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Free Trade and Taxes in Taiwan and China

By Laurence E. Lipsher - Email Editor

August

Dear Valued Reader,

Taiwan and the P.R.C. signed the Economic Cooperation Framework Agreement (ECFA), similar to a free trade agreement, in Chongqing on June 29. The choice of Chongqing as the location of the signing is symbolic, as Chongqing was the KMT (Nationalist) capital through the war against Japan. The Nationalists fled to Taiwan in 1949, and we all know what's taken place since.

Well, free trade, taxwise, means a cut in taxes, and that cut is transpiring as I write this piece. China will cut tariffs on 539 industrial items, worth US $13.8 billion to Taiwan. Taiwan, in return, will cut 267 tariffs, worth US $2.86 billion to China.

Over the next two years, China will reduce tariffs in three stages from approximately 15 percent to 5 percent to 0 percent. Effective June 29, Taiwan now enjoys a 0 percent tariff on a substantial number of goods previously taxed at higher rates.

Both sides will agree to open markets soon for services in both the financial and nonfinancial sector, including accounting, auditing, hospitals, and aircraft maintenance and repair, the South China Morning Post reported. Hong Kong and Macao are also getting similar aircraft-related business accessibility. Taiwan will remove mainland business restrictions in computer bookings for air transport services and in research and development.

I get a kick out of Taiwan's pro-independence, opposition-side reaction to all of this. Progressive Party spokesperson Lin Yu-chang was reported as saying, "Obviously such concessions" - which violate the normal standards of regular free trade pacts - are carefully calculated to achieve a political interest.

Well, of course they are Why, I can even calculate the exact monetary value myself US $13.8 billion - US $2.86 billion = US $10.94 billion. That's just for tariff and tax reduction and removal. Anything else - and it's expected that there will be other things - will be icing on this cake.

Now, if you add this to the previously announced tax cuts that Taiwan has made in both its individual and corporate tax systems, what you have, effectively, is a brand-new "offshore headquarters location" to potentially rival Hong Kong and Macao (although I could never see Macao as being part of this rivalry).

CEPA (Continuing Economic Partnership Agreement), meet ECFA. One country/two systems, meet an umbrella country in transition/two systems I'll go as far to say that I fearlessly predict, much sooner than anyone else out there predicts, a double tax avoidance agreement between China and Taiwan. Taiwan businesses obviously do not want this, but its time has come.

A recent Wall Street Journal article titled "Taiwan's Trade Harvest" summed it up best "It's hard to understate the significance of the Economic Cooperation Framework Agreement, which was two years in the making. The initial benefits are heavily skewed toward Taiwanese businesses."

FEATURED PERSPECTIVES

ECFA is projected by the government to be directly responsible for the creation of 260,000 new jobs and adding 1.72 percent to the GDP. Like CEPA, ECFA is intended to be ongoing. Bringing down the corporate tax rate to 17 percent brings Taiwan on par with Singapore. This alone makes certain the opening up of Taiwan as an offshore gateway to China equal to that of Hong Kong. Opening up the banking, accounting, and auditing sectors from Taiwan to China simply enhances that.

And then there's Taiwan's cut in estate and gift tax rates to 10 percent. This will encourage many Taiwanese expats to bring their monies home from elsewhere. There are many U.S. green card holders in Taiwan who, concerned about the ever-encroaching tentacles of U.S. taxation, are considering turning back those green cards. What with peace an apparently "permanent thing" cross-straits, and with tax reduction and a very sizable and ongoing economic stimulus package from the P.R.C. to Taiwan as well, I believe that U.S. green card abandonment is going to be fashionable on both sides of the strait. And I do not think that this byproduct of HIRE-FATCA was intended..

So what's happening regarding CEPA, Hong Kong, and Macao? Well, Supplement VII of CEPA was just issued, giving Hong Kong and Macao lead time for various trades in the regional competition for business. Thirty-five market liberalization and trade and investment facilitation measures in 19 sectors have been announced. Market access liberalization in 14 other service sectors also has been announced. These sectors include technical testing, analysis and product testing, specialty design, banking, securities, tourism, and air transport.

These measures will take effect January 1, 2011. The official CEPA press release states:

On the whole, Supplement VII will expedite and facilitate Hong Kong and Macao service industries to enter and expand in the Chinese market. Most of the market liberalization and facilitation measures cover the industries in which Hong Kong has a competitive edge. This supplement will help expand Hong Kong's status as an international financial, trade, shipping, logistics and high value-added service centre.

Is it meaningful? I don't know. Hong Kong has a very sizable competitive edge simply because of where it is and what is already established there. That Hong Kong is a world-class banking center is without question. This is obviously an initial limitation for Taipei. But yes, everything in CEPA is meaningful to business, and the more business it brings to a location, the larger the tax base of that location.

If CEPA facilitates trade, then obviously there are tax incentives included. Hong Kong has the lowest rates on this side of the Pacific, and this certainly improves its position, but as for that high cost of living and operating out of Hong Kong - ouch Competition is not something that Hong Kong is used to. Singapore is great, but it really is not in competition it is too far away. Taipei, on the other hand, could rapidly change things and this would benefit everyone (except those in Hong Kong desirous of their monopoly-like status).

Hong Kong

So what's happening in Hong Kong, taxwise? I'll start first with discussion about Hong Kong and that OECD white list, since I've had so much fun dwelling on it in detail in the past, much to the apparent chagrin of Hong Kong's Inland Revenue Department (IRD), which hasn't accepted the fact that it is not yet squeaky clean. The IRD finally seems to be coming to terms with reality and is writing treaties with reckless abandon Five conforming treaties are now in place, and eight more are to go into effect between January 1, 2011, and April 1, 2011. That means that on April Fool's Day 2011, Hong Kong will officially make that white list.

Here's the rundown:

•   -  in effect: Belgium, China, Luxembourg, Thailand, and Vietnam.
•   -  starting in 2011: Austria, Brunei, Hungary, Indonesia, Kuwait, and the Netherlands.
•   -  concluded but not yet signed France, Ireland, Japan, Liechtenstein, and Switzerland and
•   -  in negotiation Czech Republic, Denmark, Italy, Macao, Pakistan, Spain, the United Arab Emirates, and the U.K.

Singapore and India will start negotiations with Hong Kong before the end of this year, and the Philippines, sadly, responded that it is not interested.

As of January 6, 2010 (later corrected and amended on March 3), Hong Kong has a brand-new exchange of information article as part of its operating law. The article was written and enacted to protect an individual's right to privacy and confidentiality of information exchanged. It will be neither automatic nor wholesale exchange of information and will be concerned with profits tax, salaries tax, and property taxes. Hong Kong is not obliged to supply information that the requesting party itself could not obtain under its own laws.

Hong Kong adapted the new exchange of information article to avoid being labeled as a tax haven by some countries or relevant international organizations. I read both the January 6 and March 3 versions of the article, and frankly, I couldn't figure out what was amended.

I have trouble with the last IRD press release concerning the concept of tax havens. I think that both Hong Kong and Singapore (and possibly Taiwan) in the future will be, in essence, tax havens, any way you look at it. Basically, any jurisdiction that has a 16.5 percent corporate tax, a 15 percent individual tax, no estate or gift tax, ease of corporate setup and international banking, and where tax is only on territorial income, is a tax haven in my book. Hong Kong and Singapore are tax havens in the finest sense of the term. I'm spoiled - I wouldn't work anywhere else! Also, what is wrong with inclusion of an exchange of information article to the law that protects the rights of the individual?

I have a question for you readers out there: Would you care to guess why the United States is not included in that rapidly expanding list of treaty countries that Hong Kong has signed and will be signing with?

Departmental Interpretation and Practice Note (DIPN) No. 21, the territoriality guidelines, was first issued in 1992, revised in 1996, and then revised again in 1998. The December 3, 2009, revision, the first in more than a decade, covers 11 basic areas in which change has taken place. These areas are: the operations test, the agency principle, trading profits, reinvoicing centers in Hong Kong, buying offices, manufacturing (both contract and import processing), sale of listed securities, royalties, sale and purchase commissions, apportionment of profits, and processing of offshore claims.

Everything boils down to the operations test, in which, as a broad guideline, the IRD will see what the taxpayer has done to earn the profits in question as well as determine where this business has actually transpired. As key factors, the IRD will compare relevant operations with all of the taxpayer's activities. Only those activities producing the profits in question will be deemed relevant for inquiry. This is a fundamental difference from prior guidelines, in which "totality of facts" was the approach used rather than the specific activities involved.

While the entire DIPN 21 is not long and certainly not difficult to read, its guidelines still seem vague and subject to much interpretation. In particular, the area of apportionment of profits between the P.R.C. and Hong Kong for factories and businesses in China that are run from Hong Kong (and thus, how much tax is paid in each location) is of primary concern. The revised DIPN states that the 50/50 apportionment is not necessarily written in stone anymore as much as contract processing arrangements with P.R.C. factories are, and that any rational basis put forward by the taxpayer will be considered. If that doesn't call for some bold, aggressive tax planning, then I have no idea what does.

DIPN 46 Transfer Pricing

Relatively new to Hong Kong is transfer pricing as a tax vehicle to be regulated. After all, why should the IRD show the initiative in this area when, with a low Hong Kong corporate tax, it would simply mean more taxable revenue (and operating income) for Hong Kong to be the beneficiary of business and profits, solely because of low taxes? Alas, Hong Kong also has trading partners for whom transfer pricing and taxable income allocation mean a whole lot more, and for that reason alone, Hong Kong had to do something.

And yet, Hong Kong does not require contemporaneous transfer pricing documentation. That tells me how unimportant transfer pricing matters actually are to Hong Kong. Obviously, this can change. What is interesting is the section detailing with intragroup services, with markup costs apparently being acceptable if the principal business in Hong Kong is to render services to both related and unrelated parties. There is no markup on cost permitted if the service is part of general management activity. Safe harbor rates for normal back-office services of either 5 or 10 percent could be overruled if the IRD deems this filing to be outside its set standards.

Economic Recovery

The influx of money from China to purchase property is bringing in surprise stamp tax income and is raising Hong Kong real estate prices. Real estate bubble concerns still exist, but the problems of recession seem to be a thing of the past here in Hong Kong. The best way I know of judging the economy is the thickness and number of classified ad sections in the Saturday South China Morning Post. A recent paper had three complete sections, which is more than I've seen here in the last two years. Yes, social problems are increasing because of everything that goes along with inflation and the influx of money raising prices. Yet, the windfall in stamp tax revenue is making the Hong Kong treasury seem very, very healthy. And there are not that many jurisdictions in this world that can honestly boast of this right now.

Back to the Mainland

The P.R.C. government, like its Hong Kong branch, also seems confident that whatever lingering problems created as a result of world economic upheaval will eventually cure themselves and that reliable economic indicators substantiate this beyond any semblance of doubt.

With this in mind, the Ministry of Finance and the State Administration of Taxation announced that as of July 15, export tax rebates were terminated for 406 items for which rebates were given (starting in September 2008) to spur on an export market that suddenly ceased as the world's economies imploded. What is nice about this is that the large majority of terminated rebates were given to polluting, energy-intensive manufacturers. The government now feels confident that the locations in which these enterprises seem to be clustered can begin upgrading themselves to a more environmentally friendly sort of industrial mix. Is this a step up another rung of the economic ladder?

The steel industry's 9 percent tax rebate for hotrolled steel coil, sections, and galvanized coil also came to an end, leaving the P.R.C. steel industry quite nervous because the products involved in losing this 9 percent rebate make up 25 percent of China's steel exports.

The P.R.C. domestic steel market is oversupplied, which makes export competition even more intense. It also makes for trade disputes and a long series of trade dumping measures, primarily from the United States. The Chinese government, quite aware of this, is using the cessation of the 9 percent tax rebate as a means of "restructuring" the Chinese steel industry, attempting to bring it down to a more tolerable size. I think this will definitely have an impact on the steel industry in China.

The Wall Street Journal on July 1 ran an article, "China Learns From Robin Hood," saying that China has some very serious collection problems and that getting people to actually pay tax is becoming a major headache. Hey, I told you that a long time ago! I'm glad, though, for the corroboration of the Journal. I think this problem is going to change far sooner than people think.

People's Daily Online recently contained an essay by a deputy director of the Chinese Academy of Social Sciences, calling for improved collection procedures, making the closure of tax loopholes a major priority. I think that what this means is a new format for the individual income tax form this coming year, as well as a totally revamped collection process. Nothing has been done to change things over the past two years; it was inconceivable that anything would be attempted during a process of priming the economic pump to overcome any economic recession. Well, the recession is over. Not only will there be some tax system changes this year, but state-owned enterprises (SOEs), the government-run business monopolies, are going to have to pay higher dividends back to their owners the government. Isn't a dividend the same as a tax in this instance?

SOEs pay a company tax, a windfall profit tax, and a dividends tax. Long ago, the SOEs paid everything back. Then, with Deng Xiaoping's economic liberalization of the country, that changed and the successful SOEs really became big, using their profits to expand. The benevolent government isn't so benevolent anymore - it wants its revenue, and the SOEs are not exempt from this obligation.

Call 888.916.7070 or email info@trustmakers.com

By Laurence E. Lipsher

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