The Controversy over Tax-free Sales by Firms in Bonded Areas

Under the rules of Article 7, paragraphs 1 and 4, of the Value-Added and Non-Value-Added Business Tax Act (hereafter, "the Business Tax Act" or "the Act"), a zero "business tax" (VAT) rate applies to goods and labor services that are exported or sold to firms in bonded areas. These rules follow from the fact that export sales "and their equivalent" were not intended to draw tax under the Act. Attempting to clarify the issue, the Ministry of Finance (MOF) has issued a number of explanatory decrees on whether the sales activity of firms in tax-free zones should be subject to business tax or should apply the zero tax rule in Article 7 of the Business Tax Act. But in light of the recent uproar over a case involving Hewlett-Packard, the taxation authority seems intent on a thorough examination of the related explanatory decrees to see if any did not take into consideration the legislative intent of the aforementioned Act.

The main controversy in the Hewlett-Packard case is because the MOF's Letter No. 0930450281, dated March 1,1 2004, states: "Regarding: How to issue uniform invoices in the case where a domestic or foreign trading company purchases goods from a firm in a bonded area, where the designated bonded area firm ships those goods to XX international logistics center for temporary storage, and the goods are then shipped out as exports or sold to another bonded area firm under the name of the foreign trading company. …Explanation 2: Where the actual trading counterpart of a bonded area firm (an exporter in a tax-free export zone, a business in a science-based industrial park, or a Customs-managed bonded factory or bonded warehouse) is a foreign or domestic trading company, then the bonded area firm must issue a uniform invoice to the foreign or domestic trading company. Where subsequently the said goods are, under the trading company's name, shipped out as exports or sold to another bonded area firm, provided that the rules stipulated in Article 7 of the Business Tax Act are met, then a zero tax rate is applicable for business tax purposes." As a result, when a foreign firm places an order with a domestic bonded area firm, and the goods are stored temporarily in a logistics center, the bonded area firm must still issue uniform invoices to the foreign firm.

Hewlett-Packard Singapore places orders with HTC in Taiwan, and HTC stores the goods temporarily in a logistics center. According to the above decree and also MOF Letter No. 7556549, dated July 30, 1988, because the goods have not yet been exported, HTC must issue taxable uniform invoices in duplicate, and the logistics center must use a B2 export form to apply on behalf of Hewlett-Packard for import into the logistics center. If Hewlett-Packard Taiwan obtains the goods from the logistics center, then Hewlett-Packard Taiwan must apply for import, and must pay business tax on the imported goods at that time. But since Hewlett-Packard Singapore lacks a branch in Taiwan, it is unable to credit the tax paid on import, so that both Hewlett-Packard Singapore and Hewlett-Packard Taiwan are taxed. Hewlett-Packard Singapore is unable to pass on the accumulated import tax to the final consumer, so this constitutes what foreign businesses refer to as double taxation.

The logistics center involved in the Hewlett-Packard case is not actually a bonded area firm within the scope of Article 7, paragraph 4 of the Business Tax Act, so as to a bonded area firm storing goods temporarily in that logistics center, the MOF's explanatory decree took the position that the zero tax rate rule did not apply. But looking at the matter with the spirit of the Business Tax Act in mind, the logistics center received goods on behalf of a foreign firm, so it ought to be able to claim a zero tax rate, based on the foreign exchange received by a bonded area firm and referring to MOF Letter No. 0910451090, dated February 15, 2002, which recognizes "exports" as such in terms of their economic significance. Only by this interpretation may one remove all doubts about double taxation.

As for a bonded area firm selling labor services to a bonded area firm, it may not fit the rule under Article 7, paragraph 4 on the zero tax rate for sales of goods, but in Taiwan's vertically segregated semiconductor and optoelectronics industries, where OEM contract manufacturing is the rule, if upstream and downstream firms are considered bonded area firms, then the processing labor added at each stage qualifies as export selling behavior, and in terms of economic significance constitutes exporting. Given the legislative intent of "export sales and their equivalent" in Article 7, such transactions should not draw tax. This is why MOF Letters No. 780353546 of October 21, 1989 and No. 831582197 of February 2, 1994 singled out sales of labor services by firms in science parks or export processing zones to other firms in tax-free areas, explaining that the zero tax rate was applicable in such cases. However, there has been no definitive interpretation yet on whether the zero tax rate applies in the case of a Customs-managed bonded factory or bonded warehouse selling labor services to a firm in a tax-free zone. To avoid having the business tax becoming an unnecessary burden on firms, the MOF must undertake an across-the-board re-examination of its decrees regarding zero tax rate rules.