On September 18, 2018, Saudi Arabia signed the OECD Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (the MLI). By doing so, Saudi Arabia became the 84th jurisdiction to join the MLI, ahead of six other jurisdictions that have expressed their intent to sign the MLI.
The Multilateral Instrument
The MLI is a legal instrument which has been developed to amend and update countries' bilateral tax treaty networks in order to implement the tax treaty related measures under a number of actions of the G20 / Organisation for Economic Cooperation and Development's Base Erosion and Profit Shifting (BEPS) project, without requiring the renegotiation of a vast number of tax treaties. It contains a number of treaty related anti-abuse measures, each of which constitute either a minimum standard under the OECD BEPS Action Plan or an optional provision that countries may adopt.
Optional provisions offer participating jurisdictions flexibility in the choice of measures they want implemented in their tax treaties. By contrast, minimum standards are those provisions which all MLI participating jurisdictions must adopt and incorporate in their tax treaties unless an equivalent provision already exists in those tax treaties. The most important minimum standards include the anti-abuse provisions relating to treaty shopping in the form of the so-called Principal Purpose Test (the PPT) and/or the Limitation on Benefits (LOB) as well as the commitment to improve effectiveness of dispute resolution under the Mutual Agreement Procedures (MAPs).
Saudi Arabia's positions
Currently, Saudi Arabia has 46 bilateral tax treaties in force, three tax treaties that are ratified but are not yet in force and 11 tax treaties that are currently in negotiation. The majority of Saudi Arabia's tax treaties have been concluded in the past 5 years. The preliminary position indicates that 53 treaties will be covered by the MLI, including some that have not yet entered into force.
Following the adoption of the MLI, the minimum standards that are expected to be applicable to the covered tax treaties include
i. The adoption of a preamble in the covered tax treatie ii. The PPT and iii. Improved dispute resolution through the MAPs.
The MLI prescribes the modification of tax treaties' preamble language to make clear that tax treaties are not intended to create opportunities for non-taxation or reduced taxation through treaty shopping arrangements. Saudi Arabia has chosen to also include a sentence expressing the desire to further develop economic relationships and to enhance the co-operation in tax matters with its treaty partners.
The PPT looks at the principal purpose or one of the principal purposes for entering into a transaction or arrangement. If the principal purpose or one of the principal purposes of the transaction or arrangement is to secure tax treaty benefits, where granting such benefits would not be in accordance with the object and purpose of the relevant provision of the tax treaty, the PPT denies that treaty benefit.
Under one of the BEPS actions, countries have committed to strengthen the effectiveness and efficiency of the MAP. The improved dispute resolution mechanism will provide taxpayers with a more accessible MAP in cases where taxpayers are subject to taxation that is not in accordance with the provisions of the relevant tax treaty. A peer review and monitoring process is part of the improved MAP, which puts pressure on MLI signatories to resolve cases of taxation not in accordance with the provisions of the relevant tax treaty presented by taxpayers.
Upon signing the MLI, Saudi Arabia has chosen to adopt only a limited number of optional provisions, such as:
- the option to bring the terminology of the clause on relief for double taxation in line with the updated credit method
- the option to include a provision on the allocation of taxing rights for capital gains from the alienation of shares of entities deriving their value principally from immovable property and
- the provisions targeting artificial avoidance of permanent establishment (PE) status.
Except for the first optional provision listed above, the optional provisions require a "match" between Saudi Arabia and its treaty partners. That is to say both Saudi Arabia and its relevant treaty partner must have chosen the same optional provision before it effectively modifies the tax treaty application between Saudi Arabia and the relevant treaty partner.
Key takeaways for foreign companies operating and investing in Saudi Arabia
The developments around Saudi Arabia's Vision 2030 and Crown Prince Mohammad bin Salman's drive to further modernize and strengthen Saudi Arabia's economy has had a significant impact on foreign direct investment into Saudi Arabia. Saudi Arabia has been and will continue to be an important investment destination for many foreign multinationals and businesses in, for example, the infrastructure, technology and energy sectors. From a cost efficiency perspective, tax treaties often play a role in how these foreign businesses have structured their investments into Saudi Arabia – for example, to reduce domestic withholding taxes or capital gains tax on share transfers.
As Saudi Arabia has signed the MLI, its tax treaty network will be updated to include the minimum standards in respect of the preamble, principle purpose test and MAP provisions. The granting of tax treaty benefits will be subject to the PPT in addition to other (already existing) requirements, such as "residence" and "beneficial ownership." As many foreign multinationals and businesses operating and investing in Saudi Arabia rely on tax treaties to manage the effective tax burden of their investments into Saudi Arabia, the impact of the MLI will now have to be carefully analyzed to determine those structures' tax efficiency going forward.
Under the improved dispute resolution, Saudi and foreign taxpayers may be able to have better access (either directly or through competent authorities of the other countries) to Saudi Arabia's competent authorities to resolve any disputes resulting in taxation that is not in accordance with the provisions of the covered tax agreements. Due to the commitment reflected in the MLI and the pressure exerted by tools such as the OECD's peer review process, we are hopeful that the MAP will become a more effective tool for resolving cross-border tax disputes.
The adoption of the optional provision concerning real estate entities also means that it may be necessary to review, monitor, and if necessary (subject to the matching provision being adopted by the treaty partner country), revise, existing structures for real estate investments in Saudi Arabia. The same applies to supply chain structures that mitigate the existence of permanent establishments in Saudi Arabia. These issues are an immediate concern if the investors are located in a treaty partner country that has adopted these provisions in the MLI. Even where the other treaty partners have not signed up to these MLI provisions so that there is no legal basis for challenging the existing structures currently, the position of Saudi Arabia is a clear indication that real estate and supply chain structures used for investing into Saudi Arabia may need to be able to withstand such scrutiny in the longer term.