Saudization, officially known as the Saudi nationalization scheme, is a workforce nationalization program in the Kingdom of Saudi Arabia that is designed to attract Saudi nationals towards the private sector. The hiring of Saudi nationals has doubled in 2018 and this trend is expected to continue throughout 2019. Although Saudization holds the best intentions for the economy, workforce nationalization rules also impose challenges on investors. This legal briefing gives an overview of the possibility to relocate functions to the United Arab Emirates in order to fall outside of the scope of strict Saudization requirements.
1. What is Saudization?
Workforce nationalization was introduced for the first time in the Kingdom of Saudi Arabia's (KSA) fourth development plan of 1985.1 35 years later, this topic is still highly relevant.
The current Saudization program is part of the larger economic national plan called "Saudi Vision 2030". Saudization's main objective is to increase the number of Saudi nationals in the private sector, as it is the expatriate workforce that still largely dominates private companies.
One of the subprograms within Saudization is the Nitaqat system – introduced in 2011 – specifically to fight Saudi unemployment. This program classifies employers into different categories, depending on the percentage of Saudi nationals they employ. Companies are ranked:
- Yellow; and
Depending on the category, employers will face more favourable or stricter treatments by governmental authorities, especially related to the issuance of visas (e.g. platinum or green-rated companies will have easier access to expat work permits).
2. Why is Saudization a problem for Investors?
Implementing certain quotas or reserving certain professions to nationals exclusively can be beneficial in a country's fight against unemployment but can have negative side effects as well. If such measures are implemented too abruptly, a large number of investors might cope with a shortage of candidates. Another reason for such shortage is the lack of Saudi nationals having graduated in the needed field of study and/or a lack of appropriate work experience. Finally, the higher wage levels of Saudi nationals may increase the cost of doing business in KSA.
As a remedy, the Saudi government introduced the "Parallel Nationalisation Program". This program allows employers to pay the government compensation for the non-hiring of a Saudi national, equal to the respective salary in order to keep or even improve their category.
3. Why is the United Arab Emirates a good location to shift operations?
In order to circumvent the strict Saudization rules and respective financial impacts, investors can shift operations that require a strong national workforce to countries with more relaxed workforce nationalization rules. The UAE has proven to be one of the preferred locations to relocate functions. Among other things, this is due to the following reasons:
- The geographical proximity of the countries;
- The UAE allows 100% foreign shareholding in its free zones;
- As of now, the UAE's own workforce nationalization program (also known as 'Emiratisation') does not apply in free zones in the UAE; and
- The UAE status as an international hub and its developed infrastructure make it attractive for many expatriates.
In the mainland, however, depending on the company's size and activity, varying 'Emiratisation' quotas are applicable. Among other things, 'Emiratisation' quotas are effective in the insurance, banking and trade sector.
In addition, it should be noted that Art. 14 of the UAE Labour Law (Federal Law No. 8 of 1980) has been recently activated. According to this provision, the Labour Department has the right to veto the employment of employees who are not UAE nationals unless its records show that none of the unemployed national employees who are registered with the Labour Department is qualified for the job.
4. What are the risks and how can they be mitigated?
Investors located in the KSA are generally free to shift their business activities to the UAE. However, it should be noted that relocating business triggers a row of additional aspects that need to be addressed.
The UAE does not impose any corporate income tax (CIT – except for oil and gas companies and subsidiaries of foreign banks) and, therefore, no withholding tax. The KSA, on the contrary, applies a CIT of 20% for resident companies and permanent establishments. In addition, the General Authority of Zakat and Tax (GAZT) recently published its new Transfer Pricing By-Laws.
In case investors retain their operations in KSA and cross-charge services from their UAE operations to the KSA, they should need to keep in mind to apply the arm's length principle when engaging in inter-company transactions. Furthermore, such transactions are generally subject to withholding taxation in KSA. Although the KSA and UAE have concluded a Double Taxation Agreement (DTA) in 2018, it has not yet fully entered into force.
In the event of dealing primarily with governmental bodies, investors would need to keep in mind the various localisation programs (Saudi Aramco's "In-Kingdom Total Value Add" (IKTVA) Program, Abu Dhabi National Oil Company's (ADNOC) "In-Country Value" program and the Abu Dhabi Value (ADV) program) when carrying out restructuring measures. While it is not mandatory to hire national workers under these programs, the localization score will typically increase in doing so. Investors should, therefore, remain vigilant in both countries when outsourcing or transferring (a part of the) business activities. Similar incentives are granted in the defence industry (e.g. under the Tawazun Economic Program (TEP)).
Workforce nationalization programs will continue to have a large impact on how investors can structure their operations in the respective markets. While the Saudization program is certainly helping to bring Saudi nationals into the private sector, it is safe to say that de facto, investors face multiple challenges complying with the respective quotas. A shortage of educated and experienced national workforce and higher salary expectations lead to practical difficulties.
The UAE has a quite unique selling point with its various free zones, allowing a maximum of freedom for foreign investors to structure their investments and employ expatriate workers. Even though the UAE does generally not apply any CIT, investors need to consider KSA's transfer pricing rules and withholding taxation when entering into (intercompany) service agreements.
Outsourcing or relocation to UAE, in particular to one of the various free zones, can be an interesting solution to mitigate the increasing Saudization requirements.
1 For an overview of all Development plans, please visit: www.mep.gov.sa/en/development-plans.
Originally published 29 September 2019
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.