The Importance to Taiwanese Businesses of Signing a Cross-Strait Tax Agreement

The government of Taiwan has been pushing hard recently to get an Economic Cooperation Framework Agreement (ECFA) signed with mainland China. Meanwhile, the Ministry of Finance has announced plans to seek a cross-strait tax agreement in the hope of eliminating unreasonable double taxation. Such an agreement, if one can be signed, would offer a number of virtues:

1. An agreement would clarify taxing powers between the two sides and reduce double taxation problems

It is common for Taiwanese-owned firms to have production sites on the mainland filling orders received by a main entity in Taiwan. For this reason, related party transactions between Taiwan parent companies and mainland subsidiaries are very frequent, and with both sides becoming ever more rigorous in their auditing of related party transfer pricing, Taiwanese businesses now often face the risk of double taxation as tax bureaus on the two sides of the strait fight over taxing powers. For example, if the mainland subsidiary in a related party transaction has to pay supplemental tax due to a transfer pricing issue, the Taiwan parent company that was the counterpart in the transaction will have no way to make the corresponding adjustment it would need to reduce its tax bill. If the two sides can sign a taxation agreement soon clearly demarcating each other’s tax jurisdiction and establishing a mechanism to negotiate or make relative adjustments in transfer prices, such double taxation problems could be mostly eliminated.

2. An agreement would lower the tax burdens of Taiwanese personnel working on the mainland

When it come to personal income taxes, staff from Taiwan who spend a lot of time on the mainland face a different situation compared to that of Hong Kong- or Macao-based staff, since if they work there for more than 90 days in a year, their pay will be taxed by mainland China even if all of it still comes from their Taiwan employers. Taiwan’s tax law has a similar provision: Tax is payable on income received from foreign employers by non-residents who are in Taiwan for more than 90 days out of the year. With the recent opening of transportation/communication links and the opening up of Taiwan investment to mainlanders, cross-strait business travel and exchanges are expected to become increasingly commonplace, and it is easy for these 90-day rules to add to the tax burdens of personnel who go back and forth frequently. Hong Kong and Macao, in contrast, have already entered into tax agreements with the mainland, and so their residents can spend up to 182 days in mainland China without having to file a local tax return. Although the mainland taxes paid by Taiwanese staff can be credited in Taiwan, the administrative hassles for frequent or long-term visitors can be quite onerous.

3. An agreement would bring down withholding rates, improve the investment climate, and accelerate investment flows

Under mainland China’s new income tax law launched in 2008, Taiwan firms need to pay 10% withholding tax on outwardly remitted dividends, but because Singapore and Hong Kong have signed tax agreements with mainland China, their firms need only pay 5% withholding, leading many Taiwanese firms to transfer their investment holding companies to Hong Kong, Singapore or other favoured locations. If Taiwan could get an agreement along the lines of Singapore’s and Hong Kong’s, the withholding rate could be cut in half. A reduction in deductible overseas taxes would result in an increase in tax payable in Taiwan, but if the overall tax cost stays the same (that is, assuming the effective tax rate remains at 25%), then in keeping with Taiwan’s “imputation tax” policy, one could indirectly increase the tax credits allotted to shareholders when they receive dividends from Taiwanese firms, and shareholders would have more incentive to repatriate earnings to Taiwan.

With the opening of investment in Taiwan to mainland investors, cross-strait business dealings are bound to heat up. Signing a tax agreement with mainland China would improve the investment environment and help attract mainland investment; and in conjunction with tax preferences for Taiwan headquarters and so on, the reduction in tax barriers for Taiwanese firms, which have been investing in mainland China for years, would make them more inclined to let their investment returns flow back for investments at home. This would help fuel the government’s campaign to interest Taiwanese firms in listing their securities in Taiwan. For all of these reasons, signing a cross-strait tax agreement is indeed a must.

Elaine Hsieh is a partner at PricewaterhouseCoopers Taiwan. Please send your comments and questions to:  elaine.hsieh@tw.pwc.com.