International Tax Issues for New Financial Products

In recent years a continuous stream of new financial products has arisen out of the old. These new products are designed and underwritten mostly by transnational financial groups, and these institutions tend to be characterized by joint underwriting by different participating multinational organizations, joint risk sharing, and regional integration by function within an international distribution of labor. Given the international character of the new products and their underwriters, when participating institutions distribute overall profit it raises certain tax issues among the countries involved, such as how to define tax sovereignty boundaries and how to reasonably allocate that profit. In the following I will discuss these issues based on international taxation practices and Taiwan's current legal system.

International taxation puts much emphasis on the avoidance of double taxation. Therefore, the international community is committed to pursuing consistent definitions to use when determining the boundaries and the scope of tax sovereignty. Because new financial products are typically underwritten by several institutions belonging to different tax jurisdictions, and separate professional services are provided in those institutions' respective home countries, the overall underwriting income from such new financial products should be allocated separately to the home country of each participating institution, not attributed entirely to a single country. Also, the Internet and other information-sharing platforms have been widely adopted in international finance, and their effect has been to allow models of transnational cooperation to become ever more complex and meticulous, unhindered by national boundaries. Given these factors, if the source of income were determined the traditional way according to where labor is provided, and this was to be applies to the new types of business models, the result in practice would be severe bottlenecks.

The question is how to solve the above practical difficulty legally and without violating the principle of tax fairness. In its transfer pricing guidelines, the OECD recommends the adoption of the "profit split method" to fairly divide and reasonably allocate income to participating institutions, with the function performed, the risk shouldered, and the degree of contribution made by each institution being the basis for the income allocation.

For international financial institutions to apply the profit split concept means transfer pricing analysis, which has been widely adopted in the practice of international taxation to solve the problem of apportioning transnational tax sovereignty. Under Article 19 of Taiwan's "Regulations Governing Audits of Income Tax Transfer Prices Inconsistent with Arm's Length Transactions", the profit split method is applied to controlled transactions where "activities engaged in by participants are highly integrated, making it impossible to measure individually the outcomes of transactions", and overall business profit should be distributed based on the function performed by each participating institution, the risks borne, the assets used and the relative contribution made. The concept is thus the same as in international taxation.

Hence, if both sides, tax collector and tax payer, really engage in transfer pricing as required by Taiwan's existing laws, nothing would run counter to current international taxation principles. But since the business of new financial products is still in its initial stages in Taiwan, the two sides are comparatively inexperienced at integrating the practice of domestic law with customary international tax practices. The result is that Taiwan taxation in practice has still not been able to catch up and keep up with the times, despite having an internationalized tax framework. Unfortunately, this directly affects the efficiency and international competitiveness of Taiwan's financial market.

For many years now, Taiwan has been devoting much effort to financial reform, to creating an efficient and competitive financial market and introducing new financial products to invigorate that market. This is why even more effort is needed to maintain the fairness and impartiality of the tax regime.

This writer, a researcher into international tax theory and legal systems for many years, has offered just one or two important points to consider. As for the future of Taiwan's financial market, there is much to look forward to if it can be even more open and internationalized.