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Recent developments in transfer pricing audit practice in Taiwan

Transfer pricing regulations and documentation requirements have been in effect for almost nine years, since the end of 2004, and the Taiwanese tax authorities have accumulated more and more experience and knowledge. Paulson Tseng of PwC gives an overview of the Taiwanese tax authorities’ comments on how taxpayers should prepare transfer pricing reports and discusses recent tax auditing practice.

Contemporaneous transfer pricing reports are a required supplementary document when a taxpayer prepares and files its corporate income tax return. Taiwanese tax authorities examined the transfer pricing report in more detail and announced, in March 2013, various conceptual clarifications on how taxpayers should prepare the transfer pricing report.

In recent years, the Taiwanese tax authorities have initiated more challenges on the transfer pricing practices developed by taxpayers and have increased the strength of transfer pricing audits.

Conceptual clarifications on how to prepare the transfer pricing reports

As per Taiwanese transfer pricing regulations, companies engaged in related party transactions are required to meet the transfer pricing documentation requirements, including the submission of a related-party transactions disclosure form, together with the company's annual income tax return. Transfer pricing reports should be prepared upon filing of the income tax return if the safe-harbour thresholds are surpassed.

Since transfer pricing results can significantly impact the tax results of taxpayers, the transfer pricing report becomes one of the primary documents to support the corporate income tax position of taxpayers. Tax authorities pay close attention to the transfer pricing reports prepared by taxpayers. In March 2013, tax authorities published a newsletter to describe certain fundamental concepts which should be followed by taxpayers when preparing the transfer pricing report as per the Taiwanese transfer pricing regulations. This newsletter is outlined as follows:

Transfer pricing analysis should be done on a transactional basis

Tax authorities have observed that many taxpayers in Taiwan used the combined approach on testing the overall operating result of the Taiwanese company for preparation of the transfer pricing report. However, many of these taxpayers may have various types of intercompany transactions with related parties or group companies. The primary reasons that taxpayers are inclined to use the combined approach to test the transfer pricing result may include:

  • Avoiding disclosing detailed intercompany transactions and the applied transfer pricing policies to the tax authorities;

  • Reducing compliance and administrative burden to test the transfer pricing of the company on a transactional basis; and

  • The transfer pricing results of the counter parties may be challenged by the Taiwanese tax authorities, for example, excessive profit reported at the level of counter-party group companies from a Taiwanese perspective.

Therefore, in the past, many Taiwanese companies used the comparable profit method and selected themselves as the tested parties and claimed the transfer pricing result of the group was in line with the arm's-length principle based on the testing of the overall operating profit results of the Taiwanese companies. However, in many cases, the Taiwanese company may be characterised as the entrepreneur and perform strategic and high-value added functions, assume entrepreneurial risks and own unique or high-value intangible property but still select itself as the tested party. The tax authorities commented that this is an incorrect practice and not in line with the transfer pricing regulations. The tax authorities gave this example:

A Taiwanese parent company engages intercompany transactions with three of its group companies, including sale of goods to company A, purchasing of goods from company B and licensing a patent from company C. The Taiwanese company should separately test the transfer pricing of each of the three intercompany transactions and not only test the overall profit result of itself.

The test party should be correctly selected when using the comparable profit method

As mentioned above, many Taiwanese companies may select themselves as the test party for their transfer pricing analysis to apply the combined testing approach. The tax authorities said that the test party should be the company which is less complicated in terms of the functional profile and does not own high-value intangible properties, but they found that many Taiwanese companies, acting as the headquarter of the group, performing the key functions, assuming the major risks and owning the core intangible assets of the group, still select themselves to be the tested party to use the combined approach to test the overall profit result. The tax authorities said that in this case, the counter party of the group companies should be selected as the tested party.

The transfer pricing method and the profit level indicator should be correctly selected when using the comparable profit method

Tax authorities also indicated various examples of how the transfer pricing method and the profit level indictor can be incorrectly selected as follows:

  • The resale price method is used to test the transactional prices based on the resale prices sold to the unrelated party customers, deducted by the comparable uncontrolled gross margin. Therefore, if the transaction under review is for resale to the related party customers (in that the sales transaction is controlled), the resale price method should not be applied.

  • The cost plus method is used to test the transactional prices based on the cost prices purchased from the unrelated party suppliers or manufactured by themselves, plus the comparable uncontrolled gross margin. Therefore, if the transaction under review is for purchasing from the related party suppliers (in that the purchasing transaction is controlled), the cost plus method should not be applied.

  • For selecting the profit level indicators when using the comparable profit method, if the denominator of the profit level indicator involves the amount of controlled transactions, such profit level indicator should not be applied. For example, the return on sales (calculated based on the operating margin over sales) should not be applied when the denominator (sales revenue) involves controlled transactions, for example, when the tested party sells the products to the related party company.

Example of certain recent tax auditing cases

Case 1


A Taiwanese parent company of the group is allocated with part of the advertising expenses incurred by its overseas distribution subsidiary. The tax authorities requested this Taiwanese company to provide the supporting document to explain the allocation mechanism of the group advertising expense and the detailed calculation of the allocation.

Tax payer's viewpoint

The Taiwanese parent company is the global brand name owner. The advertising expenses incurred by the overseas distribution subsidiary are for the purpose of global branding promotion, which should be assumed by the Taiwanese parent company.

Tax authorities' viewpoint

The Taiwanese parent company is allocated with approximately NTD 200 million ($7 million) of advertising expenses by the overseas distribution subsidiary, which seem to be expenses which should not be paid by the Taiwanese parent company as its business expenditures and it seems that the Taiwanese parent company intends to shift the profits to the overseas countries. Therefore, the tax authorities disallow the advertising expenses deduction claimed by the Taiwanese parent company.

Transfer pricing audit result

The tax authorities finally agreed that the advertising for promoting the global brand name is beneficial to the group brand name owner, the Taiwanese parent company. However, the tax authorities challenged that the operating profit results of certain overseas distributors were above the arm's-length range. Therefore, the tax authorities imposed certain transfer pricing adjustments to reduce the profit reported in the overseas distributors down to the median of the inter-quartile range and increase the taxable profit of the Taiwanese parent company.

Our observation

The Taiwanese tax authorities have paid close attention to the intercompany transactions in relation to intangible property. Companies should regularly review the defence of the transfer pricing policies applied and prepare the supporting transfer pricing documentation for the intangible property transactions.

Case 2


The US group parent company licensed to its Taiwanese manufacturing subsidiary to use its patent, technology and trademark to conduct the manufacturing and sales in its territory. The US group parent company charged a royalty against the Taiwanese manufacturing subsidiary based on a certain percentage of the sales amount to the third parties. In past years, the royalty rate was approximately 5% of the sales revenue. However, in 2011, the royalty rate was increased up to 20% of the sales revenue. The increase of the royalty charges reduced the operation profit result of the Taiwanese manufacturing company from 16% in 2010 to 7% in 2011.

Taxpayer's viewpoint

The group has conducted a business restructuring in 2010 and US tax authorities challenged the royalty rate of 5% being too low for granting the company's patents, technology and trademark to the Taiwanese manufacturing subsidiary. Therefore, the US parent company increased the royalty rate to 15% as the median of the benchmark result in 2011 and also charged additionally the differential 2010 royalty amount in 2011.

Tax authorities' viewpoint

The functional profile of the Taiwanese manufacturing subsidiary had no changes in 2011 as compared to 2010, but the royalty payment was increased from 5% to 20%. This indicates that the US parent company intends to shift the profits from Taiwan to the US by charging a non-arm's length royalty. Therefore, the tax authorities disallow the deduction of the incremental royalty expenses claimed in 2011.

Transfer pricing audit result

The tax authorities generally agreed with the defending arguments presented by the taxpayers. After negotiation, the Taiwanese tax authorities accepted the royalty deduction for year 2011 but disallowed the deduction of the royalty additionally charged for the differential 2010 royalty amount.

Our observation

The Taiwanese tax authorities pay high attention to the significant downward changes on the profit results of the taxpayers as compared to the previous years. If this is the case, defending arguments and documentation should be well prepared. Also, tax authorities may impose tax adjustments on non-transfer pricing items via transfer pricing audits.

Case 3


The US parent company engaged a Taiwanese subsidiary to provide contract R&D services for its benefit and paid R&D service fees to it as the compensation. The R&D expenses were calculated based on the mechanism as per the contract R&D agreement entered in 1996. The R&D agreement was amended in 2003. The US parent company imposed a transfer pricing adjustment to reduce the R&D expenses paid to the Taiwanese subsidiary for the years 2003 and 2004. The adjustment was done off book via the Taiwanese subsidiary booking a sales allowance in the amount of NTD 60 million.

Taxpayer's viewpoint

The R&D payments paid before 2003 were not at arm's-length and should be adjusted from a commercial viewpoint. The R&D payments paid by the US parent company to the Taiwanese subsidiary have resulted in roughly 40% to 60% of the operating margin for the Taiwanese subsidiary between 2000 and 2002 and this operating margin rate is much higher than the group consolidated operating margin rate. Therefore, the Taiwanese subsidiary was over compensated and the US parent company conducted a downward transfer pricing adjustment to reduce the R&D payments for the years 2003 and 2004 and the Taiwanese subsidiary's operating margin was reduced to 35% and 25% respectively in these two years.

Tax authorities' viewpoint

The transfer pricing adjustment should be made based on the following requirements:

  • The transfer pricing adjustment should be agreed in advance considering the transactional terms and other factors which may affect transfer pricing (for example, there should be an intercompany agreement with adjustment clauses);

  • The transfer pricing adjustment should be reported in the book and cannot be done off-book;

  • The retroactive transfer pricing adjustment can only be done when there were uncontrollable external uncertain factors which had not been taken into account when determining the transfer pricing policy in the past.

Therefore, the transfer pricing adjustment imposed by the US parent company is not in line with the above requirements to conduct the transfer pricing adjustment.

Furthermore, the Taiwanese subsidiary has never reported any sales allowance in its business between 2000 and 2002. Considering there were not many changes on the functional profile of the Taiwanese subsidiary, it seems to be not in line with the business rationale that the Taiwanese subsidiary suddenly incurred a significant amount of the sales allowance.

Furthermore, it is not reasonable to use the group consolidated operating margin level to evaluate whether the operating margin result of the Taiwanese subsidiary fulfils the arm's-length principle because the Taiwanese subsidiary is a contract R&D service provider which differs from the functional profile of the group as a whole.

Therefore, the tax authorities disallowed the sales allowance of the Taiwanese subsidiary and imposed transfer pricing adjustments and additional tax liability.

Transfer pricing audit result

The Taiwanese subsidiary had filed appeals against the tax authorities' transfer pricing assessment. The highest court of Taiwan ruled in favour of the tax authorities and considered the transfer pricing adjustment at issue was not a real business transaction and therefore, should be disallowed.

Our observation

If taxpayers plan to do voluntary retroactive transfer pricing adjustments, they should review whether they have met the above mentioned requirements for conducting the transfer pricing adjustments. Supporting documents should be well prepared, for example, agreements, transfer pricing reports, transactional evidences etcetera.


Since transfer pricing regulations came into effect at the end of 2003, the Taiwanese tax authorities have paid much closer attention to cross border transfer pricing issues. Taiwanese tax authorities have become more aggressive on the transfer pricing audits. The width and depth of the transfer pricing audit scale has also increased dramatically in recent years.

Furthermore, it is worthwhile to note that since the Taiwanese tax authorities normally audit transfer pricing along with assessing the corporate income tax return, the tax authorities tend to audit the tax results of the taxpayers not only from a transfer pricing perspective, but also from other tax perspectives, for example, expense deductibility, withholding tax claim, granting of tax incentives, VAT or customs duties, etcetera. For example, the tax authorities may reject a company's research and development tax credit after discovering that, through its transfer pricing report or transfer pricing audit, the company's claimed R&D credits are in fact derived from the R&D activities carried out by its overseas group entities.

Multinational companies operating in Taiwan should be more cautious about the defence of the group transfer pricing arrangements and ensure the transfer pricing policy is in line with the arm's-length principle and is supported by properly prepared transfer pricing reports and other documentation (for example, intercompany agreement, valuation report, etcetera).




Paulson Tseng

Senior manager, International Transfer Pricing


Tel: +886 2729 6666 ext. 23672

Mobile: +886 972 295 935


Paulson Tseng is a senior manager in the transfer pricing group of PwC Taiwan, with a focus on international transfer pricing issues. He has more than eight years of experience working in PwC Taiwan and PwC Netherlands. He is a certified public accountant in Taiwan. He has expertise in advising large (mainly Asian) multinational companies involved in transfer pricing /international tax issues including the following:

Business restructuring of international operations and business models

Some recent examples in this area include the use and implementation of principal structures, including centralised IP centres, distribution centres, shared service centres, commissionaire centres, agency structures, contract manufacturing and contract R&D.

Evaluating and defending existing transfer pricing policies

Some recent examples in this area include:

  • formulation and documentation of policies on a multi-country basis;

  • global core documentation

  • negotiation of advance pricing agreements; and

  • assistance on extensive transfer pricing audits.

General international tax adviser for multinational companies

Some recent examples include setting up business operations/models, holding structures, licensing structures and financing structures and carrying out a role as a (global/European) coordination manager for many of his clients.

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