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BCM A commentary on Banking and Capital Markets tax issues in Asia Pacific

BCM Tax, a publication by PwC’s Asia Banking and Capital Markets Tax Network covering the hot topics in and their impact in Asia Pacific.

November 2011

Contents

Foreword 2

Lead article – VAT /GST exemption: What it means for Financial Services 4

Topical issues and country updates

Australia – Tax Forum: An opportunity for genuine ? 10

China – Recent tax developments 16

Hong Kong – Nice Cheer: How much cheer does it really bring to 26 financial institutions?

Indonesia – Recent tax developments 30

Philippines – The investment trust law 38

Taiwan – Recent tax developments 42

US – FATCA: Assessing the implications for financial institutions in Asia 48

Contact details 52

BCM Tax 1 Foreword

2 PwC While tax was not the cause of the global In the lead article of this issue, we financial crisis, it has been said in some examine the impact of indirect taxation Peter Yu quarters that it contributed to it. Among as it relates to the banking sector, and Asia Financial Services other things, the availability of deductions explore if the exemption regime in GST/ Tax Leader for interest expenses but not for returns on VAT systems indeed confers a tax capital (e.g. dividends) is often seen as advantage on banks over the non-bank encouraging enterprises to increase taxpayers. We will also consider how gearing ratios. This, in turn, helped fuel some countries in Asia Pacific alleviate the rapid increase of debt levels prior to the cost of what would otherwise be the crisis while at the same time reducing, irrecoverable input tax through various in relative terms, the buffer provided by mechanisms. Paul Lau capital; when the credit crisis arrived, Co-editor these enterprises found that their levels of The diversity of the Asia Pacific tax BCM Tax debt were unsustainable and there was landscape continues to be reflected in insufficient capital to continue to finance the country articles from across the the business. region. Nonetheless, a central theme that runs through these recent In the eyes of much of the public, the developments is that growth remains banking sector is seen as the primary the focus of this region, as governments beneficiary of the pre-crisis boom in debt fine-tune their tax policies to promote David Smith levels, but at the same time was the selected areas, for example, real estate Co-editor beneficiary of large amounts of public aid investment trusts (the Philippines), BCM Tax once the crisis arrived. It is a response to Islamic finance (Indonesia) and more this perception that has led, since the generally the opportunities for tax crisis, to a proliferation of , both reform (Australia) and the expansion of proposed and introduced, on the financial treaty network (Hong Kong and sector, including financial activities taxes, Taiwan). bank levies, financial transactions taxes, etc. These measures seek to address the In somewhat of a contrast to the perception that the financial sector is regional scene, the jury is still out on under-taxed, or at least not bearing its fair what needs to be done to rehabilitate the share of taxes, not only because of the economies of some of the Western public aid it received, but also because it countries. But whatever measures are enjoys exemption from goods and services ultimately taken, and regardless tax (GST) / value-added tax (VAT). whether tax contributed to the crisis, reform of the taxation of the financial sector would appear certain to be part of the story.

November 2011

BCM Tax 3 Lead Article VAT/GST exemption: What it means for Financial Services

4 PwC The concept of an exemption is normally On the other hand, China proves to be an So while VAT or GST welcome in the world of taxation. exception as it subjects financial services However, this is not necessarily the case to business tax which is not creditable. exemption means that where the exemption applies in the However, this may change as the country banking or financial context of value-added tax (VAT) or looks at reforming its system goods and services tax (GST)1. While to one that resembles a classic VAT or GST services are not subject to exemption means that the transaction is system. Even then, moving from business tax, the financial institution not liable to VAT or GST, it also means tax to exemption for financial services that in principle, the input VAT/GST on may give rise to the perception that it cannot recover the VAT or costs that are attributable to the making gives a to the banks if GST on costs that it incurs. of the exempt transaction is not available financial services are seen to be not liable as a credit to offset the output VAT/GST to indirect taxes. But how much of that that applies on the supply that is made by is true? the business. Paradoxically, it is better to be taxable from a VAT/GST perspective as Does exemption give banks a tax it means being able to recover the input advantage? VAT/GST. A study into the impact of VAT exemption In the Asia Pacific region where the VAT/ on European banks was recently GST systems vary as much as the commissioned by 20 banks with the economies, the common approach is to research undertaken by Professor Ben exempt financial services (including life Lockwood of the University of Warwick insurance) from VAT or GST although the and PricewaterhouseCoopers (PwC). scope of what constitutes exempt Under the VAT exemption system for financial services may vary among financial services in the European Union jurisdictions. The reason for the (EU), the report found that the exemption exemption is due to the wide that applies to European banks did not acknowledgment that financial services lead to a tax advantage for the banking can be complex and is a difficult area to sector. The report concluded that if tax. Given that the VAT and GST is a tax banking services were subject to VAT on final consumption of goods and (instead of being exempt), it would not services, the issue is in determining the lead to any significant increase in EU VAT “value add’ in a financial transaction, and revenues. The research also found that the hence the value on which the VAT/GST denial of input VAT on the banking costs should apply. led to irrecoverable VAT of an estimated amount of up to Euro33 billion So while VAT or GST exemption means per annum. that banking or financial services are not subject to tax, the financial institution Interestingly, while similar research cannot recover the VAT or GST on costs has not been done in Asia Pacific, it is that it incurs. Even where a reduced rate conceivable that any such research could applies to certain financial services in a lead to the same conclusion as the EU country like Taiwan, there are complex study. What may be more interesting to rules regarding the recovery of the input consider is whether lowering the costs of VAT/GST. the banking sector can lead to other fiscal advantages such as increased profitability for the financial institution.

1 The VAT and GST operates in the same manner, being a tax on sales or supplies (output tax) with credit given for tax on business purchases or expenditure (input tax). BCM Tax 5 In a study undertaken by PwC for the Issues with exemption European Commission to study the economic effects of the exempt treatment Tax cascade of VAT2, it was commented that “…in aggregate, firms in the financial services Given that VAT or GST is designed as a tax firms in the EU25 are somewhat less on final consumption, the VAT/GST profitable than their equivalents in certain exemption for a financial institution treats other highly developed economic regions, the bank as if it is a final consumer by including the United States. It cannot be imposing the irrecoverable tax on the stated definitively that embedded VAT bank itself. costs are the cause of profitability differentials, although it is clear that the The issue then is that if the financial VAT exemption of financial services (and institution is denied input VAT/GST the inability to reclaim VAT on costs as a deduction on its costs, it is likely that the consequence) is making at least some subsequent supply of financial services by contribution.” the financial institution will have the tax embedded as part of the cost base of Looking at the Asia Pacific and in making the supply which results in a tax Singapore in particular, the treatment is “cascade”. To recover the VAT/GST, the to exempt financial services from GST in financial institution may have to charge Singapore. However, to lower the costs of higher fees for its services or adjust the the input GST, Singapore has a special interest margin for the financial product input GST regime that enables the bank to or service that it makes. recover the GST on its inputs based on rates that vary between 76% to 96%. Barriers to outsourcing While the high input tax recovery rates mean that the financial services sector It is a general accepted principle that a tax only contributes 2.6% to net GST revenue should be neutral and not be a factor in in Singapore3, the approach is intended to the business decision making process. Yet, provide certainty and encourage an the exemption for financial services attractive business environment for the creates a bias against the outsourcing of financial institutions. The consequence of services that can be handled more this is that Singapore has a strong efficiently by a third party service financial services sector that contributed provider than the financial institution to 27.5% of the collections itself. For example, the successful by the Inland Revenue Authority of outsourcing of back office and information Singapore (IRAS) for the year ended technology activities can help a bank 31 March 2011. achieve significant cost savings from the economies of scale and streamlining of Exempting financial services gives rise to business processes. However, if the bank certain issues which are explained below. is denied VAT/GST deduction for the outsourcing costs, it may choose to provide the services internally by employing its own labour resources, the costs of which do not attract VAT or GST. However, this may result in a poor use of 2 PricewaterhouseCoopers Study to Increase resources and operational inefficiencies if the Understanding of the Economic Effects of the third party services provider can the VAT Exemption for Financial and Insurance Studies – Final Report to the European supply the services more efficiently and at Commission 2 November 2006. a lower overall cost. 3 Annual Report 2011 Inland Revenue Authority of Singapore (IRAS). 6 PwC The other issue is that the above assumes To address some of the above undesired that the financial institution has a consequences of VAT or GST exemption, sufficiently large enough operation to be particularly the costs of irrecoverable able to decide between providing the input credit for the financial institution, services in-house or to outsource the we now look at how some governments services. A smaller financial services deal with the issue in the region. provider may not have the same scale of operation and resources to handle the Lowering the cost of exemption – services internally and it has to outsource allowing input taxes the function. This will not be a desirable situation if the VAT or GST is allowed to Australia impact on the financial services business depending on its size of operation. Given that the financial institution is unable to recover the GST on inputs, Complexity of attribution or allocation Australia has a unique way of describing of costs the GST exempt financial services as “input taxed” supplies. However, the The exemption of financial services give definition of financial services in Australia rise to complexity and administrative cost excludes the arranging of financial for both the financial institution and the services which is treated as taxable which tax authorities, as the financial institution means that the financial institution pays competes to attribute or allocate its inputs GST if it purchases or acquires arranger to taxable (having creditable input tax) services. activities to maximise its recovery of input VAT/GST against the tax authorities’ goal To reduce the GST costs for the financial of maximising . Much time institution and to overcome the barrier to can be spent by the financial institution to outsourcing highlighted earlier, the Much time can be spent by build systems and processes to identify Australian government introduced a the financial institution to and track the costs and having to defend Reduced Input (RITC) of 75% the position against the tax authorities’ (an arbitrary rate) which enables the build systems and processes challenge. financial institution to claim credit for the to identify and track the GST that is incurred on certain types of There is also the complexity of defining acquisitions (including arranger services) costs and having to defend what constitutes exempt financial services for the banking business. The RITC the position against the tax and what are taxable services which in the approach is thus an attempt to make United Kingdom is solved to some extent neutral the decision of whether the authorities’ challenge. by the VAT Blue Book which covers the acquisition or arranger service should be VAT treatment of financial goods and done in-house or outsourced. services as agreed between the British Bankers’ Association and HM While the RITC does serve to reduce to and . There is similar guidance in some extent, the tax costs and compliance Singapore with the GST Handbook for costs for the Australian financial Banks published by the Association of institution, there is the issue of defining Banks of Singapore that has been the types of services that should fall produced on consultation with the IRAS. within the prescribed acquisitions that However, given the innovative and rapid qualify for the RITC. growth of financial services and products, the need to update such guidance on a regular basis can be a massive task in itself.

BCM Tax 7 New Zealand The New Zealand approach would have been taken to another level if the GST was The New Zealand government has introduced in Hong Kong. In the recognised that the GST exemption of consultation document on broadening the financial services gives rise to the problem tax base in Hong Kong that was released of tax cascading and the bias against in 2006, the document raised the outsourcing in the banking sector4 as well possibility of introducing a GST with the as the issue of valuing financial services. comment that “…having regard to the As a result, New Zealand introduced the lessons learnt from overseas jurisdictions zero-rating of financial services from and global trends, it is proposed that 1 January 2005 in an attempt to reduce certain financial services to be defined as the overall cost of GST to the financial “financial supplies” be zero-rated…”. institution. While the decision has been made to not proceed with a GST in Hong Kong, the The treatment in New Zealand is to enable proposal for a full zero-rating of financial a financial institution to zero-rate a supply services would have been a progressive of financial services if the supply is made solution to address the impact of VAT/GST to a GST-registered business with taxable exemption on financial services. supplies that are equal to or exceeds 75% of its total supplies in a 12-month period. Singapore The obvious problem with this approach is that the financial institution has to find Singapore follows the traditional some way to determine the level of taxable approach of exempting financial services supplies made by the corporate customer with the exclusion of fee-based services in and whether the customer is eligible to the nature of arranging, broking etc., receive the zero-rated services. This which are treated as taxable supplies. compliance burden has been alleviated to However, to reduce the financial burden some extent by various administrative of the GST on the banking sector, the guidelines released by the New Zealand Singapore government has prescribed Inland Revenue Department. high input tax recovery rates that range from 76% to 96% (revised each year) depending on the regulatory licence of the financial institution.

4 GST & Financial Services – A government discussion document, Hon Dr Michael Cullen, New Zealand Minister of Finance, Minister of Revenue, October 2002. 8 PwC The input tax recovery rates are set by the Conclusion Koh Soo How Ministry of Finance and are believed to be Partner based on loan statistics that are provided It is clear that the exemption of financial Indirect Tax (GST) by the banks and finance companies to the services does not give any advantage to PwC Singapore Monetary Authority of Singapore the financial institutions. On the contrary, +65 6236 3600 annually. The rates are meant to be an the denial of GST on the inputs of the [email protected] objective proxy and reflection of the financial institution presents a real cost to transactions that the financial institution the banking sector. The financial and has with retail (individuals) and corporate compliance impact of the VAT/GST customers. The broad principle is that the exemption on financial services has been higher the bank-to-business transactions, addressed to some extent by some regimes the higher the recovery rate which in Asia Pacific such as Australia with its explains the relatively lower recovery rate RITC mechanism, in New Zealand with its (of say, 76%) for a full retail bank zero-rated treatment of bank-to-business compared to the higher rate (of 96%) for a transactions and Singapore’s prescribed wholesale or merchant bank. The input input recovery rates for banks. tax apportionment formula for the insurance and the securities business Whatever the approach, the impact of largely follows the same broad principle. VAT/GST exemption on financial services in the region should be considered in view It is believed that there is a proposal in of the ability of financial institutions to Malaysia to adopt the Singapore model of move to jurisdictions where the cost of prescribed input tax recovery rates for doing business is lower, and can be a financial institutions should GST be critical consideration for whether to grow introduced in Malaysia. or limit their operations in any jurisdiction. As noted in the early part of this article, the high input tax recovery rates may mean that the banking sector is not a high net contributor to GST revenue in Singapore, but it along with the rest of the financial sector does account for the highest contribution to corporate income tax collections for the Singapore government.

BCM Tax 9 Australia Tax Forum: An opportunity for genuine tax reform?

10 PwC On 4 October 2011, the Government held • Loss utilisation. The current Over the course of the Tax a Tax Forum in Canberra, Australia. arrangements for losses were discussed. A number of reforms Forum, many suggestions In her opening speech to the Tax Forum, were suggested to encourage risk and ideas were raised Prime Minister Julia Gillard highlighted taking in investment decisions, five factors that are currently shaping the including a two-year loss carry back covering the full ambit of Australian economy, and noted that tax rule, with refunds limited to a Australia’s tax and transfer reform must be considered in the context company’s franking account balance, of these challenges. These are as below: reforms to the Same Business Test, system including business which is currently too restrictive, taxes, personal taxation, 1. The overhang from the global particularly as many businesses need financial crisis and continuing to change their business to become State taxes, tax volatility in the global markets, which profitable after a period of losses. governance, environmental have resulted in a loss of confidence and a better understanding of the • Financial transactions tax. The and social taxes. nature of risk. introduction of a financial transactions tax, such as that currently being 2. The ‘Asian century’, that is, continuing considered by the G20, was raised. The opportunities from growth in Asia and Treasurer Wayne Swan did not appear demand for our resources. In to support such a tax in the Australian particular, the Prime Minister economy, highlighting the fact that the highlighted the challenges created in consideration of this tax in Europe was respect of a two speed economy that is aimed at addressing the present debt derived from the current resources crisis, a situation which is not boom. replicated in Australia.

3. Globalisation and innovation in Over the course of the Tax Forum, information technology and many suggestions and ideas were raised communication. covering the full ambit of Australia’s tax and transfer system including business 4. A move to a carbon constrained taxes, personal taxation, State taxes, economy. tax governance, environmental and social taxes. 5. Australia’s ageing population and the burden of disease, and costs In a welcome move, the Treasurer Wayne associated with these. Swan, in his closing address to the Tax Forum, indicated that the Government Some key matters raised at the Tax Forum will draw on the priorities identified at the were: Tax Forum as the building blocks for the next stage of ongoing tax reform and • Reducing the corporate . There indicated a number of immediate was general support amongst business commitments that will be made, for lowering the corporate tax rate including: (either a general reduction or targeted to specific industries) to 25 per cent as recommended by the Australia’s Future Tax System Review (the Henry Review) to attract mobile capital into Australia.

BCM Tax 11 • A Business Tax Reform Working Group What compliance activity is the to be established to firstly consider, as ATO undertaking? a priority issue, the treatment of losses, and then look at longer term company Compliance Program for 2011–2012 tax options. On 30 June 2011, the ATO released its • The Treasury, the Australian Taxation Compliance Program for 2011–2012. The Office (ATO) and the Council of Small Compliance Program outlines the ATO’s Business to work together in the key risk areas and its strategies to manage coming months to address concerns those risks. around small business tax complexity. This year, the ATO is focussing its • The Treasurer indicated that a state compliance activities around the tax reform plan will be developed in following: conjunction with the Commonwealth, with the first reforms to be set out by • The corporate governance framework the end of 2012. of large businesses (turnover greater than $250m). • For individuals, the Government indicated that its first priority around • International tax risks including the personal tax reform will be to increase anti-deferral rules, thin capitalisation the tax-free threshold further to at rules, foreign resident disposals of least A$21,000, which should have the companies with interests in land and objective of having over one million foreign private equity disposals of individuals no longer needing to Australian investments. complete income tax returns. • Withholding tax on payments of While there are a number of tax reform interest, dividends and royalties to measures now already under way, it seems non-residents. that much more change and debate lies ahead. • risks including business restructures and losses. It is too early to assess whether there will be a genuine tax reform in Australia • The implementation of the taxation of following the Tax Forum and what impact financial arrangements (TOFA) rules. this might have on banks and financial services business in Australia. There are • Executives, directors and other highly delicate political and revenue impact paid individuals. issues to consider which may ultimately determine the tax reform agenda.

12 PwC Review of offshore bank branch Review of the implementation of the operations TOFA regime

The ATO has also commenced specific All Australian taxpayers are now subject reviews of the arrangements between to the TOFA rules, unless an exception All Australian taxpayers Australian bank head office and foreign applies. The TOFA rules are concerned bank branches. with how gains and losses on financial are now subject to the arrangements are determined and the Taxation of Financial The ATO’s key risk areas include the time at which they are brought to account Arrangements rules, unless following: for tax purposes. an exception applies. 1. Whether the Australian bank head The ATO is finalising a TOFA office has overstated foreign bank Implementation Questionnaire which has branch income which is exempt from the objectives of reviewing taxpayer Australian tax. compliance with the TOFA rules in the implementation phase and to monitor the 2. Whether the Australian bank head extent to which the objectives of the TOFA office has understated expenses regime are being met. relating to exempt foreign bank branch income which are not deductible. The Questionnaire will likely cover:

3. Whether the Australian bank head • Eligibility for making TOFA elections. office has complied with its interest withholding tax obligations in respect • Transactions undertaken just before of foreign bank branch funds transfers the TOFA commencement date. (Tax Ruling TR 2996/9). • Details of existing financial 4. Whether the Australian bank head arrangements. office has correctly applied the thin capitalisation rules for banks. • Compliance with specific tax timing and transitional rules. 5. Whether the Australian bank head office has tainted its offshore banking • Details in relation to hedging policies unit (OBU) with non-OB money in and tax hedging documentation. respect of foreign bank branch funds transfers. • Procedures for monitoring changes to the TOFA rules.

BCM Tax 13 • Governance issues associated with the Reportable tax position schedule implementation of, and procedures for monitoring changes to the TOFA rules. The ATO is piloting a reportable tax position (RTP) schedule for the 2012 • Contentious tax positions adopted. company tax return. The schedule will require large businesses (turnover greater • Tax indemnities and contingent tax than $250m) that have been notified by provisions in relation to financial the ATO to disclose their most contestable arrangements. and material tax positions to the ATO. Taxpayers that have been notified will be • Application of the accounting required to disclose their RTPs. standards. An RTP is any of the following: The Questionnaire will be piloted with between 20 and 40 taxpayers with a focus • A material position that is more likely on selected taxpayers that have made a to be correct than incorrect. TOFA transitional election and/or TOFA early start election, higher risk taxpayers • A position in respect of which and then rolled out more generally as part uncertainty about taxes payable or of normal compliance activities. recoverable is recognised and/or Australia’s major banks are unlikely to be disclosed in the taxpayer’s or a related included in the pilot. party’s financial statements.

The Questionnaire is likely to be detailed • A position in respect of a reportable and require a significant amount of transaction. information to be provided to the ATO. The industry is lobbying for a more high The ATO is currently working with level, focused risk-based approach to be industry groups on a number of issues in adopted by the ATO to its TOFA relation to how the pilot will work and compliance activities rather than how the RTP schedule will be requesting significant information that is subsequently applied to other taxpayers. unlikely to assist the ATO to identify any specific risks.

The ATO is piloting a reportable tax position schedule for the 2012 company tax return which will require large businesses (turnover greater than $250m) that have been notified by the ATO to disclose their most contestable and material tax positions to the ATO.

14 PwC Qantas Federal Court Decision – what is a “supply” under • Charges that have been treated as Matt Osmond GST law? input taxed, but no supply is made Partner (which could include loan and PwC Australia In Qantas Airways Limited v Commissioner derivative break fees). This may +613 8603 5883 of Taxation [2011] FCAFC 113, the Full impact GST credit recovery through [email protected] Federal Court unanimously held that the apportionment methodology goods and services tax (GST) was not where the charges have been included payable by Qantas in circumstances where as input taxed revenue which in turn a person booked and paid for domestic air may give rise to refunds of GST and Gavin Marjoram travel but subsequently cancelled the improved GST recovery going forward. Partner booking or did not turn up for the flight, PwC Australia and did not receive or collect a refund The Commissioner has appealed to the +612 8266 0576 from Qantas. High Court. [email protected]

The Commissioner argued unsuccessfully Financial services providers should that there was a taxable supply for GST monitor the progress of the appeal to the purposes when payment of the air travel High Court and determine whether any was made. The Court disagreed and found immediate action should be taken to that what each customer pays for is preserve the retrospective period over carriage by air and the actual travel was which GST refunds can be claimed. the relevant supply, and if it did not occur, there was no taxable supply. Tax impact of regulatory change

This decision has implications for a wide There are a number of current and range of taxpayers, including those in the proposed regulatory changes in Australia financial services sector. and overseas that have a flow-on tax impact for banks and financial services Financial services providers, including business in Australia. These include: banks should review the contractual arrangements and GST treatment of all • The impact of the Basel III capital payments made and received for an reforms, including the tax treatment of intended purpose which does not take hybrid debt capital. place or fails. This could include: • The impact and management of • Charges on which GST has been paid, liquidity and funding requirements, but no supply made (which could including the tax treatment of losses include taxable transaction break fees, and global charges, expense lease termination fees). Refunds of allocation, thin capitalisation impact GST may be available and/or GST may and withholding tax issues. not be applicable on such payments going forward. • The impact of changes in the Australian International Financial Reporting Standards, including financial instruments, hedging and leasing.

• FATCA transition and compliance.

• Covered bonds legislation.

BCM Tax 15 China Recent tax developments

16 PwC Clarifications of Corporate in State treasury bonds (“State bonds”). Capital gains from the Income Tax treatments for PN36 took effect from 1 January 2011 investment in State Treasury retrospectively. redemption of State bonds Bonds shall be recognised on the The salient points of PN36 and our On 22 June 2011, the State observations as below. interest payment due date Administration of Taxation (SAT) issued as agreed on the date of Public Notice [2011] No.36 (“PN36”) Salient points clarifying the Corporate Income Tax issuance of State bonds. (CIT) treatment in relation to investments • Interest income from State bonds

Types of interest income from State bonds Interest income recognition CIT implication

Unrealised 1. Interest accrued before the No need to recognise it Interest income accrued shall be excluded interest income agreed date of the State as from taxable income for CIT purpose bonds interest payment

Realised 2. Interest income paid by the Recognise interest income on Interest income received shall be fully interest income issuer where the State bonds the interest payment due date exempt from CIT are purchased from the issuer as agreed on the date of directly and held till maturity issuance of the State bonds

3. Interest income which has not Recognise interest income on Interest income entitled to CIT exemption become due during the holding the day when the capital gains shall be calculated based on the following period where the State bonds from the transfer of the State formula (“Formula A1”): were sold before maturity bonds are recognised as income Amount of interest income = par value or issuing price of State bonds x (applicable annual interest rate/365) x number of holding days

1 PN36 sets out how to determine the terms “applicable annual interest rate” and “number of holding days”. BCM Tax 17 • Capital gains PN36 also sets out how to determine the acquisition cost of the State bonds Timing for recognition of capital gains purchased for cash or non-cash payments. In this respect, PN36 allows the - Capital gains from the State bonds sold acquisition cost to be determined based on before maturity shall be recognised as the first-in-first-out method, weighted income on the effective date as agreed average method or specific identification in the trading agreement, or on the method. Once a calculation method has delivery date of the State bonds. been selected, it shall not be arbitrarily changed. - Capital gains from the redemption of the State bonds shall be recognised Our observations on the interest payment due date as agreed on the date of issuance of the • Accrued and unrealised interest State bonds. income for the State bonds shall not be taxable Income nature and calculation method of capital gains For accounting purposes, interest income is accrued over the holding period of the PN36 clarifies that the transfer of the State bonds. On the other hand, article 18 of the bonds shall be regarded as a transfer of Detailed Implementation Rules of CIT Law property as stipulated in the CIT Law and (DIR) as reiterated by PN36 stipulates that hence the gains or losses from such a for CIT purposes, interest income is transfer should be included in the taxable recognised as income on the interest income subject to CIT. payment due dates as agreed with the debtor in the contracts. This seems to The gains/losses from a transfer of State create a book-to-tax difference but in bonds is to be calculated as follows practice, such book-to-tax adjustment (“Formula B”): to exclude the accrued interest income from the CIT taxable income is not Capital gains/losses = Consideration common. received from a transfer or a redemption of State bonds – the acquisition cost of State bonds – interest income for the holding period (calculated using Formula A) – relevant trading taxes and expenses incurred

18 PwC • Interest embedded in the sales • Uncertain issues proceeds of the State bonds transfer is Taxpayers should treated as interest income and entitled - Article 1.2 of PN36 does not cover a monitor closely local to CIT exemption situation where taxpayers receive interest income paid by the issuers upon the implementation of PN36 Circular Caishui [2002] No.48 (Circular maturity of State bonds for bonds and assess whether there is 48) provides that the amount of interest purchased by the taxpayers from non- indicated in the delivery order shall be issuers. However, we think the principle a opportunity exempt from CIT due to the “net price of Article 1.2 should apply to this with the local tax trading” of State bonds. It is not entirely situation. clear if Circular 48 remains valid in the authorities for the Year new CIT regime effective from 1 January - In practice, interest from State bonds may 2010 for over-paid CIT on 2008. We observed that there was an be paid upon redemption, or during the inconsistent administrative practice in life of the bonds (e.g., annually). It is the interest income of different regions for granting CIT uncertain how Formula B can be applied State bonds. exemption in relation to interest income to calculate the capital gains derived on State bonds during the previous annual from the disposal of State bonds that CIT filing. With the clarification provided receive periodic interest. This is subject to by PN36, we believe that interest further clarification from the SAT. embedded in the sales proceeds of State bonds transfer should be treated as - It is uncertain how PN36 would apply to interest income (instead of gains or losses zero-coupon State bonds. from a disposal of State bonds) and thus the CIT exemption would be available. - PN36 took effect from 1 January 2011 This is a useful clarification for investors retrospectively. Whether PN36 would investing in State bonds. apply to the 2010 annual CIT filing made in 2011 is not clear. Taxpayers should • Capital gains from transfer of State monitor the implementation of PN36 and bonds is treated as income from assess whether there is a tax refund transfer of property opportunity with the local tax authorities for over-paid CIT on the interest income It is probably the first time the SAT has of State bonds for 2010. confirmed that capital gains from transfer of State bonds should be treated as income from the transfer of property for CIT purpose.

BCM Tax 19 20 PwC Impact of [Administrative Salient points The SAT issued Measures for Overseas Registered Chinese-capital Controlled Tax • Scope of PN45 administrative measures in Resident Enterprises (Trial)] on respect of deemed overseas financial service industry The scope of PN45 is the same as that defined in Circular 82, i.e., an enterprise TREs in September 2011. The PRC Corporate Income Tax (CIT) Law established in accordance with the laws of The measures covers which took effect from 1 January 2008 foreign countries (regions) with the main introduced the concept of Tax Resident investor being a Chinese enterprise or application procedure, Enterprise (TRE). In April 2009, the SAT corporate groups and with its “effective collection matters, CIT released Circular Guoshuifa [2009] No.82 management” located in China. (Circular 82) clarifying the definition of a treatment as well as Chinese TRE for Chinese-capital • Administration on the recognition of application of double tax controlled foreign companies (CCCFC). Chinese TRE status Circular 82 also provided a general treaty provisions. guidance on the CIT treatments, There are two ways to determine the application procedures of TRE status Chinese TRE status for a CCCFC. CCCFC for CCCFCs. may lodge the application for Chinese TRE status with Chinese tax authority (“the With the aim of standardising the tax first approach”)or the Chinese tax administration for the CCCFCs which authority may initiate investigation on a obtained Chinese TRE status (also known CCCFC to determine whether it should be as overseas registered Chinese-capital regarded as a Chinese TRE (“the second controlled tax resident, or “Deemed approach”). Overseas TREs”), the SAT released the [Administrative Measures for Overseas In the case of the first approach, a CCCFC Registered Chinese-capital Controlled TREs is required to self-determine whether its (Trial)] Public Notice [2011] No.45 “effective management” is located in (PN45), on 27 July 2011. PN45, effective China based on the actual facts of its from 1 September 2011, covers the production, business operation and significant tax matters of Deemed management. The CCCFC shall lodge the Overseas TREs, including application written application for TRE status with procedures of TRE status, documentation the in-charge Chinese tax authority and requirements, CIT treatment, submit relevant documentation if it administration and collection matters satisfies the criteria of TRE stipulated in and the application of double Article 2 of Circular 82. provisions. As for the second approach, PN45 The salient points, key features and our empowers the Chinese tax authorities to observations of PN45 have been covered investigate the status of effective in the August 2011 Issue 22 of PwC China management of a CCCFC and to request Tax and Business News Flash. The for relevant documentation, if the CCCFC following focuses on the impact of PN45 satisfies the prescribed criteria but fails to on financial services industry. apply for a Chinese TRE status.

BCM Tax 21 • CIT Treatment In light of above, we expect that, with the concept of “TRE” introduced in the CIT PN43 has for the first time clarified that law, the Chinese tax authorities would capital gains derived by Non-TREs from a continue to gradually reinforce the transfer of equity interest in Deemed recognition of the “Chinese TRE” status Overseas TREs shall be treated as China- and to strengthen the tax collection and sourced income in accordance with article administration of Deemed Overseas TREs 26 of PN45. The Deemed Overseas in China. This will trigger increased China TRE shall report the equity transfer tax exposures in respect of dividends, This will trigger increased by presenting the equity transfer income from equity transfer etc. derived China tax exposures in arrangement and other related documents by investors (especially the Non-TRE to the in-charge tax authority within 30 investors) as a result of the Chinese TRE respect of dividends, days from the date of the agreement. status of the invested CCCFCs. income from equity Accordingly, Non-TRE investors should PN45 also stipulates in article 24 that the consider the impact of the overall tax cost transfer etc. derived by Chinese in-charge tax authorities shall on the effective investment returns should investors in CCCFCs that conduct quarterly reviews of the CIT the invested CCCFC be recognised as a withholding obligation of Deemed Chinese TRE. have Chinese TRE status. Overseas TREs in respect of dividend, interest, rental, royalties and income However, PN45 does not provide an derived from property transfer paid to effective mechanism to keep the Non-TRE Non-TREs. investors informed of the TRE status of a CCCFC. It is not clear whether the SAT Our Observations would make a list of Deemed Overseas TREs publicly available and update it on a • Challenges facing investors of regular basis or alternatively provide an Deemed Overseas TRE enquiry mechanism. Non-TRE investors should pay regular close attention to the According to Circular 82, CCCFC “may” Chinese TRE status of the invested or lodge the application for Chinese TRE targeted CCCFC, and consider their own status with the in-charge Chinese tax Chinese tax implications should the authority. However, under PN45 the invested or targeted CCCFC be CCCFC is obligated to lodge the determined as a Chinese TRE. application and submit required documentation as long as it satisfies the prescribed criteria of a Chinese TRE. On the other hand, PN45 empowers the Chinese tax authorities to initiate investigation on the TRE status of “suspicious” CCCFCs and provides clarification of the relevant procedures.

22 PwC • Chinese tax implications of Non-TRE Non-TREs shall generally be obliged to investors of CCCFCs being recognised report the transfer of equity that is as a Chinese TRE directly or indirectly held in a Chinese TRE to the Chinese tax authorities in Dividend accordance with Circular Guoshuihan [2009] No.698 (Circular 698). An According to Circular 82, dividend and exclusion was provided to this reporting profit distribution from equity investment obligation in Circular 698 for the gains distributed by Deemed Overseas TREs to derived from the buying and selling of Non-TRE investors shall be treated as shares of Chinese TREs through public China-sourced income and subject to stock exchanges (the Exclusion). A withholding income tax (WHT) in China. number of financial institutions and other The source of dividend and profit enterprises have been relying on the distributions from equity investment shall Exclusion as the basis that there should be be determined by the location of the no Chinese tax implications on gains enterprise that distributes the dividend derived from buying and selling of shares and profit distribution in accordance with of Chinese TREs listed overseas effected the CIT Law and its DIR. Accordingly, through public stock exchanges. Circular 82 makes it clear that the “location of residency” rather than the Earlier this year, Public Notice [2011] “geographical location” or the “location of No.24 (PN24) has narrowed the scope of registration” shall be adopted when the Exclusion in Circular 698. The term determining the location of the enterprise “buying and selling of shares of Chinese that distributes the dividend and profit TREs effected through public stock distribution. exchanges” shall only refer to those transactions whereby the parties to the Capital gains from equity transfer buying and selling transaction, the quantity of shares being transferred, and The source of capital gains from a transfer the transaction price are not pre- of equity investment shall be determined determined upfront between the buyer by the location of the investee in and the seller, but are determined in accordance with the CIT law and its DIRs. accordance with the ordinary trading PN45 makes it clear that the “location of rules of the public stock exchanges residency” rather than the “geographical instead. It appears that the SAT would like location” or the “location of registration” to limit the Exclusion on gains derived shall be adopted when determining the from daily trading of Chinese TRE shares location of investee. Such determination conducted on-exchange where the by “location of residency” is consistent reporting obligation and tax collection with that adopted for determining the would be regarded as difficult to enforce source of dividend as stipulated in from an administrative perspective. We Circular 82. Accordingly, income derived are aware of a case in practice whereby from the transfer of equity in a Deemed the Chinese tax authorities have Overseas TRE shall be China-sourced successfully imposed WHT at 10% on the income because of the Chinese TRE status gains by a Non-TRE from a disposal of of the investee. Such clarification leads to shares of a Hong Kong listed “red chip” a WHT at 10% on the capital gains from a company (which has been recognised as a transfer of equity in a Deemed Overseas Chinese TRE) based on the principle of TRE for overseas investors, unless treaty “location of residency” and the fact that protection is available. the buying and/or selling was not effected through public stock exchanges.

BCM Tax 23 The aforementioned case and the Interest, rental and royalties subsequent clarification in PN45 regarding the determination of the source The source of interest income, rental and of capital gains by “location of residency” royalties shall be determined according to of the investee would likely have the location of the enterprise which bears implications for the investors in the and/or pays the income pursuant to the financial services industry. Non-TRE CIT law and its DIRs. Although PN45 is investors, (e.g., investment banks, private silent as to how to determine the equity funds) investing in shares of “location” of the enterprise concerned, we Chinese corporation listed overseas (e.g., believe that the source of such passive H shares) or overseas listed shares of income, which shall be determined by the non-Chinese corporations which are location of the enterprise which bears subsequently deemed as Chinese TREs, and/or pays the income, would also be who exit their investments through determined by the SAT according to the private placements, block and other “location of residency”, based on the non-market type transactions may not be clarifications made by Circular 82 in able to rely on the exclusion and hence are relation to source of dividend and by PN45 subject to WHT in China since, typically, in relation to the source of capital gains. the parties to the transaction, the quantity As a result, interest, rental and royalties of the shares being transferred and/or the etc. derived by Non-TRE investors from transaction price would be pre- Deemed Overseas TREs may also be determined upfront between the buyer subject to WHT in China at the applicable and the seller. tax rate.

Investors should be aware of the Chinese Capital gains from transfer of debt tax implications when disposing of shares obligation in accordance with rules in PN45, Circular 698 and PN24, and consider using an It is not entirely clear as to the source of entity within the group that has capital gains from a transfer of debt commercial substance and that is located obligation in the CIT law and its DIRs. in a jurisdiction that has concluded a According to article 16 of the DIRs of CIT favorable double tax treaty with China to Law, income from a transfer of a debt hold the CCCFC. obligation shall be treated as income from transfer of property. The SAT Public Notice [2011] No.36 (PN36) confirms that a transfer of government bonds shall be regarded as income from a transfer of property. However, clarifications are required as to whether a debt obligation shall be treated as movable property or equity investment in the context of income from a transfer of property. It would be helpful if the SAT would further clarify whether the source of capital gains from a transfer of debt obligation shall be determined by the location of the enterprise that transfers the debt obligation or by the location of the enterprise that issues the debts.

24 PwC Danny Yiu • Other matters Chinese WHT retrospectively imposed Partner on Non-TRE investors once the invested PwC China How about Chinese-individual CCCFC being recognised as a Chinese +86 (10) 6533 2787 controlled and foreign capital TRE? [email protected] controlled foreign companies? There are two ways to determine the Circular 82 and PN45 only apply to Chinese TRE status for a CCCFC. A CCCFC CCCFCs. may lodge the application for Chinese TRE status with Chinese tax authority or the We observe that quite a number of Chinese authority may initiate PN45 and Circular 82 only Chinese enterprises have adopted a model investigation of a CCCFC to determine whereby an overseas company directly or whether it should be regarded as a apply to CCCFCs. It is not indirectly held by Chinese individuals gets Chinese TRE. In practice, it may be clear whether they should listed on an offshore stock exchanges (e.g., possible for the Chinese tax authority to NASDAQ). It is not clear whether Circular deem the Chinese TRE status effective be applicable to the 82 and PN45 should be applicable to the from the year in which the CCCFC satisfies determination of Chinese determination of Chinese TRE status of the criteria of TRE. In such case, Chinese these Chinese-individual controlled tax implications of investors would likely TRE status of Chinese- foreign companies. However, we believe to be implemented from the year in which individual controlled that the current criteria for determining the Chinese TRE status of the invested Chinese TRE status of CCCFC, CCCFC is determined. Then, how about foreign companies. administration and collection of taxation those settled transactions (e.g. equity and CIT treatments should serve as good transfer)? It is unclear whether Chinese references for Non-CCCFCs in assessing WHT would be retrospectively imposed and managing the risk of being regarded on those Non-TRE investors. Non-TRE as Chinese TREs and potential Chinese investors should keep in mind such tax consequences. potential tax exposure.

We will continue to monitor the developments on how the above rules will be implemented at local-level tax authorities and development in relation to Non-CCCFC and share them with you on a timely basis.

BCM Tax 25 Hong Kong Nice Cheer: How much cheer does it really bring to financial institutions?

26 PwC We all know by now that accounting accounting practices and financial The IRD argued that under treatment plays an important role in the reporting standards in Hong Kong. Under determination of the Hong Kong profits those prevailing accounting standards the statutory tax regime tax treatment of an item of income or and practices, any unrealised gains or and applying the principle expense. Although arguably not new, the losses arising from the change in fair position was made clear by the Court of value of trading stock (being securities established in the Secan Final Appeal on CIR v Secan Ltd & Ranon listed in Hong Kong) were recognised by case, profits and losses must Ltd (“Secan case”) which reiterated the the taxpayer in its profits and loss principle that the assessable profits or accounts in the relevant financial years. be ascertained in losses of a taxpayer should be “ascertained accordance with ordinary in accordance with the ordinary principles The taxpayer excluded the unrealised of commercial accounting as modified to gains in calculating its assessable profits principles of commercial conform with the [Inland Revenue] for the relevant years. Its reasoning for accounting as modified to Ordinance”. Since then, the assessing doing so was that (i) the word “profits” as practice of the Inland Revenue used in Section 14(1) of the IRO (the conform with the IRO. Department (IRD) has been to follow charging section) means real profits and accounting treatment; a consequence of not notional profits; (ii) it is an overriding this is that the IRD have sought to tax any principle of that profits can only unrealised gains or losses on financial be taxed when in fact they have been instruments in the year of assessment in earned, realised, ascertained, arisen and which such unrealised gains or losses are derived but cannot be anticipated; and recognised in the profit and loss account. (iii) the accounting standards and Such assessing practice was set out in the principles adopted cannot have the effect Departmental Interpretation and Practice of changing the meaning and scope of Notes No. 42 – Taxation of Financial the word “profits” in Section 14(1). Instruments & Foreign Exchange Differences (DIPN 42) issued by the IRD. The IRD argued that under the statutory tax regime and applying the principle While the above position has generally established in the Secan case, profits and been adopted by taxpayers since the losses must be ascertained in accordance release of the DIPN 42, to the surprise of with ordinary principles of commercial many observers, when the Court of First accounting as modified to conform with Instance handed down its judgement in the IRO. In this regard, since (i) the Nice Cheer Investment Ltd. v CIR (“Nice taxpayer’s accounts were properly drawn Cheer case”) on 28 June 2011, doubt was up according to the prevailing accounting cast in the correctness of that assessing standards under which unrealised gains practice. In particular, it was held by the or losses arising from the fair value Court of First Instance in that case that adjustment of trading stocks were unrealised gains on shares held by the recognised in the taxpayer’s profit and taxpayer for trading were not taxable loss accounts; and (ii) there is no under Section 14(1) of the Inland Revenue provision in the IRO expressly prohibiting Ordinance (IRO). inclusion of unrealised gain as profits, it was therefore contented by the IRD that The Nice Cheer case the unrealised gains should be taxed at the time when the gains are recognised Nice Cheer Investment Limited is a private in the profit and loss accounts. company incorporated in Hong Kong with investment trading as its principal activity. The Court of First Instance ruled in The taxpayer’s accounts for the various favour of the taxpayer. This thus poses financial years concerned were prepared the question of whether this contradicts in accordance with the prevailing with the principle in Secan.

BCM Tax 27 Reconciling with the Secan case unrealised gains could be regarded as “profits” derived from a “, profession The Court of First Instance in Nice Cheer or business” carried on in Hong Kong. In did not overturn the principle established answering this question, the Court had, in in the Secan case, but clarified that turn, to decide the true and proper accounting profits become assessable meaning of the terms “profit” and “trade” profits only “in the absence of statutory for the purpose of the provision. provisions to the contrary”. If there are statutory provisions applicable to a In construing the true and proper particular situation, the law itself and the meaning of the terms “trade”, the Court In construing the true and judge’s interpretation of the law take referred to the ordinary meaning of these proper meaning of the terms precedence over ordinary commercial words and the interpretations applied in accounting principles. In Nice Cheer, the other case law. On this basis, the Court “trade”, the Court referred issue was whether the unrealised gains concluded that the essential elements of to the ordinary meaning of arising from the change in fair value of “trade” are that “it is a commercial trading stock (being Hong Kong listed operation between two parties in which a these words and the securities) held by the taxpayer should be trader provides goods or services to the interpretations applied in assessed for tax, and this is governed by other party for reward”. The Court further Section 14(1) of the IRO. It follows that held that it is a well established principle other case law. the statutory provisions concerned, i.e. of construction of income tax statutes that Section 14(1) of the IRO, should have a man cannot trade with himself and that precedence over ordinary commercial such principle remains valid in Hong Kong accounting principles if the Secan case as there is nothing in the IRO which is principle is applied correctly. Profits which inconsistent with this principle. Based on do not fall into the scope of charge as set the meaning of “trade” as constructed out in Section 14(1) of the IRO are not above, the Court considered that the word taxable even if they are recognised in the “profit” in Section 14(1) must be profit and loss accounts pursuant to the construed to mean profits arising in or prevailing accounting standards. derived from commercial transactions, which necessarily means real profits from Section 14 actual transactions and excludes anticipated profits arising from Section 14(1) of the IRO states that revaluation of trading stock. Accordingly, “profits tax shall be charged for each year of the Court held that the unrealised gains assessment at the standard rate on every arising from such revaluation should be person carrying on a trade, profession or not be chargeable for tax under Section business in Hong Kong in respect of his 14(1). assessable profits arising in or derived from Hong Kong for that year from such trade, Interestingly, the Court also took the view profession or business (excluding profits that while accounting principles arising from the sale of capital assets…)” applicable to the treatment of profits [emphasis added]. require modification to conform with Section 14(1) of the IRO, there is no In analysing whether the unrealised gains similar qualification as to the word “loss”. arising from the change in fair value of As such, unrealised losses arising from the trading stock held by the taxpayer were devaluation of trading stocks should be within this provision, Nice Cheer held that allowed for deduction. the critical point was whether such

28 PwC Implications of Nice Cheer to taxpayers do not have other taxable profits financial institutions at that time. Nonetheless, for an ongoing David Kan business, the inability to utilise realised Partner Not surprisingly, the IRD has filed an losses should not generally be a concern in PwC Hong Kong appeal against the decision of the Court of practice. +852 2289 3502 First Instance and the hearing is [email protected] scheduled for May 2012. Pending the From a financial reporting perspective outcome of the appeal, the present and in relation to the reporting of the judgement by the Court of First Instance operating results, the change brought represents the latest interpretation of the about by the Nice Cheer case, however, Roy Phan law by a court on the taxability of may mean little to financial institutions Manager unrealised gains or losses arising from the since such institutions, instead of making PwC Hong Kong revaluation of trading stock. Taxpayers provision for current tax liabilities only, +852 2289 3551 can therefore consider relying on the would still need to make provisions for [email protected] Court of First Instance’s judgement and deferred tax. excluding the unrealised gains arising from the revaluation of trading stocks On the other hand, in pursuing a tax filing while claiming a deduction on the position of excluding unrealised gains, unrealised losses. Having said that, and taxpayers would need to keep track of the putting aside the uncertainty given the amount of such excluded gains and losses pending appeal, it is worthwhile to look at and the amount of realised gains and how much benefit this change would losses for financial instrument, from the really bring to a financial institution and time of purchase until the time of the costs and effort required to obtain disposal. This may or may not, however, that benefit. be an easily achievable task in practice depending on the internal systems of each First of all, an immediate and easy to see entity. In any event, this is likely to result benefit of having the gains taxed on a in a significant additional burden on the realised basis is the deferral of tax financial control and tax departments of liabilities and tax payments and thus an institutions. improvement in cash flow. The savings would be in terms of reduced funding It will be interesting to see how Nice Cheer costs, which would vary between will develop in the higher courts. If the institutions, but should nonetheless be judgment of the Court of First Instance advantageous. ultimately prevails, the tax filing and reporting process for financial institutions In addition, having unrealised gains being in Hong Kong may become more complex, taxed at the time of recognition in the although cash flow advantages will be accounts might not be just a timing issue. reaped. On the other hand, it remains to If the unrealised gains turn into smaller be seen whether the IRD would allow realised gains or even losses, taxpayers institutions who prefer not to upgrade may suffer permanently in a situation their systems to track the excluded where they are required to pay tax when unrealised gains, to continue to file the unrealised gains are recognised in the returns on an unrealised basis. accounts, but the losses recognised in the accounts when the gains are subsequently reversed cannot be utilised if the

BCM Tax 29 Indonesia Recent tax developments 1. Transfer Pricing Landscape 3. Internal comparable data is to be The enforcement of the preferred over external comparable transfer pricing legislation The enforcement of the transfer pricing data (TP) legislation in Indonesia in relation in Indonesia in relation to to services and other transactions within 4. The following hierarchy of methods is services and other the financial services industry has been required: Comparable Uncontrolled strengthened. The current focus of the Price (CUP), resale price and cost plus transactions within the Indonesia Tax Authority (ITA) is on the methods preferred over profit split financial services industry fairness, presence and actual benefits of and Transactional Net Margin service fee, royalty, interest Method (TNMM) has been strengthened. compensation and asset transfers within related party transactions. The ITA also 5. Inter quartile range is accepted closely examines whether the value of the service is arm’s length, constitutes 6. An exemption from preparing TP duplication, is a normal shareholder cost documentation is available if the or is attributable to functions performed relevant transactions are with a by a related party. related party which has income or expenses of less than Indonesian With respect to disclosure and Rupiah (IDR) 10 million (circa documentation, the ITA requires related USD 1,200) party disclosures on the Corporate Income Tax Returns and for companies 7. The format of TP documentation may to prepare contemporaneous TP be determined by taxpayer; however, documentation outlining the selection of it needs to meet the minimum the specific TP method, comparability requirements set by the ITA, which analysis as well as function, asset and are that it must: risk (FAR) analysis to support the arm’s length principle within related party a. Contain a company overview, such transactions. as group structure, organization chart, shareholding structure, Specific guidelines on reporting and for business operations, list of the preparation of TP documentation are competitors and description of contained in the ITA regulation No. business environment; PER-43/PJ/2010 and provide that: b. Identify a price policy and/or cost 1. The documentation should largely allocation policy; follow OECD Guidelines (1995 version, not 2010 version) c. Set out a comparability analysis (i.e. based on the five 2. The comparability analysis should be comparability factors); based on five OECD comparability factors: d. List the selected comparables’, and

a. Product/service characteristics e. Explain the application of the b. Functional analysis selected method. c. Contractual terms d. Economic circumstances e. Business strategies

BCM Tax 31 b. The Indonesian resident taxpayer Following the issuance of the Transfer Pricing guidelines, believes that action by a tax authority the ITA has prescribed guidelines on the implementation of of a treaty partner country has resulted, or will result, in tax the Mutual Agreement Procedures and Advanced Pricing imposition which is not in accordance Agreement. with the relevant tax treaty in relation to the existence of, or income of, a in the treaty partner country concerned;

2. Mutual Agreement Procedures c. The Indonesian resident taxpayer (MAP) believes that action by a tax authority of a treaty partner country has Following the issuance of the TP resulted, or will result in, tax guidelines, the ITA has prescribed imposition which is not in accordance guidelines on the implementation of with the relevant tax treaty regarding MAP and Advanced Pricing Agreement tax withholding in the treaty partner (APA). country; or

In accordance with the issued regulation, d. The Indonesian resident taxpayer, MAP is conducted as a result of: who is also considered a resident taxpayer of another treaty country, 1. A request by a resident taxpayer of requests a consultation to determine Indonesia; its status as a taxpayer of one of the treaty countries. 2. A request by an Indonesian citizen who has become a resident taxpayer A treaty partner country may request a of a tax treaty partner country in MAP consultation in, amongst other relation to the non-discrimination situations, the following cases: provision in the applicable treaty; a. The ITA issues letters 3. A request by a treaty partner country; to a foreign taxpayer that has a or permanent establishment in Indonesia, which are considered not 4. Matters considered important by and to be in accordance with provisions in based on the initiatives of the ITA. a relevant tax treaty;

An MAP request by an Indonesian b. There is a TP adjustment in Indonesia resident taxpayer can be made, among in relation to the foreign taxpayer other reasons, when: that has a permanent establishment in Indonesia; a. The Indonesian resident taxpayer is subject to or will be subject to tax as a c. A tax treaty partner country asks for result of the application of TP rules in corresponding adjustments in relation relation to transactions made with a to TP adjustments made by a tax related taxpayer in a treaty partner authority of the treaty partner country; country to its resident taxpayer that has related party transactions with an Indonesian resident taxpayer;

32 PwC d. Where tax is withheld by an A taxpayer who has entered an APA must Indonesian resident taxpayer in submit an Annual Compliance report relation to income sourced in (ACR) to the ITA within four months Indonesia which is considered not to after the end of the fiscal year containing be in accordance with provisions in a the following: relevant tax treaty; or a. The compliance of the taxpayer e. Where the domicile country of a with the TP method as described in taxpayer that has status both as an the APA; Indonesian resident taxpayer and as a resident taxpayer of the treaty b. A detailed explanation concerning partner country (Dual Residence) the accuracy and consistency of the must be determined. TP application; and

It worth noting that where a foreign c. A detailed explanation of the taxpayer and related party in Indonesia accuracy of the factors that may are contemplating submitting an MAP impact on critical assumptions in request, they will also need to consider applying the selected TP method. the MAP guidelines and requirements in the foreign jurisdiction. After the APA issuance, the ITA has the authority to reconsider or cancel the APA 3. APA in the following circumstances:

To request and to negotiate an APA, an a. if the taxpayer does not comply with Indonesian taxpayer needs to follow the the APA; five main steps below: b. if the taxpayer delivers incorrect Step 1 : Pre-lodgement meeting data/information to the ITA; between the ITA and the taxpayer c. if the taxpayer does not submit an Step 2 : Filing a formal APA request to ACR or the submitted ACR is not in the ITA based on the pre-lodgment accordance with the prevailing meeting provisions;

Step 3 : Discussion of the APA between d. if a critical assumption is breached; the ITA and the taxpayers e. if errors are found in the APA; or Step 4 : The issue of the APA letter by the ITA f. if the taxpayer has been involved in a tax crime. Step 5 : The implementation and evaluation of the APA

BCM Tax 33 These conditions must be included in 2. Tax treatment of provision for loan There are numerous the APA. Should the ITA cancel the APA, losses including loan impairment technical tax and it is required to inform the taxpayer in writing. 3. Interest income recognition on non administrative issues performing loans arising from the Once agreed, an APA can also be applied to tax years before it was agreed if the 4. Recognition of interest subsidy on implementation of the following conditions are met: employee loans GAAPs which the financial a. the tax year has not been audited; 5. Tax treatment of transaction costs industry associations are and commission currently discussing with b. the taxpayer has not filed an objection or appeal for the respective 6. De-recognition of financial the ITA. tax year; and instruments

c. there is no indication of tax crime. 7. Retained earnings adjustment

Rollback of an APA to prior years is not Until further clarification and technical automatic and will be subject to guidelines are provided by the ITA, agreement between the taxpayer and taxpayers should adopt individual the ITA. technical positions in relation to their applicable transactions when preparing The current regulation, however, does the 2011 Corporate Income Tax Returns not discuss the procedures for renewing (deadline for the Returns submission is an APA that has expired after the April 2012). original three year term. 5. Implementation of 4. Tax Implications of the Withholding Tax Mechanism Implementation of the Indonesia on Bonds GAAP No. 50 and No.55 (adopted from the IAS 32 and 39 re: New regulations concerning withholding Disclosure, Presentation, tax on bonds were issued and became Recognition and Measurement effective on 23 May 2011 MOF Decree of Financial Instruments) No.85/PMK.03/2011 (“PMK 85”).

The above Indonesia GAAPs have been PMK-85 is applicable to bonds (including effective since 1 January 2010. There government bonds) issued in Indonesia are numerous technical tax and with maturity periods longer than twelve administrative issues arising from the months. PMK-85 provides more detailed implementation of the GAAPs which the implementation rules in relation to the financial industry associations are withholding tax (WHT) mechanism for currently discussing with the ITA. The bond transactions, including WHT rates, notable key tax issues are as follows: deadlines, details pertaining to the tax withholder and the mechanism to be 1. Tax treatment of unrealised gain/ used as well as other matters. loss due to mark to market (MTM) Nonetheless, there were no fundamental trading securities for Available for changes to the basic withholding tax Sale (AFS) provisions.

34 PwC Key Changes: 19 August 2011) which serve as the implementing regulations of the previous 1. The First in First Out (FIFO) method regulation. – now mandatory • Minister of Finance Decree No.136/ Under the previous regulation, the PMK.03/2011 (“MoF-136”) – Income FIFO method was required to be used Tax Treatment of Sharia-based when determining the acquisition Financing Activities cost and date of a bond sale transaction only for scrip-less bonds MoF-136 defines Sharia financing where the acquisition date could not companies as non-bank financial be determined. Now the FIFO method institutions which conduct financing must be used for all transactions. activities based on Sharia principles.

2. Netting of Losses is now prohibited Sharia principles are defined as Islamic law principles based on a When calculating the final income tax Fatwa (edict) that is issued by an due, netting off of interest income institution authorised to issue a against a loss incurred in a sale Sharia Fatwa. Therefore, taxpayers transaction (i.e. the selling price need to ensure that any structure being lower than the acquisition used under a Sharia transaction is price) is now prohibited. based on a Fatwa.

6. Islamic Finance – new MoF-136 also provides definitions of regulations on Sharia income tax the types of agreement and structures used in Sharia financing activities. New regulations concerning Islamic The tax treatments are summarised Finance have been issued (effective on below:

Type of activity Type of agreement Tax treatment Ijarah Similar to Operating Lease Lease Ijarah Muntahiyah Bittamlik (IMBT) Similar to Financial Lease with Option Rights

Factoring Wakalah bil Ujrah Gain or fee is treated as interest

Murabahah Consumer financing Salam Gain or profit margin is treated as interest Istishna

Credit card Fee or any other income is taxed in accordance Other Sharia-based Not specified with the Income Tax Law No. 36/2008 (“ITL”) financing

Mudharabah Corporate financing Mudharabah Gain and/or profit sharing derived by financiers Musytarakah (Shohibul maal) is treated as interest Musyarakah

BCM Tax 35 The deductibility of expenses is based on • Saving customers – customers who articles 6 and 9 of the ITL, including the place their funds in a Sharia bank in gain and/or profit sharing payable by the the form of savings. Savings are financing company to the Shohibul maal, defined as funds entrusted by the and the agreed amount in the Sharia customer to the Sharia bank in the agreement. form of a demand deposit (giro), saving account, time deposit, or in • Minister of Finance Decree No.137/ some other similar form. PMK.03/2011 (“MoF-137”) – Income Tax Treatment of Sharia Banking • Facility receiving customers (Debtor) – customers who receive a fund MoF-137 categorises banks’ customers facility or other similar facility. under three categories: MoF-137 defines the tax treatment based • Investor customers –customers who on the type of income, and based on the place their funds in a Sharia bank recipient of the income. The tax or Sharia business unit in the form treatment can be summarised as follows: of investment.

Tax treatment Type of income Bank Investor/Depositor Customer Bonus, profit sharing, and profit margin:

Income is treated as • from a debtor transaction interest

• from a transaction other than a Income is treated in debtor transaction accordance with the normal income tax regulations for the relevant transaction

Bonus, profit sharing, and any other income from funds entrusted or placed, and funds placed offshore through an Income is treated as Indonesian Sharia bank or an interest Indonesian branch of an offshore Sharia bank

Income is treated in Customer’s income other than that accordance with the covered by the previous point normal income tax regulations

36 PwC Both MoF regulations stipulate that if there is a transfer or lease of an asset Margie Margaret which is required to fulfill the Sharia Partner principle, the following rules apply: PwC Indonesia +62 21 52890862 • Transfer of an asset from a third party [email protected] that is carried out merely to fulfill the Sharia principle in the financing activities by the financing companies does not fall under the definition Ivan Budiarnawan of transfer of asset as stipulated in Associate Director the ITL. PwC Indonesia +62 21 52890312 • The transfer of an asset as defined [email protected] above will be considered to be directly from the third party to the financing companies’/banks’ customer, who will be subject to normal income tax.

These MoF regulations only govern Sharia transactions carried out by banks and financial institutions. The question remains of whether other types of company, such as an intermediary company in a Sukuk transaction, can rely on the same tax treatments under these regulations. Further, no implementing regulation has been issued for other types of Islamic finance activities such as insurance.

BCM Tax 37 Philippines The real estate investment trust law

38 PwC On 12 March 2010, Republic Act No. • Public ownership in a REIT must The REIT Act was one of the 9856, otherwise known as the Real comprise at least 1,000 public most anticipated pieces of Estate Investment Trust (REIT) Act, shareholders owning at least 50 came into effect. The REIT Act was one shares each, of any class of shares legislation of recent years as of the most anticipated pieces of who in the aggregate own at least 1/3 it finally provided the legal legislation of recent years as it finally of the outstanding capital stock of the and regulatory framework provided the legal and regulatory REITs framework for the establishment of for the establishment of REITs in the Philippines with the intent • 75% of the total value of the REIT’s REITs in the Philippines. of promoting the development of the assets must be invested in, or consist local capital markets as an instrument to of income-generating real estate help finance and advance infrastructure projects. • Investment of the REIT in property development activities or Under the REIT Act, a REIT can be uncompleted property developments established as a stock corporation under shall be limited to 10% of the REIT’s Philippine law principally for the deposited property purpose of owning income-generating real estate. However, foreign investment REITs have been granted various tax is limited to 40% of a REIT’s voting incentives under the law, including: shares of stock in compliance with Constitutional restrictions on land • Dividends distributed can be claimed ownership. as tax deductions.

General requirements and • Not subject to Minimum Corporate incentives Income Tax (i.e., 2% of gross income if higher than regular 30% corporate Under the REIT Act, the general income tax) requirements to set up a REIT are as follows: • Reduced Creditable Withholding Tax of 1% on Income payment to REITs • The REIT must be publicly listed and registered with the Securities and • Reduced documentary stamp rate Exchange Commission (SEC) (DST) and registration fees on sale/ transfer of real property including • The paid up capital of the REIT must security interest related to REITs be at least Three hundred million (50% of the regular DST and pesos (Php 300,000,000) registration fees)

• Exempt from Stock Transaction Tax (STT) on any initial public offering and secondary offering of shares (STT rate 1% to 4%)

BCM Tax 39 • 10% final tax on dividends paid by a REITs are not considered REIT unless: Subsequent regulations as dealers in securities a) The dividends are received by a In order to properly realise the potential and, as such, are not non-resident individual and of the REIT Act, implementing rules and subject to the 12% VAT non-resident foreign corporations regulations (IRR) were issued by the entitled to claim a lower treaty particular government agencies on sale of securities rate involved in the regulation of forming part of its real- corporations and collection of revenue, b) Dividends received by a domestic the SEC and the Bureau of Internal estate related assets. corporation or resident foreign Revenue (BIR), respectively. corporation which are exempt from income tax. SEC IRR

c) Dividends paid to overseas The SEC IRR, issued on 13 May 2010, Filipino workers which are not was received by potential investors subject to income tax/ without any major complaints as this withholding tax for 7 years from initial version closely paralleled the the effectivity of the tax original law. regulations implementing the REIT Act (i.e., 11 August 2011). On 27 April 2011, however, following discussions with the Department of • REITs are not considered as dealers in Finance and the BIR, SEC Memorandum securities and, as such, are not subject Circular No. 2 was issued amending the to the 12% value-added tax (VAT) on IRR, to provide for higher public sale of securities forming part of its ownership requirements, modification real-estate related assets. of allowable investments and restrictions on the use of capital to pay To avail itself of the tax incentives, a debts. The amendments were made REIT should: despite concerns raised by the business community due to apparent • Remain a public company as defined inconsistencies with the REIT Act. in the REIT Law,

• Maintain the listed status of its securities, and

• Distribute at least 90% of its distributable income to its shareholders annually.

40 PwC BIR Revenue Regulations (RR) The BIR’s adoption of higher public ownership requirement in REITs and the Malou P Lim RR No. 13-2011, which became effective institution of additional compliance Partner on 11 August 2011, provided for a higher measures by way of mandatory escrows PwC Philippines public ownership requirement for REITs as provided in RR No. 13-2011 have led +63 2 459 2016 in line with the SEC IRR. It is set at forty some potential investors and property [email protected] percent (40%) for the first two years and developers to postpone their plans to increased to sixty-seven percent (67%) establish a REIT. on or before the third year and thereafter. This was a departure from Conclusion the REIT Act which only provided for “at least 1,000 public shareholders owning The initial passage of the REIT Act was at least 50 shares each of any class of seen as a positive step in allowing the shares and who in aggregate own at local real estate and capital markets to least 1/3 of the outstanding capital keep pace with investor appetite and stock.” international developments.

Additionally, RR No. 13-2011 required However, existing regulatory the placing in escrow, in favor of the inconsistencies and delays in BIR, the following amounts subject to its implementation are a cause for concern compliance with the requirements of the and should be settled in order to provide regulations: certainty to potential investors in relation to their prospective investments • In relation to the reduced rate of DST in the Philippine real estate market. – the 50% DST waived as a , until the public listing Until these regulatory inconsistencies requirement with the local stock are resolved, investors are bound to exchange has been fulfilled within consider whether potential benefits from two years from the date of the establishing a REIT in the rising execution of the transfer documents. Philippine real estate market will outweigh any potential disadvantages • In relation to allowed tax deduction from the current uncertain regulatory on dividend distributions – the environment. income tax waived due to the deduction of dividends distributed for the first and second year, until proof of attainment of the minimum public ownership of 67% within three years.

BCM Tax 41 Taiwan Recent tax developments

42 PwC This article looks at some of the recent tax Although Tax Ruling Tai-Tsai-Shuei No. In recent years, M&A developments that may have a direct 10004073270 has attempted to define the activity in Taiwan’s influence on the Taiwanese Banking & term “business rights”, it has provided no Capital Markets (BCM) sector. specific guidance on the treatment of financial services industry business rights in relation to the financial has been commonplace, Deduction of amortisation of services industry. This is unfortunate business rights given the amount of M&A activity in the with foreign banks being sector in recent years and the large significant players through In recent years, merger and acquisition amounts paid for banking licenses and (M&A) activity in Taiwan’s financial other rights to operate businesses in seeking to expand their services industry has been commonplace, Taiwan. Accordingly, it remains to be seen operations in Taiwan. with foreign banks being significant whether this new ruling will bring any players through seeking to expand their much needed clarity to the issue of operations in Taiwan. As a consequence of amortisation of rights in relation to the such M&A activities, the acquiring banks financial services industry. may record intangible assets (such as branch office license and goodwill) in Deduction of management their books. fees allocated to a Taiwanese subsidiary Article 60 of the Income Tax Act (ITA) provides that the cost of acquired business In theory, a Taiwanese subsidiary of a rights may be amortised for income tax foreign company is not eligible for general purposes over a period of 10 years. In the and administrative (G&A) expense past, there have been controversies allocation under article 70 of the between taxpayers and the tax authorities Assessment Rules for Income Tax Returns on the recognition of “business rights” for for Profit-Seeking Enterprises, as this is tax amortisation purposes. Some only applicable to branches. taxpayers have taken the stand that the right to operate a business should fit the This is a major tax issue for foreign banks term “business rights” under article 60 of that have subsidiaries in Taiwan, the ITA, and thus amortisation on such especially when the amount of allocated rights should be tax deductible. head office expense is significant. According to the Ministry of Finance On 12 August 2011, Tax Ruling Tai-Tsai- (MOF) administrative appeal case No. Shuei No. 10004073270 was issued which 09913023660 dated 20 January 2011, the expresses a more conservative view and MOF ruled that the management fees limits the interpretation of the term allocated by the foreign parent company “business rights” to those rights explicitly to the Taiwan subsidiary should be tax regulated by law. Examples of such laws deductible if: mentioned in the ruling include the Statute For Overseeing Private-Owned Public Utilities and the Electricity Act. Currently, intangible assets such as “trademarks”, “copyrights”, and “patents” are regulated and defined under the Trademark Act, Copyright Act and Patent Act respectively and, therefore, these intangible assets may be amortised under the current tax regulations.

BCM Tax 43 (a) The criteria for allocating the Reduced business tax rate on management fees are in accordance services by foreign financial with the economic substance of the institution transaction. In addition, the participants in the management fee Amongst the various amendments to the allocation are required to have a Value-added and Non-value-added reasonable anticipation of deriving Business Tax Act (“Business Tax Act”) benefits from the services provided announced in early 2011 is the reduced by the foreign parent company, and business tax rate applicable to Taiwanese the management fee allocated is financial institutions with respect to required to be in proportion to the certain services purchased from foreign anticipated benefits derived business entities. therefrom; Pursuant to the revised article 36 of the (b) The transaction conforms with Business Tax Act, where a Taiwanese regular business practice and is financial institution (including companies conducted at arm’s length; and engaged in banking, insurance, investment trust, securities, futures, (c) The transaction does not involve the commercial paper and pawnshops) payment or receipt of royalties. purchases services exclusively for its authorised businesses from a foreign Introduction of thin financial institution with no fixed place of capitalisation rule business in Taiwan, the services are liable for a 3% (previously 5%) gross business In January 2011, Taiwan introduced the receipts tax (GBRT). For services The new thin capitalisation thin capitalisation rule in the revised purchased other than the authorised article 43-2 of the ITA. From 2011 businesses of a financial institution, 5% rule does not apply to onwards, deductible interest expense on GBRT will be imposed. banks, credit cooperatives, inter-company loans is capped at a prescribed inter-company debt-to-equity The revised article 36 of the Business Tax financial holding ratio of 3:1 as currently determined by Act also provides for a de minimis companies, bills finance the MOF. The new thin capitalisation exemption on a limited amount of services rule does not apply to banks, credit purchased from a foreign enterprise. The companies, insurance cooperatives, financial holding current threshold is NTD 3,000 per same companies and securities companies, bills finance companies, item of service purchase. insurance companies and securities companies. companies.

44 PwC Based on current timelines, Taiwan listed companies and financial institutions are required to adopt IFRS in 2013. The conversion to IFRS may have a material tax impact for financial institutions.

Large-scale audit on business tax Conversion to IFRS from 1 April 2011 onwards Based on current timelines, Taiwanese On 1 April 2011, the Taipei National Tax listed companies and financial institutions Administration started conducting are required to adopt International large-scale audits of business tax [value- Financial Reporting Standard (IFRS) in added tax (VAT) and GBRT] including 2013. For enterprises operating in other financial institutions that have failed to industries, adoption of IFRS will apply in pay business tax imposed on services 20151. purchased from foreign business entities, under-reported sales amount on business The conversion to IFRS in 2013 may have tax returns, or are considered to have a material tax impact for financial intended to evade business tax. institutions. For the BCM sector, one example of the issues discussed is the Transfer pricing audit trend recognition of interest income from moneylending under IFRS 9 ‘Financial In September 2011, the National Tax instruments’. Administration (NTA) announced their intention to conduct large-scale transfer IFRS 9 replaces the multiple classification pricing (TP) audits for the financial years and measurement models for financial 2009 and 2010. In the BCM sector, banks assets in International Accounting have been selected as TP audit targets. As Standards (IAS) 39, ‘Financial such, taxpayers should ensure that robust Instruments: Recognition and TP documents are in place and re-visit the measurement’ (referred to in Taiwan as scope of their TP reports which should GAAP 34), with a model that has only two include all related parties transactions as classification categories: amortised cost well as transactions booked under the and fair value. Classification under IFRS 9 Offshore Banking Units (OBU). is driven by the entity’s business model for managing the financial assets and the contractual cashflow characteristics of the financial assets.

1 Credit card companies, and insurance agencies and brokerage companies are excluded from the requirement to convert to IFRS in 2013, and may instead defer adoption until 2015. BCM Tax 45 Under IFRS 9, interest is consideration for • Yachts with taxable values of not less the time value of money and the credit than NT$3 million; risk associated with the principal amount outstanding during a particular period of • Airplanes, helicopters and ultra-light time, which resulted in a lower effective vehicles with taxable values of not less interest rate compared to that under IAS 9 than NT$3 million; or Taiwan GAAP 34. A lower effective interest rate implies a lower amount of • Turtle shells, hawksbill, coral, ivory, interest income booked periodically which furs, and their products with taxable may affect the tax base for business tax values of not less than NT$500,000 purposes. (excluding those that are not protected species under the Wildlife Although the conversion date is drawing Conservation Act, or products made near, the regulatory authority and tax from them); authority have not yet provided any proposals to address the potential issues • Furniture with a value exceeding faced by Taiwanese financial institutions NT$500,000; upon convergence to IFRS. • Any membership rights with a selling Introduction of luxury tax price of not less than NT$500,000, except when in the nature of a The Specifically Selected Goods and refundable deposit. Services Tax Act (also known as Luxury Tax), effective from 1 June 2011, was As the main purpose of the luxury tax is to promulgated by the Presidential Office on curb short-term real estate speculation, 4 May 2011. It was introduced with the some exemptions are provided for main aim of curbing real estate transfers which do not have a profit speculation, though applies more broadly making character. This includes transfers to a basket of high-end goods and rights. arising upon foreclosure, testamentary transfer of property, gifts and first-time In accordance with the provisions of the transfers of real property after completion Luxury Tax Act, tax at the rate of 10% – of construction. 15% of the gross proceeds will be imposed where selected goods and rights are sold The introduction of luxury tax may impact within two years of acquisition by a the nature and timing of investment or taxpayer. It potentially applies to divestment decisions. As luxury tax is transfers of: imposed on gross proceeds from the sale, banks, asset managers and wealth • Land and buildings; management service providers dealing with selected goods (particularly real • Upscale automobiles with taxable estate properties) should be aware of the values of not less than NT$3 million; luxury tax impact on their own investment portfolios as well as of their clients’.

46 PwC Table 1

Country Dividends (%) Interest (%) Royalties (%) Richard Watanabe Hungary 10 10 10 Partner France 10 10 10 PwC Taiwan +886 2 2729 6704 India 12.5 10 10 [email protected] Slovakia 10 10 5, 10

New tax treaties The completion of the Bilateral APA is a milestone in international tax At present, Taiwan has signed 22 developments in Taiwan, and a positive comprehensive tax treaties, of which 4 development in the mitigation of cross- were signed in years 2010 and 2011. The border tax risks and the creation of a new tax treaties signed are with Hungary, favorable tax environment. With its France, India and Slovakia. Table 1 conclusion, the first Bilateral APA in 2011 summarises the main contents of the said clearly signifies Taiwan’s openness to tax treaties: mutual agreement of Bilateral APAs and a further sign of Taiwan’s readiness to For foreign residents with no tax treaty embrace international cooperation in tax protection, dividends, interest and administration. royalties will be subject to 20% withholding tax. The APA mechanism can be an effective tool for resolving TP issues and Signing of Taiwan’s first Bilateral minimising TP disputes through Advance Pricing Agreement collaboration between taxpayers and the tax authorities. Multinational The NTA has recently announced that, corporations are encouraged to explore Taiwan’s first Bilateral Advance Pricing the mechanism and potential tax benefits Agreement (the “Bilateral APA”) was of APA. signed on 5 September 2011. The agreement was the culmination of collaborative efforts by all parties, after going through the various stages of the Bilateral APA application process which encompasses regular communication between the NTA and the applicant through its application agent, PwC Taiwan, followed by various discussions and negotiations between the tax authorities of the two jurisdictions.

BCM Tax 47 United States FATCA: Assessing the implications for financial institutions in Asia

48 PwC In an effort to crack down on To comply, virtually all foreign financial Although substantial by US citizens and residents, the United institutions (FFIs) in Asia need to adopt portions of the law’s States has enacted new information procedures designed to identify potential reporting and tax withholding US taxpayers and disclose specific implementation remain requirements for non-US financial information about them to the US Internal unwritten, the statutory institutions globally. The Foreign Account (IRS). Tax Compliance Act (FATCA) requires definitions are broad, financial institutions to employ enhanced Globally, there also is a broader move by placing many entities that due diligence procedures to identify US tax authorities to combat tax evasion. persons who may be using non-US For example, Germany and Switzerland ordinarily would not be financial accounts or entities to evade US recently concluded a treaty to facilitate considered financial taxes. the identification of undeclared deposits. Last month, the United Kingdom finalised institutions within Although substantial portions of the law’s a similar treaty with Switzerland. In the FATCA’s scope. implementation remain unwritten, the wake of FATCA and these anti-tax evasion statutory definitions are broad, placing efforts by other jurisdictions, one may well many entities that ordinarily would not argue that the end of bank secrecy and be considered financial institutions customer privacy rules is near. What is within FATCA’s scope. certain is that tax evasion will be far more difficult. Death of bank secrecy? Burdensome requirements FATCA was enacted in March 2010 in response to the perception that US To avoid FATCA’s withholding tax, a persons are evading US tax requirements non-US financial institution must enter by not declaring all of their global into an FFI agreement with the IRS. Under sourced income. The US government the terms of the agreement, it will need to estimates that this costs billions in lost implement a prescribed process to identify tax revenues annually. FATCA is an individual account holders who are US all-encompassing requirement; the citizens or residents, and, in the case of an ramifications for financial institutions FFI that is an account holder, verify that do not move quickly to understand FATCA compliance. For payments made to the implications may be massive come non-financial foreign entities (NFFEs), the 2013, when the phase-in of FATCA’s financial institution will need to obtain the provisions begins. name, address, and tax identification number of each US owner, or a Non-compliance can mean a withholding certification from the NFFE that there are tax of up to 30 percent on payment flows, no US owners. both gross and profits sourced, and also payments from FATCA-compliant institutions to non-compliant institutions. For most, this means that non- compliance is not an option.

BCM Tax 49 Financial services entities and accounts 1. increase the amount of information The timeline for in-scope they collect from new and existing implementing FATCA is account holders; and tight; financial FATCA defines a FFI as any non-US entity that: 2. adopt follow up action to ensure that institutions must have all required forms and information is entered into an FFI 1. accepts deposits in the ordinary course kept current. This will require FFIs to agreement on or before of a banking or similar business; build, sustain and ease account holders in to a culture where they 30 June 2013 in order 2. holds financial assets for the account become accustomed to regular to avoid being subject to of others as a substantial portion of its requests and updates for information. withholding tax on business; or The clock is ticking 1 January 2014. 3. is engaged (or holding itself out as being engaged) primarily in the The timeline for implementing FATCA is business of investing, reinvesting or tight; financial institutions must have trading in securities, partnership entered into an FFI agreement on or interests, commodities, or any interest before 30 June 2013 in order to avoid (including a futures or forward being subject to withholding tax on 1 contract or option) in such securities, January 2014. Further, by the effective partnership interests or commodities. date of the FFI agreement, a participating FFI must have put into place the requisite Thus, many entities that ordinarily would identification procedures for new policies/ not be considered financial institutions – accounts. including hedge funds and private equity funds – will be required to comply with Faced with FATCA’s burdensome FATCA’s identification, reporting and requirements, institutions and industry withholding provisions. groups have been lobbying Washington to mitigate the legislation’s impact. However, Challenges the extent to which the US Treasury will bow to this pressure remains unclear. Although some guidance has been issued, substantial portions of the law’s Whilst the IRS has promised detailed implementation remain unwritten. In the guidance, in the form of regulations, on face of FATCA’s tight timeline, FFIs will be the implementation of FATCA, it appears forced to adapt quickly once additional that these may not be issued until mid- guidance is issued. 2012. Despite the lack of clarity, there is no indication from the IRS that the Based on the information available, effective dates will be extended beyond FATCA compliance is likely to require those set out in the recently issued Notice FFIs to: 2011–53. This cuts two ways. On one hand, it permits continued lobbying by financial institutions to soften FATCA’s blow. On the other, it means that FFIs will have less time to incorporate the finalised requirements into their businesses.

50 PwC FATCA has no silver lining; only cost to • tax implications on entities and the business; but the potentially greater business units; Mark Jansen costs of non-compliance – on FFIs and Partner their account holders – means that most • business issues affecting key functions PwC Singapore financial institutions in Asia will need to and policyholder relationships; +65 6236 7388 be compliant, and they should begin [email protected] planning. For those who already have • legal and compliance consequences on started to assess the impact, it quickly has current and future contracts; and become clear that this is not a simple, flick-of-the-switch project, but one that • data and operational gaps across Michael Brevetta requires a coordinated, group effort. people, process and technology. Associate Director PwC Singapore Next steps The time window to make relevant +65 6236 3801 process and technology changes is [email protected] Some institutions in Asia have questioned closing. As companies seek to comply with the broad reach of the FATCA provisions increased due diligence, verification and and are adopting a wait-and-see approach reporting requirements for a larger base in the hope of additional exceptions, of customers, they will encounter carve-outs or repeal. Others have waited, significant technological and operational pending the release of regulations by issues that may require substantial time the IRS. and effort to overcome.

Although many of the details about Initiating a programme now enables FFIs FATCA’s requirements remain unclear, to respond strategically and also to reduce there are a number of steps companies the impact on customers. Importantly, a can, and should, take now to prepare for wait-and-see approach may result in an FATCA. As FATCA will affect processes inability to take on new customers come and systems enterprise-wide, and will 2013. require new and expanded information and reporting systems and procedures, The time to begin is now. preparing will require a multi-disciplinary effort. Effective and timely FATCA preparation should start with a comprehensive impact assessment that identifies and assesses the following items, based on currently available guidance:

BCM Tax 51 Contacts

Asia Leader Peter Yu [email protected] +852 2289 3122

North Asia China Matthew Wong [email protected] +86 21 2323 3052

Hong Kong Peter Yu [email protected] +852 2289 3122 Jeremy Ngai [email protected] +852 2289 5616 David Smith [email protected] +852 2289 5802

Japan Sachihiko Fujimoto [email protected] +81 3 5251 2423 Stuart Porter [email protected] +81 3 5251 2944

Korea Han Chon [email protected] +82 2 3781 3489

Taiwan Richard Watanabe [email protected] +886 2 2729 6704

South and Southeast Asia India Sunil Gidwani [email protected] +91 22 6689 1177

Indonesia Margie Margaret [email protected] +62 21 528 90862

52 PwC Malaysia Jennifer Chang [email protected] +60 3 2173 1828

Philippines Malou Lim [email protected] +63 2 459 2016

Singapore Paul Lau [email protected] +65 6236 3733 Tan Tay Lek [email protected] +65 6236 3768

Pakistan Soli R. Parakh [email protected] +92 21 3241 6434

Thailand Ornjira [email protected] +66 2 344 1118 Tangwongyodying

Vietnam Dinh Thi Quynh Van [email protected] +84 4 39 46 22 31

Australasia Australia Matt Osmond [email protected] +61 3 8603 5883 Gavin Marjoram [email protected] +61 2 8266 0576

New Zealand Mark Russell [email protected] +64 9 355 8316

BCM Tax 53 www.pwc.com

PwC has exercised professional care and diligence in the preparation of this publication. However, the information contained herein is intended to be a general guide and should not be used or relied upon as a substitute for specific professional advice. While every effort has been made to ensure accuracy, no liability is accepted by PwC or any employee of the firm on any grounds whatsoever to any party in respect of any errors or omission to act as a result of the information contained in this publication.

© 2011 PricewaterhouseCoopers. All rights reserved. Not for further distribution without the permission of PwC. "PwC" refers to the network of member firms of PricewaterhouseCoopers International Limited (PwCIL), or, as the context requires, individual member firms of the PwC network. Each member firm is a separate legal entity and does not act as agent of PwCIL or any other member firm. PwCIL oesd not provide any services to clients. PwCIL is not responsible or liable for the acts or omissions of any of its member firms nor can it control the exercise of their professional judgment or bind them in any way. No member firm is responsible or liable for the acts or omissions of any other member firm nor can it control the exercise of another member firm's professional judgment or bind another member firm or PwCIL in any way.