How to calculate Taxable Income in Saudi Arabia

How to calculate Taxable Income in Saudi Arabia: Taxable Income is the gross income including all revenues, profits and gains of any type and of any form of payment resulting from carrying out an activity, including capital gains and any incidental revenues, minus exempted income.

Tax-Exempt Income

The following types of income are exempt from income tax:

(a) Capital gains realized from disposal of securities traded in the stock market in the Kingdom in accordance with restrictions specified in the Regulations.

(b) Gains resulting from disposal of property other than assets used in the activity.

Gains or Losses from Disposal of Assets

a)The gain or loss from the disposal of an asset is the difference between the compensation received for the asset and its cost base.

b)No gain or loss on disposal of a depreciable asset is taken into account other than what is stated in Article Seventeen of this Law.

c)In determining taxable income, a natural person may not take into account gain or loss on disposal of an asset that is not for use in the activity.

d)The cost base of an asset purchased, produced, manufactured, or constructed by the taxpayer itself is the amount paid or incurred by the taxpayer in cash or in kind in the process of acquiring the asset.

e)Where a taxpayer disposes of a part of an asset, the cost base of the asset is apportioned between the part retained and the part disposed of in accordance with their market value at the time of purchase of the asset.

f)Expenses incurred to alter or improve a non-depreciable asset are added to the cost base of the asset.

g)The compensation value for disposal of an asset against assets in kind is based on the market value of those assets in kind, including exemption from debt on the asset

h.Where a taxpayer disposes of an asset by way of gift or inheritance, the disposer is treated as having received compensation equal to the market value of the asset at the time of disposal, unless the asset disposed of is encumbered by debt exceeding its market value.

i.If the asset disposed of is encumbered by debt exceeding its market value, the taxpayer disposing of the asset is treated as having received compensation equal to the value of such debt.

j.In determining the tax base, no gain or loss is taken into account on an involuntary disposal of an asset to the extent that the compensation value is used in purchasing an asset of the same kind within one year of the involuntary disposal.

k.The cost base of a replacement asset as explained above is determined with reference to the cost base of the replaced asset.

l.Where an asset owned by a taxpayer is converted to personal use or otherwise ceases to be used in the generation of income, the taxpayer is deemed to have disposed of the asset for its market value, with the recognition of the resulting gain but not the loss.

Deductible Expenses

Donations

Paid during the taxable year to public agencies or philanthropic societies licensed in the Kingdom which are nonprofit organizations and are allowed to receive donations.

Operational Expenses

Operational expenses paid or accrued which meet the following:

a) It is an actual expense, supported by verifiable document or other proving evidence.
b) Related to earning taxable income.
c) Related to the subject tax year.
d) Of non-capital nature.

Loan Charges (proceeds)

Incurred during the tax year if related to income subject to tax, or

The resultant of the following formula which ever is less:

The taxpayer’s total income from loan charges + 50 percent of (a – b).

“a” is income subject to tax other than income from loan charges.

“b” is expenses allowed under the Law other than loan charge expenses.

Banks are not subject to this formula.

Bad Debts

Provided they meet the following conditions:

a)Bad debt was previously declared in the proper year’s income.

b)Debt was resulted from sale of goods or services.

c)Having a certificate by the taxpayer’s certified public accountant certifying the writing off of the debt from the taxpayer’s books and records based on a decision by the taxpayer’s proper authority.

d)Serious efforts have been exerted by the taxpayer to collect the debt with no success; and inability of debtor to pay is proved based on a judicial ruling or bankruptcy.

e)Debt is not on a related party.

f)Commitment by the taxpayer to reinstate as income any written off debt whenever collected.

Depreciation

a)The asset is not intended for resale; it is to be used, in full or in part, for the entity’s purposes.

b)The asset is of depreciable nature that loses value because of use or because of wear and tear and obsolescence and which has a value extending beyond the end of the taxable year.

c)The asset is owned by the business as per ownership document for buildings, and contracts and invoices for other assets.

d)The asset depreciation is allowed even if the asset becomes in-operational during the tax year.

Allocations and Reserves

Formed during the year as follows:

Bank allocations to a reserve fund for doubtful debts. A bank must submit a certificate from Saudi Arabian Monetary Agency (SAMA), stating amount of doubtful debts, amount of doubtful debts collected during the year that should be reinstated in the tax base of the year of collection.
Insurance/reinsurance companies may deduct, based on industry standards, a reserve for unearned premiums and for unexpired risks provided that it is reported in the tax base of the following year.

A reserve for unearned premiums means part of premiums amount collected or stated in books that covers risks related to up-coming tax year(s). A reserve for unexpired risks means amount of compensation claimed or reported but payment process falls short of completion during the tax year.

Reserves Used

A taxpayer may reduce its book profit by the amount of a reserve used during the year that had been readjusted when it had been made to increase income/decrease expenses in the year of formation. Examples of such reserves are end-of-service award, doubtful debt, and drop in prices. Such amount is allowed provided the following conditions are met:

The used amount was paid or accrued during the year and it is supported by proving documents.
The reserve had been adjusted in the year of formation to increase tax base.

School Fee for employee kids

Deductible if meet the following conditions:

They are paid to a local licensed school.
This benefit is stated in the employment contract.

Contributions to employees’ pension funds

Employer’s contributions to employees’ pension funds or saving funds established under the Kingdom’s rules and regulations, provided that such contribution, one payment or in aggregate, is not in excess of 25 percent of the employee’s income before the employer’s contributions and that the fund meets the following:

The Fund is established according to special provisions that clearly stipulate conditions of subscription and rights of subscribers.
Such obligation is stated in the employment contract or in the Articles of Association of the establishment.
The Fund has a character independent of the establishment and has separate accounts audited by an independent certified public accountant.

Research and development expenditures

A deduction is allowed for research and development expenditures incurred during the tax year and connected with the earning of income subject to tax. These expenditures mean research and development, experiments on technical, scientific and engineering aspects, computer systems or similar aspects. This provision does not allow for acquisition of land and facilities on it, or of equipment used for research, such facilities and equipment being subject to depreciation.

Non-Deductible Expenses

■Payment to Benefit Owners, Shareholders or their relatives

a)Wages, salaries and whatever deemed so, in cash or in kind, paid to an owner, partner or shareholder, or to a member of their families: a parent, spouse, sons/daughters and brothers/sisters. This provision does not apply to stockholders in a stock company.

b)Compensation in cash or in kind paid to a partner, shareholder, or to a member of their families: a parent, spouse, sons/daughters and brothers/sisters for a property or service to the extent that the compensation is higher than the fair market value of such property or service at time of transaction.

■Entertainment Expenses

Parties, sport competitions, entertainment trips and activities, etc.

■Personal Consumption

Such as personal withdrawals, dependents’ cost of living or education.

■Financial Fines and Penalties

a)Income tax and related fines and penalties paid or payable to the Kingdom or to other countries.

b)Financial fines or penalties paid or payable to any party in the Kingdom, such as traffic fines, or fines for causing damage to public utilities

(This does not include fines or penalties paid for breach of contractual obligations, such as fines on delayed or defaulted completion of contracts, such fines are deductible provided they are documented by the contracting party and the income from such penalties reported in the year of recovery.)

■Illegal Payments

Any bribe or similar payment that is considered an illegal practice in the Kingdom, even if paid abroad.

■Insurance Commission

In excess of 3 percent of total premiums collected in the Kingdom through the agent or others and whether the agent is a partner or not.

■Employee pension Contribution

Payments by employers of their employees contributions to a legal pension fund, social insurance or saving funds.

■Payment to Head-Office

Payments made to head-offices abroad by fully owned local subsidiaries for:

royalties or commissions;
loan charges ( proceeds) or any other financial fees;
indirect administrative and general expenses allocated on estimated basis.

■Payment to Related Parties

Value of goods or services delivered to the taxpayer by related parties to the extent that it is in excess of an arm’s length value.

Depreciation

Except for land, depreciation may be deducted for a taxpayer’s depreciable tangible or intangible assets which lose value because of wear and tear or obsolescence and which are wholly or partly used in the generation of taxable income, and remain to have a value after the end of the taxable year.

Depreciation rate for Depreciable Assets

Depreciable assets are classified into groups and depreciation rates as follows:

1.Stationary buildings: five percent (5%).

2.Movable industrial and agricultural buildings: ten percent (10%).

3.Factories, machines, engines, hardware and software (computer software) and equipment, including passenger and cargo vehicles: twenty five percent (25%).

4.Expenses for geological surveying, drilling, exploration, and other preliminary work to exploit natural resources and develop their fields: twenty percent (20%).

5.All other tangible and intangible depreciable assets not included in pervious categories, such as furniture, planes, ships, trains and goodwill: ten percent (10%).

Deductible depreciation Calculation

The deductible depreciation is calculated by using the appropriate depreciation rates as follows:

1.The balance of the value of each group at the end of the taxable year is the total of the balance of the value of the group at the end of the previous taxable year after the depreciation deduction in accordance with this Article for the previous taxable year, and fifty percent (50%) of the cost base of assets in use added to the group in the current and previous taxable years after the deduction of fifty percent (50%) of the compensation received from the assets disposed of during the current and previous taxable years, provided that the balance does not become in the negative.

2.If the taxpayer converts its assets to personal use or if the asset ceases to be used in the generation of taxable income, this action by the taxpayer is deemed to be a disposal of the asset for its market value.

3.When fifty percent (50%) of the compensation of the assets disposed of during the current and previous taxable years exceeds the balance of the value of the group at the end of the taxable year, regardless of the amount of such compensation, the value of the group shall be reduced to zero and the excess is included in the taxpayer’s taxable income.

4.If the balance of the value of the group at the end of the year, after allowing for the deduction in accordance with paragraph (1), is less than one thousand (1,000) riyals, the amount of the balance may be deducted.

5.Where all the assets in a group are disposed of, the balance of the group may be deducted at the end of the year.

6.Where a land is bought or sold with constructions thereon, the value shall be reasonably apportioned to arrive at a separate value of the construction.

7.In case a part of the assets is used for the generation of taxable income, a depreciation deduction is allowed for a part of the asset value against the part of the asset used in the generation of the taxable income.

8.As an exception to the provisions of the previous paragraphs, assets under Build, Operate and Transfer (BOT) or Build, Own, Operate and Transfer (BOOT) contracts may be depreciated over the contract period or over the remaining period of the contract, if acquired or renewed during that period.

Asset Repair and Improvement Expenses

a)Expenses incurred by the taxpayer for the repair or improvement of depreciable assets in each group may be deducted.

b)The amount of expenses deductible in accordance with paragraph (a) of this Article for each year shall not exceed four percent (4%) of the balance of the value of the group at the end of that year.

c)The amount exceeding the limit stated in paragraph (b) of this Article shall be added to the balance of the value of the group.

Geological Surveying and Preliminary Work Expenses

Expenses for Geological Surveying and Preliminary Work for the Extraction of Natural Resources

a)Expenditures for geological surveying and preliminary work for the extraction of natural resources are deducted in the form of amortization expenses at the depreciation rate determined depreciation section where these expenses constitute an independent group.

b)This is also applicable to expenses of intangible assets incurred by the taxpayer in acquisition of rights to geological surveying and the processing and exploitation of natural resources.

Losses carry Forward

A taxpayer may carry forward operational losses as adjusted, in accordance with controls as stipulated in the Law and these Regulations, to the years following the loss year until the cumulative loss is fully offset. The maximum profit percentage of any year that could be used to offset cumulative losses should not exceed 25 percent of the year’s profit as reported in the taxpayer’s return.

2.Losses not determined based on legal accounts audited by a certified public accountant licensed in the Kingdom cannot be carried forward.

3.Losses that meet the provisions of loss carry-forward but incurred by a capital company that has been a subject of change of 50 percent or more in its underlying ownership or control cannot be carried over to tax years following the year of change.

4.A natural person’s operational loss is the difference between business income and related deductions only.

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