The KSA Tax Authorities (“GAZT”) released draft transfer pricing bylaws in December 2018 (there was a period of consultation until early January 2019 so the bylaws will soon be finalized). Immediate action is required if the bylaws apply to groups operating in KSA.
This article sets out a summary of the main provisions and it should be noted that there is a good amount of consistency with the OECD Transfer Pricing Guidelines; however, there are disclosure requirements due April 2019 for groups operating in KSA (Kingdom of Saudi Arabia). In addition, local files must be produced within seven days of request and as such this will place an increased compliance burden on businesses that ordinarily adopt a risk-based approach to preparing local files.
The bylaws are organized into 12 chapters.
Chapter 1: Definitions
Many of the definitions are consistent with the OECD Guidelines/Model Treaty/Commentary; however, it is worth drawing out the definition of control which includes a number of transactional elements designed to isolate effective control through business dealings—it is important to be aware of these as many joint ventures (“JVs”) below the standard 50 percent threshold may be caught by the regulations.
The transactional tests are grounded in logic where one person is over-reliant on the other from a business perspective creating a potential control relationship. The transactional tests establish a control relationship where there is:
- ability to conclude an agreement to provide management services or otherwise effectively perform functions of management;
- ability to act as a Trustee (manager) under a Trust arrangement;
- ability to directly or indirectly control the composition of 50 percent of the Board OR the right to appoint or dismiss representatives of management;
- legal or de facto right to receive (directly or indirectly) 50 percent of profits;
- loans outstanding are 50 percent of the funds needed for the borrower’s business;
- guarantees to cover 25 percent of total borrowings;
- 50 percent of business activities depend on transactions;
- directly or indirectly hold 50 percent;
- jointly or severally the principal or supplier under an exclusive agency, distributor arrangement or similar contract for the sale of goods, services or rights AND a dependent agent;
- a substantial portion of the business activities depend on transactions AND business activities depend on rights in intangible property granted on an exclusive basis; and
- jointly or severally able to control the business decisions in any other way as evidenced by the facts and circumstances.
Chapter 2: Scope of Application
The bylaws apply to all taxable persons (notwithstanding any provision to the contrary) and controlled transactions must be conducted on terms that are similar to comparable transactions between independent persons. Transactions are deemed to be at arm’s length if terms are “materially similar” recognizing that a perfect comparable may not exist. Divergence from the arm’s length principle will require (self) adjustments to the tax base to reinstate arm’s length conditions (and will require disclosure of these adjustments to the tax authority).
Where there is divergence from the arm’s length principle, the tax authority may:
- direct for tax adjustment to be made; or
- reallocate and re-categorize revenue and expenses.
The divergence sections confirm that secondary adjustments in tax returns will be sufficient and so there is no requirement for primary accounts to be impacted by transfer pricing (that said, most businesses prefer for accounting and tax reporting to be aligned and consistent).
The bylaws confirm that the tax base of a permanent establishment (“PE”) must be determined according to the arm’s length principle. This is a helpful clarification given the historic treatment of PE (10–80 percent deemed profit margins depending on the activity).
Chapter 3: Comparability
Comparability is confirmed to be in place where there are no significant differences that could materially affect the financial indicator being examined or where such material differences exist, a reasonably accurate comparability adjustment can be made to eliminate the effect of the significant differences.
The following factors should be considered (1–5 below are aligned for the most part with Chapter 1.36 of the OECD Transfer Pricing Guidelines):
- Characteristics of the property or services transferred;
- Functions undertaken, assets employed, and risks assumed;
- Contractual terms of the transactions;
- Economic circumstances;
- Business strategies; and
- Any other economically relevant aspect of the transaction.
Some differences exist in the wording of Chapter 1.37 (e.g. “property transferred” or “services provided” versus “property or services transferred”). Note that the order of the above factors is different to Chapter 1.37 with characteristics being promoted from third to first.
There are a number of examples provided in the bylaws for functions, assets and risks and it is recommended that all of these are addressed in local files (with additional items then added).
Chapter 4: Approved Methods
The bylaws require application of the method that, under the facts and circumstances, provides the most reliable measure of an arm’s-length result taking into account:
- The respective strengths and weakness of the approved methods;
- The appropriateness of an approved method determined in particular through an analysis of the functions undertaken by each person;
- The availability of reliable information; and
- The degree of comparability.
The bylaws set out approved methods that are consistent with Chapter 2.1 of the OECD Transfer Pricing Guidelines:
- Comparable Uncontrolled Price
- Resale Price
- Cost Plus
- Transactional Net Margin
- Transactional Profit Split
Most businesses will be familiar with the above methods and the bylaws confirm that multiple methods will not be required. In addition, an alternative method to the above may be considered if under the facts and circumstances it will be more accurate and there is also a provision permitting the combination of transactions if they are “economically closely linked.” The OECD guidelines are not referred to in the bylaws but it is clear that the guidelines have been applied.
Chapter 5: Arm’s Length Range
The arm’s length range is defined as a range of acceptable arm’s length financial indicator figures (such as (without limitation) prices, margins, or profit shares)) produced by the application of the most appropriate transfer pricing method selected in accordance with Chapter 4 of the bylaws to a number of uncontrolled transactions, each of which is relatively equally comparable to the controlled transaction based on a comparability analysis conducted in accordance with the bylaws.
Where the relevant financial indicator derived from a controlled transaction or from a set of transactions that are combined, falls outside the arm’s length range, the authority may adjust it pursuant to the bylaws; any such adjustment shall be to a point within the arm’s length range that best reflects the facts and circumstances of the case.
Chapter 6: Sources of Information
The bylaws confirm that tax authorities and businesses should not rely on comparable transactions or information related thereto that is not, or could not be made, available to the other party.
The authority may accept the use of foreign comparable transactions in the event that domestic comparable transactions are not available or absence of domestic comparable transactions. In such case, the business must be able to demonstrate that the foreign comparable transaction(s) are consistent with the requirements for comparability set out above and shall take into account the expected impact of geographic differences and other factors on the results of the foreign comparable transactions, including, without limitation, price and profitability.
So called “secret” comparables have been an issue in other jurisdictions and the clarification around foreign comparables is also helpful for businesses.
Chapter 7: Disclosure Form
Businesses will have to submit a disclosure form to the tax authorities 120 days after the end of the financial year. This disclosure form has 10 elements to it:
- Information about businesses (and related persons) party to the controlled transaction(s), including the name and the country or countries in which they reside and are established;
- Information about any business restructuring for the MNE group;
- Information about the legal and beneficial owners of the business, including the name and the country or countries in which they are established and reside and the percentage of ownership;
- Total revenue, total expenses and amount of net profit (loss) as reported in the annual income tax declaration for the same year;
- Information about the type and nature of the relationship among the related persons party to the controlled transaction;
- A description of the nature of the business activity or activities of the related persons and of the controlled transactions;
- Transactional information, including aggregate amounts of consideration, nature of receipt or income or nature of payment or expenditure;
- The transfer pricing method applied;
- A statement if the business has entered into any controlled transaction, or any transaction without consideration or non-monetary consideration (such as barters and trades). Details of such transaction(s) to the tax authority along with the disclosure form, including information on the fair market value of the consideration or barter exchange; and
- Whether the business maintains transfer pricing documentation including the master file and local file.
Chapter 8: Documentation
A master file must be prepared and will be due within 30 days of request.
The format is closely aligned with the OECD guidelines to include:
- organizational structure;
- description of business;
- information on intangibles;
- information on financial activities/transactions; and
- information on financial and tax positions.
A local file must be prepared and will be due within seven days of request.
The format is closely aligned with the OECD guidelines to include:
- description of management structure and business strategies;
- description of controlled transactions (and supporting documentation/contracts);
- identification of all related persons;
- comparability and functional analysis;
- transfer pricing methods;
- industry analysis; and
- financial information.
A Country-by-Country Report (“CbCR”) must be prepared and filed for ultimate parent entities in KSA.
The format is closely aligned with the OECD guidelines and must be filed 12 months after the reporting year. Notifications (i.e. that the business is filing elsewhere) are due 120 days after the reporting year and the CbCR only applies to groups with turnover exceeding 3.2 billion riyal ($853 million).
It is helpful that documentation requirements are consistent with OECD guidelines; however, the requirement to produce a local file in seven days upon request will increase the compliance burden on groups that take a modular/risk-based approach to preparing documentation. There is a 6 million riyal de minimis exemption (based on the volume of intra-group transactions) from documentation requirements which will help start-up investments in KSA.
Chapter 9: Corresponding Adjustments
The bylaws permit the tax authority to examine the consistency of adjustments with the arm’s length principle and make an appropriate adjustment to the tax base with the view to eliminating economic double taxation. When applicable, the tax authority will communicate with the relevant foreign competent authority in accordance with the mutual agreement procedures set out in the relevant international agreement with the country party to such agreement.
In order for the tax authority to invoke the corresponding adjustment procedure, businesses should submit an application by disclosing all required facts and circumstances substantiating their claim.
The authority may reject to apply the provisions of the corresponding adjustments where the arrangement is considered artificial or abusive.
Chapters 10–12: Audit Procedures, Interpretation and Final Provisions
- Audit procedures will follow general income tax law procedures.
- Transfer pricing guidelines are likely to be released helping to clarify the bylaws.
- The transfer pricing documentation requirement has effect December 31, 2018 and is applicable to controlled transactions during the fiscal year ending December 31, 2018.
- Don’t assume that the bylaws do or do not apply (we have been working with a number of businesses in this regard); the definitions of control are widely drawn yet there are some important exemptions that may help. A small amount of preliminary risk assessment/design will help to assess compliance requirements before jumping into compliance procedures.
- Businesses that are concerned about PEs in KSA may benefit from “self-assessing” the PE as the level of deemed profit attributed under the bylaws may be lower than under historic PE challenges.
- There are three immediate actions required if the bylaws do apply to groups operating in KSA:
- Submit the relevant disclosure form to the General Authority of Zakat & Tax ("GAZT") by April 2019 along with tax returns;
- Prepare the KSA local file by April 2019; and
- If consolidated global turnover exceeds $850 million, non-KSA parented groups will need to notify GAZT by April 2019 that they are filing CbCR elsewhere.
Shiv Mahalingham is Middle East Transfer Pricing Leader Deloitte LLP.