Taxing Foreign Fundraising Fees - Commentary and Analysis
There is little difference in people, but that little difference makes a big difference. The little difference is attitude. The big difference is whether it is positive or negative. - W. Clement Stone
Amidst a host of disputes over taxing underwriting fees from corporations that raise funds by issuing securities overseas, the Ministry of Finance announced an executive order on 18 May 2004 directing that where institutions raise funds and issue overseas valuable securities (such as euro-convertible bonds, global depository receipts and American depository receipts: ECB, GDR and ADR), the underwriting fees and handling charges paid in connection with such issues are considered as Taiwan-source income subject to 20% income tax (withheld by the issuer). Moreover, back taxes for the past five years would be sought from issuers.
The MOF’s interpretive order follows last year’s pronouncement that tax must be levied on payments to foreign communications companies for leasing undersea cables, as well as a directive taking the position that remuneration of services provided abroad is also taxable. In ruling as it did on underwriting, the MOF’s thinking was that a foreign-based underwriter engaging in the business of underwriting and issuing depository receipts is not purely and simply providing services abroad. Rather, it constitutes the provision of services of a mixed nature, and as such it ought to come under “Other income gained within the borders of the Republic of China” as stipulated in Article 8, Paragraph 11 of the Income Tax Act. Together with the earlier decisions, this viewpoint confirms the MOF is increasingly inclined to treat compensation for services provided abroad as “other income”.
In addition to the above, certain taxation issues also flow from taxing overseas underwriting fees. These include:
I. Permanent establishments
Some foreign underwriters have set up branch organizations in Taiwan to act as their fixed places of business here. Also, in the course of issuing valuable securities, overseas underwriters will send employees to Taiwan frequently to carry out related business in order to keep in close contact with the domestic issuing company. In substance, the activities these individuals in Taiwan engage in sometimes constitute those of a business representative. Generally speaking, if such an individual engages in the following activities, then it is possible the tax authorities will regard the individual as a Taiwan-based business representative: (1) The person is empowered to sign agreements with domestic clients; (2) The person frequently engages in marketing activity, and has the right to decide the final terms of transactions. Both a fixed place of business and business representatives are considered to be the foreign underwriter’s “permanent establishment” (PE) in Taiwan. For a foreign underwriter, having or not having a PE in Taiwan has different tax consequences, as the following analysis will show:
| 1. | Foreign underwriters from countries that have not signed taxation agreements with Taiwan | |
| a. | Those without PEs: For the underwriting or handling fee income of foreign underwriters without PEs in Taiwan, when parties with a withholding obligation (such as domestic securities issuers) make payments, they must withhold 20% tax from the total amount going to pay foreign underwriting expenses. Still, according to a press release from the MOF dated 24 June 2004, among underwriting fees or handling charges income received by foreign underwriting or depository institutions, where it is difficult to apportion the costs and expenses for that part of such income belonging to technical services, application may be made to the MOF to use the 3.75% withholding rate provided under Article 25 of the Income Tax Act. | |
| b. | Those with PEs: Where a foreign underwriter has a permanent establishment in Taiwan, the PE must declare and pay profit-seeking enterprise income tax on behalf of the foreign underwriter when filing tax declarations, in accordance with Articles 71 and 73 of the Income Tax Act. As to how the taxable income amount is to be calculated, in principle it should be the pure profit found by subtracting itemized costs, expenses, losses and taxes from gross income. All itemized costs and expenses - including realized costs incurred domestically and abroad and the apportioned costs of a multinational group of companies - may be legally claimed. However, if one is unable to present legally valid documentary evidence, the tax authority may determine the amount of income according to same-industry profit standards. | |
| 2. | Foreign underwriters from countries that have signed taxation agreements with Taiwan | |
| a. | Those without PEs: Foreign underwriters may apply to the taxation authority for exemption from tax pursuant to “Instructions for Applying Taxation Agreements in Tax Collection Operations”. | |
| b. | Those with PEs: Income tax must be paid on the profit attributable to a permanent establishment in Taiwan. However, how one determines the profit attributable to that PE involves transfer pricing issues. These are discussed separately below. | |
II. Transfer Pricing
If a foreign underwriter apportions costs and expenses to the overseas members of the corporate group, then, according to a 24 June 2004 press release from the MOF, the foreign underwriter must provide documentation demonstrating consistency with the arm’s-length pricing principle, and so prove that the conglomerate’s internal costs have been allocated in accordance with reasonable transfer pricing policies. Based on this documentation, one can determine the reasonable and necessary costs, among the internal costs of the conglomerate, that may be allocated to underwriting income, and which may therefore me claimed as deductions. On the other hand, if there is no way produce such transfer pricing documentation, or the taxation authorities discover something inconsistent with arm’s-length business arrangements, the taxation authorities may proceed in accordance with Article 43-1 of the Income Tax Act, Article 114-1 of “Standards for Profit-Seeking Enterprise Income Tax Audits” and related regulations. That is, they may calculate the overseas underwriter’s income by one of the following methods:
- Comparable Uncontrolled Price Method
- Resale Price Method
- Cost Plus Method
- Other methods specified by the Ministry of Finance
The MOF’s withholding grace period ended on 1 July. As a result, domestic security issuers and foreign underwriters must make certain as soon as possible who is responsible for withholding taxes on underwriting fees. No matter who is responsible for withholding taxes, domestic issuing companies still need to file for payment of back taxes owed for the previous five years to avoid penalties from the taxation authorities. An income earner who has applied for tax exemption under taxation agreements, or has applied to use the provisions of Article 25 of the Income Tax Act, and has received a letter of permission from the taxation authorities, may then use that letter of permission to apply for a tax refund.
If a foreign underwriter or depository institution has not yet set up a branch, but does have what qualifies as a business representative, they must make the required submissions to the tax authorities as soon as possible, and also file a closing statement prior to 28 February 2004. If a belated registration of a business representative was filed before 30 June 2004, the issuing company can avoid the withholding requirement under the 18 May executive order. Otherwise, a domestic issuer must still file a tax declaration on the back taxes owed for the previous five years. Those who are exempt courtesy of a taxation agreement may, if they have received permission letters from the taxation authorities, use the letters of permission to apply for tax refunds.