Saudi Arabia releases guidelines on related-party transactions for zakat purposes

Executive summary

In November 2023, Saudi Arabia's Zakat, Tax and Customs Authority (ZATCA) published the Guidelines on Related Party Transactions for Zakat purposes (pdf) (Guidelines) on its website.

The purpose of the Guidelines is to clarify related-party transactions for zakat purposes and provide practical guidance on the zakat treatment for such transactions in accordance with the Zakat Bylaws issued through Ministerial Resolution No. 2216 dated 7/7/1440H.

Detailed discussion

Background

On 20 April 2023, the Board of Directors of the Zakat, Tax and Customs Authority (ZATCA) issued Decision No. (8-2-23) dated 28/08/1444AH (Decision), approving certain amendments to the current Transfer Pricing Bylaws to expand its scope to include zakat payers. The amendment to the Transfer Pricing Bylaws will take effect from 1 January 2024. See EY Global Alert, Saudi Arabia approves amendments to the Transfer Pricing Bylaws to include zakat payers as part of covered entities, dated 11 April 2023.

The ZATCA has issued the Guidelines to clarify the related-party transactions concept for zakat payers and its impact on the zakat.

Highlights of the Guidelines

The Guidelines provide extensive details and classify related-party transactions under the following categories:

1. Commercial transactions (e.g., sale of goods and provision of services): For zakat computation, if the transaction is not based on the "arm's length" principle, adjustment for the excess amount is required.
2. Indirect financing (e.g., payments of any cost or invoice by a related party on behalf of the zakat payer): This will not necessarily require an adjustment for zakat purposes.
3. Direct financing (e.g., loan financing): This may include working capital financing, long-term shareholders' financing, related-party or shareholder's cash asset financing and related-party or shareholder's in-kind financing. Loans from related parties are generally treated as debts and equivalents for zakat purposes; however, based on their nature and terms, these may be reclassified as equity and treated accordingly.

The Guidelines clarify the cases in which credit balances of the above transactions should be treated as liabilities, and, as such, added to the zakat base as per Article 4(3) of the Zakat Bylaws. The ZATCA also clarifies the cases in which such credit balances are treated as equity elements and added to the zakat base in full.

The guidelines also address certain related-party transactions, related credit balances and their zakat treatment as follows:

• If an amount due to a shareholder or a related party is classified as part of equity, it will be treated accordingly for zakat purposes based on Article (4)1 of the Zakat Bylaws.
• Outstanding liabilities that arise from related-party transactions and classified as long-term, will be treated as such for zakat purposes based on Article (4)3 of the Zakat Bylaws, unless the substance of the transaction is of a capital nature.
• If any liability resulting from related-party transactions is classified as short term, and the nature of such transaction is commercial, such liability should not be treated as capital.
• Shareholder's loans in listed companies should be treated as equity or liabilities for zakat purposes, based on their classification in the financial statements.
• Owners' and shareholder's loans in individual establishments and one-person companies are treated as equity (irrespective of their classification in the financial statements) and should be added to the zakat base without applying the capping rule.
• Shareholders' loans in other capital companies will be treated as liabilities if the following conditions are met:
  • Financial statements audited by a licensed accountant in Saudi Arabia are available.
  • The shareholders' loans are classified under liabilities in the financial statements.
  • Debt financing agreement is available, including agreed terms of repayment and return/interest.
• Where the debtor treats the due-to-related-party loans as "equity," the creditor will be able to deduct the loan receivable from the zakat base.
• No offset is allowed between shareholders'/related parties' debit and credit balances that resulted from different commercial or financing transactions unless this is performed for accounting purposes.
• Zakat payers' assets that are in the name of shareholders may be deducted from the zakat base even if the title is still with the shareholders, based on the following conditions:
  • There is a restriction or justifiable delay in transferring the title to the zakat payer.
  • The assets are used for the company's activities.
  • The assets represent in-kind capital contribution.
• Shareholders' salaries and allowances are fully deductible expenses for zakat purposes if:
  • A legal employment contract is in place.
  • Registration with the General Organization for Social Insurance (GOSI) is completed.
  • The provisions of the Wages Protection System apply.

Implications

Taxpayers, zakat payers and businesses should assess the nature of their transactions with related party to determine the appropriate zakat treatment, adhering to the guidance provided in the Guidelines.

For additional information with respect to this Alert, please contact the following:

Ernst & Young Professional Services (Professional LLC), Riyadh

• Asim Sheikh, Saudi Arabia Tax Market Segment Leader
• Ahmed H Akeel, Business Tax Services
• Amr Farouk, Global Compliance & Reporting
• Atif Khan, Global Compliance & Reporting
• Esraa Albuti, Business Tax Services
• Hosam Abdulkareem, Business Tax Services
• Imran Iqbal, Global Compliance & Reporting
• Mirza Ashraf, Global Compliance & Reporting
• Babar Ali, Business Tax Services
• Wissam Merhej, Business Tax Services
• Carl Suchtelen, Global Compliance & Reporting
• Rula Dajani, Business Tax Services
• Suleiman Mohammed, Global Compliance & Reporting
• Billy Thorne, International Tax and Transaction Services
• Carsten Kuhlmann, International Tax and Transaction Services
• Ricardo M. Cruz, KSA ITTS and Transfer Pricing Leader

Ernst & Young Professional Services (Professional LLC), Jeddah

• Ayman Abu El lzz, Global Compliance & Reporting
• Hussain Asiri, Business Tax Services
• Amro El Fadly, Business Tax Advisory
• Ahmed Mubarak, Business Tax Services
• Dana D. Dandashi, Global Compliance & Reporting
• Khalid Feroze, Business Tax Services
• Asem Habis, Business Tax Services
• Suleman Mulla, International Tax and Transaction Services

Ernst & Young Professional Services (Professional LLC), Al Khobar

• Syed Farhan Zubair, Global Compliance & Reporting
• Ali K. Khamis, Business Tax Services
• Bilal Mian, Global Compliance & Reporting
• Javed Aziz, Global Compliance & Reporting
• Haytham Hassan, Global Compliance & Reporting
• Waqas Khan, Business Tax Services

EY Consulting LLC, Dubai

• Guy Taylor, MENA Transfer Pricing Leader

Ernst & Young — Middle East, Bahrain

• Miranda Baas, International Tax and Transaction Services
• David J. Macklin, International Tax and Transaction Services
• Patrick Oparah, International Tax and Transaction Tax — Transfer Pricing

Ernst & Young LLP (United States), Middle East Tax Desk, New York

• Asmaa Ali

Published by NTD’s Tax Technical Knowledge Services group; Carolyn Wright, legal editor

For a full listing of contacts and email addresses, please click on the Tax News Update: Global Edition (GTNU) version of this Alert.