Businesses worldwide are keenly observing the latest tax regulations implemented for regional headquarters based in Saudi Arabia.
These regulations establish a 30-year tax exemption specifically for earnings derived from ‘eligible activities.’ Eligible activities are defined as those that contribute to enhancing the company’s regional presence and offering strategic oversight, along with administrative support to the company itself, its subsidiaries, and affiliated entities.
Entities described as ‘related companies’ or ‘related persons’ are identified in accordance with the Kingdom’s transfer pricing regulations.
Several critical considerations must be addressed by corporations. For instance, is it possible for a regional headquarters to maintain its tax-exempt status if it provides strategic guidance to a limited selection of related entities, rather than all related entities under its purview? Is it mandatory for promotional and marketing operations for the entire region to be centralized in Saudi Arabia to fortify the group’s regional image?
Any income generated by a regional headquarters from activities outside the scope of ‘eligible activities’ will be taxable under the country’s prevailing tax laws. Guidelines suggest that these headquarters should not engage in revenue-generating activities, implying that eligible activities should be restricted to internal business matters pertaining to related parties.
One might wonder if a customer-facing role undertaken by an employee of a regional headquarters would conflict with the definition of eligible activities. Furthermore, a second fiscal incentive involves a 0% withholding tax applicable to international payments made by regional headquarters. This includes payments such as dividends, transactions with related entities, and payments to third-party service providers that are vital to the functioning of the regional headquarters.
Only careful scrutiny will confirm the necessity of third-party services for the headquarters’ eligible activities. It goes without saying that separate financial records should be kept for any revenue and associated expenses from activities deemed ineligible.
Economic substance requirements
Similar to other global tax incentives, the Saudi regional headquarters program also requires compliance with economic substance regulations, emphasizing that the entity’s operations must have a physical presence in the country. This includes maintaining adequate assets, employing a sufficient number of qualified staff full-time, and incurring enough operational expenditure to carry out its activities.
The managing and decision-making processes should take place within Saudi Arabia, including holding board meetings for strategic decision-making. It is also stipulated that at least one director of the regional headquarters should reside in the country.
It is indicated that the entity should generate revenue from eligible activities within Saudi Arabia, likely because the program is designed to foster operational entities.
Transfer pricing compliance
Furthermore, the regional headquarters must adhere to the Gulf state’s transfer pricing bylaws and adhere to guidance from the Zakat, Tax, and Customs Authority (ZATCA). Transactions with related parties must reflect arm’s length pricing. Transfer pricing compliance aims to ensure that the regional hub is not merely a conduit for the global headquarters and that income proportional to the entity’s activities is realized in Saudi Arabia.
Guidelines from the Organization for Economic Cooperation and Development (OECD) provide a safe-harbour rule for ‘low value add services’ (LVAS), with a 5% markup on costs deemed arm’s length for these services. However, given that RHQ activities often involve significant strategic input, they are unlikely to be categorized as LVAS and may demand a higher income percentage to comply with arm’s length principles.
Penalties
Non-compliance with program stipulations can lead to substantial penalties. Infringements related to economic substance requirements can incur fines ranging from SR100,000 to SR400,000. Persistent non-compliance could result in the suspension of tax benefits.
Tax advantages may also be forfeited in situations involving the submission of false or misleading information, the intentional misuse of tax incentives, or the making of overseas payments through the regional headquarters as a pretense.
With features akin to the free zone benefits seen in UAE’s corporate tax structure, the Saudi regional headquarters model presents various complexities. It is crucial for businesses to pose pertinent questions to fully grasp the implications and boundaries of each tax incentive offered.