Optimal Tax Planning: Multinationals Consider Applying for Corporate Headquarters Status in Taiwan

How to Plan for Optimal After-Tax Results

A gradual but pervasive force among Taiwan’s larger companies has been the trend toward “global deployment”. Following this trend, and after having made functional adjustments between different business locals, many Taiwan-based parent companies already possess an operational headquarters function, playing a corporate global logistics role, especially for procurement, R&D and back-office support. Given these developments, comprehensive tax planning for transnational management has become a topic that today’s globalized enterprises must face.

As a corporation’s performance from its transnational operations gradually emerges, the most pressing practical issue becomes how to pursue optimal after-tax results, which really comes down to finding out where to pay taxes in order to minimize one’s tax burden. There are several fundamental ways for an enterprise to reduce its taxable income, such as claiming early or accelerated deductions, taking care to pair income with costs, enlarging deductible costs, deferring tax assessment and transferring income to benefit from lower tax rates. These approaches lower tax burdens, and they have also been widely adopted by today’s companies.

Given these basic principles, a corporation can carry out - flexibly and reasonably - group-wide tax planning based on its particular organizational structure, business unit acquisition method and investment pattern, and on disparities between tax preferences in different countries. Some Taiwan-based businesses cling to the notion that taxation is equivalent to “personal or corporate income taxes” and neglect the effect on corporations of other taxes, such as customs duties and business tax (both input and output forms), which, because of differently designed tax systems in each country, also influence the size of a manufacturer’s tax burden.

Operational HQ Tax Preferences

The government-backed “Enterprise Operations Headquarters Plan” grants exemption from profit-seeking enterprise income tax to three kinds of income: income from R&D or management services provided to overseas affiliates; income from royalties received by overseas affiliates; and investment returns and profit distributions from investments in overseas affiliates. To date, however, corporations analyzing the utility of the HQ tax incentive policy have stressed only the third type, under which remittances of overseas investment returns enjoy tax-exempt preferential treatment. For the many corporations that reinvest such profits to meet the funding needs of expanding overseas businesses, and have not yet considered remitting overseas profits, this leads them to believe that there is little advantage to having headquarters status, and they therefore have less interest in applying for it.

In their transactions with affiliates, Taiwan’s corporations have consistently been less likely than others to declare “management services”, “royalties” or “investment returns and profit distributions” income types. But in fact, such income is commonplace among multinational conglomerates, and it is especially common among Taiwanese firms that act as the logistics and R&D centers of their corporate groups. The latter have frequent opportunities to transfer research achievements to allied businesses abroad. In consequence, their income for providing management services and R&D has been steadily increasing. Also, parent companies receive royalty payments from subsidiaries authorized to use their patented technology. Nonetheless, these kinds of income do not commonly get declared as part of the parent company’s income.

On 8 October 2004, however, the Ministry of Finance circulated “Draft Income Tax Audit Standards for Transfer Pricing Inconsistent with Arm’s Length Transactions”, under which a corporation’s transaction prices may be audited for their reasonableness and legality. Under the draft standards, corporations will have to establish reasonable and legally acceptable transaction prices for their operations “functions” and the attending risks. The corporate activity covered by this legislation is extraordinarily broad. For example, where a headquarters in Taiwan has an intellectual property rights management function, (the standards assume) it must generate royalty income and maintenance costs; and where there is a back-office logistics function, there must be management services income and costs, etc. From now on, if a corporation provides similar services to an overseas affiliate, then it is highly likely that the tax authority will require the parent company to establish reasonable transaction prices—based on the “arm’s length transaction principle”— and recognize the abovementioned income. But, if the corporation obtains an “Enterprise Operations Headquarters Letter of Certification”, then it can enjoy tax-exempt privileges on the abovementioned kinds of income.

Tax Risks in the Absence of Headquarters Status

In the future, tax authorities are certain to be stricter in their determinations of income items, costs, expenses, profits and losses. This is why companies that have not gotten an “Enterprise Operations Headquarters Letter of Certification” will run many tax risks. These could lead to much heavier tax burdens if, for example, a company’s tax preferences on fees for management services provided to an overseas affiliate get rejected because the fees are determined to come from an entity other than itself or a subsidiary. The company may lose investment tax credits because it provided R&D activities to foreign affiliates without compensation. It may even be subjected to a taxable income adjustment due to inconsistencies with arm’s length transactions.

From another point of view, when the tax units carry out audits, it frequently happens that there is a discrepancy in some income item or another compared to what the corporation originally determined in previous years, resulting in changes in the amount of tax due. At such time, if a firm has an “Enterprise Operations Headquarters Letter of Certification”, it can take advantage of the relevant income tax exemptions. Thus, one incentive to apply for operations HQ status is this ability to ward off taxation risk.

Tax Planning

When multinationals undertake tax planning, they must have a thorough grasp of the tax structures in different countries and their various tax deductions and credits. Considerations include:

• The income tax basis (global source income, own-country source income)
• The income tax system (double taxation system or a unified system)
• Tax rates and deductions/exemptions (fixed tax rates, cumulative tax rates, graduated tax rates, tax preferences)
• Taxes on dividends (taxation of stock dividends and distributions of surpluses)
• Capital gains tax (coverage, rates and exemption/deduction rules)
• Deductions for losses (limits on the amount of deductions and their time limits)
• Consolidated vs. separate tax declarations
• Recognition of fees for patents, trademarks, R&D, marketing and administration.