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TAX RULES FOR INTEREST INCOME FROM NPLS
With regard to the issue of how an asset man-agement company (AMC) that acquires non-performing loans (NPLs) from a financial institution should calculate interest income from the NPLs when filing its final annual tax return, the Ministry of Finance previously stated in an interpretation dated 23 September 2004 that such interest income should be calculated on the ac-crual basis according to the agreed rate of interest, in accordance with the provisions of Article 22 of the Income Tax Act.
Article 22 of the Income Tax Act provides that a company must use an accrual-based accounting system. But a non-performing loan is an overdue loan that a financial institution has difficulty in recovering. When a debtor is unable to pay back the principal and due interest on time, any col-lateral originally provided by the debtor becomes property that the financial institution may auc-tion off as a means to enforce its creditor's rights.
According to the above interpretation, after ac-quiring NPLs sold off by a financial institution, an AMC would have to calculate the interest income from each of the NPLs on an accrual basis. Thus it may face the problem that some of the purchased NPLs have poor collateral that is difficult to dispose of, while by definition the interest from the loan itself is difficult to collect. Therefore the AMC may be unable to collect any cash within a certain period, or indeed ever, yet it would have to pay income tax in advance.
To address this issue, on 5 February 2005 the MOF issued a further interpretation in which it stated that where it was not possible to reasona-bly determine the likelihood of an AMC's re-ceiving cash income from interest on NPLs ac-quired from a financial institution, under the proviso to Article 27 of the Guidelines for the Assessment of Business Income Tax, such in-come may be treated as overdue-account income for the year in which the amount of the income becomes known. As for what constitutes inabil-ity to reasonably determine the likelihood of re-ceiving cash income, the interpretation does not set out any criteria to be met, so this awaits a further interpretation from the MOF.
The interpretation also stated that if an AMC has appointed a certified public accountant to audit, certify, and file its income tax return in accor-dance with the Regulations for the Auditing, Certification, and Declaration of Income Taxes by Certified Public Accountants, interest income from NPLs that should be declared on the accrual basis may be verified and determined according to the CPA's certified income tax audit report