Bangkok Post (6 November 2007)
Government policies have the potential to influence economic activity for good or ill. Examples of the latter include tax systems that impose excessive burdens on income-producing activities. Thailand's taxation of foreign dividend income, for example, contains anomalies that could subvert the purpose of the original legislation.
Most countries exempt domestic dividend income from tax on the grounds that the profits from which the dividend is paid have already been taxed. In addition, many countries provide tax relief for dividends from foreign investments, either through credits for tax paid in the foreign jurisdiction or by way of exemption. The exemption may be absolute, or subject to conditions including minimum holding periods and shareholding percentages.
Thai taxation of dividend income: Under Thai tax law, domestic dividends earned by Thai corporate shareholders holding a substantial (25%) shareholding are exempt from taxation provided a minimum holding period is met.
Foreign dividend income may be exempt under one of two regimes, each with different conditions. The 2002 Regional Operating Headquarters (ROH) regulation exempts foreign dividend income of a Thai ROH. The broader-based RD 442 (introduced in 2005) exempts from tax foreign dividend income for all Thai corporate entities.
RD 442 was intended to enhance the competitiveness of Thai enterprises investing abroad. It also ends the discriminatory tax treatment of foreign versus domestic dividend income, encourages repatriation of profits to Thailand and, along with the ROH legislation, promotes the use of Thailand as a favoured holding company location.
Barriers to achieving policy objectives: Certain technical and commercial realities have not been recognised in the drafting of the regulations, with the result that they may not be effective.
A Thai ROH, for example, is not the most attractive holding vehicle for outbound investments, as ROH status (and, therefore, corporate income tax and foreign dividend exemptions) depends on its annual qualifying offshore service/royalty income amounting to at least 50% of its total income.
The problem arises in a year that the ROH receives foreign dividend income. Its ''total income'' increases and, as a result, its normal offshore service/royalty income is not likely to meet the 50% threshold. The result is a triple hit to the taxpayer: not only would the foreign dividend income become taxable (if RD 442 conditions are also not met) but the ROH would lose its concessional 10% corporate tax rate privilege for the rest of its qualifying income, and its expatriate employees would lose their personal income tax privileges. It is, therefore, no surprise that a Thai ROH is very rarely used as a holding vehicle.
Another example of potentially favourable tax legislation missing its mark is the foreign dividend exemption regime. RD 442 states that dividends should be paid from the ''taxable net profits'' of foreign subsidiaries that have been subject to a corporate income tax of at least 15% in the paying jurisdiction. The 15% headline foreign tax threshold had the objective of discouraging the use of tax havens to make outbound investments. Curiously, the Thai ROH legislation does not deny tax-exemption to such ''tainted'' low-taxed income.
The lack of flexibility in RD 442 may, however, defeat its stated purpose of increasing the competitiveness of Thai enterprises. Many investment structures interpose domestic or foreign holding companies that are exempt from tax on dividend income. These companies may exist for a number of reasons, for example, to create a local tax group, to take advantage of a favourable double-taxation agreement, to enable consolidation of an investment or to facilitate reinvestment of funds. However, the existence of such a holding company between Thailand and the operating (taxpaying) company would result in otherwise tax-exempt dividend income becoming taxable in Thailand.
For example, a typical structure for China-bound investments would be to use a Hong Kong holding company in order to have access to the favourable double-taxation agreement between China and Hong Kong. While the operating company in China pays tax on its operating income at 25%, the dividends it pays to the Hong Kong holding company are tax-exempt in Hong Kong. As a result, when the holding company subsequently repatriates the China profits to Thailand, the dividends are taxed in Thailand at 30%, on the grounds that the dividends have not been subject to tax in Hong Kong, ignoring the fact that the operating income has been taxed in China.
If the operating company in China was held directly by the Thai parent, the dividends would be exempt from tax in Thailand but would be subject (post 2008) to a higher rate of withholding tax in China. The failure to accommodate the realities of transnational investment structuring therefore results in the ironic situation of the Thai investor being able to save Thai tax only at the expense of paying more tax in China.
In view of these anomalous outcomes, Thai authorities would be well advised to obtain feedback from parties experienced in transnational investment.
They could, for example, follow the example of Singapore, which has a foreign dividend exemption regime somewhat similar to RD 442. To be tax-exempt in Singapore, foreign dividends have to be paid from a country with a headline tax rate of 15% and have to be subject to some tax in that jurisdiction.
When faced with the same issues described above, tax authorities in Singapore took a pragmatic approach by permitting the exemption for foreign dividends routed to the Singapore parent through a holding company in a low-tax country, provided the taxpayer could establish that the profits giving rise to the dividend had been subject to a corporate income tax at a rate of 15% or more in some jurisdiction.
The ROH regime and RD 442 provide an opportunity for positioning Thailand as an investment hub and for increasing the competitiveness of Thai businesses. However, the failure to recognise the realities of structuring transnational investment may, unless amendments are made, frustrate the stated objectives of the regulations.PricewaterhouseCoopers' ninth annual tax and legal conference, ''Capitalising on Change'' takes place in Bangkok on Nov 26-27. To register, please visit www.pwc.com/th
Thavorn Rujivanarom is a lead partner and Prema Rao is a director at PricewaterhouseCoopers Thailand. We welcome your comments and question at leadingtheway
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