-resident beneficiaries in exchange for services are paid in fluctuating foreign currencies, from the fixed US dollar against the exchange rate of the riyal, to other fluctuating currencies such as the British pound, the Euro, and others. When domestic entities transfer their funds abroad, they are converting hard currency outside the Kingdom. The more these transfers increase, the higher the cost of maintaining the exchange rate of the national currency. The withholding tax is not only a source of income but also a cost for maintaining the exchange rate and preserving hard currencies.
The withholding tax needs significant cognitive development in the near future. The general definition of the scope of services subject to tax without detailed specifications makes it unresponsive to the nature of rapid economic activities. Frequently asked questions and existing practices may help in understanding withholding tax, but the availability of knowledge materials gives it the potential to be understood on a broad scale. Let’s take three examples:
Example One: Among the services subject to withholding tax are international telephone communication services. Is this service scope currently repeated in the Kingdom? Have international telephone services not become confined to a limited economic sector, which is the telecommunications sector, while on the opposite side, there are international communication and information technology services for holding meetings and attending seminars, provided by companies that do not offer international telephone services, but rather information technology companies like Microsoft and Zoom, among others? Also, there are services related to software and electronic games. If there is a taxpayer who does not have significant knowledge, they will take the text at face value, and thus payments to information technology companies will not be subject to withholding tax for telephone communication services, as there are no telephone services in the previous form that are no longer practiced currently.
Example Two: It is in loan deposits. Article 5 of the Income Tax Regulation specifies that income generated from loan returns for a non-resident is realized from a source in the Kingdom in any of the following cases:
If the debt is secured by movable and immovable property located in the Kingdom
If the borrower is a resident in the Kingdom
If the borrower is linked to an activity conducted in the Kingdom through a permanent establishment
More clearly, when a permanent establishment in the Kingdom obtains loans and financing from external entities, regardless of the form of financing, whether it is bonds, securities, or syndicated loans, the interest paid on loans to non-resident funding entities will be subject to withholding tax at a rate of 5.
However, there are some operations resulting from this financing, the legal effect and tax obligation will be transitional. The obligation transfers from one party to another. When bonds and securities are issued in a financial market outside the Kingdom, and the investors in these debt instruments are non-resident entities, and the interest payment manager is a local bank in Saudi Arabia, the obligation to pay the tax will transfer from the borrower "the company" to the payment manager "the local bank," and thus the bank will be obligated to pay withholding tax on the total interest payments.
On the other hand, there are issuances of some securities and bonds taking place in international financial markets for the benefit of resident entities, and some investors in these fixed-income securities or bonds are investment entities residing in the Kingdom. If the payment manager is an international bank not residing in the Kingdom, then all interest payments – even those for entities within the Kingdom – transferred to the payment manager abroad will be fully subject to withholding tax.
What are the main reasons for developing withholding tax?
The primary reason is to know the rights and obligations. The better the taxpayer (individual – entity) understands the services subject to withholding tax and the methods of determining them, the easier it is for the taxpayer to fulfill their obligations and for the tax authority to achieve and monitor compliance.
The second reason is the nature of the services. Modern products are no longer within the scope of tangible goods and assets; some exist only in cyberspace. There are no longer rental services for tangible assets for non-residents, but there are payments for the rights to use programs, applications, designs for programs and electronic products, advertising publication, and advertisement design, making it easier for the taxpayer to determine the nature of services within the scope of products, and for the tax system to define the form of service and its rate within specific categories.
The third reason is the alignment of tax systems with each other. The Value Added Tax has imposed a direct supervisory effect on withholding tax. When the taxpayer discloses in their VAT returns services received within the classification of services accounted for under the reverse charge mechanism, the final result is that the taxpayer has disclosed during that tax period withholding tax, except for some transfers not subject to VAT such as profit distributions. Also, when disclosing exempt purchases from tax, there is a high probability that the disclosed interest expenses in the tax return have been disclosed or will be disclosed when paying interest – if they are external – due to the application of the accrual accounting basis in tax returns.
What are the appropriate methods for the successful development of withholding tax?
Withholding tax should have a separate regulation that includes updates on the nature of services.
Services should be linked to a specific rate and not be subject to interpretation within the scope of "any other payments," and the nature of services should increase so that the type of service and the applicable tax can be tracked.
Multiple guidance documents are available for specialized economic activities, such as the financial services and telecommunications sectors, and utilizing taxpayer data (disclosed expenses to the authority) in developing services subject to withholding tax.
Efforts should be made to minimize interpretation as much as possible between the 15% withholding tax (royalty) and the technical and consulting services (5%), through contracts that define the nature of each service and the resulting payments between the resident company and the non-resident company, as the taxpayer may consider the rights to use certain applications subject to the rate of technical and consulting services on the grounds that the taxpayer paid for the usage license at the beginning of the contract period, and the other payments relate to ongoing technical support covering the contract period, while the authority considers them as annual usage rights subject to the 15% rate. Similarly, the insurance tax at 5%, as it is commonly known that there are clear insurance services such as health insurance and insurance for fixed assets and properties against risks, does insurance also include hedging contracts, derivatives, currency swap contracts, and cash flow?
The nature of the service and the tax rate for non-resident individuals providing specific services such as electronic designs, product designs, and report and article writing should be defined independently.
Minimize the significant differences between tax rates, specifically between those that may share certain characteristics such as consulting services and royalties, and abolish the tax on other payments, so that this rate is attached to specific and explicit services.
The distribution tax should be updated to include free share distributions, the method of calculating withholding tax, and the extent to which the income tax rate can be deducted on the increase in capital from internal accounts of the entity, and determining the method of calculating withholding tax for non-resident investors in the Saudi capital market who are not founders, and defining the obligations of the issuer (the entity) and investment companies that practice stock custody.
Mamdouh bin Abdullah Al-Saeedi
Fellow of the Saudi Organization for Chartered and Professional Accountants - Specialist in Value Added Tax.