Offshore Tax Havens
Taiwan's NT$300 Billion Drain
While Taiwan loses billions in tax revenue to overseas tax havens, the rest of the world is chasing down its rich tax dodgers. Why is Taiwan still taking a hands-off approach?
Taiwan's NT$300 Billion DrainBy Yi-Shan Chen, Judy Lin
From CommonWealth Magazine (vol. 540 )
Late at night on Jan. 14, legislative speaker Wang Jin-pyng banged the gavel on the podium, signaling the end of the Legislative Yuan's fall and winter session.
During the previous four months, Taiwan's lawmaking body was busy indeed, passing legislation beneficial to insiders and lobbyists. One bill eliminated fines for land agents who falsely register housing transaction prices, which would reduce transparency in the market and enable developers and real estate brokers to manipulate property prices. (The legislation may be overturned after the Cabinet asked the Legislature on Jan. 21 to "reconsider" the amendments.)
Another package of amendments tightened eavesdropping constraints in response to wiretaps that have embarrassed legislators by showing they were likely involved in illicit lobbying.
Conversely, legislators ignored revisions to the "Act Governing Food Sanitation," leaving them to drift for over a month. They also silently killed revisions to the Income Tax Act. The amendments would have stopped corporations from hiding profits abroad to avoid taxes, but were essentially put on hold in the previous legislative session when lawmakers across party lines blocked it from a second reading (bills must go through three readings before they are passed) and stashed in secret cross-party consultations.
Kidnapped by Vested Interests
Sources familiar with the workings of the Legislature say several vested interests, including the clients of big law and accounting firms and global Taiwanese business associations, lobbied hard for lawmakers to shelve the Income Tax Act amendment. They were particularly opposed to the proposed addition of Articles 43-3 and 43-4, dubbed "the anti-overseas tax avoidance clauses."
Companies are opposed to the amendment, fearing it would increase their tax bill at home. The revisions would allow Taiwan's Ministry of Finance to apply "controlled foreign corporation" rules (43-3), devised in line with international practices, to tax profits stashed in low-tax havens. It would also empower the ministry to use the "place of effective management" clause (43-4) to negate such tax avoidance strategies as setting up "F share" entities or overseas shell companies. In other words, "foreign" companies would be taxed in Taiwan if they were considered to be managed in Taiwan.
Not surprisingly, legislators dutifully caved in to business interests and blocked the anti-tax avoidance amendment. That meant that three other tax code revisions contained in the same amendment, designed to help Taiwan cope with new IFRS international accounting standards put in place in 2013, were also shelved. As a result, companies listed on Taiwan's main stock exchange and over-the-counter market have been left in limbo, unsure how to file their 2014 income taxes.
These lawmakers who claim to be fighting for the interests of their constituents have in fact hurt the country and the people. Moreover, they are ignoring international realities. Since last year, G20 countries have begun cracking down on the many tiny islands sheltering global wealth from taxes, mounting a dragnet to shut down this long-abused tax avoidance channel.
China Fighting Abuses, Why Not Taiwan?
Buttressed by its national strength, China is among those pursuing taxes on profits and wealth parked overseas. Beijing has signed information exchange agreements with the eight tax avoidance havens most popular with overseas Taiwanese businesses and global tycoons – the Isle of Man, Guernsey Island, Jersey Island, the British Virgin Islands, the Cayman Islands, Bermuda, the Bahamas, and San Marino. Another low-tax paradise favored by overseas Taiwanese businessmen, Samoa, has diplomatic relations with China.
Beijing has also issued several interpretations of its domestic tax laws that underpin its authority to tax the income of Taiwanese companies in China registered in offshore tax havens. In other words, if Taiwanese enterprises opt not to pay taxes at home, where the corporate income tax rate is a relatively low 17 percent, they may have to pay income tax in China at a 25 percent rate.
One financial professional knowledgeable about international tax trends says the world can be divided into two categories: capital-exporting countries, such as the United States, Japan, Taiwan and European countries, that are having their tax bases eroded by the tax havens; and the low-tax paradises that are harming others. The global tide has now turned to stopping tax avoidance, but if Taiwan does not equip itself with the necessary tax collection tools and refrains from tightening its defenses against the outflow of its tax base, it will be victimized to a greater degree than others, the expert says.
Tax Shelter Addiction
According to the offshore leaks database of the International Consortium of Investigative Journalists (ICIJ), to which CommonWealth Magazine now has access, Taiwanese companies abuse tax havens more than those from any other part of Greater China, with Taiwan's treasury and people the hardest-hit victims.
In July 2013, CommonWealth Magazine joined an investigative journalism project of the ICIJ involving media representatives from 50 countries, and obtained customer data up through 2008 from Singapore-based Portcullis TrustNet, Asia's biggest trust company, as well as the British Virgin Islands-based Commonwealth Trust Ltd.
Documents detailing money movements in these highly secretive tax havens are normally impossible to come by, and the ICIJ's database represents the first glimpse international media have had into the practices of tax avoiders and evaders. Many prominent mainstream media, including the Guardian, the Washington Post and Le Monde, have given widespread coverage to the ICIJ's findings.
When CommonWealth Magazine first joined the project, ICIJ deputy director Marina Walker Guevara pointed out that far more Taiwanese had accounts in the tax havens than did people from Hong Kong, China or Macau, a fact she found curious.
In the Portcullis TrustNet documents obtained by ICIJ, 35 percent of the accounts were from ethnic-Chinese areas. There were 15,856 accounts held by Taiwanese clients (representing 13,607 families), about 25 percent more than the number held by Hong Kongers and 80 percent more than held by Chinese nationals. But it should be remembered that China's economy and population are 17 times and 58 times the size of Taiwan's, respectively.
Taiwan Loses NT$300 Billion Over 10 Years
Though corporate offshore tax avoidance is recognized as Taiwan's biggest tax loophole, nobody has ever calculated how much the loophole has cost national coffers, until now.
Under Taiwan's existing tax code, the profits of companies' offshore subsidiaries or sub-subsidiaries cannot be taxed until they are distributed to shareholders and remitted back to Taiwan. In other words, as long as profits booked overseas remain overseas, no matter how big the amount, Taiwanese tax authorities have no way of getting at them.
After scouring the financial statements of listed Taiwanese companies filed with the stock market's observation post system (MOPS), CommonWealth Magazine found that only 30 percent of the profits the companies booked in China on investments there over the past 10 years were remitted back to and taxed by Taiwan. Extrapolating from the amount left behind based on existing tax rates, companies had an estimated NT$162.8 billion in deferred income tax liabilities – the amount of tax they have to pay at some point in the future – over that time. What's worrisome is if the National Tax Administration does not monitor deferred tax liabilities vigilantly, they can be erased from financial statements and vanish forever.
CommonWealth then looked at Investment Commission statistics for the last 10 years and found that the ratio of overseas investment by Taiwanese companies in China and non-China destinations was 1.4 to 1.
Assuming that companies treat profits on non-China offshore investments the same way as profits booked in China, another NT$120 billion in deferred tax liabilities was left in those countries, bringing the total worldwide to NT$280 million. (CommonWealth had to use this approach because companies in Taiwan with foreign operations only have to report profits remitted back from China, not from any other overseas investment base.)
"The method used is reasonable, and the result approximates the general understanding of the problem. It was a meaningful analysis," asserts Chen Ming-chin, an accounting professor at National Chengchi University recognized as an expert on international taxation.
This analysis, which covered only 800 publicly listed companies, estimated that nearly NT$300 billion in taxes has gone uncollected on income hidden offshore over the past 10 years, or about NT$30 billion a year. That may just be the tip of the iceberg, considering that official Chinese statistics show 88,000 Taiwanese companies with investments in China.
The Common Desire to Hide Wealth
There are a number of reasons why Taiwanese companies resort to offshore tax havens to limit their tax bill. High inheritance and gift taxes, with rates that reached 50 percent before being reduced in 2009, were blamed in the past for driving companies and the wealthy to funnel funds abroad. Several CPAs cited three other non-tax factors for fueling the trend: foreign exchange controls, the unusual nature of Taiwan-China relations, and the characteristics of the contracting sector in which so many Taiwanese companies are involved.
Albert Hsueh, the former chairman of accounting firm PwC Taiwan, explains the prevalent mindset among the wealthy favoring the use of overseas hiding places to avoid taxes.
"They feel they work really hard to make money. The company pays a 25 percent tax on its income, and then they pay a 40 percent personal income tax. When they die, the government takes half of their estate. They wonder, 'Why am I working so hard?' Then there has been the uncertainty of cross-Taiwan Strait relations and foreign exchange controls that make it hard to get your money out and leave you vulnerable to audits if a remittance is made," Hsueh says.
A chief financial officer of one major electronics contractor explains that when big brands such as Dell, Apple and Lenovo place orders, they often require Taiwanese vendors to set up independent shell companies for their accounts to ensure confidentiality and block access by their competitors.
PwC Taiwan CPA Steven Wu believes it is unfair to cast tax havens solely as places that help corporate entities hide from tax authorities, because they also can be used to lower legal risk, improve investment flexibility and list publicly overseas.
"But if CPAs are not telling you now that tax havens are getting riskier, then they are being negligent," Wu says.
Tax Paradises No More?
Sung Hsiu-ling, the director-general of the Finance Ministry's Department of International Fiscal Affairs who often represents Taiwan at international financial meetings, sees bigger countries fighting back against tax haven regimes.
The alarm was first sounded in 1998, Sung says, when the OECD, at the behest of capital exporting countries led by the United States, released a report on the "emerging global issue" of "Harmful Tax Competition," in which it addressed harmful tax practices and the role played by tax havens. It defined tax havens as places having no or only nominal taxes and no requirement of substantial business activity and lacking transparency and an effective exchange of information.
The OECD then created an initial list of tax havens in 2000 that has been revised several times since, with those on the lists pressured to tighten domestic laws and cooperate with requests for customer information, or face the consequences.
Global efforts to crack down on tax havens grew stronger after the global financial tsunami. In March 2010, the United States passed the highly aggressive FATCA (Foreign Account Tax Compliance Act), which targets tax non-compliance by American taxpayers with foreign accounts. Then, the OECD released an "Action Plan on Base Erosion and Profit Shifting" in July 2013 that proposed 15 measures to address the gaps in tax rules and international standards exploited by companies to make profits "disappear" for tax purposes or to shift profits to locations where there is little real activity.
At a meeting in early September, the G20 endorsed the action plan and supported OECD efforts to develop a global standard for the automatic exchange of information, expected to be presented at the next G20 finance ministers meeting.
Sung attended the OECD's annual tax treaty meeting for tax officials from non-OECD states and organizations in late September to discuss the action plan and possible solutions to non-taxation caused in part by the favorable conditions offered by tax havens.
"At the OECD meeting, I noticed that the countries whose main selling point is low taxes were extremely nervous. They were very concerned and asked repeatedly about the timeline for trying to stop base erosion and what the next step would be," she recalls. The level of anxiety of low-tax countries indicates that the OECD is serious about its action plan and that the plan packs a real punch, she says.
Singapore, a favorite destination for Taiwanese offshore wealth, was once on the OECD watch list.
The Need for Tax Law Reform
"China has closely followed international trends the last few years. Even if Taiwan does not follow along, the effort by Taiwan's main investment destination to contain tax havens will inevitably have a huge impact on us," Sung says.
Otto Tu, a partner in the Taiwan office of accounting firm Deloitte, says China's tax authorities already have the power to pry into overseas holdings based on detailed income tax rules laid down in Circular 59 and Circular 698 issued in 2009.
For example, Taiwanese companies with businesses in China that run through shell companies believe that if they sell the dummy company, all that's involved are the shares of the holding company in a third country, without any tax liabilities. But according to the circulars, because the transaction is seen as an indirect sale of Chinese assets, Chinese tax authorities have the power to tax income from the sale. Even more onerous, China's tax code makes tax evasion a criminal offense.
In an interview with CommonWealth Magazine, Taiwan's economics minister Chang Sheng-ford said that in a proposed Taiwan-China taxation agreement that has yet to be signed, the two sides have agreed that companies treated as Taiwanese-invested foreign entities which have paid taxes in Taiwan would not have to pay taxes in China.
But because Taiwan's Legislature has been kidnapped by vested interests and continues to block the revisions cracking down on tax avoidance, Taiwan still does not have "place of effective management" and "controlled foreign corporation" tax rules in place, meaning it still cannot go after the tax liabilities of those Taiwanese-invested overseas companies.
Elsewhere in Asia, countries like South Korea, Japan and China with economic structures similar to Taiwan's have all enacted comprehensive anti-tax avoidance rules. In fact, Taiwan stands out as lagging farther behind in adopting international tax practices than any other capital-exporting country in Asia.
"It's not that companies don't want to pay taxes. But with Taiwan's tax laws the way they are, even if I want to pay taxes, the government doesn't want me to," says the chief financial officer of a listed company that has been audited by Chinese tax authorities, frustrated at how far behind the times Taiwan's tax code is.
The financial executive noted that in the proposed taxation agreement with China revealed by the Ministry of Finance, if Taiwanese companies pay taxes in Taiwan on profits booked in tax havens, Chinese tax authorities will not go after that income. For Taiwan not to pass the necessary laws to support such a system and to unilaterally cede its tax authority is simply stupid, the executive says.
The biggest problem with using tax havens is that "many people don't feel like they're committing a crime," says Taichung prosecutor Joice Lin.
Because of this lack of awareness of the potential consequences and complete disregard for international trends, vested interests have been able to throttle Taiwan's tax system. These Taiwanese companies with overseas interests may think they are benefiting by cleverly exploiting the system. In fact, they are exposing themselves to massive risk while also costing their country tax revenues and acting against the interest of the people.
Translated from the Chinese by Luke Sabatier