Profit-Seeking Enterprise Income Tax

A profit-seeking enterprise having its head office within the ROC territory (such as the subsidiary of a foreign company or a joint-venture company) will be considered a resident enterprise, subject to profit-seeking enterprise income tax for its worldwide income. Income taxes paid in other countries on incomes derived outside the ROC territory may be used as a foreign tax credit to offset its ROC income tax liability, provided that the credit shall not exceed the incremental tax liability that would result if the foreign source incomes were added to the domestic taxable income and the applicable domestic tax rate were applied.


A profit-seeking enterprise having its head office outside the ROC territory (such as the branch office of a foreign company) will be considered a non-resident for tax purposes. It will be subject to profit-seeking enterprise income tax only for its incomes derived from ROC sources.

ROC-source incomes for tax purposes include the following:

1. Dividends distributed by companies incorporated and registered in accordance with the ROC Company Act.

2. Profits distributed by profit-seeking enterprises organized in the form of a cooperative or a partnership within the ROC territory.

3. Payments for services rendered in Taiwan, except for the payments obtained from a non-resident employer by a non-resident employee whose total length of stay in Taiwan does not exceed 90 days during a taxable year.

4. Interest obtained from ROC government agencies, from juristic persons in the ROC territory and from resident individuals.

5. Rental income received from the lease of property situated within the ROC territory.

6. Royalties obtained from patents, trademarks, copyrights, trade secrets, and franchises used in Taiwan.

7. Profits from the transactions of properties within the territory of ROC.

8. Payments for services rendered by personnel sent abroad by the ROC government and for services rendered abroad by employees in general.

9. Profits from manufacturing, commerce, agriculture, forestry, fishery, animal husbandry, mining, metallurgy, and other business activities conducted in Taiwan.

10. Awards or grants obtained from participating in various skill contests, games, or lotteries held in Taiwan.

11. Any other incomes generated in Taiwan.


Tax-Exempt Income

The following categories of income shall be exempted from profit-seeking enterprise income tax:

1. Income earned from the sale of land.

2. Income tax on gains derived from securities transactions ceased to be imposed, effective January 1, 1990. At the same time, losses on securities transactions shall no longer be deductible from the taxable income.

3. Income tax on income from transactions of futures under the Statute for Futures Transaction Tax shall be suspended for the time being and losses in such transactions shall not be deductible from the taxable income.

4. Properties received by way of gift, except for properties obtained as a gift from another profit-seeking enterprise;

5. Business income obtained from operation inside the territory of ROC of a foreign enterprise engaging in international transportation; provided that reciprocal treatment is accorded by the counterpart foreign country to a ROC international transport enterprise operating in its territory;

6. Royalties paid to a foreign enterprise for the use of its patent rights, trademarks, and/or various kinds of special licensed rights in order to introduce new production technology or products, improve product quality, or reduce production cost under the approval of the competent authority as a special case.

7. Remuneration paid to a foreign enterprise for its technical services rendered in the construction of a production facility for an important manufacturing enterprise as determined and approved by the competent authority;

8. Interest derived from loans offered to the government of the ROC or legal entities within the ROC territory by a foreign government or international financial institution for economic development;

9. Interest earned by foreign financial institutions from the financing resources offered to their branch offices and other financial institutions within the ROC territory.

10. Interest derived from loans extended to legal entities within the ROC territory by foreign financial institutions for financing important economic construction projects under the approval of the MOF.

11. Interest derived from preferential rate export loans offered to or guaranteed for the legal entities within the ROC territory by foreign governmental institutions and foreign financial institutions that are specialized in offering export loans or guarantees;

12. The net dividends or net surplus earnings received by a profit-seeking enterprise organized as a company from its investment in another domestic profit-seeking enterprise are excluded from its taxable income.


Deductible Expenses/Costs

The costs and expenses that an enterprise incurs for its main and auxiliary operations can be recognized as such provided that the enterprise provides sufficient supporting documents. Expenses that do not meet the requirements of the foregoing rules can not be recognized as deductions from taxable income. Expenses that do not conform to tax regulations are not deductible in the calculation of taxable income. In addition to variances in accounting and taxable income created because of different tax regulations, non-deductible expenses mainly result from expenses greater than the limits prescribed in tax laws or the lack of legally recognized supporting documentation. Most non-deductible expenses can be claimed as deductible in the declaration of a profit-seeking enterprise’s 10% retained earnings tax.


Depreciation

In the depreciation of fixed assets, any one of the straight-line, fixed percentages on diminishing book value, or working-hour method may be adopted.

A profit-seeking enterprise may apply to the tax office prior to the annual estimate of yearly income for approval to use different depreciation methods for different kinds of fixed assets in the same tax year. If such an application is not duly filed, by default the straight-line method is adopted. To change the depreciation method requires advance approval.

For income tax purposes, the service life of fixed assets for depreciation must not be less than those prescribed in the Table of Service Life of Fixed Assets. Basically, depreciation is calculated based on the purchase price of the depreciable asset. However, for a sedan acquired by a profit-seeking enterprise before January 1, 2004, the depreciable cost shall not

exceed NT$1,500,000; those acquired after January 1, 2004, the depreciable cost ceiling of each car becomes NT$2,500,000. For the profit-seeking enterprise which engages in passenger car rental business, the depreciable cost ceiling of each car acquired after January 1, 2004 is NT$5,000,000.

Depreciation expenses over the above-mentioned limits will not be allowed. Thus, the depreciation expenses for accounting and tax purposes may be different.


Bad Debt

An allowance for doubtful accounts must be provided for accounts receivable and notes receivable. It may not exceed 1% of the outstanding balance of total accounts receivable and notes receivable. For financial institutions, such allowance may not exceed 1% of the outstanding balance of credit. If the projected bad debts qualified to be written off according to the law exceed the limit mentioned above, the taxpayer may set aside an allowance that is the average of its actual bad debts incurred in the three preceding years.

Realized bad debt losses should be charged to the allowance for doubtful accounts in the year of realization. A bad debt in accounts receivable, notes receivable or other uncollectible credits could be considered realized under any of the following conditions:

1. The outstanding amount is wholly or partly uncollectible due to insolvency, disappearance of the responsible officer, composition, bankruptcy, or any other cause, or

2. The outstanding amount has been past due for over two years, during which neither the principal nor the interest accrued has been paid despite demands for payment.


Loss Carryover

Previous losses can be carried over for five years. Specifically, for a profit-seeking enterprise organized as a company that keeps a complete set of account books under specific criteria of the tax rules, has incurred losses, if it used the Blue Returns for annual tax filing in the years the losses occurred and in the years of declaring such losses, or if it has had the losses duly certified by a certified public accountant and declared within the prescribed period, losses incurred in the preceding five years may be deducted from its net income after it has been verified and approved by the local collection authority-in-charge.


Tax Rate

The taxable income of a profit-seeking enterprise shall be the net income, which is defined as the gross yearly income after deductions of all deductible costs, expenses, losses and taxes. The minimum taxable income, tax brackets, and tax rates for profit-seeking enterprise income tax are listed below:

PROFIT-SEEKING ENTERPRISE INCOME TAX RATES

Taxable Income Bracket (NT$) Tax Rate

Under $50,000 None

$50,000-$100,000

15% of total taxable income but the income tax liability shall

not exceed 50% of the portion of taxable income over $50,000

Over $100,000 25% on the portion of taxable income over $100,000


Imputation Income Tax

Effective January 1, 1998, individual resident shareholders receiving dividends from an ROC company are entitled to imputed credit for the income tax paid by the company. For corporate shareholders, the dividends received are not considered taxable income; however, the tax credits shall be included in the balance of its shareholder-imputed credit account (ICA) and will be imputed to the shareholders for future dividend distributions. Imputed tax credit does not apply to non-resident shareholders.

Starting from the year 1998, profits that are earned in a year but not distributed by December 31 of the following year are subject to 10% advance retained earnings tax, which can be claimed as a credit against the final tax liability of both resident and non-resident shareholders. Currently, the 10% retained earnings tax is calculated based on the company’s taxable income and then do some adjustments in order to consist with accounting income. In the future, the MOF plans to amend the Income Tax Law and the calculation of the 10% retained earnings tax will be based on accounting income.


When making earning distribution for the year 1998 or each ensuing year thereafter, a profit-seeking enterprise shall use the formula listed below to compute the tax credit distributable to its shareholders along with the dividends distributed:

Imputed Tax Credit Ratio = balance of the imputed credit account / aggregate balance of the retained earnings

Amount of shareholder tax credits = amount of the net dividends*imputed tax credit ratio


There is an upper limit allowed for the imputed tax credit ratio. If the ratio calculated is higher than the upper limit, the upper limit shall be used in determining the amount of shareholder tax credits. The applicable upper limits of the imputed tax credit ratio are fixed as follows:

1. 33.33% for accumulated retained earnings that has not been assessed the 10% retained earnings tax;

2. 48.15% for accumulated retained earnings that has been assessed with the 10% retained earning tax;

3. for accumulated retained earnings partially assessed with the 10% retained earning tax, the upper limit shall be the weighted average of the upper limits for both categories, calculated as follows:

(The amount of retained earnings that has not been assessed with the 10% retained

earning tax/ total retained earnings)*33.33% + [1-(the amount of retained earnings that has not been assessed with the 10% retained earning tax/ total retained

earnings)]*48.15%


Fiscal Year and Return Filing

In general, the fiscal year commences on the first day of January and ends on the thirty-first day of December of each calendar year under the Income Tax Law. At the time of establishment, a profit-seeking enterprise can also elect to adopt a special fiscal year.

A profit-seeking enterprise can apply for tax authority’s approval to change its fiscal year.

A registered profit–seeking enterprise must file the following returns to settle its enterprise income tax and imputation income tax:

1. Annual Tax Return

Between May 1 and 31 of each year, an annual income tax return must be filed covering the income of the preceding tax (calendar) year. A profit-seeking enterprise, whose fiscal year is different from the calendar year, must file the return on or before the last day of the fifth month after the close of the fiscal year.

The annual tax return will report an enterprise’s revenue, cost of goods sold, gross margin, operating expenses, net profit, and non-operating incomes or losses. In addition, the enterprise must attach to its annual return a balance sheet, a statement of movement of its imputed tax credit account for the preceding year, the retained earnings as calculated in accordance with the Income Tax Law.

2. Provisional Tax Return

A profit-seeking enterprise must also file a declaration for provisional payment of tax on a prescribed form along with the receipt of the provisional payment in the ninth month of each fiscal year. The provisional tax is equivalent to one half of the amount of tax payable as shown on the tax return of the preceding year. In the case of a profit-seeking enterprise organized as a company that keeps a complete set of account books under specific criteria of the tax rules, uses the Blue Return or entrusts a CPA to examine and certify its provisional tax return, and files the return within the said period, it may alternatively compute the amount of provisional tax payment based on the operating income incurred for the first six months of the current year under the relevant regulations of Income Tax Law at applicable tax rates.


Transfer Pricing Issue

The Rules Governing the Assessment of Income Tax for Profit-Seeking Enterprise on Non-Arm’s Length Transfer Pricing Issues (“Transfer Pricing Guidelines” or “the Guidelines”) officially took effect on December 28, 2004. Issues regulated in the Transfer Pricing Guidelines are described below.

Definition of Related Parties

The Guidelines provide a specific definition of related parties, and include the following examples of what constitutes a related party:

1. 20 Percent Subsidiary -- When a taxpayer’s direct or indirect ownership of the total number of issued shares or the total amount of the capital stock of another profit-seeking enterprise is 20 percent or more.

2. 20 Percent Common Ownership -- When 20 percent or more of the total number of issued shares or capital stock of two or more profit-seeking enterprises is controlled directly or indirectly by the same shareholder.

3. 10 Percent Major Shareholder -- When a profit-seeking enterprise holds at least 10 percent or more of the total number of issued shares or capital stock of another profit-seeking enterprise and at the same time has the highest percentage of ownership.

4. Common Directors -- The majority (50 percent or more) of executive shareholders or directors of a profit-seeking enterprise are also executive shareholders or directors of another profit-seeking enterprise.

5. Control over Board of Directors -- The majority (50 percent or more) of directors of a profit-seeking enterprise are appointed by another profit-seeking enterprise and its 50 percent subsidiary. The significance of this requirement is that the profit-seeking enterprise and its 50 percent subsidiary together appoint the directors of another profit-seeking enterprise.

6. Common Chairperson or President -- The chairperson or general manager of a profit-seeking enterprise, or any individual that holds an equivalent or a higher position, is identical to that of another profit-seeking enterprise or to the spouse, brother, sister, or a lineal descendant of that of another profit-seeking enterprise.

7. Branch Offices -- Foreign headquarters or its foreign branch and its Taiwan branch; a Taiwan branch or Taiwan headquarters and its foreign branch.

8. Control over Personnel, Finance, or Operations -- The personnel, finance or operations of a profit-seeking enterprise are directly or indirectly controlled by another profit-seeking enterprise, including:

• When patent, trademark, copyright, secret formula, technical know-how or franchise is provided by a profit-seeking enterprise for another profit-seeking enterprise, and the foregoing patent, trademark, copyright, secret formula, technical know-how or franchise is crucial to another profit-seeking enterprise’s operation and generates 50 percent or more of its total production value.

• When a profit-seeking enterprise purchases or sells raw materials or products from/to another profit-seeking enterprise, and such purchases or sales amount to 50 percent or more of the profit-seeking enterprise’s total sales or purchases, respectively.

9. Joint Ventures -- Any profit-seeking enterprise that enters into a joint venture or business consortium agreement with another profit-seeking enterprise.

10. Other Situations -- Other situations whereby an individual exercises substantial control over the personnel, finance, operations or management of another profit-seeking enterprise.

In addition to the foregoing, the Guidelines provide that any individual or organization may be considered a related party under specific conditions. For example, a foundation and a donor that is a profit-seeking enterprise are considered related parties when the donations received by the foundation amount to one third of its funds. Also, a profit-seeking enterprise and the chairman, general manager or his/her spouse, brother, sister or a lineal descendant of such profit-seeking enterprise are also related parties.


Disclosure Requirements

On April 20, 2005 after meeting with the representatives of the four largest accounting firms and the CPA Associations in Taiwan, the MOF liberalized disclosure requirements for taxpayers by requiring them to fill out a four-page disclosure form when filing their 2004 Taiwan tax returns. The purpose of this requirement was to reduce both the taxpayer and CPA disclosure burden in the first year following the introduction of the new Transfer Pricing Guidelines. This provisional requirement only applied to taxable year 2004. Whether it will also apply to 2005 will depend on further MOF notice in either late 2005 or early 2006.

Eligible taxpayers that conduct reportable transactions with related parties are required to fill out the four-page disclosure form. The eligible taxpayers are of the following:

1. Taiwan public companies, including companies which shares are traded on the Taiwan Stock Exchange or Over-the Counter Market.

2. Non-public companies, which include:

• A Taiwan branch of a foreign office, a subsidiary of a foreign parent company, or a investee entity of a foreign investor;

• A Taiwan company which has a branch, subsidiary or investee entity overseas; or

• A company which enjoys tax incentives and saves income tax of more than NTD 500,000.

Examples of tax incentives are investment tax credit, five-year tax holiday, operational headquarters, etc.

For transactions with non-enterprise (i.e. individuals and foundations) related parties, either of the following transactions will be qualified as reportable:

1. Top five of the related party transactions are in the same category and the amount of any single transaction reaches NTD 1 million (approximately USD 33,000);

2. The total annual amount of the transactions in the same category with the same related person is at least NTD 5 million (approximately USD 160,000) and it is also at least 5% of the total annual amount of the transactions in the same category.

For transactions with related parties that are enterprises, any of the following three transactions will be qualified as reportable:

1. Any single transaction amount reaches NTD 5 million (approximately USD 160,000);

2. The total annual amount of transactions in the same category with the same related party reaches NTD 10 million (approximately USD 330,000), with 2% of the total annual amount in the same category; or

3. The total annual amount of transactions in the same category with the same related party is NTD 100 million or more (approximately USD 3,330,000).

The significant relief in disclosure requirements on MNCs is that now only related parties with which their Taiwan entities had transactions in 2004 have to be disclosed. With the new announcement, the MNCs no longer have to submit their complex worldwide structures for 2004 filing.

As to the means of disclosing the foregoing reportable transactions, there are two important updates addressed in the MOF’s announcement.

The first one is when disclosing details of related party transactions, taxpayers are required to present transactions separately with the same related party if any one transaction reaches 10% or more of the total amount of such transactions during the year.

Secondly, taxpayers no longer have to specify transfer pricing methodologies adopted but to make additional explanations in the four-page disclosure form.


Documentation

The Guidelines provide a list of required information. Although the Guidelines do not explicitly impose a requirement for taxpayers to prepare ”contemporaneous documentation,” they do provide that documentation must be:

1. Prepared in the year of operation (in effect, contemporaneous documentation);

2. Available when the return is filed; and

3. Furnished within one month from the tax office’s written request. Under special circumstances, a one-month extension may be obtained to furnish the documentation.

The following is a list of required information:

1. An overview of the enterprise’s business;

2. A description of the enterprise’s organizational structure;

3. A description of the controlled transactions, including transaction flow, pricing, quantity, and the terms of trade pertaining to the transactions;

4. A transfer pricing report, including industry and economic analysis, functional and risk analysis, the selection of comparable companies and an analysis on their comparabilities, the selection of the best method, the assumptions, adjustments and an evaluation on whether the profitability/pricing of the controlled transaction is within arm’s length range;

5. An affiliated report and a consolidated operation report on related parties prescribed in the Taiwan Company Law;

6. Other documents that pertain to the related party or controlled transaction which would affect the pricing policy.


Advance Pricing Agreements

The Guidelines introduce the following criteria for taxpayers applying for an advance pricing agreement (APA). The aggregate amount of the controlled transactions over the prospective period of the APA must be at least NT $1 billion (e.g., if the APA is for a three-year period, the aggregate amount of the controlled transactions for the three-year period must be at least NT $1 billion, or approximately US $30 million) or the amount of annual controlled transactions must be NT $500 million or more (about US $15 million).

The applicant may not have any prior incidence of tax evasion for the previous three years, and must have prepared transfer pricing documentation. The general procedures for an APA are as follows:

1. Taxpayer files an application for an APA;

2. The tax authorities notify the taxpayer within a month whether the application has been accepted;

3. Taxpayer submits the required documents within a month after receiving the written notice of acceptance from the tax office;

4. The tax authorities review the documents and provide their conclusions within 12 to 18 months; and

5. The tax authorities and the taxpayer execute the APA within six months after the conclusion has been provided.

An APA may be effective for a term of three to five years, and an extension of up to five years may be obtained. After concluding an APA with the tax office, the taxpayer must file an annual report with the tax office to update the profit/loss condition under the APA and provide details of any changes to the assumptions used in the APA.


Alternative Methods for Assessing Income

The Guidelines provide the following alternative methods to assess a taxpayer’s income.

Interquartile Range - The Guidelines provide that a taxpayer’s controlled transaction is considered in compliance with the arm’s length standard if the taxpayer’s results fall within the interquartile range of results of the arm’s length comparables. If the result of a taxpayer’s controlled transaction falls outside the interquartile range, the tax office will adjust the controlled taxpayer's result to the median of the range.

Standard Profit Rate - According to Article 33 of the Guidelines, when engaged in an audit, review, or examination of the taxpayer’s taxable income, the tax authorities may assess the taxpayer’s taxable income according to the documentation requirements specified in Article 22 of the Guidelines. If the taxpayer does not comply with the documentation requirements, or does not provide documents for the tax office to assess the taxpayer’s income, the Guidelines refer to Article 83 of the Income Tax Law, which provides that the tax office may use the standard profit rate to adjust and asses the taxpayer’s taxable income. The standard profit rate is issued annually by the tax authorities. The rates are categorized by industry, and are a way to penalize taxpayers if no accounting records or supporting documents are provided when a tax official requests them. The rates are usually higher than industry standards.


Penalties

Substantial adjustments made by the tax authorities based on the Transfer Pricing Guidelines in any of the following circumstances will trigger the penalty under Article 110 of Income Tax Law, which is a fine of up to 200% of underpaid tax due from the underreporting of taxable income, starting from taxable year 2005

1. when a taxpayer’s reported transfer pricing for its controlled transactions is two times more or 50 percent less than the arm’s length price assessed by the tax authorities;

2. when the additional income of the taxpayer assessed by the tax authorities is either 10 percent more than the taxpayer’s reported income or 3 percent more than the taxpayer’s net revenue;

3. when a taxpayer does not comply with the documentation requirements and the taxpayer cannot prove that its pricing is based on arm’s length transactions; or

4. when the tax authorities has evidence and is able to prove that the taxpayer has evaded tax and the amount of unreported income is significant.

The tax authorities will begin to impose penalties on non-compliant taxpayers that meet the above conditions when they file their 2005 corporate income tax returns in year 2006.


Legal Status of the Guidelines

Article 80 of Taiwan Income Taw Law provides that the tax office has the authority to review and audit an enterprise’s corporate income tax return, and that the relevant guidelines or rules for such review/audit should be prescribed by the MOF. Accordingly, the MOF has issued the Rules Governing the Assessment of Income Tax for Profit-Seeking Enterprise, which governs the tax office’s review and audit of corporate tax returns. The Transfer Pricing Guidelines are issued for the same purpose and are authorized under the same article.

In turn, Article 43-1 of the ITL allows the tax office, with the approval of the MOF, to make an adjustment to the revenues, costs, income, or expenses of enterprises with controlled transactions between their related parties. Article 114-1 of the Assessment Rules was added on January 2, 2004, to provide further guidance regarding related-party transactions, and introduced the concept of an advance pricing agreement.

However, because transfer pricing issues are complicated, the MOF promulgated the Transfer Pricing Guidelines on December 28, 2004. Application of the Transfer Pricing Guidelines shall have priority over the general Assessment Rules in cases of related-party transactions.

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