Reduction of Taxes on Income From Oil

Mar 28, 20170 comments

Aramco: Tax reduction was one of three solutions to make the Armco IPO worth $2 trillion

After months of speculation on the Saudi Aramco IPO – which is planned for next year– the Saudi government took on Monday a serious step towards making the transaction possible. A new regulation was announced changing the income tax payable by Saudi Aramco from 85% to 50%, with the cut backdated to 1st January.

The new 50% tax rate will apply to all Saudi oil companies with a capital of more than 375 billion Saudi riyals ($100 billion). Saudi oil companies valued at between SR375 billion and SR300 billion Riyals will pay 65% income tax, and those valued at between SR300 billion and SR225 billion will pay 75%, with those of a lesser value paying 85%.

Selling Armco’s share offering is part of the long-needed reform plan that the Saudi government was forced to focus on following the drop in oil prices since 2014. The plan, called Vision 2030, aims to reduce Saudi Arabia’s dependence on hydrocarbons. At present, the government gets over 60% of its income from oil, so the changed tax rates may affect its finances.

It is planned that the cash generated from Saudi Aramco’s share sale will be used to inject cash into the sovereign wealth fund that will invest outside of the oil business and in support of developing non-oil sources of income within Saudi Arabia.

Saudi Aramco’s spokespersons have said that they would like the company to run its accounts as they would function after the IPO for at least a year before any offering. Furthermore, the company plans to give potential investors unprecedented access to its financial data, information that had previously been regarded as top secret. To date, Saudi officials have made a good PR and marketing job by valuing Saudi Aramco at $2 trillion.

The royal decree authorizing the transaction is a milestone in setting the stage for what could be the world’s biggest IPO. It is likely that there will be more such moves in coming weeks and months.

To date, one big worry of foreign investors has been the lack of transparency. It is an issue for any businessman setting up an entity in Saudi Arabia, since rules and regulations on paper can differ from what is done in practice. Saudi Aramco never needed to publicly release information about its reserves, its earnings or the taxes and royalties that it pays the Saudi government. In the case of the IPO, specialists say commodity prices and sales will determine profits and payments to shareholders, including the government and the royal family, with dividends taking the place of the higher taxes.

This measure might not have a big impact since tax revenue was expected to be replaced by dividend payments from Saudi Aramco, but the company has not revealed its post-IPO dividend policy.

Saudi Finance Minister Mohammed al-Jadaan said that any tax revenue reductions applicable to hydrocarbon producers operating in Saudi Arabia will be offset by stable dividend payments by publicly owned companies, and other sources of revenue including profits resulting from investments. The 2017 state budget had been prepared with the tax change in mind.

A few months ago, there were doubts whether the Saudi government will actually be taking that step to the end as the requirements of transparency in the structuring of the IPO is not based in Saudi business mentality. The tax cut is the conclusion of intensive discussions with international bankers about how the offering should be structured best.

All Saudi “stakeholders” are involved — the state, the public investment fund, the royal family and the public. A rare step happening in Saudi Arabia and a strong sign that the intention to make this IPO a success and implement the reform plan happen is serious.

The taxation announcement was also a sign that the planned IPO, which has been slow to get off the ground, may be gaining momentum. King Salman recently completed a three-week tour of Asia in which he advanced Saudi Aramco’s campaign to become a major refining and petrochemical power in China, Japan, Malaysia and Indonesia. Mounting joint investments with some of Saudi Aramco’s biggest customers should increase the value of Saudi Aramco to investors in the future.

Privatisation plans have been talked about for months. The public’s concern is how such an ambitious plan can be implemented. Key issues are the relevant regulatory framework, transparency and the power to create a new investment environment.

The offering requires Saudis to overcome their mentality. Saudi Aramco will need to meet strict disclosure requirements to be listed on a stock exchange, and it looks that this might be the New York Stock Exchange.

The steps that have been taken so far prove the serious intentions that every party in Saudi Arabia is interested and serious in making it happen. Most importantly, what this means to the people of Saudi Arabia, who are scared as the question of the how of implementation is looming over their heads. There is a general understanding that cutting subsidies is a necessary evil, but knowing that a medicine is good for you does not remove the bitter taste.

Since the announcement of Vision 2030, there are constant announcements in media and statements by the government on how the planned reforms will create a better future. Privatization requires a lot of investment, in Saudi Arabia it is investing in trust. Hopefully, doing what it takes will end in a beneficial result for all.