Critical tasks for overseas firms listing in Taiwan

Taiwan's securities market has become considerably more active in the last couple of years, no doubt due to the government's loosening of restrictions on local public offerings by Taiwanese-owned firms registered abroad, and its providing additional channels to choose from for raising funds.

The first wave of overseas Taiwanese-invested firms to list securities in Taiwan consisted mostly of well-known and strongly positioned companies looking for Taiwan IPOs or secondary listings. Now, a second wave of firms is poised to drive the market's development. Compared to their predecessors, companies in this second wave possess less technological capacity, but they expect to grow along with China's domestic market.

The second wave of firms are not yet on the same scale as the first wave in terms of their mainland operations, and they may not yet meet the profitability, minimum capital or net worth requirements for a Taiwan IPO, but by hitching their sails to China's internal demand juggernaut, they will likely possess the qualifications for a TWSE or GreTai Securities (OTC) listing application in two or three years. Precisely because a certain period of time is required to prepare for such a listing, if these companies were to began the preparatory work in the second half of 2010, it would certainly not be too early.

Of the major tasks involved in this preparation, two are of primary importance:

Group restructuring

Prior to formally beginning counseling for an TWSE or OTC listing, a firm must first reorganize its investment structure, and for the overall restructuring, one must first consider the functionality of each operational entity and which companies must be included in the group enterprise. That is, the restructuring plan must start by differentiating between core and non-core businesses.

The next consideration is taxes for the group company. If a Taiwanese-owned company in China carries out adjustments in a restructuring, it may have to factor in the 10% tax on capital transaction income under State Administration of Taxation Notice No. 59 (2009), and perhaps also the tax on property transaction income under Notice No. 698. On the other hand, if a Taiwanese firm wants to enjoy the dividend tax treatment provided under the new double taxation arrangement between China and Hong Kong, the definitions of beneficial owner and conduit company in another notice (No. 601) are crucially important. Hence, in a prospective group reorganization, it is necessary to properly assess the corporate and personal tax effects of each proposal in light of these various tax directives.

In addition, it is necessary to assess reorganization proposals for their potential financial effects. In particular, one must assess the actual funding arrangements or share swap methods to be used in carrying out the reorganization.

Establishing a complete, documented internal control system

Article 9 in Taiwan's "GreTai Securities Market Rules for Review of OTC Trading of Foreign Securities," issued in March 2010, provides that a foreign share issuer applying for a primary OTC listing must submit with its application a CPA-issued special internal control audit report with an unqualified opinion. Similarly, Article 4-1 in TWSE's "Operational Procedures for the Review of Foreign Securities for Listing" requires that a foreign issuer applying for a primary listing appoint a CPA to issue a special audit report on its internal control system. This means that the CPA must carry out a special audit of the internal control system before the foreign issuer applies for a primary listing on the TWSE or the OTC market; and the company, naturally, must also first establish a compete and documented internal control system, with appropriate rules and standards, and implement it faithfully.

A complete, documented internal control system must cover all of the firm's operating activities, and it must differentiate between different transaction cycles according to the nature of the industries the firm is engaged in. For internal control purposes, there are nine such transaction cycles, in addition to thirteen management methods. The nine cycles are: (1) sales and collection; (2) procurement and payment; (3) production; (4) payroll; (5) finance; (6) fixed assets; (7) investment; (8) R&D and (9) IT system management. The 13 management methods refer to the management of: (1) legal seal usage; (2) vouchers/requisition; (3) budget; (4) property; (5) endorsements; (6) commitments and contingent liabilities; (7) authorization and agent system implementation; (8) loans to third parties; (9) financial and non-financial information; (10) related-party transactions; (11) the financial statement preparation process; (12) subsidiary company oversight; and (13) board meeting procedures.

Up till now, most of the Taiwanese-owned, overseas-registered companies coming to list in Taiwan have been firms operating principally in mainland China. Moreover, most such companies have well-established standard workflows for their various transactions. In the main, however, the control tasks to be used for these workflows are only spelled out in detail for front-end units (such as sales, purchasing, production and human resources departments). Much less attention is given to the control activities that back-end accounting departments must use in the course of transactions to obtain transaction data and record it on the books. For example, in the case of workflows involved in sales transactions, firms are likely to have detailed descriptions of certain control tasks (for handling orders, accepting credit, shipping goods or providing services, issuing sales receipts and opening accounts), yet lack a description of how records of these transactions are to be transferred to the accounting department, and entries recorded in the books for accounts receivable, sales revenue, sales discounts, product returns and cash income. Hence, these workflows do not constitute a complete internal control system for the sales and collection cycle.

When the Taiwanese owners of an overseas-registered firm decide to "return," they must be clear about why they want a Taiwan listing. In addition to the main considerations – integrated industry clusters, good stock market liquidity and high P/E ratios – they must understand that coming to list securities in Taiwan is an interlocked process, and that, once embarked upon this process, the firm must prepare fully for each stage in order to achieve the objectives of the Taiwan listing. For the firm, the Taiwan listing process should be seen as a way to enhance its operating processes and financial planning, and to improve its overall fitness. In this view, the path to a Taiwan market listing is a way to boost the firm's competitive strength.

This article appeared in the Commercial Times in June, 2010