Taiwan's Right to Tax

Tax havens, with their general lack of financial transparency, have long been targeted for investigation by governments around the world seeking to prevent tax evasion and curb international money laundering. The OECD maintains a blacklist of tax havens containing the names of over 30 jurisdictions, the most well-known of which is probably British Virgin Islands. Multinational conglomerates overseas seldom use such tax havens. This is because doing so would have a negative impact on their international reputation, and it would arouse the suspicions of the securities and tax authorities about the transparency of their financial statements and the possibility of tax evasion, leading to frequent and costly audits.

Last year (2005), Taiwan began implementing "Regulations Governing Audits of Income Tax Transfer Prices Inconsistent with Arm's Length Transactions", which were enacted as an anti-tax evasion measure. However, there are a couple of rather large blind spots when it comes to using transfer prices to track down tax evasion. First, transfer pricing audits and tax adjustments only apply to controlled transactions with overseas related parties. If the taxpayer sets up shop in a tax haven under its own name, and then engages in international trade, it seems the tax authorities would have a hard time investigating its transactions. Second, Taiwan applies the doctrine of territoriality to the collection of personal income taxes, so only income from the Republic of Taiwan can be taxed. From an American or European perspective, however, there are plenty of effective tax measures and methods available to investigate and uncover tax evasion through tax havens.
Tax systems in countries around the world can be divided into two types depending on which principle they use to determine tax residency: "incorporation" or "effective management". The former determines that a company is a tax resident based on the fact that it is incorporated under the local country's company law(s). The latter determines tax residency based on the fact that the main organization constituting the effective management of a profit-seeking enterprise is located within the nation's borders, regardless of whether it is incorporated under domestic or foreign company laws. In both cases, governments claim the right to tax companies' worldwide income.

Article 3 of the Income Tax Act reads in part: "For any profit-seeking enterprise having its head office within the territory of the Republic of China, profit-seeking enterprise income tax shall be levied on its total profit-seeking enterprise income derived within or without the territory of the Republic of China…" No definition of "head office" is given here, and "profit-seeking enterprise" is not defined as being either foreign or domestic. Article 8 of the same Act states, however, that the definition of Taiwan (R.O.C.)-source income includes "profits from operation of industry, commerce, [etc.] enterprises within the territory of the Republic of China". Consequently, Taiwan's tax sovereignty must be said to apply the "effective management" principle.
In other words, if a foreign-registered company in Taiwan constitutes the effective management of a profit-seeking enterprise, Taiwan has the right to tax that enterprise's worldwide income. That is, if a tax haven-based company has within Taiwan's borders most elements of its operations - the board of directors and its members, majority shareholders, managers responsible for business decisions, the bulk of its day-to-day operations, cash and bank accounts, its business information control points, etc. - then that tax-haven company's general headquarters may be viewed as being a Taiwan profit-seeking enterprise that must file income tax returns.

In order to collect taxes from companies in tax havens, many countries have special controls over, and supervision of, offshore banking units (OBUs). If it is discovered that an account-holding offshore company is essentially a tax-haven shell corporation, the country concerned has the right to determine that the net flow of funds deposited into the account (including interest) constitutes income sourced in that country. It can then levy the statutory tax rates on that amount and require the bank to notify the accountholder of the tax assessment, which the accountholder must then pay within a fixed period or face the seizure of all the funds in the account.

International taxation theory places a rather heavy emphasis on the "substance over form" principle. In contrast, Taiwan has in the past overemphasized a kind of "documentary formalism". Having implemented the new transfer pricing audit regulations, however, the fiscal authorities need to do more to educate the public as to the current tax system's basic principle, as well as the means by which the government can exercise is tax sovereignty. They must try to prevent taxpayers from assuming that all they need to do is set up a company in a tax haven, use that company to open an account in an OBU, and then start avoiding taxes. For in fact, such conduct is serious, illegal tax evasion, which if not pursued would lead to billions of dollars of fiscal revenue being hidden uncollected in offshore bank accounts.

To Taiwan's own group enterprises, the best advice is to forego the use of tax havens when investing and trading. For one thing, this is essential if they wish to boost their international reputations, increase the transparency of their financial statements, and lower the risks associated with tax management, all of which contributes toward the larger goals of expanding into international markets and assuring sustainable business operation.