Not only is Taiwan a hub that connects Europe, the US, Japan, and emerging Asian markets, but it also has a highly skilled labour force, and is very active in the global research and development (R&D) and high-tech fields. Taiwan's access to mainland China's productive capacity, and its capability to commercialise innovative products, makes it highly competitive in the global economic landscape.
Completing the anti-tax avoidance framework
In line with recent global tax developments, Taiwan has also made a number of significant changes to its income tax regime, completing its anti-avoidance framework by introducing the controlled foreign company law (CFC) and the place of effective management (POEM) law.
Articles 43-3 (CFC rules) and 43-4 (POEM rules) were inserted into the Taiwan Income Tax Act (ITA) in 2016 when the Legislative Yuan passed its third reading. However, the actual effective dates of these rules are still to be announced. One key factor that will affect the effective dates of these new rules is the timing of the ratification of the China-Taiwan cross-straits double tax agreement (cross-straits DTA).
Historically, Taiwan companies have invested into China via intermediate holding companies in low or tax haven jurisdictions (e.g. the British Virgin Islands, Samoa, etc.). These arrangements will be significantly impacted upon by the new CFC and POEM rules entering into force. However, with the use of the cross-straits DTA, these impacts could be minimised. This could be achieved by treating the intermediate holding company as a Taiwan tax resident company, under the POEM rules, which are the same as the residency definitions under the cross-straits DTA, and thereby accessing the benefits under the cross-straits DTA.
Introduction of the CFC rules
According to Taiwan's ITA, as long as offshore subsidiaries do not repatriate earnings to Taiwan, their Taiwan parent company would not be subject to Taiwan income tax on such foreign earnings. As a result, Taiwan companies can defer Taiwan income tax on their foreign investment revenue by parking investment income in an offshore entity.
There had been concern about Taiwan companies indefinitely retaining profits in their offshore subsidiaries located in tax havens or low tax jurisdictions and circumventing income tax by not distributing dividends. It was considered that this could end up eroding the domestic tax base. To prevent this, the Taiwan Ministry of Finance (MOF) introduced the CFC rules in the ITA under Article 43-3.
By introducing the CFC rules, which have already been in place in many other countries for a long time, the MOF would be able to focus on those CFCs that retain profits offshore for the purpose of deferring Taiwan taxation. The Taiwan parent company would be required to recognise the amount as (foreign) investment income based on its holding percentage. This would deem the revenue to have been distributed to Taiwan and result in it being treated as taxable profits for the Taiwanese parent company in the relevant tax year.
An offshore entity will be considered as a CFC under the Taiwan ITA if a Taiwan company directly or indirectly controls such an entity and where the offshore entity is located in either a low-tax jurisdiction (currently where the benchmark tax rate is below 11.9%) or a jurisdiction which taxes on a territorial basis. Once an entity is determined to be a CFC, then the Taiwan parent company must recognise and include its pro-rated share of the offshore entity's profits as its investment income within its taxable income for the relevant year. A CFC will be exempted from such treatment if a substantial amount of income derived by the CFC arises from actual business operations or if the profit of the CFC for the particular year is below the de-minimis threshold (which is yet to be prescribed by the authorities).
Introduction of the POEM rules
Under the ITA, Taiwan uses a tax residence test that is based on incorporation, rather than a test based on a company's place of central management and control. As such, to minimise tax, Taiwan companies can set up foreign incorporated entities and divert profits to such overseas paper companies, and thereby fall outside the scope of Taiwan income taxation. Usually these offshore companies exist only for tax minimisation purposes with no economic substance or commercial necessity, with management and control of the entity effectively being performed in Taiwan.
Increasingly, it has been international tax practice to determine the tax residency status of an entity according to the location of its POEM. Consequently, the MOF has introduced this concept into the ITA to ensure that an offshore company with its POEM in Taiwan will be determined or deemed as having its head office within Taiwan. This treats the offshore company as a Taiwan company for corporate income tax purposes and subject to taxation similar to that of a Taiwan incorporated company.
Expanding the tax treaty network
Although Taiwan is enhancing its anti-avoidance framework, it is also seeking to remain competitive in the international tax realm.
Taiwan continues to expand its tax treaty network and it has now signed DTAs with 32 tax jurisdictions.
DTA between Taiwan and Japan
The agreement with Japan was signed on November 26 2015 and marked the 30th DTA that Taiwan had signed. It is also the first DTA signed with another northeast Asian country, which signifies the solidification of Taiwan's treaty network in Northeast Asia.
The agreement will come into effect from 2017.
The purpose of the DTA is to clearly distribute taxing rights, eliminate double taxation, decrease uncertainties with taxation, and improve both Taiwan and Japan's investment environments.
Both the OECD Model Tax Convention and the UN Model Double Tax Convention served as blueprints for the Taiwan-Japan DTA. The domestic tax regulations, economic and trade conditions, various income-generating cross-border activities and existing double taxation eliminating relief measures for each jurisdiction were taken into consideration in finalising the DTA. The agreement addresses methods to resolve tax disputes and enhance bilateral economic and investment relations. A few key features of the Taiwan-Japan DTA are discussed below.
Reduced withholding tax (WHT) rates
The WHT rates on dividends, interest and royalties in the source territory will be reduced as follows:
- Dividends: If the company paying a dividend is a resident and if the beneficial owner of the dividend is a resident of the other territory, the tax charged will not exceed 10% of the gross amount of the dividend;
- Interest: If the beneficial owner of the interest is a resident of one territory, the tax charged in the other territory will not exceed 10% of the gross amount of the interest; and
- Royalties: If the beneficial owner of the royalty is a resident of the other territory, the tax charged in the other territory will not exceed 10% of the gross amount of the royalty.
|Applicable WHT rates|
|Japan domestic WHT||Taiwan domestic WHT||DTA Rates|
We note that dividends received by Japanese companies from their wholly owned foreign subsidiaries can effectively be tax exempt in Japan. As such, the preferential dividend WHT rate of 10% should reduce the overall tax burden of the Japanese parent company.
For Taiwanese parent companies, the dividend received from its Japanese subsidiaries will still be subject to tax in Taiwan at 17%. However, the DTA reduces the issue of excess foreign tax credits being wasted under Taiwan's foreign tax credit regime and thus reduces the overall tax burden for the Taiwanese parent company.
Based on the above, the Japan-Taiwan DTA should encourage more direct investments between Taiwan and Japan.
Where a company is a resident of a territory that sells its shares in the company, which is a resident of the other territory, then the capital gains taxing rights will lie with the alienator resident territory. This is the case unless the subsidiary is a company deriving at least 50% of the value of its property directly or indirectly from immovable property situated in the other territory.
Permanent establishment (PE) and business profits
Typical to treaties, there is a provision within the Japan-Taiwan DTA governing PE profit attribution that draws on the OECD Model. It provides that profits from an enterprise of one jurisdiction will not be taxed by the other jurisdiction if the enterprise does not carry on business through a PE in that other jurisdiction.
In addition to the general definitions of a PE, the DTA also stipulates that companies furnishing services, including consultancy services, will create a PE in the other jurisdiction only if the enterprise, through employees or other personnel engaged for the same or a connected project, provide services for a period or periods aggregating more than 183 days in any 12-month period commencing or ending in the taxable year concerned. This services PE article provides an opportunity for Japanese companies to benefit from the exemption under the business profits article.
Pursuant to the Taiwan ITA, foreign companies may be subject to a Taiwan income tax liability where they derive Taiwan sourced income. The existence of a PE (a fixed place of business or a business agent) in Taiwan does not affect the determination that income is taxable, instead it only affects the tax rate and manner of making the tax payment.
If a foreign company does not have any PE in Taiwan (under the Taiwan ITA definition), yet derives Taiwan sourced income, such income will be subject to WHT at 20%, provided that the type of income is within the scope of WHT. If a foreign company derives Taiwan sourced income, which is not within the scope of the WHT, the foreign entity would need to report such income by appointing an agent to file Taiwan income tax on its behalf.
Before the Taiwan-Japan DTA is effective, where a Japanese company derives (Taiwan sourced) service income from Taiwan customers, the service fees will be subject to 20% WHT. Once the Taiwan-Japan DTA comes into force, where the Japanese company can evidence that it does not have a PE pursuant to the PE article (e.g. its employees stayed in Taiwan for less than 183 days in any 12-month period), the Japanese company can apply for such income to be exempt from Taiwan taxation under the business profits article and the 20% Taiwan WHT should not apply. For using the business profits exemption under the Taiwan-Japan DTA, the Japanese company will need to obtain pre-approval from the Taiwan tax authorities.
Profits from shipping and air transport operations in international traffic carried on by an enterprise of a territory will be taxable only in that territory.
Dependent personal services
Remuneration derived by a resident of a territory in respect of an employment exercised in the other territory will be exempt from income tax in the other territory if all of the following conditions are fulfilled:
- A continuous or cumulative stay in the other territory for no more than 183 days in any 12-month periods;
- The remuneration is paid by (or on behalf of) an employer who is not a resident of the other territory; and
- The remuneration is not borne by a PE in which the employer has that other territory.
Under Taiwan domestic law, where a foreign company sends its employees to provide services in Taiwan, and the individual employees stay in Taiwan for 90 days or less in a calendar year, such individuals will generally be exempt from Taiwan income taxation. However, where the individuals stay in Taiwan for more than 90 days, but less than 183 days, in a calendar year, he/she will be required to report and pay tax in Taiwan.
Pursuant to the new Taiwan/Japan DTA, having satisfied the conditions under the aforementioned article, the particular individual could be exempt from Taiwan income taxation where he/she stays in Taiwan for less than 183 days (but more than 90 days) in a calendar year.
Minimising double taxation
Under the DTA, should the conduct of businesses between a Taiwanese company and a related Japanese company lead to issues with respect to transfer pricing adjustments in Japan, which increase the Japanese company's taxable income, the companies are entitled to access a tax dispute resolution mechanism. They may request the initiation of a mutual agreement procedure (MAP) with the Taiwanese tax authorities concerning the right of taxation, effectively eliminating double taxation.
Apart from the MAP, a Taiwanese company and Japanese company may approach the respective tax authorities to apply for a bilateral advanced pricing agreement. Once a consensus is reached and approved, this will not only comprehensively address and resolve any potential transfer pricing disputes for the relevant years, but also minimise scrutiny from the tax authorities from either contracting jurisdictions in reviewing or making post-transactional adjustments.
Revisiting Taiwan-Japan investment holding structures
In the past, given the high domestic WHT rates in Taiwan and Japan without a DTA in place, we had observed the common use of intermediate holding companies in a third jurisdiction (e.g. the Netherlands) for inbound and outbound investment holdings structures by Japanese and Taiwanese investors, respectively. The Taiwan-Japan DTA may trigger a need for Japanese investors to revisit their investment holding structures for investing into Taiwan and vice versa.
Overall, the DTA is a very positive development, providing more attractive investment options in terms of taxation and opening doors for potential tax efficiencies.
Draft VAT proposal to catch foreign e-commerce businesses in the Taiwan VAT net
In additional to the above changes, on September 22 2016, draft VAT law changes were passed by the Executive Yuan.
The proposed changes seek to include foreign e-commerce enterprises, without a Taiwan fixed place of businesses (e.g. a Taiwan branch), that sell electronic services to individuals in Taiwan, within the Taiwan VAT net. This will be achieved by requiring those foreign entities to register for and remit VAT in Taiwan.
Under existing provisions, where a foreign enterprise without a fixed place of business in Taiwan sells services to Taiwan businesses/consumers (individuals or enterprises), it will be the Taiwanese business/consumers which will be the VAT taxpayer in Taiwan. Based on the proposed changes to the VAT Act, this will no longer apply for foreign enterprise selling electronic services to domestic individuals. The VAT taxpayer status will be shifted to the foreign enterprise itself.
The foreign enterprise (or appointing a local agent) will need to register and file for VAT with the competent tax authorities if it has annual sales exceeding a certain threshold. Should the taxpayer or the tax-filing agent for the business entity fail to remit VAT within the prescribed period of time, penalties will be imposed.
Aligning with the OECD BEPS recommendations and recent observed changes in this regard in the EU, Japan, and South Korea, the draft proposal highlights an increase in the compliance requirements for foreign e-commerce businesses selling services to individuals in Taiwan. Although not officially announced, it is anticipated that there would be future developments in the income tax rules in relation to this area.
We note that the Taiwan tax authorities are actively observing and studying the outputs under the 15 action items of the OECD BEPS Project. In view of the various changes (e.g. the CFC and POEM rules) that have taken place in Taiwan over the past year, as well as the proposed VAT changes, we are expecting more changes to come.
Companies should closely monitor the development and implementation details of the upcoming and proposed changes to ensure that tax risks are appropriately managed. They should also keep an eye out for tax efficiencies (e.g. the use of the Taiwan-Japan DTA) so they do not miss out on any potential tax opportunities.
68F, Taipei 101 Tower, No. 7,
Stephen Hsu is head of the tax and investment department of KPMG in Taiwan. Before joining KPMG, Stephen was a tax officer of the Taipei National Tax Administration, within the Ministry of Finance.
Stephen specialises in the provision of financial services. He has assisted multinational enterprises in the tax evaluation of mergers and acquisitions (M&A), international tax planning and tax planning services for corporate investment and operation structures. He has also been actively providing global transfer pricing services to both foreign and domestic companies and assistance in tax appeal consultations and filings.
Stephen is an instructor, both internally at KPMG in Taiwan, and externally at the National Taiwan University's College of Management, and a lecturer at the training institute of the Ministry of Finance. Stephen serves as an adviser of the Taiwan Insurance Institute. He is also a member of the Taipei City CPA Association, a member of the Taxation Agency, Ministry of Finance, and a member of the Government Information Office.
68F, Taipei 101 Tower, No. 7
Hazel Chen joined the tax service department in Taiwan in 2006. Before her tax consulting career, Hazel was a former tax officer of the Taipei National Tax Administration, with more than four years of experience in the field of individual income tax and corporate income tax audit. Her experience has strengthened her understanding of the practices of the tax administration.
Hazel provides tax consulting services to both domestic and multinational groups in areas of transfer pricing, corporate investments and operational structuring, as well as tax audit assistance. She also assists multinational companies in handling global transfer pricing and tax compliance issues. Her specialisation is in the technology, media and telecommunications sectors in both industrial and consumer markets.
Hazel has been involved in numbers of tax field audit projects for merger transactions conducted by multinational and large local companies. She also has extensive experience in corporation with many foreign KPMG teams through co-execution of varies transfer pricing analyses.
Hazel is a frequent speaker at tax and transfer pricing seminars, and workshops for clients and the public.
68F, Taipei 101 Tower, No. 7
Betty is an international tax director in KPMG Taiwan in Taipei. She has more than 10 years of professional experience gained in a number of jurisdictions, that is, Australia, Hong Kong and Taiwan. She joined KPMG Hong Kong in 2007 where she provided corporate tax advice and compliance services to Hong Kong as well as multinational companies.
Betty joined KPMG in Taiwan in 2011 where she specifically provides outbound tax and investment consulting services for both domestic and multinational groups in Taiwan and the Asia Pacific region. Betty has extensive exposure and specialises in numerous facets of taxation for a range of clients as well as identifying the needs and provisions of required solutions, including investment holding structuring and tax planning, group restructuring and relevant tax implications, general tax compliance and advisory support.
She is a member of the Institute of Chartered Accountants in Australia, a chartered tax adviser of The Taxation Institute in Australia as well as an international affiliate member of the Hong Kong Institute of Certified Public Accountants.