For Proper Tax Management, Know Which Direction Tax Authority Audits Are Headed

The tax authorities are becoming progressively stricter about all kinds of tax obligations. In order for a corporation to lower the risk it faces of being fined or charged back taxes, one needs to understand the tax-related regulations as well as the direction that the tax authorities' audits are moving in practice, and proceed with the necessary tax management measures as early as possible so that the company's interests can be protected. This article, which explains of some of the more frequently encountered "business tax" (VAT) and income tax issues encountered by technology firms, is provided to technology firms as a reference for their annual tax examinations.

Check whether there are dual-status tax-exempt sales amounts in the current year, on which tax must be filed in accordance with the non-deductible ratio.

1. The regulations interpreting the business tax require that a business entity's income from stock dividends, whether from foreign or domestic sources, shall constitute tax-exempt sales amounts, and under the provisions in "Regulations for the Computation of Business Tax for Dual-Status Business Entities" (or "Dual-Status Regulations", for short), the amount of tax shall be adjusted in accordance with the non-deductible ratio in the current year, and then declared together with the business tax for the final period of the same year.
   
   
2. Provided that there were dual-status tax-exempt sales amounts, and if at the same time in the current year there was some procurement of foreign labor services (e.g., compensation for technical services, royalties, fees for the use of secret methods, etc.), then the amount of tax with respect to the procured foreign labor services must also be adjusted in accordance with the non-deductible ratio, and declared together with the business tax for the final period of the same year. Those with very large amounts of dual-status tax-exempt goods or labor services on their books may consider adopting the direct deduction approach, which perhaps can lower the adjusted tax payment they will have to make. The fifth revision of the Dual-Status Regulations, just issued recently by the Ministry of Finance, allows firms whose books are in order, and that can clearly differentiate between the actual uses of the purchased goods or services, to adopt the direct deduction approach without the need of an application, having eliminated the requirement that a dual-status business entity must first apply for and receive approval before beginning to apply direct deduction.
   
   
3. Under the Dual-Status Regulations, starting in 2006, when dual-status business entities adopting direct deduction adjust and declare their taxes in the final period of the current year, they must be audited and certified by a qualified accountant or tax representative. The tax authority may decide to stop those that do not follow the relevant rules from using direct deduction, which decision may not be changed for three years.

1. De facto salary expenses in corporate income tax declarations:
   The compensation cost of employee stock options issued by a domestic company, declared each year under "Accounting Treatment of Employee Stock Options", may be recognized as part of the company's salary expenditures when corporate income tax is filed. Where a foreign company's Taiwan subsidiary, branch or business office gives the employees it hires employee stock options issued by the foreign company, allocation of the compensation cost (as calculated by the fair value method or the intrinsic value method) of the stock options issued by the foreign company must be deferred to the year that the employees are certain to exercise the options, at which time they can be recognized as salary expenditures under Article 71 of "Regulations Governing the Examination of Profit-seeking Enterprise Income Tax".
   
   
2. Reporting employee income:
   In the year that an employee exercises his or her stock options, the amount by which the spot price on the exercise date exceeds the exercise price must, in accordance with procedures stipulated in Article 92 of the Income Tax Act, be entered as "Other income" in declarations filed with the governing tax authorities. A withholding exemption certificate must also be filled out and issued, and the employee must declare and pay personal income tax on the options in the year they are exercised.

1. Expenses amortized on the books are not approved for recognition:
   The previous tax law interpretation allowing certain capitalized intangible assets to be amortized the same as start-up costs. However, it was rejected in 2001. More recently, the Supreme Administrative Court ruled that "…intangible assets to which Article 60, item 3 of the Income Tax Act applies are those acquired with cash payment, and the scope of application is confined to franchises, trademarks, copyrights, patents and various licenses", so where companies issue stock and give it to shareholders in exchange for technology, it is "also difficult to apply the related provisions of Article 64 in the Income Tax Act which regulate amortization". Therefore, the National Tax Administration is not inclined to accept amortization of expenses in connection with reported "technology stock".
   
   
2. Reporting technology stock income:
   Since January 1, 2004, the technology stock has been treated as taxable income of the year the was stock obtained; however, such tax liability can be deferred, according to rules in Articles 19-2 and 19-3 of the Statute for Upgrading Industries. In order to have income in connection with technology stock reported, in December 2006, the National Tax Administration issued sample formats for a technology capitalization declaration certificate, a declaration form and a declaration booklet. The forms in the latter are divided into four kinds based on the legal basis for applying for the technology capitalization. Companies should first ascertain which regulation is applicable and then fill out the appropriate form. The technology capitalization declaration form categories are based on the following:

1. Regulations Governing the Application of Investment Tax Credits to the Procurement of Equipment and Technology in the Internet, Manufacturing and Technology Services Industries" (amended March 1, 2006):
   
   Companies that place purchase orders after January 1, 2006 for equipment or technology for the purpose of automation, reducing greenhouse gas emissions, raising the efficacy of their digital information, recycling resources, preventing pollution or reusing industrial-use water may, if they conform to the regulations, apply for preferential tax credits of 5% (for the technology portion of the investment) and 7% (for the hardware and equipment portion), based on the "acquisition cost", within six months from the day following the date of delivery. According to the amended regulations, "acquisition cost" means the price paid to obtain the equipment, plus insurance and shipping expenses, but does not include any other expenses incurred in order to acquire the equipment. Hence, installation expenses have been excluded from "acquisition cost" beginning in 2006, and they may not enjoy preferential tax credits.
   
   
2. Regulations Governing the Application of Investment Tax Credits to Company Research & Development and Personnel Training":
   
   The following conditions should be borne in mind while applying the investment tax credits:
   
   
   • It appears that enterprises that "conduct R&D in Taiwan while producing on the mainland", and that have not yet received reasonable compensation for their research results from their mainland China subsidiaries or affiliates, are not eligible for R&D investment credits.
   • If new product R&D is not forward-looking, risky or innovative, the associated R&D expenditures are not eligible for R&D investment credits.
   • Tax-exempt expenditures on royalties, applying Article 4, clause 21, of the Income Tax Act, are provided for use in manufacturing and are ineligible for R&D investment credits.
   • For overseas personnel training, the training institution must be a legal personnel training school in compliance with local laws and regulations; if the expenses are for attending conferences or other types of professional sharing, such activities do not constitute personnel training and they are not eligible for personnel training investment tax credits.
     
     
3. The amended "Regulations Governing the Application of Investment Tax Credits to Investments in Township Areas with Scarce Resources or Slow Development" issued on December 28, 2005 by the Ministry of Economic Affairs:
   
   In 2006, the tax credit rates were revised in some instances to be 10% or 15%, depending on the circumstances; and certain townships in Miaoli County with elevated income levels have been removed from the areas to which the tax credits apply. The tax credit rate for township areas with scarce resources or slow development announced in 2005 for a company or branch registered there within the same year remains at 20%, for which the last date for filing investment plans was set as June 30, 2007. Enterprises wishing to take advantage of the higher investment tax credit rates can still use the remaining months to invest in "township areas with scarce resources or lagging development".