Promoting a taxation system that boosts foreign direct investment by adhering to accepted international practices.
During a period of economic challenge, the Taiwan government has continued its commitment to upgrade the country’s infrastructure and industries by attracting more foreign investment and cutting-edge technology. However, several gray areas regarding tax treatment have remained unresolved, presenting an obstacle to progress. For example, tax issues related to turnkey contracts frequently have a major impact on infrastructure projects. Another example is the uncertainty as to whether income derived from activities carried out in a free trade zone can qualify for tax exemption.
We urge the government to continue its efforts to create a friendly and transparent tax environment by considering the proposals below.
Suggestion 1: Revisit the tax treatment on turnkey contract arrangements from both local law and international tax practice perspectives.
The “Special Act for Forward-Looking Infrastructure” was passed in 2017 to enhance Taiwan’s infrastructure and boost its competitiveness by increasing public investment in green energy, the digital infrastructure, water resources, railway systems, and urban and rural development. A prime example is the proactive role the government has assumed in expanding the use of renewable energy, aiming to phase out nuclear power and decrease dependency on imported fuel. Foreign developers will inevitably play a key role in the renewable energy sectors, especially for offshore wind power projects, including the building of associated industries. It is therefore important to review the relevant tax policies and regulations to ensure that they are consistent with the government’s development plans.
Ministry of Finance (MOF) Ruling No. 770526922 states that when a foreign enterprise having its head office outside of Taiwan carries out construction or installation projects in Taiwan, the entire contract price – including the amount attributable to the supply of offshore materials and/or equipment – shall be subject to Taiwan income tax. That is the case even if the amount of remuneration for services performed onshore, such as construction and installation, can be identified separately from the sourcing of materials and/or equipment offshore.
However, according to the “Guidelines for Determining Taiwan-sourced Income,” the direct supply of goods by a foreign enterprise to a Taiwanese individual, enterprise, or organization shall be treated as international trade, which is exempt from income tax assessment. As a result, to minimize income-tax liability in Taiwan, foreign EPC (engineering, procurement, and construction) contractors tend to adopt a split contract approach, creating separate onshore and offshore contracts. In general, the onshore contract covers construction work and installation of equipment, which are subject to Taiwan income-tax assessment. The offshore contract covers the supply of offshore materials and/or equipment, which is treated as international trade.
While the two contracts are typically entered into by two different affiliates, the arrangement may still be challenged by the tax office from a substance-over-form perspective, deeming the two contracts as in effect a single EPC contract due to the foreign contractor’s obligation to perform both functions. If that is the case, the entire contract value would be subject to income tax, including the goods portion which was originally treated as international trade and therefore income-tax free. Should that interpretation prevail, foreign developers will be subject to a very heavy tax burden for projects carried out in Taiwan. That burden may discourage their participation in Taiwan’s renewable energy projects.
In addition, when determining the taxable income of an EPC project, foreign entities may calculate income based either on actual profits or the deemed-profit method provided for under Article 25 of the Income Tax Act, where 15% of the total contract price is deemed as taxable income. When foreign entities choose the actual-profit method, the level of documentation and evidence required to substantiate the actual profit is often extremely time-consuming and costly, as it may require (as stated in MOF Ruling No. 861924459) a foreign certified public accountant to issue a report covering the offshore costs and expenses associated with the Taiwan-sourced construction revenues. The Committee hopes that the tax authority will relax the documentation requirement to create a friendlier tax environment in Taiwan.
Furthermore, since some activities under the EPC contract will be carried out on the ground, the tax authority may determine that the foreign contractor has a permanent establishment (PE) in Taiwan. In practice, how to determine the existence of a PE and the profits attributable to the PE is often debatable. From a tax treaty perspective, according to Article 7 of Taiwan’s existing tax treaties, the profits of a foreign enterprise shall be taxable only in the country where it is a tax resident, unless profits are attributable to a PE situated in Taiwan. The determination of profits attributable to the PE is based on similar profits that would be attributable to a “separate and independent enterprise,” with direct application of OECD transfer pricing guidelines, taking into consideration functions performed, assets used, and risks assumed.
Therefore, even if the foreign enterprise is deemed to have a PE in Taiwan by virtue of Article 5 of applicable tax treaties – for example, by carrying out a construction or installation project lasting more than a specified period – the profits associated with the supply of offshore materials and/or equipment which are designed, engineered, manufactured, and procured offshore by the foreign enterprise should not be deemed attributable to the Taiwan PE. Nevertheless, the local tax office tends to tax the entire construction profit, including both the onshore service and offshore supplies components, which is not in line with international tax practice and may result in double taxation. Though the mutual agreement procedure (MAP) provided by existing tax treaties may be initiated by the taxpayer to resolve the double taxation issue, the MAP process is often extremely time-consuming.
In view of the above, on the precondition that such attribution of profit is consistent with transfer pricing principles, we urge the MOF to revisit the abovementioned rulings and relevant tax laws and to consider excluding profits attributable to the supply of offshore materials and/or equipment in its assessment of income tax liability and also tax-treaty applications.
Suggestion 2: Include “flash title” transactions within the scope of tax exemption under the tax incentives for Free Trade Zones.
An amendment to the Act for the Establishment and Management of Free Trade Zones was passed on January 16, 2019. The amendment was intended to offer tax incentives for qualified activities in a Free Trade Zone (FTZ) such as import, storage, and delivery. It is not clear, however, whether the amendment includes “flash title” transactions within the scope of the tax exemption.
“Flash title” transactions are commonly seen in practice. For example, a foreign company may take title from another foreign company of goods that were imported from overseas and then stored in the FTZ. The goods will be subsequently delivered outside the FTZ for further processing. In this case, the foreign company with title to the goods is only involved in the storage and delivery aspects and does not carry out any value-added activities in the FTZ.
It is uncertain whether the income the foreign company earned in the foregoing scenario can be eligible for the preferential tax regime under Article 29 of the Act and its relevant regulations. Although the goods were originally from overseas, they may be viewed as having been procured/sourced onshore and not imported directly from overseas. We urge the tax authorities to reexamine this situation to determine whether it qualifies for income tax exemption under the new amendment. If so, it would be aligned with the government’s goal to develop Taiwan as a regional logistics hub.
If the tax authority is unable to conclude that the above scenario qualifies for income tax exemption in the FTZ, we would urge the authorities to extend the application of MOF Ruling No. 10600664060 – which is related to the taxation of import, storage, processing, and delivery activities in Taiwan – by including “flash title” transactions within its scope. Mitigating the tax impact could help attract more such economic activity to Taiwan.
Suggestion 3: Develop an English user interface for Country by Country Reports in the online tax filing system.
Starting from financial year 2017, Taiwan for the first time is implementing three-tier transfer-pricing documentation requirements, including a Master File, Country by Country Reports (CBCR), and a Local File. If the consolidated revenue of the multinational enterprise group (MNE) exceeds a threshold of NT$27 billion, the Taiwan affiliate is obliged to file a CBCR report with the Taiwan tax authority – except when the country where its ultimate parent entity (UPE) or surrogate parent entity (SPE) is filing the CBCR is under an information exchange agreement with the Taiwan tax authority.
As of now, only New Zealand and Japan have concluded such a competent authority agreement (CAA) with Taiwan for the exchange of CBCRs. Hence, CBCRs filed with the U.S. Internal Revenue Service by any American UPE or SPE cannot be exchanged with the Taiwan tax authority. Instead, the Taiwan affiliate has to file the CBCR of its U.S. group to the Taiwan tax authority. Furthermore, at present the accepted CBCR filing methods are hardcopy submission, a compact disc with files in XML format, or online submission via the tax-filing system (only available during the tax-return filing period).
As the CBCR discloses the MNE’s confidential global information – such as tax payment status, number of employees, revenue derived from transactions with affiliated or non-affiliated companies, and each entity’s functions –most UPEs of MNEs prefer to file the CBCR on their own rather than through their Taiwan affiliates. However, the fact that the user interface of the tax filing system is only in Chinese characters makes it difficult for foreign UPEs to file their CBCR directly.
Furthermore, most MNEs prohibit transmission of these confidential documents electronically by using CDs or an online filing system due to concerns about the leakage of confidential information. As a result, many chose to submit the CBCR in the form of a hard copy.
We urge the Taiwan tax authority to study this issue carefully to find an optimum solution for MNEs. In addition, as most UPEs are located in non-Chinese-speaking countries, we also suggest that the Taiwan tax authority develop an English user interface for the tax filing system so as to remove the language barrier. In this way, the UPEs would be able to file the CBCR on their own to avoid involuntary information disclosure to entities other than the proper authorities.