Taxing Times for Taiwan's Bankers
Taiwan’s Ministry of Finance (MOF) has said enough is enough. And, with a new interpretation of its tax regulations in hand, is signalling its intent to demand its share of the spoils that securities and investment banks in Taiwan make in fees on their offshore underwriting services. Fees that the MOF has, until now, been unable to claim.
While the impact of such a decision is unclear in terms of how much money financial institutions will have to cough up, two things are certain: it is wide in its scope, affecting a range of financial securities from American and global depositary receipts (ADRs and GDRs) and ECBs through to cross-border securitizations; and it’s going to hurt. As one investment banker in Taipei notes: “Taiwan is the second biggest market in Asia after Japan in terms of total funds raised through international offerings.”
But the bad news for those caught in the MOF’s line of fire is that it doesn’t stop there. The new interpretation of the tax law is retrospective, meaning the MOF could go after the securities houses’ previous five years’ of underwriting earnings. And with Taiwanese issuers raising approximately NT$400bn (US$11.85bn) in 2002 and NT$730bn in 2003 from offshore issues, the National Tax Administration (NTA) may stand to collect as much as NT$3bn to NT$4bn from international underwriters if it decides to pursue only the past two years’ worth of fees earned.
In the past, underwriting fees were normally collected and deducted from the underwriting proceeds outside Taiwan. The net proceeds, after deducting the underwriting fees, were then remitted back to the Taiwanese issuers and withholding tax liabilities were avoided. This practice is now well and truly barred.
Richard Watanabe, tax partner at PricewaterhouseCoopers, says the MOF’s new interpretation “affirms that underwriting fees earned by international investment banks in Taiwan are regarded as Taiwan source income and are classified as other income, as per Item 11, Article 8 of Taiwan Income Tax Law”. Tom McGowan, a partner at Russin & Vecchi in Taipei, adds that a long list of exclusions have been granted to the concept of Taiwan-sourced income, but underwriting fees are not among them.
From the beginning of July, Watanabe says that underwriting fees paid to foreign underwriters have had to be withheld at the rate of 20 per cent, although several significant mitigating factors do exist to lower the final tax burden. Taiwanese companies that fail to meet the new withholding tax obligations are subject to stiff penalties. “Taiwanese issuers have also had to withhold and file returns for all applicable withholding taxes for the past five years,” he says. McGowan explains that, according to Taiwan’s Tax Collection Law, the tax authorities could seek to claw back a maximum of five years’ unpaid taxes.
But the term “five-year period” is misleading, according to Richard Chuang, a partner at Taipei law firm Yangming Law, and could, in fact, be worse. He explains: “If an underwriter earned its commission or fees in January 1997, it has to file its income tax return for the year 1997 and pay its income tax during May 1998. The five-year period will start from June 1, 1998, the next date following the last date of income tax payment due for income generated in the previous taxable year.” Put more simply, that means commission earned in January 1997 is still vulnerable.
The potential penalties to be imposed on Taiwanese issuers for not meeting withholding tax obligations are severe. Therefore, most Taiwanese issuers elected to pay their outstanding withholding taxes by the MOF-imposed cut-off date of June 30, 2004, and have not raised any challenge to the MOF interpretation.
Chuang says there is no penalty liable against underwriters who voluntarily report their tax on income generated from Taiwan-related securities offered to market before the end of last year. However, the tax authority will charge interest at an annual rate equivalent to the rate on Chunghwa Post’s one-year fixed term savings deposits. The rate is currently at 1 per cent a year.
Finance firms themselves will not be liable for the tax in all instances. Their liability will depend, in part, on whether a particular institution was able to write a clause into its underwriting contracts obliging the issuer to pay the withholding tax instead, if any became applicable. “Some investment banks have been able to secure this sort of agreement,” says McGowan.
Watanbabe says underwriters can hold bilateral negotiations with the MOF to try and obtain some form of withholding tax relief, meaning several avenues do exist to reduce the tax burden. One method Chuang outlines is the formation of a permanent establishment in Taiwan. He says: “If a foreign underwriter sets up a permanent establishment in Taiwan, such as a liaison office or representative office, it does not have to withhold any tax relating to underwriting commission.” Of course, as Chuang points out, the applicable tax rate on the establishment may be lower or higher than 20 per cent, depending on the foreign underwriter’s annual revenues and the amount of expenses and costs associated with the permanent establishment.
A second mitigant, according to Watanabe, lies in making use of the transfer pricing rules introduced by Taiwan at the start of this year. Employing these rules would allow financiers to specifically identify that portion of the underwriting service actually carried out in Taiwan. Taiwan tax would be applicable on that portion only.
Underwriters can also appoint a business agent in Taiwan. Chuang says: “The agent would keep separate accounts recording all necessary and reasonable expenses and costs associated with underwriting the cross-border offering and the profit generated. The tax treatment would be the same as, or close to, the foreign underwriter with a permanent establishment in Taiwan.” Tax experts believe this will be the most common method employed to lessen the withholding tax burden.
In addition, an underwriter can apply for special approval to use the short-form tax reporting rule under Article 25 of Taiwan’s Income Tax Law, if part of its commission and fees are compensation for technology services. Chuang states: “Under the short-form tax reporting rule, a foreign business that provides technical services in Taiwan can report 15 per cent of its business revenues generated inside Taiwan as its taxable income and pay its tax at brackets from 10 per cent to 25 per cent, depending on its taxable income.”
Finally, if an investment bank or securities house can perform the underwriting service using bankers who work from an office that is in a country with a tax treaty with Taiwan, the withholding tax problem can be eliminated. Unfortunately, Watanabe says that Taiwan’s tax agreement network is not very comprehensive – it has tax treaties with only 12 territories. Key investment-banking jurisdictions, such as Hong Kong or the US, do not have double tax agreements with the island.
This withholding tax interpretation is not the only recent instance of a more vigorous enforcement of Taiwan’s tax laws. Investment bankers indicate that the NTA is considering increasing the tax rate on the returns from the equity portion of securitization issues from the current 6 per cent to 20 per cent. “Nothing has been settled yet. The potential tax rise is still being debated,” says one investment banker. The Banking Bureau of the Financial Supervisory Commission champions securitization as a means to increase the effectiveness of Taiwan’s financial markets and has viewed the lower tax band as an incentive to encourage more securitizations. For that reason, it may resist the NTA’s attempt to raise the tax rate.
But concerns over an increase in taxes have started to delay potential asset-backed and mortgage-backed securities (ABS and MBS) deals. “Some mandates are on hold and I think the overall market volume could be hit hard if the tax change is put into effect,” says a banker in Taipei.
According to McGowan there is no evidence that the securitization tax problem and the withholding tax issue are linked. The banker agrees: “The authorities are worried first and foremost that securitization is becoming a vehicle for tax arbitrage as many arrangers are marketing securitization structures as a method to reduce company tax returns. It’s not really part of a drive to increase overall tax income, but rather a defensive measure.” In contrast, many agree that the withholding tax drive has been spurred by Taiwan’s budget deficit.
But questions arise as to how the aggressive application of withholding tax on underwriting fees will impact Taiwan’s offshore issuer market. This financial year, underwriters are going to have to make adjustments in upcoming financial reports for corrections to previously reported tax figures. In future, the increased tax burden may be priced into the cost of issues, making offshore deals more expensive. In marginal cases this could, in turn, cause Taiwanese companies to revert to other means in order to raise capital.
However, Watanabe believes that the highly competitive nature of the Taiwan securities market, including the offshore component, means that it is the issuers who have the greatest bargaining power. They will not, therefore, see the full cost of the tax passed on. So for the island’s financial institutions, the already slim margins will just get slimmer.