NEW SYSTEM FOR CONSOLI-DATED INCOME TAX FILING

01/01/2003

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The Financial Holding Company Law (FHCL), which was promulgated in July 2001, and the Corporate Mergers and Acquisitions Law (CMAL), which came into force in February 2002, both include provisions to allow parent and subsidiary companies to file joint income tax return, generally referred to as the consolidated taxation system. The precondition for using this system is that the parent must have held at least a 90% stake in the subsidiary throughout the entire tax year. The items that can be filed jointly are corporate income tax and the additional tax on undistributed retained earnings. Other tax-related matters must still be dealt with sepa-rately by the parent and subsidiary.

Income tax returns for 2002 must be filed by the end of May 2003. Some financial holding companies may choose to file joint returns for 2002, so the Ministry of Finance (MOF) is now actively preparing guidelines for processing joint tax returns, to deal with technical details such as how to calculate the amount of tax jointly pay-able. Although these guidelines have not yet been finalized and formally announced, their basic orientation and most of their provisions are fairly specific and clear, so that one could un-derstand and analyze their possible impact once they come into effect.

The main topics covered by the draft guidelines are: how to define the qualifications for joint filing, how to calculate the amount of tax jointly payable, how profits and losses should be offset against each other, how investment tax credit should be applied, and how to handle share-holders’ tax credits. The main structure and provisions of the MOF's draft as it currently stands can be summarized as follows:

The tax returns of all Taiwan subsidiaries that meet the shareholding requirement must be included in the joint filing, and all must have the same accounting year.

After opting for joint filing, companies may not subsequently revert to individual filing unless there is a change in shareholding status, or with the authorization of the MOF.

The amount of income tax payable is calcu-lated as follows:

1.First separately calculate the taxable in-come of each company;

2.Sum them up to arrive at the joint income (losses may be deducted from profits);

3.Multiply the joint taxable income by the applicable tax rate to arrive at the joint in-come tax payable; and

4.Calculate the income tax liability attribut-able to each company according to the ratio of their taxable incomes.

It should be explained that losses incurred by companies in years before joint filing began can be offset when calculating the taxable income of the individual companies; operating losses incurred after joint filing began can be offset when calculating joint income; and loss-making companies are not included when attributing tax liability to the individual com-panies, i.e. losses need not be included in the apportionment calculation. Naturally, tax al-ready withheld on behalf of each company, and tax paid overseas, may be deducted from the amount of income tax jointly payable.

One issue that deserves closer consideration is whether residual losses not yet offset during the period of joint filing can be individually calculated and continue to be used by the sub-sidiary when it files individually due to a change in the parent company's shareholding resulting in that the subsidiary is no longer eligible for joint filing. The present draft of the guidelines does not contain any explicit guidance on this point, but on initial inquiry, the MOF expressed a positive attitude toward such a possibility. However, as losses can be carried over for a period of five years, and there may be great variations in the profits and losses of individual subsidiaries participating in joint filing, thus finding a reasonable method to distinguish or calculate the amount of loss attributable to the individual company is likely to be a highly complex task.

The method for calculating the additional tax on undistributed retained earnings is the same as that described above for calculating the income tax payable. In other words, the un-distributed retained earnings of each company are first calculated individually, and then combined to calculate the joint undistributed retained earnings (positive and negative amounts can be offset against each other). This figure is multiplied by the tax rate of 10% to arrive at the joint tax payable. This is then apportioned to the individual companies pro rata to the contribution of each, to arrive at the undistributed retained earnings tax liability attributable to each company.

Similarly, the undistributed retained earnings of each individual company are calculated by deducting its apportioned tax liability from its individual taxable income. When apportion-ing the undistributed retained earnings tax payable, loss-making companies are not in-cluded in the calculation, i.e. their contribution is counted as zero. For uniformity of tax treatment, in a year that a company is the subject of joint filing, its retained earnings from the previous year should be included in the joint filing; and in the year that a company lawfully switches to individual filing, its re-tained earnings from the previous year should also be filed individually.

The treatment of investment tax credit is dif-ferent. Calculation of the investment tax credit available to each company is not based on the individually calculated taxable income of the company. Instead, it is based directly on the amount of income tax and undistributed retained earnings tax apportioned to each company. In other words, if the tax liability is reduced by joint filing (since losses can be offset against profits), this will result in a corresponding reduction in the amount of tax credit.

The MOF takes the view that because in-vestment tax credit is granted to an individual company, it would be inappropriate for the tax credit to be shared among companies. Even if the tax credit was approved after companies began joint filing, it cannot be directly applied to their joint tax liability. Naturally, if any of the companies is eligible for investment tax credit, then the group's joint tax liability will be the sum of their income tax and undistrib-uted retained earnings tax liabilities after in-vestment tax credit is applied.

Because the amount of each shareholder's tax credit account affects the interests of share-holders of each company, the amount of in-come tax and undistributed retained earnings tax payable after the application of investment tax credit should be individually added to the balance of each shareholder's tax credit ac-count of each company.

Under the FHCL and CMAL, provisional payment of tax does not fall within the scope of joint filing, and therefore the draft guide-lines explicitly provide that each company should make its provisional payment indi-vidually, in the amount of 50% of the income tax liability apportioned to it in the previous year's joint filing.

The draft guidelines provide that after companies opt for joint filing, in principle they are not permitted to return to individual filing. But there is still the possibility of manipulating the share-holding which is the precondition for joint filing. Both Article 50 of the FHCL and Article 42 of the CMAL contain provisions to combat tax evasion. However, according to the principle that taxation is imposed on individual business entities, legal entities are normally required to file their tax returns individually, and the com-bination of multiple entities into a single unit for tax filing purposes is an exception. Therefore the joint filing system must surely be seen as a choice available to tax-paying entities to achieve a more advantageous tax position, and it is re-mains to be seen how the simple sale of holdings to return to individual filing could be regarded as evading or reducing the obligation of paying taxes.

To maintain stability in entities' (joint or separate) filing status, and to avoid the abuse of the system, some foreign legislations include the provision that where a member of a group of companies in joint filing changes to individual filing, it may not return to joint filing for a period of five years. Such provision creates a five-year period of un-certainty for those tempted to take the advantage of switching status, before they know whether such an arrangement will be beneficial, and this may reduce the desire for such manipulation. The MOF has stated that it will consider intro-ducing such a provision.

The MOF's draft provides that in the case of a joint filing, the parent company is the taxpayer. Thus, since the statutory duty to pay tax does not fall on the subsidiary, sanctions or enforcement for any irregularities or underpayment of tax will be directed toward the parent company.

Many recent media reports have expressed the view that this will affect the right of minority shareholders in subsidiary companies to make use of their tax credit. But in fact, although the tax laws refer to a variety of persons with a duty to make tax payments, including taxpayers, tax withholders, tax indemnity payers, tax agents and collection agents, these various terms simply make clear the order of precedence in which the responsibility to pay tax devolves, and the reason for such responsibility; in substantive terms, the duty to pay tax falls upon the person who re-ceives taxable income. If the joint filing system makes the parent company the taxpayer, this does not mean that subsidiary companies are relieved of their duties under the tax laws, but rather that the parent company files and pays taxes on their collective behalf. After a parent company calculates, files and pays the amount of tax jointly payable, there is nothing to prevent it from internally apportioning creditable tax amounts to its subsidiaries, to allow subsidiaries' minority shareholders to make use of their shareholder's tax credit.

Different countries inevitably have different taxation systems, and it would be improper to take the entirety of the joint calculation methods used in the consolidated taxation system of an-other country as the basis for judging the appro-priateness of the MOF's draft. Nor is the system that is most advantageous to businesses neces-sarily the best. A more pragmatic view is surely that the best system is one that is simple and workable, and has a high degree of compatibility with the existing tax system.