VAT on Real Estate in Saudi Arabia: Treatment, Exemptions and Input VAT Calculations

Real estate transactions have been subject to VAT since its introduction in 2018. Initially, the VAT rate on real estate was 5%, in line with other supplies. However, this rate increased to 15% effective July 1, 2020.

A tax circular from ZAT exempted most real estate supplies from VAT starting October 4, 2020, except leasing or renting commercial real estate. This exemption was introduced alongside a 5% real estate transaction tax (RETT) on most real estate transactions, which also took effect on October 4, 2020.

This blog will explain the VAT exemption for real estate supplies, input tax claim for mixed supply, the proportional deduction formula for residual VAT calculation.

Meaning of Real Estate Supply Under VAT

In the context of VAT, a real estate supply refers to any transaction where real estate is sold, rented, or transferred as part of an economic activity. 

Real Estate Properties

The Sale, purchase and leasing of the following property are considered real estate supply 

• Commercial Real Estate: Includes offices, factories, and other business premises.
• Residential Real Estate: Covers permanent homes and residential properties.
• Vacant/Bare Land: Includes undeveloped land and farmland.
• Partially Completed Construction: Encompasses buildings that are still under construction.

Transactions Covered Under Real Estate Supplies

Here are the transactions considered as a real estate supply

Sales

• Ownership Transfer: Involves any legal transaction that results in the transfer of real estate ownership, including sales, gifts, wills, and barter.
• Usufruct Rights: Long-term leases or usage rights typically lasting more than 50 years.
• Financial Lease: Leasing arrangements that effectively transfer real estate ownership.

Leasing and Renting

• Commercial Leasing: Renting out commercial spaces, such as offices and retail stores. This is subject to VAT.
• Residential Leasing: Renting out residential properties. This is exempt from VAT.
• Short-Term Accommodation: Hotels and similar accommodations fall under commercial leasing.

Transaction Not Considered Real Estate Supply

Shariah-Compliant Financing: Involves the purchase and sale of real estate as part of Islamic financing arrangements. This is not subject to VAT or RETT as it falls under Islamic finance services.

VAT and RETT Applicable on Real Estate Supply

Input VAT Recoverability for Real Estate Transactions

Proportional Deduction of Residual Input Tax

When businesses engage in both taxable and exempt activities, it is necessary to proportionally deduct input tax to ensure compliance with tax regulations and fair tax recovery.

The proportional deduction of residual input tax is a method used to determine the portion of input VAT that a business can reclaim when the input VAT is incurred on goods or services used for both taxable and exempt supplies. This ensures that businesses only deduct the amount of input tax related to their taxable activities.

Residual Input Tax

Residual input tax refers to the VAT incurred on inputs that cannot be directly attributed to either taxable or exempt supplies. It typically includes overheads and general expenses such as office utilities, internet services, or stationary costs, which support the overall business activities without being tied to specific transactions.

Methods to Calculate Proportional Deduction Percentage

The proportional deduction method involves calculating the deductible portion of residual input tax based on the ratio of taxable supplies to total supplies (taxable + exempt). There are mainly two methods to calculate the proportional deduction percentage and the taxpayer can opt for any based on which results in claiming more input tax deduction.

Standard Method

This method includes all exempt real estate supplies for calculating proportional deduction percentages. 

Proportional Deduction Percentage=

(Value of Taxable Supplies/(Value of Taxable Supplies + Value of Exempt Supplies))*100%

Example: If a business has taxable supplies worth SAR 400,000 and exempt supplies worth SAR 100,000, the calculation is: (400,000/ (400,000+100,000)) *100%=80%

Thus, 80% of the residual input tax is deductible.

Alternative Method (for Real Estate Financing)

This method excludes exempt real estate supplies from financing transactions in the calculation to avoid distortions in the recovery percentage.

Modified Formula: 

Proportional Deduction Percentage=

(Taxable Supplies/Taxable Supplies+(Exempt Supplies−Exempt Real Estate Supplies for Financing)) *100%

Example: A bank has taxable supplies worth SAR 100 million, exempt supplies worth SAR 200 million, and additional exempt supplies from real estate financing worth SAR 750 million:

Standard Method: (100 million/ (100 million+200 million+750 million) *100%=9.5%

Alternative Method: (100 million/ (100 million+200 million) =33.3%

The alternative method results in a higher deduction ratio, better reflecting the use of residual input tax in taxable activities.

Real Estate Financing as VAT Exempt Supply

VAT Exemption: Real estate financing, compliant with Shariah principles, is generally exempt from VAT.

Alternative Proportional Deduction Method: Licensed financiers or banks providing Shariah-compliant real estate financing may use an alternative method for VAT deductions as mentioned above. 

Eligibility Criteria: To

• The Central Bank of Saudi Arabia must license the financier.
• The financing must comply with Shariah principles.
• The financier must meet other specific criteria 

 Regulatory Compliance:

• If a financier no longer meets the eligibility criteria, they cannot use the alternative method and must follow standard VAT rules.
• ZATCA has clarified regulations to ensure proper application of the alternative method and exclusion of exempt supplies from the proportional deduction formula.

Conclusion

The VAT treatment of real estate supplies has significantly changed since VAT's introduction in 2018. Most real estate transactions are now exempt from VAT, except leasing and renting commercial properties. However, these transactions are subject to a 5% Real Estate Transaction Tax (RETT). 

For mixed supplies involving taxable and exempt transactions, businesses can claim input VAT on a proportional basis using one of two methods: the standard method or the alternative method, which excludes exempt real estate supplies from financing transactions.