RESTRICTED Report No. EAP-17a Public Disclosure Authorized This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views.

INTERNATIONAL BANK FOR RECONSTRUCT'ION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION Public Disclosure Authorized

ECONOMIC POSITION

AND PROSPECTS

OF THE

REPUBLIC OF CHINA

(in three volumes) Public Disclosure Authorized

VOLUME II

TAX SYSTEM AND REFORM

September 11, 1970 Public Disclosure Authorized

East Asia and Pacific Department CURT?NTY EQUIVALENTS

1 U.S. dollar = 0 New Taiwan dollars NT$1 = US$0.025 NT$l,OO,OOO = US$25,000

PLAN PERIODS

Fourth Four-Year Plan: 1965 - 1968 Fifth Four-Year Plan: 1969 - 1972 This report is based on the findings of an Economic Mission which visited the Republic of China in March-April, 1970. The Mission was composed of the following members:

Shu-Chin Yang Chief of Mission Russell J. Cheetham Planning Economist Sijbren Cnossen Fiscal Economist (IMF) Zia Kalim General Economist John T. Purcal General Economist Guenter H. Reif General Economist

Mr. Jack Baranson was also with the Mission for most of the time.

VOLUME II

TAX SYSTEM AND REFORM

TABLE OF CONTENTS

Page No.

A. INTRODUCTION ...... 1

B. TAX STRUCTURE ...... 1

Intergovernmental Relationships ...... 1 Tax Structure ...... 4 Comparative Analysis ...... 7 Taxes on Income and Profits ...... 9 Taxes on Property and Capital transactions ...... 10 Taxes on Commodities and Services ...... 12 Taxes on International Trade ...... 14

C. TAX INCENTIVES ...... 14

D. TAX REFORM ...... 17

Objectives of the Reform ...... 17 Taxation of Income and Profits ...... 18 Tax Incentives ...... 18 Taxation of Property ...... 20 Taxation of Commodities ...... 21 Taxation of International Trade ...... 23 Tax Administration ...... 23

E. APPRAISAL AND RECOMMENDATIONS ...... 24

Taxation of Income and Profits ...... 24 Tax Incentives ...... 25 Taxation of Property ...... 26 Taxation of Commodities ...... 27 Tobacco and Wine Monopoly Profits ...... 28 Custom Duties ...... 28 Tax Administration ...... 29 TABLES IN THE TEXT

II.1: Consolidated Receipts of Central, Provincial, and Local Governments 2 II.2: Consolidated Tax Revenues of all Levels of Government 5 II.3: Consolidated Tax Revenues of all Levels of Government (In percentages of total tax revenues) 6 II.4: Structure of Tax Revenues, Selected Countries 1966-68 8 TAX SYSTEM AND REFORM 1/

A. INTRODUCTION

1. Although the economy of the Republic of China has taken great strides towards development, tax revenue has not been very elastic in re- sponse to changes in national income which in recent years has shown re- markable growth. The level of revenue in relation to GDP remained very much the same from the early sixties until the financial year 1967/68. Since then there has been some improvement in the relative importance of tax revenue as a result of the enlargement of the tax base and the im- provement of tax administration.

2. The rather slow increase in the level of revenue of recent years has produced limited financial resources for the Government to finance the development of much needed basic facilities in power, transportation and urban development. These, together with the need for resources for manpow- er development especially at a time when the private sector as a whole is showing greater dynamism for growth, have convinced the Government of the need to have a closer look at the tax system from the point of view of in- creasing its revenue capacity. Thus, a Commission on Tax Reform was set up and its work over the past two years is now coming to an end. In view of these developments, the Mission attempts in this volume to review the present tax system and the proposals of the Commission as comprehensively as possible and to make suggestions for improvement.

B. TAX STRUCTURE

Intergovernmental Relationships

3. Taxes in the Republic of China are classified into three catego- ries according to the level of government to which they are assigned: Cen- tral Government taxes, provincial government taxes, and hsien and municipal government taxes. Table II.1 shows these taxes at each level of government. This assignment does not imply a concurrent administration of the taxes at these levels of government. Apart from customs duties and salt tax, all taxes, as well as the tobacco and wine monopoly bureau operations, are ad- ministered by local governments under the supervision of the provincial government, which is responsible for tax administration in the province of Taiwan with the exception of Taipei city. The capital city is a special municipality directly responsible to the Executive Yuan (the Cabinet). In the province, taxes are collected by 52 tax collection offices. At the Central Government level, the Department of Taxation within the Ministry of Finance is responsible for planning, drafting tax legislation and gener- al supervision of the tax system. As provided by law, the Central Govern- ment reviews the budgets of other governments for financial coordination each year.

1/ Prepared by Mr. Sijbren Cnossen of the International Monetary Fund. Table II.1 Consolidated Receipts of Central . Provincial. and Local Gover"ments/

(In millions of new Taiwan dollars)

1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 FY/1961 FY/962 FY/1963 FY/ 1964 FY /1965 FY/1966 FY /1967 FY/1968 FY/1969 FY /1970

Central Government 4,672 4,502 5,095 6,331 7,726 8,798 10,091 12,544 17,602 16,277

Custom duties 1,822 1,963 2,242 2,693 3,477 4,110 4,446 5,655 7,405 6,749 Commodity tax 1,147 1,017 1,455 1,788 2,073 2,382 2,955 3,654 5,657 5,004 Income tax 998 830 767 1,131 1,364 1,280 1,375 1,822 2,547 2,964 Stamp tax 368 343 371 436 510 537 637 770 965 949 Salt tax 146 147 138 153 155 150 175 171 176 193 Estate tax 7 6 9 18 17 13 18 30 64 34 Tax on securities transactions ------8 9 13 9 10 Mining lot tax 2 1 2 2 2 2 3 2 5 2 Surcharge on power and petroleum 182 195 111 110 128 316 473 427 458 -- Export duties ------316 372

Provincial government 1,507 1,619 1,846 1,962 2,363 2,718 2,872 4,220 6,184 6,336

Business tax 561 620 687 764 906 955 960 1,208 1,719 1,779 Crop tax 363 437 578 560 619 661 645 971 1,129 1,100 Urban land tax 105 96 95 100 241 389 403 436 1,082 1,127 Land increment tax 154 112 104 82 25 26 85 499 803 727 Harbor dues 216 237 259 319 417 509 571 861 1,159 1,325 Vehicle licence tax 108 117 123 137 155 178 208 245 292 278

Hsien and municipal governments 1,186 1,296 1.431 1,665 1j4 2,073 2,338 2.804 3.383 3,389

Slaughter tax 338 388 472 485 555 636 729 927 962 1,004 Real estate tax 340 323 365 413 468 467 503 228 17 -- Buildings tax 262 312 336 400 438 510 573 815 1,279 1,238 Amusement tax 124 137 118 140 176 202 241 302 370 384 Deed# tax 82 92 99 176 185 183 203 409 568 567 Feast tax 40 44 41 51 62 75 89 123 187 196

Tobacco and wine monopoly revenue 2,286 2,740 2,886 2,882 3,273 3,697 4,244 4,779 5,433 5,626

Total tax revenue 9,651 10.157 11.258 12,840 15,246 17,286 19,549 24,347 32,602 31,628

Profits of public enterprises 1,035 1,417 1,090 2,183 3,109 2,371 3,946 3,069 4,529 3,976

Other receipts 1,668 1,890 1,674 2,275 3,053 2,576 4,528 3,955 4,874 5,230

Revenues from property 365 845 780 1,041 1,536 934 2,322 1,479 1,678 l,891 Fees 350 349 416 542 608 678 958 1,160 1,414 l,397 Fines and indemnities 92 111 130 163 214 253 288 305 363 274 Contributions and donations 28 70 62 48 54 51 50 41 40 32 Others 833 515 286 481 641 660 910 970 1,379 1,636

Total receipts 12,354 13,464 14,022 17,298 21,408 22,233 28,023 31,371 42,005 40,834

Source: Ministry of Finance. 1/ Actual figures for FY's 1961-1969; budget data for FY 1970 (FY = July 1 - June 30). -3-

4. The assigned taxes do not precisely reflect the revenues at each level of government. This is because revenues from certain taxes are shared by various levels of government. Of the Central Government taxes, revenues from income tax, estate tax, and stamp tax are shared with the provincial (of the Taipei municipality) and local governments; revenues from land taxes and business tax are shared between the provincial and local governments if collected in the province, or between the municipality of Taipei and the Cen- tral Government if collected in the municipality. The following tax revenue sharing ratios are at present in effect:

Tax Revenue Sharing Ratios

(In percentages)

In the Province In Taipei Central Provincial Local Central Municipal

(a) Central Government taxes: Income tax 80 10 10 90 10 Estate tax 20 30 50 70 30 Stamp tax 50 20 30 80 20

(b) Provincial Government taxes: Land taxes 20 80 30 70 Business tax 50 50 30 70 Vehicle license tax 10 90 30 70

(c) Tobacco and wine mono- poly profits 65 35

5. Revenues from urban land tax and land increment tax are earmarked for the construction of local public facilities, the extension of compulsory education, and social welfare programs. Education surcharges, 1/ primarily on local taxes, are also earmarked for the extension of compulsory education. Among other government revenues, the petroleum surcharge is assigned for highway construction and maintenance.

6. Intergovernmental grants are extremely complicated. At the local level, most governments rely heavily on provincial grants, and in certain cases the Central Government extends grants to the provincial government in support of special projects.

1/ As from July 1, 1968 at the rate of 25 percent on business tax and at 30 percent on buildings tax, deed tax, slaughter tax, and feast tax. -4-

7. As a result of the system of assigned taxes, tax sharing, and grant provisions, the Central Government's share in the total receipts amounted to 56 percent of the budget for FY 1969, 1/ and the provincial government and the hsien and municipal governments' shares accounted for 28 and 13 percent respectively. The remaining 3 percent went to town and village offices which do not have their own financial means.

Tax Structure

8. In Table II.2 all the taxes levied in Taiwan are classified ac- cording to their nature and incidence. Four major categories of taxation are distinguished: (a) taxes on income and profits; (b) taxes on property and capital transactions; (c) taxes on commodities and services; and (d) taxes on international trade. Taxes on income and profits are relatively insignificant in the tax structure; they contribute only about 8 percent of total tax revenues or 1.2 percent of GDP. 2/ This has been due to defi- ciencies in the tax administration, the comparatively low rate of the business income tax, and the broad scheme of tax incentives. Recently the revenue picture has improved considerably following upward adjustments in the income tax rate structure and a tightening up of the tax administration.

9. Taxes on property and capital transactions play a much more im- portant role in revenue than is the case in most other developing countries. Collections from this source amounted to NT$5,248 million, which was more than 16 percent of total tax collections. Recently the tax bases have been reassessed and this has led to a considerable increase in revenue. Only the real estate taxes can be considered as true taxes on property, while the other two important taxes in this group (crop tax, land increment tax) have elements of income taxation. Revenue from real estate taxes accounted for 45 percent of total property tax collections; crop and land increment taxes accounted for 22 and 15 percent of this total.

10. Taxes on commodities and services were by far the most important revenue producers, yielding almost half of all tax revenue, representing 7.9 percent of GDP. These figures indicate the heavy reliance on indirect taxation for revenue. Excise duties brought in the bulk of revenue in this category; they accounted for 20.8 percent of total tax revenue, virtually all of it being derived from commodity taxes. Next in importance in terms of revenue were monopoly profits on tobacco and wine; they accounted for 16.7 percent of total tax revenue. Other taxes on commodities and services

1/ All figures in this Appendix relate to the final accounts for FY 1968/ 69, unless otherwise stated.

2/ If the crop tax were included, the contribution to total tax revenue would rise to more than 11 percent, or 2 percent of GDP (at current prices and adjusted to the fiscal year). Table II.2 Consolidated Tax Revenues of all Levels of Government (In millions of new Taiwan dollars)

FY FY FY FY FY FY FY FY FY FY 1960/61 19ol/62 1962/63 1963/64 1964/65 1965/66 1966/67 1967/68 1968/69 1969/70

1. Taxes on income and profits 998 830 767 1,131 1,364 1,280 1,375 1,322 2,547 2,964 a. Individual income tax 379 220 225 287 352 426 516 744 1,048 1,360 b. Business income tax 619 610 542 344 1,012 854 859 1,078 1,499 1,604 2. Taxes on property and capital transactions 1,423 1,496 1,711 1,888 2,150 2,437 2,654 3,643 5,248 5,083 a. Real estate taxes 707 731 796 913 1,147 1,366 1,433 1,479 2,378 2,365 (1) Building tax 262 312 336 400 438 510 573 815 1,279 1,233 (2) Urban land tax 105 96 95 100 241 389 403 436 1,082 1,127 (3) Real estate tax 340 323 365 413 463 467 503 228 17 -- b. Crop tax 363 437 578 560 619 661 645 971 1,129 1,100 c. Land increment tax 151 112 104 82 25 26 85 499 803 727 d. Other taxes 199 216 233 333 359 3S4 441 699 933 891 (1) Deecd tax 82 92 99 176 185 183 203 409 568 567 (2) Vehicle license tax 108 117 123 137 155 178 208 245 292 278 (3) Estate tax 7 6 9 18 17 13 18 30 64 34 (4) Tax on securities transactions ------8 9 13 9 10 (5) Mining lot tax 2 1 2 2 2 2 3 2 5 2

3. Taxes on commodities and services 5,192 5,631 6,279 6,809 7,838 8,9?5 10,'C, 123u' - 13,927 15,13D a. Turnover taxes 969 1,007 1,099 1,251 1,478 1,567 1,686 2,101 2,871 2,924 (1) Business tax 561 620 687 764 906 955 960 1,208 1,719 1,779 (2) Stamp tax 368 343 371 436 510 537 637 770 965 949 (3) Feast tax 40 44 41 51 62 75 89 123 187 196 b. Excise duties 1,631 1,552 2,065 2,426 2,783 3,168 3,859 4,752 6,795 6,201 (1) Commodity tax 1,147 1,017 1,455 1,788 2,073 2,382 2,955 3,654 5,657 5,004 (2) Slaughter tax 338 388 477 425 555 636 729 927 962 1,006 (3) Salt tax 146 147 138 153 1'5 150 175 171 176 193 c. Tobacco and wine monopoly profits 2,286 2,740 2,886 2,882 3,273 3,697 4,244 4,779 5,433 5,626 d. Other taxes 306 332 229 250 304 518 714 729 828 384 (1) Amusement tax 124 137 118 140 176 202 241 302 370 384 (2) Surcharge on power and petroleum 182 195 111 110 128 316 473 427 458 --

4. Taxes on international trade 2,038 2,200 2,501 3,012 3,894 4,619 5,017 6,516 8,880 8,446 a. Import duties and harbor fees 2,038 2,200 2,501 3,012 3,894 4,619 5,017 6,516 8,564 8,074 b. Export duties ------316 372

5. Total tax revenues 9,651 10,157 11,258 12,840 15,246 17,286 19,549 24,347 32,602 31,628 - 6 -

Table I.3 Consolidated Tax Revenues of all Levels of Government

(:n percentages of total tax revenues)

FY FY FY FY FY FY FY FY FY FY 1960/61 1961/62 1962/63 1963/64 1964/65 1965/66 1966/67 1967/68 1963/69 1969/70

1. Taxes on income and profits 10.3 3.2 6.8 3.8 8.9 7.4 7.0 7.5 7.8 9.4 a. Individual income tax 3.9 2.2 2.0 2.2 2.3 2.5 2.6 3.1 3.2 4.3 b. Business income tax 6.4 6.0 4.8 6.6 6.6 4.9 4.4 5.4 4.6 5.1

2. Taxes on property and capital transactions 14. 7 14.7 15.2 14.7 14.1 14.1 13.6 15.0 16.1 16.1 a. Real estate taxes ; 3 7.2 7.1 7.1 7.5 7.9 7.6 6.1 7.3 7.5 (1) Buildings tax '.7 3.1 3.0 3.1 2.9 2.9 2.9 3.3 3.9 3.9 (2) Urban land tax 1.1 0.9 0.9 0.8 1.6 2.3 2.1 1.8 3.3 3.6 (3) Real estate tax 3.5 3.2 3.2 3.2 3.1 2.7 2.6 0.9 0.1 -- b. Crop tax 3.8 4.3 5.1 4.4 4.1 3.8 3.3 4.0 3.5 3.5 c. Land increment tax 1.6 1.1 0.9 0.6 0.2 0.2 0.4 2.0 2.5 2.3 d. Other taxes 2.1 2.1 2.1 2.6 2.4 2.2 2.3 2.9 2.9 2.8 (1) Deed tax 0.8 0.9 0.9 1.4 1.2 1.1 1.0 1.7 1.7 1.8 (2) Vehicle license tax 1.1 1.2 1.1 1.1 1.0 1.0 1.1 1.0 0.9 0.9 (3) Estate tax 0.1 -- 0.1 0.1 0.1 0.1 0.1 0.1 0.2 0.1 (4) Tax on securities transactions ------0.1 -- -- (5) Mining lot tax ------

3. Taxes on commodities and services 53.8 55.4 55.8 53.0 51.4 51.8 53.7 10.8 43.9 47.9 a. Turnover taxes 10.0 9.9 9.8 9.7 9.7 9.1 8.6 3.6 8.8 9.2 (1) Business tax 5.8 6.1 6.1 5.9 5.9 5.5 4.9 5.0 5.3 5.6 (2) Stamp tax 3.3 3.4 3.3 3.4 3.4 3.1 3.3 3.2 3.0 3.0 (3) Feast tax 0.4 0.4 0.4 0.4 0.4 0.4 0.4 0.5 0.6 0.6

b. Excise duties 16.9 15.3 18.3 18.9 18.3 18.3 19.7 19.5 20.8 19.6 (1) Commodity tax 11.9 10.1 12.9 13.9 13.6 13.8 15.1 15.0 17.4 15.8 (2) Slaughter tax 3.5 3.8 4.2 3.8 3.6 3.7 3.7 3.8 2.9 3.2 (3) Salt tay 1.5 1.4 1.2 1.2 1.0 0.9 0.9 0.7 0.5 0.6

d. Tobacco and wine monopoly profits 23.7 27.0 25.6 22.4 21.5 21.4 21.7 19.0 16.7 17.9 d. Other taxes 3.2 3.3 2.0 1.9 2.0 3.0 3.7 3.0 2.5 1.2 (l) Amusement tax 1.3 1.3 1.0 1.1 1.2 1.2 1.2 1.2 1.1 1.2 (2) Surcharge on power and petroleum 1.9 1.9 1.0 0.8 0.8 1.8 2.4 1.8 1.4 --

4. Taxes on international trade 21.1 21.7 22.2 23.5 25.5 26.7 25.7 26.8 27.2 26.7 a. Import duties and harbor fees 21.1 21.7 22.2 23.5 25.5 26.7 25.7 26.8 26.3 25.5 b. Export duties ------1.0 1.2

5. Total tax revenues 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0

Source: Tsble TI.2- - 7 -

were turnover taxes, consisting of business tax, stamp tax and feast tax; they yielded 8.8 percent of the total tax revenue, while others - amusement tax, and a surcharge on power and petroleum - made up the remaining 2.5 per- cent.

11. Revenues from taxes on international trade derive almost exclusive- ly from import duties, the single most important source of revenue in Taiwan; revenue from these duties accounted for 26.3 percent of total tax collections, or 4.7 percent of GDP. Revenue from export duties, which were introduced on- ly recently, amounted to a little over 1 percent of the total.

Comparative Analysis

12. In evaluating the tax system of the Republic of China, it is of interest to compare the country's "tax burden" or "tax effort" with that of other countries in similar circumstances. In a study 1/ covering the peri- od 1963-65, the tax efforts of 72 countries are measured by relating them to various indicators of taxable capacity. The traditional approach which uses the tax revenue to GNP ratio ranks the Republic of China 48th in the list. The study notes that various factors other than aggregate income, namely the level of economic development and the size of the foreign trade sector, also determine a country's taxable capacity. In the study the most common indicator of economic development, per capita income, is introduced as a variable, while the "degree of openness" is defined as the sum of ex- ports and imports expressed as a proportion of GNP. With the introduction of the per-capita-income-variable, the Republic's position in the list im- proves considerably; its rank then improves to 36 out of 72 countries. The position of China becomes even better - raised 34th place - if openness is also taken into account. If 52 developing countries are singled out the Republic's ranking according to the tax revenue to GNP ratio would be 28. If allowance is made for per capita income, the Republic moves up to twenty-third. It should be noted that the study advises a cautious inter- pretation of these results and, in particular, stresses that the rankings do not imply that taxes should be increased or decreased.

13. In Table II.4 the revenue structures of 7 countries roughly com- parable to the Republic in terms of economic development have been pre- sented. The countries have been listed in ascending order of per capita GNP (in U.S. dollars) 2/ and their data are presented as averages for the years 1966-68. The Republic ranks second in terns of the tax revenue to

1/ J.R. Lotz and E.R. Morss, Measuring "Tax Effort" in Developing Countries, Staff Papers, International Monetary Fund, 'Volume XIV, 1967.

2/ Average for the period 1966-69; Korea - 131.2, Ceylon - 144.1, Thiland - 155.9, Philippines - 183.7, China - 262.0, Malaysia - 315.7, and Singa- pore - 644.6. Table IJo 4: Structure of Tax Revenues, Selected Countries 1966-68

(In nercan-

Total Excise and Other Taxes on Total Income Property Direct Sales Fiscal hionopoly Indirect International Indirect Othier Taxes Taxes Taxes Taxes Profits Taxes Trade (Import Taxes Un- Total Country (a) (b) (a+b) (c) (e) (e) (f) Taxes) (c+d+e+f) classified Taxes

Percentage of total tax revenue

1. Korea 33.66 2.61 36.27 -- -- 47.83 15.84 15.84 63.73 -- 100.00

2. Ceylon 20.68 2.92 23.60 4.34 23.21 0.87 47.61 32.44 76.03 0.37 100.00

3. Thailand 13.59 2.12 15.72 20.91 17.12 4.80 41.45 29.86 84.28 -- 100.00

4. Philippines 24.37 8.22 32.59 17.73 19.7-2 5.94 21.37 19.41 64.76 2.66 1U0.C0

5. China 7.42 14.74 22.16 8.73 39.48 3.07 26.56 26.33 77.84 -- 100.03

6. Malaysia 26.29 12.93 39.22 1.56 9.32 2.31 46.26 28.38 59.46 1.32 100.00

7. Singapore 18.21 28.17 46.38 1.82 11.25 13.62 26.91 26.91 53.62 -- ICo.00

Percentage of GNP

1. Korea 3.62 0.28 3.91 -- -- 5.16 1.71 i.71 6.86 -- 10.7)

2. Ceylon 3.24 0.46 3. )0 0.68 3.;4 0.13 7.46 5.08 11.91 0.06 15.66

3. Tlhailand 1.74 0.27 2.02 2.66 2.20 0.62 5.32 3.33 lO.A2 -- 12.83

4. Philippines 2.39 0.81 '.20 1.74 1.(4 0.55 2.10 1.9' 6.36 0.26 9.S3

5. China 1.17 2.32 3.49 1.37 6.23 0.48 4.19 4.15 12.27 -- 15.76

6. Malaysia 4.40 2.17 6.5S 0.26 1.5o 0.;9 7.7G 4.76 9.97 0.22 1c./7

7. Singapore 3.75 3.52 7.27 0.23 1.4: 0.21 3.36 3.36 5.23 -- 12.50

Source: Staff Estimates Fiscal Affairs Departnent, IMF - 9 -

GNP ratio, next after Malaysia and is closely followed by Ceylon. If allow- ance is made for per capita income it would move down to fourth place, switching rank place with Thailand.

14. Other interesting relationships are those of the various taxes to GNP, ad well as their contribution to total tax revenue. Defining direct taxes as the sum of income and property taxes and indirect taxes as the sum of taxes on commodities and services and taxes on international trade, the Republic scores relatively low on the ratio of direct taxes to indirect tax- es. Almost 78 percent of its revenue is derived from indirect taxation and only 22 percent from taxes on income and property. Among the seven Asian countries only Thailand collects a higher proportion of its revenue from in- direct taxes. Income tax collections inTaiwanare extremely low.

15. The Republic's heavy dependence on excise and fiscal monopoly pro- fits is very significant, and the revenue from this source is largely de- rived from the commodity tax and profits of the tobacco and wine monopoly bureau. Yield from sales taxes are the highest :Ln Thailand with a turnover tax at the manufacturer's and importer's level w:ith rates ranging from 1.5 percent to 25 percent (the most common rate is 5 percent); next comes the Philippines with a levy on manufacturers and importers. Ceylon and Malaysia collect substantially higher revenue from taxes on international trade. Their large agricultural export sectors, which are highly developed, are subject to export duties, and the earnings from these sectors enable these countries to foot a larger import bill which in turn facilitate larger im- port duty collections. Thailand also collects more revenue from this source, because of the heavy rice exports and the higher levies on goods imported.

16. In general the Republic appears to score better than average on tax effort. IHowever, there is still considerable room for improvement in income tax collections. The tax potential of sales taxation has recently been explored more fully and figures should improve.

Taxes on income and profits 1/

17. Individual income tax is a modern tax on a person's global income; it applies to an individual's income from salary and wages, profits, inter- est and rent afising from business, farming, fishing, mining and some other activities. The total income from these sources is taxed after making allow- ance for statutory exemptions and deductions. These exemptions include a basic relief of NT$7,000 per year for both the taxpayer and his spouse and a NT$6,000 allowance for each dependent living with the taxpayer. Deductions are also allowed for taxes paid other than those on income, donations, life insurance premiums, medical, wedding and funeral expenses, and losses due to natural disasters. The current rates on income range from 6 percent on tax- able income below NT$30,000 to 60 percent on taxable income over NT$2 mil- lion. For profit distributions of partnerships and companies, withholding

1/ The changes introduced on January 1, 1969, as part of a general reform, are included in the text; reference is made to paragraphs 49 and 50. - 10 -

at source at the rate of 5 percent is in effect, while for a nonresident alien or a foreign enterprise with a branch office or agent in the country a withholding of 10 percent is prescribed.

18. Business income tax is levied on the next income of all profit- seeking enterprises, defined as any business organization in the form of a sole proprietorship, partnership, or corporation engaged in industry, com- merce, agriculture, forestry, fishing, pasture, mining, or metallurgy, un- der a business license. Incomes of NT$20,000 or less are exempt from the tax and for reasons of equity it has been stipulated that the tax cannot be more than 50 percent of the taxable income above the basic exemption. Rates range from 8 percent on taxable income over NT$20,000 but under NT$50,000, to 25 percent on taxable income in excess of NT$250,000. After deduction of business income tax, the taxable income of profit-seeking en- terprises organized in the form of sole proprietorships and partnerships is also subject to individual income tax.

Taxes on property and capital transactions

19. Buildings tax, also referred to as house tax, is the biggest re- venue producer among all real estate taxes. It is a tax on the market val- ue of buildings used for residential or business purposes which are leased or used by the owners themselves. The owner has to pay the tax at a rate of 3 percent of the market value if the building is used for business pur- poses and 1.38 percent if used for residential purposes. A special rate of 1.5 percent is applied to factory buildings if owned and used by the owner for manufacturing purposes. A surcharge of 30 percent is imposed on all building tax liabilities to finance the extension of compulsory educa- tion.

20. Urban land tax is levied on all urban land within city planning areas. The owners have to declare the value of their land after the local government has announced the value of representative plots. If the declared value is less than 80 percent of the announced value the government may either purchase the land or impose the tax at the announced value. Values can be reannounced at three-year intervals if they differ by more than 50 percent from their last announced values. Subject to central government approval, each local government determines a basic exemption which is the average price of seven ares 1/ of urban land. The basic rate on the value of land in excess of the basic exemption is 1.5 percent; however, with sur- taxes the rate can reach a maximum of 7 percent. A preferential rate of 0.7 percent is applicable to owner-occupied residential land (provided that the plot does not exceed three ares); similar preferential rates are appli- cable to land use directly by factories, urban land still being used for agricultural purposes and land situated in 'green belts'. On vacant land the tax may be increased from 2 to 5 times that otherwise payable. In FY 1968, the real estate tax imposed on the aggregate value of all immovable property at the rate of 0.6 percent was abolished.

1/ One are equals 100 square meters. - 11 -

21. Crop tax or rural land tax is levied on all registered land out- side city planning areas. Originally, the levy was assessed on productivity ratings per unit of land (chia) made at five years' interval. Tax payable annually was then computed by multiplying the productivity of the grade of land with the applicable rate and then convertecl into tax liability by using the prescribed amount of rice grain per chia as conversion rate. After the retrocession of Taiwan productivity ratings were not reviewed periodically; however, the conversion rate was increased from time to time. Taxes are pay- able in two instalments; for rice growing land payments have to be made in kind, while for land not suitable for growing rice the tax is levied in cash. For rice land the present conversion rate of 27 kg per chia is almost double the rate applicable during the period 1953 to 1961.

22. The teachings of Dr. Sun Yat-sen, the founder of the Republic, have had a profound influence on land taxation in Taiwan. This is parti- cularly so with regard to the land increment tax, a capital gains tax, which is based on the idea that the increase in the value of land is un- earned and belongs to the community. For administrative and other reasons the tax has so far been applied only to lands within city planning areas. The tax is levied on the gross land increment (defined as the difference between the transfer value and the cost of acquisition if the acquisition date is later than 1964 or the 1964 value) realized at the time of trans- fer of urban land. In computing the tax, costs of improvements and special assessments already paid are deducted. The seller (the recipient of land in the case of a gift) has to pay the tax at progressive rates ranging from 20 percent on the first multiple of the acquisition cost to 80 percent on any increment in excess of the third multiple of such cost. For land used directly by factories, the rates applied to the second and higher multiples are reduced by 50 percent. In the case of owner-occupied residential land, a flat rate of 10 percent is applied if the area does not exceed three ares. Land sold by the Government or transferred on account of an inheritance are exempt from taxes. There is a provision for refunds of tax paid on owner-oc- cupied residential land and land occupied by factories, if such lands are replaced by similar plots later on.

23. Of the other taxes on property and capital transactions only deed tax and vehicle license tax have any impact on revenue. Deed tax is levied on transfer of titles, and mortgages, and when division of real estates takes place except where the land increment tax is levied, i.e., not inside city planning areas. The tax is payable at the time of transfer and is com- puted on an ad valorem basis at 7.5 percent in the case of sale, gift, or occupancy and 2 percent in the case of exchange or division. An educational surcharge of 30 percent is added to the tax liability. Enterprises using real property directly for productive purposes are taxed at only half the statutory rate. Exemptions are granted when land is acquired through ex- change with the Government or through land redistribution or inheritance.

24. Vehicle license tax is levied annually on all types of vehicles which for the purpose of the tax are distinguished into motor-driven, human- powered, and animal-drawn vehicles. In the case of motor-driven cars, the - 12 -

tax varies with total piston displacement and the kind of vehicle. The high- est annual duty on a sedan is NT$10,920, on a bus NT$6,840 and on a truck NT$5,220. For a pedicab the tax amounts to NT$54 per year and for a bicycle NT$18 per year.

25. Estate tax is levied at progressive rates on the net value of an estate in excesss of NT$60,000. For estates between NT$60,000 and NT$120,000 a rate of 4 percent is applied; estates in excess of NT$6 million are taxed at an average rate of approximately 48 percent plus 70 percent of any excess over NT$6 million. The tax on transactions in securities is levied at 0.15 percent on the value of each transaction in stocks and securities; government bonds are exempted. On mining areas, a mining lot tax is levied; it is pay- able by the owner, or by the lessee where the mining right is let by the Gov- ernment.

Taxes on commodities and services

26. Of the turnover taxes the business tax is the most important; it is levied on the gross monthly receipts of all profit-seeking enterprises. These enterprises are divided into four categories for tax purposes. The rates applicable are: (1) a rate of 0.6 percent on the gross receipts of trading, handicraft, agriculture and forestry, animal husbandry, fisheries, manufacturing, publishing, and mining; (2) a rate of 0.7 percent on re- ceipts of contracting, printing, public utilities, restaurants, amusements, potographic studies, decorating, advertising and transport enterprises; (3) a rate of 1.5 percent on the turnover of repair shops, processing, cleaning services, hotels, service contractors, barber shops, bathrooms and renting business, and 3 percent on warehouses and agents; and (4) a rate of 5 per- cent applies on gross monthly receipts of banking, trust and notary business, insurance, pawnshops, brokers, technical, and designing business. A sur- charge of 25 percent is added to all tax levies. A number of exemptions are allowed; for the first two categories monthly sales of less than NT$3,000 and for the third and fourth category sales less than NT$1,500, and process- ing are reduced by 50 percent. Transactions of producers which have paid the commodity tax, as well as those of consumers' cooperatives and philan- thropical institutions are exempt from tax; this exemption is not allowed if the goods on which the tax was paid constituted an ingredient only of the final commodity. Exports are also exempted from business tax.

27. Stamp tax is levied on vouchers, receipts and documents which bear evidence of business transactions and personal contracts. A wide variety of rates has been established. Business invoices and cash receipts are taxed at a rate of 0.4 percent, sales evidencing export sales at 0.1 percent, and documents conveying properties at 0.1 percent. In addition to these ad valorem rates, a great number of specific rates are in effect. About 80 per- cent of the yield from stamp taxes is derived from business transactions and 20 percent from services rendered by the Government. Exemptions are general- ly similar to those for the business tax. - 13 -

28. Feast tax has gained in importance recently on account of the rapid expansion of tourism, better enforcement and an increase in rates. It is levied on charges for food and drinks consumed in hotels, restaurants, tea houses, bars, and the like. The tax, depending upon the nature of the estab- lishment, amounts to 10 percent or 20 percent on bills exceeding a specified amount. A surcharge of 30 percent is also levied.

29. Commodity tax, originally limited to a few items, such ax textiles, matches and cement, now covers a broad group of 28 commodities produced do- mestically or imported. The manufacturer or the importer pays the tax on the ex-factory value or the import value plus import duties. Rates range from 5 percent on paper to 100 percent on cosmetics. Between this range are rates of 10 percent on linen yarn, fuel oil and natural gas, television sets, radios and electric fans, sewing machines, and structural steel; 15 percent on cotton yarn, leather, foreign timber, liquefied petroleum gas, refrigera- tors, air-conditioners, electric meters, and automobiles; 20 percent on matches, specified cosmetics, synthetic silk, electric bulbs, synthetic fiber yarn and mixed yarn containing wool, rubber tires and tubes, kerosene, and motorcycles; 23 percent on sheet glass and plastics; 25 percent on mixed yarn, not containing wool; 29 percent on flavoring essence; 30 percent on woolen yarn and worsted, and cement; 32 percent on diesel oil; 36 percent on non- alcoholic beverages; 48 percent on compressed natural gas; 55 percent on gas- oline; 60 percent on sugar and saccharin; and 80 percent on specified cos- metics. Exports are exempt from the commodity tax and a refund is given when the goods for which the tax has been paid are exported by someone other than the manufacturer. Four main commodities accounted for more than 61 percent of the total yield; petroleum products 25.4 percent, cement 12.8 percent, motor vehicles 12.6 percent and sugar and saccharin 10.4 percent.

30. Slaughter tax and salt tax are relatively minor excises; their com- bined proceeds account for 3.4 percent of total tax revenue. The more impor- tant of the two is the slaughter tax which is levied on the slaughter of live- stock (swine, cattle, and goats) at an ad valorem rate of 12 percent of the wholesale market value (plus a surcharge of 30 percent). The salt tax is a specific duty at different rates applicable to table salt, salt used in fish- eries, industrial salt, and salt used for agricuLtural purposes.

31. Profits from the tobacco and wine monopoly have always greatly con- tributed to revenue. The term 'wine' includes all alcoholic beverages. For imported items of tobacco and wine a duty is levied at the time of import. In 1968 total sale procees amounted to NT$7,770 million, of which NT$4,704 million derived from tobacco and NT$3,065 million from wine. Of those pro- ceeds approximately 62 percent (the surplus over costs) went as profits to the Government. Costs included retailing expenses by licensed dealers which amounted to 8 percent of the retail price.

32. Amusement tax is levied on admission charges to theatres, athletic events, shows, and various other forms of entertainment at rates ranging from 20 percent to 100 percent. The surcharge levied on power and petroleum has been abolished since FY 1970 and incorporated in the power rate and the duty on petroleum. - 14 -

Taxes on international trade

33. Import duties, the most important revenue producer, are levied ad valorem on the actual value of the imported commodities, which is either the wholesale market value at the port of entry or the c.i.f. price plus 20 per- cent. For machinery, apparatus, and raw materials the actual value is deemed to be the c.i.f. value plus 20 percent. Rates range up to 160 percent on luxury items. Some selected tariff rates are: 7.5 percent on tools; 10 per- cent on agricultural machinery, prime movers and steam boilers, and metal working machinery; 15 percent on high voltage electric machinery and equip- ment, sewing, knitting and embroidery machines; 25 percent on low voltage electric machinery and equipment, textile machinery, and metal manufacturings for industrial use; and 40 percent on hardware. In addition, a provision sur- tax of 26 percent has to be paid on imported machinery and 30 percent on raw materials. Imports consisting of 1142 items are classified into 15 categories and the rates on these are reportedly fixed by reference to domestic economic conditions and the nature of the goods: i.e. whether they are raw materials, semifinished or finished, and whether they are essential or nonessential.

34. Starting in FY 1969, the Government has successfully exploited the favorable export position of processed agricultural products for revenue pur- poses and has imposed a 5 percent export duty on bananas, mushrooms, and as- paragus. Yields from this tax amounted to approximately 1 percent of total tax collections last year.

C. TAX INCENTIVES

35. It is generally agreed that the tax incentives which the Government has incorporated in the country's tax system have contributed to establishing a favorable business climate and have been instrumental in promoting economic growth. Basic policies and principles on tax incentives have been laid down in the Statute for Encouragement of Investment of 1960; this was amended later on 4 January, 1965. The Statute has now been in force for ten years and ex- pires at the end of 1970, and the Commission on Taxation Reform set up in March 1968 is now reviewing the tax incentives program. In this section an attempt is made to review the present statute of incentive measures, followed by a description of the new proposals by the Commission.

36. Tax incentives in Taiwan compare favorably with those in other countries and result in a significantly lighter tax burden. The tax incen- tives scheme incorporates both general features such as rate reductions and specific measures for promoting exports, savings and the capital market. Virtually the whole tax system has been affected by these incentives. The incentives are available to any productive enterprise, broadly defined as a company engaged in manufacturing, handicraft, mining, agriculture, forestry, fishery, animal husbandry, transportation, public utility, public housing construction, tourist hotels or technical services. In specific cases, the statute also uses the concept "profit-seeking enterprise" as found in the - 15 - business income tax law which implies an extension of its application to pro- prietorships and partnerships.

37. The tax incentives as listed in the Investment Encouragement Statute have been rather costly in terms of revenue. For FY 1969 it is estimated that the revenue loss on account of concessions in the field of income tax, stamp tax, and business tax amounted to NT$1,120 million or approximately 17 percent of total revenues under these heads. The highest loss was registed in stamp tax revenue where it amounted to 25 percent of the total collections. The re- venue loss from income tax came to almost 15 percent (in term of business in- come tax, however, the loss would amount to 25 per cent) and for business tax the loss is estimated at 19 percent of the total collections. The loss of re- venue from other taxes, such as property taxes, was negligible.

38. The loss of revenue due to the reimbursement of import duties and domestic taxes on consumption and production when goods are exported is a different matter. As the aim is to neutralize the effect of these taxes on export commodities, the refunds cannot be considered as revenue losses. Re- imbursement of import duties, commodity tax, and salt tax amounted to NT$3,993 for FY 1969 representing 27 percent of the total collections. Among these the reimbursement of import duties (which included harbor dues and de- fense surtaxes for this purpose) accounted for the largest share; it came to 33 percent of total import duty collections while the share of the commodity tax was 19 percent and that of the salt tax 9 percent of their respective to- tal collections. The revenue foregone from duty free import of machinery and equipment is included in the above figures.

39. The most notable incentive is the five-year tax holiday free from business income taxes, which can be enjoyed by all productive enterprises for their new plant or the expansion of existing plant by at least 30 percent of productive capacity; it is effective from the date the enterprise starts mar- keting its products or rendering its services. This exemption from taxes is transferable in case of merger. Of equal importance as the tax holiday is the provision that for all other productive enterprises the maximum rate of business income tax shall not exceed 18 percent as compared with the general rate of 25 percent. In addition, virtually all these productive enterprises are entitled to a further 10 percent rate reduction, making the effective business income tax 16.2 percent. To encourage the reinvestment of earnings, all these enterprises are also exempt from tax on the profits earned up to 25 percent of taxable income, provided an equivalent increase in capital stock takes place. To promote the modernization of industry, accelerated deprecia- tion involving a reduction representing up to two thirds of the useful life of machinery or equipment acquired to renovate the enterprise, is also given.

40. To encourage the development of a capital market, shareholders are exempt from income tax on new stocks issued subsequent to the reinvestment of earnings or on the appreciation of outstanding stocks. If the reinvest- ment is in excess of 25 percent of taxable income, payment of the income tax can be postponed until a further transfer of st:ocks takes place. Other ex- emptions include that on gains from stocks sold above par and on realized - 16 - capital gains on stock or bonds held for one year or more. Incentive meas- ures also provide for avoiding "double" taxation; for instance, corporate di- vidends do not have to be included in taxable income, provided the payee is not exempt from tax.

41. In January 1961, the Government, to modify the distortionary ef- fects of rampant inflation of the fifties on profits, allowed a revaluation of general fixed assets, depletable natural resources, and amortizable in- tangible assets. Thereafter gains from the revaluation of assets would be exempted from business income tax if in any one year the wholesale price in- dex increase were to exceed 25 percent. A tax free reserve is also allowed for exchange losses on obligations in foreign currencies incurred in secur- ing productive equipment from abroad. All productive enterprises are al- lowed to set aside annually 7 percent of any unpaid balance; the reserve be- comes chargeable to tax when the obligations are liquidated.

42. To encourage exports, the incentive scheme provides that all pro- fit-seeking enterprises may deduct 2 percent of export receipts from their taxable incomes. Other deductions include the amount of export promotional expenses abroad which are in excess of the statutory allowable amount. Based on the principle that exports should not bear domestic taxes on pro- duction and consumption, the Government has exempted the export sales of an enterprise from the commodity tax and the business tax. A foreign enter- prise without a branch office or an agent in Taiwan is also exempted from the business tax on any business originating in the country. Further, no business tax is imposed on transactions effected abroad by enterprises with headquarters in Taiwan.

43. Another incentive of great importance to potential investors are the concessions in the field of customs duties. Duties on machinery and equipment imported for one's own use may be paid for in installments. More- over, a corporation engaged in specific industries with an investment of NT$30 million or more is exempted from duties on imported machinery and euqipment which cannot be produced domestically. Furthermore, the import duty payable on machinery and equipment by a foreign enterprise and by a so- called priority enterprise may be recorded for five years and written off thereafter if machinery and equipment is re-exported within five years and the enterprise exports no less than 90 percent of its total output.

44. The incentives in the realm of the individual income tax are aimed at the promotion of savings and the development of the capital market. Some of these incentives are similar to that of the business income tax. They exempt from taxes new stocks issued subsequent to the reinvestment of earn- ings; similar exemptions on the appreciation of outstanding stocks and on realized capital gains on stocks or bonds held one year or more are allowed. In addition to these incentives, the statute provides that the amount paid for the purchase of an original issue of registered stocks or corporate bonds with a maturity of three year or more issued by corporations in specified basic industries is deductible from the individual's taxable income in the - 17 - third year of continuous holding, provided that the deduction shall not ex- ceed 25 percent of the income of that year. To stimulate savings the inter- est on development bonds, and the interest on savings deposits held for two years or longer, is exempted from tax. Of a similar nature is the exemption of security tax on transactions in government bonds.

45. Some concessions are also given in the field of property taxes; for instance, factory buildings are given a declining exemption from build- ing tax. Other incentives include concessions like the postponement of land increment tax when a merger takes place. Land increment tax on land acquired for productive purposes may also be paid in five annual instalments instead of a lump sum payment.

46. There are various other incentives; for example, exemptions from stamp tax are allowed on a number of specified documents such as those exe- cuted abroad, receipts for the delivery of goods and contract slips on tran- sactions in securities, while reduced stamp tax is in effect on accounts, loan agreements, discounts and term contracts and on some specified invoices. Further, there is a complete exemption from stamp tax and deed tax in the case of merger. In addition, the deed tax rate is reduced to one half of the statutory rate for titles on property used by enterprises for productive purposes.

D. TAX REFORM

Objectives of the Reform

47. In March 1968, the Government appointed a Commission on Tax Reform, which started its work in July of the same year. The Commission's term ex- pires in July 1970. Since its inception, the Commission has reviewed nearly every aspect of the tax system. It has also paid considerable attention to the problems of tax administration, and the collection and dissemination of public finance data.

48. The reform aims primarily at making the tax system a more suitable instrument for the promotion of economic development, with built-in features of stabilization. Structurally, the objective of the reform is to increase the proport:Lon of direct taxes in total tax revenues. Revenues from taxes on income and profits are too low and the tax system has regressive charac- teristics. On indirect taxes, the objective is to improve them so that a more rational allocation of resources is possible, especially in view of the cascade effects of many of these taxes. Above all, the reform aims at a sub- stantial increase in the government's resources so as to finance the much needed investments in infrastructure and education as well as increases in the remuneration of government personnel. Another important purpose of the reform is the improvement of tax administration in order to check avoidance and evasion, thereby making the tax system more equitable. - 18 -

Taxation of Income and Profits

49. The Commission began its work with a review of the individual in- come and the business income tax. For this purpose, it engaged the services of Professor R. A. Musgrave, who spent six weeks in Taiwan in the summer of 1968. With regard to the individual income tax, the Commission share Pro- fessor Musgrave's conclusion that a sifnificant increase in tax yield could not be brought about without increasing the burden on the lower income brackets. This could be solved either by reducing the exemptions allowed or by increasing the rates on the lower brackets. Because the Commission felt that the exemptions were at a relatively low level already, the solution of increasing the rates was preferred and as of January 1, 1969, the lowest rate was doubled to 6 percent; all other rates were also increased with the mar- ginal rate moving up from 52 percent to 60 percent. To alleviate the burden on the taxpayers in the lowest income group, a minimum deduction of NT$9,000 was introduced. (The standard deduction is 10 percent of gross income with an upper limit of NT$15,000).

50. To alleviate the business income tax burden on small businesses, the Commission proposed and the legislature accepted that business enter- prises with less than NT$20,000 net income would be exempted from the tax. For those enterprises whose income exceeded NT$20,000, the whole income would be taxed. However, for reasons of equity, the amount of tax payable would not be more than 50 percent of that part of net income which exceed- ed NT$20,000. This revised provision is similar to that in the Hong Kong income tax statute. The proposed statute has also a provision to prevent the avoidance of the individual income tax through the retention of pro- fits, particularly in the case of closely held companies; in such cases a 10 percent withholding of tax on undistributed profits was introduced for which credit against the individual income tax would be given at the time of distribution.

Tax Incentives

51. The present tax incentives give more encouragement to quick yield- ing labor intensive projects than to capital intensive investments with slow returns. With industrialization now proceeding towards the use of more so- phisticated technology, many new industries require large capital outlays, although the return on these investments at this stage may be slow and un- certain. In view of these considerations the proposals drafted by the Com- mission stress the desirability of equal treatment of capital intensive and labor intensive production. Simultaneously, the cost in terms of tax re- venue foregone should be as small as possible.

52. The Commission has therefore proposed that accelerated deprecia- tion be given as an alternative to the tax holiday. For machinery and equip- ment the present statutory prescribed number of years over which the machin- ery and equipment could be depreciated would be reduced by one half; for buildings and construction, transportation and communication equipment, the period of depreciation would be reduced by one third. It would also be pos- sible to extend accelerated depreciation beyond the tax holiday period, if any unused balances remain. - 19 -

53. For expansion of existing plant, the statute at present provides for exemption from business income tax of an enterprise whose productive capacity is increased by at least 30 percent. The Commission considers that the 30 percent figure is arbitrary; it puts a premium on enterprises which started with a low productive capacity, while ignoring expansions be- low the 30 percent minimum which might be important economically. Moreover, the provision has been most difficult to administer and supervise; therefore, the Commission recommends its abolition and suggests that it be replaced by two new alternative incentives, namely, accelerated depreciation or an in- vestment credit. The accelerated depreciation would be similar to the pro- vision described above, while the investment credit would amount to 7 per- cent of the new investment to be deducted from the tax liability in the year of investment with the possibility of carrying any remaining balance forward for the next five years.

54. The Commission has made important proposals with regard to the rates of business income tax. It has suggested that the 25 percent maximum rate be retained -- and that the Government should commit itself to this rate for the duration of the next investment incentive statute -- but that both the special rate of 18 percent, as well as the 10 percent reduction be abolished. The loss of revenue from these concessional rates has been sub- stantial; besides the 25 percent rate is very low compared to other coun- tries.

55. Some outdated provisions are expected to be abolished or changed as recommended by the Commission. In view of the stable prices which have prevailed over the last few years, the provision dealing with the revalua- tion of assets if the wholesale price index increases by 25 percent or more in any one year will be abolished. Similarly, exchange rate stability make the allowance of a special reserve for exchange losses on foreign currency liabilities less necessary and the Commission proposes to limit the reserve in total to 7 percent of the amount of the obligation, instead of the an- nual 7 percent allowance which would enable the whole amount of the obliga- tion to be deducted over the years in ascertaining profits.

56. To promote the development of the capital market, the Commission proposes to exempt corporations from the 10 percent income withholding tax which presently has to be paid on undistributed profits (and for which credit is received by the individual stockholder at the time of eventual distribution), if such a corporation becomes public by listing its stock on the exchange and issuing it to the public. Furthermore, it is proposed that companies whose shares are not traded on the exchange, but who have issued their stocks through brokers who sold them publicly, receive the same facility provided the amount of such stocks sold is at least 20 per- cent or 30 percent of the total stock of the company. Such withholding tax exemption would be for two or three years. To induce the public to buy registered stock, it is also proposed that dividends be deductible from taxable income in the individual income tax return up to NT$6,000 and that such stocks be exempted from the security transactions tax. At pre- sent, the payment of income tax on new shares or stock dividends issued in connection with the reinvestment of undistributed profits in machinery or - 20 - industrial equipment can be postponed until the new shares are sold. It is proposed to extend this facility to investment in transportation equipment.

57. Exemption from import duty on machinery and equipment is now granted to newly established productive enterprises if so designated by the Ministry of Economic Affairs. With the further development of the economy, it is now proposed to extend this concession to the expansion of equipment and machinery of such enterprises.

58. To promote savings, the Commission proposes to extend the present exemption from income tax on interest earned on savings deposits by reducing the deposit requirement period from two years to one year and to extend the incentive to all deposits and trust funds with approved financial institu- tions. The interest on development bonds will be completely exempt from tax.

59. The Commission has proposed that the stamp duty exemption be ex- tended to mergers so as to stimulate the formation of larger business enti- ties. This means then that a merger would have no effect on current liabili- ties accruing from the income tax, the stamp tax, the deed tax, and the land increment tax. Finally, it has suggested that the business income withhold- ing rate (which represents the final liability) be raised for nonresident individuals and for enterprises without branches or assets in Taiwan from 10 percent to 15 percent.

Taxation of Property

60. The Commission feels that the present laws and regulations govern- ing the imposition of the various property taxes, including the crop tax and the land increment tax, are very complciated and often inconsistent. At pre- sent the imposition of the urban land tax and land increment tax is limited to city planning areas and has to await the completion of the urban plan. As a result large areas which have already been approved for use as construc- tion sites are still taxed as rural land and land increment tax cannot be levied when it is transferred. This runs counter to the Government's policy of preventing land speculation and have the community share in unearned land increments. In view of this the Commission has drafted a single land tax law aiming, not so much at raising more revenue, but at the proper implementation of the Government's social objectives.

61. The Commission considers that there is no justifiable reason for different basic exemptions in the land value tax. It has suggested that these be abolished and that a standard exemption of five ares be introduced. Other suggestions include the extension of the tax to areas outside city planning limits and the taxing of land used for industrial purposes at a pro- portional instead of a progressive rate. However, it recommends the reten- tion of progressive rates for businesses engaged in trading, so as to avoid too great a loss of revenue. The Commission also suggests that the rate structure be completely revised and that the rate should not be applied to the multiple of the basic exemption but by reference to value; the present structure as applied discriminates against small holdings. The Commission, - 21 -

in order to promote the productive utilization of vacant lands, suggests that they continue to be subject to the higher rate of taxation.

62. In the opinion of the Commission land should be taxed in the same way regardless of its use and there is a strong case for extending the land value tax to rural land as well. However, to apply the measure equally to rural land would present considerable valuation problems which cannot be easily solved as it makes up 75 percent of total registered land. The Com- mission, therefore, has recommended that the crTop tax be retained in its present forrn for the time being.

63. The Commission has proposed that all lands, whether they are in the city planning areas or not, be subject to the land increment tax and the progressive rates be applied to the absolute gain rather than to mul- tiples of the original value which has the effect of taxing small units as heavily as larger plots. It has also recommended that the limit for re- funds be extended from three ares to five ares and that this be applied to non-owner-occupied land as well. Furthermore, the Commission, in order to alleviate pressure on the sprawling urban areas, has recommended that in the case of industrial land a refund of the land increment tax be granted to a business which moves out of an urban area and establishes itself in a rural area.

64. Other taxes on property have also received the Commission's atten- tion. A draft bill revising the scope of the application of the buildings tax with changes in exemptions is now before the Legislative Yuan. Bills for the estate and gift tax have been drafted as well. The underlying prin- ciple of the estate tax of taxing the value of the estate rather than im- posing rates by reference to kinship has been maintained; the draft bill proposes reductions in rates and larger exemptions to close relatives of the deceased person. Similarly, because of its close relation to the estate tax, the gift tax will be revised; the provision of this tax will also be tight- ened up to prevent tax avoidance and evasion.

Taxation of Commodities

65. The present system of taxation on consumption and production in Taiwan, relying mainly on the commodity tax, the business tax, and the stamp tax, has been considered as out of date and not suitable as an instrument for promoting economic growth and meeting the increasing revenue requirements of the Government. Its main defects are administrative complication, cascade effects, and an unevenly distributed and regressive tax burden. Mr. J. C. Duignan, a member of the fiscal panel of the International Monetary Fund and assigned as advisor to the Commission on Taxation Reform advised in December 1969 that these three taxes be replaced by a value-added tax while retaining a number of commodity tax levies in the form of excise duties.

66. The commodity tax in its present form resembles an excise levied on 28 categories of goods produced domestically or imported; on domestic goods it is levied at the manufacturer's level. Although this tax has in - 22 - the past been an important revenue producer, it appears to have reached the limits of its productive capacity. Moreover, it has been relatively income inelastic; over the last ten years, the increase in yield was mainly due to extensions in coverage and only partly to the growth of the economy. From a consumption based tax the commodity tax has come to rely more and more on the taxation of producers' and intermediate goods. The business tax repre- sents a cumulative turnover tax levied at all levels of production and dis- tribution. The cascade effects to which this tax gives rise have distorting effects on production and distribution. Similar criticism can be leveled against the stamp tax, inasmuch as it relates to business sales. Another serious drawback of the commodity tax, the business tax, and the stamp tax is that they may hamper exports. The cumulative nature of the business tax and stamp tax, as well as the imposition of the commodity tax on capital and intermediate goods, prevent the calculation of the exact amount of re- fund when goods are exported. Reportedly, a full rebate is hardly ever granted.

67. The Commission is convinced that a value-added type sales tax as a substitute for the business tax, the commodity tax, and the stamp tax on business documents is not only theoretically sound, but also practically feasibile. The Commission is now working on a legal draft for a value-added tax. It suggests a value-added tax of 8 percent extending to the retail stage. However, it is proposed that retailers with annual sales of NT$50,000 (NT$60,000 in Taipei City) or less be subject to a turnover tax of 1 percent instead of the proposed value-added tax. Taxpayers with monthly sales of NT$3,000 or less would be exempt from the value-added tax or the 1 percent charge; at the same time some marginal relief for taxpayers just liable to the value-added tax is also suggested.

68. In principle, the combined burden of the value-added tax and the new excise duties could be equivalent to the present burden under the com- modity tax. However, the Commission suggest that the opportunity be seized during the period of transition to effect a slight reduction in the burden on cement, diesel oil, and motorcycles and to increase slightly the burden on gasoline, cars, refrigerators, television sets, and air conditioners; a uniform rate of 80 percent is suggested to replace the present differentia- ted rate on cosmetics. The Commission has also recommended that no credit be allowed for expenditure on, e.g., entertainment, restaurant consumption, travel, and employee welfare. For capital goods, the granting of full credit is included; this should promote the capital intensiveness of the industry.

69. In view of the Government's policy to keep price levels as stable as possible, the Commission has made a study of the price effects of the new tax. It calculated that if the effects were properly reflected in present prices, an over-all drop of 1.23 percent would occur. Basic commodities and clothing would drop by 1.5 percent and 2.3 percent respectively. Housing would go up by 0.25 percent, communications and transportation by 1.3 per- cent, medical services by 0.32 percent, education and entertainment by 1.3 percent, and miscellaneous goods by 6.6 percent. To prevent any unnecessary price increases (if not to effect a general price decrease), the Commission - 23 - has recommended the widest possible publication of the results of its find- ings. It would also organize meetings with the business community to ex- plain the intricacies of the value-added tax. The Commission expects that one or two years may elapse before the new tax can be fully implemented.

70. Slaughter tax, a minor excise duty, has recently been revised. The establishment of new slaughter houses with greater automation and the institution of a separate municipality for Taipei City necessitated this revision. The arrangements for the allocation of revenue between the place of slaughter and the place of consumption have been improved; penal- ties for private slaughter have also been increased.

Taxation of International Trade

71. The present customs tariff no longer meets China's needs. The tar- iff on which it is based is narrow in scope and hence not a suitable instru- ment for an imaginative import duty policy. It strongly resembles the Geneva Tariff Nomenclature; the goods exempted are listed separately rather than treated as part of the tariff. In general, the structure of the tariff is rather haphazard and important distortions may be found in the horizontal and vertical structure. The Commission realized these weaknesses and recommended the introduction of the Brussels Tariff Nomenclature. As of the beginning of this year, the BTN has been introduced as a guide along with the present tar- iff, so as to enable customs officers to become acquainted with the new tar- iff classification. The Commission expects the full use of BTN as from the beginning of next year.

72. The Commission is at present working on a review of the tariff rates. For this, it has sent out questionnaires to industry in order to de- termine import input coefficients and the value they add in the production. On the basis of this information, it will determine the ratio between the effective rate, defined as the nominal rate minus the sum of the input coef- ficients multiplied by the tariff rate on the imports, and the value added rate, which in turn is defined as one minus the sum of the import input co- efficients. In case this ratio is less than one, the Commission suggests that the duty be raised and, where it is more than two, that it be decreased.

Tax Administration

73. The Commission has also concerned itself with the administration of taxes. One of its measures has been the simplification of the import duty rebate system on raw materials used in export products which was imple- mented on January 1, 1969. Instead of a detailed case by case calculation for each commodity, the customs authorities now use standard coefficients whereby the rebate can be read off from a prescribed list. A statute for strengthening all tax collection and assessment has also been drawn up. It aims at the prevention of tax evasion, inter atlia, by increased penalties. A computerized tax data processing and control center has been set up to aid tax assessment work. A comprehensive coding system has been devised for the business income tax. Data for the individual income tax, information on immovable property, and the deed tax have also been fed into the computer. - 24 -

The machine has already been used to sort out 1968 individual income tax re- turns and in tracing delinquent taxpayers. A special investigation branch to find out fraud and evasion, and to promote the effective prosecution of the culprits, is being established. The Commission has realized that im- proving tax administration by increasing deterrents to noncompliance in all forms is not sufficient; it has also devised measures to improve accounting practices of taxpayers -- of great significance if the policy objective is to increase revenue from taxes on income and profits -- and has simplified procedures by means such as the use of less formal language in income tax returns. Training and supervision of tax officials have also been strength- ened, with the establishment of a training institute, provision of scholar- ships at selected universities and the clear separation of operational per- sonnel from supervisory personnel.

E. APPRAISAL AND RECOMMENDATIONS

Taxation of Income and Profits

74. The revisions of the individual income tax and the business income tax so far undertaken have made a considerable contribution to revenue. But there remains the issue of discrimination against the proprietorship and partnership form of business arising from the application of business income tax not only to incorporated businesses as companies, but also to unincorpor- ated businesses as sole traders and partnerships. A company, particularly closely held, can avoid some taxation on the owners, if it retains its pro- fits. 1/ However, this is not the case with the sole trader or partnership. Their profits are subject to the business income tax; in addition, the pro- fits net of tax are also subject to personal income tax. It is desirable that consideration be given to (a) taxing proprietorships and partnerships under the individual income tax only by allocating the profits to the indi- vidual partners 2/ and retaining the ascertainment of profit provisions of the business income tax; and (b) changing the business income tax to a cor- poration tax proper with a flat (higher) rate. The withholding rate should be retained and a differentiation between public and closely held corpora- tions introduced with a higher withholding rate on distributed profits being applied in the case of the latter entities.

1/ Of course, the 10 percent withholding rate on retained earnings penal- izes to some extent the closely held corporation. If no distribution takes place, then the corporation will in effect be subject to a 10 percent higher corporation tax.

2/ This practice may encourage proliferation of partners. However, as income of minors up to 20 years of age is grossed up with that of their parents, proliferation of partners is probably not a major draw- back. - 25 -

Tax Incentives

75. Undoubtedly, the incentives presently on the statute to promote investment, exports, and savings have stimulated growth. These incentives compare favorably with those found elsewhere. However, now that the basis for industrial development has been laid, the Government may wish to give more weight to its revenue requirements. Taiwan's geographical situation, its business climate, and the availability of low cost but fairly skilled labor are already substantial inducements to investment.

76. For FY 1969, concessions in the field of income tax, stamp tax, and business tax taken together amounted to NT$1,120 million representing approximately 17 percent of total revenues under these heads or 3.4 per- cent of total tax revenues. The Government is badly in need of more re- venue and one way to increase collections would be to cut into incentives and exemptions. The abolition of the special rate of 18 percent of business income tax and the associated further reduction of this rate by 10 percent is a step in the right direction. So also is the proposed re- placement of the exemption of reinvested earnings from business income tax by the accelerated depreciation. However, the proposed extention of accelerated depreciation appears more generous than what is really needed as an investment incentive. Also, the proposed alternative of an invest- ment credit seems unnecessary in view of the low rate of tax.

77. Regarding other incentives, limiting the special reserve for ex- change losses on foreign currency liabilities is a laudable step, but it would have been better to abolish this provision altogether. The prevail- ing exchange rate stability makes the revised measure quite superfluous. In practice it will result in a postponement of a part of the tax liability.

78. Industrial products which are exported are rightly exempted from domestic taxes on consumption and production such as the business tax, the stamp tax, and the commodity tax, as well as import duties paid on raw materials or intermediate products used in export products. Such exemptions are not used as special incentives but to neutralize the tax impact on com- modities for export. However, the 2 percent deduction of foreign exchange export receipts from the taxable income of profit-seeking enterprises seems excessive and should be abolished. As regards the taxation of profits of export industry and trade, the tax administration should carefully scrutin- ize the export prices which are declared, as well as the import prices of raw materials, particularly in the duty-free exports processing zone.

79. The contribution that tax incentives can make towards the develop- ment of a capital market should not be overestimated. Despite the incentives provided, there has been little change in the ownership form of businesses, although some are severely discriminated against in taxation. The proposal to exempt companies, which spread the ownership of their stock from the 10 percent withholding tax obligation may not be effective in bringing about a - 26 - wider ownership. Likewise, the exemption of interest income from savings deposits and government development bonds may cost more in terms of revenue than it contributes towards savings or the purchase of bonds. The tax-cost and the savings-benefit should be carefully studied.

80. The effect of tax incentives on foreign investment will be in- creased if double taxation could be avoided. When the Republic of China exempts the profits of foreign businesses from taxation, while a foreign country taxes such profits, the exemption merely means a transfer of the tax revenue from the Republic to a foreign treasury. To safeguard against such loss of revenue, the Republic should explore the possibility of enter- ing into tax treaties with its major capital exporters. Such arrangements will become even more important when the tax-holiday periods of enter- prises expire. Efforts to establish tax sparing arrangements through tax treaties should be made.

Taxation of Property

81. The revisions proposed by the Commission are undoubtedly an im- provement upon the present system of land taxation. In particular, the Mis- sion welcomes the proposal to extend the urban land tax to properties within urban reach but outside city planning areas. Local variations in the basic exemption of the urban land tax should indeed be abolished. However, it would be better if the basic exemption could be given by reference to value of property, thus breaking away from the notion that the size of the plot is of any relevance. The Mission also welcomes a revision of rates applicable by reference to value to replace rates applied to a multiple of the basic exemption. Proportional rates for industrial properties should be introduced as well, with some mitigation in the steep rate schedule, which now goes up to 7 percent. The revenue capacity of urban land tax (which has been useful in curbing land speculation and minimizing deterrents to investment in build- ings) should be explored more fully, by using expert land appraisers rather than relying on self-declaration in the appraisal of land values.

82. Another improvement would be the extension of the land increment tax to all registered land. This broadening of the tax base will have the effect of drawing into the net those landowners who todate benefit from ris- ing prices, but have not had to pay tax on transfer. The land increment tax is a special form of capital gains tax and its existence can be justified if the imposition of the latter is premature. The tax would have a restraining influence on the increase in land prices and so serve a useful purpose in curbing land speculation. It may make investment in land less lucrative and divert resources to more productive ends. The Commission's proposal to widen the scope of the land increment tax deserve support. With the expansion of the land increment tax, consideration should be given to extend the deed tax within city planning areas.

83. The crop tax has certain commendable features and the Commission thinks that it should be retained for the time being. As its basis is pre- - 27 - sumptive, there is an incentive to produce more than the standard output used as a tax base. Collections in kind are sometimes easier than those in cash. The tax, being proportional, is regressive but this may have a beneficial effect on land consolidation resulting in the creation of larger holdings and thus contributing to improve efficiency. As farms become more and more commercialized, consideration should be given to amalgamating the crop tax with the global income tax. The urb.n land tax should then be ex- tended to rural properties as well.

Taxation of Commodities

84. The Commission proposes to replace the commodity tax, the business tax, and the stamp tax, by a single tax on value added. The present commo- dity tax does not respond sufficiently to increases in income and tends to distort resource allocation through the taxation of producer and intermediate goods (about 54 percent of total commodity tax revenue). Taxation of pro- ducer goods tends to discourage capital formation, while at the same time the Government is encouraging capital formation through the use of investment in- centives. The business tax and the stamp tax have serious drawbacks on ac- count of their cascade effects. One important: advantage of a value-added tax, as against these drawbacks, is its inherent neutrality with regard to domestic consumption or capital formation, through the application of a credit system for taxes paid on raw materials, intermediate and capital goods, as well as with regard to international trade. Calculations show that the introduction of the value-added tax would have little effect on the price level.

85. The Mission supports the recommendation of the Commission that in order to maintain revenue at a high level with least disturbance to the pre- sent price structure, especially of basic commodities, the value-added tax should be supplemented by a number of excise duties on goods now subject to the commodity tax. These commodities as recommended by the Commission and in order of revenue productivity are: petroleum products, cement, auto- mobiles, trucks and morotcycles, sugar and saccharin, beverages, television sets, refrigerators, cosmetics and airconditioners. These items account at present for more than 70 percent of revenue from the commodity tax and their retention would greatly facilitate the proposed transition. However, the Mission feels that in the interest of revenue, consideration should also be given to retaining the present commodity tax burden on cement and diesel oil. Moreover, a great differentiation of rates could be applied to a number of luxury articles. Thus, when implemented, the combined rate of value-added tax and excise duty, for instance on television sets, could well be higher than the proposed 23 percent. The rate of tax on automobiles and motorcy- cles could also be increased further and, if necessary, a differentiation between trucks and other automobiles could be introduced. The question of whether or not the retention of the commodity tax burden on sugar and cement should be of a temporary nature only should be left to subsequent detailed consideration. The duties are old and well established; besides, Taiwan enjoys a considerable comparative advantage in both commodities on account of their low production costs. - 28 -

Tobacco and Wine Monopoly Profits

86. Monopoly profits from tobacco and wine have always made a substan- tial contribution to revenue amounting to approximately 3 percent of GNP. Nevertheless, these profits have been inelastic to increases in income. Over the last ten years the relative share of monopoly profits in total re- venue has remained the same, whereas revenues from commodity taxes have shown substantial gains. In recent years these profits have even shown a decline, although the demand for tobacco and wine produts has increased sub- stantially with rising incomes.

87. Prices of tobacco and wine are low. They have not been changed since August 1963, while the cost of living index has risen by over 30 per- cent since then and wages by over 60 percent. The more expensive brands of cigarettes (for a packet of 20) cost NT$10, while the cheaper varieties are priced from NT$7 to NT$5.50. In U.S. currency, prices for standard cigar- ettes range from 14 cents to 25 cents in Taiwan, compared with 15 cents to 30 cents in Thailand and 34 cents in Singapore. Retail prices for a bottle of 0.60 liter of alcoholic beverages are equally low: a cheap rice wine can be brought for NT$7.50, and the most commonly consumed brand costs only NT$14.

88. The Mission recommends that prices of tobacco and wine be re- examined with the objective of raising more revenue, taking into account the rising costs of labor and tobacco leaf. Since demand for tobacco and wine is expected to be relatively inelastic, a moderate increase in prices would not lead to any significant decrease in demand. If demand were to remain the same, a 20 percent increase in prices of all products should lead to an increase of one third in revenue from monopoly profits. At pre- sent, the Government receives 62 percent of total sales receipts, and an increase of 20 percent in prices would enable the Government to receive ap- proximately 70 percent of the new retail prices if the whole of the pro- ceeds of such an increase is transferred to the Treasury.

Custom Duties

89. As regards the tariff itself, obviously, it is not possible to transpose the existing tariff on 1142 items classified into 15 categories into the more sophisticated and highly diversified BTN. If this were done mechanically, the small base of the tariff, as well as its horizontal and vertical distortions, would be carried over into the BTN without resulting in any material improvement. The Commission has realized this and has made a study of the effective and value-added tariff rates now prevailing and this has shown some major imbalances in the rate structure. But even this is not sufficient as the new tariff structure should reflect as close- ly as possible the emerging diversification of the industry. It is there- fore necessary as proposed by the Commission to make sectoral studies of the industrial structure with a view to firm up the new tariff structure.

90. Tariffs are closely related to other trade policy measures, parti- cularly import controls. These measures together determine the level and - 29 - structure of total protection. Thus, the new tariff rates cannot be fixed intelligently without knowing what will be the future import control policy. As explained in the main report, the Mission favors a significant shift from import control to tariff protection. The required changes, if considered desirable by the Government, should be implemented simultaneously in the tariff and import control area in a coordinated manner.

Tax Administration

91. The Government has rightly emphasized the improvement of the tax administration in connection with the tax reform. Indeed, tax reform is wholly futile if it cannot be implemented effectively. Tax incentives would not work if the benefits so provided can just as easily be obtained through tax evasion. Generally the taxpaying community would have less dif- ficulty in accepting an unfavorable tax which is equitably administered than an equitable designed tax which is not properly enforced. Also, the income elasticity of a tax system depends not only on its inherent characteristics but also on the effectiveness with which it is administered.

92. The Mission recommends that after the tax reform has been imple- mented, the main thrust of the Government's revenue efforts should be con- centrated on improving tax administration further. The proposed tax policy division within the Ministry of Finance should not be viewed as an extension of the Commission on Taxation Reform and should for some years to come con- fine itself to research rather than aim at a continuing overhaul of the tax system, which would have an unsettling effect on the taxpaying community. After all the changes have been introduced, attention should also be given to the development of a sound and highly qualified appellate system. With all these changes the tax burden may be high, but people will know that it is equitably and fairly administered.