Francisco A. Laguna & Jimmy Wang
As international businesses expand globally, comprehensive knowledge of intricate international tax becomes even more imperative. In April 2013, Taiwan’s Legislative Yuan proposed the incorporation of two concepts into its international tax regime: controlled foreign corporations (“CFC”); and place of effective management (“PEM”). The proposal is currently awaiting legislative approval. This article discusses the new amendments.
Controlled Foreign Corporations Rule (“CFC Rule”)
The proposed rule defines a CFC as a corporation, not domiciled in Taiwan, which is either majority owned or controlled by a Taiwanese business entity. Generally, companies incorporated in Taiwan are taxed on income earned in Taiwan. Income received from their foreign subsidiaries is taxed when such income is repatriated to Taiwan in the form of dividends. Proponents of the CFC Rule argue that the current law results in a “tax deferral” mechanism and effectively gives companies an interest-free loan from the government until the CFC declares a corresponding, taxable dividend. To close this loophole, the following draft amendment to Income Tax Act has been proposed – informal translation:
Article 43-3 of the Income Tax Act
Effective January 1, 2015, a profit-seeking enterprise (“PSE”) that directly or indirectly owns affiliated enterprises in low-tax jurisdictions outside the territory of Taiwan, shall recognize and include its pro rata share of the affiliated enterprise’s taxable profits as investment income in its taxable income for the year. Subsequent actual dividends and distributions from such affiliated enterprises that were previously recognized as investment income will then not be subject to income taxation; any surplus to previously recognized investment income shall be included as taxable income in the allocated year. Low-tax jurisdictions are defined as countries where the PSE income tax rate is lower than 30% of the tax rate pursuant to Article 5 Paragraph 5 Subparagraph 1.
The proposed rule intends to eliminate the deferral of taxation and discourage businesses from leaving earnings in foreign jurisdictions. The new rule would require a Taiwanese company to recognize and include in its current taxable income its pro rata share of the taxable profits of its CFCs. However, the CFCs’ earnings will only be subject to taxation once. There is no second level of taxation when the earnings are actually distributed to the Taiwanese parent company in the form of a dividend.
Place of Effective Management Rule (“PEM Rule”)
Currently, Taiwan only taxes foreign corporations on their Taiwan-source income if such corporations operate their business in fixed places / establishments or through agents in-country. Consequently, corporations often structure their businesses by setting up companies in low or no tax jurisdictions and having the Taiwanese branch of these companies employ the management team. According to the new PEM Rule, foreign corporations will be taxed in Taiwan if their activities are substantively managed from Taiwan. The proposed rule reads as follows – informal translation:
Article 43-4 of the Income Tax Act
Effective January 1, 2015, if a profit-seeking enterprise (“PSE”) is incorporated based on foreign legislation but its place of effective management (“PEM”) is maintained within the territory of Taiwan, the head office of such PSE will be determined to be within the territory of Taiwan and profit-seeking enterprise income tax shall be levied in accordance with the Income Tax Act and relevant tax regulations. The aforementioned PEM refers to the place where substantive key management and commercial decisions of an entity’s business and its operations are made. The relevant definition and provisions shall be determined by the Ministry of Finance.
Under the new PME rule, foreign companies located in tax-havens, but whose management decisions are by / through their Taiwan branch, can no longer avoid paying taxes on worldwide income if the Taiwan tax authorities determine that the place of effective management of such companies is, indeed, Taiwan. This proposed rule, in effect, treats foreign companies with PMEs in Taiwan as if their head office in Taiwan; thereby, making them subject to a worldwide taxation.
The two proposed rules, if approved by the legislature, will change the contour of the taxation of business entities in Taiwan that have foreign subsidiaries, as well as foreign business that have permanent establishments in Taiwan. Multinational corporations engaging in business activities in Taiwan should keep a close watch on the progress of these rules and the possible impact to their business. Call TransLegal with your questions concerning how these amendments might affect your business.