In July, the Kingdom of Saudi Arabia has implemented new customs rules of origin aiming at increasing local content and securing higher customs duty revenues for all goods imported into the Kingdom. These news rules are already impacting many groups manufacturing outside the Kingdom and exporting to it.
While customs are not a new tax topic and most probably the oldest tax in the GCC region, transfer pricing regulations have recently been implemented in an increasing number of countries in the Middle East, including UAE, Saudi Arabia, Qatar, Jordan, Oman and Bahrain.
Both tax fields have many touch points in common and Saudi Arabia is probably one of the few countries, if not the only one, which understood the powerful impact of bridging the gap and joining the dots through one single body named Zakat, Tax and Customs Authority (ZATCA).
It becomes critical for all economic operators with related party inbound flows of goods in Saudi Arabia to train their supply chain and finance functions to work together with the objective to be compliant and consistent across tax fields to avoid a situation of inconsistency where ZATCA would severely adjust.
Without giving much time for operators to assess their impact, Saudi Arabia enacted in July new rules of origin that include a set of conditions for origin verification.
Before diving into the details, one needs to understand that three main elements are required to levy customs duties:
This is on the second item that Saudi Customs issued a new set of conditions for origin verification.
Since beginning of July, the importers have to provide a cash or a bank guarantee to cover for the customs duties applicable to the products imported into the Kingdom.
Then, the importer has the right to ask for a refund of the bank guarantee or the cash provided that the refund application includes:
While some of the above conditions were already present in the previous rules of origin, others are completely new and reflect the intention of the Kingdom to impose a shift of the core economic activities to Saudi Arabia.
It is worth focusing on the new conditions in the next section.
The additional conditions to meet the Saudi rules of origin require that 25% of the workforce used in the manufacturing process of the imported goodsis a local workforce. This has a significant impact on many groups given the structure of the workforce in the GCC countries.
Assuming a group would already meet this condition, it is not yet clear which body will providethe required attestation. Based on discussions with Dubai Customs, it won’t be the customs authority that will deliver such attestation and the group might be redirected to the Ministry of Economy which in turn might refer to the Ministry of Human Resources and Emiratisation.
It is worth noting that the new rules of origin allow for a flexibility whereby if you have 15% local workforce you can make up for the 10% missing by having 50% added value in your imported products instead of 40% and vice versa.
The 40% added value rule is not new but the request for a certified public accountant attesting the percentage of value added is an additional piece that further increases the administrative burden for the economic operators. Also,in this respect the process is not yet clear on the side of the accounting firms as to how this will be delivered and on which basis.
Last but not least, it is not clear if the above attestations and certifications will have to be provided per shipment or for a bulk of similar shipment. If this would be applicable per shipment, it might be wise for accounting firms to open stamp offices to cover for these needs.
To align with international practices, Saudi Arabia formally introduced in 2019 the obligation for certain corporate taxpayers in Saudi to prepare specific transfer pricing documentation justifying the arm’s length nature of their intra-group transactions.
Saudi Arabia has largely aligned its requirements with the OECD Transfer Pricing Guidelines and requires the preparation of a Master file, Local file and a TP disclosure form together with an affidavit from a certified public accountant.
The purpose of this set of elements is to demonstrate the arm’s length nature of the intra-group dealings.It is interesting to note that for consistency purposes, Saudi transfer pricing guidelines are currently being revisited to include zakat entities which were excluded from the original scope of the transfer pricing bylaws.
In an intra-group context, the price of the imported items would be based on the transfer pricing policy of the group for corporate tax purposes and the documentation would justify such transfer pricing policy. In addition, an affidavit would have been delivered by a certified public accountant to attest that such policy has been implemented in the accounts.
On the other hand, upon importation of the goods, a customs declaration would have been prepared and filed towards customs authorities including the value of the imported goods for customs duty purposes.
In an ideal situation, the transfer pricing value and the customs value are the same. However, in practice, it does not seem to be often the case. On the customs side, one might be tempted to undervalue the imported goods to reduce the payable customs duties upon importation in the Kingdom. On the other side, one might be tempted to overstate the transfer price of the inbound flow to reduce the corporate tax base and related tax bill in Saudi Arabia.
Given the opposite interests, it is rather common to see important gaps between the customs value and the transfer pricing value, especially if a customs exemption is applicable or if corporate tax attributes are available at the level of the importing entity in Saudi Arabia.
The new Saudi rules of origin have further exacerbated this existing tension. More precisely, the 40% added value rule is in most cases computed based on the invoiced price of the imported goods which happens to be also the transfer pricing value if for instance the goods are sold by a UAE manufacturing entity to an affiliated entity in Saudi Arabia for further distribution in the Kingdom.
The conundrum to know where the truth is gets even harder when in both sides you have attestation from certified public accountants stating on the one hand that the 40% value added has been well computed for customs purposes and on the other hand that the arm’s length transfer pricing policy has been well implemented for corporate tax purposes.
Saudi Arabia has a very well organized and structured tax administration which is about to grasp the full potential of its digitalization and recent reorganization.
In May, the Saudi Council of Ministers, chaired by King Salman bin Adbulaziz, approved the merging of the General Authority of Zakat and Tax (GAZT) and the General Authority of Customs (GAC) to form the Zakat, Tax and Customs Authority (ZATCA).
This approach is somewhat unique to Saudi Arabia and underlies the strength and vision of the Saudi tax administration, as it now allows the tax auditor to have a helicopter view, to perform cross-checks and ask the taxpayer to justify the potential gaps. ZATCA has enough data through the various tax returns and it has now the frame to exchange and reconcile the data provided.
The results speak for themselves. Since the merger, the number of audits, the amplitude of the adjustments and related litigations have skyrocketed. Across all Saudi taxes (zakat, customs, excise, real estate, VAT, withholding taxes and corporate income taxes), controversy is on the rise and the trend will continue for the foreseeable future while Saudi Arabia is on its journey to transform its economy under vision 2030.
AEO, rulings on HS classification, origin, value and transfer pricing
Given the above context, the economic operators which are willing to continue to do business in Saudi Arabia are required to be more transparent on their dealings.
It is not a coincidence that Saudi Arabia has introduced transfer pricing regulations, but also Mutual Agreement Procedure (MAP) in roughly the same period. There is no doubt that this is to align with international practices. However,it is also on the one hand, to give better tools to the tax administrations to perform risk assessments and, on the other hand,to give the opportunity to tax payers to eliminate double taxation through MAP or to secure their transactions in advance through proactive discussion with the authorities.
From a customs perspective, it is possible to get an agreement with ZATCA on the HS classification of the imported goods which leads to the applicable customs tariff but also on their origin and customs value. Saudi Arabia had also introduced the Authorized Economic Operators (AEO) by way of which the operator gets preferential treatment at the border in exchange of an increased transparency on its supply chain. From a corporate tax perspective, it is also possible to agree on the most appropriate transfer pricing policy and its arm’s length character. Given it is one single body, it might even be possible to gather different ZATCA departments from direct and indirect taxes around the table and get one agreement covering all type of taxes.
While the customs topic is not new, transfer pricing has put more emphasis on it. A clear rise in customs and transfer pricing controversy has been noticed in every major importing country that has recently implemented transfer pricing regulations. It is of particular importance in the GCC countries which are primarily importing nations of all kinds of goods while exporting their natural resources such as oil and gas.
Saudi Arabia has now bridged the gap between the tax fields and will use this to further challenge taxpayers and increase revenues.
While in most jurisdictions, strong transfer pricing documentation remains the best first line of defence to keep transfer pricing auditors at arm’s length, in other jurisdictions which have a helicopter view on the transactions,this might prove insufficient to avoid litigation, especially if the gaps cannot be justified.
To avoid controversy, the tax rulings and other kinds of programs such as AEO are probably the way to go for mitigating direct and indirect tax risks in the Kingdom of Saudi Arabia. The current audit landscape in the countryunderlines the importance of securing its key intragroup transactions across taxes and in advance.
By Mourad Chatar & Sarah Bahous, Partners at Value Square, Dubai
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