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Saudi Arabia Clarifies Taxation of Service Permanent Establishments in the Context of Double Taxation Agreements — Orbitax Tax News & Alerts

The Saudi Zakat, Tax, and Customs Authority (ZATCA) has issued a Circular dated 17 May 2023, Taxation of Permanent Establishments in the Context of Double Taxation Agreements. In particular, the Circular contains information and guidance regarding service permanent establishment (PEs), including their determination and tax implications in Saudi Arabia according to Double Taxation Agreements (DTAs) signed with foreign jurisdictions. In this regard, the Circular notes that the service PE concept in 54 of Saudi Arabia's 57 DTAs is based on paragraph 3 (b) of Article 5 of the UN Model Tax Convention (Article 5.3(b)) and provides clarity on the interpretation of Article 5.3(b), addressing:

  • The activities and business models that do or do not result in the creation of a PE under this Article; and
  • The taxation mechanism applicable in Saudi Arabia in instances where a PE is deemed to exist.

Instances where a Service PE Exists

Key points regarding instances where a service PE exists include the following:

  • In accordance with Article 5.3(b), a service PE would be deemed to exist when a non-resident enterprise provides services to a customer in Saudi Arabia;
  • The exact provision under Article 5. 3(b) may vary between DTAs, however in most of the DTAs signed with Saudi Arabia, the furnishing of services, including consultancy services, by an enterprise through employees or other personnel engaged by the enterprise is deemed to constitute a PE to the extent that the activities are conducted (for the same or a connected project) within a contracting state for a period or periods aggregating more than 183 days in any 12-month period commencing or ending in the fiscal year concerned;
  • There are three main tests to determine whether a service PE is deemed to exist:
    • "Furnishing of services", which means that the enterprise must be providing services through its employees;
    • "Within", which means that the employees must be physically present on the ground in Saudi Arabia; and
    • "More than 183 days in any 12-month period", which means that being physically present in the country for a certain period of time to perform the services is fundamental to determining whether or not the non-resident entity is deemed to create a PE in Saudi Arabia;
  • In most of Saudi Arabia's DTAs that have Article 5.3 (b), the threshold stipulated in the DTA is more than 182 days/ 183 days/ 6 months in any 12-month period, according to the respective DTA;
  • Under the DTAs, only the profits directly attributable to the PE may be taxed in Saudi Arabia provided that the relevant DTA does not contain a provision extending the scope of taxation under the Force of Attraction concept;
  • Profits directly attributable to the PE encompass the income derived from the sole activity of the PE in Saudi Arabia;
  • If a PE exists in Saudi Arabia, the non-resident is deemed to be subject to tax according to the relevant DTA and under the terms of Saudi law; and
  • In accordance with Saudi law, the PE shall be subject to income tax on a net basis measured by the gross income and reduced by the expenses attributable to the PE, provided that they are incurred for the purposes of conducting business through the PE.

Instances where a Service PE Does Not Exist

Key points regarding instances where a service PE does not exist include the following:

  • In accordance with Article 7 (Business Profits) of the DTAs, the profits of an enterprise of a contracting state shall be taxable only in that state unless the enterprise carries on business in the other contracting state through a PE situated therein;
  • Where a service PE does not exist, the profits of the non-resident enterprise should generally be taxable only in the residence state based on its domestic law;
  • Article 7 applies to all types of income from conducting business that are not covered by other articles of the DTAs with Saudi Arabia, which generally include service fees that do not trigger a PE and are not included in other articles;
  • In instances where a PE does not exist, the income generated by the non-resident in respect of activities performed for the benefit of a Saudi resident would not fall within the scope of income tax in Saudi Arabia, although in certain cases it may fall within the scope of withholding tax, in which case withholding tax will be imposed on the gross payment and not on the net profit (as with income tax); and
  • A limited number of DTAs treat technical services under Article 12 (Royalties), including the DTAs with Egypt, Ethiopia, Gabon, Georgia, Malaysia, Morocco, and Vietnam, under which the income generated from the provision of technical services should be subject to withholding tax under the Royalties Article on the gross amount paid to the non-resident enterprise (usually a lower rate than that the domestic rate).

Virtual Service PE

Although not mentioned in the Circular, the new guidelines are an important change from the tax authority's past approach regarding tax relief claims made under a tax treaty. Previously, it was provided that a non-resident could be deemed to have a "virtual service" PE in Saudi Arabia in cases where services are furnished under contract for a period exceeding the threshold set in the relevant tax treaty, even if there is no physical presence of employees or other engaged personnel in Saudi Arabia. As clearly specified in the new Circular, employees must be physically present in Saudi Arabia for a service PE to exist.