Applicability of VAT on Salaries and Wages, in the Kingdom of Saudi Arabia KSA

Ganesh NairGanesh Nair    06 February 2020
Applicability of VAT on Salaries and Wages, in the Kingdom of Saudi Arabia KSA

As we know, the Kingdom of Saudi Arabia introduced Value Added Tax (‘VAT’) @ a Standard rate of 5%, on the importation and supply of goods and services with very minimal exceptions, from 1st January 2018 onwards.

Businesses or Individuals who carries out an Economic activity to generate Income are subject to VAT.

Economic Activity is defined in the GCC VAT Framework agreement, which reads as ‘An activity that is conducted in an ongoing and regular manner…………………..’

During the implementation days, there were concerns amongst the business fraternity that, whether the services given by Employees to the Employers would be treated as Economic activity and whether such Salaries or wages received against the services offered by Employees, be subject to Standard rated VAT? 

General Authority of Zakat & Tax (‘GAZT’), the authority to monitor the implementation of VAT in KSA, was quick to respond and issued technical FAQ, vide which, made it clear that ‘VAT is an Indirect Tax which is imposed on goods and services only.  VAT is not applied on Employee Salaries’

As the services given by Employees to their Employers (Direct Contract between Employee and Employer) is not an Economic Activity, the payments made in the form of Salaries / Wages, reimbursement of Actual expenditures, Bonus or Increments shall NOT be subject to VAT obligations.

But most often than not, businesses choose torope in Staff or workers for business needs, through outsourcing from Human Resource (‘HR’) Companies or agencies.  The Contracts are between the business entities and the HR Companies and not directly between the employees.  The HR Companies along with the Salary (to be paid to the employees) also charge the HR Fees or Commission or Services Charges to the Business entities. 

In such cases, HR Companies issues a single Tax Invoice on the Business entities and charges 5% VAT on the entire amount i.e. Salary to be paid to Employees + Fees or Commission or Service Charges.

The VAT paid on such Invoices, by the Business entities can be claimed as Input Tax in entirety, if the Services of such employees are taken for business operations, we shall not discuss the scheme of Input Tax credit here in this article.

GAZT in the Guideline (mentioned above) stated that, if the Contract is between the Business and HR Companies and is having the same essence that of a relation between Employer and Employee, then the remunerations paid by the Business entities are NOT subject to VAT and only the Fees or Commission or Service Charges paid to HR Companies are liable to VAT @ Standard rate.

Meaning, such outsourced employees should be exclusively and directly working / reporting to the Business entities and not to HR Companies. If this fact can be established, then VAT need not be paid by HR Companies on the Salary part and Businesses will not take any Set-off of such amount in their VAT Returns.

For e.g., Nurses / Staff working for Hospitals (not on direct payroll of Hospitals, but working through HR Companies)

Though there is a guideline available, unfortunately even today most of the HR firms are continuing to charge VAT on the Total value of Invoices (Including Salaries paid to their employees), and the businesses are claiming the Set-off against such VAT paid. Net-net there may not be any financial burden on the businesses, as whatever VAT paid, been claimed as Input Tax, however, there may be a working capital issue and also the hazzles of claiming the Input tax of such big amounts, because every now and then during VAT Audits, business may need to provide the documentary evidence of VAT paid to GAZT in order to claim the VAT paid.

Businesses are advised to speak to their third party service providers and the third party service providers in turn may file a letter with GAZT informing them about such non-charging of VAT on the salaries / wages or remunerations paid to the Employeeswho are exclusively working for the Business entities.

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