Insights into transfer pricing in Taiwan and recent tax developments
Sherry Chang, a partner in KPMG in Taiwan, and Karl W Chan, a director, discuss the Panama Papers, BEPS, transfer pricing audits and recent amendments to transfer pricing guidelines.
The impact of the Panama Papers
The revelations of the Panama Papers are stimulating actions globally to combat tax avoidance. Without exception, they are also prompting the Taiwanese government to take more progressive enforcement action and crack down on tax evasion. Domestically, the existing anti-tax avoidance regulations consisting of transfer pricing rules, thin capitalisation and the principle of sustenance, are already promulgated by the Taiwan tax authorities. As for Controlled Foreign Company (CFC) rules and Place of Effective Management (PEM) – two essential anti-tax avoidance instruments that specifically tackle the use of tax havens to avoid paying taxes – have been suspended for three years.
With the global phenomenon of anti-tax avoidance, it is highly anticipated that Taiwan's legislature will swiftly pass two crucial anti-tax avoidance amendments. However, due to the historical background, many investment structures of Taiwanese companies were designed to invest in China through a company located in an offshore country. Hence, in order to alleviate the impact on Taiwanese companies, the Ministry of Finance (the MOF) proposed that the draft amendments will only be ratified with the condition of the effective of cross-strait tax treaty.
Updates on BEPS actions
Though Taiwan is not a member of the OECD, the MOF publicly expressed their intention to implement some aspects of the BEPS action plans – with at least minimum standards – in response to any new international trends. Meanwhile, the MOF also addressed the BEPS project on the whole, which could have a significant impact on the way tax treaties are drafted in the future in order to prevent treaty abuse. Apart from undertaken internal evaluations, several public consultative meetings with industry and tax professionals have been held by the MOF to discuss the BEPS Action plans, including BEPS Actions 1, 2, 3 and 13. It is widely expected, with some degree of certainty, that the revelations of the Panama Papers will prompt the MOF to take more action at a quick pace to respond to the BEPS Action plans.
For BEPS Action 1, related to the tax challenges of the digital economy, various issues have led to discussion as the tax system has been unable to collect a fair share of taxes from e-commerce transactions. From a VAT perspective, it is considered that the possibility to remove or stricter VAT exemptions on the import of low value goods in order to shut down tax loopholes.
The proposals for non-resident e-commerce suppliers (B2C transactions) are engaging sales within Taiwan is obliged to the VAT registration as B2C transaction is presently applying for the change reverses charge mechanism in Taiwan.
In relation to income tax, there are suggestions to revisit the feasibility of PE treatment in connection with foreign entities engaging in e-commerce activities in Taiwan. Although these issues are still under discussion, some relevant amendments and regulations are expected be made within next few years.
Taiwan tax authorities adopted the concepts of the BEPS Action 2, that tax planning based on hybrid mismatches should be restricted, even though cross-border hybrid instruments are not commonly used in Taiwan due to regulatory restrictions. However, the MOF welcome any public feedbackand opinions and continually evaluate any feasibility proposals on BEPS Action 2.
Regarding CFC rules in BEPS Action 3, as previously mentioned, in the wake of the revelations of the Panama Papers, the application of CFC rules will be soon implemented into domestic law in order to curb perceived tax avoidance through foreign retention.
In respect of the implementation and application of BEPS Action 13 on transfer pricing documentation and CbCR, Taiwan tax authorities have indicated that it may be possible to amend domestic transfer pricing regulations in order to reflect BEPS Action 13 guidelines. From the Taiwanese tax perspective, it is anticipated that the content of CbCR will align with the OECD format as long as the threshold for preparing CbCR complies with OECD's recommendations. However, the timeframe for implementing CbCR is uncertain in Taiwan. As a result, the preparation of CbCR for Taiwan multinational companies may be subject to earlier deadlines for subsidiaries or branches located in other countries where the timing requirement is in line with the OECD's recommendations. In relation to the Master File requirements, specific information relating to intangibles and financial activities will surely be embedded into the revised TP rules in the future.
The key focus of transfer pricing audits
Taiwan tax authorities have been intensifying the strength of TP audits for quite a number of years. While Taiwan tax authorities continually focus on the application of transaction-by-transaction approaches and the examination of selecting appropriate profit-level indicators in applying transactional profits methods, the following issues are the main areas for TP adjustment once TP audits come into place. It is advisable for taxpayers to take proactive actions regarding these issues, including reviewing TP policy and preparing TP document, because once TP adjustments are posed it can lead to serious double taxation.
Technical services fee
For the synergistic benefits of group operations, larger Taiwanese companies dispatch their employees as expatriates to overseas manufacturing affiliates to provide technical support. However, Taiwanese companies provide such technical services to their affiliates without charging compensation, as the cost of expatriates are still recorded into Taiwanese company accounts. From tax authorities' point of view, the Taiwan tax revenue base is seriously deteriorating by that arrangement.
Taiwan tax authorities conducting TP audits obtain data from the immigration bureau to scrutinise how many days of the employees have remained overseas. If the duration of the overseas stay exceeds 183 days in one calendar year, the tax authorities regard these employees as being sent by Taiwanese companies to overseas affiliates to provide services, and therefore technical services fee should be charged.
As a result, this leads to a huge number of TP adjustments in many TP audit cases by calculating salary expenditures of dispatched employees with certain mark-up rate.
Taiwan tax authorities take a strong view that once employees of Taiwanese company stay overseas more than 183 days, they will consider rendering services to overseas affiliates, no matter how strongly the taxpayers argue that the purpose of dispatching their employees is for the synergy of the group as a whole.
Exploitation of intangibles
The employment of intangible assets is another key focus for tax authorities when conducting a TP audit. Considering group cost-effectiveness, a number of Taiwanese-based companies shift manufacturing functions overseas and keep core-value functions, including R&D and sales activities performed in Taiwan.
Initially, the overseas manufacturing affiliates merely carry out minimal manufacturing functions. For the time being, the affiliates are engaging in sales functions locally for the expanding oversea local market. However, when tax authorities inspect the financial performance of Taiwanese-based companies and their affiliates during a TP audit, it may come to light that the profit of manufacturing affiliates is more lucrative than the Taiwanese headquarters.
Tax authorities argue that the reason the affiliates are more profitable is because the affiliates are involving the use of intangibles in connection with sales of goods. The intangibles are developed by the Taiwanese headquarters through the performance of substantive R&D activities and the expenditure spend on R&D activities also applies for tax incentives in Taiwan. Therefore, Taiwan tax authorities hold a strong position that at least a portion of such excess profits generated by the overseas manufacturing affiliates should be reallocated to Taiwan headquarters by compensating the use of intangibles. Therefore, it is critical to evaluate how value is generated by the group and the contribution that the associated affiliates make to that value creation in order to mitigate TP risk.
Intra-group guarantee arrangements
Regarding intra-group guarantee arrangements, although there is a strong argument about whether or not the guarantor situated in Taiwan should charge guarantee fees from the guarantee for the intra-group guarantee arrangement. However, tax authorities strongly declare that the guarantee generally has received economic benefits from the guarantee arrangement through savings of funding costs; in addition, the guarantor has been exposed to financial risk arising from the default of the guarantee. With key strong aspects, the tax authorities believe that a guarantor must be compensated with arm's length guarantee fees. However, the difficulty is in how to determine the guarantee fees is within arm's length since there is rarely comparable information in these conditions and economically relevant circumstances. Practically, it leaves room for negotiation with tax authorities if there is no comparable information.
Recent amendments to transfer pricing guidelines:
Additional TP amendments have been introduced by the MOF since the TP assessment rules were promulgated nearly a decade ago. The major amendments include that application of the arm's length principle in business restructuring and simplification of Advance Pricing Agreements (APA) application procedures.
With reference to the report on the transfer pricing aspect of business restructurings in Chapter 9 of the OECD TP guidelines, the new requirements for business reorganisation, is that businesses should comply with the arm's length principle in their related-profit distributions that are involved in the business restructure.
In order to justify whether the arm's length principle is met, business should take into account certain factors such as whether business restructuring is in conformity with the economic substance, or identifying the allocation of functions, assets and risks before and after the restructuring, and whether the attributed profit is arm's length. According to the amendments, businesses involved in the business restructuring are required to prepare the function and risk analysis of the current and the preceding years.
Advance Pricing Agreements
The thresholds for applying for APAs are significantly reduced from total amount of the transactions being no less than NT$1 billion ($31 million) or the annual amount of such transactions being no less than NT$500 million to total amount of the transactions being no less than NT$500 million or the annual amount of such transactions being no less than NT$200 million. Regarding the new mechanism for the application of APA, the period for submitting full documentation and the transfer pricing report would be extended from one month to three months. In addition, there is the option for taxpayers to apply a pre-filing meeting with tax authorities to facilitate the tax authorities' assessment of whether to accept the APA application. It is highly recommend that a multinational enterprise with large amounts or complex related-party transactions considers utilising APAs as means to eliminate tax risks and secure tax certainty.
In addition, Taiwan is expanding its treaty network. It is encouraging taxpayers to apply bilateral APAs to limit transfer pricing risks in the future.
KPMG in Taiwan
68F, Taipei 101 Tower, No.7, Sec.5, Xinyi Rd., Taipei, 11049, Taiwan, R.O.C.
Tel: +886(0)2 8101 6666
Sherry Chang is a senior partner of Tax & Investment Dept. and the country leader of KPMG's transfer pricing practice in Taiwan. She had over nine years of experience with the Taiwan tax authority before she joined KPMG in 2000.
Sherry Chang has extensive experience in providing general tax advisory services to multinational enterprises; particularly, she specialises in assisting multinational enterprises in resolving tax (including transfer pricing) disputes with the Taiwan tax authority. Her areas of industrial specialisation covers electronics, petrochemical, construction, telecommunication, automotive, media, consumption products, and financial services, etc.
Sherry Chang holds a bachelor degree in accounting from the National Chung-Hsing University (now known as National Taipei University). She is an accredited member of the Association of Certified Public Accountants in Taiwan and a frequent speaker for industry conferences on various tax topics.
Karl W Chan
KPMG in Taiwan
68F, Taipei 101 Tower, No.7, Sec.5, Xinyi Rd., Taipei, 11049, Taiwan, R.O.C.
Karl is a Director with the Global Transfer Pricing Services team of KPMG in Taiwan.
He has extensive experience advising clients on transfer pricing and cross-border tax issues. His areas of focus include transfer pricing documentation, dispute resolution, planning and cross-border business structuring.
Karl's client portfolio covers multinational enterprises involved in electronics, petrochemical, construction, telecommunication, automotive, marine transportation, apparel, and cosmetics, etc.
He has also participated as a speaker for transfer pricing seminars hosted by KPMG, Taiwan tax authorities, and various foreign trade organisations.