Analysing the South Korea-KSA Double Tax Treaty and Its Impact on Business Operations
Korea Focus
South Korea and Saudi Arabia's Double Tax Treaty (effective 1 January 2009) offers Korean residents potential tax benefits. This article compares KSA tax law with the treaty on key tax areas.
Law Update: Issue 370 - From Africa to Asia: Legal Narratives of Change and Continuity
Hyungmin SongSenior Associate,Korea Group
South Korea (“Korea”) and the Kingdome of Saudi Arabia (“KSA”) signed a Double Tax Treaty (“Korea-KSA DTT”), which entered into force on 1 December 2008 and became effective on 1 January 2009. By means of the Korea-KSA DTT, the residents of Korea may be eligible for more favourable tax treatment than under the Saudi domestic tax law. This article compares the KSA Income Tax Law with the Korea-KSA DTT from the perspective of a virtual permanent establishment, force of attraction rule, capital gains tax and withholding tax rates.
a. Virtual PE under the KSA Income Tax LawThe KSA domestic tax law accepts the concept of a virtual PE without physical presence. A virtual PE can be triggered for a non-resident providing services remotely. Article 6 of the Executive Regulations of the KSA Income Tax Law provides that “Services shall be considered performed in the Kingdom in any of the following cases: 1. The work required to achieve the service is performed in full or in part in the Kingdom, even if implemented remotely. The physical presence of the person performing the service is not required.”
b. Virtual PE under the Korea-KSA DTTUnder the Korea-KSA DTT, a virtual PE cannot be triggered without physical presence. Article 5.3 of the Korea-KSA DTT provides that the permanent establishment includes, among others, “the furnishing of services, including consultancy services, by an enterprise through employees or other personnel engaged by the enterprise for such purpose, but only where activities of that nature continue (for the same or a connected project) within the country for a period or periods aggregating more than 183 days within any 12-month period”.
a. FOA in the KSA Income Tax LawParagraph 10 of Article 5 of the KSA income tax law provides that income from a source within Saudi Arabia should include income from sales in the Kingdom of goods of the same or similar kind as those sold through such a PE, and income from rendering services or carrying out another activity in the Kingdom of the same or similar nature as an activity performed by a non-resident through a PE. The KSA domestic provision refers to the concept of a partial application of the FOA, whereby the income derived by a non-resident company having a PE in KSA would be brought into the scope of KSA taxation regardless of whether the income is directly attributed to the PE or facilitated by the PE. The condition of similarity of activity only exists to restrict the application of the FOA. Example 1 illustrates the application of the FOA.
Example 1A branch of an American bank is operating in KSA through a branch. The bank’s headquarter in the USA has a contract with a KSA third party company to provide funding services in respect of the company’s project in KSA and overseas. The income derived from the banking activity performed in KSA by the foreign bank’s branch (i.e., borrowing and lending funds to third parties) is directly attributable to the PE and therefore brought within the scope of corporate tax in KSA. It is also attributed to the PE in KSA, the income generated by the headquarter in respect of the funding contract with the Saudi third party company, on the basis that the activity performed by the USA headquarter is similar to the one from which the PE is deriving its income.
b. FOA in the Korea-KSA DTTUnder the Korea-KSA DTT, conversely, only the profits directly attributable to the PE may be taxed in KSA. Profits directly attributable to the PE encompasses the income derived from the sole activity of the PE in KSA. Article 7.1 of the Korea-KSA DTT provides that “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 permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to that permanent establishment”. Example 2 below illustrates the application of this clause.
Example 2A company based in Korea is supplying material in KSA for the purpose of a construction project for which the company also provides on-site installation/ maintenance and project management services for the duration of the project (which is expected to exceed a year). Based on the Korea-KSA DTT, the company is deemed to have a PE in KSA due to the installation/ maintenance and service activity performed locally. In addition, the company provides maintenance services in Korea for equipment belonging to another Saudi company. The income derived from the services rendered in KSA is directly attributable to the PE and therefore brought within the scope of corporate tax in KSA. However, due to the provisions of the Korea-KSA DTT nullifying the application of the force of attraction, the income derived from the mere sale of material and the income from the maintenance services rendered in Korea should not fall within the scope of tax in KSA.
a. CGT under the KSA Income Tax LawThe capital gains are, in principle, subject to the income tax in accordance with Article 8.1 of the KSA Income Tax Law, which provides that “The taxable income shall be the gross income, including all revenues, profits and gains of any type, regardless of the form of payment, resulting from carrying out an activity, including capital gains and any incidental revenues, excluding the exempted income”. As exception, capital gains realised by disposing of financial securities traded on the stock exchange in Saudi Arabia are exempt from income tax.
b. CGT under the Korea-KSA DTTUnder Article 13.5 of the Korea-KSA DTT, capital gains arising from the alienation of interests representing a substantial shareholding of the capital of a company are taxable in the country of which the company is a resident. A substantial interest shall be deemed to exist when the seller, alone or together with associated or related persons, holds directly or indirectly 15 per cent of the total shares issued by the company. If the substantial interest requirement (holding directly or indirectly 15% of the total shares) is not met, the capital gains shall not be taxed in the country of which the company is a resident.
a. Withholding tax rates under the KSA Income Tax LawTax residents and PEs in the KSA which pay an amount to a non-resident from a source in the KSA are required to withhold tax on such payment. The rate of withholding tax applicable depends on the nature of the payment. In the KSA Income Tax Law, withholding tax rates are e.g. 5% on dividends, 5% on interest and 15% on royalties.
b. Withholding tax rates under the Korea-KSA DTTThe Korea-KSA DTT provides for a more favourable withholding tax rate for royalties. Pursuant to Article 12.2 of the Korea-KSA DTT, 5% of WHT rate is applicable to the gross amount of such royalties which are paid for the use of, or the right to use industrial, commercial or scientific equipment and 10% of WHT rate is applicable to the gross amount of such royalties in all other cases.
From a practical standpoint, taxpayers shall note that ZATCA’s interpretation of the Korea-KSA DTT is not always consistent. If ZATCA’s taxation is not in accordance with the Korea-KSA DTT, the taxpayer may resort to the mutual agreement procedure. [1] The discussion on the FOA is extracted and modified from ZATCA’s circular, “Force of Attraction rule in the context of permanent establishment”.
For further information,please contact Hyungmin Song.
Published in Septemeber 2024
