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Saudi Arabia is experiencing an ongoing boom in construction and related infrastructure projects supported by the approval in August 2010 of the 9th five-year development plan for the Kingdom of Saudi Arabia ("KSA"). According to the plan issued by King Abdullah bin Abdulaziz al-Saud, the KSA will see $385 billion invested in infrastructure development for the next five years of 2010 to 2014. As a result of this tremendous injection of funding, opportunities abound for foreign companies seeking to participate through direct construction projects, but also through a large number of services and support activities.

It is appropriate to review the primary laws in force in the KSA to understand some of the issues foreign investors looking to enter this market will encounter.

 

Islamic Law (Shari'ah)

The law of the KSA is Shari'ah, drawn from the Holy Qur'an (the divine revelation to the Prophet Mohammed) and the Sunnah (a record of the sayings and actions of the Prophet Mohammed). Unlike other jurisdictions in the Muslim world where Shari'ah law is applied only in specific contexts (e.g., family law and inheritance), in the KSA, Shari'ah law is the law of the land in all cases, and other laws are enforceable only to the extent that doing so does not violate the precepts of Shari'ah.

Shari'ah is a unique and distinctive system and in no instance should parties assume that matters addressed under Shari'ah will have outcomes comparable with those anticipated in other jurisdictions. Judgments in the KSA are not usually published, and cannot establish binding precedents, unlike in common law jurisdictions. The laws themselves are not entirely codified, and as such, the processes for reaching a judgment in any specific matter are driven by methodologies distinct from those understood in civil code jurisdictions.

Shari'ah recognises broad freedoms for parties to negotiate terms in their own contracts, unless the activities are prohibited elsewhere in the Shari'ah or violate the requirements of public policy. Parties are required to honour principles of fairness and good faith in their dealings, which implies absolute clarity on certain contract terms and provisions, and also requires avoiding uncertainty or deception. 

One critical distinction between Shari'ah and other legal systems involves the concept of interest as applied in the KSA. Terms in contracts involving payment or receipt of interest are not generally enforceable, which affects numerous aspects of contracting from payment arrangements, late payment penalties, shipping terms, insurance terms, and damages, where concepts of interest are typically ingrained into terms and clauses and assumptions applied in other jurisdictions.

 

Key Government Laws

While the substance of Shari'ah is not alterable, the processes for applying Shari'ah in specific matters are subject to government control, which may adopt processes for dispute resolution (see below), enforcement procedures, and establish other general principles and key terms as requirements before companies will be entitled to do business in the KSA, or may establish additional criteria before companies are entitled to contract with the government itself. For foreign companies looking to contract directly with the KSA government, the most important laws include:

Government Tenders and Procurement Law
All government entities, and most government-owned companies, apply the Government Tenders and Procurement Law to all contracts with third parties selling goods or services. The law generally follows international best practices to ensure free and fair bidding, but interpretation of the principles and application of the law to actual contracts results in a series of confirmations and verifications, which require rigorous review to determine precisely how a foreign company may best comply with the requirements to actually execute projects or deliver goods or services. 

Foreign investors need to be aware of the context of this Law, because it may override the wording in a specific Government contract to the extent of any inconsistency.

Foreign Investment Law
One of the key assumptions built into both the Government Tenders and Procurement Law and many other contracts is the requirement that companies seek to establish themselves in the KSA and provide goods and services through a local establishment. While many foreign companies prefer to provide goods and services from offshore, failure to establish a legitimate presence in the KSA will bar companies from directly meeting with their clients and customers, and will restrict their ability to operate effectively and receive payments.

Foreign investment in the KSA is regulated by the Foreign Investment Law and all foreign investors in the KSA must have a license issued under this law. In some ways, the Foreign Investment Law in the KSA is uniquely favourable to foreign companies, as it permits 100% ownership of either branches of most forms of limited liability companies. 

Foreign companies are authorised to establish branches of foreign companies, which are 100% owned by the parent that established the branch, limited liability companies (LLCs), in which at least two partners are required to participate, joint ventures, and consulting offices, among others. Foreign companies may also qualify to invest in joint stock companies, subject to more stringent requirements. In practice, the LLC is the most common business structure. There is no minimal capital requirement but in practice there are certain levels of capital established in various business sectors, which are set by the government on a case-by-case review of the proposed activities of the company. In most cases, a minimum of Saudi Riyals 100,000 is to be expected, unless the type of entity requires additional capitalisation.

One critical exception to the broad permission for 100% ownership consists of foreign companies practicing any form of "wholesale or retail trading," a term that extends to cover companies seeking to market their products in the KSA, companies looking to import products for sale to third parties, and many other types of activities that in other jurisdictions might be performed by a representative office. For a "trading company," a foreign company must invest a minimum of Saudi Riyals 20 million, and foreigners are restricted from owning more than 75% of the equity in a "trading company." If a foreign company does not establish a trading company, it will be permitted to only trade in products through duly appointed agents and distributors, or if those products are themselves produced within the KSA in an industrial facility.

The Saudi Arabia General Investment Authority (SAGIA) is the primary government entity responsible for foreign investment into the KSA. SAGIA serves multiple functions involving foreign investors, from implementing the foreign investment licensing regime, reviewing conduct by licensed companies to ensure they comply with foreign investment and all other laws, and promoting the KSA as an attractive destination for investment. SAGIA operates primarily through a network of "one stop shops" where SAGIA houses representatives and offices of other ministries and government agencies so that foreign investors can find most of the various rules and regulations with which they need to comply from a single location.

Establishing SPVs to channel investment into the KSA can be a problematic strategy. In recent years, SAGIA began requiring all foreign investors to present audited and attested financial statements for the last 3 years, and new requirements can arise at any time and without notice. As such, it is best to confirm the arrangements before undertaking any investment.

Employment Law
Relations between employers and employees are governed primarily by the Labour Law (Royal Decree No. M/51 dated 23 Sha'ban 1426), which covers all aspects of employment relations, including employment contracts, wages and benefits, leaves, working hours and the termination of employment. There is also extensive regulation relating to the women in the workplace.

Non-Saudi nationals may work in Saudi Arabia provided they have prior approval from the Ministry of Labour. Applicants must have an entry visa issued by the Saudi Embassy from the country of origin. Employers are required to secure work permits and residence permits ("Iqama") for foreign employees brought into the country within 90 days of the employee's arrival. Similar to other Gulf countries, Saudi Arabia has a sponsorship system, which means that expatriate workers can enter, work and leave the host country only with the permission or assistance of their sponsor. However, in Saudi Arabia, the sponsorship system extends to a number of other services and routine activities, with requirements often arising for presentation of a letter of support from a sponsor before an expatriate will be permitted to lease a residence, open a bank account, rent a vehicle, or perform many other types of common transactions.

The KSA government has long implemented various "Saudization" policies intended to encourage employers to hire Saudi nationals in preference to foreign expatriates. A system called "Nitaqat" also exists, by which employers are penalised if they fail to achieve the Saudization targets that apply to them.

Zakat and Income Tax Law
Saudi Arabia operates a dual taxation system, with KSA nationals and entities owned 100% by other nationals of the Gulf Cooperation Council (the countries of Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates) (the "GCC") paying "zakat," a wealth tax based on 2.5% of the total capital held by a person. Foreign entities, which include almost every company owned by non-GCC persons, are subject to the requirements of the "income tax" law. When the two entities operate jointly, accounting requirements to determine tax assessments can be an unusually challenging, but in principle, the tax obligations of the mixed parties will be incurred separately by each party in proportion to their holdings.

Non-KSA entities pay income tax on KSA income derived from KSA sources at a flat rate of 20%, as adjusted.

KSA registered entities are required to also withhold payments to foreign entities for purposes of paying a withholding tax. Amounts of such withholdings include:

  • management fees: 20% withholding tax

  • royalties: 15% withholding tax

  • rent/technical/consulting fees: 5% withholding tax

Note that in practice, determining the correct tax withholdings will require consulting with a suitable tax advisor. As a legal matter, it is imperative for foreign companies to obtain certificates of tax clearance and to maintain such certificates in effect at all times, as failure to do so, or the expiration of such certificates, will bar companies from performing other government operations, entering into contracts, and renewing other permits and registrations critical to operating the company in the KSA.

 

Language

Although KSA courts and authorities will only enforce contracts presented to them in an Arabic form, many foreign companies find it is possible to operate in the KSA using primarily their English contracts for a number of purposes. Companies are prudent however to plan translations in advance of any documents executed, as it is regularly required for companies to present these documents to government inspectors and other parties who will not deal with documents prepared in a language other than Arabic. Note that all official company records, including human resources, accounting, corporate documents, and other materials must be in Arabic.

 

Dispute Resolution Processes

General Courts 
The General Courts, or Shari'ah courts, have primary jurisdiction in criminal and many types of civil matters, and have ultimate jurisdiction to hear any dispute involving matters of Shari'ah law unless a statute has specifically transferred jurisdiction to another forum (see below).

Board of Grievances 
The Board of Grievances deals with disputes in which the KSA Government is a party and with disputes in the private sector over commercial transactions between private sector parties. Shari'ah Law will apply to all cases heard by the Board of Grievances. Enforcement of judgements is made by the execution judge under the Enforcement Law 2012.

Arbitration
Arbitration is allowed within the KSA and is governed by the new Arbitration Law of 2012 and its implementing Regulations. Arbitral awards have immediate effect, subject to limited objection grounds, and can be enforced under the Enforcement Law 2012. Foreign Arbitration remains an option, but enforcement remains difficult, depending on the specific location of the foreign arbitration and the substansive law applied by the arbitral tribunal. Arbitration is not permitted where one of the parties is a KSA Government entity, except by specific permission of the Council of Ministers. 

Alternative Dispute Resolution Authorities
Several separate authorities, committees, and dispute resolution entities have been implemented by statute to handle specialised matters. Among these, some of the more important entities include the Banking Dispute Resolution Committee, the Insurance Dispute Resolution Committee, the Securities Dispute Resolution Committee, the Labour Dispute Resolution Committees, and the Media Dispute Resolution Committee. These judicial entities can issue decisions and judgments up to limits prescribed by the relevant statute establishing the authority. There are plans underway to shift ultimate authority from these tribunals and committees to the General Courts, with the Board of Grievances to act as an administrative authority, but implementation has been part of a broader effort of judicial reform in the KSA.

Qualification - This is a brief overview of some of the legal principles that will apply to any transaction or business activity in the Kingdom of Saudi Arabia. It is necessarily an overview and is intended to be only an introduction. Reference should be made to qualified Saudi Arabian counsel before embarking on any particular transaction or business in the Kingdom of Saudi Arabia.

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For more information regarding Saudi Arabian Law, please contact Clyde & Co LLP

 

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