Lexis Middle East

Transfer Pricing and Disputes

Type Gulf Legal Advisor

Document type Practice Note

Date 18 Aug 2022

Jurisdiction Saudi Arabia

Copyright LexisNexis

Document link: https://www.lexismiddleeast.com/pn/SaudiArabia/Transfer_Pricing_and_Disputes

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Transfer Pricing and Disputes

Overview
Transfer pricing for tax purposes has long been an extensively discussed issue globally, and recent political and public
concerns about tax avoidance have energised tax regimes globally to update laws and regulation in this regard. In the Kingdom
of Saudi Arabia (KSA), the Zakat, Tax, and Customs Authority (ZATCA) issued Transfer Pricing Bylaws (the Bylaw) which apply
to all taxable persons (being persons subject to Saudi Arabia Royal Decree No. M1/1425 Related to the Income Tax Law (Saudi
Arabia Cabinet Decision No. 278/1424 On the Approval of the Income Tax Law)). This Bylaw set out a framework to regulate
prices for controlled transactions, including but not limited to the transfer of goods, services, loans and intangibles
(intellectual property).
The importance of the Bylaw lies in the necessity to implement and enforce the arm’s length principle on transactions
between related persons or persons under common control, as if they were conducted between independent persons.
In this Note, we aim to highlight some of these concepts and circumstances in which taxpayers are subject to the Bylaw, while
considering the views of ZATCA on the arm’s length principle and related aspects, such as ‘effective control’. We also briefly
highlight the suggested methods by ZATCA on how to establish an arm’s-length sale, and the extent to which ZATCA feels
that it may intervene to achieve an arm’s length price. The main takeaway of the article aims to highlight learnings on
common litigation issues observed in transfer pricing disputes against ZATCA, the aspects and actions that taxpayers should
be aware of and follow when litigating with ZATCA, and the actions to implement into their transfer pricing strategies once
these issues with ZATCA are resolved.

Practical Guidance
Persons subject to transfer pricing
The TP Bylaw applies to every taxable person pursuant to Saudi Arabia Royal Decree No. M1/1425 (Saudi Arabia Cabinet
Decision No. 278/1424) and Saudi Arabia Ministerial Decision No. 1425/1435 Implementing Regulation of the Income Tax Law
in Saudi Arabia. At the time of writing, ZATCA has also commenced public consultation for expanding the coverage of transfer
pricing requirements to Zakat payers as well, which was open to comment until 30 July 2022. In terms of the suggested
amendments to the TP Bylaw, ZATCA may apply the arm’s length principle to Zakat payers, requiring such related parties to
deal at arm’s length with each other.

Definitions
In terms of the Bylaw, transfer pricing refers to the setting of prices for controlled transactions, including but not limited to
the transfer of goods, services, loans, capital, and intangibles (for instance, intellectual property). Controlled transactions are
transactions between related persons or persons under common control.
Regarding the concept of ‘related persons’, there are two types of persons (natural and juridical) and thus the concept of being
related would differ accordingly. The Bylaw defines persons as follows.
Natural persons
Two or more natural persons are related if they are:

relatives through marriage or are otherwise relatives to the fourth degree; or

partners in partnership.

Natural person with juridical person

A natural person is considered related to a juridical person in any of the following circumstances:

if the natural person is a partner in a partnership and they, either alone or together with a related person or persons,
directly, indirectly (or both) controls 50% or more of the voting rights, income, capital of the partnership;
if the person or a related person thereto is a shareholder in a capital company and they, either alone or together with a
related person or persons, directly, indirectly (or both) controls 50% or more of the voting rights, income or capital of
the capital company;
as for agencies administering property held in a trust, fund or any such similar arrangement, a natural person is
considered related thereto if they benefit or are capable of benefiting from them, either alone or with a related person
or persons; or
if the person alone or jointly with a related person thereto directly or indirectly participates or is able to participate in
the management, control or capital of a juridical person.

Juridical person
Two or more juridical persons are considered related persons in any of the following cases:

they are under common control;

when the person who controls or has the ability to control the business decisions of a juridical person has, alone or
together with a related person, effective control over the other juridical person;
when the person who has effective control over a juridical person, and the person who has effective control of the other

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when the person who has effective control over a juridical person, and the person who has effective control of the other
juridical person are related persons.

Common control
Regarding the concept of common control, two or more juridical persons are deemed persons under common control if either:

The person or related persons, either individually or jointly, control directly or indirectly 50% or more of such persons
where:
with respect to partnerships, control means the actual ownership, right to use and dispose of as an owner, or
the ability to own with reasonable certainty the rights to its income or capital;
with respect to capital companies, control means actual ownership, right to use and dispose of as an owner, or
the ability to own with reasonable certainty, the voting rights to its capital or its income; and
with respect to agencies that administer properties endowed for specific purposes, control means having the
rights to, or a beneficial interest in their income or assets; or

The person or related persons, either separately or jointly, directly or indirectly is or are able to control the business
decisions of such juridical person or otherwise have effective control over such juridical person.

Effective control
In addition to the definition of common control, ZATCA highlights the meaning of effective control as the ability of a person
to control the business decisions of another person.
According to article 1(12) of the Bylaw, a person or group of persons, either jointly or severally, directly or indirectly, are
presumed to be able to control the business decisions of another person in any of the following cases, without limitations[1 p.9
]
:

such person or persons have the ability to conclude an agreement to provide management services to the company or
otherwise effectively perform the functions of management for the other person;
such person or persons have the ability to act as trustee (manager) of the other person or persons under a trust
arrangement;
such person or persons have the ability to directly or indirectly control the composition of 50% or more of the board of
directors or has/have the right to appoint or dismiss the representatives of management of the other person or persons;
such person or persons have a legal or de facto right to receive, directly or indirectly, 50% or more of the profits of the
other person or persons;
such person or persons, except where such person is a financial institution, have provided loans to the person or
persons directly or indirectly and the total outstanding balance of such loans represents 50% or more of the of long
term and short term debt and capital excluding retained earnings as of the year-end balance of the reporting year;
such person or persons, with the exception of financial institutions, have issued guarantees to cover 25% or more of
the value of the person’s total borrowings as of the year-end balance of the reporting year;
50% or more of the absolute aggregated value of a person’s business activities as of the year-end balance of the
reporting year depends on transactions with such other person or persons;
such person or persons are related person to a person who directly or indirectly holds 50% or more of a juridical person
or they participate, directly or indirectly, in the management of the juridical person;
a person is or related persons, jointly or severally, are the principal or supplier of a person under an exclusive agency,
distributorship arrangement or any such similar contract for the sale of goods, services or rights and such person is a
dependent agent of the principal and who is prohibited from entering into other similar agency, distributorship
arrangement or any such similar arrangement for the duration of the person’s relationship with the principal;
in the case of a non-resident person or related persons, where a substantial portion of the business activities of a
resident person depends on transactions with the non-resident person or related persons, and the resident person’s
business activities depend on rights in intangible property granted to such person on an exclusive basis directly or
indirectly by the nonresident person or related persons; or,
the person is or related persons, jointly or severally, are able to control the business decisions of the other person in
any other way as evidenced by the facts and circumstances.

The application of the arm’s length principle

In terms of the Bylaw, the “arm’s length principle” or “arm’s-length” refers to conditions which are made or imposed between
two or more related persons in their commercial or financial relations which differ from those which would be made between
independent persons. In such instance, any profits which would, but for those conditions, have accrued to one of such related
persons, but, by reasons of those conditions, have not so accrued, may be included in the profits of that person and taxed
accordingly.
Regarding the comparability of companies, the Bylaw indicates that an uncontrolled transaction is comparable to a controlled
transaction when:

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there are no significant differences between them that could materially affect the financial indicator being examined
under the appropriate transfer pricing method; or
when such material differences exist, if a reasonably accurate comparability adjustment is made to the relevant
financial indicator of the uncontrolled transaction in order to eliminate the effects of such differences on the
comparison.

Transfer pricing methods

In terms of the Bylaw, the arm’s length price of a controlled transaction must be determined by applying the method that,
under the facts and circumstances, provides the most reliable measure of an arm’s-length result.
Article 6(a) of the Bylaw requires that in each analysis, the most appropriate transfer pricing method must be used, taking into
consideration the following criteria:

the respective strengths and weaknesses of the approved methods;

the appropriateness of an approved method of the nature of the controlled transaction, determined in particular
through an analysis of the functions undertaken by each person in the controlled transaction (taking into account
assets used and risks assumed);
the availability of reliable information needed to apply the selected transfer pricing method; and
the degree of comparability between the controlled and uncontrolled transactions, including the reliability of
comparability adjustments -if any- that may be required to eliminate differences between them.

Moreover, article 7 of the Bylaw lists the following approved methods:

comparable uncontrolled price method;

resale price method;
cost plus method;
transactional net margin method; and
transactional profit split method.

ZATCA has no preference toward the above methods. In fact, it may, from time to time, set forth any relevant information on
this, regarding the selection of an appropriate Transfer Pricing method in the Guideline. ZATCA suggests different methods to
provide the opportunity to companies to select the appropriate approach according to its business and activity.
We will discuss one of the above methods to briefly understand how it works and what actions ZATCA may take under such
methods.
The transactional net margin method
The transactional net margin method (TNMM) makes a comparison between the net profit margin relative to an appropriate
base (e.g., costs, sales, or assets) that the party receives in a controlled transaction, with the net profit margin relative to the
same base achieved in comparable uncontrolled transactions, as per article 7(4) of the Bylaw.
In order to apply the TNMM, a profit level indicator PLI should be selected to determine the appropriate net margin indicator
for the controlled transactions. In fact, there are different PLIs that may be considered appropriate (without limitation),
according to article 4(3)(4) of the Guidelines:

operating profit margin (OPM) or return on sales (ROS);

net cost-plus (NCP) or full cost mark-up (FCM);
return on (operating) assets (ROA) or return of capital employed (ROCE)
berry ratios (ratios of gross profit divided by operating expenses).

Additionally, in applying the TNMM, it is important to determine the relevant profits from the controlled transaction and
uncontrolled transactions, and to select the correct net margin indicator to use in analysing those transactions. In the
selection of the most appropriate net margin indicator, the respective strength and weaknesses of the various possible
indicator should be considered, such as:

the appropriateness of the indicator considered in view of the nature of the controlled transaction, determined in
particular through a functional analysis;
the availability of reliable information needed to apply the TNMM based on that indicator; and
the degree of comparability between the controlled and uncontrolled transactions, including the reliability of
comparability adjustments.

In the TNMM approach, when certain margins achieved by comparable independent persons are used as reference point to the
arm’s length nature of the controlled transactions, the premise is that if independent persons report a certain margin on a
transaction, this could be considered at arm’s length when achieved by the related person. The following sub-steps should be
applied when applying such method, according to article 4(3) of the Guidelines:

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selection of tested party;

selection of appropriate database;
selection of appropriate search criteria and years to be covered;
selection of sufficiently comparable persons;
selections of a relevant profit level indicator; and
determination of arm’s length range of comparable margins.

After a taxpayer selects the appropriate method, in our case the TNMM, there are factors or circumstances a taxpayer should
consider while choosing the comparable companies, according to article 5(b) of the Bylaw:

the characteristics of the property or services transferred;

the functions undertaken, assets employed, and risks assumed by each person with respect to the transactions;
the contractual terms of the transactions;
the economic circumstances in which the transactions take place;
the business strategies pursued by the parties to the transactions; and
any other economically relevant aspect of the transaction.

As a result, it is not sufficient to accept persons for compatibility purposes without conducting a thorough review on whether
the set of comparable independent persons are reasonably comparable to the related persons under analysis. A “data-dump” of
database information without review is not considered sufficient substantiation for the arm’s length nature of controlled
transactions. Moreover, as part of the selection of comparables, ZATCA does not accept loss making entities as comparable
persons, as per article 4(3)(4) of the Guidelines.

Particular views of ZATCA observed and lessons learned

We have observed a specific focus by ZATCA on the selection of comparable uncontrolled transactions and challenging the
taxpayer’s transfer price and transfer pricing report for tax purposes based on this.
In terms of the Transfer Pricing Guidelines, comparable uncontrolled transactions must be obtained within a similar industry,
and in a geographical market comparable to Saudi Arabia. Where the taxpayer is unable to demonstrate the appropriateness of
the comparable transactions, ZATCA may challenge the selected comparable companies during an audit, and ZATCA’s
discretion on comparability may include companies owned by a natural person. There is also no explicit reference in the Bylaw
to the number of the comparable companies which a taxpayer is required to include in its analysis, and ZATCA is entitled to
add to this number of comparables selected by the taxpayer.
In assisting a particular client during a transfer pricing audit and related litigation, we have observed ZATCA’s addition of five
extra comparable companies to the arm’s length analysis to reach an arm’s length price during ZATCA’s audit, also increasing
the appropriate margin for the taxpayer. It can be inferred that ZATCA has left the amount of comparable companies to use
unaddressed due to the nature of any taxpayer’s specific activities, the specific commercial circumstances or establishment of
new business etc. Nonetheless, such taxpayer should provide a justifiable list of comparables in its methodology, including
proper information and the aforementioned criteria.
ZATCA has also (in its audits) taken the position to eliminate certain comparable companies selected by the taxpayer on the
basis that the taxpayer did not provide sufficient information and non-financial data (to the satisfaction of ZATCA) which the
taxpayer relied on. On this basis, ZATCA takes the position that it is entitled to add comparable companies which it views as
appropriately comparable (bearing in mind that the taxpayer might take the view that these entities are not comparable).
Based on our observations in certain cases, it would be important for the taxpayer to consider the below action points during
any planning, audit process or related litigation. We have demarcated these points under technical actions and procedural and
strategic actions. These lists are not closed lists.
Technical action points
We recommend that the taxpayer:

Ensure that the company has defensible substantiations regarding the appropriateness of the transfer pricing method
applied. While the Guidelines do not express any binding order in the application of the methods, and that the most
appropriate method would be determined according to business and activity of the specific taxpayer having regard to
certain factors, we have observed cases where ZATCA has challenged the specific method applied by the taxpayer as
inappropriate, and as a result has applied its own method that it deemed most appropriate. We have seen such
positions taken in other jurisdictions as well, and whether a tacit or subliminal method is dictated in the Saudi law will
depend specifically on expression of the KSA legislation, and it may be that various interpretations may be put forth at
this stage. However, we would advise that in transfer pricing audits or dispute resolution processes where required,
that the taxpayer specifically and substantially motivate why its method applied is the most appropriate in the
circumstances, and conversely, specifically substantiate why ZATCA’s method applied is not the most appropriate
method to arrive at the transfer price. It is recommended that these submissions are not simply made in a broad or
sweeping manner, but that such submissions should be specific and precise to ZATCA’s claims, with substantiations as
to the incorrectness of ZATCA’s approach.

Specifically provide ZATCA with a detailed comparability and functional analyses which supports the comparable

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Specifically provide ZATCA with a detailed comparability and functional analyses which supports the comparable
company selection.
Assess and bolster the defensibility of the comparable companies selected in its transfer pricing analysis.
Remain vigilant in ensuring that comparable companies chosen by ZATCA for adjustment of the price, are appropriate.
Identify any material differences between the comparable entities chosen by ZATCA to be compared against the
taxpayer.
Particularly elicit and address (in its objection) the technical reasoning elected by ZATCA in adjusting the transfer
price or rejecting comparable companies.
Particularly address (in its objection) the selection of additional comparable companies by ZATCA and the reasons that
they are not comparable or were not selected by the taxpayer.
Assess and methodically address and challenge the search strategy of ZATCA in its selection of comparable companies
where justifiable bases exist.
Clearly and expressly articulate and highlight the business realities and industry norms in the papers and to the panel,
in order to illustrate the circumstances specific to the industry of the taxpayer, and whether ZATCA considered this or
not.
Ensure that ZATCA and the General Secretariat of Zakat, Tax and Customs Committees (GSTC) are aware of the
screening criteria of the company, and demonstrate the appropriateness of such criteria, or demonstrate that ZATCA’s
criteria is inappropriate and unreasonable.
Assess ZATCA’s search strategy presented and demonstrate clearly and substantively in the objections and hearing
why these entities cannot be relied upon.
Demonstrate clearly in its objection how the adjustment suggested by ZATCA is above industry benchmarks in the
circumstances.
Demonstrate how any of the companies used by ZATCA in its adjustment does not qualify as appropriate, supported by
factors such as the difference in activities and thus margins of the compared companies, the difference in products of
the companies (or additional products sold) between the companies and the taxpayer, or that while similar, the entity
does not sell the products of the comparable entity.

Procedural or strategic action points

We recommend that the taxpayer ensure that:

During the audit or controversy process, information is presented as exactly requested by ZATCA or the GSTC to the
best extent possible. Where the information as exactly requested is not possible, substantiate clearly and defensibly
why this is not or why the request is unreasonable, arrange for the best alternative evidence and how this addresses the
point or allegation, and present this in the most user friendly and clear manner as possible as a best alternative. In this
respect, we have observed that the GSTC can be swift in arriving at a decision which may be unfavourable to the
taxpayer based on its view that the taxpayer did not provide the specific documents requested, or satisfactory
alternatives to such documents requested. Direct and specific evidence is therefore critical to the taxpayer’s case in
this respect.
Any allegations made by ZATCA or enquiries by the GSTC should be specifically and expressly addressed in the papers
with corresponding direct evidence.
Dovetailed with the technical aspects properly catered for and addressed, the legal, evidentiary, strategic and
procedural aspects are specifically and expressly considered and addressed, whether in the process, strategy or in the
GSTC papers.
Any submissions made are submitted on the portal in strategically and legally good time, and the panel of judges and
ZATCA should be given sufficient time to consider the documents. Where the panel or ZATCA have not considered the
documents or the panel feels that they have not been afforded enough time to do so, we have seen cases where the
GSTC has decided to continue or disregard the requests or submissions of the taxpayer or its representative.
Legal representatives are briefed and appointed with an authorised power of attorney (POA) well in time before
proceedings or hearings. Where legal representatives are not appointed in time, the GSTC panel has the discretion to
postpone or continue. It may very well opt to continue and require that the employee company representative defend
the case him/herself (and it has in the past). We infer that this is on the basis that the taxpayer has opted to represent
itself since inception of the matter, and since it is able to and has opted to, there is no direness or urgency that
warrants postponement for appointment of counsel at the specific stage of hearing. We have thus observed instances
where the GSTC has not accepted attorneys to represent the client in critical instances where the POA was still in
process, or where the newly appointed attorney required a postponement to study the case. In such instance, the
company representative is left unprepared, required to make legal submissions to the GSTC and ZATCA though not
legally trained, and thus potentially damaging its case or not at best articulating its position.
Any information submitted to specific enquiries or points by ZATCA is put before the GSTC in translated Arabic, with a
memorandum explaining such document, how it assists the client’s case, and that the taxpayer demonstrates
sufficiently to the GSTC that it has duly complied and had fully and willingly participated in all ZATCA’s or the GSTC’s
requirements.

There is an accurate understanding of the questions as posed by ZATCA in Arabic during the audit period, and that the

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There is an accurate understanding of the questions as posed by ZATCA in Arabic during the audit period, and that the
responses in English by the taxpayer and subsequently translated to Arabic are mindful of the message that the Arabic
query of ZATCA aims to communicate. Also, that any evidentiary documents (such as contractual arrangements) are
translated into Arabic in a manner that is sensitive and mindful to the technical tax and commercial terms, so that
such submissions or responses from the taxpayer are unambiguous. For instance, we were required to remedy a
translation and make legal submissions to the GSTC accordingly in a matter where a commercial agreement was
translated by the client to Arabic (early on in the audit), with the English commercial and legal terms translated to
Arabic in an ambiguous manner, which led to the tax authority basing the strength of certain of its submissions on its
understanding of such translation.
The online portal is checked regularly for responses lodged by ZATCA and that an attorney skilled in tax advocacy is in
attendance during the hearing. We have observed hearings where the client is required to attend the hearing while
having not received any written submissions made by ZATCA, while ZATCA making verbal submissions during the
hearing that it has made such written submissions on the portal, and that a technical error may exist, requesting the
GSTC that ZATCA’s written submissions be accepted during the hearing. Where the taxpayer is not able to understand
the ad hoc submissions made, or articulate on the spot its views on the submissions made contemporaneously by
ZATCA, this may adversely affect the taxpayer’s case, without the taxpayer having an adequate opportunity to furnish
adequate responses to any additional submissions made by ZATCA.
In the above vein, compose a detailed list of all documents provided to ZATCA and to which point the document
responds, the date that the document was submitted to ZATCA and how the taxpayer demonstrated that such
document assists its case or negates the points made by ZATCA.

Related Content
Legislation

Saudi Arabia Royal Decree No. M1/1425 Related to the Income Tax Law
Saudi Arabia Cabinet Decision No. 278/1424 On the Approval of the Income Tax Law
Saudi Arabia Ministerial Decision No. 1425/1435 Implementing Regulation of the Income Tax Law in Saudi Arabia

Regulations

Transfer Pricing Bylaws issued by the General Authority of Zakat and Taz pursuant to Saudi Arabia Ministerial
Resolution No. 6-1-19 dated 25 /05/1440H corresponding to 31/01/2019

Guidance

Saudi Arabia Transfer Pricing Guidelines, Third Edition

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Produced by

Zain Satardien
Global Trade and Tax Law Leader, Hourani & Partners (Dubai, UAE)
zsatardien@houranipartners.com

Areas of expertise
Trade Law; Customs; Tax; Corporate Regulatory; Litigation

Biography
Zain Satardien currently leads the Global Trade and Tax Law practice at Hourani & Partners law firm in Dubai, UAE. He is an
admitted attorney with 14 years’ experience in the areas of WTO & international trade law, customs & excise law, tax law
(such as income tax, transfer pricing, and zakat), corporate regulatory, and related litigation. His experience includes
furnishing legal, regulatory and strategic advice to various major multinationals, and to GCC and South African government
authorities in the aforementioned areas. Zain is completing his Doctor of Laws in WTO valuation and Transfer Pricing from
the University of Pretoria, South Africa.

Saud Al Darmi
Associate, Hourani & Partners (Riyadh, KSA)

Areas of expertise
Corporate Law; Tax Law; Litigation; Mediation; Regulatory

Memberships

Licensed attorney by MoJ

Member of SBA
Certified Mediator by SCCA

Biography
Saud is based in our Riyadh office, and he practices a variety of legal disciplines in Saudi Arabia, and in the US throughout
his LL.M. studies. During his five years of legal experience, Saud has worked on multiple areas of Saudi law, including but
not limited to tax law, litigation, corporate law and mediation. Prior to joining Hourani, Saud also served as Legal Adviser at
the Saudi Arabian Tax Authority, ZATCA, on taxation matters. Saud earned his Masters in Dispute Resolution from
Pepperdine University School of Law, which was ranked number one in 2016 according to US News Education.

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Notes
1. ^ [p.3] Clause (12) of the Article (1) of Transfer Pricing Bylaw Issued by the General Authority of Zakat and Tax
pursuant to Board Resolution NO [6-1- 19] DATED 25/05/1440H corresponding to 31/01/2019

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