Guideline for

Supplies of Goods as Part of Financing Products The VAT exemption for Financial Services does not apply to the Supply of tangible Goods. The Supply of Goods in the KSA by a Taxable Person (for example, a tangible asset sold together with finance) is a Taxable Supply. However, Islamic Financing structures can entail a temporary transfer of ownership of an asset, which may be considered outside the scope of VAT under specific circumstances (these are discussed in more detail in Section 4.3). 4.2.2 Equivalent Application of VAT Exemption for Islamic Financing Products The Implementing Regulations prescribe15 that Islamic Financing Products will be treated in the same manner as the equivalent non-Shari’ah Financial Product for the purpose of exemption from KSA VAT. This applies to arrangements which are: • Shari’ah-compliant; • simulate the intention of a non-Shari’ah-Compliant Financial Product; and • achieve effectively the same result as a non-Shari’ah Compliant Financial Product. However, not all Shari’ah-Compliant Financing Structures have an equivalent non-Shari’ah- Compliant Financing Structure. To the extent that there is no equivalent, the Shari’ah-Compliant Financing Structure has its own unique VAT treatment. The objective is to apply VAT exemption to Shari’ah-Compliant Financial Products where equivalent non-Shari’ah-Compliant Financial Products are eligible for exemption. This means that the implicit profit margin included in any fees or installments payable under the Islamic finance product may be treated as a VAT-exempt supply, even if it is part of an explicit fee or commission, despite any payment of an explicit fee or consideration, or the underlying sale and purchase of goods. This means, for example, that the profit on the transfer of ownership of a tangible asset that occurs due to Shari’ah requirements only, which under normal circumstances would be viewed as separate taxable Supplies of those Goods is viewed to be an exempt implicit margin on the provision of financial services. 15. Article 29(3), Implementing Regulations. Example (3): An Islamic financier enters into a Tawarruq agreement whereby it purchases a specified amount of commodities from a seller for 20,000 SAR, and sells these to the financee for 23,000 SAR with an embedded margin (of 3,000 SAR) with deferred payment over twelve months. The financier arranges for the seller to re-purchase the goods from the recipient of the finance for 20,000 SAR, and this amount is credited to the financee. In this case, the transfer of title to the goods is not intended to result in possession permanently passing to the owner, and therefore the Supply of Goods in this transaction is, in principle, ignored for VAT purposes. The embedded margin of SAR 3,000 is equivalent to the interest earned on a non-Shari’ah financing product and is treated as VAT-exempt income for the financier earned over the 12-month term of the Tawarruq. Example (4): A KSA-based furniture manufacturer enters into a Murabaha agreement with a finance provider to finance the purchase of a new sewing machine. The Murabaha agreement intends for a physical supply of the sewing machine (including the transfer of possession and ownership) from the finance provider to the furniture manufacturer. The transfer of Goods is a commercial supply in its own right and does not only occur due to Shari’ah requirements. The supply of Goods is recognized as a taxable supply of goods and is subject to VAT at 15%. However, the profit earned by the finance provider is the implicit margin for the supply of financial services, equivalent to the interest earned on a non-Shari’ah financing arrangement. The profit element is VAT exempt.