Tax Alert: Guidelines for transactions

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On 26November 2023, the Zakat, Tax, and Customs Authority (ZATCA) issued guidelines underlining the Zakat treatment of transactions between related parties for the purposes of calculating the Zakat base in accordance with the Zakat collection implementing regulations, issued pursuant to the Ministerial Resolution No. 2216 dated 4 March 2019, the “Zakat Regulations.”

In summary

ZATCA has outlined the Zakat treatment with explanatory examples of the most common transactions executed between related parties to limit the disputes with the Zakat payers. These common transactions have been categorized into the following three categories:

Commercial transactions, like the provision of goods or services or both.
Expenses paid on behalf of the related parties, which are termed as indirect financing under these guidelines.
Direct financial transactions (non-banking).

Further, ZATCA has specified threshold to maintain transfer pricing documentation for Zakat payers in accordance with the Transfer Pricing Bylaws issued by ZATCA.

In detail

The transactions between related parties and their treatment are as follows:

1. Commercial transactions – Transactions, such as provision of goods or services, that are not at arm’s length price shall be treated in accordance with Paragraph No. 6 of Article No. 9 of the Zakat Regulations and accordingly, expenses which are more than the market price shall be disallowed when calculating the Zakat-adjusted profits of the year.

2. Expenses paid on behalf of related parties – ZATCA has specified that since these transactions are merely payments on behalf of related parties and do not impact the income statement of the Zakat payers, therefore, no adjustment is required to the Zakat base. However, if there are any outstanding balances at the end of the financial year, these shall be considered as debts and treated in accordance with the provision of the Zakat Regulations.

3. Direct Financial transactions (non-banking) – Financial transactions illustrated by ZATCA are described in the following table.

Transactions	Zakat treatment
Long-term liabilities, classified in substance as loans and not as capital.	Long-term liabilities shall be added to the Zakat base (proportionately, if obtained during the year, unless used in financing a Zakat deductible asset, in such case the entire liability amount shall be added to the Zakat base).
Financing, classified as short-term loans.	Short-term liabilities shall not be added to the Zakat base (unless used in financing a Zakat deductible asset, in such case the entire liability amount shall be added to the Zakat base).
Long-term liabilities, which are in substance classified as equity and not as loan.	Equity shall be added to the Zakat base (proportionately, if obtained during the year, unless used in financing a Zakat deductible asset, in such case the liability entire amount shall be added to the Zakat base).

4. Financial transactions specified as loan or equity – ZATCA has also identified certain financing transactions that should be treated as either loan or equity.

Transactions	Zakat treatment
Loans from shareholders in joint-stock companies listed in the stock market.	Such loans shall be treated according to their classification in the statutory financial statements. For instance, if these loans are classified as long-term loans, these shall be treated as such for Zakat purposes.
Loans from shareholders in single person companies, sole proprietorships, and similar partnerships.	Such loans shall be treated as equity, regardless of their classification in the statutory financial statements.
Loans from shareholders in capital companies or partnerships that do not end up under the control of a single party.	Such loans are treated as liabilities when the following conditions are met: a) Maintenance of audited financial statements. b) Must be classified as liabilities in the Zakat payer’s financial statements. c) Maintenance of loan agreements that specify the repayment and interest terms.

5. In-kind contribution by shareholders – In cases where shareholders provided an in-kind contribution to the company’s equity by transferring a property or machinery and as such assets are allowed as a deduction from the Zakat base. Accordingly, the corresponding equity contribution shall be added as well to the Zakat base.

6. Compensation paid to company board members – ZATCA emphasized that the Zakat Regulations allow the deduction of the compensation paid to board members, under the condition that these rewards are fair and at an arm’s length.

7. Partners’ salaries – Partners’ salaries and allowances registered with GOSI are considered deductible expenses without specifying a limit, provided the existence of an employment contract and that the same compensations are disclosed with GOSI and are subject to the Wage Protection System (WPS) in Saudi Arabia.

8. Assets recognized in the financial statements, whereas legal ownership remains with the shareholder instead of the company – Such assets are allowed as a deduction from the Zakat base, to the extent of the corresponding equity added to the Zakat base, provided that:

A. There is an obstacle preventing the transfer of ownership of the asset to the company;

B. Asset is used in the company's activities; and

C. Corresponding in-kind equity is recognized as capital in the financial statements.

Transfer pricing documentation for Zakat payers – Zakat payers are required to disclose related party transactions without any threshold starting from 1 January 2024. In addition, Zakat payers are required to maintain transfer pricing documentation, i.e., local file (LF) and master file (MF) in two phases in accordance with the following thresholds:

Phase 1 (fiscal years starting 1 January 2024 to 2026):

Arm’s length value of related party transactions	Documentation requirement
SAR 100 million or more	Mandatory
More than SAR 48 million and less than SAR 100 million	Optional
SAR 48 million or less	Not required

Phase 2 (fiscal years starting 1 January 2027 onward) (*):

Arm’s length value of related party transactions	Documentation requirement
More than SAR 48 million	Mandatory
SAR 48 million or less	Not required