1. Summary
In late 2023, Saudi Arabia’s Zakat, Tax and Customs Authority (“ZATCA”) initiated a public consultation process to introduce a new Income Tax Law (“ITL”) to replace the current framework. The proposed law, still under review, is designed to modernize the ITL in line with leading global tax standards while fostering a more business-friendly tax environment.
This article explores the key provisions of the draft ITL, the implications of its potential implementation, and notable aspects that have been omitted but warrant consideration.
2. Context
Saudi Arabia’s tax framework is distinct, featuring both Income Tax (“IT”) and Zakat, a religious levy and one of the five pillars of Islam. The taxation of capital companies depends primarily on the nationality of shareholders and the proportion of profits attributed to them, though exceptions exist and each case requires individual assessment. The draft ITL maintains this principle, meaning its primary impact will be on taxpayers fully or partially subject to IT. However, companies paying Zakat should also be attentive, as provisions regarding withholding tax apply to all businesses regardless of tax status.
The ITL, originally enacted in 2004, has undergone some amendments over the years while largely retaining its core framework. The following chart illustrates IT revenue trends and its relative contribution to overall government income, using data from the Ministry of Finance:
| Year | IT Revenue (SAR billion) | Total Tax Revenue (SAR billion) | Total Revenue (SAR billion) | IT Contribution to Total Tax Revenue | IT Contribution to Total Revenue |
|---|---|---|---|---|---|
| 2019 | 17 | 220 | 927 | 7.73% | 1.83% |
| 2020 | 18 | 226 | 782 | 7.96% | 2.30% |
| 2021 | 18 | 317 | 965 | 5.68% | 1.87% |
| 2022 | 24 | 323 | 1,268 | 7.58% | 1.93% |
| 2023 | 38 | 356 | 1,212 | 10.83% | 3.19% |
Key Observations:
- The IT’s share of total tax revenue remains relatively small, with most revenue derived from indirect taxes such as VAT and excise duties.
- Its contribution to overall government revenue is even lower due to Saudi Arabia’s heavy reliance on oil income.
- The slight decline in IT’s share of total tax revenue in 2021-2022 may be linked to pandemic-related tax losses carried forward under existing rules, as well as the rise in indirect tax revenues following the VAT increase from 5% to 15% in 2020.
- Recent years have seen steady IT revenue growth, with a significant 50% year-on-year increase in 2023, surpassing Zakat revenue. This reflects Saudi Arabia’s economic diversification efforts, foreign investment inflows, and initiatives such as penalty waivers for tax settlements.
Looking ahead, IT is expected to play a more prominent role in Saudi Arabia’s fiscal strategy as international investment expands. Recognizing this, ZATCA is working to overhaul the IT system to align with global best practices while maintaining the Kingdom’s long-term economic vision. The draft ITL was open for public consultation between October and December 2023, attracting substantial engagement from the legal and tax sectors, with 219 Arabic and 103 English comments submitted via the Istitlaa platform. The proposal is currently under review by ZATCA.
3. Proposed Reforms
The draft ITL introduces significant modifications aimed at enhancing investment incentives while curbing tax avoidance. Key proposals include:
- Expanded tax residency criteria: New conditions for tax residency include domicile status in Saudi Arabia or a recurrent but intermittent presence over three years.
- Broader income sourcing rules: Capital gains from indirect transfers of shares or interests in Saudi entities with significant domestic assets or real estate would now be subject to IT.
- New permanent establishment threshold: A service-based permanent establishment could be established after just 30 days of business presence within a 12-month period.
- Preferential tax regimes list: Introduction of a “blacklist” of jurisdictions considered preferential tax regimes, with tax consequences for transactions involving entities based in such locations.
- Defensive tax measures: Transactions with entities in preferential tax regimes may face limitations on tax deductions, exemptions, and depreciation.
- Investment incentives: Tax deductions for reinvested capital gains, research and development expenditures, and environmentally friendly projects.
- Hybrid mismatch rules: Limitations on tax deductions for financial instruments that result in hybrid mismatches.
- Foreign tax credits: Clearer guidelines on deducting foreign income taxes paid, subject to certain limits.
- Thin capitalization rules: Deductibility of net financial expenses capped at 30% of adjusted profits, in line with international standards.
- Regulations for non-Saudi tax residents: Clarification on taxation of non-Saudi residents conducting economic activities in the Kingdom.
- Participation exemption regime: Expanded exemptions for dividends, capital gains, and liquidation proceeds.
- Exit tax: A tax on companies and certain individuals relocating their tax residency outside Saudi Arabia.
- Revised partnership taxation: Transition from transparent to opaque taxation, shifting liability from partners to the partnership itself.
- Tax relief for M&A transactions: Favorable tax treatment for intra-group reorganizations and certain corporate restructurings.
- Withholding tax reform: Overhaul of the withholding tax regime, with higher rates for payments to entities in preferential tax regimes.
Omissions and Future Considerations
The draft ITL does not explicitly address:
- OECD’s Pillar One and Pillar Two: While Saudi Arabia is a signatory to the OECD’s global tax reforms, no domestic provisions have been announced.
- Special Economic Zones (SEZs): Despite recent government initiatives to establish SEZs with attractive tax incentives, the draft ITL remains silent on their treatment. However, a separate article suggests that ZATCA or relevant authorities may issue special tax provisions for designated activities or locations in future regulations.
- Regional Headquarters (RHQ) tax incentives: Although ZATCA initially proposed exempting RHQs from IT, the final ITL draft did not incorporate this measure. However, in February 2024, new RHQ Tax Rules introduced a 0% IT rate and 0% withholding tax for qualifying RHQs.
4. Final Thoughts
Saudi Arabia is progressively aligning its tax framework with advanced global practices. The proposed ITL includes a mix of business-friendly measures and anti-avoidance mechanisms, positioning the Kingdom as a more competitive international tax jurisdiction.
While further regulatory details are expected, the ITL introduces new complexities, making ZATCA’s interpretations and the Tax Committee’s rulings crucial in shaping its practical application. Additionally, forthcoming legislation on SEZs and OECD tax reforms will further define the Kingdom’s tax landscape.
5. How We Can Assist
Our team specializes in Saudi tax law and has extensive experience advising on IT matters, regulatory compliance, and tax dispute resolution. With deep insights into ZATCA’s practices and the Tax Committee’s rulings, we are well-positioned to help clients navigate the evolving tax landscape, optimize tax planning, and ensure compliance with the new ITL requirements.