How to Joint Venture in Saudi Arabia

Establishing a joint venture in Saudi Arabia can be an extremely attractive option for foreign investors. It provides access to local expertise, market knowledge, business networks, and the financial strength of a Saudi partner. Additionally, potential economies of scale can be leveraged through such a partnership.

Despite the clear advantages of forming a joint venture in Saudi Arabia, foreign investors should undertake thorough planning that focuses on financial, legal, and strategic aspects. This article provides a practical guide to the key considerations.

Foreign investors must familiarize themselves with the local tax and financial framework to optimize their chances of success. Contractual agreements with local partners should clearly regulate the following key points:

• Capital Contribution: The parties should clearly define what assets (e.g., cash, intellectual property, know-how) and in what amounts they contribute to the joint venture. A realistic valuation of the contributed tangible and intangible assets is required.
• Profit Distribution: It must be determined when, how often, and in what proportion the profits generated by the joint venture will be distributed to the partners.
• Loss Allocation: The parties should agree on how potential losses of the joint venture will be borne.
• Financing Arrangements: Various financing options should be considered to cover the joint venture’s operational and investment capital needs. These include shareholder loans as well as Sharia-compliant financing models such as .
• Tax Regulations: The tax obligations of the parties must be clearly defined. Foreign investors are subject to a corporate tax rate of 20%, while Saudi partners pay a Zakat levy of 2.5% on their net income. Foreign investors should also examine whether double taxation agreements (DTAs) provide benefits such as tax exemptions or deductions. Notably, Germany has not concluded a DTA with Saudi Arabia. Moreover, companies operating in newly established Special Economic Zones (SEZs) can benefit from significant tax advantages.
• Exit Strategies: It is advisable to include clear exit strategies in the contract. These may include clauses regarding the purchase or sale of shares, as well as valuation methods for situations where a party wishes to exit the joint venture.

Foreign investors should familiarize themselves with the relevant legal framework in Saudi Arabia. This includes Saudi corporate law, the Foreign Investment Law and its implementing regulations, the Arbitration Law and commercial courts, as well as labor law.

Legal Forms of Joint Ventures

Investors should understand the different corporate structures available for joint ventures:

• Limited Liability Company (LLC): The most common structure for joint ventures, offering a flexible framework and limited liability.
• Joint Stock Company (JSC): Often used for large projects and ventures requiring significant capital.
• Simplified Joint Stock Company (SJSC): A new structure combining elements of LLCs and JSCs, providing greater flexibility in corporate governance.

Foreign Investment Law

Foreign investors should be aware of the key provisions of Saudi Arabia’s investment law, which governs their business activities in the Kingdom. The most important aspects include:

• Approval by the Ministry of Investment (MISA): Every foreign investment must be approved by MISA, which acts as a one-stop-shop for all necessary formalities, from company registration to obtaining licenses and permits. Notably, the previous licensing system will soon be replaced by a registration system, with detailed regulations expected in February 2025.
• Liberalization of Investment Restrictions: Saudi Arabia has significantly eased foreign investment restrictions and now allows up to 100% foreign ownership in most sectors, except for strategic areas such as oil and gas, media, security, and defense, which remain restricted.

Why is ISIC4 Relevant?

The classification of investment activities under the International Standard Industrial Classification (ISIC), Version 4 (ISIC4), is a key consideration for foreign investors in Saudi Arabia. ISIC4 is an internationally recognized system for categorizing economic activities, developed by the United Nations.

Correct classification of an investment activity under ISIC4 is crucial, as it directly impacts approval and regulation by MISA. The choice of the appropriate classification affects:

• Approval Procedures: MISA uses ISIC4 as a reference for categorizing investment projects, but responsible officials are often not sufficiently familiar with the classification details. Incorrect classification can therefore lead to delays or unnecessary restrictions.
• Permitted Activities: Certain sectors are subject to regulatory restrictions or specific requirements. A precise ISIC4 classification helps avoid unclear or incorrect restrictions.
• Investment Incentives: Tax benefits and incentives often depend on correct industry classification. Choosing an ISIC4 category that best matches the joint venture’s business activity can provide financial advantages.
• Minimum Capital Requirements: The choice of ISIC4 classification can have direct implications on the required minimum capital. For example, an industrial license for a business activity involving production requires a minimum capitalization of SAR 1,000,000.
• Trade/Distribution Licenses: Any sales activity, whether following a production phase or through resale, may require a trade or distribution license with significant capital requirements (at least SAR 26,667,000 with Saudi participation and SAR 30 million for 100% foreign ownership). Therefore, classification under certain trade categories should be avoided if the goal is to minimize capital requirements.
• Service Categories: Activities classified under service categories generally require significantly lower capital requirements.

Strategic Considerations

• Understanding local business culture and etiquette is crucial for the success of a joint venture in Saudi Arabia. Personal relationships and trust-building play a central role in business interactions.
• Investors should conduct thorough due diligence on potential local partners, including financial audits and assessments of market reputation. Ensuring that both partners share similar business goals can prevent conflicts. A deep understanding of the business and social environment is essential to avoid misunderstandings or negative consequences arising from disregard for prevailing business, social, and religious norms.

Practical Tips

• Business agreements should be documented in a comprehensive joint venture contract and a detailed business plan that allows for flexible adaptation.
• A well-structured joint venture should include a Matrix of Authority, defining roles, responsibilities, and decision-making powers. Critical decisions should be classified as Reserved Matters, requiring the approval of all partners.
• Investors should establish robust licensing agreements to protect intellectual property when contributing technology or know-how to the joint venture. Confidentiality agreements and regular audits can provide additional security.

Compliance with Local Regulations

• Anti-Money Laundering & Anti-Corruption Laws: Investors must ensure compliance with Saudi regulations on money laundering and corruption by conducting due diligence and implementing internal compliance programs.
• Labor Law & Saudization Requirements: Foreign companies must comply with the Nitaqat system, which mandates quotas for employing Saudi nationals. Non-compliance can lead to sanctions or restrictions on work permits for foreign employees.
• Dispute Resolution: A dispute resolution clause is essential in joint venture agreements. Saudi arbitration law, based on the UNCITRAL model, provides an effective dispute resolution mechanism. The Riyadh Commercial Arbitration Center and the International Chamber of Commerce (ICC) are widely recognized arbitration institutions.

Conclusion

Setting up a joint venture in Saudi Arabia presents substantial business opportunities but requires careful financial, legal, and strategic planning. Foreign investors can maximise their success by understanding local regulations and cultural nuances. Partnering with experienced legal advisors familiar with Saudi laws and business practices is essential to navigate the complexity of the establishment process and ensure long-term success.