The rapid growth in popularity of e-commerce in recent years has totally changed the world’s business environment, impacting business models, supply chain management practices, and consumer behavior. Many fundamental tax concepts such as “permanent establishment” and the imposition of business tax have to be adjusted in response to the new business models and activities. In this light, many current tax laws and regulations also need to be re-assessed. We encourage the Taiwan government to undertake a comprehensive review of current tax laws and regulations to ensure that they are compatible with the changes that have been taking place in the marketplace.
Suggestion 1: Apply the new tax regime for cross-border electronic service providers to generic services rendered by foreign enterprises in other industries as well.
Recently new tax regulations were introduced to address the income-tax treatment of remuneration derived by foreign enterprises from the provision of cross-border electronic services to Taiwanese consumers (including individuals, profit-seeking enterprises, and organizations). The new tax regulations are effective from January 1, 2017 onwards – that is, they should be reflected in 2017 income-tax returns required to be filed by May 31, 2018.
The tax authority has provided a simplified calculation method that allows foreign enterprises to obtain prior approval to determine the applicable industry-standard profit rate and onshore profit-contribution ratio, such that taxable income is calculated as: Taxable Income = Taiwan-sourced revenues x Industry-standard profit rate x Onshore profit-contribution ratio.
Following the introduction of that simplified formula, other foreign enterprises not engaged in the provision of cross-border electronic services to Taiwanese consumers have been asking whether they could adopt a similar approach to determine taxable income and taxes due for generic services rendered. Historically, foreign enterprises that have suffered from the standard 20% withholding-tax rate have found that adoption of various preferential tax treatments, including Articles 8 and 25 of the Income Tax Act (ITA) and business-profit tax exemption applications based on tax treaties, can be extremely time-consuming and require excessive amounts of documentation.
Therefore, there is a clear need for a simplified formula, involving minimal documentation and review time, to determine Taiwan-sourced taxable income. Such a formula would also increase the tax certainty and reduce potential tax disputes related to partial approvals, which frequently occur in applications citing Article 25 of the ITA where intercompany service fees are charged. An easy and straightforward approach to determining taxable income and taxes due may also encourage passive Taiwan enterprises which chose not to withhold payments to foreign enterprises due to unclear tax regulations or difficulty in obtaining preferential tax treatments – but who may actually bear responsibility for the withholding tax – to revisit their tax position and reconsider whether it makes sense to comply with necessary withholding-tax obligations.
According to Article 3 of the ITA, if a foreign enterprise has income sourced from Taiwan, such income shall be subject to Taiwan income-tax assessment, irrespective of whether the enterprise has a fixed place of business or business agent – that is, a “permanent establishment” – in Taiwan. If a profit-seeking enterprise lacks a permanent establishment in Taiwan and has income in accordance with Article 88 of the ITA, the enterprise shall be subject to withholding tax based on the prescribed withholding-tax rate at the source.
In practice, foreign enterprises would seek alternatives to reduce the withholding tax payable, such as usage of tax treaties, application of non-Taiwan-sourced income rulings, adoption of the deemed-profit method under Article 25 of the ITA, application for exemption from income tax on royalties and technical service fees under Article 4 of the ITA, and application for tax refunds based on Article 8 of the ITA and the Guidelines for Determination of Taiwan Sourced Income under Article 8 of the ITA. The Guidelines allow foreign enterprises with no permanent establishment in Taiwan – but which receive service fees, rental income, business profit, awards/grants, and other income – to claim a tax deduction for costs and expenses incurred (supported by evidentiary documents).
Although it seems that foreign enterprises have many alternatives available to reduce the standard withholding tax rate, the enterprises face practical difficulties and restrictions when seeking to utilize these alternatives. With regard to tax treaty coverage, for instance, Taiwan has signed tax treaties so far with only 32 countries, not including the United States, which is one of Taiwan’s main trading partners.
For adoption of the deemed-profit method under Article 25 of the ITA, a foreign enterprise engaged in construction contracting, provision of technical service, or machinery and equipment leasing in Taiwan can apply for approval from the tax office on a contract-by-contract basis to deem 15% of its total revenues as taxable income, provided that the costs and expenses relevant to the Taiwan-sourced income are difficult to allocate and calculate, regardless of whether the foreign enterprise has a branch or a business agent in Taiwan.
However, determination of what should be considered technical service versus general and administrative service (G&A) under Article 25 of the ITA is comparatively subjective, and often becomes an area of dispute between taxpayers and the tax authorities. It should also be noted that where intercompany services are provided, in practice the tax authority is typically willing to grant only 50% approval or less, regardless of whether the technical service component is significantly higher than the G&A service components.
For tax refund applications using Article 8 of the ITA, foreign enterprises may seek to deduct onshore and offshore costs and expenses incurred in relation to Taiwan-sourced revenues, and elect to be taxed at 20% on a net-income basis rather than opting for 20% withholding on gross revenues as the ultimate taxes due. In practice, where foreign enterprises adopt certain transfer-pricing policies to determine net profit retained (for example, a 3% return on sales), the tax authorities typically challenge that the transfer-pricing adjustment is not adequately supported or that no real services were provided – and therefore still wind up assessing the profit attributable to Taiwan based on the industry-standard profit rate.
As for determining non-Taiwan sourced income, Taiwan’s income-sourcing rules have always been controversial in terms of cross-border transactions, particularly with regard to the provision of cross-border services. Under the Guidelines for Determination of Taiwan Sourced Income, service fees received by a foreign entity should not be considered as Taiwan-sourced income if the service is entirely performed outside of Taiwan, without participation or assistance from Taiwan entities or individuals. However, since it is very difficult to prove the lack of participation and involvement from Taiwan entities or individuals, it is often difficult to obtain a ruling confirming non-Taiwan-sourced income, even if the services are rendered offshore.
In view of the above, since each alternative presents practical difficulties, the Committee suggests exploring the feasibility of extending the simplified formula used in determining taxable income for cross-border electronic service providers to foreign enterprises in other industries that receive Taiwan-sourced income for services rendered. Permitting all such foreign enterprises to use the simplified calculation method would reduce the time needed for negotiations between taxpayers and the tax authority. The result would be a tax environment that is equal, friendly, and less uncertain, and one that is more beneficial to Taiwan’s economic growth and the attraction of inbound investment.