Andersen

2021/06/09

The Impacts of Low Oil Prices and the Corona Virus

Saudi Arabia has adopted measures to combat the jeopardy of low oil prices and the COVID-19 impact on its economy in contrast to the previous measures that were taken when oil prices recovered. On a notable side, the value-added tax increase (from 5% to 15%) will be the same as last July, which has been a challenge for people and businesses with low-income and local recovery plans. However, with the emergence of the global pandemic (COVID-19) and the impacts it had on the economy, the Ministry of Finance announced May 2020 the increase of the value-added tax from 5 to 15% to support the kingdom finances in the face of the repercussions of the pandemic on the country’s budget, to protect the Kingdom’s economy, and help it overcome the crisis and its financial and economic consequences with the least possible damage.

On October 4, 2020, Royal Decree No. 84/A (14/2/1442) was issued, exempting all real estate supplies in the process of transferring ownership or the right to dispose of it as an owner from the VAT according to the recently modified section (1) from Article Thirty of the Executive Regulations of the Value Added Tax Law, whereby the VAT on real estate was abolished at 15%, and the real estate transaction tax was imposed at 5% of the property value. The main purpose of this modification is to reduce speculation, the rise in real estate prices, and encourage licensed realtors to build new housing units by exempting them from value-added tax on building materials and supplies, which will enable citizens to own housing units.

Many economic sectors were affected by the imposition of value-added tax especially the real estate sector due to the large value of its supplies. That impact increased with the rising of value-added tax from 5 to 15%, which had caused some confusion for real estate investors regarding the impact of VAT on income generated as a result of selling commercial or residential renting or any other real estate as collateral with a mortgage starting from January 2018 to October 3, 2020.

What are real estate collateral and mortgage?

It is when the borrower provides a mortgage or real estate mortgage when applying for a loan. On the other hand, a mortgage means the temporary transfer of a right or interest in the borrower’s property to the lender as a form of security against the repayment of the loan. This property may be immovable (as real estate) or movable.

Real estate mortgages and guarantees VAT implementation mechanism

Andersen in Saudi Arabia experts have concluded (according to the VAT Law and Regulations), that granting guarantees related to the borrower’s property (whether movable or immovable) does not constitute a supply of goods and is not subject to VAT.

In many cases, the real estate guarantee or mortgage does not give the lender the right to take possession of the movable asset nor the right to dispose of the property (unless the borrower defaults on his/her obligations under the loan agreement). Therefore, real estate guarantees do not constitute a supply of goods as defined under the basic principles of the value-added tax system for the Cooperation Council Countries.

The provisions of the implementing regulations for value-added tax also confirmed that any temporary transfer of property in such cases (i.e., as security) is not considered a supply of goods in the Kingdom, and this interpretation also applies to cases in which legal ownership is transferred to the lender, provided that the transfer of ownership is temporary as per the loan agreement and that does not give the lender the right of possession or to dispose of the property.

Upon completion of the entire loan repayment process under the agreement, the lender’s entire rights to the property under the mortgage expire. According to the agreement between the parties, the mortgage may be automatically terminated between the parties, or in the case of a real estate guarantee through a formal and notarized transfer of ownership from the lender to the borrower.

In either case, the lender is not deemed to be making a supply of the property for VAT purposes. The release of the real estate collateral does not create any VAT obligations for the lender or borrower.

In cases where the borrower defaults on his/her obligations under the loan agreement, the borrowing agreement may allow the lender to take possession of the secured property, or sell it and use the proceeds to cover the unpaid loan amount.

When the lender has the right to dispose of the property of the borrower in the event of default, the transfer of property from the borrower to the lender as collateral is not temporary.

As a result, the transfer of ownership from the borrower is considered a supply of goods for VAT purposes. Thus, the tax treatment of a supply in such cases depends on the specific circumstances of each case.

In the event that the lender acquires the mortgaged property for his/her own use, or retains it as an asset for subsequent sale, then it is considered a supply of goods (the mortgaged property) from the borrower to the lender. If the borrower is not subject to pay tax and owns it for his/her personal use (outside the context of any economic activity), no tax obligations will apply to the supply made by the borrower.

However, if the borrower is subject to pay tax (or becomes subject to pay tax as a result of a sale), then the supply will be subject to VAT. The property will form part of the lender’s assets, and the lender is therefore obligated to pay VAT on any subsequent supply he/she makes in respect of such property.

Where the lender arranges for the sale of the mortgaged property to a third party without keeping it as his/her own asset, the lender arranges for the supply of goods (which is the mortgaged property) directly from the borrower to the third party. If the borrower is not subject to pay tax and the property is held by the borrower in his/her personal capacity outside the context of economic activity, then no VAT obligations will apply on the supply made by the borrower, and there will be no tax implications as a result of the measures taken by the lender to sell the borrower’s mortgaged property.

If the borrower is subject to pay tax (or becomes subject to pay tax as a result of the sale), the supply will be subject to VAT. The value of this supply is the total monetary and non-monetary consideration received in connection with the sale of the mortgaged property. Also, any deductions from the value of the supply intended to meet the unpaid loan amounts or to cover selling costs do not affect the value of the defaulting borrower’s supply.

The borrower is also obligated to issue a tax invoice for the supply and declare the value-added tax due. If a lender arranges the sale as a result of a borrower’s default, he/she can also assist in complying with the defaulting borrower’s VAT obligations. Andersen’s team of experts in Saudi Arabia advises companies and financing entities to fully understand the provisions and mechanism of applying the value-added tax on real estate mortgages and guarantees so they are not charged with it on nontaxable real estate transaction supplies.