Tax Management-based Structural Change among Taiwanese-owned Multinationals

Written By: Steven Go

For the many Taiwanese corporates endeavoring to expand their operations globally, it is fair to say that 2007 has left a deep impression on account of all the tax challenges they faced from tax authorities at home and abroad. Looking back on the past year, the taxation issues with major consequences for Taiwan-based multinationals include:

  • The amendment of China's "Corporate Income Tax Law" adjusted and substantially reduced the tax incentives offered to foreign companies operating locally, and added income tax withholding on outward earnings remittances, producing an impact on corporate business models and investment structure design.

  • To help balance U.S.-China trade and restrain appreciation of the renminbi, China adopted a number of tax policy measures (such as adjusting export rebates) and non-tax measures (adjusting the processing trade catalogue and payment of bonds for importing raw materials, for example), all of which produced rather significant effects on the business operations and taxes of Taiwanese firms. According to China's Ministry of Commerce, these policies are aimed at improving the structure of China's merchandise exports, curbing the export of low-value-added, low-tech products, and promoting the transformation and upgrading of the processing trade. As reflected in taxation, those Taiwanese-owned firms on the mainland earning "risky money" from policies that ignore tax laws will be facing additional challenges from the tax authorities unless they adjust their corporate policies, transforming themselves or relocating, and firms that rely on lowering their tax cost (including tariffs) to raise their competitive strength or improve micro-profit conditions will cease to exist. Businesspeople report that many Taiwanese-owned firms on the mainland have had to pay far more in back taxes last year than they had "saved" in taxes in all the previous years. This reflects the importance of corporate tax management and related policies.

Many of Taiwan's corporations have been impacted by tax law rules, interpretations and investigations, including those in Taiwan and her main trading partners, and there is rather a strong sense of foreboding, especially with Taiwan's Statute for Upgrading Industries expiring in 2009. What will Taiwan's future tax policy be? Will it continue to use tax measures to supplement national industrial policy, or will it emphasize tax fairness and make major adjustments in tax policy? Or, can it do both at once? The uncertainty is a cause of concern among enterprises.

While some of the impacts and influences may not be beneficial, others will be. In fact, some large-scale multinationals stand to benefit overall from these changes. One large corporation based in southern and central Taiwan asserts that, owing to its prior macro-level global deployment and tax risk management strategy, mainland China's tax policy adjustments, such as export rebates, have not resulted in major effects. On the contrary, its relative competitive strength has been boosted because of inappropriate or negative responses to policy adjustments by others in its industry. At the same time, its earnings have improved markedly, even after undergoing the self-examination and self-reporting required by the mainland tax bureaus for tax and Customs filings, plus tax investigation, transfer pricing audits and other major tax audit measures. Also, because the corporation instituted effective tax management systems and reasonable tax policies that allow it to manage its affairs well and fend off dangers, it has not suffered any significant downside effects. In other words, due to audit measures by the tax authorities, and with the help of effective tax management, corporations can compete with others in their industry on a more equal and equitable footing, with the least fit being eliminated. In terms of orderly business operations, who is to say this is not a good thing?

The demands of corporate governance

Strengthening corporate governance is a major trend among multinationals, and tax management is one link that firms promoting corporate governance cannot overlook. Consider: If a multinational's tax issues and chosen tax policies have a substantial influence over its financial statements, so that those statements cannot realistically reflect tax risks or costs, how can it claim to promote good corporate governance?

In order for a multinational to implement global tax management effectively, it must first invest internal resources in the establishment of effective tax control policies and measures, and permeate the various business units with tax risk consciousness. Such measures include doing before-the-fact compliance assessment and management of the tax issues that could derive from the corporation's investment and business activities, and conducting after-the-fact internal tax audits to ensure that execution and filing are carried out on a legally sound basis. This allows directors and senior management to understand the firm's tax policies, tax plans, tax payment consequences, and the regulatory compliance of its tax filings and operations; and it allows them to respond to the tax authority's audits, while making related management more transparent.

Tax compliance and risk management

Effective tax management emphasizes regulatory compliance and risk management, not the blind adoption of aggressive tax schemes and plans to lower tax costs. In practical tax management, the goal is to manage and control a corporation's internal business units so that they do not, on account of unfamiliarity with the tax code, become "tax risk manufacturers", and keep the corporation from having to fight unforeseen "tax fires". This suggests a structural change in tax management that multinational corporations must attend to in the course of their day-to-day tax operations.

So, why do there commonly exist "tax risk manufacturers" within the internal business departments of transnational enterprises? It is mainly because, under the demands of enterprises to spur performance, lower operating costs and boost competitiveness, the necessity of tax code compliance under the corporation's different business and trading models gets neglected, along with the tax problems that may derive from doing so. The problem is most evident when dealing with different countries' tax systems and tax authorities, where each has different regulations and tax law interpretations, as these are not generally understandable other than by professional tax specialists.

To execute important tax management measures, managements of multinationals must give greater weight to providing internal business units with adequate resources and consultation channels, and establish effective tax management platforms. This is another kind of structural change for corporate tax management.

Among Taiwanese-owned transnational corporations, traditional tax management is conducted on the decentralized tax management model. That is to say, the financial accounting personnel at the Taiwan headquarters manage the local tax work and filing in Taiwan, while their overseas subsidiaries use their financial accounting personnel to carry out their own management and bear responsibility for it. Financial accounting personnel at Taiwan headquarters summarize financial information from overseas subsidiaries at most quarterly or annually, or wait until an important tax problem arises before getting involved in handling it. This traditional decentralized approach, it turns out, has a major shortcoming in terms of tax management because the corporate head office cannot see the corporation's overall tax picture, and hence is unable to design an optimal tax management strategy for the group as a whole.

The headquarters should have answers to the following questions affecting overseas subsidiaries:
  • What risks are being taken in local tax operations and filings? Are they aligned with the corporate group's interests or is there room for improvement?
  • Do subsidiaries' business models harbor relatively high tax risk? Which subsidiaries pose the highest risks? How can they be identified and managed better?
  • What changes have occurred in local tax law? What are the tax authorities' audit posture and demands?
  • What is the overall organization's risk in relation to local tax issues? What is the risk of producing a significant double taxation issue or impacting the group's reputation?

To frame the problem another way, from the perspective of the entire organization, one must pay close attention to three levels of risk: (1) business operations risk, (2) tax filing compliance risk, and (3) financial accounting and statement preparation risk. For the entire organization, however, one must also be concerned about overall risk to the group and linked, derivative tax issues, especially those that may harm the corporate group's goodwill. It is encouraging that Taiwanese-owned multinationals already share a fairly deep appreciation of these issues, and they are increasingly likely to have established dedicated departments for managing them. For Taiwanese firms, this is a major improvement in tax management, and another important structural change.

Elements of tax management

According to a 2006 PricewaterhouseCoopers survey report on tax management in the Asia Pacific region, transnational corporations ranked transfer pricing as their most important tax issue, followed by tariffs, withholding taxes, turnover tax and taxes of individuals on overseas assignments. The difficulty is that all of these tax issues exist as a result of an enterprise's business activity and investment structure, and there is a rather large degree of interdependence and consistency in their relationships from one year to the next, so that transnationals have real problems when trying to respond to audits from the tax authorities. For such problems, sound tax management measures must be relied upon to lift control and management to the next level. A transnational corporation needs to manage the individual tax issues of the parent company and subsidiaries in various jurisdictions, but another important task for the future is to give consideration both to the tax advantages for the group and the effects on the financial statements.

Effective enterprise tax management should manifest the following benefits:
  • Value creation for the company, which considers both tax-related cash flow benefits and the effect of tax rates on financial statements, and reduces inefficiencies in business operations resulting from tax laws;
  • Prevention of tax filing that conflicts with laws and regulations;
  • Ability to coordinate tax management and operations among the corporation's global, regional and individual country units;
  • Tax/financial department personnel with the ability to respond to tax system and tax law changes;
  • Law-abiding and compliant corporate image and reputation.
  • Active participation, before and after the fact, in the corporation's investment and trade decision-making activity, to achieve effective proactive management.

Transnational corporations must understand that an enterprise's competitive strength and source of profit should not come from "costs" saved through non-compliant manipulation, nor should they come from tax benefits earned through overly aggressive tax planning. In the current environment, broadly taken to include investors in capital markets and regulators in various countries, more and more emphasis is being put on corporate tax conduct that complies with regulations and abides by the law. Improper tax avoidance behavior and aggressive tax planning are discouraged, and they may even call into question management's integrity and managerial ability, causing irreparable harm to one's corporate image. Also, in the coarse of a corporation's business activity and decision-making, one must give serious thought to the harm that tax risk can inflict on corporate reputation, balancing that against the possible tax benefits to be gained and going through the cost-benefit considerations.

Taiwan's pragmatic corporations have long been disinclined to accept "risk management" concepts because "risk" is very difficult to capture and make concrete. What's more, risk management requires the investment of considerable cost and may produce a negative effect on a corporation's competitive strength. Now, however, Taiwanese-owned transnationals recognize that "tax risk" is not some predictive, hazy risk concept, but presents a real problem that must be faced, the only question being whether it will emerge sooner or later. Because of this recognition, Taiwanese-owned transnational corporations acknowledge that they must confront the problem, and they are gradually establishing effective management strategies and measures to grapple with and solve these problems. This sort of conceptual change bodes well for corporations and the investing public.

According to recent reports, when corporations apply for market listings in Taiwan in the future, Taiwan's securities regulators will require them to explain how they will be affected by China's tax law reforms and new labor law. This requirement, which is similar to rules in FASB Interpretation 48 in the U.S., shows that Taiwan's regulators have begun to take seriously the potential impact of taxes on financial statements.

Some adjustments may be called for in the current pattern of investment in mainland China by Taiwanese-owned enterprises, given the combined effect of escalating costs, appreciation of the renminbi, industry crowding effects, implementation of the new labor law, and the tax law reforms. The hottest topic now, it seems, is how to relocate to countries like Vietnam.

However, any such adjustment has to be a long-term strategic decision. After all, corporations cannot act like they were nomadic tribes, moving with the seasons in search of fresh pastures. A change in one's investment deployment pattern involves major tax costs, especially when it entails cross-border transfers of resources and technology, and it is inappropriate for transnational corporations to venture upon a new course of action based solely on tax system reform. If, for example, Vietnam were to adopt similar measures in the near future, would those companies that relocated there from China move yet again?

Of course, for the sake of competitive strength and survival, companies are bound to weigh various subjective and objective criteria in making their strategic decisions. Nonetheless, before they commit to such decisions, they must carefully assess the different "exit" costs – especially tax costs – that may occur in withdrawing from mainland China, and assess all the business problems and costs that may arise when entering an unfamiliar country with different funding, manpower and tax/legal regulatory regimes.

Corporations must be thoroughly aware and informed in order to make strategic decisions, consistent with maximizing their benefits, in the face of known and potential costs and problems. This is the approach corporations must take when carrying out their business strategies and addressing their current and future tax management challenges.

Steven Go is a partner at PricewaterhouseCoopers Taiwan. Please send your comments and questions to Steven.Go@tw.pwc.com .