Why Intercompany Financing Is a TP Priority
Intercompany loans create two distinct economic effects that ZATCA focuses on simultaneously. For the Saudi borrower: interest paid to a non-resident related party is a deductible expense and a WHT-bearing payment. A high interest rate maximises the deduction — potentially at the expense of the Saudi tax base. For the foreign lender: a low rate minimises taxable income.
ZATCA’s June 2024 Guidelines dedicate a full chapter (Chapter 8) to financial transactions, covering intercompany loans, guarantees, cash pooling, receivables factoring, securitisation, hedging, and captive insurance. What makes this area particularly complex in Saudi Arabia is the interaction of two parallel regimes: the arm’s length TP analysis of the interest rate, and the thin capitalisation rules on total debt levels. Both apply to the same loan. Passing one does not resolve the other.
The TP Framework for Intercompany Loans
Under Article 3 of the Bylaws, intercompany loans are controlled transactions subject to the arm’s length principle. The CUP method — comparing the intercompany rate to rates for comparable loans between independent parties — is the primary approach under the June 2024 ZATCA Guidelines (Chapter 8.1).
Key loan terms to analyse: interest rate (fixed or floating, reference rate); currency; maturity and repayment schedule; security or collateral provided; covenant conditions; and the borrower’s creditworthiness at loan inception.
A key analytical step is establishing the borrower’s credit rating — both on a standalone basis (how a bank would assess the entity independently) and on a group-supported basis. Group membership may enhance creditworthiness, but this does not mean the borrower should receive parent-level terms without any credit risk pricing.
Sources for arm’s length interest rate data: Bloomberg/capital market data for investment-grade borrowers; bank lending rates for commercial loans of comparable term, security, and risk; credit default swap spreads; commercial database benchmarks for intercompany loan pricing.
Worked Example: SAR 50 Million Intercompany Loan
Al-Baraka Manufacturing Co. — Intercompany Loan Analysis
Al-Baraka Manufacturing Co. (Riyadh, 100% German-owned) receives a SAR 50 million intercompany loan from the German parent — 5-year maturity, 2% fixed interest, unsecured.
Step 1 — Assess terms: 2% fixed, 5-year, unsecured, SAR-denominated, parent to subsidiary.
Step 2 — Determine arm’s length rate: The rate should reflect the risk-free rate for the currency and term, a credit spread for Al-Baraka’s standalone creditworthiness, and a term premium. A CUP analysis using Bloomberg data for comparable SAR-denominated corporate loans: arm’s length IQR of 4.5%–6.5% per annum. The 2% rate is below this range.
Scenario A — Rate at 2%: Al-Baraka is charged below the arm’s length rate. The German parent is forgoing income it would earn from an independent borrower. TP risk sits primarily in Germany (underpayment of taxable income). ZATCA may also examine whether the arrangement reflects a genuine loan or an effective equity contribution disguised as debt — if recharacterised as equity, Al-Baraka’s interest deduction would be lost entirely.
Scenario B — Rate at 8%: Above the arm’s length range. Al-Baraka is overpaying interest — over-deducting from its CIT base. ZATCA may adjust Al-Baraka’s taxable income upward by the excess interest deduction. The German parent may receive a corresponding adjustment. The WHT on interest payments (5% standard) would also be assessed on the amount actually paid.
Thin Capitalisation: The Parallel Restriction
Independent of the arm’s length interest rate analysis, Saudi Arabia applies thin capitalisation rules under Article 16 of the Income Tax Implementing Regulations. These restrict the deductibility of interest on related-party loans (or loans guaranteed by related parties) where debt-to-equity ratios exceed specified thresholds. Where the rules apply, the excess interest is disallowed regardless of whether the interest rate itself is arm’s length.
Al-Baraka’s SAR 50M intercompany loan requires both:
TP analysis: Is the 2% rate arm’s length? (Answer: likely not — below the 4.5%–6.5% market range.)
Thin cap analysis: Does the total intercompany debt (SAR 50M) relative to Al-Baraka’s equity exceed the permitted debt-to-equity ratio? If so, a portion of the interest is disallowed regardless of the rate.
The specific thin capitalisation thresholds and calculation methodology should be confirmed with current ZATCA guidance, as these sit in the Implementing Regulations rather than the TP Bylaws.
Guarantee Fees
Where a Saudi entity’s borrowing is backed by a related-party guarantee, the guarantee has economic value — an independent guarantor would charge for providing credit support. Under the arm’s length principle, a guarantee fee should be charged. The June 2024 ZATCA Guidelines (Chapter 8.2) address this directly.
The arm’s length guarantee fee is typically based on: the credit benefit conferred (reduction in interest cost enabled by the guarantee); the credit exposure assumed by the guarantor; and market rates for standalone guarantee arrangements.
Al-Nour Commercial Co.
Al-Nour borrows SAR 80M from a Saudi bank at 5.5% interest, backed by a UK parent guarantee. Without the guarantee, the bank’s indicated rate for Al-Nour standalone would be 7.5%. The guarantee reduces borrowing cost by 2% per annum (SAR 1.6M per year benefit).
An arm’s length guarantee fee: typically 25%–75% of the benefit conferred, giving a range of approximately SAR 400,000–SAR 1.2M per year. If Al-Nour pays no guarantee fee to the UK parent, ZATCA may impute an arm’s length fee — affecting both the Saudi entity’s CIT/Zakat position and the WHT analysis on the implied payment.
Cash Pooling and Cash Management
The June 2024 Guidelines (Chapter 8.3) address both notional and physical cash pooling. For Saudi entities participating in a group cash pool:
- Interest on deposits: A Saudi entity placing surplus cash in a group pool should earn a rate reflecting arm’s length returns for that currency, term, and credit exposure — comparable to what the entity would earn from an independent deposit
- Interest on borrowings: A Saudi entity drawing on a cash pool should pay borrowing rates reflecting arm’s length short-term credit
- Pool leader remuneration: The pool leader earns a coordination fee reflecting the genuine cash management functions performed
The arm’s length analysis for pooling typically uses a CUP approach referencing short-term benchmark rates adjusted for currency and credit spread. The challenge: cash pool structures blend deposit and revolving credit elements, making direct comparables difficult. Reference to short-term market rates with appropriate adjustments is the standard approach.
Documentation for Financial Transactions
The Local File documentation for intercompany financial transactions must include:
- Loan agreement including all commercial terms (rate, maturity, security, covenants)
- Arm’s length interest rate analysis (CUP benchmarking data, credit rating analysis, comparable market rates)
- Credit rating assigned to the borrower (standalone and group-supported) and methodology
- For cash pooling: the pool agreement, interest rate calculation methodology, and evidence that rates reflect arm’s length terms
- For guarantees: the guarantee agreement, credit benefit quantification, and basis for the fee charged (or explanation for no fee)
- The thin capitalisation analysis for the relevant year
WHT on Intercompany Financial Payments
Outbound interest payments to non-resident related parties are subject to 5% WHT in Saudi Arabia (standard rate, subject to treaty reduction). This applies to interest on intercompany loans, guarantee fees, and cash pooling interest to non-resident pool leaders. The WHT must be withheld at the time of payment and remitted to ZATCA. A TP adjustment to the interest rate is separate from the WHT obligation on the cash paid.
Frequently Asked Questions
- Intercompany financial transactions require two separate compliance analyses: the TP arm’s length assessment of the interest rate, and the thin capitalisation assessment of total debt level. Both must be addressed.
- A loan at a perfectly arm’s length rate can still have disallowed interest if the debt-to-equity ratio exceeds the regulatory threshold.
- Guarantee fees and cash pool deposit/borrowing rates must also reflect arm’s length terms — these are controlled transactions subject to the same standard as any other related-party arrangement.
- WHT on outbound interest, guarantee, and cash pool payments adds a third dimension. All three must be managed together.
Also worth reading
This article reflects the Saudi Transfer Pricing Bylaws (March 2023 version) and the ZATCA Transfer Pricing Guidelines (June 2024 edition). It is for informational purposes only and does not constitute legal or tax advice. Readers should confirm the current position with ZATCA guidance or a qualified Saudi TP advisor. dariba.co is an independent platform with no consulting relationships.
Leave a Reply