Taiwan: Challenges and opportunities from TP perspectives

In the past two to three years, several measures have been taken by Taiwan tax authorities to enhance the effectiveness and efficiency of transfer pricing (TP) audit. On the other hand, intensive discussions have been undertaken between the governments of Taiwan and China to develop possible solutions for mitigating cross-strait double taxation with significant progress likely to be achieved in the near future. The enforcement trends and key focus areas, as well as the development in cross-strait taxation as described below will have significant impact on multinational enterprises having material controlled transactions involving Taiwan.

Recently, the taxation bureaus in Taipei and northern Taiwan have set up a specialised TP teams respectively. Although how these specialised TP teams will operate remains unclear at this moment, based on our preliminary understanding, their mission will at least cover the following:

• In charge of negotiation of advance pricing arrangements (APAs);

• Selection of TP focused audit targets; and

• Conduct TP focused audit.

Centralising the above-mentioned work at these specialised TP focus teams will be helpful for expediting the accumulation of TP audit experiences and enhancement of technical knowledge/skills within the tax authorities. It is foreseeable that the enforcement of TP audit in Taipei and northern Taiwan region will be intensified significantly and more and more in-depth, and the processing time for APAs negotiation could be shortened going forward.

The TP regulations specifically provide, unless in situations where an inter-relationship and continuity exist between different controlled transactions, that the arm's-length nature of these transactions should be evaluated on transaction-by-transaction basis. Nevertheless, quite a few taxpayers tend to bundle different transactions together in conducting TP analysis based on certain considerations or because of availability of information from associated enterprises. This is particularly the case for Taiwan subsidiaries of foreign-headquartered multinational enterprises (MNEs). Aiming at intensifying the application of transaction-by-transaction approach in evaluating the arm's-length nature achieved by each controlled transaction, the National Taxation Bureau of Taipei developed a very detailed inspection form to provide guidance to tax officers in review of TP documentation reports prepared by taxpayers for tax year 2011. To complete the inspection form, tax officers started requesting taxpayers to re-perform economic analysis on transaction-by-transaction basis for bundled transactions. The inspection form has been proven to be a highly effective vehicle for increasing revenue resulting from TP adjustments and has been circulated to all taxation bureaus for reference. This development has significant impact on taxpayers not only from increase in compliance costs but also TP adjustment exposure, given different conclusions could be achieved under the transaction-by-transaction approach.

Selection of profit-level-indicator (PLI) might also have significant impact on the conclusion achieved by a benchmarking study performed for specific related-party transactions. Recently, Taiwan tax authorities have incorporated their internal standard procedures and an additional criterion for examining the selection of PLI under transactional profits methods. The new criterion requires the tax officer to reject conclusion achieved by transactional profits method based TP analyses provided the denominator of the PLI selected contain results achieved by controlled transactions.

An unintended effect of the above criterion is the acceptability of Berry ratio to the tax authorities in evaluating the profitability achieved by foreign invested companies mainly acting as a procurement centers or acting as the middle party in a controlled sandwich transaction (purchase from affiliated suppliers followed by sell to affiliated customers). The application of Berry ratio to low-risk buy-sell distributors has been intensively debated between the tax authorities and taxpayers in situations where the return on sales (ROS) achieved by the tested party falls outside the arms-length range. This situation may change because of adoption of the criterion mentioned above because the denominator of the Berry ratio is less likely to contain results achieved by controlled transactions.

Taiwan tax authorities' major focus areas for TP audits include the followings:

Intra-group funding arrangements are more and more common within global MNEs because of the credit crunch resulting from global financial crisis, and have gained increasing attention from the tax authorities in recent years.

Cash-pooling arrangement is a cash management tool frequently adopted by foreign-headquartered MNEs, and is a topic of interest to the tax authorities. Taiwan tax authorities tends to raise TP issues against taxpayers involved in cash-pooling arrangements and constantly maintaining excessive cash position in cash pool abroad. This is particularly the case when the cash pool is situated in a jurisdiction with relatively low market interest rate. In the absence of a robust TP study, the tax authorities may make TP adjustments based on local market interest rates. In the worst situation, the tax authorities could even argue maintaining excessive cash position in the pool should be regarded as lending, and make adjustment based on much higher lending based interest rates.

In addition, intra-group guarantee arrangements are one of the most popular means preferred by Taiwan-based MNEs in funding their associated enterprises abroad, and has become a constant and key focus of TP audits since the introduction of Taiwan TP regulations in 2004. Whether guarantee fees should be charged by the guarantor to the guarantee is a sophisticated TP issue. Generally speaking, guarantee fees should be charged by the guarantor to the guarantee because the guarantor indeed has been exposed to financial risk arising from default of the guarantee and; the guarantee generally has received economic benefits from the guarantee arrangement through saving of funding cost or accessing loan capital originally not available from financial institutions. Based on our experience, credit spread method and comparable uncontrolled price method (CUP) are the two methodologies most commonly acceptable to the Taiwan tax authorities for substantiating the arm's-length nature of intra-group guarantee arrangements.

From corporate finance perspectives, provision of guarantees by a parent company to facilitate its subsidiaries to raise money at lower cost might create financial synergy for both parties. Providing guarantee to a subsidiary could be a better choice for a parent company than either equity or loan capital injection. That is to say, the guarantor might choose to fund its subsidiary with guarantee based on genuine business considerations. A parent providing guarantee to its subsidiary is unlikely to be exposed to higher risk than injecting equity capital to fund the subsidiary. Based on the above, the guarantor might argue that no compensation should be charged for guarantee provided to its subsidiaries, and up to 2012, such arguments had been accepted by quite a few tax inspectors.

However, in recent cases, the position taken by the tax authorities generally is a guarantor must be compensated with arm's-length guarantee fees. In situations where no supporting documents could be provided, the tax authorities generally will make adjustment based on the charging policy adopted by small and medium enterprise (SME) credit guarantee fund of Taiwan (SMEG) for provision of credit guarantee to SMEs. The prevailing range of credit guarantee fee charged by SMEG is between 0.5% and 1.5%.

Taiwan tax authorities' interest in intangible property (IP) related transactions is mainly focused on cross-border licensing arrangements. Although marketing intangibles are not a current key focus of the tax authorities, they may challenge the arm's-length nature achieved by inbound trademark licensing arrangements entered into between local distributors of consumption products (for example marketing distributors for sports products and luxury goods) and their foreign associated enterprises, particularly if either of the following conditions are satisfied:

• The local entity continuously makes significant investment on marketing and advertising activities; or

• The products enjoy leading position in local market.

Comparison between the profitability achieved by the licensor and the licensee generally is the starting point for identifying possible audit targets. On the other hand, audits could be triggered by the application filed for refund of tax levied on outward payments for license or transfer of IPs. Different TP methodologies are preferred by the tax authorities based on quality and availability of information related to IP related transactions under review. Conclusion achieved by comparable uncontrolled transaction method (CUT) could be acceptable to tax officers if the issue is raised during the course of general corporate income tax audit (non-TP focused audit). But, in TP-focused audit situations, where the final TP adjustments have to be approved by the Ministry of Finance (MOF), CUT analysis is likely to be rejected by the MOF based on comparability concerns. Based on our experiences, most TP audit on licensing arrangements are closed based on results achieved by transactional profits methods.

Although the tax authorities emphasise more and more on the application of transaction-by-transaction approach in reviewing transfer pricing documentation reports prepared by taxpayers, they do understand and to certain extent accept the reality that the Taiwan subsidiary of a foreign-headquartered MNE group has very limited access to financials achieved by foreign associated enterprises. In situations where the Taiwan entity is selected as the tested party under a transactional profits method and the profitability achieved by the Taiwan entity is more lucrative than the overall profitability achieved by the group, applying the bundled-transaction approach in preparing the TP study remains a possible and relatively more cost-effective alternative to be considered, particularly when inter-relationship and continuity exist between several controlled transactions. MNEs may consider revisiting the analytical strategies and economic approach adopted for preparing Taiwan TP documentation report in prior years by taking into consideration of the above-mentioned enforcement trends and take actions to counter the possible challenges from the tax officers in the future.

In terms of cash-pooling and intra-group guarantee arrangements, from a practical and cost-effectiveness perspective, preparation of a CUP-based TP documentation report is recommended. In case no internal CUPs exist, the guarantor in Taiwan may consider either to charge any fees for guarantees provided to foreign associated enterprises or alternatively not to take the time and effort to prepare a TP study and leave this topic as a cushion for negotiation with the tax authorities for a better result based on the following considerations:

• Estimated cost to be incurred for preparing a credit spread method based TP study;

• The amount of TP adjustment to be made by the tax authorities based on the SMEG fee standard; and

• Possible double taxation arising from mismatched tax treatment of guarantee fees between the jurisdiction where the guarantee is situated and Taiwan.

The intensification of TP examination in China in recent years and cross-strait double taxation so-triggered has been the major headache of Taiwan companies entering into significant controlled transactions with associated enterprises in China. But a positive development could be expected to alleviate this issue. According to the Finance Minister of Taiwan, the governments of Taiwan and China have reached consensus regarding entering into an OECD model based cross-strait taxation agreement (CSTA) to avoid double taxation and it is expected that the two governments will ink the taxation agreement soon.

MNEs with significant cross-strait controlled transactions should closely monitor the development of the CSTA. It will create an incentive to review cross-strait business models as well as transfer pricing policies to identify possible restructuring opportunities and develop realistic strategies for mitigating transfer pricing exposures more effectively.

Biography
		Sherry Chang KPMG in Taiwan 68F, Taipei 101 Tower No.7, Sec.5, Xinyi Rd. Taipei, 11049 Taiwan, R.O.C. Tel: +886(0)2 8101 6666 ext. 04590 Fax: +886(0)2 8101 6667 ext. 04590 Email: schang1@kpmg.com.tw Sherry Chang is a senior partner of tax & investment dept. and the country leader of KPMG's transfer pricing practice in Taiwan. She had more than nine years of experience with the Taiwan tax authority before she joined KPMG in 2000. Sherry Chang has extensive experience in providing general tax advisory services to multinational enterprises; particularly, she specialises in assisting multinational enterprises in resolving tax (including transfer pricing) disputes with the Taiwan tax authority. Her areas of industrial specialisation covers electronics, petrochemical, construction, telecommunication, automotive, media, consumption products, and financial services. Sherry Chang holds a bachelor degree in accounting from the National Chung-Hsing University (currently known as National Taipei University). She is an accredited member of the Association of Certified Public Accountants in Taiwan and a frequent speaker for industry conferences on various tax topics.

Biography
		Karl Chan KPMG in Taiwan 68F, Taipei 101 Tower No.7, Sec. 5, Xinyi Rd. Taipei, 11049 Taiwan, R. O. C. Tel: +886-2-81016666 ext. 07117 Fax: +886-2-81016667 ext. 07117 Email: kchan6@kpmg.com.tw Karl is a director with the global transfer pricing services team of KPMG in Taiwan. He has extensive experience advising clients on transfer pricing and cross-border tax issues. His areas of focus include transfer pricing documentation, dispute resolution, planning and cross-border business structuring. Karl's client portfolio covers multinational enterprises involved in electronics, petrochemical, construction, telecommunication, automotive, marine transportation, apparel, and cosmetics. He has also participated as a speaker for transfer pricing seminars hosted by KPMG, Taiwan tax authorities, and various foreign trade organisations.

Biography
		Amber Lee KPMG in Taiwan 68F, Taipei 101 Tower No.7, Sec.5, Xinyi Rd. Taipei, 11049 Taiwan, R.O.C. Tel: +886(0)2 8101 6666 ext. 08688 Fax: +886(0)2 8101 6667 ext. 08688 Email: amberlee1@kpmg.com.tw Amber Lee is an associate director of KPMG's global transfer pricing service practice in Taiwan. Before joining transfer pricing practice in KPMG Taiwan in 2006, she worked for performance improvement, assurance and corporate tax practice for four years in PwC Taiwan. Amber Lee holds a bachelor degree in accounting from the Tamkang University. She has a wide range of transfer-pricing experience, having been involved in preparing contemporaneous documentation, assisting in tax audits for multinational corporations operating in information and communication service and advising transfer pricing planning.

Biography
		Anita Lin KPMG in Taiwan 68F, Taipei 101 Tower No.7, Sec.5, Xinyi Rd. Taipei, 11049 Taiwan, R.O.C. Tel: +886(0)2 8101 6666 ext. 03418 Fax: +886(0)2 8101 6667 ext. 03418 Email: anitalin@kpmg.com.tw Anita Lin is an associate director of KPMG's global transfer pricing service practice in Taiwan. Before joining transfer pricing practice in KPMG Taiwan in 2006, Lin worked for assurance and corporate tax practice for three years in KPMG Taiwan. Lin has a wide range of transfer-pricing experience, having been involved in advising transfer pricing planning, preparing contemporaneous documentation and assisting in tax audits for multinational corporations operating in information, communication and financial service. In addition, Lin seconded to KPMG Singapore's transfer pricing practice and engaged in a variety of international transfer pricing projects. Lin is a US certified public accountant and holds MSc international business and management degree from Sheffield Hallam University in UK and BA accounting administration degree from Soochow University in Taiwan.