Saudis Mull Hiking Tax as High as 20% for Local Banks, Sources Say

(Bloomberg) -- Saudi Arabia is considering plans to increase an Islamic tax paid by local banks to as much as 20 percent, or double the current rate, according to people with knowledge of the matter, as the world’s biggest oil exporter seeks to bolster alternative sources of revenue.

The tax authority is in talks with lenders about raising the religious levy, known as Zakat, potentially bringing it in line with the 20 percent rate paid by foreign banks in the kingdom, the people said, asking not to be identified because the discussions are private. The talks are ongoing and the final rate could be lower, they said.

Local lenders started paying Zakat at 10 percent of profit after deducting returns on government bonds from last year as part of a settlement with the authority. They used to pay at 2.5 percent of equity and the new rate was applied retrospectively for many years, in some cases stretching as far back as 2002. A spokesman for the General Authority of Zakat and Tax declined to comment.

The Tadawul Banks Index fell the most in more than two months. Al Rajhi, the biggest Islamic lender, sank to its lowest level in over a month, while National Commercial Bank dropped 1.7 percent. The benchmark Tadawul All Share Index was trading 0.6 percent lower.

“This is certainly negative for Saudi banks and will dent the euphoria surrounding them because they were supposed to do better than other sectors,” said Chiro Ghosh, an analyst at Bahrain-based investment bank SICO BSC. “But the Zakat will be adjusted against equity and won’t affect profit and loss, so the numbers will not look that bad.”

Lost Dividend

While Saudi banks are well capitalized and able to afford a rise in the levy, “higher zakat is effectively a dividend opportunity lost for investors,” said JPMorgan Chase & Co. analyst Naresh Bilandani.

“We see limited risk of a flat 20 percent of net income being the new norm. We think this is likely to come with certain adjustments,” he said. “We are of the view that zakat, under the ongoing discussions, is likely to shift to the traditional way of calculations which is 2.5 percent of the assessable base.”

Bloomberg Intelligence: Saudi Banks Heading into 2019

The proposed tax increase comes as the biggest Arab economy seeks to shore up its public finances. While the government expects the budget deficit to narrow this year, economists say the projections were probably based on unrealistically high oil prices. Still, the ongoing discussions show a reluctance to alienate a private sector that’s already struggling with economic reforms.

“The fact that there is dialogue about this is positive,” said Monica Malik, chief economist at Abu Dhabi Commercial Bank. “Instead of saying ‘these banks can just absorb it,’ there’s actually a consultative process. The government needs to balance between its need for revenue and the impact on economic activity.”

Last year, the tax authority also extended Zakat by including items that were previously exempt, while eliminating some deductions.

Saudi Arabia’s banking landscape is changing with lenders exploring mergers. The kingdom’s biggest lender, National Commercial Bank, in December announced the start of merger talks with Riyad Bank. The potential deal would follow the combination of HSBC Holdings Plc affiliate Saudi British Bank and Alawwal, which was backed by Royal Bank of Scotland Group Plc.

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