Sale and leaseback: the tax treatment of the transaction

Two forms of the transaction

In practice the transaction takes one of two forms. The first is a sale of the property to an investor, such as a real estate fund or a company, followed by a long lease back from it, sometimes with an option to buy back. The second is a financing arrangement in which the property passes to a licensed financier under an Ijara ending in ownership, a Murabaha or a finance lease, and returns to the owner once the financing is repaid. Although the economic effect is similar, the tax treatment of the two forms is fundamentally different.

Real Estate Transaction Tax: once or twice?

In the first form, the sale to the investor is a taxable disposal at 5%, calculated on the agreed consideration within the limit of fair market value. ZATCA may verify the value where the parties are related or there is reason to do so. If the seller later exercises a buy-back option, the property's return is a new taxable disposal.

There is a subtle pricing point: if the sale price is reduced in exchange for below-market rent, the taxable value does not necessarily fall, because fair market value is what counts.

In the second form, the Regulations provide that a real estate disposal under Murabaha, Ijara ending in ownership and finance lease contracts is taxed only once, on the first transfer to the licensed financier, subject to conditions, chiefly:

• Both transfers must be stated in the financing contracts, identifying the parties to each transfer, the property and its value.
• The description and value of the property must not change in the financing contracts.

If these conditions are not met, or the buyer is not a licensed financier, the general rule applies and each transfer is taxed separately.

The Regulations also look to the substance of a transaction rather than its form: a sham disposal is taxed according to the real disposal it conceals. And granting usufruct rights for more than fifty years is treated as a taxable disposal, with the tax calculated on present value.

Value Added Tax

1. 01The saleA real estate supply that is subject to Real Estate Transaction Tax is exempt from VAT.
2. 02The leaseCommercial rent is standard-rated at 15%, and residential rent is exempt. If the tenant uses the property for taxable activity, VAT on the rent is in principle deductible; if it uses it for exempt activity, the VAT becomes a cost.
3. 03The payment periodThe 2025 amendments to the Regulations exempt certain financing contracts, such as operating leases, Murabaha and Ijara ending in ownership, from having to reverse the deduction when the consideration is not paid within twelve months, provided specific conditions are met.

Accounting does not decide the tax

Accounting standards may treat the transaction as a financing rather than a sale if the transfer of the property does not meet the requirements for a sale under IFRS 16, in which case the property stays on the seller's books with a financial liability recognised against it. Real Estate Transaction Tax, however, turns on the legal transfer of ownership, so it may be due even where the transaction is accounted for as a financing. Keeping the two treatments apart is essential when assessing the economics of the deal.

Before signing

1. Establish who the buyer is: a licensed financier or an investor? The answer decides how many times the tax is charged.
2. Draft the financing contracts so that they meet the conditions for single taxation.
3. Obtain and document an independent valuation of fair market value, especially where the parties are related.
4. Agree which party bears the tax under the contract and its effect on pricing, bearing in mind that the law places the obligation to pay on the transferor in principle.
5. Register the transaction with ZATCA on or before its date, and pay the tax on time.
6. Consider the VAT effect of the lease for the tenant according to the nature of its activity.

In summary

A sale and leaseback is at heart a financing decision, but its tax cost can change its economics. Whether the tax is charged once or twice is usually decided when the transaction is structured and its contracts drafted, not after it is completed.