Growing Mkts of East South Asia

Growing Markets
Millbank Tower
21-24 Millbank
London SW1P 4QP
29th Floor
in East and South Asia
Tel +44 (0)20 7559 4801
www.bnai.com
Tax Planning International: Special Report
Tax-TPD.indd 1 8/5/06 23:38:24

2
Growing Markets in East and South Asia
Six months ago the Asian economies were among the hardest hit in the world, as exports to the rich
countries plunged. However, the doughty resilience of these economies should not be
underestimated as they have already survived the Asian crisis of the late 1990s and are now
rebounding more strongly than expected thanks to the biggest fiscal stimulus of any region of the
world.
With the aversion of the economic crisis, whether temporary or permanent, certain Asia Pacific
countries have nevertheless been established as being increasingly important business locations,
generally offering low costs, incentives and long-term growth prospects.
In “Growing Markets in East and South Asia”, a number of KPMG experts and practitioners, attempt
to discern the tax and legal landscape of each of the eight countries discussed, and beyond the
obvious differences, whether there are certain features that are common to them all. The depth of
this understanding and comparison is facilitated by the unique layout of this Report in that each
section comprises four articles with much the same titles: The tax and legal framework; Tax
treatment of cross-border service activities; Holding and financing strategies for investment;
Investing in real property: Some tax aspects.
At the end of each section, readers will not only have a firm grasp of the corporate tax system and
company law unique to each country, but will also understand how legal changes affect investment
in real property; what the treatment of cross-border service activities means for foreign enterprises,
as well as what financial planning considerations are associated with foreign investment strategies.
Commissioning Editor: Bronwyn Spicer per page per copy fee may reproduce portions of this
publication, but not entire issues. The Copyright Clearance
Center is located at 222 Rosewood Drive, Danvers,
Growing Markets in East 2 and
0 South
0 : 9Asia is published Massachusetts (USA) 01923; tel. (508) 750-8400.
by BNA International Inc., a subsidiary of The Bureau of
National Affairs, Inc., Washington, D.C., U.S.A. Permission to reproduce BNA International Inc. material may
be requested by calling +44 (0)20 7559 4800; fax. +44 (0)20
Administrative Headquarters: BNA International Inc., 1st Floor, 7559 4880 or e-mail: customerservice@bnai.com
38 Threadneedle Street, London, EC2R 8AY, U.K.; tel. +44
(0)20 7847 5801; fax. +44 (0)20 7847 5840; e-mail: The information contained in this Report does not constitute
marketing@bnai.com; website: www.bnai.com legal advice and should not be interpreted as such. All efforts
have been made to ensure that the information contained in
Copyright © 2009 The Bureau of National Affairs, Inc.
this Report is accurate at the time of publication.
Reproduction or distribution of this publication by any means,
including mechanical or electronic, without express 2 in East
Growing Markets 0 and 0 South
: 9 Asia forms part of
permission is prohibited. Subscribers who have registered BNAI’s Tax Planning International: Special Reports, a series of
with the Copyright Clearance Center and who pay the $1.00 Reports focusing on key topics in international tax.
3
3
The material contained in this Special Report is written by tax specialists who are experts in the laws of their
own jurisdiction. Tax and legal matters are frequently subject to differing opinions and points of view, therefore
signed articles within this report express the opinions of the authors and are not necessarily those of their firms,
BNA International or the editor. While the authors and editor have tried to provide information current at the
date of publication, tax laws around the world are subject to change and therefore readers should consult their
tax adviser before taking any action related to the content of this Report.
4
Contents
Growing Markets in East and South Asia
Indonesia
The tax and legal framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Graham Garven and Jim Nichols
Tax treatment of cross-border service activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Michael Gordon and Jim Nichols
Holding and financing strategies for investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Investing in real property: Some key tax aspects . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
China
The tax and legal framework. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
Mario Petriccione and William Zhang
Lewis Lu and Mario Petriccione
Vietnam
Ninh Van Hien
Ninh Van Hien
Ninh Van Hien
Ninh Van Hien
Korea
Jae Won Lee and Na Rae Lee
Jae Won Lee and Deok Hyun Seo
Investing in real property: Key tax implications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49
Jae Won Lee and Chung Wha Suh
5
5
Contents
Malaysia
Outline of the corporate tax regime . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51

Leanne Koh Li Ann
Tax treatment of cross-border service by non-residents . . . . . . . . . . . . . . . . . . . . . . . . 55
Peggy Then
Nicholas Crist
Tax planning for real estate investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63
Chew Theam Hock
The Philippines

Jim Nichols, in consultation with KPMG Manila
Pakistan

Shabbir Vejlani and Asif Ali Khan
Shabbir Vejlani and Asif Zia
Investing in real estate: Some key tax aspects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89
Shabbir Vejlani
India
The tax and legal system . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91

Amarjeet Singh
Taxation of cross-border services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95
Amarjeet Singh
Holding companies and financing operations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97
Amarjeet Singh
Real estate investment: Key regulatory and tax aspects . . . . . . . . . . . . . . . . . . . . . . . 101
Amarjeet Singh
6
6
Indonesia
The tax and legal framework

KPMG Hadibroto, Jakarta and KPMG LLP, London
During colonial times, Indonesia was the hub of a vast Dutch trading empire stretching from South Africa to the Pacific.
In more recent years, after four decades of authoritarian rule, in 1998 Indonesia transitioned to a democratic system of
government.
Indonesia is the world’s largest archipelago and fourth most populous nation. This, combined with its strategic location,
rich natural resources and growing economy make it an increasingly important business location.
I. Applicable company law The Investment Law No. 25 of 2007 was introduced mainly to
improve on the previous foreign investment legal framework
Indonesia has a civil law system, based on Dutch law. and regulates both foreign and domestic investment. With
Indonesian company law is governed by Law 40/2007. regard to foreign investment, the law encourages foreign direct
investment by granting the right of entry for foreign business
Law 40/2007 permits only one corporate form – the limited
through a government licensing procedure. The procedure is
liability company (Perseroan Terbatas or “PT”). A PT is very
controlled principally by the Investment Coordinating Board
broadly analogous to the Dutch BV corporate form. It requires a
(“BKPM”) which is responsible for the evaluation and approval
minimum of two shareholders and must have a minimum
of most foreign investment proposals and the coordination of
authorised capital of IDR50 million, of which at least 25 percent
licensing requirements. Similar procedures apply for wholly
must be paid up.
domestic investment, but with a broader range of permitted
activities.
II. The foreign direct investment framework
Initial investment proposals to BKPM need to be in fields that
Although there is a general recognition that Indonesia needs are not closed to foreigners, as do applications for expansion of
the development capital and the technical and management existing facilities. Periodically, the government publishes a
skills of foreigners, there are a number of restrictions and Negative Investment List which lists the business ventures
procedures that must be addressed. The desire to control restricted or closed to foreign investment. Sectors that are
foreign investment is manifested in a variety of ways, for generally closed to foreign investment include healthcare, small
example, in general: scale retail and media.
■ All foreign investment is approved and monitored through
In some cases where there are restrictions on participation by
government bodies;
foreign companies, such as in construction, oil and gas and in
■ A domestic shareholding may be required in a foreign government projects, participation may be possible in
invested company; conjunction with an Indonesian company. Indirect involvement
■ Companies can employ only a limited number of by means of technical assistance and management
expatriates and are required to demonstrate plans for agreements is also common, particularly in sectors where
replacement of those expatriates by Indonesians; direct investment has not been permitted. The Investment Law
■
specifies that foreign investment must be in the form of a
Foreign companies are required to work jointly with
limited liability company, Perseroan Terbatas (“PT”),
Indonesian companies in order to undertake government
incorporated in Indonesia with the approval of BKPM and/or,
contracts;
potentially, requiring various approvals from other government
■ Certain fields of business are closed or may be restricted ministries. In addition, for certain specified sectors such as
to investment by foreigners; banking, oil and gas, mining and construction, the set up of a
■ Land holding and/or land rights are covered by a number registered branch by a foreign enterprise may also be
of restrictions. permitted. There is an anomaly in that the Indonesian Tax Office
7
7
Indonesia: The tax and legal framework
will often allow the registration of a branch for tax purposes in IV. The corporate tax system
the absence of a business license. This means that although
the branch is operating unlawfully, it is still able to fulfil its tax The Indonesian corporate income tax system is based on two
obligations. main laws:
■ The Tax Administration Law (Law 28/2007);
A PT company having an approved foreign shareholding is
■ The Income Tax Law (Law 36/2008).
known as a “PMA” company (Penanaman Modal Asing). The
legal form and operation of a PMA company is otherwise the These laws are the most recent amendments to tax laws
same as that provided for in respect of entirely domestically originally issued in 1983.
owned companies. A “foreign investor” is usually a foreign
In addition, there are tax laws covering VAT, taxation of Land
company. However, foreign individual investors are also
and Buildings (both a “rates” style annual tax and the taxation
acceptable to BKPM. Foreign investors can initially hold in
of sale and acquisition), a stamp duty law (stamp duty applies
many cases up to 100 percent equity, except for in the case
at a low nominal rate on most financial and legal documents)
of restricted industry sectors. Under Indonesian company law,
and various local and regional taxes which may not have
a minimum of two shareholders is required for every company.
significant impact. There is no separate capital gains tax, as
The Investment law grants the foreign investor the freedom to gains are taxed as income.
manage a company including the right to appoint directors
At the outset, it should be noted that in Indonesia there is a
and, if necessary, foreign technicians and managers where
fairly high degree of uncertainty regarding the interpretation
skilled Indonesians are not available.
and application of laws. This is very evident in respect of the
PMA manufacturing companies may not directly distribute tax laws and the conduct of the Indonesian Tax Office (“ITO”).
domestically to end consumers. They may however establish The ITO conducts tax audits with a comparatively unfettered
a separate company to distribute domestically (which can be degree of power and the administrative provisions of the tax
100 percent owned by the PMA company or another foreign laws are often seen to be geared to favour the ITO rather than
entity). In addition, PMA companies are permitted to sell their taxpayers.
products directly to:
A. Fundamental principles
■ Another PMA distribution company; Indonesian tax residents are taxable on worldwide income
■ Manufacturers who use the products as raw materials or under a system described as “self assessment”. This is largely
for plant and equipment; a misnomer as the ITO follows a rigorous and extensive tax
■ Construction companies who use the products in their audit regime. Non-residents are taxable only on income
projects; or derived from or received from Indonesia.
■ Wholesale entities. Under domestic law, a company is considered resident in
Indonesia if it is incorporated there. Having a place of
III. Exchange controls management in Indonesia can only result in creating an
Indonesian permanent establishment, rather than having any
BKPM, together with Bank Indonesia, the country’s central wider implications for corporate residence under domestic
bank, will monitor the source and disbursement of funds law.
approved for the establishment of a venture. For PMA
companies, sources external to Indonesia in foreign To eliminate double taxation, Indonesia allows a credit against
currencies must be used to finance all loan capital and the income tax payable for taxes paid abroad subject to certain
foreign parent’s equity capital. Certain external borrowing limitations. This relief can be availed of only by resident
requires official approval, but loans for wholly private sector taxpayers in respect of the foreign tax paid or incurred. The
projects are not subject to this approval. PMA companies may foreign tax credit is limited to the same proportion of the tax
borrow from domestic non-state banks for working capital against which such credit is taken.
requirements.
B. Tax base
The import and export of Indonesian currency (“IDR”) is Taxable profits are based on accounting profits after
subject to exchange controls and the lending of IDR to a adjustment for tax depreciation and non-deductible expenses.
foreign enterprise by an Indonesian bank is generally Expenses are generally deductible provided they are incurred
prohibited. However, it is possible to structure a loan to a to “earn, secure or collect profits.” Tax depreciation for both
PMA company from a foreign parent so that it may make tangible and intangible assets connected with the enterprise’s
remittances in foreign currency, such as USD, by reference to business operations is generally provided for as a tax
the prevailing USD-IRD exchange rate. The loan agreement deduction, except in the case of internally generated goodwill.
would thus be economically in IDR, but will specify that the Provisions are not generally deductible, except in certain
settlement currency was USD. industries (notably banking and insurance). In addition the
costs of providing benefits to employees are generally not
One further alternative that achieves much the same result
deductible.
would be to make a USD loan to the PMA company from its
foreign parent combined with a USD-IDR swap agreement Losses may be carried forward to offset future profits. The
between the parties so as the loan plus the swap are losses are offset against the first profit to arise, and they can
economically equivalent to an IDR loan. Either of these two only be used in the five subsequent years after the year of
options should prevent taxable exchange differences from loss. In remote areas and certain fields, a longer loss carry
arising in the PMA company in respect of the loan. forward up to 10 years may be permitted.
8
8
Indonesia: The tax and legal framework
C. Tax rates F. Anti-avoidance

The corporate tax rate applies at a single flat rate of 28 percent Whilst there are no explicit anti-avoidance provisions in the tax
in 2009 and will be reduced to 25 percent in 2010, in contrast law, the ITO makes extensive use of provisions allowing
to the progressive rates which applied up to 2008, with a adjustment to related party transactions, which are its main
maximum rate of 30 percent. anti-avoidance tool. Indeed, amendments to the related party
■ The corporate tax rate for a public company is subject to provisions, effective for the 2009 tax year, indicate a purpose to
a discount of five percent if 40 percent of its paid-up attempt to use such provisions in a manner akin to a “general
capital is publicly owned by at least 300 parties (individual anti-avoidance provision”. The approach to transfer pricing
and/or corporation) and no single shareholder has more principles taken by the ITO is often markedly different and
than five percent; counter to TP principles in any established tax jurisdiction.
■
Therefore, where there are related party (defined as where there
Companies with a gross annual turnover less than IDR4.8
is a direct or indirect 25 percent shareholding) transactions,
billion are eligible for a 50 percent rate cut, resulting in a
particular care must be taken.
flat rate of 14 percent for fiscal year 2009 and 12.5
percent for fiscal year 2010 and thereafter. This applies to Generally, there are no specific provisions in respect of thin
Indonesian companies, even if they are part of a far larger capitalisation. However, interest on excessive related party debt
worldwide group; may be disallowed as a tax deductible expense under the rules
■ Where gross annual turnover exceeds IDR4.8 billion but allowing for adjustments to be made where there are related
is less than IDR50 billion, the 50 percent rate reduction party transactions. Whilst there are no set limits for an
applies on the proportion of taxable income which results acceptable debt/equity ratio, a 3:1 ratio (as used as a guide by
when IDR4.8 billion is divided by the gross annual turnover; BKPM) is often used by tax auditors as a benchmark.
■ There is a branch profits tax levied at 20 percent on the
Indonesia has rules on the taxation of controlled foreign
post tax profits accruing in an Indonesian permanent
companies (“CFCs”). Broadly these rules apply to deem a
establishment of a foreign enterprise.
dividend to have been made from a company more that 50
D. Tax incentives percent directly owned by Indonesian resident shareholders.
There are a limited range of tax incentives available in Compliance requirements are rigorous and the penalties for
Indonesia. The incentive system includes both activity based non-compliance harsh. In addition, the need for taxpayers to
and geographically based components. These incentives settle an assessment prior to objecting or appealing has
include accelerated tax depreciation and an extension of the historically led to many adjustments being made on the basis of
maximum loss carry forward period to 10 years. fiscal budgetary pressures rather than technical merit.
Assessments of underpaid tax are subject to penalty interest
E. Withholding taxes and surcharges ranging from two percent per month to 100
Except where preferential tax rates or exemptions are provided percent of the unpaid tax, depending on the perceived
for under a tax treaty, payments to non-resident corporations transgression. Higher penalties apply if criminal acts have been
without a registered Indonesian permanent establishment are committed.
subject to final withholding tax at a rate of 20 percent. This
Tax strategies require careful consideration. In this regard a
includes dividends, financing costs, royalties and payments for
strong focus should be placed on complete documentation
services (whether or not rendered in Indonesia).
which has a detailed focus on the facts and circumstances of
Tax treaties to which Indonesia is party may provide for lower the Indonesian operational circumstances. Rigorous adherence
rates of withholding tax on dividends, interest and royalties of to processes and procedures (on an annual basis) is also
between 0 percent and 15 percent. required.
A final withholding tax is the amount of income tax withheld by A clear understanding of the potential issues that could be
a withholding agent which constitutes as a full and final raised by the ITO and the detailed/practical operational aspects
payment of the income tax due from the payee on said income. of the business (and transactions) are all essentials to reduce
The liability for payment of the tax rests primarily on the payor the risk of a lengthy and costly tussle with the ITO.
as a withholding agent.
On the other hand, a creditable withholding tax is tax withheld V. Conclusion
on certain income payments to domestic corporations or Whilst Indonesia has made some progress recently in the
permanent establishments. This is intended to equal or at least fields of foreign investment and tax law to provide clarity and
approximate to the tax due of the payee on said income. The encourage growth and investment, there remain a number of
income recipient is still required to file an income tax return to bureaucratic hurdles to investment and the application of laws
report the income and/or pay the difference between the tax and regulations is often inconsistent. In particular, transactions
withheld and the tax due on the income. If the tax withheld with related parties remain an area where there is significant
turns out to be greater that the tax due on the income it is uncertainty over tax outcomes.
possible to obtain a refund, but only after a tax audit has been
completed by the ITO. Graham Garven is a Tax Partner with KPMG’s Indonesian firm.
As a general rule, withholding tax arises at the time when Jim Nichols is a Tax Manager in KPMG London’s International
income is paid or payable to the non-resident or when it is Corporate Tax practice, specialising in Emerging Markets.
accrued as an asset or an expense in the books, whichever For further information, please contact the authors by email at:
comes earlier. graham.garven@kpmg.co.id and james.nichols@KPMG.co.uk
9
9
10
10
Tax treatment of cross-border
service activities
This article addresses the tax treatment of non-Indonesian enterprises carrying out service work in Indonesia. This could
be, for example, a consultancy business providing advice to clients in Indonesia and sending staff to work at the client’s
premises, or a manufacturing business selling heavy machinery to Indonesia and sending personnel to supervise its
installation. In either case the question will arise whether any part of the income is taxable in Indonesia under
Indonesian domestic law, and whether any relevant double tax treaty provides protection.
I. Introduction tax is also levied on net profits of any PE, after deduction of
corporate income tax or any final withholding taxes. The
The licensing and regulatory rules in Indonesia can be quite
branch profits tax may be reduced subject to any lower rate
complex. The applicable regulations will often depend on the
specified in a relevant tax treaty.
type of project at issue. For example, there are specific
regulations governing the power and telecommunications
sectors. In addition to understanding the relevant rules, III. Withholding tax on other Indonesian
investors must also consider the most appropriate business source income
structure for their role in the proposed project. Thus, it is
important to seek professional advice at the beginning of a In the absence of having a PE in Indonesia, a foreign
project in order to avoid unnecessary complications later. enterprise may still be subject to Indonesian withholding tax
on other income considered to be Indonesian source, which
generally means that it is derived from property or activities in
II. Indonesian permanent establishment (“PE”)
Indonesia. Such income is subject to final withholding tax of
A PE is defined in Indonesian domestic law as “running a 20 percent in Indonesia. This includes income from dividends,
business or carrying out activities in Indonesia.” This definition interest, royalties, technical assistance and service fees
is further clarified by a non-exhaustive list of activities that (whether the services are rendered in Indonesia or otherwise),
would result in a PE. Specifically, this includes the supply of rental and leasing income.
services in any form by an employee or other person for more
Furthermore, withholding taxes may apply to payments made
that 60 days in any 12-month period. A construction,
to an Indonesian PE of a foreign enterprise or local subsidiary.
installation or assembly project is also included on the list,
These include a creditable withholding tax (of 1.5 percent -
without specifying any minimum time period before a PE is
4.5 percent depending on the service) applicable to service
created.
fees paid to such a PE or subsidiary. Technical/management
A registered branch of a foreign enterprise is included in the services and most other services including consulting and
definition of PE. However, Indonesian tax law also provides for advisory fees are subject to a creditable withholding tax at two
the registration of an “unlicensed” PE – i.e. activities of a percent of gross income.
foreign enterprise in Indonesia that are taking place without
obtaining regulatory approval to set up a branch. Apart from discussion of the technical and practical
Notwithstanding the fact that such activities are technically requirements in respect of management and technical service
not allowed under the foreign investment laws, such a PE can fees are the issues of:
register for income tax and VAT and file tax returns as for a ■ Treatment of such expenses as “royalty” payments; and
registered branch.
■ Treatment of such payments as “deemed dividends”
The above definition of PE is fairly wide. As such, where where they are paid to connected parties and deemed to
cross-border services are being performed it is usually be excessive and therefore non-deductible for the payor.
preferable if the service provider is resident in a country with a
Royalties (which are widely defined under domestic law) are
tax treaty with Indonesia that can provide some protection
subject to a creditable withholding tax of 15 percent if paid to
(see below).
an Indonesian PE of a foreign enterprise or local subsidiary. A
Profits of a PE would generally be taxed as for a resident 20 percent final withholding tax applies to royalties paid to a
company and hence would be subject to 28 percent foreign resident without a PE. Treatment of service fees as
corporate income tax. In addition a 20 percent branch profits royalties may result if inadequate documentation is
11
11
Indonesia: Tax treatment of cross-border service activities
maintained. In Indonesia it is essential to have an agreement more than the minimum period specified. This minimum
in place which formalises the arrangement, sets out the types period generally varies from two months to six months (see
of services to be provided, the basis of operation of the table at the end of this article).
arrangement and the allocation basis of costs.
In the case of construction, installation or assembly projects,
Other specific considerations most of Indonesia’s tax treaties provide for a minimum period
of six months before a PE is created, although some provide
1. “Turnkey” contract model
for only three months. The recently signed treaty with North
Any turnkey type contract must be structured carefully to Korea is the only exception, with a 12 month period.
ensure that the offshore procurement activity and offshore
services, if any, are not subject to tax in Indonesia. The Where a treaty applies and the service activities performed fall
Indonesian Tax Office (“ITO”) takes the position that turnkey outside of the scope of the definition of a PE in the relevant
contracts are subject to withholding tax on the whole contract treaty, then service fees can be paid without deduction of
value (including equipment and offshore services) unless there Indonesian withholding tax in accordance with the “business
are provisions to the contrary in a relevant tax treaty. profits” article of the relevant treaty. However, under certain
circumstances service fees may be characterised as royalties
2. Purchase of goods
under Indonesian law. This could occur, for example, when
Purchases of goods and equipment from Indonesian suppliers the services included a transfer of knowledge or information
will be subject to VAT in almost all cases, but will not be when the service provider has the relevant intellectual property
subject to any withholding taxes. or “know how”.
Some types of projects are granted import facilities for
There are cases where companies enter into “combined”
equipment on a “Masterlist”. Purchases of “non-masterlist”
agreements, e.g. covering royalty or “know-how” matters as
goods and equipment from overseas suppliers will be subject
well as “service” fees. Such combined type of agreements
to import taxes:
present practical problems in Indonesia. The ITO is quick to
■ VAT at 10 percent; determine that all payments under the agreement should be
■
treated as payments for “know-how” and, accordingly, subject
Import duty and surcharges at variable rates;
to withholding tax – as a royalty. This will result in the
■ Income tax prepayment at 2.5 percent. imposition of a withholding tax assessment and penalties.
Income tax prepayments on imports can be offset against the
importer’s income tax liability for the same financial year. It can Where service fees fall to be treated as royalties, the
only be used for other purposes, or repaid, after tax audit payments will be subject to a final withholding tax of 20
verification. Exemption from prepayment may be requested percent under domestic law or to a lower rate to the extent
annually during the period before the importer has permitted by the relevant treaty. Most tax treaties have a
commenced trade. maximum royalty withholding tax rate of 10 percent-15
percent. However if procedures are not complied with in
terms of a Certificate of Tax Domicile (“CoD”) of the recipient
IV. The position under double tax treaties of the royalty, then the 20 percent domestic rate will apply. A
CoD must be renewed annually. It is essential that a
Most of the tax treaties entered into by Indonesia use
Certificate of Domicile of the supplier is on file with the
definitions of permanent establishment found in the OECD
Indonesian entity at the time payment is made.
Model Conventions (to which there are some modifications
drawn from the UN Model). Where such a treaty applies, this When considering the treatment of such fees, the
can therefore add significant protection for the service commentary to the OECD Model Convention provides
provider from creating a taxable presence in Indonesia or guidance on the distinction between service fees and royalties
being subject to Indonesian withholding tax on services that may be referred to in a treaty situation and may narrow
performed in Indonesia. In such a situation, a PE will generally the scope of what the ITO can argue to constitute royalties.
only be created in Indonesia where:
The Indonesian Tax Office may have regard to the “beneficial
■ The foreign enterprise has a fixed place of business in
ownership” issues and the foreign lender would have to
Indonesia through which the business of the enterprise is
demonstrate that it was beneficially entitled to the income in
wholly or partly carried on;
order to benefit from the treaty. Unfortunately the
■ The foreign enterprise has an agent in Indonesia with the circumstances in which the beneficial ownership concept
power to conclude contracts in the name of the would be applied are not well defined in Indonesian tax law
enterprise; or and therefore this may be subject to significant uncertainty.
■ The foreign enterprise furnishes services in Indonesia for
a specified minimum period of time.
V. Other points to be considered
In common with many Asia Pacific jurisdictions, there is a
specific “services PE” concept in most of the tax treaties to There are likely to be other considerations, besides those
which Indonesia is party (which usually draws on the wording referred to above, in deciding how to structure the provision of
in the UN Model in this respect). Where the relevant treaty services into Indonesia. For example, if the nature and extent
includes provisions based on the UN Model in relation to the of the services is such that a PE will definitely be created, then
furnishing of services, this would generally mean that a PE consideration may be given to setting up a local subsidiary to
would be created in Indonesia if employees or other personnel provide the services. A local subsidiary would not suffer the
of the foreign enterprise furnished services in Indonesia for branch profits tax, but would be required to deduct dividend
12
12
Indonesia: Tax treatment of cross-border service activities
withholding tax of up to the maximum rate prescribed by a Table

relevant tax treaty instead. Country/ Technical services Construction Services PE?
Territory withholding tax? project PE?
A PE generally offers more flexibility and fewer administrative China No 6 months 6 months
burdens in relation to its set up and operation. However, the France No 6 months 183 days
choice will depend on the specific circumstances of the Germany Yes – 7.5% 6 months No
activities and where a PE is feasible care must be taken to Japan No 6 months 6 months
ensure that only those profits attributable to the PE are Luxembourg Yes – 10% 5 months No
subjected to Indonesian tax. Pakistan Yes – 15% 3 months No

Switzerland Yes – 5% 183 days No
UAE No 6 months 6 months
VI. Conclusion UK No 183 days 91 days
USA No 120 days 120 days
Where services are being provided to an Indonesian taxpayer,
it is important to ensure that these are fully supported with
Michael Gordon was formerly a Tax Partner with KPMG’s
documentation evidencing active services and that activities
Indonesian firm.
do not in themselves create a PE. Where the creation of a PE
is unavoidable, consideration should be given to the legality of Jim Nichols is a Tax Manager in KPMG London’s International
such an operation, given the complex licensing procedures, Corporate Tax practice, specialising in Emerging Markets.
and ultimately to the attribution of taxable profits of the PE. In For further information, please contact Graham Garven of
many cases it may be necessary to establish an Indonesian KPMG Indonesia and Jim Nichols by email at: graham.garven@
subsidiary to remain within the licensing regulations. kpmg.co.id and james.nichols@KPMG.co.uk
13
13
14
14
Holding and financing strategies
for investment
A foreign direct investment into any country requires planning on how to hold the investment, whether directly from the
investing parent, or through one or more tiers of intermediate holding companies, how to finance it, whether wholly by
equity or through a mixture of debt and equity, and in the latter case how to structure the debt.
We shall consider each of these aspects in turn below. As can be seen from the analysis of some of the other countries
in this report, some of these issues are common to other jurisdictions, whereas others are more peculiar to Indonesia.
I. Holding company strategies The tax treaties to which Indonesia is party typically provide
for a reduced rate of interest withholding tax of 10-15 percent.
In general, holding company strategies may be intended to
The only major treaty with a provision for a rate lower than this
achieve any or all of the following objectives:
is the treaty recently negotiated with the Netherlands. This
■ To reduce withholding tax on dividends in the source provides for a 0 percent rate on interest on loans with a term
country (Indonesia) or direct tax on dividends received in of more than two years. However, a circular letter
the residence country; (SE-17/PJ/2005) issued by the Indonesian Director General of
■ To mitigate any tax on capital gains either in the source Taxation on June 1, 2005 states that the “Competent
country or the residence country on disposal of the Authorities” of the Netherlands and Indonesia have not yet
shares to a third party or within the group. discussed the law to implement this, as required by the treaty.
As such the Indonesian tax authorities have denied the use of
The following analysis deals with the source country issues
the 0 percent rate and instead require tax to be withheld at 10
only, from the perspective of a foreign investor in Indonesia.
percent until such time as a procedure is adopted.
A. Indonesian domestic law position
The Indonesian Tax Office may have regard to “beneficial
Under the Indonesian Income Tax Law, dividends and interest ownership” issues and the foreign lender would have to
paid to non-resident shareholders are subject to 20 percent demonstrate that it was beneficially entitled to the income in
withholding tax, whilst the sale of unlisted shares by order to benefit from the treaty. Unfortunately the
non-residents is subject to a five percent final withholding tax circumstances in which the beneficial ownership concept
on the gross sales proceeds or market value, if greater. would be applied are not well defined in Indonesian tax law
and therefore this may be subject to significant uncertainty.
Foreign investors are subject to the same special tax rules on
Export credit agencies or other foreign government provided
sale of listed shares as Indonesian investors, such that a tax
loans are usually exempt from withholding tax pursuant to tax
of 0.1 percent applies on the gross value of the transaction.
treaties.
Interest costs are generally deductible in Indonesia, subject to
provisions denying a deduction on related party debt deemed In order to take advantage of reduced tax treaty rates or
to be excessive (see below). exemptions, a certificate of domicile must be obtained from
the tax authority in the jurisdiction in which the foreign
B. Double tax treaties shareholder is a tax resident.
Shareholders resident in a country with a double tax treaty
with Indonesia may benefit from a reduced rate of dividend II. Financing strategies
withholding tax of 10 percent or 15 percent (see table at the
As discussed above, for foreign lenders in treaty countries, a
end of this article). Thus, for foreign shareholders, total
reduced interest withholding tax rate of 10 percent or 15
Indonesian taxes on profits will range from 35.2 percent to
percent generally applies. As interest is generally a tax
42.4 percent (28 percent income tax plus withholding tax on
deductible expense, debt financing is usually preferable to
dividends) in 2009.
equity financing from an Indonesian tax point of view, as it
Furthermore, most tax treaties provide for an exemption from achieves a saving of both corporate income tax and dividend
Indonesian tax on gains realised by a non-resident withholding tax, the combination of which would be greater
shareholder on shares in an Indonesian company. However than the interest withholding tax burden. Related party debt
some of these do not permit an exemption in cases where the can also be used to finance an Indonesian PE of a foreign
assets of the company whose shares are transferred consist enterprise in a similar way to an Indonesian subsidiary,
principally of Indonesian immovable property. although it should be noted that loans from the head office or
15
15
Indonesia: Holding and financing strategies for investment
branches of the same enterprise will not generate tax B. Deductibility of finance costs for an acquisition of
deductible interest, except in the case of PEs of banks. shares
There are no specific thin capitalisation rules in the tax law. As noted above, interest on loans taken out by an Indonesian
However, the loan to equity ratio is fixed by the BKPM company to acquire a 25 percent or greater share in another
approval. 25 percent equity is normal, but higher gearing may Indonesian company is generally not tax deductible and so
be permitted where this can be justified commercially. In this strategy would not be effective in such circumstances.
addition interest on excessive related party debt may be Additionally there is no group taxation modus available in
disallowed as a tax deductible expense under the rules Indonesia. Therefore, in order to be part of an effective tax
allowing for adjustments to be made where there are related planning strategy any interest expense will need to arise in the
party transactions. Whilst there are no set limits for an hands of a company which has sufficient taxable income
acceptable debt/equity ratio, a 3:1 ratio is often used by tax against which to utilise it.
auditors as a starting point.
One further notable exception, where interest is not tax One strategy could be for the foreign investor to acquire the
deductible, is where the loan has been taken out for the shares directly, with the Indonesian target subsequently
purpose of acquiring shares in an Indonesian company in borrowing funds to effect a share buy-back. However, this
circumstances where the dividends that may arise from those option is likely to run into difficulties in securing the necessary
shares would be non-taxable in the hands of the shareholder. regulatory approval from BKPM in relation to granting approval
This generally applies where an Indonesian company holds at for the foreign enterprise to invest into Indonesia.
least 25 percent of the shares in another Indonesian company.
As such leveraging a share acquisition of an Indonesian target
Interest expense is recognised on an accrual basis for tax and in a way that will give rise to deductible interest expense is
accounting purposes. Rolling-up unpaid interest does not likely to be difficult to achieve.
alter the timing of deduction, or withholding tax obligations.
Foreign exchange differences on borrowings, whether realised III. Conclusion

or not, are taxable/deductible in the period they arise.
However it is possible to structure a loan so that it is Indonesia has a fairly extensive double tax treaty network and
economically denominated in IDR. This could be achieved for multinationals may find that they can obtain tax savings on an
example by having a loan agreement economically in IDR, but investment depending on the vehicle used. Leveraging may
specifying that the settlement currency was USD at the also be possible to increase tax deductions although there
prevailing USD-IDR exchange rate. may be restrictions on the level of debt at initial approval stage
and care must be taken to ensure that the debt is not seen as
One further alternative, which achieves much the same result being utilised for the financing of equity or interest costs may
would be to make a USD, combined with a USD-IDR swap be treated as non-deductible.
agreement between the parties, so as the loan plus the swap
are economically equivalent to an IDR loan. Below is a table setting out the key features of selected treaties.
A. Bank financing
Table
Interest and fees payable to an Indonesian bank and other Country/ Capital gains Maximum Interest
financial institutions are not subject to withholding tax. Territory protection on dividend Withholding Tax
share disposal? withholding taxa
Indonesian banks include banks established in Indonesia, as
well as branches of foreign banks which have been granted Australia No 15 10
operating licenses in Indonesia. China Yesb 10 10

Kuwait Yes 10 5
The overseas branches of Indonesian established banks Netherlands Yes 10 10c
should similarly be exempt from withholding tax, however this Portugal Yes 10 10
has not always been accepted by the Indonesian Tax Office. Switzerland Yes 10 10
In principle, a “back to back” arrangement could be entered UAE Yes 10 5
into with an international bank whereby an IDR loan to the UK Yes 10 10
Indonesian subsidiary is granted by an Indonesian branch of USA Yes 10 10
the bank, with a corresponding deposit made by the foreign a Assuming a 25% or greater holding; UK shareholding requirement is only 15%.
parent at a branch in its home country. This has the benefit of b Except where assets of the Indonesian company comprise principally of
immovable property located in Indonesia.
eliminating interest withholding taxes. However, either the
c 0% rate if on loan with a term of more than 2 years. However ITO deny
bank or the foreign parent would need to bear the foreign this in practice.
exchange risk. This could be managed by either making a
payment to the bank to bear this risk or entering into an
Graham Garven is a Tax Partner with KPMG’s Indonesian firm.
appropriate instrument to ensure that the overseas deposit is
economically in IDR. In either case there will be practical Jim Nichols is a Tax Manager in KPMG London’s International
issues to address and the additional expenses incurred may Corporate Tax practice, specialising in Emerging Markets.
not be justified by a potential interest withholding tax saving of For further information, please contact the authors by email at:
10 percent. graham.garven@ kpmg.co.id and james.nichols@KPMG.co.uk
16
16
Investing in real property:
Some key tax aspects
The law relating to real property in Indonesia can be complex. This article gives an introduction to some of the aspects
that may be relevant to the tax structuring of Indonesian real property.
I. The legal framework billion (approximately USD4.5m). (Refer to the article Indonesia:
The tax and legal framework)
A foreign investor may invest in Indonesian real property
through a wholly foreign-owned company or in a joint venture There is a 20 percent withholding tax on interest, dividends,
company with a local partner. These are referred to as “PMA” royalties and other fees payable outside the country, which is
companies, which is a category of limited liability company generally reduced to 10-15 percent by tax treaties. The
where some or all of the shares are owned by foreign non-resident must provide the PMA company with a certificate
shareholders. A foreign investor can either establish a new of tax domicile from the competent tax authority in the country
PMA company or it can acquire an existing PMA company; of residence in order to take advantage of the tax treaty.
similar rules apply to both methods.
A PMA company may obtain the right to lease, build on or use B. Deductions
land for between 70 and 95 years, depending on which right is
In respect of income to which a final withholding tax applies,
obtained and each of these is renewable simultaneously for
expenses relating to rental income are not deductible, including
between 45 and 60 years with a further shorter renewal period
interest, depreciation and other costs. In respect of other
available on later application.
income, interest should be allowed as a deductible item, unless
In some situations, where property is being developed, the such charges are from a related party and are in excess of
property developer does not own the land and there is a commercial rates.
common practice of “BOT” (Build Operate Transfer)
arrangements. In such arrangements, a property developer Land is not depreciable, except for plantation and certain other
contracts with a landowner to construct a property on the industries. Depreciable assets other than building and
owner’s land at the developer’s cost. The developer will construction are specified by tax regulation to fall into one of
manage the property and will receive the income generated by four asset categories according to the type of asset. Building
the property for a predetermined period. The landowner will and construction are divided into permanent and
receive a ground rent during the “operating” period and at the non-permanent structures. Buildings and other immovable
end of the period, the building will revert to the landowner. property are depreciated based on the straight line method at
five percent (permanent) or 10 percent (non-permanent).
Where a foreign company operates as a branch, no investment
in real estate would be permissible. Generally, tax losses in respect of income not subject to final
withholding tax can be carried forward for five years beginning
II. Outline of ongoing tax position of an the first year after such loss occurs.
Indonesian real estate company C. Other annual taxes
A. Income There is an annual tax on land and buildings. Tax is imposed at
Rental income on real estate is subject to final withholding tax an effective rate of 0.1 percent for properties with an appraised
at an effective rate of 10 percent from gross rental. This is value of less than IDR1 billion, and 0.2 percent for properties
normally withheld by the lessee. However, if the lessee has not with an appraised value over IDR1 billion, or for certain
been appointed as a tax withholder, the tax should be self-paid businesses (e.g. plantations). The appraised value is fixed every
by the taxpayer who receives the income. There is then no three years in most cases. Although the owner is normally
further tax on the rental income. responsible for paying the tax due on rented property, the lease
Other income of a real estate company, for example from agreement can specify who is liable for this tax.
property management, may be subject to income tax at the
general corporate rates as follows: III. Outline of tax consequences of a disposal
2009 fiscal year 28% Broadly, there are three options for structuring a disposal of the
2010 fiscal year and thereafter 25% property, the tax consequences of each of which are outlined below.
A reduction in rates may apply if revenues are less than IDR50 ■ A direct disposal of the property itself;
17
17
Indonesia: Investing in real property: Some key tax aspects
■ A disposal of the shares in the Indonesian company by various tax treaties, for example, the Netherlands (10 percent),
the foreign shareholder; Australia (15 percent), Singapore and many others (15 percent, or
■ A disposal of the shares in an offshore holding company 10 percent if 25 percent shareholding). If profits are retained in the
above the Indonesian company. company rather than distributed as dividends, withholding taxes
are not imposed until the distributions are declared.
A. Disposal of the property
Although the company law permits a company to issue shares
Proceeds from the sale of land and building by a company are of different classes, preference shares and redeemable shares
subject to a five percent withholding tax on the sale value, are extremely unusual. Investors have so far been reluctant to
which is a final tax. undergo the delays and uncertainty of seeking approval for
Additionally, there is a five percent transfer tax on the sale of such arrangements.
land and buildings that is payable by the purchaser. As a result, shareholder debt arrangements are a common
means to enhance the return to investors relative to a pure
B. VAT
equity holding.
VAT at a rate of 10 percent applies to real estate transactions.
Royalties and technical assistance/management fees can be
In addition to 10 percent VAT, there is a 20 percent sales tax on paid where a foreign shareholder or other entity provides
apartments of more than 150 square meters or if the price is more support services relating to the Indonesian project. An
than IDR4 million/square meter. Care is therefore required in relation Indonesian withholding tax is imposed at the applicable tax
to apartment properties in case the vendors have previously treaty rate (generally 10-15 percent). Technical assistance fees
engaged in dubious transactions aimed at avoiding this tax. are subject to withholding tax unless they represent active
services under a relevant tax treaty. Passive services are treated
C. Conveyancing taxes/stamp duties
as a form of royalty. Fees for travelling to Indonesia to
A nominal stamp duty of either IDR3,000 or IDR6,000 applies undertake a specific property review for the Indonesian
to certain documents, such as receipts, agreements, and company could be treated as an active service. Note, however,
notarial deeds. that where a business is subject to final tax, such as property
rental, these charges (royalties, technical
D. Disposal of shares in an Indonesian real estate
assistance/management fees) are not tax deductible.
company
There is a five percent tax on the disposal of shares in an V. Leveraging the investment
unlisted Indonesian company. This is based on the sale price,
irrespective of any actual gain or loss. Many treaties provide for The Investment Coordinating Board (“BKPM”) generally will
an exemption from this tax, however some of Indonesia’s tax consider that initial debt funding should normally not exceed 75
treaties deny this exemption if the assets of the Indonesian percent of total investment. The local entity should report the
company are principally immovable property located in debt to Bank Indonesia.
Indonesia. Therefore, the shareholders of the Indonesian There are no thin capitalisation restrictions for tax purposes.
subsidiaries ideally should be resident in a country with an Where there is a special relationship between taxpayers, the tax
advantageous treaty and an exemption from any gains realised office can re-determine the amount of income and/or
on the shares in their home jurisdiction. deductions, and reclassify debt as equity in determining taxable
E. Disposal of shares in an offshore holding company income. Nevertheless, convertible debt and subordinated loans
are commonly encountered and these are treated as debt for
Indonesia does not generally seek to assert extra-territorial tax purposes.
taxing rights in this situation. However, the income tax law now
However, where a final withholding tax applies to a particular
contains a provision which may allow Indonesia to tax the sale
income stream, there is no deduction for interest against the
of shares in an offshore special purpose vehicle holding
relevant income and therefore leveraging the investment may
company as if the sale was of the shares of the Indonesian
not be tax efficient.
subsidiary.
IV. Structuring the investment VI. Conclusion

There are several factors to consider when selecting the The new investment law has relaxed previous restrictions on
structure of the shareholding, in particular, the tax treaty real estate ownership and it would now seem that there is
provisions relating to dividends and disposal of shares by greater flexibility for foreign investors to obtain land on a
non-residents. long-term lease basis. Income earned from real estate
investment is subject to a final tax and therefore care must be
A. Profit repatriation taken in structuring investments to avoid tax leakage from
Foreign currency can be freely remitted into and out of non-deductible costs, including interest.
Indonesia. For a foreign investment project the Foreign Michael Gordon was formerly a Tax Partner with KPMG’s
Investment Law further guarantees this position. There are Indonesian firm.
certain restrictions on remittances of local currency and there Jim Nichols is a Tax Manager in KPMG London’s International
are reporting requirements for foreign currency purchases Corporate Tax practice, specialising in Emerging Markets.
exceeding USD100,000 per month.
For further information, please contact Graham Garven of
Dividends to foreign shareholders are subject to a withholding tax KPMG Indonesia and Jim Nichols by email at: graham.garven@
of 20 percent. This is generally reduced to 10-15 percent under kpmg.co.id and james.nichols@KPMG.co.uk
18
18
China

KPMG LLP, London and KPMG Huazhen, Shanghai
In this article on China we look at: applicable company law; the foreign direct investment framework; exchange
control; and the corporate tax system.
I. Applicable company law Foreign companies in certain industries such as banking,

insurance and shipping may set up branches in China, which
Chinese company law is based on the Company Law of the are not separate legal entities in China.
People’s Republic of China (the “CL”), promulgated on October In general, most foreign direct investment is subject to an
27, 2005. Essentially the CL allows two types of companies, approval process, which, depending on the size of the
namely the “joint stock company” (“JSC”, very broadly investment, is governed by the central or local authorities. The
equivalent to the European plc/ SA/ AG legal form) and the rules which provide guidance for foreign investment in China
limited liability company (“LLC”, broadly equivalent to the were overhauled in 2004 and distinguish four areas of the
French Sarl or the German GmbH). Only the JSC is allowed to economy:
issue shares to the public.
■ The prohibited sector, including projects regarded as
In general, for both types of company, once share capital has endangering state security or the public interest, projects
been issued it cannot be repaid or redeemed. Dividends may that cause pollution or endanger health, and projects that
be paid only out of after-tax profits, after making good past use large areas of agricultural land;
years’ losses and subject to any compulsory transfers to ■ The restricted sector, including areas where there is a
reserves. The general rule on such transfers is that 10 percent state monopoly and extraction of mineral resources;
of after-tax profit must be transferred to a statutory reserve,
■ The encouraged sector, for example certain high
until such reserve has reached 50 percent of the paid-in capital.
technology activities, activities relating to re-use of
However, in the special case of an Equity Joint Venture (“EJV”:
resources, activities relating to environmental protection,
see below), the specific legislation referred to below prescribes
and investment in the central and Western regions of
that it is the Board of Directors that decides the proportion of
China; and
after-tax profit to be transferred to the various reserves. Hence,
the percentage stipulated in the CL is not applicable to EJVs. ■ The permitted sector, which covers all other activities.
Investment in the restricted sector requires central government
II. The foreign direct investment framework approval if the investment exceeds USD50 million, whereas in
the permitted and encouraged sectors the local authorities can
Foreign direct investment can take three main forms: approve investments up to USD100 million. All investments in
■ A Wholly Foreign Owned Enterprise (“WFOE”), governed excess of USD100 million require approval of the National
by the law of October 31, 2000 and the related rules and Development and Reform Commission (“NDRC”) in the central
regulations; this should generally take the legal form of an government.
LLC;
■ An Equity Joint Venture, governed by the law of March 15, III. Exchange control
2001 and the related rules and regulations; this must take China has a comprehensive exchange control system, which is
the legal form of an LLC, and the Chinese shareholder administered largely by the State Administration of Foreign
must be a company rather than an individual; or Exchange (“SAFE”). Some of the foreign investment into a
■ A Co-operative Joint Venture, governed by the law of WFOE or joint venture company can generally be made in the
October 31, 2000 and the related rules and regulations; form of debt from other group companies outside China. When
this may take the form of an LLC or simply of a the company is first registered, the authorities will require a
contractual relationship (which in China does not have certain proportion of the total investment to be made in the
separate legal personality), but it must prepare accounts. form of equity rather than debt; the percentage of equity
19
19
China: The tax and legal framework
required depends on the amount of the investment, so for percent for FIEs in Coastal Open Economic Zones, 15 percent
investments above USD36 million up to two-thirds of the for manufacturing FIEs in Export Processing Zones, etc.).
investment can be made as debt, whereas for lower investment The CITL and its Implementation Rules set out the following
amounts higher equity percentages are required. In addition, general principles related to tax depreciation:
more stringent requirements are imposed on the capitalisation
■ Tax depreciation is generally available on fixed assets
of real estate foreign-invested enterprises (“FIEs”). For instance,
connected with the enterprise’s business operations,
under a notice issued by the SAFE in July 2007, foreign debts
provided, in the case of assets other than buildings and
to real estate FIEs established on/after June 1, 2007 are no
structures, they are assets put into operational use;
longer allowed.
■ Some more favourable tax depreciation treatments are
provided under the CITL and its Implementation Rules,
IV. Corporate tax system
e.g. there is no restriction on the residual value of fixed
A. The tax reform assets under the CITL in contrast to the old regulations
applicable to FIEs where the residual value of the fixed
On March 16, 2007, the National People’s Congress
assets should be at least 10 percent of their costs; the
promulgated the new Corporate Income Tax Law of the
minimum depreciation periods for transportation vehicles
People’s Republic of China (“CITL”), which has taken effect
other than aircraft, trains, vessels and electronic
from January 1, 2008. The new law replaces the old dual tax
equipment are reduced from five years (provided under
system, whereby domestic and foreign owned enterprises were
the old regulations), to four and three years respectively;
subject to different sets of tax rules, with a single tax system
■ Tax depreciation is also available on intangibles
applicable both to domestic enterprises and Foreign
Investment Enterprises (i.e. enterprises with a foreign connected with the enterprise’s business operations, but
participation of at least 25 percent). As is usual with Chinese not on self-generated goodwill or on intangibles in relation
legislation, the actual law sets out only the broad framework of to which the development expenditure has been claimed
the new system. The Implementation Rules which were issued as tax deductible;
by the State Council in December 2007 provide more details, ■ Tax depreciation on fixed assets and intangibles should
however, the rules are still silent on some key areas (e.g. tax be calculated using the straight-line method.
treatment on various reorganisation transactions). Therefore, Tax losses can be carried forward for a maximum period of five
the CITL and its Implementation Rules are likely to leave ample years. No carry-back of losses is allowed.
discretion for the Ministry of Finance and/or the State
Unless specifically allowed by the State Council, enterprises are
Administration of Taxation which have been issuing circulars
not allowed to file tax returns on a consolidated basis.
specifying further details on how the new rules are to be
applied. However, it is still expected that there is likely to be C. Tax incentives
continuing uncertainty on many of the detailed aspects of the new
By contrast with the old geographically based incentive system,
rules although the CITL has taken effect for more than a year.
under the new law, incentives are based on type of activity or
As will be seen below, underlying the new law is a shift from the size of business. Specifically, “high tech” enterprises will qualify
previous policy of subsidising the import of capital to a more for a 15 percent tax rate, and small-scale enterprises with
neutral approach where imported capital is taxed on a level “small profits” will be taxed at 20 percent.
playing field with domestic capital.
Enterprises are required to obtain recognition of being
B. Fundamental principles “high-tech” enterprises in accordance with the new recognition
criteria and procedures in order to enjoy preferential tax
The new law introduces a concept of residence based either on treatments.
incorporation or effective management (whereas the old law
Small-scale enterprises are defined as industrial enterprises of
effectively bases residence – while not using that term – solely
which the taxable income for the year should not exceed
on incorporation). In common with the old law, the new law
RMB300,000, total employees should not exceed 100, and
also has a concept of PE (“an establishment or place of
total assets should not exceed RMB30 million; or as other
business in the PRC”). Non-resident companies are taxable at
enterprises of which taxable income for the year should not
the normal corporate tax rate (see below) on the profits
exceed RMB300,000, total employees should not exceed 80,
attributable to such “establishment”. By contrast, the profits of
and total assets should not exceed RMB10 million.
a non-resident enterprise that are not attributable to such
“establishment” will be subject only to the withholding tax The State Council stipulates the grandfathering treatments for
described further below under withholding taxes. enterprises with business licences dated prior to March 16,
2007 that are entitled to preferential tax treatments under the
A Chinese resident company is taxed on its worldwide profits.
old laws.
However, losses of foreign branches are not deductible in China.
For CIT rates:
Dividends paid by a Chinese resident company to another
qualifying Chinese resident company are exempt from Transitional treatments for the reduced rate of 15 percent under
corporate taxation, whereas dividends received by Chinese the old laws will be as follows:
resident individuals are taxed at 20 percent.
Table
The corporate tax rate under the new law is 25 percent (down 2007 2008 2009 2010 2011 2012
from 30 percent plus three percent local tax). In principle this 15% 18% 20% 22% 24% 25%
applies across the country, in contrast to the old system where
a tax rate of 15 percent applies in Special Economic Zones and The 24 percent reduced rate under the old tax laws will transit
reduced rates applying in other special economic areas (e.g. 24 to the standard CIT rate of 25 percent immediately from 2008.
20
20
China: The tax and legal framework
D. Withholding taxes H. Transfer pricing

The new law stipulates a 20 percent tax rate for Chinese The State Administration of Taxation released key transfer
sourced income of a non-resident who does not have an pricing regulations in January 2009, which guide the
“establishment or place of business in China” (normally to be implementation of special taxation adjustment matters covering
levied by withholding tax). Such tax rate is reduced by the State transfer pricing, advance pricing arrangements,
Council in the Implementation Rules to 10 percent. “Chinese contemporaneous documentation, cost sharing agreements
sourced income” includes dividends, interests, rentals, royalties (“CSAs”), CFC, thin capitalisation and general anti-avoidance
and gains from transfer of property derived by a non-resident as formulated under the new law and its Implementation Rules.
enterprise.
The regulations are retroactively effective from January 1, 2008.
Under the old Foreign Enterprise Income Tax Law (“FEITL”, For 2008 tax years onwards, taxpayers in China have to
Article 19), there is an exemption from dividend withholding tax comply with the following requirements each year:
for dividends paid by FIEs. The CITL and its Implementation
■ Annual filing consisting of nine forms detailing related
Rules contain no such exemption. However, enterprises may
seek double tax treaty protection under the relevant double tax parties and related-party transactions;
treaties. It is also now clarified that any dividends paid out of ■ Contemporaneous documentation with detailed content
pre-2008 retained earnings will still be exempted from the requirements. However, the contemporaneous
withholding tax even if paid in 2008 or a subsequent year. documentation is not required for companies meeting
certain criteria;
E. Reinvestment relief ■ Additional documentation for CSAs for taxpayers who
Under Article 10 of the FEITL, a refund of Chinese corporate have CSAs in place; and
income tax is made to foreign investors who reinvest their share ■ Additional documentation regarding thin capitalisation
of the profits of an FIE. The refund is generally 40 percent of the financing for taxpayers whose lending exceeds the
tax paid by the FIE on the corresponding profits. No similar debt-equity safe-harbour limits.
mechanism is envisaged under the new law.
The regulations come at a challenging time for many
F. International aspects multinational corporations. In addition to having to adjust to the
sudden decrease in demand caused by the current economic
As stated earlier, the new tax system, like the old one, is based
crisis, enterprises are now facing an increased risk of a transfer
on taxation of worldwide profits of Chinese companies,
pricing audit.
wherever arising. Subject to the Controlled Foreign Company
(“CFC”) rules discussed below, it appears that under the new
system the profits of foreign subsidiaries will be taxed only V. Turnover taxes
when distributed up to the Chinese parent. The new law In addition to the corporate income tax reform and the new
provides unilateral double tax relief for withholding tax, and, transfer pricing rules, the State Council issued revised
subject to holding a controlling participation, underlying tax; the Value-added Tax (“VAT’), Business Tax (“BT”) and Consumption
working of the legislation is unclear but suggests it is intended Tax (“CT”) regulations and their Implementation Rules in late
to give the relief regardless of the number of tiers of 2008, which could have a significant impact on the operation of
shareholdings involved. The relief is subject to a maximum the enterprises which are liable to these types of taxes.
equal to the Chinese tax liability on the income. Under the old
system, the tax credit is computed on a country-by-country In view of the reforms of the VAT, BT and CT regimes,
basis; this method is adopted under the new tax system. taxpayers are recommended to study these regulations and
Unrelieved foreign tax credits can be carried forward up to five rules and to assess the impacts of these regulations and rules
years. on their operation, based on which the taxpayers can take
proper arrangements/plannings to reduce their tax costs or to
G. Anti-avoidance minimise the tax risks.
The CITL and its Implementation Rules contain CFC rules
whereby, where a foreign enterprise controlled by VI. Conclusion
China-resident enterprises (or individuals) is located in a China is still a highly regulated environment and there are still
jurisdiction that has a tax rate less than half of China’s (i.e. less many additional constraints compared with those faced in
than 12.5 percent), the portion of the enterprise’s profits many western countries. However, the new corporate tax
attributable to Chinese shareholders will be taxed immediately system as well as the reforms on VAT, BT and CT represent a
in China, unless there are “reasonable business needs” for major step towards a modern tax and legal framework where
retaining the profits. there is clarity on the rules for the taxation of business profits.
There is also the “thin capitalisation” rule whereby interest on The new tax system broadly creates a level playing field
related party borrowings in excess of a prescribed debt/equity between imported and domestic capital and can be expected
ratio is disallowed. The debt-equity safe-harbour limits are 5:1 to favour the development of privately owned Chinese
and 2:1 for financial institutions and other companies enterprises and their growth outside China.
respectively. Mario Pettricione is a Director of International Corporate Tax
Finally, the new law contains a general anti-avoidance rule and may be contacted by email at:
mario.petriccione@kpmg.co.uk
whereby, where enterprises have entered into transactions that
do not have reasonable business purpose, the tax authorities William Zhang is a Senior Tax Manager and may be contacted
have the power to make reasonable adjustments to those by email at: william.zhang@kpmg.com.cn
enterprises’ taxable profits or revenue. © KPMG (UK) LLP 2008
21
21
22
22
service activities
This article addresses the tax treatment of non-Chinese enterprises carrying out service work in China. This could be, for
example, a consultancy business providing advice to clients in China and sending staff to work at the clients’ premises,
or a manufacturing business selling heavy machinery to customers in China and sending personnel to supervise its
installation. In either case the question will arise whether any part of the income is taxable in China under Chinese
domestic law, and whether any relevant double tax treaty provides protection.
Under the new Corporate Income Tax Law (“CITL”) enacted

II. Withholding tax on other Chinese-source
on March 16, 2007 and which has entered into force on income
January 1, 2008, a foreign enterprise is taxable in China under In the absence of an “establishment or place of business”, a
two alternative scenarios: foreign enterprise will be taxable in China on other income
regarded as having a Chinese source. Again, the Implementation
■ If the enterprise has an “establishment or place of Rules of the CITL define this concept as follows:
business” in China, then such enterprise is subject to the
normal 25 percent corporate income tax rate on the ■ Profits (dividends) earned by enterprises in China;
Chinese-source income of the “establishment” and on ■ Interest derived within China (on deposits, loans, bonds,
non-Chinese source income effectively connected with advance payments made provisionally on another
such “establishment”; person’s behalf, or on deferred payments);
■ In all other cases, Chinese source income of a ■ Rentals on property leased to and used by lessees in China;
non-resident enterprise is subject to a 20 percent tax rate ■ Royalties such as those received from the provision of
under the CITL, normally by way of withholding tax, patents, proprietary technology, trademarks and
which is reduced to 10 percent under the Implementation copyrights for use in China;
Rules of the CITL issued by the State Council in
■ Gains from the transfer of property, such as houses,
December 2007.
buildings, structures and attached facilities located in
China and from the assignment of land-use rights within
I. “Establishment or place of business” China;
■ Other income derived from China and stipulated by the
The concept of “establishment or place of business” is
Ministry of Finance or the State Administration of Taxation
defined in the Implementation Rules of the CITL as an
(“SAT”) to be subject to tax.
establishment or a place of business that is engaged in the
production and business operations in the PRC, which is So, generally, where there is no “establishment or place of
along the concept under the old law. Examples are business” in China, fees for services are not subject to tax by
“management organisations, business organisations, way of withholding tax either.
administrative organisations, and places for factories and the
exploitation of natural resources, places for construction, III. The position under double tax treaties
installation, assembly, repair and exploration work, places for
In view of the wide definition of “establishment or place of
the provision of labor services and business agents”. It is
business” in domestic law, it is usually desirable to ensure that
obvious that this is a very wide definition. First, there is no
the enterprise providing the services is protected by an
requirement of permanence: an “establishment or place of
appropriate double tax treaty. Most treaties, of course, have a
business” can be a very short-lived presence. Secondly, the
narrower definition of “permanent establishment” (“PE”) than
definition would seem automatically to catch any construction,
the above definition of “establishment or place of business”. In
installation or assembly project, as well as any business
particular, as a general rule, treaties provide that a permanent
agent. Thirdly, the meaning of “places for the provision of
establishment exists only if either:
labour services” is also potentially very wide; it would seem to
cover many cases where the foreign enterprise sends ■ The foreign enterprise has in China a fixed place of
personnel to the premises of the customer in China to business through which the business of the enterprise is
execute or complete the work. wholly or partly carried on; or
23
23
China: Tax treatment of cross-border service activities
■ The foreign enterprise has in China an agent with power by the SAT, with regards to the interpretation of “month” in the
to conclude contracts in the name of the enterprise. double tax arrangement between Mainland China and Hong
In relation to services, many of China’s treaties provide for an Kong. According to Circular 403, the Mainland will take the
additional category of PE, namely the “services PE” concept period from the month in which an employee of a Hong Kong
in the UN Model Treaty. This provides, broadly, that there is a enterprise arrived in the Mainland for furnishing services, up
PE of the foreign enterprise if the foreign enterprise furnishes until the month in which the project was completed and the
services “through employees or other personnel engaged for employee left the Mainland, as the relevant period. Even if the
that purpose”, if such activities continue for longer than a employee is present in the Mainland for one day in a particular
specified period (six months in the UN Model) within any month, it will be treated as one month. If during this relevant
12-month period. As will be seen in the table, some of China’s period, no service was provided by the employee in the
treaties, namely the ones with Cyprus, Hungary and Mauritius, Mainland for a period of 30 consecutive days, one month can
extend this six-month period to 12 months, of course so be deducted.
making it less likely that the service activities result in the
existence of a PE under the relevant treaty. The treaties with Although Circular 403 relates specifically to the double tax
the United Kingdom and Ireland are exceptions and do not arrangement between Mainland China and Hong Kong, it may
provide for such a “services PE” concept. have an impact on the way the tax bureau interprets “month”
for other tax treaties. The tax bureau may potentially adopt the
In this regard, an interesting point is that, following revision of restrictive interpretation of “month” as provided in Circular 403
the commentary to the OECD Model in 2003, the OECD for other tax treaties.
interprets the “fixed place of business” concept as potentially
covering a situation where an enterprise carries out services So, to what extent can a foreign enterprise choose which
work at a customer’s premises (see paragraph 4 of the treaty to rely on for protection? The opportunity that many
commentary to Article 5, particularly the example in paragraph multinational enterprises take up is to set up a company in the
4.5 of the painter who spends three days a week at a client’s jurisdiction chosen as having the appropriate protection in its
premises over a two-year period). In this regard, it may be that treaty with China, and conclude and perform the contract for
treaties that follow the UN Model and contain a clear rule on the services in question through that company. Careful
when the provision of services gives rise to a PE provide thought needs to be given to the degree of substance
better protection than treaties based on the OECD Model, required by the company; for example:
where there is far more uncertainty on the circumstances
where a service activity conducted at a client’s premises gives ■ Does the company need to employ the staff performing
rise to a PE. the contract or is it enough for the staff to be seconded
to it?
Another important difference among the PE Articles of China’s
■ What level of substance does the company need in its
treaties is in the duration that a construction, installation or
assembly project needs to have before it is regarded as a PE. chosen home country?
Normally, this is six months, but, as shown in the table, the ■ Who should be the directors of the company?
treaties with Cyprus, Hungary and Mauritius allow 12 months.
The above are all difficult questions that will require advice in
In determining the number of “months”, one may make each individual case. The Chinese tax authorities have not so
reference to Guoshuihan 2007 No.403 (“Circular 403”) issued far taken a great amount of interest in cases of treaty abuse,
Table
Country/ territory Technical services withholding tax? Service PE? Construction project PE?
Australia No Yes – 6 months 6 months
Austria No Yes – 6 months 6 months
Barbados No Yes – 6 months 6 months
Canada No Yes – 6 months 6 months
Cyprus No Yes – 12 months 12 months
France No Yes – 6 months 6 months
Germany No Yes – 6 months 6 months
Hong Kong No Yes – 183 daysa 6 months
Hungary No Yes – 12 months 12 months
Ireland No No 6 months
Italy No Yes – 6 months 6 months
Japan No Yes – 6 months 6 months
Mauritius No Yes – 12 months 12 months
Netherlands No Yes – 6 months 6 months
Singapore No Yes – 6 months 6 months
Spain No Yes – 6 months 6 months
UK Yes – 7%b No 6 months
US No Yes – 6 months 6 months
a The Second Protocol to the China-Hong Kong Double Tax Arrangement which has taken effect from June 11, 2008 replaced the “six months” requirement with
“183 days” in determining the service PE.
b But generally no withholding tax under domestic law.
24
24
China: Tax treatment of cross-border service activities
but this may well change as a result of the attention given to are subject to a business tax (rates vary, but for many services
this subject in many other countries and at OECD level. the applicable rate is five percent). Business tax is not limited
by treaties, not being in the nature of an income tax, and is
IV. Other points to be considered often a permanent cost for the business. Generally, under the
recently revised business tax regulations which have become
Of course, there will be considerations other than the above effective from January 1, 2009, the business tax will apply as
that need to be taken into account in deciding how to carry long as the enterprises or individuals which either provide or
out business with China. First, and most obviously, in many receive services are located in China. Careful study is needed
cases a PE will be unavoidable whatever the applicable to consider whether any of the available exemptions could
double tax treaty. In such circumstances the choice will be apply.
between taxation on a PE basis and setting up a local
subsidiary. A PE may give more flexibility (for example, profits
can be remitted to head office as they arise and the relevant V. Conclusion
taxes have been settled rather than only after the financial
The decision on how to structure a service activity is a
accounts for the year have been prepared and the transfers
complex one both from the commercial viewpoint and from
to reserves required by law have been made), as well as
that of tax. There will often be opportunities to lower the
eliminating the charge to dividend withholding tax. Setting
overall tax burden with appropriate structuring, as well as
up a company also carries additional burdens in terms of
pitfalls that may result in a very high effective tax rate on the
set-up requirements, annual audit, tax filings and other
contract profit. Good professional advice should be taken to
administrative costs. However, in many cases regulatory and
identify these.
other non-tax considerations will impose the choice of a
local subsidiary. Mario Pettricione is a Director of International Corporate Tax
and may be contacted by email at: mario.petriccione@kpmg.co.uk
Secondly, it is important to take into account not just the
direct tax position (corporate income tax) but also the indirect William Zhang is a Senior Tax Manager and may be contacted
tax. While for goods there is a VAT system, services (other by email at: william.zhang@kpmg.com.cn
than repairing and replacement services) performed in China © KPMG (UK) LLP 2008
25
25
26
26
for investment
A foreign direct investment into any country requires planning on:

■ How to hold the investment, whether directly from the investing parent or through one or more tiers of
intermediate holding companies;
■ How to finance it, whether wholly by equity or through a mixture of debt and equity, and in the latter case how to
structure the debt.
We shall consider each of these aspects in turn below. As will be seen, some of the issues which need to be addressed
are common to investments in many other jurisdictions, whereas others are particular to China.
I. Holding company strategies Even under the old system, capital gains on disposal of
shares in Chinese companies by non-residents were taxable
A. Chinese domestic law position in China, albeit at the reduced rate of 10 percent. The State
Broadly speaking, holding company strategies may be Council has also reduced the 20 percent charge under the
intended to achieve any or all of the following objectives: CITL to 10 percent, so that capital gains taxation continues at
the same rate.
■ To reduce withholding tax on dividends in the source
country (China) or direct taxation on dividends received in B. Double tax treaties
the residence country;
The table (at the end of this article) summarises the protection
■ To mitigate capital gains taxation either in the source available under China’s treaties with a number of favoured
country or in the residence country, on disposal of the holding company jurisdictions, as well as briefly outlining the
shares to a third party or within the group. tax treatment in those jurisdictions (described in the table as
This article deals only with the source country issues. The the “home” country). It will be seen that the lowest dividend
residence country issues will of course depend to a large withholding tax rate is five percent and is available under the
extent on the home jurisdiction involved, whether it operates treaties with Barbados, Hong Kong, Ireland, Mauritius and
an exemption or credit system, whether it has CFC rules, and Singapore (under the treaty that entered into force on
what rules it has on repatriations of cash in a form other than September 18, 2007), whereas protection from Chinese
dividends. capital gains taxation on the disposal of a substantial (usually
25 percent plus) shareholding is available only under the
As always, we have to start from the domestic law position. treaties with Barbados, Ireland and Switzerland. Interestingly,
China has undergone a major corporate income tax reform, in 2006 the Mauritius treaty was amended to give China the
that is contained in the new Corporate Income Tax Law taxing right on capital gains on substantial shareholdings, and
(“CITL”) which has taken effect from January 1, 2008. The the “double tax treaty” between Hong Kong and mainland
CITL imposes a general 20 percent withholding tax on China, also published in late 2006, similarly gives the
Chinese source income derived by companies without a mainland the right to tax capital gains on substantial
taxable presence in China, and specifically on Chinese source shareholdings. Similarly, China retains the taxing right under
dividends and capital gains. Under the CITL, the State Council the new treaty with Singapore. This may suggest that the
has authority to reduce or waive the tax charge, as discussed Chinese government has decided on a policy of retaining the
further below. taxing right over capital gains on substantial participations,
and accordingly that the remaining three treaties giving
The introduction of a dividend withholding tax is a major protection in this regard may be renegotiated. There is,
departure from the old system, under which dividends paid by however, no clarity in this respect.
Foreign Investment Enterprises, i.e. companies in which
non-Chinese residents hold at least 25 percent, were exempt In comparing holding company jurisdictions, it is also
from withholding tax. The State Council has exercised its appropriate to consider how tax residence is achieved. In
discretion to reduce such withholding tax under the Barbados and Singapore, achieving residence depends on
Implementation Rules of the CITL, but only to 10 percent, and demonstrating that central management is exercised there.
not to zero as under the old system. This will require a significant amount of effort to be put into
27
27
China: Holding and financing strategies for investment
attaining the desired residence status. By contrast, a Treaties reduce interest withholding taxes but none of them
company incorporated in Mauritius is automatically a resident eliminate it entirely. The lowest withholding tax rate is available
for Mauritian tax and therefore for treaty purposes; similarly, under the treaty with Hong Kong, which reduces the
although Hong Kong has no concept of residence in its withholding tax rate to seven percent, and that with
domestic law, for the purposes of the treaty with the Singapore, which also reduces the withholding tax rate to
mainland, a company incorporated in Hong Kong is seven percent but only if the lender, is a bank or financial
automatically a resident. So it is more difficult for the Chinese institution. Most other treaties reduce the withholding rate to
authorities to challenge a Hong Kong or Mauritius company’s 10 percent, i.e. the same as the withholding rate under the
entitlement to treaty protection than that of a Barbados or CITL and the old law.
Singapore company.
Any debt from abroad necessarily has to be in foreign
There is also a point to consider in relation to the transition currency; while in theory the exchange rate exposure could
into the desired holding company structure. In the past, be hedged with an appropriate hedging instrument, in
especially in view of the dividend withholding tax exemption practice this is difficult because of the need for exchange
for Foreign Investment Enterprises, it has been common to control approval for making swap payments to a
hold a Chinese subsidiary through a tax haven vehicle, often non-resident counterparty, while the market for hedging
in the BVI. As the State Council does not introduce a full instruments within China is still at an early stage of
exemption on withholding tax under the new CIT regime, development. Similarly, in principle it would be possible to
many such multinational enterprises should reconsider their structure the debt so that, while it is legally in foreign
strategy, and in future hold through a treaty-protected currency, say USD, it is economically in Chinese currency
location. However, a disposal of the Chinese subsidiary to (RMB) by virtue of the fact that the amount repayable is
the new holding company will generally be a taxable event, determined by reference to the RMB-USD exchange rate;
the tax rate being 10 percent under both the CITL and the however, in practice this is not likely to be possible as
old law; where the insertion takes place as part of “a group exchange control approval to repay more USD than originally
reorganisation for reasonable business purposes”, under a borrowed would be unlikely to be given. Therefore, in
notice issued by the State Administration of Taxation (“SAT”) practice borrowings from abroad have to be denominated
on April 17, 1997, and which ceased to apply on January 1, economically, as well as legally, in foreign currency. Now that
2008, the transfer can take place at cost for Chinese tax the RMB-USD exchange rate is no longer fixed, and the
purposes. Whether there is “reasonable business purpose” general expectation is that the RMB will rise, there is a
will of course depend on the facts of the case; many factors serious possibility that exchange gains will arise in the
will be relevant, for example, whether the holding company Chinese company. Such exchange gains would generally be
only holds the shares in the FIE or also holds subsidiaries in taxable, albeit on a realisation basis.
other countries, or whether the holding company conducts
The alternative is a RMB-denominated borrowing from a
any activities other than holding shares in subsidiaries. No
bank in China (or Chinese branch of a foreign bank), possibly
hard-and-fast rule can be given, and in many cases it will not
with a corresponding deposit being placed by the foreign
be possible to be confident that the conditions for the
parent with an overseas branch or affiliate of the lender.
transfer to be tax neutral are fulfilled. As an alternative, it
While this has the benefit of eliminating withholding tax, it
may be possible to redomicile the company in the desired
introduces a five percent business tax charge on the interest,
jurisdiction (i.e. move its legal incorporation there); for
which is normally a cost to the borrowing company. There is
example, this is possible under Mauritian company law.
also the question whether it is the bank or the foreign parent
It is worth noting that although the full exemption on dividend who bear the exchange rate risk. In the former case, the
withholding tax has been removed under the CITL, there is a bank will need to be appropriately remunerated, while in the
transitional treatment which clarifies that companies can still
enjoy full exemption on withholding tax for any dividends paid Table
out of pre-2008 retained even if they are paid in 2008 or Country/ Capital gains Maximum Applicable tax rate in home country
territory protection?a dividend with-
subsequent years. holding taxa Dividends Capital gains
Austria No 7% Exemption Exemption

II. Financing strategies Barbados Yes 5% 1–2.5% Exemption
Cyprus No 10% Exemption Exemption
Under the CITL and its Implementation Rules, the rate of Hong Kong No 5% Exemption Exemption
withholding tax on interest is reduced to 10 percent which is Hungary No 10% Exemption Exemption
the same as that under old law. When a new Foreign Ireland Yes 5% 25%b Exemptionc
Investment Enterprise is registered, it is normally allowed to Mauritius Nod 5% Maximum 3%e Exemption
have some of its capital in the form of shareholder debt Netherlands No 10% Exemption Exemption
rather than equity, the debt proportion allowed increasing Singapore No 5% Exemption Exemption
with the amount of the investment, up to two-thirds for Switzerland Yes 10% Exemption Exemption
investments over USD36 million (except in the case of real UK No 10% 30%b Exemptionc
estate companies, which are now required to be financed
a Assuming shareholding of at least 25%.
wholly with equity). Under the CITL, interest on related party
b With credit for underlying tax.
debt is disallowed where the ratio of related party debt c Subject to “trading” requirement.
investment to equity investment exceeds a prescribed d Exemption removed by protocol signed September 5, 2006.
debt/equity ratio. The debt-equity safe-harbour limits are 5:1 e 15% with credit for actual or deemed underlying tax, resulting in
and 2:1 for financial institutions and other companies maximum effective rate of 3% if there is no underlying tax. If underlying
tax is 15% or more, then no tax is payable.
respectively.
28
28
China: Holding and financing strategies for investment
latter case an appropriate instrument will need to be some effort dedicated now to the structuring opportunities
designed to ensure that the overseas deposit placed by the and pitfalls may well pay generous returns in future years.
parent is economically in RMB. The practical issues that
arise are complex. Mario Pettricione is a Director of International Corporate Tax
and may be contacted by email at:
mario.petriccione@kpmg.co.uk
III. Conclusion
William Zhang is a Senior Tax Manager and may be contacted
Due to recent developments in the tax and legal framework
by email at: william.zhang@kpmg.com.cn
and the economic environment, many multinationals are
rethinking their holding and financing strategies for China and © KPMG (UK) LLP 2008
29
29
30
30
Lewis Lu and Mario Petriccione
KPMG Huazhen, China and KPMG LLP, London
The law relating to real property ownership in China, as in any country, is complex and in this article we comment only
on two aspects that are directly relevant to the tax structuring side.
I. The legal framework Rental income is also subject to real estate tax levied by the
local authorities. Depending on the authority involved, this tax
Until mid-2006, it was possible to invest in real property in
may be charged at 12 percent of rentals or 1.2 percent of the
China either directly out of a foreign company or through a
book value of the property. Some authorities charge this tax at
Chinese subsidiary (“Foreign Investment Enterprise” or “FIE”).
a lower effective rate, for example Shenzhen charges 1.2
Since then, the government has taken steps to cool down the
percent on only 70 percent of the book value of the property.
property market by restricting the choice of vehicle through
which investments are made and the funding which can be Rental income is also subject to business tax at five percent.
used. The first step in this regard was taken in July 2006, Business tax is an indirect tax and accordingly only the net
when six government authorities jointly issued a notice rentals are subject to corporation tax.
(“Notice 171”) requiring all foreign investment in Chinese real
estate to be made through an FIE. III. Outline of tax consequences of a disposal
The second major change has occurred in 2007, when the A disposal of the property can be structured as:
State Administration of Foreign Exchange issued its Circular
a. A disposal of the property itself;
50 (May 23, 2007) and Notice 130 (July 10, 2007), which
stipulates that capital injections into real estate FIEs must b. A disposal of the shares in the FIE (the Chinese
henceforth be in the form of equity rather than debt. An company); or
additional requirement was also introduced, namely that any c. A disposal of the shares in an offshore holding company
local authorities registering a real estate FIE should transmit above the FIE.
the documentation to the central Ministry of Commerce The tax consequences of each of these three options are
(“MOFCOM”); without central registration of the outlined below.
documentation, the foreign investor will not be allowed to
convert into Chinese currency the amount required as capital A. Disposal of the property
to set up the FIE. This option is normally the most costly. The profit on disposal
will be subject to the normal corporate income tax rate (25
Commercially, using an equity-financed FIE has the
percent from 2008); however, it will also be subject to LAT at
consequence that the accumulating profit has to be retained
progressive rates ranging from 30 percent to 60 percent. LAT
in the FIE until the year end; a dividend can be paid only after
is deductible for corporate income tax purposes. So the
accounts have been prepared and any necessary transfer to
effective marginal rate of taxes on a disposal can be as high
legal reserve has been made. The transfers to reserve, as well
as 70 percent.
as any depreciation charged in the accounts, will result in
some of the cash building up in the company not being In February 2007, the State Administration of Taxation
distributable as a dividend. (“SAT”) issued Notice 187 to strengthen Land Appreciation
Tax (“LAT”) collection from China real estate development
II. Outline of ongoing tax position of a real companies. Previously, the detailed application of LAT varied
from city to city. While the ultimate LAT liability should
estate FIE
amount to 30-60 percent of the gain in land value, certain
As with any other Chinese company, from January 2008, a local tax authorities have only collected LAT based on a
real estate FIE has been subject to 25 percent corporate certain percentage of the sales proceeds. In such cities, the
income tax. Tax depreciation is generally available on fixed real estate companies may not have performed final
assets connected with the enterprise’s business operations, settlement of LAT. Notice 187 requires final LAT settlement
provided they are put into operational use. There is a 10 on a project-by-project basis, and for multi-phase projects,
percent withholding tax on dividends paid to the foreign on a phase-by-phase basis. However, in practice, this notice
shareholder, subject to reduction by any relevant tax treaties. has not yet been strictly enforced. Notwithstanding, this
31
31
China: Investing in real property: Some key tax aspects
reflects the general trend of the government’s policy and its foreign bank; if desired, the foreign parent can place a
strict application would potentially have a major impact on corresponding deposit with an overseas affiliate of the bank
real estate companies’ return on investment. In practice, we (this is often referred to as a “back-to-back” loan). Of course,
have already witnessed the difficulty faced by real estate if the finance is provided on a back-to-back basis the bank
development companies in trying to liquidate without the will charge a spread, which will depend partly on the extent to
LAT final settlement. which the bank assumes credit risk and/or exchange rate risk.
It is worth noting that, because of the non-convertibility of the
The vendor will be subject to five percent business tax on the
Chinese currency, very careful structuring is required unless it
total sales consideration for sale of real estate including land
is desired that the bank should assume the exchange rate
use rights. In the case where the real estates to be sold were
risk. Also, unless the deposit is with an overseas branch or
previously purchased by the vendor, the taxation basis will be
affiliate, rather than with the Chinese bank in China, Chinese
the transaction value of the real estates less their original
interest withholding tax will apply to the interest paid to the
purchase cost.
foreign depositor. Furthermore, interest charged by the bank
The purchaser will be liable for deed tax of 3-5 percent, and to the FIE will be subject to business tax at five percent, so
purchaser and vendor will each be liable for a 0.05 percent creating an additional tax cost in the structure. So, in
stamp duty, which is calculated based on the total summary, structuring a back-to-back loan in China is not as
consideration of the sales and purchase agreement. easy as in many other countries.
B. Disposal of shares in the FIE Additionally, a practical difficulty may be that, when the foreign
The profit on selling the shares in a Chinese company that investor approaches the authorities to form the FIE and
derives its value from real estate in China is subject to Chinese presents its business plan, the authorities may require the
tax at 10 percent. The double tax treaty with Barbados entire projected capital expenditure to be covered by the
provides protection in this regard; most other treaties (and all equity injected; if this happens, then effectively the FIE is
the ones with jurisdictions likely to be used as holding allowed to borrow only for expenditure going beyond the
company locations) allow China to tax the gain where the original capital expenditure plan. It is still too early to say what
shares in the Chinese company disposed of derive their value line the authorities are taking in the new environment. This is a
primarily from real estate in China. developing area and the exact scope of the new rules has yet
to be established.
Purchaser and vendor will each be liable for a 0.05 percent
stamp duty, which is calculated based on the total B. Shares acquisition
consideration of the sales and purchase agreement.
In the case of the acquisition of shares in a Chinese company
C. Disposal of shares in a holding company above the FIE owning real estate, there is normally no easy way to insert
debt in China. First, while in principle it may be possible to set
China does not seek to assert extraterritorial taxing rights, and
up an FIE for the sole purpose of acquiring shares in a single
accordingly does not seek to tax profit on the sale of a
target company, there are a number of practical obstacles (for
non-Chinese resident company even if such company in turn
example, the minimum registered capital would be USD30
holds shares in a Chinese real estate FIE.
million). Furthermore, it is not clear that that FIE and the target
Of course, these three options have different consequences could effect a tax-free merger (which would be necessary in
for the buyer. In particular, under option a) (sale of the property order to achieve tax relief interest expense in the holding FIE,
itself) the buyer will obtain a different (usually higher) tax as tax consolidation is in general not allowed). And, finally, it is
depreciation profile; also option a) is, in general, the only one not clear that even after such merger the interest expense
that will allow the buyer to place leverage into China so that would be deductible. Therefore, in general on a shares
tax relief for interest expense is obtained against the rental acquisition it will not be possible to place leverage in China.
income. Against this, a sale of the property itself will in many
cases involve a high tax charge on the seller that may V. Conclusion
outweigh these benefits.
Recent changes to the legal and regulatory framework make
IV. Is it still possible to leverage the investment? it more difficult to structure investment into Chinese real
estate tax efficiently. Very careful planning will allow investors
We shall deal separately with the case of acquisition of the to avoid pitfalls and take advantage of the available
real property itself and of acquisition of shares in a real estate opportunities.
company (that becomes an FIE as a result of the acquisition).
Lewis Lu is a Tax Partner and may be contacted by email at:
A. Asset acquisition lewis.lu@kpmg.com.cn
As explained above, the foreign capital provided into a real Mario Pettricione is a Director of International Corporate Tax
property FIE must now be in the form of equity and not of and may be contacted by email at: mario.petriccione@
debt. However, in principle such an FIE can still take out a kpmg.co.uk
local borrowing from a Chinese bank or Chinese branch of a © KPMG (UK) LLP 2008
32
32
Vietnam

Ninh Van Hien
KPMG Limited, Ho Chi Minh City
In this article on Vietnam we look at: applicable company law; the foreign direct investment framework; exchange
I. Enterprise Law old law on Domestic Investment Promotion 1998 and the law
on Foreign Investment in Vietnam 1996/2000.
The Enterprises Law (“EL”) was passed by the National
Assembly on November 29, 2005, taking full effect on July 1, The IL regulates the investment activities, the rights and
2006. Through the issuance of the EL, for the first time in obligations, the state guarantees and investment incentives
Vietnam there is common legal ground for the establishment, provided to all investors to, in and from Vietnam, including local
organisation and operation of all types of companies, and foreign investors.
regardless of their ownership structures. The state undertakes to implement its international
The typical legal corporate structure set up in Vietnam for commitments on investment (e.g. the Vietnam-US Bilateral
foreign investors may include the following: Trade Agreement, Vietnam WTO entry commitments, etc.). This
means that the restrictions on certain business sectors will be
a. One-member limited liability company – A private limited removed step by step in accordance with the schedule upon
liability company with no physical share issued. Wholly which Vietnam has agreed. The previous restrictive rules on the
foreign owned companies would fall under this category. use of domestic goods and services, local contents in
b. Two or more member limited liability company – A private manufactured goods, export/import, etc. have all been
limited liability company with no physical share issued removed.
and may have up to a maximum of 50 members.
With regard to investment sectors and areas, the IL provides:
c. Joint stock company – This company has physical shares
issued by the company to shareholders and it must have ■ The prohibited sectors, including projects which are
a minimum of three shareholders (no cap on the detrimental to national defense, security, cultural tradition,
maximum). A pre-requisite form of set up for public listing public health, natural resources and environments and
in Vietnam stock market. projects for the treatment of toxic waste brought into
d. Lastly, a less common form of set up is formally known in Vietnam or for the manufacture of any type of toxic
Vietnam as “Business Cooperation Contract” which does chemicals or for the use of chemical agents prohibited by
not have a separate legal personality. Historically, this international treaties.
form of set up typically applied to some oil and gas and ■ The conditional sectors, including projects in banking and
telecom projects. finance sector, public health, culture, information, the
Foreign companies setting up business operations in Vietnam press and publishing, entertainment, real estate business,
under the form of a branch has been very rare except in the mining of natural resources, education and training, etc.
field of banking, law firms and some tobacco companies. ■ The encouraged sectors, including projects in the
Vietnam does not encourage a branch set up form. manufacture of new materials and production of new
energy; manufacture of high-tech products;
In general, foreign business set-ups in Vietnam are not required
bio-technologies; information technology; breeding,
to set up and contribute after-tax profits to any compulsory
rearing, growing and processing agricultural, forestry and
reserves. This means that profits remittance overseas can be
aquaculture products; labour intensive industries;
made fully of all the after-tax profits.
construction and development of infrastructure facilities
and important industrial projects with a large scale.
II. Investment Law
The government of Vietnam also encourages investment in
The Investment Law (“IL”) was introduced and become poor and undeveloped regions of Vietnam with appropriate
effective in Vietnam at the same time as the EL. It replaced the incentives given.
33
33
Vietnam: The tax and legal framework
Foreign investors must fulfill investment application procedures tax rules (see the separate article “Tax treatment of
and receive an investment certificate issued by the local cross-border service activities in Vietnam”) on a deemed basis.
investment licensing authority which also doubles up as a
A Vietnamese resident company is taxed on its worldwide
business registration certificate/certificate of incorporation. With
income. There are rules on the Vietnamese taxation of income
each additional investment project, the enterprise may choose
earned by overseas subsidiaries of Vietnamese companies.
to register the project but not re-register the enterprise or
However, due to the very limited overseas investment made by
incorporate a new enterprise for the new project.
Vietnamese companies, it remains to be seen how these new
rules may applied and enforced in practice.
III. Exchange control
Dividends paid by a Vietnamese company to other Vietnamese
Generally, the foreign exchange control regime in Vietnam is resident companies are exempt from corporate taxation. The
tight and highly restrictive of any outflows of foreign currency. same dividends paid to offshore corporate investors are also
Therefore, during its course of operations the foreign investor not subject to any further withholding tax. However, individuals
may only remit money out of the country when it has a valid receiving dividends, effective from January 1, 2009, are subject
reason to do so, supported by sufficient evidence. to a five percent flat personal income tax rate.
Current regulations guarantee foreign investors the ability to The standard corporate income tax (“CIT”) rate is set at 25
repatriate profits and invested capital. The law also permits percent. Preferential rates of 10 percent or 20 percent, together
foreign investors to remit abroad payments for the provision of with tax holiday/reduction, may also be given for certain
goods or services, the principal and interest on offshore loans encouraged projects.
incurred over the course of their operations, and other monies Tax incentives are awarded on a case-by-case basis. Vietnam
and assets in their lawful ownership. CIT is only applied at the national level and there is no other
separate local/state income tax in Vietnam.
In broad terms, the foreign investors can authorise the
remittance of funds out of Vietnam for the following reasons: Tax depreciation on assets is well regulated by the Ministry of
Finance’s Decision 206 under which each category of fixed
■ Repatriation of profits earned from the Vietnam’s asset is given a minimum and maximum useful life range within
operations. which businesses are free to choose a fixed number of years of
■ Payment for goods and services purchased overseas. useful life and hence the depreciation rate on a straight-line
■ Repatriation of capital contributions. basis can be determined. Typically, most businesses apply the
same depreciation rates for both accounting and tax purposes.
■ Repayment of loans including interest.
Interest on loan within the approved “loan capital” is fully tax
In all foreign investment projects in Vietnam, the level of total
deductible. Related party loan interest may only be accepted
investment capital must be stated and approved in the
for tax deduction at a rate not higher than 1.5 times the base
investment certificate. This “total investment capital” is made
rate set out by the State Bank of Vietnam.
up of “charter capital” which is basically shareholder equity
contribution. The balance is classified as “loan capital” which A company may carry forward operating losses of a financial
may be raised via onshore or offshore bank, third parties or year to offset against future profits for a period of up to five
even related parties including the shareholders. Under the now consecutive years for CIT calculation purposes. Enterprises are
abolished foreign investment law, the level of charter capital in a not allowed to file tax returns on a consolidated basis.
company must be accounted for at least 30 percent of the total In the past, Vietnam allowed corporate income tax refund on
investment capital (in special cases and with specific approval the portion of profits reinvested in Vietnam by foreign invested
from the authorities, this may go down to 20 percent). The enterprises. However, this incentive has been abolished.
current new IL no longer requires this 70:30 debt to equity rule.
However, in practice, the licensing authorities do still take this Vietnam currently has no General Anti-avoidance Rule.
matter into consideration during its investment appraisal and
licensing process. V. Conclusion
Foreign investment projects in Vietnam are still tightly
IV. Corporate tax system regulated due to the need for project appraisal and approval.
However, the relevant legal environment has developed a long
Vietnam has successfully implemented one single, uniformed
way since the early days of the foreign investment law back in
tax system applicable to all enterprises and business in
the mid-1980s. Additionally, so far it can be said that Vietnam
Vietnam without differentiating between foreign investment
does respect fully its commitments made on the opening of
projects and local ones over the last few years. A new
the market under the WTO entry. The tax regulations have
corporate income tax law has been introduced and is effective
also improved a lot over the years catching up with the new
as of January 1, 2009. However, compared to the previous law,
enterprise law, investment law and the rest of the legal
there are no fundamental changes.
environment in general. However, one common complaint is
The concept of residence effectively, while not specifically spelt that the interpretation and application of the tax regulations
out, is based solely on incorporation. The widely defined are not consistent at the local tax office level. This may pose
permanent establishment concept is included in the tax law but significant challenges and uncertainties for taxpayers.
with no practical application except perhaps for a few licensed Ninh Van Hien is a Tax Partner with KPMG’s Vietnamese firm.
foreign branches. Non-resident companies are generally Ninh can be contacted by email at:
taxable in Vietnam based on the foreign contractor withholding ninhvanhien@kpmg.com.vn
34
34
service activities
Ninh Van Hien
Vietnam has long imposed foreign contractor withholding tax on foreign enterprises doing business in, or deriving
income from Vietnam. Many updates and changes to the regulations have taken place over the years and the latest
applicable regulations are set out under Circular 134 as recently as December 31, 2008.
A foreign enterprise may be taxed in Vietnam under two In practice, and it is also expected that moving forward under
alternative scenarios: Circular 134, there may be very few foreign enterprises doing
business in Vietnam wishing to and being allowed to adopt this
■ If the enterprise has a “permanent establishment” in method.
Vietnam, carrying out business in Vietnam under contract
for 183 days or more, and adopts the Vietnam II. Withholding method
Accounting System, it shall register, file and pay tax like a
local company, e.g. conventional VAT and corporate Circular 134 specifically exempts the following cases from
income tax at 25 percent – this is known as the full Vietnam tax:
registration method. 1. Pure cross-border supply of goods without any
■ In other cases, simple withholding tax would apply on associated onshore services provided by the foreign
gross revenue earned/derived by the foreign enterprise enterprise to the Vietnamese importer/buyer.
from Vietnam – this is known as the simple withholding 2. Services “performed” and “consumed” outside of
method. Vietnam.
3. The following specific services “performed” outside of
I. Full registration method Vietnam by foreign services providers (no need to satisfy
the “consumption” test as well):
It is important to note that all the three conditions as listed
■ Repair of machinery and equipment with or without
should be met before a foreign enterprise may adopt this full
the supply of parts;
registration taxation method. The first two conditions may be
■ Advertising and marketing activities;
met as a matter of fact whereas the last condition is a matter of
choice. ■ Trade and investment promotion activities;
■ Brokerage services for the selling of goods;
The permanent establishment definition under the Vietnam ■ Training;
corporate income tax law is very broad including:
■ Telecommunication revenue split for outbound/input
■ Branches, operational offices, plants, workshops, means traffic and bandwidth leases.
of transportation, mines, petroleum and gas fields, and The applicable withholding tax here comprises of two elements.
any other locations in Vietnam where natural resources One is the value added tax component and the other is
are mined. corporate income tax (see the applicable rates in the table).
■ Construction sites and construction, installation and There are also some additional important peculiar rules with
assembly works. regard to the withholding method as follows:
■ Establishments providing services, including consultancy ■ All the foreign contractor withholding tax filing and
services provided via people working for such registration (except personal income tax of employees of
establishment or via other organisations or individuals. foreign enterprise) rest with the Vietnamese contracting
■ Agents of foreign enterprises. party. The foreign contracting party has no obligations to
■ Representatives in Vietnam where they are carry out any of these including maintaining books and
representatives with authority to sign contracts in the accounts onshore in Vietnam.
name of the foreign enterprise, or where they are ■ The VAT component of the withholding tax can be
representatives without authority to sign contracts in the claimed as input VAT credit by the Vietnamese
name of the foreign enterprise but regularly deliver goods contracting party provided that they make VATable
or provide services in Vietnam. supplies.
35
35
Vietnam: Tax treatment of cross-border service activities
■ Any identifiable portion of the main contract V. Conclusion

subcontracted out to Vietnamese subcontractors or
foreign subcontractors registered under the “full Foreign contractor withholding tax in Vietnam can be complex
registration method” can be excluded in the calculation of and confusing given the many smaller details which cannot be
the foreign contractor tax due for the main contractor. explained within the scope of this article. For significant
contracts, prior to signing with the Vietnamese contracting
III. The position under double tax treaties party, they should be reviewed and advised by professional tax
advisors so potential tax planning opportunities can be
Vietnam has to date over 40 working tax treaties in place. exploited as well as avoiding pitfalls that may result in
However, the Vietnamese tax system is unusual in that the significant tax exposure.
normal method of taxing foreign enterprises is through a final
withholding tax, rather than by taxing profits of a PE. Treaty
Table 1: Deemed Corporate Income Tax withholding rate
claims to exempt business profits of a foreign enterprise from
Business activities CIT rates as a percentage
Vietnamese tax are rare in practice due to the onerous and time (%) of taxable turnover
consuming process taken in a formal tax treaty claim. under Circular 134
Trading: distribution and supply of goods, raw 1
Note, the other tax treaty claims in relation to interest and materials, supplies, machinery and equipment
royalties’ withholding tax and personal income tax are more attached to services in Vietnam
common. Services, lease of machinery and equipment, 5
insurance
Construction 2
IV. Other points to be considered
Other production or business activities, 2
Traditionally, the local company set up route for foreign transportation (including sea and air transportation)
enterprises entering and doing business in Vietnam had not Lease of aircraft, aircraft engines, aircraft spare 2
parts, sea-going vessels
always been straightforward. Each and every company set-up
Reinsurance 2
had to be scrutinised, appraised and approved by the
Securities transfer 0.1
investment licensing authority. Accordingly, for a number of
Loan interest 10
companies and industries (e.g. oil and gas, project
Income from royalties 10
management, supply and provision of production plant and
technical services, etc.) entering Vietnam to provide goods and
services under specific contract signed with the local Table 2: Deemed Value Added Tax withholding ratea
contracting parties and accepting paying foreign contractor Business activities Value Added Tax as (%) of
turnover for the direct application
withholding tax may be the optimal route operationally. of the related VAT rates
Many foreign companies have chosen to stay with this route for Services, lease of machinery and 50
equipment, insurance
years without the need to set up local companies due to the
Construction with or without supplies 30/50
burdens which they wish to avoid regarding company set-up
Transportation, other production or 30
approval, reporting, compliance and administrative business activities
requirements and costs.
a Vietnam’s standard VAT rate is 10%. The lower 5% rate applies to some
Vietnam’s entry to the WTO in 2007 may have made it easier specific essential goods and services.
for many foreign companies and industries to formally set up
their subsidiaries in Vietnam but many players may still wish to Ninh Van Hien is a Tax Partner with KPMG’s Vietnamese firm.
stay with the current foreign contractor route. Ninh can be contacted by email at: ninhvanhien@kpmg.com.vn
36
36
for investment
Ninh Van Hien
The issues to consider in the decision on the appropriate investment structure for Vietnam direct investment may
include Vietnamese regulatory restrictions on investment licensing, taxation and flexibility in divestment options.
I. Holding company strategies II. Financing strategies

With much improvement in the licensing process for foreign There is no minimum level of investment capital set in the law.
direct investment projects under the new Investment and However, the amount of investment capital is an important
Enterprise Laws and Vietnam’s commitment under WTO to factor in investment certificate application evaluation.
open up the market, delay and challenges are still expected
with regard to the set up of new foreign invested enterprises The investment capital in a foreign invested project is clearly
and any subsequent changes in the shareholdings and stated in the investment certificate. This is made up of first,
shareholders. Specific approval from the licensing authority via the Charter capital (i.e. equity) which means the amount of
the issuance and amendment of investment certificates are capital contributed or undertaken by members or
required and the whole process can be onerous and time shareholders to contribute within a specific period and
consuming. recorded in the charter of the company. To date, charter
capital contributions from the investor may be in the form of
However, this regulatory approval should only apply in a cash, machinery and equipment, building, land, etc.
company incorporated in Vietnam. Accordingly, if the Vietnam
trading company is 100 percent or partially held by a company The balance between investment capital and charter capital is
that is not incorporated in Vietnam, regulatory approval should known as loan capital or more precisely the debt capacity
not be required for the change in shareholders of that holding which a local project company can borrow.
company not incorporated in Vietnam. Under the now abolished foreign investment law, the level of
charter capital in a company must have accounted for at least
A complication may however arise with regard to the use of an
30 percent of the total investment capital (in special cases
offshore intermediate holding company due to the fact that
and with specific approval from the authorities, this may be 20
domestic Vietnamese investors cannot freely make investment
percent).
overseas, i.e. they cannot freely buy and hold the shareholding
of the foreign investors in an offshore intermediate holding Loan capital may be in the form of loans from banks, third
company with the investment in Vietnam. For Vietnamese parties or even related parties including the shareholders.
investors to take over the foreign shareholding in a project in Unexpectedly, the current law on investment and its
Vietnam, direct buy-in in the local project company may be the implementing Decree did not mention/include this 70:30 debt
only viable and practical route. to equity rule.
On taxation, Vietnam has no withholding tax on remittance of Notwithstanding the above, in practice, in the evaluation of
dividends by Vietnamese subsidiaries to offshore corporate the feasibility of investment projects before granting an
shareholders so the setting up of the appropriate holding investment certificate, the licensing authority still consider the
company structure may not be too important from the dividend 70:30 rule as one of the approving criteria. They are still
withholding tax perspective. However, on disposing expecting the charter capital to account for approximately 30
shareholding in the local project company, subject to double percent of a project’s total investment capital, and in some
tax treaties, capital assignment profits tax is imposed at 25 cases may accept as low as 20 percent.
percent on the gains made by the investors under the current
domestic regulations effective from January 1, 2009. Under the domestic tax regulations, debt financing arranged
locally would not attract any withholding tax. However, on
Based on the above, the use of appropriate intermediate cross-border financing, the interest withholding tax rate of 10
holding company structure set up in tax haven territories such percent would apply.
as BVI and Cayman Islands has been very common to date.
Singapore has also been proven as a popular location due to Of over 40 tax treaties currently in force, the one tax treaty
its favourable domestic tax rules and its tax treaty with Vietnam with France provides straightforward tax exemption on interest
that protects businesses from Vietnamese tax on capital gains. for commercial loans. The other treaties generally specify a
37
37
Vietnam: Holding and financing strategies for investment
maximum interest withholding tax rate that is equal to or III. Conclusion

higher than the Vietnamese 10 percent domestic rate.
The right decision on holding company and financing strategies
Long-term offshore loans are required to be registered with the under the current simple and friendly investment regulatory
State Bank of Vietnam. framework and taxation of Vietnam can generate significant
Vietnam corporate income tax deduction for interest on loans benefits. Good professional advice should be taken to identify
within the borrowing capacity as stated in the investment and realise these.
certificate is allowed, except that on related party borrowing, for Ninh Van Hien is a Tax Partner with KPMG’s Vietnamese firm.
tax deduction purposes, interest rate cap is set at 1.5 times the Ninh can be contacted by email at:
State Bank of Vietnam’s base rate. ninhvanhien@kpmg.com.vn
38
38
Ninh Van Hien
The law relating to real property in Vietnam can be complex. This article gives an introduction to some of the aspects
that may be relevant to the tax structuring of Vietnamese real property.
I. The legal framework be given for up to 30 percent foreign ownership. This

blanket restriction is being removed under a recent Prime
During the early stages of foreign investment flow into Vietnam
Ministerial Decision No. 88.
up to around 2000, almost all real estate projects were set up
under the form of joint venture limited liability companies. Local It is important to note that companies with foreign investment
parties typically contributed land use right (“LUR”) as capital are not allowed to be set up to buy existing real estate
contributions and the foreign parties would contribute cash to properties for trading or renting purposes. Also, a real estate
develop hotel, office and serviced apartment projects. Back property in Vietnam cannot be owned by a foreign person
then, under the Foreign Investment Law, no restriction on (natural or legal).
foreign ownership was imposed on these projects. Typically, the
local party ownership was in the region of 30 percent. During II. Outline of ongoing tax position of a real
and after the Asian financial crises of the late 90s, some of estate foreign invested enterprise (“FIE”)
these joint venture companies were turned into wholly foreign
Unlike the legal structure mentioned above where there may
owned companies.
still be some differences between real estate wholly local
The foreign investment in the real estate market went through owned companies and FIEs, Vietnamese taxation applies
significant expansion in the early 2000s until now when foreign equally to both. The applicable standard corporate income tax
investors are allowed to invest in residential projects. According rate of 25 percent applies from January 1, 2009.
to the Foreign Investment Agency under the Ministry of
Planning and Investment, by early November 2008, registered No tax incentives (in the form of lower preferential rate, tax
foreign direct investment (“FDI”) in Vietnam had hit $61 billion, holiday or tax reduction) are generally available for real estate
the figure may reach $65 billion for the whole year and real projects nowadays except when the project is located in
estate projects account for approximately 40 percent of these remote locations classified as poor with difficult
figures. socio-economic conditions. Earlier licensed projects may
continue to enjoy any tax incentives given as stated in the
Foreign investors can now make investment in real estate investment certificates.
sectors in Vietnam through the following main legal routes:
Tax depreciation is generally available for both buildings and
1. Lease the land from the government directly and set up fixed term LUR. Since January 1, 2004, Vietnam has abolished
100 percent foreign-owned company to develop the land. profits remittance tax so dividends remitted to foreign corporate
2. Team up with local parties with LUR under their shareholders are not subject to any withholding tax.
ownership and set up joint venture companies to develop Vietnamese corporate income tax is only applicable at the
the project. Again, as mentioned above, the percentage national level. There are no separate local business or income
of foreign ownership is not restricted. taxes.
3. Acquire shares/shareholding from foreign or local
Rental income on commercial properties is fully subject to 10
investors in existing companies set up under (1) or (2)
percent value added tax. Advance lump-sum rental income (i.e.
above.
rental payment for a number of years), is subject to corporate
4. Acquire shares/shareholding from local investors in income tax on a deferred and spread basis. Note, input VAT
existing wholly local owned real estate companies. Due to incurred during the project development can fully be claimed as
the fact that wholly local owned real estate companies cash refund.
are allowed to conduct all real estate business without
restriction (a position not fully opened to foreign
III. Outline of tax consequences of a disposal
investment), under this entry route, foreign investors may
not be allowed to purchase more than 49 percent of the A property may be disposed in Vietnam through the following
shareholding in the target. Practically, approval may only ways:
39
39
Vietnam: Investing in real property: Some key tax aspects
a. The disposal of the property itself. IV. Is it still possible to leverage the
b. Disposal of shares/shareholding in the Vietnamese investment?
project company owning the property.
c. Disposal of shares/shareholding in the offshore For real estate projects the current regulations (i.e. Decree 153)
intermediate holding company above the Vietnamese set the minimum charter capital at VND6 billion, i.e.
project company. approximately USD350,000.
The tax implications of each of these options are explained Under the now abolished foreign investment law, the level of
below. charter capital in a company must account for at least 30
percent of the total investment capital (in special cases and
A. Disposal of the property
with specific approval from the authorities, this may go down to
From the buyer’s perspective, this may be the desirable 20 percent). Other funding for the project may be in the form of
position so that the tax base cost of the property may be loans from banks, third parties or even related parties including
brought up to the market level. However, this option is not really the shareholders. Both the charter capital and loan capital are
viable for foreign investor buyers. This is because, as together known as total investment capital and these must be
mentioned above, foreign investors are not permitted to set up registered and approved under the investment certificate. The
a legal entity to use as a vehicle in purchasing and owning an current law on investment and its implementing Decree do not
existing property. include this 70:30 debt to equity rule. However, in practice, in
the evaluation of the feasibility of investment projects before
Accordingly this option may only typically happen between a
granting an investment certificate, the licensing authority still
local seller and buyer. Under the tax regime applicable to
consider the 70:30 rule as one of the approving criteria. Based
December 31, 2008, 10 percent VAT applies on the building
on our observation to date, they are still expecting the charter
value. All gains on both buildings and land are subject to 25
capital to account for approximately 30 percent of a project’s
percent corporate income tax rate from January 1, 2009. The
total investment capital, and in some cases, for larger projects,
gains portion attributable to land was also technically subject to
may accept as low as 20 percent. For this to be possible, the
additional surtax with the marginal rate of up to 20 percent (this
level of charter capital and loan capital must be stated in the
surtax no longer applies after January 1, 2009).
investment certificate of the FIE as approved by the licensing
The buyer is separately subject to property registration tax of authority.
0.5 percent for both land and buildings.
The contribution of capital in the set up and development of a
B. Disposal of shareholding in the Vietnamese project company/project can be carried out in phases. For example,
company the investors may choose to contribute the charter capital of,
say USD10 million over 12 to 24 months. However, this must
First of all, it is important to note that any change in the
be included in the license application and adhered to by the
shareholders of a FIE must be approved via the investment
investors. Any delays or deviations from the scheduled capital
certificate amendment by a project licensing authority in
contribution plan must be approved by the licensing authority.
Vietnam.
Failure in observing this without specific approval from the
Under the Vietnam domestic tax law, capital gains derived by licensing authority may lead to the investment certificate being
the vendor on the disposal of its shareholding are subject to withdrawn.
capital assignment profits tax currently set at 25 percent from
January 1, 2009. Most tax treaties which Vietnam has entered Please note that under the new Decree 153 on real estate
with other countries allow Vietnam to tax these gains, except development, it is also additionally required that charter capital
the one with Singapore. must be at 15 percent – 20 percent of total project costs. This
may result in a very high capital commitment for a big project.
No other Vietnamese tax should apply on the share transaction In addition, under this Decree, pre-sale revenue for residential
here. projects can only be collected after the
infrastructure/foundation work has been completed.
C. Disposal of shareholding in the offshore intermediate
holding company above the Vietnamese project Based on the above, the leverage in a Vietnamese project
company company is determined and fixed at the investment licensing
The current Vietnam tax regulations do not specifically seek to stage. Acquisition of a Vietnamese real estate project via option
tax gains derived by any entity above the parent company of III.b and III.c as explained above would not really allow the new
the Vietnamese project company. This means that the disposal foreign investors many opportunities with debt/leverage
of shareholding in the offshore intermediate holding company restructuring. The interest cost accepted for tax purposes
above the Vietnamese project company would not be taxed in should be within the level approved and stated in the
Vietnam. Additionally, there should be no need to apply to the investment certificate.
licensing authority to register such change, as the ownership of
Note, any cross-border long-term loan would need to be
the Vietnamese project company does not change.
registered with the State Bank of Vietnam for foreign exchange
This option has a serious shortcoming that the disposal cannot control purposes. Interest charged by related parties for tax
be made to local Vietnamese investors. Under the current deduction purposes may be capped at 1.5 times the base rate
Vietnamese investment regulations, local Vietnamese set by the State Bank of Vietnam. Additionally, interest payment
companies are not freely allowed to invest and hold share in made to foreign lender is subject to withholding tax at 10
offshore companies without specific appraisal and approval by percent. Currently only the Vietnam-France Tax Treaty allows
the licensing authority of Vietnam. tax exemption for this.
40
40
Vietnam: Investing in real property: Some key tax aspects
V. Conclusion all become effective. All these can provide many challenges as
well as opportunities for new foreign investors in structuring
The regulatory environment affecting foreign investor in real their real estate investment in Vietnam.
estate projects in Vietnam is evolving and subject to constant
changes and updates. There can also be significant difference
between what is written in the law and the application in Ninh Van Hien is a Tax Partner with KPMG’s Vietnamese firm.
practice. From January 1, 2009, the new Corporate Income Tax Ninh can be contacted by email at:
Law, Value Added Tax Law, and Personal Income Tax Law will ninhvanhien@kpmg.com.vn
41
41
42
42
Korea

Jae Won Lee and Na Rae Lee
KPMG Samjong Accounting Corp., Seoul
This article addresses the fundamentals of business operations in Korea, such as foreign direct investments framework,
applicable company law, tax systems, international aspects, and so forth.
A Chusik Hoesa, established with KRW50 million of minimum

I. Foreign direct investment paid-up capital, is the only form of corporate entity that is
allowed to publicly issue shares. The vast majority of
After the economic crisis in 1997, the Korean Government has
corporations in Korea choose this form of business.
been advocating expansion in foreign investment through a
series of controls and promotions. Since stimulating foreign Yuhan Hoesa is a closely held company that offers limited
investment and injecting market competition into the domestic liability to its members according to the number of contribution
economy were critical to revitalise the economy, the units.
government has accelerated liberalisation of foreign investment Hapja Heosa and Hapmyong Hoesa are the forms of a
which virtually opened up all of the previously restricted partnership which are treated as corporations for tax purposes.
markets to both foreign direct investment and portfolio However, under extensive reforms, it is expected to treat them
investments. The legislation governing inward investment are as transparent entities in the future.
the Foreign Investment Promotion Act (“FIPA”) and other related
laws. The FIPA has been enacted to facilitate foreign III. Tax system
investment and to provide convenience for foreign investors.
A. Fundamental principles
The FIPA provides the following types of foreign investment:
Under the Korean tax law, domestic and foreign corporations
■ Acquisition of shares of a Korean corporation. This refers are subject to corporate taxes in Korea. A domestic company
to possession of 10 percent or more of the voting shares established under the Korean law is liable for tax on the
or total invested capital of a Korean corporation with the worldwide income whereas a foreign company is only liable for
minimum investment amount of KRW50 million. tax on its Korean source income. As for the matter of fair and
■ Long-term loan contract. This is recognised as foreign equal application of the tax regime amongst foreign companies
direct investment if a foreign parent company, or a foreign operating business in Korea, the concept of a permanent
investor under a capital investment relationship with a establishment (“PE”) exists to differentiate a foreign company
foreign parent company, provides a loan with a maturity with a taxable presence from a foreign company without a
of five years or more for the concerned foreign invested taxable presence in Korea. This concept clarifies the application
company. of income tax by means of imposing the normal corporate
■ Technology inducement contract. A contribution to a income tax on a foreign company with a PE in Korea in the
non-profit organisation (“NPO”) is recognised as a foreign same way as on a domestic company, while allowing a foreign
investment when the NPO is an independent research company without a PE to be liable for withholding tax on each
facility in the field of science and technology. class of Korean-sourced income separately.
Under the current laws, corporate tax is levied at a rate of 11
II. Company law percent for the first taxable income up to KRW200 million and
22 percent for the taxable income in excess of KRW200 million.
Under the Korean Commercial Code (“KCC”), four basic In addition, 10 percent of resident surtax on the corporate
business entities are available for foreign investors: Chusik income tax is applied, so that the effective corporate tax rates
Heosa, Yuhan Hoesa, Hapja Heosa and Hapmyong Hoesa. are 12.1 percent and 24.2 percent, respectively.1
1 Per the amendment in the corporate income tax law on December 2008, the income tax rate is reduced as above from 14.3 percent for the
taxable income up to KRW100 million and 27.5 percent for the taxable incoming exceeding KRW100 million.
43
43
Korea: The tax and legal framework
B. Tax reform and development activities (“R&D”) is increased to 10 percent

on the invested amount. This rate of tax credit is applicable for
With the gradual adoption of International Financial Reporting
investments made after September 26, 2009. The previously
Standards (“IFRS”) in Korea starting from 2011, a series of tax
provided 15 percent tax credit on qualified R&D expenditures
revisions were enacted on December 26, 2008 as a movement
incurred by small and medium sized enterprises (“SME”) is
towards global standards. The revisions include, to name a few,
increased to 25 percent effective January 1, 2009. In addition,
corporate income tax rate cuts, adoption of consolidated tax
a reserve for potential R&D expenses is introduced in order to
returns and extension of relief for net operating losses.
allow three percent deductibility of gross sales from the taxable
Under the tax revision, the corporate tax rate was reduced to income of a concerned year, effective January 1, 2009.
11 percent for the first taxable income up to KRW200 million Furthermore, tax incentives for newly established SMEs
and 22 percent for the taxable income in excess of KRW200 encouraging their development include 50 percent to 100
million. As a 10 percent resident surtax on the corporate percent reductions on income tax and other local taxes.
income tax is applied, the current effective corporate tax rates
are 12.1 percent and 24.2 percent, respectively. From 2010,
V. International aspects
this rate will again be reduced further to 11 percent (including
10 percent resident surtax) for the first taxable income up to Korea has entered into bilateral tax treaties with more than 70
KRW200 million and 22 percent (including 10 percent resident countries all over the world. In addition to the primary objective
surtax) thereafter. of avoiding international juridical double taxation, tax treaties
serve purposes such as encouraging business expansion of
A consolidated tax return is introduced under the tax revision
domestic companies in foreign countries and vice versa.
from fiscal years beginning on or after January 1, 2010,
allowing taxpayers to elect the current separate filing or the Korea has also been adopting various international standards
consolidated filing system. Under the new system, the and guidelines in applications of international tax affairs. The
consolidated income for a parent company would be the sum anti-avoidance measures imposed on the Korean taxation
of taxable income of consolidated subsidiaries which are regulates that accumulated earnings of a foreign company
calculated after income or losses from intra-company located in low tax jurisdictions, where the effective tax rate on
transactions amongst which consolidated entities are the taxable income for the past three years is an average of 15
eliminated. The consolidated tax return system would only be percent or less, are taxed as deemed dividend paid to a Korean
applicable to a parent corporation and its 100 percent resident with 20 percent or more of direct or indirect
subsidiaries. shareholding in that foreign company.
The previous allowed loss carry-forward of five years was For cross-border or international transactions with
extended to 10 years under the tax revision. This change would overseas-related parties, the international guideline of transfer
be applicable to losses incurred from fiscal years beginning on pricing rules was adopted by Korea under the Law of
or after January 1, 2009. Coordination of International Tax Affairs. By this rule, the
transaction prices should be determined on an arm’s length
C. Withholding taxes
basis and be documented accordingly. Otherwise, the tax
Domestic laws provide the withholding tax obligation on the authorities may exert power to determine or recompute the
Korean-sourced income derived by a non-resident company resident’s taxable income and taxes based on the arm’s length
without having a PE in Korea. Most of the income derived from price level they deem more appropriate.
Korea is taxed at a rate prescribed under the Korean corporate
tax law or at a reduced rate in accordance with an applicable VI. Conclusion
double tax treaty.
Korea is presently developing fast. However, along with such
development and movement towards globalisation, there still is
IV. Tax Incentives
a lack of transparency and clarity on its tax regime in many
Tax incentives are comprehensively prescribed under the Tax aspects compared to other industrial nations. In this sense, the
Incentive Limitation Law (“TILL”). The major purpose of this law Korean Government continuously carries out various
is to implement fair and effective tax policies through provisions implementations and tax reforms with the vision of creating a
on tax exemptions and restrictions with an ultimate view of simple, fair and pro-growth system, in particular considering tax
contributing to development of the domestic economy. burdens. By such endeavour, it can be expected to create a
Tax incentives are generally established based on the type of favourable environment for more investment and consumption,
activities or scale of businesses. to establish a business-friendly environment for foreign
investors as well as to advance and upgrade Korea’s tax and
In particular, tax incentives granted to FDI are aimed at legal regime to the level of global western standards.
attracting high-technology and large-scale manufacturing
Mr Jae Won Lee is a Senior Partner with the tax practice of
investments. For the FDI, the TILL provides partial or full
KPMG’s Korean firm, specialising in M&A, Transactions and
exemption on corporate income tax, local taxes and for
International Tax Advisory Services and may be contacted by
imported capital goods. In addition, full exemptions from email at: jlee20@kr.kpmg.com
customs duties or VAT may also be granted.
Ms Na Rae Lee is a Manager with the tax practice of KPMG’s
Under the recent tax revision, the previously allowed seven Korean firm, specialising in International Tax Services and may
percent tax credit on investments made for facilitating research be contacted by email at: naraelee@kr.kpmg.com
44
44
service activities
KPMG Samjong Accouting Corporation, Seoul
This article discusses the Korean tax implications related to the permanent establishment (“PE”) issue and withholding
tax issue likely to arise in connection with foreign service providers doing business in Korea.
Business activities in Korea may cause foreign service providers to have a fixed place of business.1
In either circumstance, they are subject to pay taxes on their Korean source income. As the tax amounts and
compliance burdens may significantly differ from each case, they need to determine whether their business activities
may create a PE in Korea based on the relevant domestic tax laws and the applicable tax treaty.
I. Establishment of PE C. Deemed PE (dependent agent)
In general, under Korean domestic law a PE can be created in However, if the agent fails to meet the independent status test,
two principal ways: (i) the establishment of a fixed place of and if such agent performs essential or significant activities in
business through which the business of an entity is wholly or Korea for foreign service providers, then they may be deemed
partly carried on (“ordinary PE”); and/or (ii) the conduct of to have a PE in Korea. Such agent whose activities may create
business through a dependent agent (“deemed PE”). a PE for a foreign service provider is a so-called dependent
agent. A dependent agent can be an individual, including an
A. Ordinary PE employee or a company.
Activities by foreign service providers in Korea will be regarded
as having an ordinary PE: (i) if such services are rendered The analysis of the “essential or significant activities” phrase in
through an employee for a period exceeding six months in the determining the existence of deemed PE varies depending on
aggregate during any period of 12 consecutive months, or (ii) what rules are applied.
if the period during which these or similar services are
continuously or repeatedly provided spans over two years. The OECD Model Tax Treaty stipulates that where a person –
other than an independent agent – is acting on behalf of a
The key concept from here is that sending employees to foreign entity and has, and habitually exercises, the authority to
Korea for longer than the above threshold periods may cause conclude contracts in the name of the foreign entity, the foreign
them to have a PE in Korea. The question may arise as to entity is deemed to have a PE unless the activities of such
what the tax consequence would be if they contract with an person are of a preparatory or auxiliary nature.
agent in Korea and perform all of business activities through
the agent as opposed to sending employees to Korea. The Korean tax laws apply broader scopes of “essential or
significant activities” in determining a foreign entity’s deemed
B. Independent agent PE issue than that of the OECD Model Treaty. For example,
When foreign service providers engage in business through an such activities are listed below:
agent, they may not be deemed to have a PE in Korea as long ■ Contract-concluding dependent activity: Holding and
as the agent is a broker, general commission agent or any using on a permanent basis the authority to conclude
other agent of an independent status, and such broker or contracts on behalf of the foreign corporation (this would
agent is acting in the ordinary course of his/her business. also create a PE under the OECD Model).
Under Korean tax laws, to qualify as an independent agent, a ■ Intermediary activity: Performing deemed dependent
person should be independent of the foreign corporation both activities catering to the specific foreign entity’s essential
legally and economically and act in his/her ordinary course of business transactions on its behalf. Domestic tax law
business when acting on behalf of the foreign corporation. specifies that this condition is met even if the agent is
Specifically, if the agent’s commercial activities for the foreign independent from foreign entity and its activities are made
corporation are not subject to detailed instructions or to the during its normal course of business as long as the
foreign corporation’s comprehensive control, such agent can activities are considered as deemed dependent activities
be regarded as independent of the foreign corporation. in fact.
1 The Korean income tax law uses the terminology “fixed place of business” when referring to a PE issue. As PE is a commonly used terminology in
international taxation, this article interchangeably uses both of them.
45
45
Korea: Tax treatment of cross-border service activities
■ Inventory-holding activity: Storing foreign entity’s assets income classification rules are applied per the treaty and
and delivering or transferring them according to orders domestic tax laws; business income may be reclassified as
received from customers. personal service income, royalty, or other income. For example,
■ Insurance activity: Collecting insurance premiums or if certain services cannot be provided by any other entities
insuring property on behalf of foreign insurance since such service requires unique techniques, know-how, or
companies. any other secret method, then income from such activities can
be defined as royalty income.
Of course, the above is subject to any applicable double tax
treaty. Thus, withholding rates on the income may vary depending on
the income classification and on the withholding rates specified
D. Tax consequences of PE
at the applicable tax treaty. If the foreign service provider’s
Once a PE exists, it has to register with the district court, the origin country does not have a tax treaty with Korea, then the
district tax office, and a foreign currency bank. Korean tax laws will be applied and appropriate withholding tax
The PE should fulfill all tax compliance and payment obligations rates will be used.
under various applicable Korean tax laws that are applied to
domestic corporations in relation to Korean-sourced income III. Employee perspective
attributable to the PE. Thus, the foreign service providers have
to file income tax returns and pay income taxes on their Korean Taxation on the employees’ salary income while performing
source income. Presently, the first KRW200 million of the service in Korea is determined based on the existence of the
taxable income is taxed at 12.1 percent and the excess is tax treaty and number of days staying in Korea. If no treaty
taxed at the rate of 24.2 percent (including 10 percent resident exists, then all of salary income will be taxable to Korea
surtax). The PE is also liable to issue VAT invoices, to file VAT regardless of the number of days staying in Korea. On the other
returns, and to pay VAT with respect to the services provided to hand, if the treaty exists, income earned while staying less than
domestic customers. The PE is also required to follow other 183 days is generally tax exempted.
various tax rules and regulations including payroll taxes, social
security taxes, local tax and others. IV. Conclusion
If any of the above requirements are not met, then applicable
Korean tax law applies a broad definition of a PE. Failure to
penalties will be imposed. For example, if a foreign entity has a
recognise a PE would only end up with paying penalties as well
PE in Korea but does not register the PE with the relevant
as taxes. Also, even if PE doesn’t exist, withholding tax rates
authorities, then it will be subject to penalties for failing to
may vary per the income classification rule.
register the business. In addition, it will be subject to penalties
for failure to file returns and for underpayment of taxes. Mr Jae Won Lee is a Senior Partner with the tax practice of
KPMG’s Korean firm, specialising in M&A, Transactions and
II. Withholding taxes email at: jlee20@kr.kpmg.com
In the absence of a PE in Korea, under Korean domestic law, Mr Deok-Hyun Seo is a Manager with the tax practice of
foreign service providers will suffer withholding tax at 2.2 KPMG’s Korean firm, specialising in Transactions and
percent, including resident surtax on their Korean source International Tax Services and may be contacted by mail at:
business income. This withholding rate may be changed if deokhyunseo@kr.kpmg.com
46
46
for investment
Newbridge Capital, a US private equity fund, recognised USD1.25 billion of profits from the sale of its investment into
Korea First Bank in year 2005. The Carlyle Group, another US private fund, recognised USD761 million of gains from
the sale of its investment into KorAm Bank in year 2004. No taxes were paid to the Korean government from the above
transactions.
The Korean Government considered these as severe threats to achieving its international taxation goal; getting a fair
share of revenue from cross-border transactions. Thus, the National Assembly enacted revised international tax laws in
2006 to regulate foreign investors’ tax planning strategies. Also, the tax authorities have issued numerous tax rulings and
notices to guide its position against such tax planning strategies. With these domestic laws, rulings, and notices, the tax
authorities now pay closer attention to foreign investors’ tax issues.
In these circumstances, foreign investors may want to keep in mind that investment structuring and capital planning
have to be carefully reviewed before entering the Korean market. This article may provide foreign investors with a
general guideline about two tax strategies – investment structuring and capital planning and how the Korean tax
authorities respond to these strategies.
I. Holding strategy However, when the holding company is in a location included

on a list of tax havens, as designated by the Ministry of
Establishing a holding company in one country and its Strategy and Finance (formerly referred to as the Ministry of
subsidiary in Korea is a commonly used method among Finance and Economy), the treaty will then be disregarded.
foreign investors. The holding company’s residence Currently, Labuan is the only listed jurisdiction as tax haven.
jurisdiction is often determined based on the tax treaty
between Korea and such jurisdiction and based on the tax No concrete guidelines exist at present to satisfy the other
treaty between such jurisdiction and the originating investors’ condition of beneficial ownership of the income. Certain court
jurisdiction. By implementing holding company structures, cases and Korean tax authority’s private letter rulings indicate
foreign investors may maximise treaty benefits, e.g. reduced that the tax authority considers various factors in determining
or even exempted withholding rates on dividends, interest, the existence of beneficial ownership on a substance over
and other income or deferral of capital gains taxation. The two form basis. For example, the tax authority considers how
private equity funds mentioned above were able to pay no many years the holding company has operated, how much it
taxes using the treaty benefits made between Korea and spends on office lease expense, what salary expenses have
Malaysia. Under the tax treaty, Malaysian residents are not been paid, and other factors.
liable to pay any Korean taxes on capital gains derived on the
sale of shares in a Korean company. In addition, the Malaysian If a holding company fails to meet the beneficial ownership
Government provides a tax exemption if any taxpayer is test, then the withholding rate will be determined depending
located in Labuan Island. As a result, many foreign investors, on the tax treaty between Korea and the country in which the
including the above two funds, established holding companies real beneficial owners resides.
in Labuan and were successfully able to pay no taxes in both
countries. II. Financing strategy
In response to the above strategy, Korea looks critically at In general, foreign investors raise funds for doing business
treaty claims by holding companies. Korea recognises the through long-term loans or capital injections.
existence of a holding company only if it meets the following
two conditions: Since dividends are non-deductible while interest expenses
are deductible for corporate income tax purposes, most
a. Residence status in the jurisdiction of holding company
foreign investors tend to prefer loans to capital injections. The
for tax purposes, and
advantage of paying interest to non-residents compared to
b. Beneficial ownership of the income. paying dividends constitutes an inherent bias in favour of debt
The condition of “residence status” can be easily clarified by a financing of domestic entities by foreign investors. As a result,
certificate of residence issued by the relevant tax authorities. the Korean Government enacted thin capitalisation rules to
47
47
Korea: Holding and financing strategies for investment
regulate the companies’ tendency to use related-party exiting stages. Thus, if foreign investor plans to enter into
borrowings to finance their activities. Korea, it is strongly recommended to consult with tax
specialists to build tax efficient strategies in advance while
A thin capitalisation rule was enacted at the end of 1995 to
observing Korean tax rules.
discourage the practice of thinly capitalising foreign controlled
companies in Korea. It provides that if the loans obtained by a
domestic corporation directly from, or under the guarantee of, Summary of withholding tax ratesa
its foreign controlling shareholder exceed three times the Country Interest Dividend
equity amount it has invested in the domestic corporation, the Belgium 10% 15%
interest expenses on that excessive debt will be treated as Canadab 15% 5 or 15%
deemed dividend, and thus such portions of interest Hungaryc 0% 5 or 10%
expenses become non-deductible. The three to one ratio is Ireland, Republic ofd 0% 10 or 15%
increased to 6:1 if both Korean corporation and its foreign Luxembourgd 10% 10 or 15%
controlling shareholder are primarily engaged in banking or Russiae 0% 5 or 10%
similar types of financing business. The deemed dividend is Singapored 10% 10 or 15%
then subject to withholding taxes in line with the applicable United Kingdomb 10% 5 or 15%
treaties. United Statesf 12% 10 or 15%
Generally, if a domestic company pays a dividend to foreign a Please note that the table does not include 10% of resident surtax on the
withholding taxes; accordingly, 10% and 15% withholding tax ends up
shareholders whose state of residence does not have a treaty with the Company paying 11% and 16.5% of taxes, respectively.
with Korea, Korean domestic tax law imposes a 22 percent b The 5% rate applies if the beneficial owner is a company (other than a
withholding tax on the dividend. The same withholding rate is partnership) that controls directly at least 25% of the voting power of the
company paying the dividends; the rate is 15% in all other cases.
applicable to interest paid to foreign creditors if the State of
c The 5% rate applies if the beneficial owner is a company that holds
residence does not have a treaty with Korea. Foreign entities directly at least 25% of the capital of the company paying the dividends;
based in countries having a treaty with Korea are entitled to the 10% rate applies in all other cases.
much lower withholding taxes. Korea has signed treaties with d The 10% rate applies if the beneficial owner is a company (other than a
partnership) that holds directly at least 25% of the capital of the company
70 countries worldwide, and a summary of withholding rates paying the dividends; the 15% rate applies in all other cases.
for major treaties is included at the end of this article. e The 5% rate applies if the beneficial owner is a company (other than a
partnership) that holds directly at least 30% of the capital of the company
paying the dividends and invests not less than 100,000 USD or an
III. Other information equivalent amount of local currencies to the company paying the
dividends; the 10% rate applies in all other cases.
Foreign investment is required to contribute a minimum of f The 10% rate applies if the recipient is a corporation and at least 10% of
KRW50 million per entity in accordance with Article 329 of the the outstanding shares of the voting stock of the paying corporation was
corporate income tax law. There is no such minimum owned by the recipient corporation during the part of the paying
corporation's taxable year that precedes the date of payment of the
requirement placed on subsequent increases in investment. dividend and during the whole of its prior taxable year, and not more than
25% of the gross income of the paying corporation consists of interest or
dividends for such prior year (other than interest from banking or
IV. Conclusion insurance of financing business or subsidiary corporations, 50% or more of
which is owned by the paying corporation at the time the such dividends
Since the economic crisis of 1997, Korea has been an or interest is received); the 15% rate applies in all other cases.
attractive country for foreign investors to perform investing
activities. However, there are some burdens they have to bear,
including tax. Accordingly, this article discusses tax issues Mr Jae Won Lee is a Senior Partner with the tax practice of
that investors may need to consider from the investment KPMG’s Korean firm, specialising in M&A, Transactions and
structuring and capital planning perspectives. Beneficial
email at: jlee20@kr.kpmg.com
ownership is a controversial issue today. It requires a very
judgmental call based on facts and circumstances. The thin Mr Deok-Hyun Seo is a Manager with the tax practice of
capitalisation rule may hinder investors maximising their rate KPMG’s Korean firm, specialising in Transactions and
of returns. There are also various other tax issues foreign International Tax Services and may be contacted by mail at:
investors may need to consider in the entering, operating, and deokhyunseo@kr.kpmg.com
48
48
Key tax implications
Jae Won Lee and Chung Wha Suh
A representative of the Korea Association of Realtors had an interview with the press on November 2008 and
mentioned that “the average housing price has dropped by 30 percent while the Korean won to the US dollar exchange
rate has soared by 60 percent in one year. Also, the government is easing various regulations on the real estates to
defend a sharp decline in real estate price.” In this regard, Korea’s real estate market may be one of the most attractive
places for foreign investors to consider.
In most cases, foreign investors are in favour of ordinary corporate types (e.g. Chusik Hoesa, Yuhan Hoesa) as the
acquisition and holding vehicle for their Korean real estate investment. On the other hand, if a foreign investor acquires
real estate directly, such acquisition causes him to have a permanent establishment (“PE”) in Korea – even if he fails to
register the PE with the relevant authorities (deemed PE).
The impact on the real estate investment therefore substantially varies depending on the entity type and foreign
investors’ investment stage. This article focuses on the general tax implication at the acquisition stage, at the holding
period, and at the exit phase, when an investor sets up an ordinary corporation (the “company”) and performs its
business activities.
I. Acquisition stage When a foreign investor establishes the company, 0.48

percent of capital registration tax on the company’s
In principle, foreign investors are not restricted from acquiring paid-in-capital is levied. Capital registration tax rate increases
any real estate situated in Korea. However, certain categories threefold if the company is located in the Seoul Metropolitan
of real estate, such as land reserved for military facilities, Area (“SMA”).
cultural assets, ecological preservation, as well as certain land
on islands required for military purposes, would first require At the real estate acquisition stage, 2.4 percent asset
obtaining official approval prior to the acquisition. Also, registration tax on land and buildings will be imposed. This 2.4
reciprocal treatment applies in the acquisition of real estate in percent tax rate may be lowered to 0.96 percent though if the
Korea. Thus, if one nation forbids Koreans or Korean building is to be constructed or is construction in progress. In
corporations acquiring land and/or buildings situated therein, addition to the asset registration tax, the acquisition tax will be
the same treatment shall apply to a person or a corporation of levied at 2.2 percent of the acquisition and/or construction
the other country trying to acquire real estate situated in cost of real property. Both the asset registration tax and the
Korea. acquisition tax rate increases threefold if land and newly
constructed building is located in the SMA and used for head
Generally, there are no legal restrictions concerning the type of office. However, if the building is constructed for use in a
overseas capital invested (e.g. requiring debt or equity lease business, only asset registration tax will be increased;
investment) in the domestic company. However, the thin the acquisition tax stays at the regular 2.2 percent rate to land
capitalisation rule should be considered. Thus, if the company and buildings, even if it is constructed in the SMA.
borrows an amount that exceeds a certain amount of equity,
the interest expenses from the excess borrowing would be If a foreign investor acquires more than 50 percent of
denied as a deductible expense for corporate income tax ownership in an existing Korean company that already owns
purposes. Under the current thin capitalisation rule, if the real estate, then the purchaser shall be deemed to indirectly
loans obtained by a domestic corporation directly from, or acquire the concerned company’s real estates under the
under the guarantee of, its foreign controlling shareholder Korean tax laws. Thus, the investor is subject to pay deemed
exceed three times the equity amount it has invested in the acquisition tax for the amount of 2.2 percent on the net book
domestic corporation, the interest expense on that excessive value of such real estates. It is not required to pay asset
debt will be treated as deemed dividend, and thus such registration tax from the acquisition.
portions of interest expenses become non-deductible.
Deemed dividend will then be subject to withholding taxes Both capital and asset registration tax as well as (deemed)
with the applicable per tax treaties. acquisition tax are filed under the self-compliance method; the
49
49
Korea: Investing in real property: Key tax implications
company files the returns and pays taxes to the appropriate In pursuant to LTA, the company is also obligated to pay city
governmental entity. planning tax at the rate of 0.15 percent of the building’s
standard value and common facilities tax which is taxed
II. Ongoing ownership progressively at rates ranging from 0.023 percent to 0.26
percent of the building’s standard value.
Various types of Korean taxes will be imposed by both national
government and local governments during the holding period
including corporate income tax, value added tax, property tax, III. Exit phase
city planning tax, and others. At the exit phase, invested capital can be repatriated generally
A. National tax through two methods: (i) disposal of real estate and liquidating
the company, or (ii) disposal of shares in the company.
If the real estate company generates lease income, then the
investor may be liable for paying income taxes on such income A. Disposal of real estate
in pursuant to Corporate Income Tax Laws (“CITL”). Presently,
the first KRW200 million of the taxable income is taxed at 12.1 Proceeds from the sale of assets are added to taxable income
percent (including 10 percent resident surtax) and the excess is with other incomes and income taxes are paid when the final
taxed at the rate of 24.2 percent (including 10 percent resident corporate income tax returns are filed. VAT also applies on the
surtax). From 2010, this tax rate will be reduced further to 11 sale of buildings, but not on the sale of land. The company may
percent (including 10 percent resident surtax) for the first be liable to charge 10 percent VAT on the building’s sale price
taxable income up to KRW 200 million and 22 percent and pay the collected tax to the tax authority.
(including 10 percent resident surtax) thereafter.
B. Disposal of shares
Also, the company may be required to collect 10 percent VAT
on the lease income received from the tenants and pay the When the company’s shares are sold to a buyer, the buyer is
collected VAT to its jurisdictional tax office in pursuant to the required to withhold taxes at the rates of 22 percent of the
VAT Act. gains realised from the sale of such rights or 11 percent of the
sales proceeds under the tax law, unless a tax treaty between
In addition, the company is obligated to withhold taxes on Korea and the country where the foreign investor resides
interest, dividends, and other types of Korean source income provides a capital gain exemption for share transfers.
paid to non-resident shareholders, including its ultimate
investors. Depending on the recipient of the income, Also, the company is required to pay a 0.5 percent security
companies are required to withhold taxes using the applicable transaction tax (“STT”) based on the sales price of the shares in
rates prescribed in the Korean tax law. In addition to the above pursuant to STT Act. The buyer is responsible for withholding
withholding taxes, 10 percent resident surtax shall be this tax from the transaction.
assessed. If interest and dividends are paid to its foreign
investors, the payments are subject to withholding tax at the IV. Conclusion
domestic statutory withholding tax rate of 22 percent including
resident surtax. However, the withholding tax can be lowered or The company needs to consider several tax issues at each
even waived if the applicable tax treaty allows reduced or stage. If a foreign investor uses special purpose companies
exempted withholdings. such as REIT, ABS companies, REF, and others, the investment
tax implication may significantly differ from the above analysis. It
B. Local tax is uncertain though which entity type is appropriate for each
The company owning buildings as of June 1 of each year are investor. Accordingly, an investor will want to plan ahead for the
obligated to pay property tax pursuant to the Local Tax Act tax structuring of the implementation which will also need be
(“LTA”). The property tax base is either the publicly announced done with care.
price of land or the standard value of a building, as determined Mr Jae Won Lee is a Senior Partner with the tax practice of
by the local government. Land and buildings are taxed at KPMG’s Korean firm, specialising in M&A, Transactions and
progressive rates, which range from 0.07 percent to 0.5 International Tax Advisory Services and may be contacted by
percent for land and 0.15 percent to 4.0 percent for buildings, email at: jlee20@kr.kpmg.com
depending on the use and nature of the real property. Property Dr Chung Wha Suh is a Senior Manager with the tax practice of
tax is paid by notice method; the investor pays the tax for the KPMG’s Korean firm, specialising in ICT, Transactions and
amount stated on a notice issued by the government and no International Tax Advisory Services and may be contacted by
return filing is needed. email at: csuh@kr.kpmg.com
50
50
Malaysia
Outline of the corporate tax regime

Leanne Koh Li Ann
KPMG Tax Services Sdn Bhd, Malaysia
In the following article, we examine applicable company law; exchange control and the corporate tax system within
Malaysia.
I. Formation of a company checks and audits to ensure full compliance and declaration
of income. Under the self-assessment system, severe
The Malaysian Companies Act, 1965 allows the formation of a:
penalties will be imposed for non-compliance and
■ Company limited by shares; under-declaration of income.
■ Company limited by guarantee;
With effect from April 1, 2007, the Government of Malaysia
■ Company limited both by shares and guarantee;
has exempted any person from real property gains tax
■ An unlimited company; or imposed on the disposal of any real property or shares in real
■ A registration of foreign branches to conduct businesses. property companies.
The above formation is administered by the Companies
The principal direct taxation legislation is as follows–
Commission of Malaysia.
On the other hand, a Representative Office is not required to

■ The Income Tax Act 1967 which gives the MIRB the
be incorporated under the Malaysian Companies Act, 1965 authority to impose and collect income tax.
and is instead approved by the Malaysian Industrial ■ The Petroleum (Income Tax) Act 1967 which governs tax
Development Authority. on profits from petroleum operations.
■ The Promotion of Investments Act 1986 which provides
II. Tax system for tax incentives for persons engaged in promoted
industries or activities.
Malaysia adopts a territorial system of income taxation, such
that only income accruing in or derived from Malaysia or ■ The Stamp Act 1949 imposes duties on certain
received in Malaysia is subject to Malaysian taxation. Income instruments and documents. The rate of duty varies
tax is levied on the chargeable income of a person. A according to the nature of the instruments/documents
“person” for tax purposes includes a company, a body of and transacted values.
persons and a corporation sole as well as an individual. At present there is neither a value-added tax nor a goods and
However, all income arising from sources outside Malaysia services tax in Malaysia although the introduction of the latter
and received in Malaysia by a resident company (other than a has been proposed but the actual implementation date has
company carrying on the business of banking, insurance, yet to be determined. Instead there is an indirect tax
shipping and air transport) is exempted from income tax. framework that consist of the following core taxes/duties–
The tax system of the country evolved to a self-assessment ■ The Customs Act 1967 imposes duties on the
system in 2001 for companies and then in 2004 for other
importation/exportation of goods.
taxpayers. Under this system, tax returns submitted by
taxpayers will be accepted as correct without further review.
■ The Sales Tax Act 1972 which governs a single stage tax
In short, the tax return furnished is deemed to be a notice of imposed on taxable goods manufactured locally or
assessment and the notice of assessment is deemed to be imported.
issued on the day the return is submitted to the Malaysian ■ The Service Tax Act,1975 which is a consumption tax
Inland Revenue Board (“MIRB”). The MIRB will make random levied on taxable services.
51
51
Malaysia: Outline of the corporate tax regime
■ The Excise Act 1976, imposes duties on a selected of expenses of a revenue nature wholly and exclusively
goods manufactured locally and imported. incurred in the production of income. The excess of
allowable deductions over income from a business
III. Equity participation source constitutes an adjusted loss which is allowed to
be set off against income derived from other sources in
The Malaysian Foreign Investment Committee (“FIC”) was the same year, and thereafter against income from
established for the purpose of implementing guidelines for the business sources only in subsequent years.
regulation of acquisitions, mergers and take-overs by local and
■ Unabsorbed Capital Allowances (“CA”) & Unabsorbed
foreign interests.
Business Losses (“BL”). CA and BL can be used to offset
Where the transaction or investment requires approval of any against the adjusted income of the company except for a
government agencies/statutory body, the equity condition dormant company which fails the 50 percent continuity of
imposed by these relevant government agencies/statutory ownership test.
body will be based on the FIC guidelines. A key effect of the ■ Imputation System – Single Tier. From January 1, 2008
FIC guidelines is in many cases to impose a limit on the there is a single tier company income tax system. Under
percentage of foreign ownership. this single tier system, tax on a company’s profits is a final
The percentage of foreign shareholding permitted in Malaysian tax and dividends distributed to shareholders will be
companies depends on the types of activities being exempted from tax. The single tier system replaces the
undertaken. A simple synopsis of the equity participation is imputation system whereby dividends carry a credit for
illustrated in the following: tax paid by the company. There is a six year transitional
period starting from January 1, 2008, during which the
Table 1 two tax systems operate in parallel, and companies that
Activity Foreign Equity Policy have imputation credits (“section 108 credits”) will
Manufacturing Generally can be up to 100% foreign owned continue to be able to use them during that period.
(subject to certain conditions)
■ Group Relief. It is possible for companies resident and
Other sectors Foreign shareholding up to 70% with 30%
reserved for Bumiputrasa incorporated in Malaysia to surrender no more than 70
Companies listed on the stock Must have 30% reserved for Bumiputrasa percent of their current year tax adjusted business loss to
exchange upon listing one or more related (70 percent) companies resident and
a Bumiputras are defined as indigenous Malays. incorporated in Malaysia. There are however a number of
exclusions and conditions.
The FIC guidelines have recently been amended and now only ■ Withholding Tax. A non-resident person, whether an
apply to acquisition of real properties above a certain value. individual or company, is liable to a withholding tax on the
Companies incorporated under the Companies Act 1965 are gross amount of the income received relating to interest,
now allowed 100% foreign shareholding with the exception of royalties, rental payments for moveable property and
companies involved in certain regulated industries, e.g. remuneration in respect of services performed in
banking, insurance, telecommunications, etc. Malaysia. Subject to the Double Taxation Agreements
between Malaysia and the country of residence of the
IV. Tax rates and deductibility recipient, the withholding tax ranges from 10 percent to
15 percent.
For ease of reference, outlined below are the salient tax issues
under the Malaysian income tax system:
V. Incentives
■ Resident Status. For companies, resident status is
generally determined based on locality of the Malaysia has a wide range of tax incentives catering to the
management and control of the company. needs of domestic and foreign investors. There are incentives
■ Chargeable Income. Income arising from sources outside available in Malaysia for investments in promoted products and
Malaysia and received in Malaysia by resident companies activities in the manufacturing, agriculture, hotel and tourism
is generally exempted from income tax. However industry, research and development (“R&D”) and training
residents carrying on the business of banking, insurance, activities and specific business activities as promoted by the
shipping and air transport are taxed on a “worldwide” Malaysian Government. These incentives are contained in the
basis. A resident individual is also exempt from income Promotion of Investments Act 1986 and the Income Tax Act
tax on income received in Malaysia from sources outside 1967 as well as various statutory orders. Generally, the
Malaysia. Non-residents are taxed on Malaysian derived incentives provide for total or partial relief from income tax and
income only. a number of the available incentives require prior approval and
may be granted subject to certain conditions.
■ Tax Rates. Currently for the purposes of income tax,
companies with a paid up share capital of RM2.5 million Some of the main tax incentives are as follows:
and below are subjected to a corporate tax rate of 20
percent on the first RM500,000 of chargeable income 1. Pioneer Status (“PS”)
and 25 percent on the subsequent chargeable income. PS is a tax incentive which provides a full or partial exemption
Individual residents on the other hand are taxed based on from income tax on qualifying projects. The profits that are
scale rates starting from one percent to a maximum of 27 exempted from tax are transferred to an exempt income
percent. account for the purpose of paying tax-exempt dividends.
■ Allowable Deductions. The Income Tax Act 1967 permits Redistribution by shareholder companies of such exempt
a tax deduction only with respect to outgoings and dividends are also exempt from tax.
52
52
Malaysia: Outline of the corporate tax regime
2. Investment Tax Allowance (“ITA”) VI. Exchange control measures

Eligible projects with large capital investment and long
gestation periods can consider ITA. ITA is a tax incentive based Malaysia has a number of exchange control measures. These
on the qualifying capital expenditure incurred and may be are contained in the Exchange Control Act 1953 as well as
applied for by companies participating or intending to various Exchange Control Memorandums (“ECM”). Since their
participate in a promoted activity or in the production of a inception, these ECM’s have undergone a number of
promoted product. The ITA is deducted in arriving at taxable modifications and there has been a general relaxation. The key
income and any unutilised allowance can be carried forward ECM’s include:
until it is fully utilised.
PS and ITA are mutually exclusive. Table 2
3. Reinvestment Allowance (“RA”) ECM 2 Dealings in gold and foreign currency
Under the Income Tax Act 1967, a resident company, which ECM 4 General payments
incurs capital expenditure on a factory, plant or machinery used ECM 6 Credit facilities to non-residents
for a qualifying project in Malaysia can claim RA generally ECM 7 Foreign currency accounts
equivalent to 60 percent of that expenditure.
ECM 9 Investment abroad
A qualifying project refers to a project undertaken by a
ECM 10 Foreign currency credit facilities and Ringgit credit facilities from
company in expanding, modernising or automating its existing non-residents
business in respect of manufacturing or in diversifying its ECM 15 Labuan international offshore financial centre
existing business into a related product.
ECM 16 Approved operational headquarters
To qualify for the allowance, the company must be in
operations for at least 36 months. Companies which are
currently enjoying certain incentives (e.g. pioneer status or We have attempted to briefly cover the salient aspects of the
investment tax allowance) will not qualify for RA. A company tax, legal and exchange control system of Malaysia. At this
purchasing an asset from a related company within the same juncture, let us end by reiterating that Malaysia does have
group where RA has been claimed on that asset is not allowed numerous tax incentives in place to cater for the specific needs
to claim RA on that asset. of the foreign investor.
The utilisation of RA is generally restricted to 70 percent of Leanne Koh Li Ann is an Executive Director with KPMG Tax
statutory income. Any unabsorbed allowance is allowed to be Services Sdn Bhd, (Malaysia) and may be contacted by email
carried forward indefinitely. at: leannekoh@kpmg.com.my
53
53
54
54
Tax treatment of cross-border services
by non-residents
Peggy Then
This article aims to address a number of the Malaysian tax considerations in relation to cross-border services rendered
by non-residents in or to Malaysia. Most cross-border services, if not all, would face a number of similar Malaysian tax
issues which will be covered below. Nevertheless, it is recognised that there may also be peculiarities unique to the
transaction which may impact upon the tax position of the non-resident.
A non-resident could render services to Malaysia in a number B. Malaysian withholding tax

of ways, including through:
Depending on circumstances, the non-resident may be subject
■ Incorporation of a Malaysian subsidiary; to the following types of withholding tax:
■ Setting up of a Malaysian branch of the non-resident’s 1. Section 109B of the ITA
company;
Withholding tax under section 109B of the ITA typically relates
■ Setting up of a joint-venture with a Malaysian entity – this to payments relating to the so called “special classes of
could take the form of an incorporated joint venture or an income” where the non-resident does not have a PE (or
unincorporated joint venture; or business presence) in Malaysia, which includes:
■ Alternatively, the non-resident could render the services
a. Amounts paid in consideration for services rendered by
from its own jurisdiction.
the person or his employee in connection with the use of
property or rights belonging to, or the installation or
I. Is there Malaysian source income? operation of any plant, machinery or other apparatus
A. The Malaysian Income Tax Act, 1967 (“ITA”) purchased from, such person;
b. Amounts paid in consideration of technical advice,
The ITA is the principal legislation which imposes tax on income
assistance or services rendered in connection with
in Malaysia. Generally, income of any person accruing in or
technical management or administration or any scientific,
derived from Malaysia, or received in Malaysia from outside
industrial or commercial undertaking, venture, project or
Malaysia would be subject to income tax. However, the income
scheme; or
of a person, other than a resident company carrying on the
c. Rent or other payments made under any agreement or
business of banking, insurance or sea or air transport derived
arrangement for the use of any moveable property.
from outside Malaysia and received in Malaysia is exempted
from Malaysian income tax. Payments falling within the above scope of special classes of
income are deemed derived from Malaysia if:
Amongst other things, the ITA provides that so much of the
gross income from the business that is not attributable to 1. Responsibility for payment of the above or other
operations of the business carried on outside Malaysia shall be payments lies with the government, state government or
deemed to be derived from Malaysia. a local authority;
2. Responsibility for the payment of the above or other
It is evident that where the services are provided in Malaysia
payments lies with a person who is a resident for that
through a locally incorporated company or a branch set-up by
basis year; or
the non-resident, such income will generally be viewed as
Malaysian sourced and subject to Malaysian corporate tax at 3. The payment of the above or other payments is charged
the prevailing rate, which is now reduced to 25 percent. as an outgoing or expense in the accounts of a business
carried on in Malaysia.
In other situations, the position may be less clear and careful
Note that (a) and (b) above only apply to amounts attributable
consideration would need to be given to come to a view
to services which are performed in Malaysia.
whether the non-resident’s income is deemed to be derived
from Malaysia or the non-resident may have a business Under the ITA, the withholding tax rate under section 109B is
presence or a Permanent Establishment (“PE”) in Malaysia. In 10 percent of the gross payments made to the non-resident,
this regard, the interaction of the ITA with the provisions of the although the withholding tax rate may be reduced under the
relevant Double Taxation Agreement (“DTA”) would be relevant. relevant DTA. The responsibility to account for withholding tax
55
55
Malaysia: Tax treatment of cross-border services by non-residents
to the Malaysian Inland Revenue Board (“MIRB”) is with the includes any advisory, consultancy, technical, industrial,
payer. commercial or scientific service.
Generally, income comprising of management fees, technical Withholding tax is due to the MIRB within one month of paying
fees, consultancy fees and fees of a similar nature could fall or crediting the non-resident, whichever is the earlier. Failure to
within the ambit of section 109B. It should be noted however comply would result in penalties being imposed, and
that withholding tax would only apply if these services are non-deductibility of expenditure which would otherwise be
rendered in Malaysia by the non-resident. In the case where the deductible for tax purposes.
fees comprise of both onshore and offshore services, then Section 107A is an advance collection of tax and the 10
insofar as the contract document clearly segregates the fees percent portion withheld can be used to offset against the
relating to the onshore and offshore services, withholding tax contractor’s Malaysian corporate tax liability. The non-resident
should only apply to the portion of work performed in Malaysia. contractor would be required to file a Malaysian tax return. If
In practice, the MIRB adopts a very wide interpretation of the the final tax liability of the non-resident is less than the 10
term “technical” in relation to technical advice, services or percent tax withheld, the excess will be refunded. The three
assistance. Based on the Public Ruling 4/2005 on Withholding percent tax withheld is refunded to the non-resident contractor
Tax on Special Classes of Income issued by the MIRB, the when the MIRB is satisfied that the employees’ income tax
scope of payments made to a non-resident person for obligations have been discharged.
“technical advice, assistance and services” covers payments 3. Section 109 of the ITA
for technical assistance, non-technical assistance, technical If a non-resident receives interest or royalty which is derived or
services or non-technical services rendered in connection with deemed to be derived from Malaysia, the interest or royalty
any scientific, industrial or commercial undertaking, venture, would be subject to Malaysian withholding tax of 15 percent
project or scheme. and 10 percent respectively (subject to reduction under the
The MIRB views technical advice, assistance or services to relevant DTAs).
include the passing over or utilisation of expert or specialised Withholding tax is due to the MIRB within one month of paying
knowledge, skills or expertise. Examples of technical or crediting the non-resident, whichever is the earlier. Failure to
management would include, among others, the provision of comply would result in penalties being imposed, and
marketing, consultancy, legal services and inter-company non-deductibility of expenditure which would otherwise be
technical services. deductible for tax purposes.
The MIRB takes the view that reimbursements of out-of-pocket 4. Introduction of section 109F of the ITA
expenses (e.g. hotel costs, airfares, etc.), other than The introduction of the new section 109F in the 2009 Budget,
reimbursements relating to hotel accommodation in Malaysia, provides that where the payer is liable to make payments to a
are also subject to withholding tax on the basis that these non-resident in relation to miscellaneous gains or profits falling
expenses constitute part of the contract value for services under section 4(f) of the ITA which are derived from Malaysia,
rendered (where the underlying services provided are subject to he shall upon paying or crediting such payments deduct
withholding tax). therefrom tax at the rate of 10 percent. This is effective from
Withholding tax is due to the MIRB within one month of paying January 1, 2009.
or crediting the non-resident, whichever is earlier. Failure to It appears that the withholding tax under section 109F would
comply would result in penalties being imposed, and include income in respect of gains or profits that arise to a
non-deductibility of expenditure which would otherwise be non-resident from an activity which is outside his ordinary trade
deductible for tax purposes. or vocation. It would appear that the withholding tax is payable
regardless whether the arrangements or services are carried
2. Section 107A of the ITA
on, in or outside Malaysia. Such income may in the MIRB’s
Section 107A of the ITA typically applies (instead of section view include commissions, guarantee fees and introducer’s
109B) where the non-resident has a PE or business presence fees.
in Malaysia. Generally, section 107A of the ITA provides that
where any person is liable to make a contract payment to a
non-resident contractor in respect of services under a contract,
II. DTAs
he shall upon paying or crediting such payment deduct Malaysia has concluded agreements for the avoidance of
therefrom tax at the rates of: double taxation with 70 countries. However not all of these
have been gazetted and entered into force, and not all of these
a. 10 percent of the contract payment on account of tax
are comprehensive.
which is or may be payable by that non-resident
contractor for any year of assessment; and These DTAs follow the general principle that the country of
b. 3 percent of the contract payment on account of tax source of the income has the primary right of tax and the
which is or may be payable by employees of that country of residence of the taxpayer provides either a tax
non-resident contractor for any year of assessment. exemption or tax credit.
Services under a contract for section 107A purposes means The general effect of DTAs is that business profits derived from
the performing or rendering of any work or professional service Malaysia by a resident of another treaty country are not subject
which includes any advisory, consultancy, technical, industrial, to Malaysian tax unless the non-resident of Malaysia carries on
commercial or scientific services in connection with or in business activities in Malaysia through a PE. A PE, as defined in
relation to any contract project carried out in Malaysia. the respective DTAs, usually refers to a fixed place of business,
Professional service, in relation to any non-resident contractor which could include a branch, an office or place of
56
56
Malaysia: Tax treatment of cross-border services by non-residents
management. In assessing whether a non-resident would be If the non-resident has a PE in Malaysia, the business profits
viewed to have a PE in Malaysia, regard would need to be attributable to the non-resident’s PE in Malaysia would be
given to the facts of the case. subject to Malaysian income tax. The income of the PE would
be subject to the prevailing Malaysian corporate tax rate. In
It is pertinent to note that there may be variations to the PE
addition, there would also be Malaysian withholding tax issues
Article in Malaysia’s DTAs. For example, under Article 5(4)(c) of
under section 107A to consider (covered above).
the Malaysian-Australia DTA, a PE is deemed to exist where an
Australian tax resident furnishes services, including consultancy
services, in Malaysia through employees or other personnel III. Conclusion
engaged by the enterprise for such purpose, where those
activities continue (for the same or a connected project) within As a consequence of globalisation and growth in international
Malaysia for a period or periods aggregating more than three trade, it is becoming increasingly common for non-residents to
months within any 12-month period. provide cross-border services in or to Malaysia. The tax
implications arising from service activities should be identified
Consequently, where there is no PE in Malaysia, the Australian
prior to the rendering of such services as there may be avenues
tax resident should not be subject to Malaysian withholding tax
to manage the effective tax burden on service income received.
on business income even though it may render services in
Malaysia. The provisions of the DTA would prevail over the Peggy Then is an Executive Director with KPMG Tax Services
provisions of ITA which deem such income to be derived from Sdn Bhd, (Malaysia) and may be contacted by email at:
Malaysia. pthen@kpmg.com.my
57
57
58
58
for investment
Nicholas Crist
When planning an investment from a tax perspective, investors would typically consider how to structure the
investment (e.g. holding investments via one or more tiers of intermediate holding companies or holding the investment
directly) as well as methods of funding (whether to use equity or debt or a combination of these).
I. Holding company strategies credits attached. The franking credits were used to set off
against the Malaysian tax liability of the shareholders.
A. Malaysian domestic law position
In situations where a Malaysian holding company received
As a general principle of international tax planning, only taxable dividend income and no deductible expenditure
intermediate holding companies are strategically used by was associated with the dividends received, the tax liability of
investors with a view to reducing withholding tax on dividends the shareholder arising from the dividends would be fully offset
and/or to mitigate capital gains tax on the disposal of shares by the franking credits received.
in the source or resident country.
However, where the shareholder incurred deductible expenses
However, the use of a holding company in Malaysia would not associated with the dividends received, such as an interest
necessarily provide tax benefits to the investor as Malaysia expense, the tax liability of the shareholder attributable to the
does not impose withholding tax on dividends nor does it dividends received would be lower than the available franking
impose tax on capital gains. The capital gains tax regime credits. The excess franking credits could be claimed as a
previously adopted by Malaysia, which only applied to real refund (commonly known as the “section 110 refund”) from
properties or shares in real property companies, has been the Malaysian Inland Revenue Board (“MIRB”).
suspended with effect from April 1, 2007.
The imputation system was not, however, without its
In limited cases, the use of a Malaysian holding company to concerns. Companies with profits not subject to tax under the
hold the Malaysian target company could provide tax savings. ITA, e.g. capital gains, would generally have insufficient
This is in view of the dividend imputation system which has section 108 franking credits to frank such profits, with the
been operational in Malaysia as illustrated below. exception of profits which were specifically allowed by the ITA
to be credited to an exempt account.
B. Dividend imputation system (only applies until
December 31, 2013 under the transitional provisions) In cases where the Malaysian company paid dividends and
there were insufficient credits in the section 108 account, the
Pursuant to the Malaysian Companies Act, 1965 and the
shortfall in the Account would be a debt due to the
Malaysian Income Tax Act 1967 (“ITA”), Malaysian companies
government. The shortfall, when paid to the government,
were required to have retained profits as well as sufficient
could not be used to offset against the future tax liability of the
dividend franking credits to pay dividends to shareholders.
Malaysian company.
The dividend imputation system required the Malaysian
company to attach franking credits to dividends paid.
C. Single-tier system
Dividend franking credits were maintained in a memorandum The Finance Act 2007 (“the FA”) introduced a single-tier
account known as a section 108 account which represented dividend system to replace the imputation system. Under the
the Malaysian income tax paid by the Malaysian company single tier system, Malaysian companies are entitled to pay
under the ITA. Chargeable income of the Malaysian company tax exempt dividends as long as they have sufficient retained
which is exempt from tax due to tax incentives or to income profits.
being foreign source, could be credited to an exempt
As the single-tier system abolishes the imputation system in
account. Dividends distributed from the exempt account were
relation to dividends, the Malaysian income tax paid by the
tax exempt in the hands of the shareholders.
company constitutes a final tax and dividends would be tax
Dividends franked from the section 108 account were “taxed” exempt in the hands of the shareholders. This single-tier
in the hands of the shareholders. These dividends were paid system is effective from January 1, 2008, but companies
net of tax at the prevailing corporate tax rate (i.e. at the rate of with existing section 108 credits are given a six year
25 percent from year of assessment 2009) with franking transitional period to utilise the remaining section 108
59
59
Malaysia: Holding and financing strategies for investment
credits. Once a company has exhausted its section 108 C. Withholding tax
credits, it will move automatically to the single-tier system.
Withholding tax is applicable on interest derived from Malaysia
Any unutilised section 108 credits as at December 31, 2013
and paid or credited to non-Malaysian residents. Interest
will be forfeited.
would be deemed to be derived from Malaysia if:
With the abolition of the imputation system, Malaysian holding ■ The responsibility for the payment lies with a Malaysian
companies with an interest expense will be unable to obtain
resident and the loan is laid out on assets used in or held
an effective offset against dividend income. While the
for the production of any gross income derived in
single-tier system allows capital gains to be distributed to
Malaysia or the loan is secured by an asset situated in
shareholders without the Malaysian company incurring a
Malaysia; or
shortfall in the dividend franking account, it also closes the
■ The interest is charged as an outgoing or expense
door on the section 110 refund.
against any income accruing in or derived from
D. Stamp duty Malaysia.
The Malaysian stamp duty regime extends to instruments of The Malaysian withholding tax rate is 15 percent. This rate
transfer of shares in a Malaysian company. Stamp duty (on may be reduced under a relevant double taxation
unlisted shares) is imposed at 0.3 percent on the higher of agreement.
the consideration price or market value of the shares. The
D. ITA exemptions
MIRB has issued a guideline to assist taxpayers to
ascertain the market value for stamp duty purposes. The The ITA provides for withholding tax exemptions on various
stamp duty on a transfer of shares is normally paid by the types of interest and these include:
purchaser.
■ Interest attributed to a business of the non-resident in
Malaysia;
II. Financing strategies
■ Interest paid by a person carrying on the business of
With the abolition of the dividend imputation system, tax relief banking or finance in Malaysia and licensed under the
for an interest expense in relation to an equity investment will Banking and Financial Institutions Act 1989 or the Islamic
no longer be effective through offset against dividend income. Banking Act 1983 or by any other institution approved by
Instead, financing strategies would need to be able to match the Minister of Finance;
borrowings with the acquisition of businesses and business ■ Interest paid or credited to any individual, unit trust or
assets rather than shares. The aim of this is to offset the closed end fund in respect of:
interest expense against business income.
1. securities or bonds issued or guaranteed by the
A. Thin capitalisation government; or
2. debentures, other than convertible loan stock,
The 2009 Budget inserted section 140A(4) to the ITA, which is
approved by the Securities Commission (“SC”).
effective from January 1, 2009. Section 140A(4) deals with
■ Interest paid or credited to any company not resident in
thin capitalisation. Section 140A(4) prescribes that where the
value of all financial assistance from an associated company Malaysia, other than such interest accruing to a place of
is excessive in comparison to the fixed capital of the borrower, business in Malaysia of such company:
the interest, finance charge or other consideration payable on 1. in respect of securities issued by the government;
the excessive amount shall not be deductible. The MIRB has or
yet to issue any guidelines or rules on the acceptable debt to 2. in respect of Islamic securities or debenture issued in
equity ratio. Ringgit Malaysia, other than convertible loan stock,
approved by the SC.
B. Interest restriction
■ Interest paid or credited to any person in respect of
In addition to the proposed thin capitalisation rules, a Islamic securities originating from Malaysia, other than
restriction is currently imposed on the deductibility of interest convertible loan stock:
where a company has an interest bearing loan liability as well
1. issued in any currency other than Ringgit; and
as non-trade applications, e.g. investments.
2. approved by the SC.
The interest restriction rule seeks to allocate a portion of the
interest expense to non-trade applications. Interest E. Use of Labuan as a funding vehicle
attributable to the non-trade applications may only be set off The use of a Labuan offshore company established under the
against the investment income from such applications. Where Offshore Companies Act 1990, may offer an effective funding
the interest so attributed exceeds the investment income, the route. Interest paid by a Labuan offshore company to a
excess interest is lost. non-resident is not subject to withholding tax due to a specific
The balance of the interest expense not attributed to exemption accorded to Labuan offshore companies.
non-trade applications may be set off against the business However, various approvals may be required in establishing a
income of the company. Where the interest expense exceeds Labuan offshore company as a funding vehicle.
the business income, the excess interest may be carried
forward indefinitely to be utilised against the future business
income of the company provided that the company is not
dormant otherwise the continuity of ownership test has to be Foreign exchange transactions are regulated by the
satisfied. Malaysian Central Bank. The Central Bank’s Exchange
60
60
Malaysia: Holding and financing strategies for investment
Control regime allows, amongst others, a Malaysian IV. Conclusion

company to obtain foreign currency credit facilities of any
amount from: When considering the investment holding structure for an
investment into Malaysia, the absence of dividend withholding
■ Its non-resident non-bank parent company; tax and tax on capital gains makes the tax residence of the
■
investor less of an issue for Malaysian tax purposes. Further,
Other resident companies within the same corporate
the introduction of the single-tier tax system will make it easier
group in Malaysia;
for capital gains to be repatriated to the foreign investor.
■ Licensed onshore banks and licensed International
Nicholas Crist is an Executive Director with KPMG Tax Services
Islamic Banks; and
Sdn Bhd, (Malaysia). For further information relating to this
■ Non-resident suppliers (in respect of supplier’s credit for article, please contact the author by email at:
capital goods). nicholascrist@kpmg.com.my
61
61
62
62
Tax planning for real estate
investments
Chew Theam Hock
From a tax perspective, when contemplating an investment in Malaysian real estate a non-resident investor would need
to consider several issues. These include the acquisition and financing structure of the investment, Malaysian stamp
duty, Malaysian tax exposures on the income generated from the real estate investment as well as the exit options
available. Local regulatory issues including exchange control and the Foreign Investment Committee (“FIC”) rules could
also impact the acquisition and financing structures used.
This article highlights only the relevant tax and regulatory issues that may arise in Malaysia. Tax implications outside
Malaysia for non-resident investors would also need to be considered.
I. Options as to acquisition structures The FIC guidelines have recently been amended and now only
apply to acquisition of real properties above a certain value.
A first option for acquiring real estate could be one where the Companies incorporated under the Companies Act 1965 are
non-resident individual or company acquires the property now allowed 100% foreign shareholding with the exception of
directly. Generally the acquisition of property in Malaysia by a companies involved in certain regulated industries eg banking,
non-resident requires approvals from the relevant local state insurance, telecommunications, etc.
authority as well as the FIC. Non-residents for this purpose
would include local companies with a foreign shareholding of Yet another option would be the use of a Real Estate
30 percent or more. In addition, restrictions under the National Investment Trust (“REIT”) to acquire the property. Various
Land Code for non-residents to acquire property directly will proposals introduced by the Malaysian Government in the past
need to be addressed. The FIC has issued guidelines which indicates its encouragement for the establishment of REITs. For
impose conditions on the acquisition of various types of example, an income tax exemption is given to the REIT where it
properties whether commercial, industrial and residential distributes at least 90 percent of its income. Certain start-up
depending on the purpose of acquisition (whether for own use expenses which would generally be considered as capital
or otherwise). expenditure, incurred for the establishment of the REIT also
qualify for tax deductions. Furthermore, the income tax rates
However, there are various exemptions from FIC approval such (levied through withholding taxes) on distributions from a REIT
as for the acquisition of residential units costing more than for some categories of non-residents are lower than the
RM250,000 by a non-resident. Where non-resident acquires prevailing corporate tax rate (see below for further details of the
one unit or more of contiguous properties with a total value of applicable rates).
RM10 million and above, or an entire building or property
development project or land with or without a building for II. Stamp duty
redevelopment on a commercial basis, there is a requirement
pursuant to the FIC rules to incorporate a local company to At the point of acquisition, stamp duty would be payable on the
make the investment. instrument used to transfer the property. The stamp duty is
normally borne by the purchaser and is computed on the
This leads to the second option where the real estate higher of the consideration paid or the market value of the
investment could be undertaken via a locally incorporated property at ad valorem rates of one percent to three percent
company. The non-resident investor may also have to obtain depending on the value of the property. There are exemptions
FIC approval for its investment in the locally incorporated available for transfers between related parties and for transfers
company. Generally, the FIC rules impose a requirement of a to a REIT.
minimum 30 percent local native shareholding (also known as
“Bumiputra” shareholding) and a two-year period may be given III. Financing options
for this condition to be met. The remaining 70 percent
Like in any investment, a real estate investor has the option of
shareholding may be held by foreign interests. There are
funding his investment either via equity or debt or a
various exemptions from the above equity condition. For
combination of these.
example, the acquisition of industrial property for own
manufacturing operations is exempt from the above equity The use of equity funding such as ordinary shares would
condition. generate dividend income. Dividends paid are not subject to
63
63
Malaysia: Tax planning for real estate investments
Malaysian withholding tax. The payment of dividends is limited IV. Income from the real estate investment –
to the profits of the Malaysian company and its distributable Malaysian tax exposure
reserves. Malaysia previously operated a dividend imputation
system whereby the distribution of dividends was limited to the Generally, income derived from the ownership of real estate,
availability of dividend franking credits (representing the amount e.g. rental, would be subject to Malaysian tax. In this respect,
of tax paid by the company) otherwise a shortfall penalty would where a local company is used to hold the real estate
arise. However, with effect from the year of assessment (“YA”) investment and such property is held for purposes of deriving
2008, a single-tier system of taxation replaced the dividend rental income, the rental income would be subject to tax at the
imputation system. Under the single-tier system, companies no prevailing corporate tax rate of 25 percent. For resident
longer require dividend franking credits to pay dividends and companies with an ordinary paid up share capital not
the dividends received would be exempt in the hands of the exceeding RM2.5 million, the first RM500,000 of the
shareholder for Malaysian tax purposes. A six-year transitional chargeable income enjoys a reduced rate of 20 percent. It
period up to December 31, 2013 with various rules is should be noted that with effect from YA 2009, changes have
applicable to any unutilised dividend franking credit balances as been effected to limit the applicability of the reduced tax rate
at January 1, 2008 (subject to a concession by the authorities even where a resident company’s paid up ordinary share capital
to allow the last tax instalment payment for YA 2007, which does not exceed RM2.5 million. Among other things, the
may be made after January 1, 2008, to be included in the reduced tax rate will not apply to a resident company where
company’s dividend franking credits, provided that the more than 50 percent of its paid up ordinary share capital is
instalment is paid by January 10, 2008). directly or indirectly owned by another company which has a
paid up ordinary share capital of more than RM2.5 million at the
beginning of the relevant YA.
The repatriation of the capital injected into the company in the
form of ordinary shares would be through a liquidation or a Generally, expenses incurred in the production of the rental
court-approved capital reduction exercise. income would be allowed as deductions against that income.
However, there may be restrictions on the deduction of indirect
expenses incurred.
The investor could consider introducing some debt funding
Notwithstanding the above, rental payments to non-residents
such as shareholders’ loan into the Malaysian company to fund
for the use of real estate are not subject to Malaysian
the acquisition of the real estate.
withholding tax on the basis that it is rental of immoveable
property. However, the non-resident recipient is required to
The use of debt funding may be attractive considering that lodge Malaysian tax returns to declare such income on the
profits can be extracted by way of interest payments (which are basis that it is Malaysian sourced.
not subject to the availability of profits) and the principal amount
can be repaid at the end of the loan period. Note however that V. REIT
the recent 2009 Budget introduced a new section 140A into
the Malaysian Income Tax Act 1967 (“the Act”), bringing in a Rental income received by a REIT would be subject to income
thin capitalisation regime. Pursuant to such provisions, which tax at the prevailing rate. However, where a REIT distributes at
are effective from January 1, 2009 onwards, the portion of least 90 percent of its chargeable income in the same basis
interest relating to the amount of debt which is deemed to be period it will not be subject to income tax. Instead, the unit
excessive shall be disallowed a tax deduction. Note that there holders will be taxed at their respective tax rates on the income
is no guidance issued to date in this respect. distributed in the same period. Generally, non-resident unit
holders (other than non-resident individuals and institutional
investors) will be subject to withholding tax on the income
Generally, Malaysian withholding tax is imposed at 15 percent distributed (see below for specific rates applicable to different
on the payment of interest to non-residents although this rate classes of non-resident investors).
may be reduced under relevant double tax treaties with
Capital gains from the realisation of investments by a REIT will
Malaysia. There is no Malaysian withholding tax on the
not be subject to tax. There are also income tax exemptions for
repayment of the principal amount of the loan.
specified interest income or profit earned by a REIT, including
interest from a bank or financial institution licensed under the
Central Bank approvals may also be required for loans from Banking and Financial Institutions Act 1989 or Islamic Banking
non-residents and exchange control rules may apply. These Act 1983, among others. Such income distributed by the REIT
rules have been liberalised by the Central Bank and a resident to the unit holders is also exempt from tax in the hands of the
company may now freely borrow any amount in foreign unit holders. The above is based on the treatment that a REIT
currency from its non-resident non-bank parent company (note is viewed as a unit trust for Malaysian tax purposes.
that foreign currency borrowings from other non-residents
There are also stamp duty exemptions for transfers to a REIT
which exceed the RM100million in aggregate on a corporate
resulting in savings for the REIT.
group basis and would still require Central Bank approval). A
resident may now also freely borrow in ringgit (including via the
issuance of ringgit denominated redeemable preference shares
VI. Repatriation of profits from a REIT
or loan stocks) any amount from its non-resident non-bank All unit holders (except for Malaysian resident corporate
parent company to finance activities in the Malaysian real holders) are subject to a final withholding tax on distributions
sector and up to RM1 million in aggregate from other from a REIT as follows:
non-resident non-bank companies/individuals for use in
Malaysia.
64
64
Malaysia: Tax planning for real estate investments
Table For a REIT, gains realised by the unit holders (other than
Status of investor Withholding tax rate financial institutions, insurance companies and those dealing in
Individual investor (resident or non-resident) 10%a securities) from the transfers or redemptions of the units are
Non-resident institutional investor 10%a generally treated as capital gains which are not subject to
Non-resident corporate investor 26% for YA 2008 income tax in Malaysia. It is a general understanding that the
25% for YA 2009 onwardsb
purpose of a REIT is to generate investment income from
a Rate is effective from January 1, 2009 to December 31, 2011.
holding real estate, and not from the trading of real estate.
b The prevailing corporate tax rate is applicable for distributions to a
non-resident corporate investor. Therefore, gains from disposals of real property by the REIT
itself should also not be subject to income tax as such gains
are capital in nature.
VII. Exit strategies
Malaysia does not have a capital gains tax regime apart from VIII. Conclusion
Real Property Gains Tax (“RPGT”), applicable on the disposal of
real property. However, all disposals of real estate from April 1, Foreign investment into the Malaysian real estate sector has
2007 onwards are exempt from RPGT. Consequently, RPGT been encouraged by the Malaysian Government. This may be
does not apply to capital gains arising from the disposal of real evidenced by the exemption from RPGT and the relaxation of
estate from April 1, 2007 onwards. However, if such gains are various foreign exchange control rules and FIC rules. The
viewed as trading gains (where the act of disposing the land is various tax incentives given for the establishment of REITs also
a trading activity including an adventure in the nature of trade) encourages the use of REITs as a vehicle to hold real estate
income tax would be imposed on the gains made. investments in Malaysia. Malaysia also has a comprehensive
Where a local company is used to invest in real estate, the double taxation agreement network with over 60 countries thus
investor has the alternative to dispose of the company instead providing some measure of treaty protection.
of the real estate itself. Capital gains from such a disposal Chew Theam Hock is an Executive Director with KPMG Tax
would also be exempt from RPGT. Income tax would only be Services Sdn Bhd (Malaysia) and may be contacted by email
applicable where the investor is viewed as trading in shares. at: theamhockchew@kpmg.com.my
65
65
66
66
The Philippines

Jim Nichols
KPMG London (in consultation with KPMG Manila)
Companies that want to position themselves in the Asia Pacific region have a wide range of advantages in choosing the
Philippines as an investment site. Foremost among these are the country’s strategic and centrally located position, vast
natural resources, and widely recognised abundant supply of highly trainable and English-speaking labour; this is
especially true for global companies involved in offshore service operations. As home to the world’s fourth largest
English-speaking population and the 14th largest work force, the Philippines distinguishes itself as one of the most
attractive business destinations today.
In this article we look at: applicable company law, the foreign direct investment framework, exchange control, and the
corporate tax system.
I. Applicable company law procedures for registering enterprises doing business in the
Philippines, and other regulations.
The Philippine legal system is based on both Anglo-American
common law and Spanish civil law. Philippine company law is Generally, the FIA permits foreign investment into the
governed by the Corporation Code 1980 (“CC”). Philippines, subject to two important exclusions:
Two types of company are permitted by the CC, namely stock 1. Situations where the foreign enterprise is already
and non-stock corporations. A stock corporation is very operating in the same line of business in the Philippines
broadly analogous to the European plc/SA/AG legal form, with a joint venture partner if the existing joint venture
whereas a non-stock corporation is more similar to the German enterprise, particularly the Filipino partners therein, can
GmbH or French Sarl. A stock corporation has capital stock reasonably prove they are capable to make the
divided into shares and is authorised to distribute surplus investment needed for the domestic market activities to
profits as dividends to the holders of each share. Corporations be undertaken by the competing applicant.
not organised on this basis are automatically defined as 2. Sectors on the “foreign investment negative list”. This list
non-stock corporations. Only stock corporations may issue is sub-divided into:
shares to the public (subject to regulatory approval). ■ Sectors where no foreign equity participation is
The CC requires that at least 25 percent of the authorised permitted such as professional practices, mass media,
capital must be subscribed at the time of incorporation, and at small-scale retail and small-scale exploitation of natural
least 25 percent of the subscribed capital must be paid up. resources;
However, the paid-up capital shall in no case be less than ■ Sectors where a foreign minority equity participation of
PHP5,000. a maximum of between 20 percent and 40 percent is
There are no requirements as to compulsory transfers of profits permitted such as utilisation of natural resources,
to reserves. All post-tax profits, net of accumulated losses are government construction contracts or contracts for
generally available for distribution to members. the supply of goods to the government or
management of public utilities;
■ Sectors where foreign equity participation is limited to
a maximum of 60 percent – i.e. regulated financing
Republic Act No. 7042 (the “Foreign Investments Act” or “FIA”) companies and investment houses.
was enacted in 1991 in recognition of the vital role that foreign
An investor may establish their presence in the Philippines by
capital plays in the country’s economic development. The FIA,
the creation of any of the following entities:
which seeks to encourage foreign investments in areas that
contribute to the development of the Philippines, prescribes Locally incorporated subsidiary
67
67
The Philippines: The tax and legal framework
As a general rule, the required minimum paid-up capital is III. Exchange control
US$200,000. However, this amount may be reduced to
US$100,000 if: Exchange control regulations in the Philippines were liberalised
over 15 years ago and generally foreign currency may be
■ Advanced technology is involved; or purchased and transferred in and out of the country freely
■ The business directly employs at least 50 employees. where a foreign investment has been registered with the
Additionally, the minimum paid up capital of US$200,000 does Bangko Sentral ng Pilipinas.
not apply to enterprises that export 60 percent or more of Certain restrictions in relation to the movement of local currency
output or domestic purchases. do remain however. Local borrowings by foreign investors are
Branch office allowed, as are PHP loans from overseas connected parties –
although any remittances out of the Philippines would legally
The minimum assigned capital of a branch is US$200,000. This (but not economically), have to be in foreign currency.
can be reduced to US$100,000 if advanced technology is used
in the branch’s activities or the branch directly employs at least
IV. Corporate tax system
50 employees similarly as for a subsidiary as described above.
Representative office of a foreign corporation organised and A. Fundamental principles

existing under foreign laws In the Philippines, corporations are taxable entities. Under the
The representative office is fully subsidised by its head office National Internal Revenue Code of 1997 (Tax Code of 1997), as
and does not derive income from the host country. It amended, the term “corporation” includes partnerships
undertakes activities such as, but not limited to, information (regardless of how created or organised), joint stock
dissemination, promotion of the company’s products, as well companies, joint accounts (cuentas en participación), and
quality control of products. associations or insurance companies. It does not, however,
include inter alia joint ventures or consortiums formed for the
An initial minimum inward remittance of US$30,000 is required purpose of undertaking a construction project or engaging in
to cover its operating expenses. petroleum, coal, geothermal and other energy operations under
an operating or consortium service contract with the
A representative office is not subject to Philippine income tax as
government.
it does not derive income from its host country.
A corporation may be either a domestic or a foreign
Regional or Area Headquarters (“RHQ”)
corporation. A foreign corporation is one incorporated or
These are branches that can be established by multinational organised under the laws of a country other than the
companies not earning or deriving income from the Philippines Philippines. It is considered a “resident foreign corporation” if it
and which act as a supervisory, communications and engages in trade or business in the Philippines and will be
coordinating centre for their affiliates, subsidiaries or branches subject to tax on its taxable income sourced in the Philippines
in the Asia-Pacific region and other foreign markets. An RHQ is as a result.
required to have an initial minimum inward remittance of at least
US$50,000. Furthermore, an RHQ is not subject to Philippine A domestic corporation is taxable on its worldwide income.
income tax, subject to compliance with the limitations provided However, a foreign corporation, whether engaged or not in
for by law, with respect to their activities and operations. trade or business in the Philippines, is taxable only on
Philippine source income. Income is considered to be sourced
Regional Operating Headquarters (“ROHQ”) in the Philippines if the income is derived from property or
activities within the Philippines.
These are branches that can be established in the Philippines
by multinational companies that are engaged in any of the B. Double tax relief
following services:
To eliminate double taxation, the Philippines allows a credit
■ General administrative and planning;
against income tax payable for taxes paid abroad subject to
■ Business planning and coordination; certain limitations. This relief can be availed of only by citizens
■ Sourcing and procurement of raw materials and of the Philippines and domestic companies in respect of the
components; foreign tax paid or incurred. The foreign tax credit is limited to
■
the same proportion of the tax against which such credit is
Corporate finance and advisory services;
taken.
■ Marketing control and sales promotion;
■ Training and personnel management; C. Tax base
■ Logistic services; Generally, the tax base for corporate income tax purposes is
■ Research and development services and product calculated by deducting the cost of sales/services and
development; expenses that are “ordinary and necessary expenses” among
■
other allowed deductions from gross taxable income. There
Technical support and maintenance;
are some further minor adjustments such as restrictions on
■ Data processing and communication; entertaining expenditure.
■ Business development.
D. Exempt income
An ROHQ is required to have an initial minimum inward
remittance of at least US$200,000 and is subject to a Inter alia, the following income items are not subject to income
preferential tax rate of 10 percent of taxable income. tax:
68
68
■ Dividends received by a domestic company or by a of production, in case of Filipino-owned enterprises, or 70

resident foreign corporation from a domestic company; percent in case of enterprises with more than 40 percent
■ Remittance of profit to the foreign head office of a branch foreign equity. Where tax incentives are granted by the BOI, it is
that is registered with the Philippine Economic Zone usual for certain conditions to be attached. These include a
Authority (“PEZA”) on profits arising from the registered maximum permitted debt/equity ratio of 3:1.
activities; Under the 2009 IPP, the priority investment areas are classified
■ Gains from sale of bonds, debentures or other certificate into preferred activities, mandatory list, export activities and
of indebtedness with maturity of more than five years; ARMM list. Preferred activities are further subdivided into two
■ Gains from redemption of shares in mutual fund; groups:
■ Income derived from any public utility or from the exercise ■ Contingency list which is a temporary inclusion in the IPP
of any essential governmental function accruing to the to mitigate the effects of the global crisis. This include
Government of the Philippines or to any political existing projects and/or activities as well as new projects
subdivisions. of micro, small and medium enterprises;
■ Regular list, which includes: agriculture/agribusiness and
E. Tax rates fishery; infrastructure; engineered products; tourism;
1. Corporate income tax business process outsourcing; creative industries;
Corporations are subject to corporate income tax at a flat rate strategic industries; and research development.
of 30 percent from January 1, 2009 (previously 35 percent) on BOI-registered enterprises are entitled to fiscal and non-fiscal
the applicable tax base. incentives, including the following:
2. Minimum Corporate Income Tax (“MCIT”) ■ Income tax holiday or exemption from the payment of
Beginning in the fourth year from the time that a business income taxes for six years (for new projects with pioneer
begins its operations, a two percent MCIT on gross income is status), four years (for new projects with non-pioneer
imposed when the MCIT is greater than the regular corporate status), and three years (for expansion projects) counted
income tax. For these purposes “gross income” is defined as from the start of commercial operations;
income received, less any expenses directly incurred in earning ■ Additional deduction for labour expense;
that income. General administrative expenses and interest are ■ Tax credit for taxes and duties on raw materials used in
therefore not included. the manufacture, processing or production of export
In such a case, the MCIT paid in excess of the regular income products;
tax can be carried forward and offset against the regular ■ Employment of foreign nationals;
income tax liabilities for the next three succeeding taxable ■ Simplified customs procedures.
years.
2. Philippine Economic Zone Authority
3. Capital gains The PEZA implements the Special Economic Zone Act of 1995
Net capital gains realised by residents or non-residents from which also grants incentives to PEZA-registered enterprises
the sale, exchange or other disposition of shares of stocks in located in special economic zones (“ecozones”) created for
any domestic corporation (not sold through the stock industrial expansion, employment generation and promotion of
exchange) are taxed at five percent on net capital gain not over export products, foreign exchange generation, and transfer of
PHP100,000 and 10 percent in excess of PHP100,000. technology.
4. Branch profits remittance tax Foreign investors are allowed to register with PEZA. However,
Profits of a Philippine branch remitted to its overseas head total production or, in certain instances approved by PEZA, at
office are subject to a branch profits remittance tax of 15 least 70 percent of total production, must be for export.
percent of the amount of profits for which the branch has PEZA-registered export and free trade enterprises are given
applied to be remitted. This rate can be reduced to 10 percent incentives. Including the following:
under certain tax treaties.
■ Income tax holiday for four years for non-pioneer firms or
F. Investment incentives six years for pioneer firms;
The government encourages investments in the Philippines. ■ Tax and duty free importation of capital equipment, spare
Fiscal and non-fiscal incentives are available to investors under parts, materials, and supplies;
investment laws implemented by various government agencies. ■ Additional deduction for training expenses;
1. Board of Investments (“BOI”) ■ Additional deduction for incremental labour expense;
The Omnibus Investments Code of 1987, which is ■ Permanent resident status for foreign investors and
implemented by the BOI, offers a system of incentives available immediate members of the family;
to enterprises that register with the said government agency. ■ Employment of foreign nationals;
The nature and extent of incentives received by enterprises will ■ Simplified import-export procedure.
depend on the nature of their business activities in the
Philippines. As a general rule, an enterprise must engage in a 3. Subic Bay Freeport (“SBF”)
preferred area of activity listed in the current Investment The SBF is a special economic and freeport area established
Priorities Plan (“IPP”) in order to qualify for BOI incentives. Even under the “Bases Conversion and Development Act of 1992.” It
if the business activity is not listed in the IPP, an enterprise may is a former US military facility located northwest of Manila which
still be entitled to the incentives if it exports at least 50 percent was converted into a special economic zone intended for a
69
69
comprehensive economic development program of the no earnings stripping or thin capitalisation rules to limit interest
government. deductions against taxable income. However, where special tax
incentives are granted by the BOI, these are typically
Incentives granted to domestic and foreign investors registered
conditional on a maximum debt/equity ratio of 3:1. This ratio
with the Subic Bay Metropolitan Authority (“SBMA”) and
will also apply to the initial setup of a Philippine branch of a
operating within the SBF include:
foreign enterprise and to a Regional Operating Headquarters
■ Tax and duty free importation of raw materials, capital entity.
goods, and equipment;
■ Five percent preferential tax on gross income earned,
The Philippines has no transfer pricing rules and regulations,
which is in lieu of all national and local taxes.
but the tax authorities adhere to the OECD transfer pricing
4. Clark Special Economic Zone (“CSEZ”) guidelines.
Republic Act (RA) No. 9400 officially declared the CSEZ as a
freeport zone where the effective tax rate is five percent based
on gross income earned. This preferential rate is in lieu of all
V. Conclusion
national and local taxes. The CSEZ is located about 70
kilometres from SBF. The Philippines offers a relatively flexible and lightly regulated
business environment compared with many other jurisdictions
G. Anti-avoidance in the region. However, there are still many additional
There is no general anti-avoidance rule however courts will constraints compared with those faced in many western
apply a “substance over form” approach where transactions countries.
have a tax avoidance purpose.
Jim Nichols is a tax manager in KPMG Londons International
There are no rules in the Philippines in relation to the taxation of Corporate Tax practice, specialising in Emerging Markets. Jim
controlled foreign companies. Furthermore, there are generally may be contacted by email at: james.nichols@KPMG.co.uk
70
70
service activities
Jim Nichols
This article addresses the tax treatment of non-Philippine enterprises carrying out service work in the Philippines. This
could be, for example, a consultancy business providing advice to clients in the Philippines and sending staff to work at
the client’s premises, or a manufacturing business selling heavy machinery to the Philippines and sending personnel to
supervise its installation. In either case the question will arise whether any part of the income is taxable in the
Philippines under Philippine domestic law, and whether any relevant double tax treaty provides protection.
I. Territorial scope ■ The foreign enterprise furnishes services in the

Philippines, though personnel in the Philippines, for a
Under Philippine domestic law, a foreign enterprise is taxable in specified minimum period of time.
the Philippines if it “does business” in the Philippines. The
There is a specific “services PE” concept in most of the tax
domestic law does not limit the territorial scope of tax by
treaties to which the Philippines is party (which usually draws
reference to a permanent establishment (“PE”) concept.
on the wording in the UN model in this respect).
“Doing business in the Philippines” is a very wide concept; for In the case of construction, installation or assembly projects,
this reason, where cross-border services are being performed, most of the Philippines’ tax treaties provide for a minimum
it is usually advisable to ensure that the service provider is period of six months before a PE is created. Furthermore,
resident in a country with a tax treaty with the Philippines that certain treaties specify that the minimum period is by reference
can provide some protection (see below). to a given calendar year. Therefore, were a project to start on
July 2, it could continue for almost 12 months before creating a
Where a foreign enterprise is “doing business” in the
PE.
Philippines, it is usually advisable to formalise this by registering
a branch in the Philippines where significant expenses are Where a treaty applies and the service activities performed fall
incurred in earning the income. This is because where service outside of the scope of the definition of a PE in the relevant
fees are paid to an unregistered enterprise for services treaty, then service fees can be paid without deduction of
rendered in the Philippines, the payor is required to withhold tax Philippine withholding tax in accordance with the “business
at 30 percent on the gross payment as a final withholding tax. profits” article of the relevant treaty. However, before any
Therefore there is no possibility to deduct any expenses from payments can be made gross, it is recommended that the
the Philippine tax base. foreign enterprise obtains tax treaty relief in the form of a ruling
from the Philippine tax authorities that there is no PE under the
II. The position under double tax treaties terms of a relevant tax treaty. Such rulings will usually only be
granted on a contract, by contract basis after submitting a
All of the tax treaties entered into by the Philippines use copy of the contract, certificate of residence of the service
definitions of permanent establishment found in the OECD provider and other relevant information to the authorities.
model conventions (to which there are some modifications
In addition, under certain circumstances service fees may be
drawn from the UN Model). Where such a treaty applies, this
re-characterised as royalties under Philippine law. This could
can therefore add significant protection for the service provider
occur, for example, when the services included a transfer of
from becoming taxable in the Philippines or being subject to
knowledge or information when the service provider has the
Philippine withholding tax on services performed in the
relevant intellectual property or “know how”. In this respect, the
Philippines. In such a situation, a PE is generally created in the
commentary to the OECD model convention provides guidance
Philippines where:
on the distinction between service fees and royalties which has
■ The foreign enterprise has a fixed place of business in the persuasive effect to the Philippine tax authorities in a treaty
Philippines through which the business of the enterprise situation.
is wholly or partly carried on; Where service fees fail to be treated as royalties, the payments
■ The foreign enterprise has an agent in the Philippines with will be subject to a final withholding tax of 30 percent under
the power to conclude contracts in the name of the domestic law or to a lower rate to the extent permitted by the
enterprise; or relevant treaty. Where a lower treaty rate applies, obtaining a
71
71
The Philippines: Tax treatment of cross-border service activities
ruling from the Philippine tax authorities in advance of payment enterprise without a registered Philippine branch. In the case of
is recommended. the provision of services in the Philippines by a registered
Philippine branch of a foreign enterprise, or a Philippine
There are generally no minimum requirements as regards the
subsidiary, the branch/company should register for VAT and
level of substance required in the entity providing the service in
add this to its fees at a rate of 12 percent.
order for treaty benefits to be granted. Therefore, in principle it
is possible, for example, to second staff to a company resident
in a country with a favourable tax treaty with the Philippines that IV. Other points to be considered
would then enter into the contract with the Philippine entity to
provide services. However, to manage the risk of challenge it is There are likely to be other considerations, besides those
advisable to have some substance in the chosen jurisdiction. alluded to above in deciding how to structure the provision of
services into the Philippines. For example, if the nature and
III. Withholding tax extent of the services is such that a PE will definitely be
created, then consideration may be given to setting up a local
If instead, the service provider registers a branch in the subsidiary to provide the services.
Philippines, the branch may be subject to a creditable 15
percent withholding tax applicable to management or technical
consultancy fees in respect of services rendered in the
V. Conclusion
Philippines. In addition royalties (which are widely defined under
Any decision as to how to structure service activities in the
domestic law) are subject to a creditable withholding tax of 20
Philippines is likely to be complex from both a tax perspective
percent if paid to a registered branch of a foreign enterprise.
and a commercial one. Professional advice should be taken as
In the case of “turnkey” type contracts that include both supply early as possible in order to identify risks and potential solutions
and installation services, it is important to split out the element relevant to the structuring of any service contract. In addition,
of the contract value relating to services rendered in the to the extent that Philippine tax will be suffered, consideration
Philippines explicitly in the contract in order to avoid the risk should be given to the availability of a tax credit in the service
that some or all or the remainder of the contract will be subject provider’s home country.
to withholding tax and VAT.
Jim Nichols is a tax manager in KPMG Londons International
VAT at 12 percent should be accounted for by the Philippine Corporate Tax practice, specialising in Emerging Markets and
recipient of services provided in the Philippines by a foreign may be contacted by email at: james.nichols@KPMG.co.uk
72
72
for investment
Jim Nichols
This article on the Philippines looks at tax planning in the context of holding and financing.
A foreign direct investment into any country requires planning B. Double tax treaties
on:
Shareholders resident in a country with a double tax treaty with
■ How to hold the investment, whether directly from the the Philippines may benefit from a reduced rate of dividend
investing parent, or through one or more tiers of withholding tax as low as 10 percent or 15 percent. Thus, for
intermediate holding companies; foreign shareholders, total Philippine taxes on profits will range
■ How to finance it, whether wholly by equity or through a from 37 percent to 51 percent (30 percent income tax plus
mixture of debt and equity, and in the latter case how to withholding tax on dividends) in 2009. At the end of this article
structure the debt. is a table setting out a summary of the protection available
under the Philippines’ tax treaties with a number of locations.
We shall consider each of these aspects in turn below. As can
be seen from the analysis of some of the other countries in this Furthermore, most tax treaties provide for an exemption from
supplement, some of these issues are common to other Philippine tax on gains realised by a non-resident shareholder
jurisdictions, whereas other are more particular to the on shares in a Philippine company, subject to minimum
Philippines. shareholding requirements. However, many treaties remove this
exemption where the company whose shares are transferred
I. Holding company strategies derives more than 50 percent of its value from immoveable
property in the Philippines.
In general, holding company strategies may be intended to
achieve any or all of the following objectives: In order to take advantage of reduced tax treaty rates or
exemptions, tax treaty relief in the form of an advance ruling
■ To reduce withholding tax on dividends in the source from the Philippine tax authorities is recommended.
country (the Philippines) or direct tax on dividends
received in the residence country; The lowest rate of dividend withholding tax of 10 percent, and
■
protection from Philippine tax on capital gains on shares, are
To mitigate any tax on capital gains either in the source
available under many treaties and therefore finding a suitable
country or the residence country on disposal of the
holding location in which tax residence and the necessary
shares to a third party or within the group.
substance can be achieved should not be too onerous a task.
The following analysis deals with the source country issues Furthermore, in principal there are generally no minimum
only, from the perspective of a foreign investor in the requirements as regards the level of substance required in the
Philippines. holding entity in order for treaty benefits to be granted; as a
A. Philippine domestic law position practical matter, however, it is advisable to have some
substance in the chosen holding company location.
Any distributions, except for stock dividends, paid by a
domestic corporation to non-resident corporate shareholders
II. Financing strategies
are subject to 30 percent withholding tax under domestic law,
except when the foreign shareholder is a resident of a country Under Philippine domestic law, withholding tax is levied on
that allows a credit for taxes paid in the Philippines (or exempts interest payable to non-resident foreign corporations at 30
the dividends) in which case a rate of 15 percent may apply, percent. This rate is reduced to 20 percent on “foreign loans”.
depending on the extent to which credit is given. A “foreign loan” is defined as a loan to a Philippine resident
from a non-resident that is not denominated in PHP. Tax
Net capital gains realised by a non-resident shareholder from
treaties entered into by the Philippines generally provide for a
the sale, exchange or other disposition of shares of stocks in
lower rate of interest withholding tax of between 10 percent
any domestic corporation (not sold through the stock
and 15 percent.
exchange) are taxed at five percent for net capital gains not
over PHP100,000 and 10 percent in excess of PHP100,000. As interest is generally a tax deductible expense, debt financing
There is no Philippine tax on gains realised by a non-resident is usually preferable to equity financing from a Philippine tax
on shares of a company not incorporated in the Philippines. point of view, as it achieves a saving of both corporate income
73
73
The Philippines: Holding and financing strategies for investment
tax and dividend withholding tax in exchange for a relatively straight-forward to implement, is to use a local special purpose
modest interest withholding tax burden. There are no specific vehicle holding company to effect a debt financed acquisition of
thin capitalisation rules in Philippine tax law, although a 3:1 the target, followed by a tax-free merger of the two entities.
debt / equity ratio may be required in order to benefit from This results in debt in the target generating tax deductible
certain tax incentives and is also applicable to Philippine interest expense.
branches of foreign enterprises.
Exchange differences on borrowings, whether realised or not, III. Conclusion
are taxable / deductible in the period they arise. For this reason, Substantial tax benefits can be achieved by structuring the
borrowings by Philippine subsidiaries are normally equity and debt investments into a Philippine subsidiary in
denominated, legally or economically, in PHP. a tax efficient way. Careful planning is required to ensure
It may be possible to bring the effective rate of interest that the risks are properly managed and the benefits
withholding tax below the minimum treaty rates. One such maintained.
approach could be to make a deposit with a Philippine bank,
which would then on-lend to the Philippine entity. The deposit Table
by the foreign parent would be structured so as to be Treaty country Capital gains Dividend Interest
protection on sharesa WHTb (%) WHT (%)
economically in PHP; this will ensure that the bank does not
China Yes 10 10
take any foreign exchange risk. Obviously, the bank will require
France Yes 10 15c
a margin and this will reduce the benefit of the withholding tax
Germany No 10 15c
saving.
Netherlands Yes 10d 15c
Another approach may be to make a loan from the foreign Singapore Yes 15 15c
parent to the local subsidiary in a currency that carries a lower Sweden Yes 10 10
interest rate than the PHP, for example USD, and combine this Switzerland Yes 10 10
with a USD-PHP swap. However, the Philippine tax authorities United Kingdom Yes 15 15c
may try to re-characterise some or all of the swap payments as a Assuming minimum 25% holding and that assets do not comprise more
interest, and therefore subject them to withholding tax. than 50% immovable property.
b Assuming minimum 25% holding.
There is no group taxation in the Philippines. Therefore, in order
c A lower, 10% rate applies to public issues of bonds or debentures and
to be tax effective, interest expense will need to arise in the certain other situations.
hands of a company which has sufficient taxable income d 15% rate will apply if the Netherlands company suffers tax on the dividends.
against which to utilise it. This may present particular problems
in the case of the acquisition of a Philippine target company Jim Nichols is a tax manager in KPMG Londons International
where debt is used to fund the acquisition of shares in the Corporate Tax practice, specialising in Emerging Markets and
target. One strategy that is effective and relatively may be contacted by email at: james.nichols@KPMG.co.uk
74
74
Jim Nichols
The law relating to real property in the Philippines can be complex. This article focuses on two aspects that are directly
relevant to the tax structuring side.
I. The legal framework A resident Philippine real estate company, or registered

Philippine branch of a foreign enterprise, will be subject to a five
Constitutionally, Philippine real property can only be owned by percent creditable withholding tax on gross rents received on
Philippine nationals or companies that are at least 60 percent real property. This tax is creditable against the corporate tax
owned by Philippine nationals. liability arising on the taxable income of the enterprise – but not
However, even though outright foreign ownership of Philippine against any minimum corporate income tax due. In addition,
real property may not be possible, laws exist (RA 7652, PD rent is subject to VAT at 12 percent.
471) allow foreigners to hold long-term leases over real Non-resident companies with rental income from Philippine real
property, subject to certain conditions. estate otherwise than through a branch will be subject to a final
withholding tax. The applicable rate from the start of 2009 is 30
The maximum permitted length of a lease over real property
percent. In addition, VAT at 12 percent has to be accounted for
held by a foreigner, depends, inter alia on whether it is being
by the payor.
acquired for the purposes of using the site for an investment
into the Philippines. Such leases connected with investment In addition to the above taxes on income, profits remitted to the
into the Philippines can be for up to 50 years and can be head office of a Philippine branch of a non-resident company
renewed for up to a further 25 years if certain conditions are will be subject to 15 percent branch profits remittance tax
met. These conditions include that the leased land is used (subject to reduction pursuant to a relevant tax treaty).
solely for the purposes of the investment, which must Dividends paid to a non-resident shareholder of a Philippine
commence within three years of the start of the lease. company will be subject to up to 30 percent dividend
withholding tax (subject to reduction pursuant to a relevant tax
Alternatively, foreign corporations not investing in the
treaty).
Philippines may lease real property for a maximum of 25 years
and can renew such a lease for a further 25 years, which if the
parties agree, may be done from the outset. III. Outline of tax consequences of a disposal
Broadly, there are three options for structuring a disposal of the
II. Outline of ongoing tax position of a property, the tax consequences of each of which are outlined
Philippine real estate holding company below.
As with any other Philippine company, from 2009 a real estate ■ A direct disposal of the property itself;
company will be subject to 30 percent corporate income tax (or ■ A disposal of the shares in the Philippine company by the
the minimum corporate income tax if applicable). Deductions foreign shareholder;
from taxable rental income are available in respect of any costs ■ A disposal of the shares in an offshore holding company
incurred in the earning of that income. Tax deductions in
above the immediate foreign shareholder in the Philippine
respect of depreciation are generally not allowed for land.
company.
However, a lessee can claim a tax deduction in respect of
capital expenditure on the construction of buildings and A. Disposal of the property
permanent improvements to land. Such deductions for capital
Generally, capital gains are subject to the ordinary 30 percent
expenditure must be spread over the lower of the time
corporate income tax rate on the book gain. However, there is
remaining on the lease, or the estimated useful life of the
a special regime in place in the case of a disposal of real
improvement or construction.
property located in the Philippines held as a capital asset. In
There are a range of annual property taxes in the Philippines this instance a final withholding tax of six percent of the higher
imposed by provinces, cities and municipalities that are levied of the gross selling price or the fair market value of the asset
based on a percentage of the assessed market value of real applies irrespective of the status of the seller. It is important to
property located within their respective jurisdictions. These can note, however, that in this specific context “capital asset”
be up to three percent p.a. of the assessed value in the case of excludes any asset which is used in the trade or letting activity
real property located in the Manila Metropolitan Area. of the company. Therefore, the final withholding tax regime
75
75
The Philippines: Investing in real property: Some key tax aspects
applicable to capital assets is rarely applied to corporations and place leverage into the Philippines resulting in tax-deductible
would not generally apply to a real estate holding company interest expense.
earning rental income. It follows that the 30 percent corporate
income tax applies to the gains instead. IV. Leveraging the investment
B. Disposal of shares in a Philippine real estate Leveraging a real property holding company is relatively
company straight-forward and in principle, the same as leveraging any
Under domestic law, net gains from the sale of shares in an other Philippine company. Acquisitions of properties can be
unlisted Philippine company held as capital assets are subject debt financed to the extent desired interest will, in principle, be
to tax at 10 percent on gains of more that PHP100,000 (five tax deductible. One of the main barriers to fully eliminating the
percent of below PHP100,000) for all taxpayers. A tax filing tax base through this approach is that rents received will have
must be made by the seller before the share transfer process suffered a creditable withholding tax of five percent, which in
can be completed and the shares formally held in the name of practice would be difficult to get refunded. Secondly, after the
the purchaser. first four years of its existence, the minimum corporate income
tax would apply to the Philippine real estate company. This
If the shares are listed and traded on the Philippine stock would impose a minimum tax of two percent of the gross
exchange, then they will be exempt from Philippines tax on income. In this context “gross income” would generally equate
capital gains, however a stock transaction tax of 0.5 percent of to rents receivable less any directly incurred costs (which
the gross proceeds would apply. excludes interest) incurred in earning those rents.
Nearly all the tax treaties entered into by the Philippines limit the Any withholding tax costs on interest payments would have to
right of the Philippines to tax gains on shares in Philippine be considered when assessing the optimum level of debt to
companies realized by non-resident shareholders to situations insert.
where the assets of the Philippine company comprise more
that 50 percent Philippine real property. Therefore, in the case It may also be possible to leverage an acquisition of shares in a
of a disposal of shares in a Philippine real estate company, Philippine real estate holding company target. This would best
treaty protection may be limited and the taxation regime under be achieved by setting up a new Philippine company special
domestic law would apply as described above. The tax treaty purpose vehicle to borrow funds to acquire the share capital of
with the UK is an exception and does not restrict the capital the target. The two companies would then execute a tax-free
gains exemption the case of a real property company. merger resulting in a single, leveraged, Philippine entity in which
interest should be tax deductible.
C. Disposal of shares in an offshore holding company
The Philippines does not seek to assert extra-territorial taxing V. Conclusion
rights in this situation where there is a gain realized on the sale Subject to restrictions of foreign ownership of real property in
of shares in a non-Philippine company – even when such a the Philippines, the setup and ongoing tax position of a
company indirectly derives the majority of its value from Philippine real estate company are, in principle, much like those
Philippine real property. of any other Philippine company. Withholding taxes and the
Each of the three disposal options outlined above may have minimum corporate income tax may not allow income taxes to
additional tax consequences beyond that applicable to any be sheltered altogether. However, with careful planning the tax
capital gain realized by the seller. For example, depending on burden can be significantly reduced.
the buyer’s tax profile a direct acquisition of the real property Jim Nichols is a tax manager in KPMG Londons International
may afford them a higher tax base to depreciate. In addition, a Corporate Tax practice, specialising in Emerging Markets and
direct acquisition of real property may allow the purchaser to may be contacted by email at: james.nichols@KPMG.co.uk
76
76
Pakistan

Shabbir Vejlani and Asif Ali Khan
KPMG Taseer Hadi & Co., Pakistan
In this article on Pakistan we look at: applicable company law; the foreign direct investment framework; exchange
I. Applicable company law Foreign companies in certain industries including banking,

insurance and shipping may set up branches in Pakistan,
Pakistani company law is based on the Companies Ordinance which are considered as companies for compliance of some
1984 (“CO”) pro-mulgated on October 8, 1984 which corporate and tax requirements.
replaced the Companies Act of 1913 from the days of the
British Government. The CO provides for several types of Pakistan investment policy has been formulated to create an
company including companies limited by shares, where the investor-friendly environment, with a focus on opening up the
personal liability of the shareholders is limited to the amount (if economy and attracting foreign direct investment. Various
any) unpaid on their shares. Effectively, the shareholders’ facilities have been offered to attract foreign investments
liability does not exceed the amount committed when taking including full repatriation of capital, capital gains, dividend and
up the shares in the company. This is usually the type of profits. Earlier only the manufacturing sector was open to
company contemplated by a non-resident interested in foreign investment. Now the policy regime is much more
investing in Pakistan. liberal with most other sectors also open for foreign
investment.
A company incorporated in Pakistan, limited by shares may
Foreign investors are permitted to hold 100 percent of the
either be a “public limited” (public company) or “private
equity without requiring any permission from government,
limited” (private company). Generally, in the initial stages it
except specified industries like arms and ammunitions, high
would be appropriate for a foreign investor to form a private
explosives, radioactive substances, security printing, currency
company and consider its conversion to a public company at
and mint. The requirement for minimum foreign equity has
a later stage depending on business needs.
been reduced to US$150,000 for the services sector and
US$300,000 for infrastructure and social sectors, whereas
Dividends can be paid only out of after-tax profits, after
there is no such minimum limit for the manufacturing sector.
making good past years losses and any statutory transfers to
The foreign equity must be brought through the normal
reserves.
banking channel and must be converted into Pakistani
Rupees.
Any benefit or incentive for investment provided by the
Foreign direct investment can take three main forms: government shall continue to be in force and will not be
reduced or altered to the disadvantage of investors.
■ Establishing a local company with 100 percent foreign
equity;
■ Acquiring equity interest in an existing Pakistani company
or joint equity investment with a Pakistani investor in a Foreign exchange dealings are regulated under the Foreign
new company; Exchange Regulation Act 1947. Foreign currencies are made
available to persons/companies doing business in Pakistan for
■ A Joint Venture in the form of an Association of Persons
all purposes under rules which have been clearly defined by
(“AOP”), where the Pakistani shareholder may be a
the State Bank of Pakistan (“SBP”).
company or an individual; an AOP is simply a contractual
relationship and is considered as having a separate legal Foreign investment enjoys full protection and repatriation
personality only for tax purposes. facilities. The Foreign Private Investment (Promotion and
77
77
Pakistan: The tax and legal framework
Protection) Act 1976 provides guarantees for repatriation of B. Repatriable basis

foreign investment to the extent of original investment, profits
earned on such investment, and appreciation of capital. The loan must be interest free and for a period not less than
one year. No bank guarantee for securing such loans would
Under a general permission given by the SBP, shares can be be provided from Pakistan. No forward cover shall be
issued to non-resident investors against investments in those provided. The agreement for a loan on repatriable basis and
sectors which are open for foreign investment, provided the its repayment schedule are required to be registered with SBP,
purchase price is received in foreign currency through banking where after, the authorised dealer is allowed to remit
channels and the conditions pertaining to investment in that instalment of principal on due date.
sector are met. If foreign investment is made in the shape of
plant and machinery, the SBP gives permission for issuance of C. Domestic borrowings for working capital
shares after verifying the import documents. Once the above
requirements have been completed, the foreign investment Authorised dealers (Pakistani banks and Pakistani branches of
“must be registered with the SBP” by sending prescribed foreign banks) are allowed to grant Rupee loans and credits to
information to the SBP through a designated bank. When foreign controlled companies for meeting their working capital
SBP registers the foreign investment, it facilitates requirements.
repatriation/remittance of dividend and disinvestment
proceeds, after paying applicable taxes. D. Domestic borrowings for capital expenditure
A company intending to remit dividends to its foreign Foreign controlled companies engaged in manufacturing are
shareholders must advise SBP the particulars of its bankers allowed to obtain Rupee loans for meeting capital expenditure
through whom remittance will be made; this is normally done requirement from banks, development financial institutions
at the time of registration of the shares. If the shares issued to and other financial institutions. However, other foreign
the foreign investors have been registered with the SBP, it will controlled companies require special permission to obtain
authorise the bank concerned to effect remittance of medium and long-term Rupee loans.
dividends, whether interim or final, to the non-resident
shareholders of the company without its prior approval. IV. Corporate tax system
Commercial banks are authorised to remit dividends to foreign
investors net of applicable taxes. A. The tax reform
Banks can remit disinvestment proceeds to the extent of From July 1, 2002 the present Income Tax Ordinance 2001
market value less brokerage/commission on submission of a (“TO”) came into force. Income Tax Rules 2002 lay down the
stock broker’s memo showing the particulars of sale, in case procedures for applying the provisions of the Income Tax
of listed companies and to the extent of break up value of Ordinance 2001.
shares, as certified by a practicing chartered accountant, in
case of a private limited company or unlisted public limited The reason for introducing the new TO in 2001 was to simplify
company. the tax law and providing facilitation to the taxpayers for
voluntary compliance. A major shift from the past in the new
Payment of royalty, franchise/technical fee by the
law is that a complete return of income filed is deemed as an
non-manufacturing sectors opened for foreign direct
assessment made by the Commissioner under
investment like international food franchises is permissible,
self-assessment scheme and filing of revised return of income
subject to the maximum limit of $100,000 on the initial
is treated as an amended assessment.
lump-sum payment, irrespective of number of outlets, and
maximum five percent of net sales. B. Fundamental principles
The initial period, for which such fees will be allowed, should
Pakistani tax law contains two types of taxation procedures
not exceed five years. Subsequent extension in time period
for all types of taxpayers, i.e. normal tax regime (“NTR”) and
will be considered provided these projects also make
final tax regime (“FTR”). The taxability of a company depends
investment in allied upstream projects.
upon its residence status. A resident is subject to tax in
Authorised Dealers (Banks) provide forward cover for export, respect of both Pakistan and foreign sources of income
import, foreign private loans, repatriable foreign currency loans irrespective of place of accrual or receipt of income. A
(excluding loans obtained by foreign contractors and non-resident is subject to tax in respect of Pakistan source
branches of foreign companies), in accordance with the income only. The source of income is determined in
conditions prevailing in the market. accordance with rules laid down in the Ordinance for various
streams.
Pakistani firms and companies functioning in Pakistan,
excluding banks, may obtain foreign third party private loans A Pakistani resident company is taxed on its world-wide
on non-repatriable or repatriable basis, subject to the profits. However, losses of foreign branches are not
following conditions: deductible in Pakistan. The corporate tax rate is 35 percent.
A. Non-repatriable basis 1. Normal tax regime

These loans are treated as Rupee loans and neither principal Under the NTR, the net income is determined after allowing
nor interest/profit can be remitted abroad. Repayment of admissible expenses/deductions against the gross receipts
loans and interest would be made in Pakistan in Pakistani from a source of income. Tax is then charged on the net
Rupees. income at the applicable rates.
78
78
2. Final tax regime that head up to six tax years immediately succeeding the tax
Under the FTR, tax is deducted at source from the gross year in which the loss was incurred.
amount of the specified sources of income and is deemed to 5. Consolidated returns
be the final discharge of tax liability. With effect from July 1, 2007, holding companies and
The following are the main categories of income falling under subsidiary companies of 100 percent owned group may opt to
the FTR: be taxed as one fiscal unit, subject to certain conditions.
6. Tax incentives
Table 1
A reduced tax rate of 20 percent has been provided for small
Category Tax rate (%)
companies with specified conditions and tax exemption is
Royalty received by non-residents, except where the property 15 available to profits of industrial undertaking in specified zones.
or right giving rise to the royalty is effectively connected with
a permanent establishment (PE) in Pakistan
C. Withholding taxes
Fee for technical services to non-residents, except where the 15
services are rendered through a PE in Pakistan The Ordinance contains a withholding tax regime covering
Shipping business by non-residents 8 almost all types of payments made to non-residents from which
Air transport business by non-residents 3 tax is required to be withheld at source. Some significant
Import of goods 4 payments subject to withholding tax include salary, profit on
Export of goods 1 debt, fee for technical services, royalty, supply of goods and
Execution of contracts other than by public listed companiesa 6 services, execution of contracts, commission or brokerage,
Sale of good by private non-manufacturing companies 3.5 import of goods, export of goods, dividends, rent and
Income from property 5 to 10 electricity, telephone and gas bills, etc.
Commission and brokerage 10
Significant payments made to non-residents which are subject
a Incomes of non-residents from execution of contracts shall be taxed under
the FTR, subject to the filing of an option to be taxable under the NTR. to withholding tax on the gross amounts are summarised
below:
3. Depreciation rates
Table 2
Depreciation rates provided in the Ordinance range from 10 Nature of payment Withholding
percent to 100 percent. In addition, an initial allowance of 50 tax rate
(%)
percent on the cost is allowed for an eligible depreciable asset
placed into service for the first time in a tax year. With effect Execution of contracts 6
from July 1, 2008, first year allowances at 90 percent, in lieu of Dividend 10
initial allowances at 50 percent, are allowed on plant, Fee for technical services 15
machinery and equipment installed and used by any industrial Royalty 15
undertaking set up in specified rural and underdeveloped Supply of goods by a PE 3.5
areas. Services rendered by PE 6

A contract or sub-contract under a construction, assembly or 6
Intangibles with useful life exceeding one year can be installation project in Pakistan, including a contract for the
supply of supervisory activities in relation to such project
amortised over their useful life or 10 years whichever is less.
Any other contract for construction or services rendered 6
Amortisation of pre-commencement expenditure at 20 percent relating thereto
on a straight-line basis is also tax deductible. A contract for advertisement services rendered by TV Satellite 6
Channel
4. Carry-forward of losses and unabsorbed depreciation
Profit on debt to a non-resident person not having a PE in 10
Loss from any source, except speculation losses and capital Pakistan
losses, can be set-off against other sources of income in the Insurance and re-insurance premium 5
same tax year in which the losses arise. Fees paid to a non-resident media person in relation to 10
advertisement services relaying from outside Pakistan
Unabsorbed business losses can be carried forward for set-off Commission and brokerage 10
against future business income for up to six tax years Other payments to non-residents, not specified in the 30
immediately following the tax year in which the losses were Ordinance
incurred. Unabsorbed tax depreciation, initial allowances and
amortisation of intangibles can be carried forward indefinitely. Some of these withholding tax rates may be reduced or
Similarly, business losses can be carried forward indefinitely for avoided under the applicable tax treaties. A reduced rate under
operating industries located in Export Processing Zones. There a treaty may be applied by the payer/withholding tax agent
is no concept of carry-back of losses in Pakistan. without informing the Commissioner, but for applying
Speculation business losses can be set-off against other withholding tax exemption under a treaty, the Commissioner’s
taxable speculation business income in that tax year. approval is required.
Unabsorbed speculation business losses can be carried
D. International aspects
forward for set-off against future speculation business income
up to six consecutive tax years. 1. Treaty network
The Ordinance provides that where a double tax treaty applies,
Capital losses can be carried forward for a maximum of six
the treaty provisions shall have overriding effect in so far as they
years and can be set-off against capital gains only.
provide for relief from the tax payable under the Ordinance, the
The foreign tax loss under a head of income can be carried determination of Pakistan-source income of non-resident
forward for set-off against future foreign source income under persons, determination of income chargeable to tax in Pakistan
79
79
in the hands of non-resident persons, determination of income ■ Disregard a transaction that does not have substantial
attributable to any resident person having a special relationship economic effect; or
with a non-resident person and the exchange of information for ■ Re-characterise a transaction where the form of the
the prevention of fiscal evasion or avoidance of taxes on transaction does not reflect the substance.
income chargeable to tax under the Ordinance and under the
corresponding law in force in the other country. Pakistan has a The term “tax avoidance scheme” means any transaction
good treaty network with over 50 countries which provide relief where one of the main purposes of a person in entering into the
from Pakistan tax for specified income which inter alia includes transaction is the avoidance or reduction of any person’s liability
business profits, interest, royalty, fee for technical services and to tax under this Ordinance.
capital gains.
E. Anti-avoidance V. Conclusion
1. Transfer pricing
Pakistan is still a highly regulated environment and there are still
Pakistan generally follows the arm’s length principle in relation
many additional constraints compared with those in many
to transactions between associated parties.
western countries. However, the new corporate tax system
2. Thin capitalisation represents a major step towards a modern tax and legal
Interest deductions in respect of foreign related party are framework where there is clarity on the rules for the taxation of
generally limited to the extent that the foreign related party debt business profits. The new tax system broadly creates a level
to foreign equity ratio does not exceed 3:1. playing field between foreign and local capital and can be
expected to favour the development of privately owned
3. Recharacterisation
Pakistani enterprises and their growth outside Pakistan.
The Ordinance provides that for the purposes of determining
liability to tax, the Commissioner may: Shabbir Vejlani is a Partner with KPMG’s Pakistani firm and can
■ Re-characterise a transaction or an element of a be contacted by email at: shvejlani@kpmg.com
transaction that was entered into as part of a tax Asif Ali Khan is an Executive Director with KPMG’s Pakistani
avoidance scheme; firm and can be contacted by email at: asifkhan@kpmg.com
80
80
service activities
This article addresses the tax treatment of non-Pakistani enterprises carrying out service work in Pakistan. This could be,
for example, a consultancy business providing advice to clients in Pakistan and sending staff to work at the client’s
premises, or a manufacturing business selling heavy machinery to Pakistan and sending personnel to supervise its
installation. In either case the question will arise whether any part of the income is taxable in Pakistan under Pakistani
domestic law, and whether any relevant double tax treaty provides protection.
I. Introduction c. A contract for advertisement services rendered by tv

satellite channels.
Under the Income Tax Ordinance 2001 which came into force However, a non-resident person is required to opt for
on July 1, 2002, a foreign enterprise, depending upon the assessment of income from aforesaid contracts under the final
nature of its activities in Pakistan and whether it has a tax regime for which the non-resident shall file a written
permanent establishment in Pakistan, may be taxed under the declaration within three months of the commencement of the
following methods: tax year. Such a declaration shall be irrevocable and shall
remain in force for three years.
■ Tax at 15 percent is imposed on every non-resident
■ If a permanent establishment of a non-resident person
person who receives any Pakistan source royalty or fee
for technical services (“FTS”). This tax is required to be renders or provides any services or executes any contract
withheld at source and is considered as final tax. in Pakistan, tax at six percent, is required to be withheld
However, where the property or right giving rise to royalty at source on payments to such PE. The tax so withheld
is effectively connected with a PE in Pakistan of the would be adjustable against final tax liability of such PE to
non-resident person or services giving rise to FTS are be worked out on net income basis.
rendered through a PE in Pakistan of the non-resident ■ Tax at 10 percent, which is treated as final tax, is required
person, such royalty and FTS shall be treated as income to be withheld at source on payments for advertisement
from business attributable to such PE. In that case the services to a non-resident media person relaying from
withholding tax rate would be six percent and final tax outside Pakistan.
would be at 35 percent on net income. ■ Tax at 10 percent, which is treated as final tax, is required
■ Tax at eight percent is imposed on every non-resident to be withheld at source from any payment made to a
person carrying on the business of operating ships and at resident or non-resident person on account of brokerage
three percent on every non-resident person carrying on or commission.
the business of operating aircraft, as the owner or ■ In all other cases, Pakistani source income of a
charteror thereof, on the gross amount received or non-resident enterprise is subject to withholding tax of 30
receivable inside or outside Pakistan for carriage of percent which is adjustable against final tax liability at the
passengers, livestock, mail or goods embarked in rate of 35 percent on net income for companies and final
Pakistan and on the gross amount received in Pakistan tax liability at applicable slab rates up to 25 percent in
for the carriage of passengers, livestock, mail or goods non-company cases.
embarked outside Pakistan.
■ Tax at six percent, which is treated as final tax, is required II. Definitions under the Ordinance
to be withheld at source on payments to a non-resident
Definitions under the Ordinance of various terms relevant for
person on the execution of:
the taxation of non-residents are discussed below:
a. A contract or sub-contract under a construction,
assembly or installation project in Pakistan, including a A. Permanent establishment
contract for the supply of supervisory activities in The term “permanent establishment” (“PE”) is defined as a
relation to such project; or fixed place of business through which the business is wholly
b. Any other contract for construction or services or partly carried on by a person and it includes a place of
rendered relating thereto; or management, branch, office, factory or workshop, premises
81
81
Pakistan: Tax treatment of cross-border service activities
for soliciting orders, warehouse, permanent sales exhibition or f. The supply of any assistance that is ancillary and
sales outlet (other than a liaison office), a place of extraction of subsidiary to, and is furnished as a means of enabling the
mineral resources, any agricultural, pastoral or forestry application or enjoyment of, any such property or right as
property, building site, construction/assembly/installation mentioned in sub-clauses (a) through (e); and
project and supervisory activities related thereto, if lasting for g. The disposal of any property or right referred to in
90 days or more in a 12 month period, rendering of services sub-clauses (a) through (e).
through employees or other personnel engaged for such
purpose, a dependent agent, property and any substantial III. The position under double tax treaties
equipment installed, or other asset or property capable of
activity giving rise to income. The position of tax rate applicable on royalties and fee for
technical services under tax treaties of Pakistan with various
The definition of PE provided under a treaty shall prevail over countries is summarized in the table given at the end of this
the definition stipulated in the Ordinance. article along with the details of the period considered in the
treaties to constitute a service PE or a construction project
The above definition of PE is in line with the definition under
PE.
most of tax treaties except that:
■ The furnishing of services, including consultancy services, IV. Other points to be considered
by any person through employees or other personnel
engaged by the person for such purpose, even for a Of course, there will be considerations other than the above
single day, gives rise to a PE; that need to be taken into account in deciding how to carry
■ Any substantial equipment installed, or other asset or out business with Pakistan. The first and most obvious factor
property capable of activity giving rise to income. is that in many cases a PE will be unavoidable what-ever the
applicable double tax treaty. In such circum-stances the
B. Fee for technical services choice will be between taxation on a PE basis and setting up
a local subsidiary. A PE may give more flexibility (for example,
The term “fee for technical services” means any consideration,
profits can be remitted to head office as they arise and the
whether periodical or lump sum, for the rendering of any
relevant taxes have been settled rather than only after the
managerial, technical or consultancy services including the
financial ac-counts for the year have been prepared and the
services of technical or other personnel, but does not include–
trans-fers to reserves required by law have been made).
a. Consideration for services rendered in relation to a
Setting up a company also carries additional burdens in terms
construction, assembly or like project undertaken by the
of set-up requirements, annual audit, tax filings and other
recipient; or
administrative costs. However, in many cases regulatory and
b. Consideration which would be income of the recipient other non-tax considerations will impose the choice of a local
chargeable under the head “Salary”. subsidiary.
C. Royalty Secondly, it is important to take into account not just the
The term “royalty” means any amount paid or payable, direct tax position (corporate income tax) but also the indirect
however described or computed, whether periodical or a lump tax. Generally, levy of indirect taxes like sales tax and federal
sum, as consideration for: excise duty is unaffected by whether the entity providing the
services is a foreign company or a Pakistani company, but is
a. The use of, or right to use any patent, invention, design determined based on whether the services are provided in
or model, secret formula or process, trademark or other Pakistan. Careful study is needed to consider whether any of
like property or right; the available exemptions could apply.
b. The use of, or right to use any copyright of a literary,
artistic or scientific work, including films or video tapes for V. Conclusion
use in connection with television or tapes in connection
with radio broadcasting, but shall not include The decision on how to structure a service activity is a
consideration for the sale, distribution or exhibition of complex one both from the commercial viewpoint and from
cinematograph films; that of tax. There will often be opportunities to lower the
c. The receipt of, or right to receive, any visual images or overall tax burden with appropriate structuring, as well as
sounds, or both, transmitted by satellite, cable, optic fibre pitfalls that may result in a very high effective tax rate on the
or similar technology in connection with television, radio contract profit. Good professional advice should be taken to
or internet broadcasting; identify these.
d. The supply of any technical, industrial, commercial or Shabbir Vejlani is a Partner with KPMG’s Pakistani firm and can
scientific knowledge, experience or skill; be contacted by email at: shvejlani@kpmg.com
e. The use of or right to use any industrial, commercial or Asif Zia is a Director with KPMG’s Pakistani firm and can be
scientific equipment; contacted by email at: asifzia@kpmg.com
82
82
Pakistan: Tax treatment of cross-border service activities
Table
Country Royaltya (%) Technical Services (%) Service PE Construction Projects PE
Austria 10 10 No Yes - 6 months

Azerbaijan 10 –b Yes - 183 days Yes - 6 months
Bangladesh 15 –b No Yes - 6 months
Belarus 15 15 No Yes - 6 months
Belgium 0/15/20 –b Yes - 3 months Yes - 6 months
Bosnia-Herzegovina 15 –b No Yes - 6 months

Canada 0/15/20 –b Yes - 3 months Yes - 3 months
China 12.5 12.5 No Yes - 6 months
Denmark 12 12 No Yes - 6 months
Egypt 15 15 No Yes - 3 months
Finland 10 10 Yes - 6 months Yes - 6 months

France 10 10 No Yes - 183 days
Germany 10 10 No Yes - 6 months
Hungary 15 15 No Yes - 6 months
Indonesia 15 15 No Yes - 3 months
Iran 10 –b No Yes - 12 months

Ireland 0 –b No Yes - 12 months
Italy 30b –b Yes - 3 months Yes - 6 months
Japan 10 10 No Yes - 6 months
Jordan 10 10 Yes - 3 months Yes - 6 months
Kazakhstan 15 –b Yes - 6 months Yes - 6 months

Korea 10 10 No Yes - 6 months
Kuwait 10 –b Yes - 9 months Yes - 6 months
Lebanon 7.5 –b Yes - 3 months Yes - 6 months
Libya –d –b No No
Malaysia 15 –b No Yes - 6 months

Malta 0/10 –b No Yes - 12 months
Mauritius 12.5 –b No Yes - 6 months
Netherlands 5/15 –b No Yes - 6 months
Nigeria 15 –b Yes - 3 months Yes - 3 months
Norway 12 12 No Yes - 6 months

Oman 12.5 12.5 No Yes - 6 months
Philippines 15/25 –b Yes - 90 days Yes - 6 months
Poland 15/20 –b No Yes - 12 months
Portugal 10 10 No Yes - 6 months
Qatar 10 10 No Yes - 6 months

Romania 12.5 –b No Yes - 12 months
Saudi Arabia 10 –b Yes - 12 months Yes - 6 months
Singapore 10 10 No Yes - 183 days
Sri Lanka 20 –b Yes - 183 days Yes - 183 days
South Africa 10 10 Yes - 6 months Yes - 6 months

Sweden 10 10 No Yes - 6 months
Switzerland 10 10 No Yes - 6 months
Syria 10/15/18 –b No Yes - 6 months
Tajikistan 10 –b No Yes - 6 months
Thailand 20/10/0 –b Yes - 183 days Yes - 183 days

Tunisia 10 –b – Yes - 6 months
Turkey 10 –b No Yes - 6 months
Turkmenistan 10 –b Yes - 183 days Yes - 6 months
United Arab Emirates 12 12 No Yes - 6 months
United Kingdom 12.5 12.5 No Yes - 6 months

United States of America 0 –b No No
Uzbekistan 15 –b No Yes - 6 months
Yemen 10 10 No Yes - 183 days
Vietnam 15 15 No Yes - 6 months
a Rates vary mainly due to nature of payments.

b No specific article for Fee for Technical Services (FTS) in these treaties, however, in certain cases FTS may be exempt subject to provisions contained to that effect in
other articles of respective treaties.
c If a lower rate with an OECD member country is agreed in future then that rate would apply.
d No specific rate prescribed.
83
83
84
84
for investment
Most of the issues that arise while considering holding company and financing strategies for investment into Pakistan
are the same as may arise in other countries while some issues are specific with regard to Pakistan. The holding
company and financing strategies are deliberated upon in the following paragraphs.
I. Holding company strategies sale of shares of companies listed on the stock exchange in
Pakistan has been exempted from tax up to June 30, 2010.
Holding company strategies are generally intended to achieve
one or more of the following objectives: B. Double tax treaties
■ To reduce withholding tax on dividends in the source The table (at the end of this article) summarises the protection
country (Pakistan) or direct taxation on divi-dends from tax on capital gain on sale of shares available under
received in the residence country; some of the Pakistan’s treaties and the rates applicable on
■ To mitigate capital gains taxation either in the source dividends and interest under the treaties.
country or in the residence country, on dis-posal of the It will be seen that protection from tax on capital gain on sale
shares to a third party or within the group. of shares is available under the treaties with some countries,
The residence country issues would generally de-pend on the in particular that with Mauritius and the Netherlands.
tax rules applicable in the country of residence and have not
As far as dividends are concerned, treaties do not reduce the
been considered as we have dealt with only source country
applicable tax rate below 10 percent.
issues.
A. Position under the domestic law II. Financing strategies

The Income Tax Ordinance 2001 as amended to date A. Position under the domestic law
imposes a general 10 percent withholding tax on dividends.
Under the Ordinance, if foreign-debt to foreign equity ratio of a
Until June 30, 2007 this was considered as final tax in all
foreign controlled resident company (“FCRC”) is in excess of
cases. However, through an amendment made by Finance
3:1 at any time during a tax year, a deduction shall be
Act 2007 which is effective from July 1, 2007, the provisions
disallowed for the interest paid by the FCRC in that year on
treating the amount of withholding tax as final tax have been
that part of the debt which exceeds the 3:1 ratio.
made inapplicable to a shareholder who is a company. This
would effectively mean that in the case of a company, FCRC means a resident company in which fifty percent or
expenses incurred for the purpose of earning dividend income more of the underlying ownership of the company is held by a
can be claimed as a deduction against such income and non-resident person either alone or together with an associate
losses under any other head of income can be set-off against or associates.
dividend income. However, the downside of this interpretation
Thin capitalisation rules are not applicable:
would be that in such case the net dividend income may be
taxed at 35 percent. The other interpretation is that the ■ If FCRC is a banking company or a financial institution; or
language of the section pertaining to withholding tax on ■ If interest on foreign debt is chargeable to tax under the
dividends has been framed as a charging section therefore Ordinance and does not enjoy any exemption or
the tax withheld at 10 percent on gross dividend would also application of tax rate lower than the corporate tax rate.
be the ultimate tax payable on dividend income.
The rate of withholding tax under the Ordinance on any
Shares are included in the definition of capital asset. Gain payment of interest to a non-resident not having a PE in
arising on the disposal of capital asset is included in the total Pakistan is 10 percent and 30 percent in the case of other
income of the taxpayer and taxed at the rate applicable to the non-residents. This effectively means that where payment of
taxpayer. If the recipient of capital gain is a company, the interest is made to a Pakistani PE of a non-resident person,
same would be taxed at 35 percent. However, where the tax is required to be withheld at 30 percent. However, with the
capital asset has been held for a period of more than one written approval of the Commissioner, the relevant withholding
year, only 75 percent of the gain arising on disposal is taxed tax provision is not applicable to the amount of interest that is
and the remaining 25 percent is exempted. Further, gain on taxable to a PE in Pakistan of the non-resident person. The
85
85
Pakistan: Holding and financing strategies for investment
tax withheld is adjustable against final tax liability at 35 III. Conclusion

percent on net income for companies and final tax liability at
applicable slab rates up to 25 percent in non-company cases. Room for holding company and financing strategy exist in view
of beneficial treatment available under some treaties but a
B. Double tax treaties
careful analysis will be required in respect of the prescribed
The rate of tax on interest in treaties range between 10 percent conditions for availing such benefits.
to 30 percent and may be beneficial where under the local law
the effective tax rate applicable on interest after allowing the Shabbir Vejlani is a Partner with KPMG’s Pakistani firm and can
expenses incurred for earning such interest works out to be be contacted by email at: shvejlani@kpmg.com
more than the treaty rates applicable on gross amount of Asif Zia is a Director with KPMG’s Pakistani firm and can be
interest. contacted by email at: asifzia@kpmg.com
Table
Country Exemption for tax on capital Dividend Interesta
gains on shares
Individuals and companies Qualifying companiesb
Austria Noc 15 10 15/0

Azerbaijan Yes 10 –d 10
Bangladesh Yes 15 –d 15/0
Belarus Yes 15/10e 10 10
Belgium No –d 10f/15 15/0
Bosnia-Herzegovina Yesg 10 –d 20
Canada Yesg –d 15f/20 25/0
China Nog 10 –d 10/0
Denmark Noh 15 –d 15/0
Egypt Nog 15/30e –d 15/0
Finland Yes 15/20 e 12 15/10/0

France Nog 15 10 10/0
Germany Nog 15 10 20/10/0
Hungary Nog 20 15 15/0
Indonesia No 15 10 15/0
Iran Yes 5 –d 10/0

Ireland Yes –d 10 0
Italy No 25 15 30/0h
Japan Yesg 10 5 / 7.5 10/0
Jordan No 10 –d 10
Kazakhstan Yes 15 12.5 12.5/0

Korea Noi 12.5 10 12.5/0
Kuwait Yes 10 –d 10/0
Lebanon Yes 10 –d 10
Libya No –d –d –d
Malaysia Yes 20 15 15/0

Malta Yes –d 15 10/0
Mauritius Yes 10 –d 10/0
Netherlands Yes 20 10 20/15/10/0
Nigeria No 15 12.5 15/0
Norway Noj 15 –d 10/0

Oman Yes 12.5 10 10/0
Philippines No 25 15 15/0
Poland No –d 15 0
Portugal Yes 15 10 10
Qatar Yes 10 5 10/0

Romania Yes 10 –d 10/0
Saudi Arabia Nog 10 5 10
Singapore No 10k/12.5l/15 –d 12.5/0
Sri Lanka Noc 15 –d 10/0
South Africa Yes 15 10 10/0

Sweden No –d 15 15/0
Switzerland Noc 20 10c 10
Syria Yes 10 –d 10
Tajikistan Yes 10 5 10
86
86
Pakistan: Holding and financing strategies for investment
Country Exemption for tax on capital Dividend Interesta

gains on shares
Individuals and companies Qualifying companiesb
Thailand Yes 25 15f 25/10/0

Tunisia Yes 10 –d 13
Turkey No 15 10 10/0
Turkmenistan Yes 10 –d 10
United Arab Emirates Yes 15 10 10/0
United Kingdom No 15/20e 10 15/0

United States of America No –d Reduction by 6.25% –
Uzbekistan Yes 10 –d 10/0
Yemen Yes 10 –d 10
Vietnam No 15 –d 15
a Rates apply mainly due to nature of recipients, 0% rate applies to central banks/government loans, etc.
b Under different treaties there are specified minimum qualifying shareholdings.
c Holds 20% capital.
d No specific rates prescribed.
e Rates for individuals.
f In case of an industrial undertaking.
g Holds 25% capital.
h If a lower rate with an OECD member country is agreed in future then that rate would apply.
i Holds 25% capital taxable at 10%.
j Holds 30% capital.
k When payer is an industrial undertaking and the recipient is a company.
l When the recipient is a company.
87
87
88
88
Investing in real estate:
Shabbir Vejlani
The law relating to real property in Pakistan can be complex. This article gives an introduction to some of the aspects
that may be relevant to the tax structuring of Pakistani real property.
I. The legal framework or unrealised, is distributed by the RMC amongst the unit
holders in each financial year.
Foreign investment is allowed in the “Housing and
■ Any distribution received by a unit holder, out of capital
Construction sector” which has been declared as industry in
gains arising to a REIT scheme, is exempt from tax.
Pakistan. However, in order for local and foreign companies
involved in real estate projects to market these projects, the ■ No tax is payable on capital gain arising on sale of
title of the property must be in the name of a locally immovable property to a REIT scheme.
incorporated company (which can be 100 percent foreign
owned) and the “Commencement of Business” certificate is II. Taxation of a locally incorporated company
issued by the Securities and Exchange Commission of dealing in real estate
Pakistan (“SECP”) to the company.
Under the Income Tax Ordinance 2001 (“the Ordinance”)
Foreign investment is also permissible in “Agricultural immovable property other than that entitled to depreciation is
Sector Activities” which cover land development/ excluded from the definition of capital asset and as such gain
reclamation of barren land, desert and hilly areas for on sale of such immovable property is not liable to tax
agriculture purposes and crop farming, reclamation of applicable on capital gains. However, where a company is
water front areas/creeks. engaged in the business of purchase and sale of immovable
property, such immovable property will be considered as its
Minimum foreign investment of USD0.3 million is required in stock in trade and the income derived therefrom will be
infrastructure, social and agriculture sectors and USD0.15 considered as its business income.
million in the services sector with no upper limit on the
amount of foreign equity investment. The locally incorporated company would be treated as a
resident company for Pakistan tax purposes. Net profit of
The requirement of using a locally incorporated company for such company from sale of immovable properties forming
making investment would mean that net profits can only be part of its trading stock would be liable to tax at 35
remitted by way of dividend after the year end after charging percent.
depreciation and income tax, etc. Further, tax would also be
levied on dividend at 10 percent unless a lower tax rate on Rental income derived by such company would be taxable at
dividend is available under a tax treaty. None of Pakistan’s the following rates:
double tax treaties reduce this withholding tax rate below 10
Table 1
percent.
S. No. Gross amount of rent Rate of tax
Another vehicle for investment in real estate is through a Real (1) Where the gross amount of rent 5% of the gross amount of rent
does not exceed Rs.400,000
Estate Investment Trust (“REIT”) for which the required rules
(2) Where the gross amount of rent Rs.20,000 plus 7.5% of the gross
have been recently framed. For this purpose a REIT
exceeds Rs.400,000 but does not amount of rent exceeding
management company (“RMC”) will be required to be formed exceed Rs.1,000,000 Rs.400,000
which would float the REIT scheme. Though this option has (3) Where the gross amount of rent Rs.65,000 plus 10% of the gross
some tax advantages as mentioned below, it may only be exceeds Rs.1,000,000 amount of rent exceeding
Rs.1,000,000
considered feasible where the foreign investor is willing to
dilute equity and profits by bringing in the general public and
is willing to take the risks and costs associated with public III. Other taxes applicable on immovable
participation. The tax advantages of a REIT structure are as properties
follows:
A. Capital value tax (“CVT”)
■ Any income derived by a REIT scheme is exempt from
tax, if not less than 90 percent of its accounting income CVT is levied at the following rates (see Table 2 on the following
of that year, as reduced by capital gains whether realised page):
89
89
Pakistan: Investing in real estate: Some key tax aspects
Table 2 provincial governments at rates ranging from 10 percent to 20

S. Description of assets Rate of CVT (%) percent on annual value of properties. Some properties are
No.
exempt from such levy.
1 Residential Immovable property (other than flats) situated in urban
area, measuring at least 500 square yards or one Kanal (whichever is
less) and more:
IV. Disposal of shares of local company
• Where the value of immovable 4% of the recorded value
property is recorded engaged in real estate business
• Where the value of immovable Rs.100 per square yard of
property is not recorded the land area Which Under the Ordinance, shares are included in the definition of
ever is
• Where the immovable property Rs. 10 per square feet of
higher capital asset. Gain arising on the disposal of capital asset is
is a constructed property the constructed area in
addition to the value worked
included in the total income of the taxpayer and taxed at the
out above rate applicable to the taxpayer. If the recipient of capital gain is
2 Commercial immovable property of any size situated in urban area: a company, the same would be taxed at 35 percent. However,
• Where the value of immovable 4% of the recorded value where the capital asset has been held for a period of more than
property is recorded one year, only 75 percent of the gain arising on disposal is
• Where the value of immovable Rs.100 per square yard of taxed and the remaining 25 percent is exempted. Further, gain
property is not recorded the landed area Which
ever is on sale of shares of companies listed on the stock exchange in
• Where the immovable property Rs. 10 per square feet of
higher
is a constructed property the constructed area in Pakistan have been exempted from tax up to tax year ending
addition to the value worked on June 30, 2010.
out above
3 Residential flats:
Pakistan has tax treaties with over 50 countries. Most of these
• Where the value of immovable 4% of the recorded value
treaties provide that gains from alienation of shares or rights in
property is recorded Which
ever is a company the property of which consists directly or indirectly
• Where the value of immovable Rs.100 per square feet of the
higher
property is not recorded covered area principally of immovable property situated in a contracting state
may be taxed in that state. The new treaty with Japan specifies
B. Stamp duty that gains from alienation of shares where the shares derive at
Stamp duty is governed under the Stamp Act 1899 (“the least 50 percent of their value from immovable property
Stamp Act”) which provides for levy of duty on specified situated in a state is taxable in that state, whereas the treaties
instruments including instrument executed by any person with the Netherlands and Norway specify such minimum
outside Pakistan relating to any property situated or to any shareholding percentage at 25 percent and 30 percent
matter or thing done or to be done in Pakistan and received in respectively. However, the treaties with Belarus, Jordan,
Pakistan. “Instrument” includes every document by which any Kuwait, Lebanon, Malaysia, Malta, Mauritius, Oman, Portugal,
right or liability is, or purports to be, created, transferred, Qatar, South Africa, Sweden, Thailand, Tunisia, UAE,
limited, extended, extinguished or recorded. If an instrument Uzbekistan and Yemen would allow gain on sale of shares to
effecting transfer of property is not specifically dealt under the be taxed in only the country of residence of the shareholder.
Stamp Act, it is treated as “conveyance”; which includes
conveyance on sale and every instrument by which property, V. Conclusion
whether movable or immovable, is transferred inter vivos.
Due to the requirement of forming a locally incorporated
Stamp duty is payable by the grantee (i.e. the purchaser)
company for making investment in real estate projects, it will
unless the seller and purchaser agrees otherwise. The stamp
generally be attractive for foreign companies having long-term
duty is a provincial matter and rates of stamp duty vary from
investment plans in Pakistan. Protection from tax on capital
province to province.
gain on sale of shares of such companies would be available
C. Property tax under some of Pakistan’s double tax treaties.
Annual property tax is levied on urban immovable properties Shabbir Vejlani is a Partner with KPMG’s Pakistani firm and can
under the Urban Immovable Property Tax Act 1958 by the be contacted by email at: shvejlani@kpmg.com
90
90
India
The tax and legal system

Amarjeet Singh
BSR & Co (currently seconded to KPMG LLP, London)
I. Tax system in India aggregated to determine the total taxable income. However,
losses under certain heads cannot be aggregated with
India has a federal system of taxation wherein the authority for income earned under other heads.
levying taxes is divided between the central and the state
■ Salaries cover those incomes that are received for
governments. Principal taxes like income tax, custom duty
(duty on imports), excise duty (VAT on manufacturing) and services rendered and include wages, pension, fees,
service tax (an indirect tax on services) are levied by the commission and the taxable value of perquisites.
central government. The state governments are authorised to ■ Income from house property includes income arising from
levy various indirect taxes, including VAT, entry tax, Octroi, etc. use of residential and commercial property. Only
prescribed deductions are permitted while computing the
The taxation system in India, lately, has seen substantial
income.
rationalisation. The Indian government is trying to modernise
■ Profits and gains from business or profession covers
its tax system and has made important policy announcements
regarding the introduction of a GST regime by 1 April, 2010 income earned from a business or profession net of
and a new income tax code (which encompasses various permissible deductions.
elements of cross-border taxation). It is expected the drafts of ■ Capital gains cover gains arising from transfer of capital
new legislation will shortly be put for public debate. assets. The period of holding determines the
classification of the asset, which then determines the
The tax to GDP ratio in India is much smaller than compared manner of taxation. Capital assets held for less than 36
to other parts of the world. Accordingly, the changes in the months (12 months in case of shares/securities) are
Indian system of taxation are also being undertaken to make it treated as short-term assets. Other capital assets are
more broad-based and elastic. There is a continuing effort to categorised as long-term capital assets. Long-term
reduce peak rates and simplify the regulations to facilitate capital gains enjoy a lower rate of tax/tax exemptions
better compliance and enforcement. specified under the Indian Domestic Tax Law (“DTL”).
A. Corporate income tax ■ Income from other sources is the residuary head which
covers any income not specifically dealt with under any
India follows a residence based taxation system. Broadly, other head. A deduction in respect of expenses incurred
taxpayers are classified as residents or non-residents. Under for earning the income is also available.
domestic law, an Indian company is always an Indian resident.
Additionally, any other company whose affairs are wholly C. Kinds of taxes
controlled and managed from India is also a resident.
1. Annual tax
Income earned in a tax year is liable to tax as per the rates An annual tax is levied on income earned in a tax year as per
prescribed for that tax year. A tax year runs from April 1 to the rates prescribed for that year. The annual tax is payable in
March 31 of the next year. India follows the source based advance by way of quarterly instalments during the tax year
taxation model and hence also taxes incomes, which are itself.
“deemed” to be received, accruing or arising in India. Interest,
The income tax rates for companies applicable for the tax
gains from sale of Indian shares, royalties/technical services
year April 1, 2009 to March 31, 2010 is as follows:
consumed in India and dividends from Indian companies are
taxed in India.
Table 1
B. Heads of income Status Effective tax ratea
Domestic company, i.e. an Indian company 33.99%
The income is categorised under five broad heads or classes.
Foreign company 42.23%
The taxable component of income is ascertained according to
a Including surcharge and education cess.
the rules for a particular head/class of income and then
91
91
India: The tax and legal system
Foreign companies may also be taxed on a gross basis or on a Inclusive of surcharge of 10 percent for domestic companies
presumptive basis in certain cases. Such basis has been and 2.5 percent for foreign companies (if income exceeds
prescribed for specific industries or category of income. INR10,000,000) and education cess at three percent in both
cases.
For example profits and gains earned by non-residents in
connection with business of exploration of mineral oils are D. Withholding of taxes
deemed to be 10 percent of receipts and taxable at the rate
prescribed to a foreign company (42.23 percent). Most income payable to residents or non-residents are liable to
withholding tax by the payer. The rates in case of residents
Categories of passive income such as interest, royalties,
would vary depending on the nature of payment and the status
technical services, etc. sourced from India by foreign
of payee involved. The royalties and technical services fees
companies are taxed on a gross basis. However, where a
payable from India to a non-resident are taxable in India based
foreign company earns such income through a “permanent
on the source rule of “actual use” of such royalties or service
establishment” in India, such income is taxable on a net income
fees for a “business carried on in India”.
basis at the rate applicable to a foreign company.
The taxation and the gross rates prescribed under DTL for the As mentioned earlier, payments made to foreign
above-mentioned passive income sourced by foreign companies/non-residents are subject to prescribed preferential
companies from India have to be examined in conjunction with tax rates provided in DTAA.
relevant clauses under the Double Taxation Avoidance Current rates for withholding tax (also the final tax liability on the
Agreements (“DTAA”) entered by India. following income without a PE) for payments to non-residents
2. Minimum alternate tax (“MA”) are:
MAT is levied on all companies whose tax payable on the
taxable income computed according to the normal provisions Table 2
of the DTL is less than 15 percent of the book profits. MAT is Nature of payment Withholding tax ratea
payable in lieu of the regular corporate tax where the regular Interest 20%
corporate tax is lower than 15 percent of book profits. MAT is Royalties 10%
payable at 17 percent by domestic companies and at 15.84 Technical service fees 10%
percent by foreign companies, of the book profits. a Excluding surcharge and education cess.
Book profit means the net profit as per the profit and loss
account of the company, prepared as per the provisions of the E. Tax incentives
Indian Companies Act 1956 (“Companies Act”) after making Various tax incentives are available in DTL which may grant full
certain adjustments prescribed under the DTL. or partial tax exemption, reduced tax rates, tax rebates,
The provisions also allow carry forward of amounts paid as accelerated depreciation or special deductions. The tax
MAT against normal taxes in future. incentives apply to a broad range of industries.
3. Dividend distribution tax (“DDT”) Some of the industry segments eligible for tax incentives
There is no withholding tax on dividends in India and dividends subject to fulfilment of prescribed conditions are:
earned by a shareholder are currently exempt from tax in India. ■ An undertaking established in special economic zones
However, the company paying the dividends is required to pay
and deriving profit and gains from the export of articles or
DDT (i.e. a tax payable on the dividend declared, distributed or
things or computer software;
paid, whichever is earliest) at the rate of 16.995 percent. DDT is
■ A 100 percent export oriented undertaking;
classified as an additional income tax and hence cannot be
equated to withholding tax. ■ An enterprise carrying on the business of developing,
operating and maintaining infrastructure facilities such as
4. Fringe benefit tax (“FBT”)
a road, highway projects, etc.;
FBT is a tax payable by the employer on certain specified
■ An industrial undertaking engaged in the generation
(collective) benefits (fringe benefits) that employees receive
and/or the distribution of electricity;
pursuant to their employment. FBT is leviable on every
employer (excluding individuals/Hindu Undivided Family and ■ An enterprise engaged in the business of building,
certain institutions enjoying certain exemptions). owning and operating multiplex theatres/hotels/
convention centres;
Fringe benefits are defined as any consideration for
■ An undertaking engaged in the business of operating and
employment provided by way of privilege, service, facility,
concessional ticket, contribution to select funds, etc. It also maintaining hospital in rural areas; etc.
includes certain expenses incurred by an entity on The tax holiday period varies in each case and is available on
entertainment, conferences, hospitality, welfare, etc. The satisfying certain conditions, as well as on complying with
provisions clearly prescribe the methodology of valuation of specified procedural formalities.
various kinds of fringe benefits and tax is payable on such
values at the rate of 33.99 percent. F. Transfer pricing regulations in India
FBT is not applicable on or after 1 April 2009. In place of FBT, The Government of India introduced the transfer pricing related
the regime of personal taxation of perquisites, in the hands of regulations in India in 2001. These regulations require
employee, has been inserted w.e.f. 1 April 2009 and it is commercial outcomes arising from international transactions
expected that the detail rules for taxability and valuation of between associated enterprises to be consistent with the arm’s
different perquisites will be issued in due course. length principle. The arm’s length principle endorsed as the
92
92
standard for transfer pricing in DTL is broadly based on the ■ Advance Pricing Agreements;
OECD principles on transfer pricing. ■ Thin capitalisation; and
The DTL also provides for methods to determine the arm’s ■ General anti-avoidance rules.
length price in relation to international transactions with
associated enterprises and a set of rules gives the manner and II. Foreign Exchange Management Act
circumstances in which different methods may be applied, and
(“FEMA”)
the factors governing the selection of the most appropriate
method. The regulatory aspects of foreign exchange transactions are
governed by FEMA in India. The objective of FEMA is to
Rules require taxpayers having international transactions with
consolidate and amend the law relating to foreign exchange
associated enterprises to prepare and maintain prescribed
with the objective of facilitating external trade and payments
information and documentation annually to establish that their
and for promoting the orderly development and maintenance of
dealings with associated enterprises are conducted on an
foreign exchange market in India.
arm’s length basis.
Under the provisions of FEMA, foreign exchange transactions
Union Budget 2009 has proposed the empowerment of Central
have been divided into two broad categories: capital account
Board of Direct Tax (“CBDT”) [the apex statutory body in India
transactions and current account transactions.
with functional responsibility of administration of the DTL] to
make Safe Harbour Rules to minimise disputes relating to A. Capital account transactions
transfer pricing matters.
A capital account transaction is one that alters the assets or
Further, an Alternate Dispute Resolution Mechanism is being liabilities, including contingent liabilities, outside India of
formulated to facilitate the expeditious resolution of transfer persons resident in India or assets and liabilities in India of
pricing matters and other matters of foreign companies. persons resident outside India and includes specified
transactions. Such transactions require prior regulatory
G. Income tax authorities in India
approval in all cases unless specifically permitted.
As mentioned above, CBDT in India is the apex statutory body
with functional responsibility of administration of the DTL. The B. Current account transactions
appellate officers within the Indian Revenue Services (“IRS”) are All transactions other than capital account transactions are
separated from administrative functions and constitute the first considered as current account transactions. Without prejudice
level of appellate authority. The first appellate authority which is to generality of the foregoing, such transactions include:
a part of IRS itself, adjudicates on all appeals filed against the
■ Payments due in connection with foreign trade, other
orders passed by the tax inspector in respect of return filed by
current business, services, and short-term banking and
a taxpayer.
credit facilities in the ordinary course of business;
The executive and the judicial system have further been ■ Payments due as interest on loans and as net income
separated in India and the next level of appellate authority is in from investments;
the nature of quasi court and is known as the Income Tax
■ Remittances for living expenses of parents, spouses and
Appellate Tribunal (“ITAT”). ITAT in India is the final fact finding
children residing abroad; and
authority for the tax matters.
■ Expenses in connection with foreign travel, education and
The cases decided by ITAT can only be appealed before the
medical care of parents.
state High Court. The High Courts only pronounce judgments
on questions of law. High Court judgments can only be All payments in the nature of current account transactions for
appealed before the Supreme Court of India. The Supreme remittance outside India are permitted either under automatic
Court of India is at the top of the pyramid in respect of any tax route or government approval route.
litigation. The judgments pronounced by the Supreme Court of
India on any legal issue/interpretation, etc. is considered to be III. Foreign Direct Investment (“FDI”)
the “law of the land”. framework
H. Authority of Advance Ruling (“AAR”) Foreign investment in India is regulated by the FDI policy of the
Government of India. The following two routes are available for
The AAR is an autonomous body constituted by the Indian
FDI in India: the automatic route and the approval route.
Government comprising retired Supreme Court judges, and
retired officers from the Indian Revenue Services and Legal FDI up to 100 percent is allowed under the automatic route in
Services. The AAR pronounces a ruling on the questions of fact all activities/sectors except the following which require prior
or law in respect of a transaction in relation to which it is approval of the government:
sought. ■ Manufacture of cigars and cigarettes of tobacco and
A non-resident or certain categories of resident can obtain manufactured tobacco substitutes;
binding rulings from the authority out of any ■ Manufacture of electronic aerospace and defence
transaction/proposed transactions which are relevant for the equipment of all types;
determination of its tax liability. ■ Manufacture of items exclusively reserved for small scale
sector with more than 24 percent FDI;
I. Anti-avoidance provisions
■ Proposals in which the foreign collaborator has an
At present, India does not have provisions dealing with:
existing financial/technical collaboration in India in the
■ Controlled Foreign Corporation Rules; “same” field; and
93
93
■ All proposals falling outside notified sectoral policy/caps. without limited liability. the limited liability structure can be
To keep a pace with the rapid changing economy, FDI policy is achieved through limitation by shares or by guarantee.
reviewed on continued basis and changes in sectoral
policy/sectoral equity cap are notified through appropriate
1. Private company
notifications.
A Private company means a company, which has a minimum of
A. Procedure under automatic route two members and a minimum paid up capital of INR100,000,
and which by its articles of association:
FDI in sectors/activities to the extent permitted under automatic
route does not require any prior approval either by the ■ Restricts the right of members to transfer its shares;
government or RBI. The investors are only required to notify the
■ Limits the number of its members/shareholders to 50. In
regional office concerned of RBI within 30 days of receipt of
determining this number of 50, employee-members and
inward remittances and file the required documents with that
ex-employee members are not to be considered; and
office within 30 days of issue of shares to foreign investors.
■ Prohibits an invitation to the public to subscribe to any
B. Procedure under government route shares in or the debentures of the company.
FDI in activities not covered under the automatic route, requires 2. Public company
prior government approval. Application for FDI under approval
route should be submitted to the concerned Ministry. A company which is not subject to any of the above restrictions
is a Public company. A public company is required to have a
C. Prohibited sectors minimum paid up capital of INR500,000 and a minimum of
The policy does not permit FDI in some areas such as: seven members and three directors.
■ Retail trading (except single branded product retailing);
3. Foreign company
■ Gambling and betting;
■ Lottery business; A foreign company is a company incorporated in a country
outside India under the law of that other country and has
■ Atomic energy.
established the place of business in India. A foreign company is
required to register, within 30 days of establishment of place of
IV. Company law business in India, with the jurisdictional Registrar of Companies
(“RoC”) and RoC of New Delhi. Other compliances also involve
A. Introduction
the annual filing of balance sheets and profit and loss accounts
The Companies Act governs the creation, continuation, winding of the foreign company with the RoC.
up of companies and also the relationships between the
shareholders, the company, the public and the government. Amarjeet Singh is a Tax Partner with KPMG’s Indian firm,
currently seconded to KPMG LLP in London. For further
B. Types of companies information, please contact the author by email at:
Amarjeet.Singh@KPMG.co.uk
Companies incorporated under the Companies Act can be
categorised as “public” or “private” companies either with or © KPMG LLP 2009
94
94
Taxation of cross-border services
Amarjeet Singh
Over the last five years, India has achieved an average annual growth rate of 8.8 percent and ranks among the fastest
growing economies on the globe. From an abysmal equity inflow of USD2,908 million in 2000-01 to USD23,885
million in 2008-2009 (April - January), the Indian economy seems to have opened its arms to foreign direct investment
(“FDI”) unconditionally.
Multiplicity of taxes, complex legislation, cascading tax burden and aggressive tax administration pose one of the major
challenges for foreign investors. The Indian tax administration scrutinises all kinds of cross-border revenue flows
(sometimes even capital flows) from India, extremely closely. The detailed scrutiny and conservative interpretation of tax
regulations by the Indian tax administration has resulted in a substantial amount of litigation relating to cross-border
flows from India.
In order to appreciate the genesis of the case law associated with cross-border flows, it is important to understand the
relevant rules in Indian domestic law as well as the relevant provisions in the tax treaties which India has entered with
various countries.
I. Basic domestic law provisions relating to ■ A business connection is in nature of a common thread in
cross-border taxation a trading activity of a non-resident inside and outside
India.
A. Source based taxation principle and business
In 2004, the Indian legislature amended the law and provided
connection
specifically that the following automatically give rise to a
Under the Indian Income Tax Act 1961 (“the Act”), a business connection for non-residents:
non-resident is taxable in India for all income: ■ Habitual exercise in India of an authority to conclude
■ Which accrues or arises in India or which is deemed to contracts;
accrue or arise in India; or ■ Habitual maintenance in India of a stock of goods for
■ Which is received in India or deemed to be received in delivery; and
India. ■ Habitual securing of orders in India.
The deeming provisions of the Act are very wide and bring into An agent of independent status acting in the ordinary course of
the charge to tax all incomes which accrue or arise in India on business was excluded from the purview of business
account of: connection. Further, levy of tax in India was limited to incomes
which were attributable to operations carried out in India.
■ A business connection with India;
■ Any property in India; It is evident from the above analysis that the scope of “business
connection” under the Act is very wide. For this reason it is
■ An asset or source of income in India;
usual for non-residents to seek to operate from a jurisdiction
■ The transfer of capital asset in India. having a favourable treaty with India.
The expression “business connection” was not defined under
B. Royalty
the Act until 2004. Prior to that, the Supreme Court of India
addressed the point (the leading case being CIT v R. D. Any royalty paid by a resident or payable in respect of any right,
Aggarwal & Co (1965) 56 ITR 20 SC). The Supreme Court held property, or information or services utilised for business or
that: profession carried in India or for making or earning any income
from any source in India is deemed to be taxable in India.
■ A business connection is “something more than
business”; The definition of royalties is very wide and also includes income
■ A business connection is something real, intimate and from rental of equipment.
continuous;
C. Technical services fees
■ A business connection produces, by itself, all profits or
gains and not a mere state or condition which is Any technical services fees paid by a resident or payable in
favourable to the making of profits; respect of services utilised for business or profession carried on
95
95
India: Taxation of cross-border services
in India or for making or earning any income from any source in absence of a fixed place of business, if the non-resident
India is deemed to be taxable in India. furnishes services “through employees or other personnel”, if
activities of that nature continue in India for more than a
The Act also clarifies that royalties and technical services fees
specified period. Many treaties set this period at much less
would be taxable in India, irrespective of whether the
than the six months in the UN Model, for example, under the
non-resident has a residence or place of business or business
UK-India Treaty the period is generally 90 days, but only 30
connection in India. The clarification was issued in 2007 to
days for services provided to related parties.
override the effect of a court decision which held that in case of
technical services, the place of rendering services will Some treaties, for example that with Mauritius, do not include a
determine if such income is taxable in India or not. “services PE” concept at all and therefore offer greater
The income arising on account of royalties and technical protection.
services fees is liable to tax on gross basis with no deduction of Accordingly, it is possible for the non-resident entities to use
expenses being allowed. The applicable tax rates under the Act the scope of PE under the DTA, to mitigate Indian taxation.
are as follows:
B. Royalty and technical services fees
Table
Most of India’s treaties allow source country taxation not only
Income stream Rate of tax (%) under the Act
on royalties but also on “technical fees”. However, the
Royalty 10.55
definitions of royalty and technical services fees under treaties
Fee for technical services 10.55
are usually much more restrictive than those under the Act.
Accordingly, it is possible to achieve substantial tax efficiency
However, any royalty or technical services fees received by a through use of appropriate treaties.
non-resident which carries on business in India through a
permanent establishment situated in India or through a fixed Some examples in this connection are as follows:
place of business in India and where such royalty or technical ■ Payment for use of industrial, commercial and scientific
services fees are effectively connected with such permanent equipment is outside the purview of definition of royalty
establishment or fixed place of business, is taxable in India on a under treaties with Netherlands, Israel and Greece.
net income basis.
■ The treaties with the US, the UK and the Netherlands
D. Withholding tax obligations under the Act (among others) contain the “make available” clause in
case of fees for technical services – under the “make
Every person responsible for paying to a non-resident any sum
available” clause, the source country has the taxing right
chargeable to tax in India, is obligated to withhold taxes from
only if the non resident makes available the relevant
such payments. Taxes need to be withheld “at the rates in
technical knowledge, experience, skill, know-how to the
force” at the time of credit or payment, whichever is earlier. In
recipient.
case a non resident has a business connection/ fixed place of
■ The treaty with Mauritius does not have any clause
business/ permanent establishment, the appropriate rate of
withholding would need to be determined based on an relating to fees for technical services.
application made to the tax administration in India. Other treaties also provide similar planning opportunities for
various kinds of cross-border flows. Since India requires
Further, the non-resident recipient is also under an obligation to
withholding tax on all the payments to non-residents, use of
file a tax return for almost all kind of cross-border income
appropriate DTAs can improve both the tax costs and the cash
arising from India (even if full taxes are withheld at source).
flows.
II. Effect of tax treaties

III. Conclusion
A. Permanent establishment
The Indian tax system is complex and services income will be
India’s treaties are based on UN Model Convention and hence taxed in different ways depending on the fact pattern and the
the treaties have clear bias towards source based taxation. provisions of any applicable treaty.
Nevertheless, the definition of PE under the Indian DTAs is
Amarjeet Singh is a Tax Partner with KPMG’s Indian firm,
usually narrower than that of business connection under currently seconded to KPMG LLP in London. For further
domestic law. information, please contact the author by email at:
Most, but not all, of India’s treaties include the UN Model’s Amarjeet.Singh@KPMG.co.uk
“services PE” concept, whereby a PE exists, even in the © KPMG LLP 2009
96
96
Holding companies and financing
of operations
Amarjeet Singh
A Holding company is defined as a corporation that holds stock in other corporation. A company may also become a
holding company by acquiring enough voting rights in another company (“the subsidiary”) to exercise control of its
operations, composition of directors, etc.
Use of an appropriate ownership structure by an investor into a country is critical to ensure overall corporate
philosophy in relation to optimisation of taxes and time frame in which the investment needs to be consummated.
I. Investing into India through an International 16.99 percent1 (inclusive of a surcharge of 10 percent and
Holding Company (“IHC”) education cess of three percent). After having suffered tax in
the hands of the company, dividends are not taxable in the
Typically, the following four countries are considered as hands of the recipient, i.e. the shareholders2. Double tax
favoured jurisdictions for investing into India: treaties do not give protection from DDT.
■ Mauritius;
■ Singapore; DDT also applies to redemption or repayments of share capital.
■ Cyprus; and However, it does not apply to share buybacks. Therefore share
■ Netherlands. buybacks are often a tax efficient alternative to dividends where
shares in the Indian company are held through a holding
The main criterion for the above selection is essentially the fact
company in a country whose treaty with India gives protection
that the respective treaties with India give protection from
from Indian capital gains taxation (see below).
Indian tax on capital gains on the sale of shares in the Indian
company or buy-back of shares by that company. This is
2. Interest
important also because share buy-backs are often a tax
efficient alternative to dividends.
Interest paid by an Indian company to a foreign company is
The Indian Income Tax Act 1961 (“Act”) provides that where the subject to Indian tax at the rate of 21.11 percent (inclusive of a
Indian Government has entered into a Double Taxation surcharge of 2.5 percent and education cess of three percent)
Avoidance Agreement (“DTA”) with any foreign country, then a payable by withholding. The tax is payable on a gross basis
taxpayer to whom such a DTA applies, has the option to without allowing deduction of any expenses.
choose between the provisions of the Act or the DTA,
whichever are more beneficial for him. 3. Capital gains
The streams of revenue / income which are most relevant for
selection of a HoldCo / IHC are the taxation of: Taxability of capital gains under the Act is as under:
■ Dividends;
■ Long term3 capital gains arising on the transfer of shares
■ Interest; and in an unlisted Indian company are subject to tax at 21.12
■ Capital gains. percent4; and
■ Short-term capital gains are subject to tax at 42.23
A. Position under the Indian Income Tax Act 1961
percent.
1. Dividends
Under the Act, an Indian company declaring dividends is Long-term capital gains on listed securities are exempt from tax
required to pay Dividend Distribution Tax (“DDT”) at the rate of subject to payment of securities transaction tax.
1 This rate is applicable for the fiscal year 2008-09 i.e. from April 1, 2009 to March 31, 2010.
2 Section 10(34) read with section 115-O of the Act.
3 Investment in shares should be held for more than 12 months.
4 Inclusive of a surcharge at 2.5 percent and education cess of three percent.
97
97
India: Holding companies and financing of operations
Table 1
Particulars India domestic law position India–Singapore treatya India–Mauritius treatya India–Cyprus treatya India–Netherlands treatya
Dividend Not taxable in the hands of the recipient. Indian company would have to pay a DDT at 16.995%
Interest 21.11% 10% / 15% 21.12% 10% 10% / 15%
(Nil if loan from (Nil for loans guaranteed by
Mauritius resident bank) specified bodies)
Capital gains on sale Taxable as long term / short Exempt in India, subject to Exempt in India Exempt in Indiab Exempt in India except when
of shares in an term depending on period of LOB conditions, e.g. sold to an Indian resident by
Indian company holding and listed / unlisted expenditure of Sing$200,000 a shareholder having more
/ last 24 months than 10% holding
a The rates of tax mentioned above are lower of the applicable rates under the Act and the relevant tax treaty.
b It was reported last year that the Indian and Cypriot authorities had reached agreement to allow source county taxation of capital gains, so that the Indian domestic
low position would apply.
B. Taxability of dividends, interest and capital gains II. Use of two layered structure for investing in
under shortlisted IHC jurisdictions India
Table 1 above provides a high-level overview of the taxability of
There are certain sectors in India, e.g. real estate where there
various income streams under Indian domestic law, and
are restrictions on the minimum period for which a foreign
through use of DTAs with shortlisted IHC jurisdictions.
investor needs to hold the investment into the business activity
C. High level taxation of the identified streams of in India. In such a case, a two tiered holding company structure
revenue/ income in respective IHC jurisdictions may help to facilitate sale / exit, the presumption being that
regulators can / will only look to the direct ownership of the
See Table 2 below. Indian company in deciding whether the minimum holding
period requirement under relevant guidelines is satisfied.
The Indian Supreme Court decision in November 2003 in the
case of Azadi Bachao Andolan and others v Union of India However, planning as above needs to be undertaken, keeping
allowed treaty benefits to Mauritian-based collective investment in mind the recent Vodafone ruling in India. In the Vodafone
vehicle even though these had little commercial substance in case, the tax authorities are seeking to tax a capital gain
practice. However, in order to avail the treaty benefits in India, it realised by a Cayman company.
is recommended that any holding company:
The case emphasises the need to ensure that treaty protection
■ Has commercial substance; is available.
■ Demonstrates a larger business purpose (for electing the
offshore jurisdiction); and III. Financing of operations in India
■ Cannot be construed by the Indian tax authorities as
Typically, the following modes of financing are available to a
merely a “pass through” entity to make investments in
foreign investor seeking to invest in India for the purpose of
India.
capitalising an Indian entity:
Neither the Act nor tax treaties with the above-mentioned
countries have specific antitreaty shopping provisions. ■ Equity share capital;
The Indian tax authorities, however, have inherent powers to ■ Preference Share Capital / Compulsory Fully Convertible
ignore or modify as appropriate, any transaction that has been Preference Share (“CFCPS”);
entered into with the sole or dominant purpose of avoiding tax. ■ Compulsory Fully Convertible Debentures (“CFCD”);
The tax authorities can examine the substance of the
■ Debt in the form of foreign debts (referred to as External
transaction and disregard its legal form where such transaction
was executed solely to avoid taxes (commonly referred as the Commercial Borrowing (“ECB”) under the Indian
“substance over form” rule). Exchange Control regulations) or domestic debt; or
■ Any combination of the above options.
Table 2
Particulars Singapore Mauritius Cyprus Netherlands
Dividends • No tax on dividends received • Taxed at corporate tax rate of 15% • Exempt, subject to • Eligible for participation exemption
from an Indian company, • 80% deemed tax credit or actual prescribed conditions and will be exempt from tax on
subject to specified conditions underlying tax credit, whichever is higher fulfillment of the specified conditions
is granted
• Effective tax rate is effectively reduced to
0%/3%
Interest • Taxed as normal business • Taxed as normal business income and • Taxed as normal • Taxed as normal business income at
income at 18% subject to tax at 15% business income at 25.5%a
• Credit available for foreign taxes • 80% deemed tax credit or actual tax 10% • Credit available for foreign taxes
• Further, overseas sourced credit, whichever is higher is granted • Credit available for
income not taxed subject to • Effective tax rate on foreign sourced foreign taxes
certain prescribed conditions interest is effectively reduced to 0% / 3%
Capital gains • No capital gains tax • No capital gains tax • No capital gains tax • Eligible for participation exemption
(except on immovable and will be exempt from tax on
property) fulfillment of the specified conditions
a From January 1, 2008, the corporate income tax rates are 20% on profits up to EUR 40,000, 23.5% on profits between EUR 40,000 and 200,000 and 25.5% on the excess.
98
98
India: Holding companies and financing of operations
In the earlier paragraphs, we have already examined the minimum average maturity period of such loans has also been
taxability of “interest” paid to a HoldCo / IHC. The regulatory prescribed.
regime on ECB is quite stringent and needs to be considered in
detail before using it for financing business activity in India. End use restrictions
Some of the key features of the ECB guidelines are:
Recognised lenders ECB proceeds can be utilised for investment in the real
property sector, industrial sector and infrastructure sector. ECB
ECBs can be raised from internationally recognised sources proceeds are not allowed to be used for onward lending or
such as international banks, international capital markets, investment in the capital market or for working capital, general
multinational financial organisations, export credit agencies, corporate purpose and repayment of rupee loans.
institutions, suppliers of equipment, foreign collaborators,
foreign equity holders, etc.
IV. Conclusion
In order to qualify as a recognised lender under “foreign equity
holder” category, the following additional conditions have been
Indian tax and exchange controls as well as company and
prescribed:
commercial law are highly complex. Overall, India is a high tax
■ For ECB up to USD5 million – minimum equity of 25 country and very careful planning is needed to manage the tax
percent held directly by the lender; burden. The strong rule of law in the India legal system makes it
■ For ECB more than USD5 million – minimum equity of 25 all the more important to obtain good advice.
percent held directly by the lender and debt: equity ratio
Amarjeet Singh is a Tax Partner with KPMG’s Indian firm,
not exceeding 4:1.
currently seconded to KPMG LLP in London. For further
Limits and average maturity periods information, please contact the author by email at:
There are limits in relation to the amount of ECB which can be
raised by an entity / project in various industry segments. The © KPMG LLP 2009
99
99
100
100
Real estate investment:
Key regulatory and tax aspects
Amarjeet Singh
The Indian Real Estate (“RE”) sector has shown an annual growth of more than 30 percent in the last five years. It is
currently the second largest employer in India after agriculture. The Indian regulators over the years have been
circumspect about allowing open-ended Foreign Direct Investment (“FDI”) in the RE sector. While most of the other
sectors in the Indian economy were opened to FDI between the years 1991 to 2004, the FDI in RE sector was opened
only in 2005.
Liberalisation of the sector saw a flurry of investor interest with global realty companies and private equity (“PE”) funds
making a beeline for projects across all asset classes.
I. FDI guidelines in RE sector B. Project related guidelines
India has seen substantial FDI in the RE sector in the last few ■ If the project entails development of serviced housing
years despite the restrictive nature of the “liberalised” regulatory plots, the minimum land area to be developed should be
guidelines. 10 hectares.
■ If the project relates to construction-development of
To be eligible for investment under the category of Press Note 2
(2005 series) projects, certain conditions need to be satisfied. residential or commercial projects, the minimum built up
Any foreign investor investing in the Indian real estate sector area should be 50,000 square metres.
has to comply with and adhere to the below-mentioned ■ If the project involves both of the above, then any one of
guidelines. the two aforesaid conditions should be complied with.
■ At least 50 percent of the project should be developed
A. Investment related
within a period of five years from the date of obtaining all
■ Direct ownership of real estate is not permitted. statutory clearances.
Investment can only be made through an Indian
■ Selling of undeveloped plots is not permitted.
company.
■ The project should adhere to all the norms and standards
■ The Indian company having foreign investment must be
engaged in construction and development of the real as prescribed by the applicable building control and other
estate project. regulations of the state governments / local body /
municipal authorities.
■ Minimum capitalisation of the project company if it is a
wholly owned subsidiary of the foreign investor should be FDI is also permitted under the automatic route in the hotel and
USD10 million. If the FDI is in joint venture with an Indian tourism sector without any restrictions. Development of
partner, the minimum capitalisation should be USD5 industrial parks and technology parks is permitted subject to
million. conditions relating to a minimum number of units and a
■ The funds must be brought into India within six months of minimum percentage of the area to be allocated for industrial
commencement of business of the company. activity. Foreign investors are also allowed to develop
The original investment is subject to a lock in period of three townships and special economic zones subject to government
years from the date when the minimum capitalisation is policy relating to the same.
achieved. Recently, it has been clarified that “original
investment” means the entire investment brought in as FDI for In order to provide impetus to the RE sector and address
the purpose of taking up Press Note 2 (2005) compliant liquidity issues/ complications, the Indian Government has also
construction development projects which will be subject to lock issued:
in period of three years. Please note that the said clarification is
yet to be notified by Department of Industrial Policy and ■ Draft regulations on Real Estate Investment Trusts
Promotion (DIPP). (“REIT”) – 2007; and
■ In special circumstances and with prior approval of the ■ Real Estate Mutual Funds Regulations (“REMF”) – 2008.
Foreign Investment Promotion Board (“FIPB”), the foreign
investor may be allowed to repatriate the capital before The REMF regulations were introduced as an amendment to
the lock-in period of three years. the existing regulations governing mutual funds in India.
101
101
India: Real estate investment: Key regulatory and tax aspects
II. Taxation of real estate in India ■ The said taxes are allowed as deduction only on payment
basis, i.e. they have to be actually paid to the respective
The Indian Income Tax Act 1961 (“the Act”), does not prescribe authorities before or at the end of the year.
any special tax rates or mechanism for taxation of the RE
■ A mere provision for tax does not suffice to achieve a
industry. However, tax holidays are available in relation to select
deduction.
asset classes (industrial parks, special economic zones, hotels,
etc.) subject to prescribed conditions. Standard deduction
Typically the real estate development cycle has the following ■ A standard deduction at the rate of 30 percent of the net
phases: rentals (after reducing the local taxes) is allowed as a
■
deduction.
Acquisition of land;
■ The standard deduction is a fixed percentage irrespective
■ Development of property – residential/ commercial/ hotel,
etc.; of actual expenses incurred. No other costs / expenses
like repairs, etc. are allowed as tax deductible.
■ Lease of developed property or disposal of developed
■ No depreciation on assets is allowed.
property.
Interest on borrowed capital
A. Tax ramifications associated with acquisition of land
■ The capital should be borrowed for the purposes of
Actual price paid for acquisition of land and all incidental
charges (stamp duty, brokerage, etc.) are allowed to be added acquiring, constructing or reconstructing the property.
to the cost of acquisition of land. No step up on cost of ■ There is no upper cap on the amount of interest that is
acquisition of land can be achieved pursuant to any revaluation allowed as a deduction.
(say increased market value). ■ Interest during the construction period is accumulated
and allowed as a deduction in five equal instalments,
B. Taxation during development phase
commencing from the year in which the construction is
The characterisation of income earned by real estate complete.
developers has been a subject matter of debate in India both at
In case of taxation under the heading “Profits & Gains from
the stages of development and the point of lease/ disposal.
Business or Profession”, the income earned from lease of
The tax controversy at the development stage is basically
property is taxed at 33.99 percent on a net-income basis. All
around revenue recognition during the construction phase.
bona fide expenses (municipal taxes, collection charges,
Development of most real estate projects spans multiple
commissions, etc.) incurred to earn the lease income are
accounting / tax periods. Therefore, a developer has the ability
allowed as a deduction. Depreciation can be claimed based on
to allocate both the costs and thus corresponding revenues of
the provisions of the Act.
a project over accounting/ tax periods. Since at any point most
of the developers could have a series of ongoing projects,
D. Taxation of disposal income
exact determination of profit or loss becomes complicated. This
problem gets further accentuated because of differences Taxation of surplus generated on sale of real estate is also a
between accounting and tax rules for profit recognition. subject matter of considerable debate. Under the Act, the
person earning income from disposal of real estate may be
C. Taxation of leasing income taxable either as business profits (taxable under the head
The classic basis of taxation of leasing income from real estate “Profits & Gains from Business or Profession”) or under the
in India is under the head “Income from House Property”. head “Capital Gains”. Similar to taxation of leasing income,
However, real estate developers usually adopt a position that there is no accurate test to determine the exact
income earned from leasing of real estate should qualify as characterisation of disposal income from a tax perspective and
normal business profit which is taxable under the heading reliance needs to be placed on all facts and circumstances.
“Profits & Gains from Business or Profession”. The
characterisation of income in this case depends on whether the Taxability as business profits is based on the premise that the
income is earned pursuant to a normal letting activity or as part main business is to develop and sell properties. This would
of a larger exploitation scheme of letting and provision of imply that the properties would be treated as “stock in trade”
services/ facilities, etc. There is no accurate test to determine for accounting (balance sheet) purposes. In such a case, the
the exact characterisation of leasing income from a tax income would be taxable at 33.99 percent on a net-income
perspective and reliance will need to be placed on all facts and basis. All bona fide expenses incurred to earn the income
circumstances. would be allowed as a deduction.
In case of taxation under the heading “Income from House For supporting the characterisation of disposal income as
Property”, the net income earned from lease of property is capital gains, it would need to be demonstrated that the
taxed at 33.99 percent on a net-income basis. However, a properties are held as “capital assets” by the seller. The fact
separate computational mechanism is laid down under the Act that the asset is held as a “capital asset” and not as “stock in
for determining taxable profits, which specifies only the trade” would need to be practically demonstrated by collateral
following deductions against lease rentals: corporate records which may inter alia include Board minutes,
internal correspondences, accounting treatment and
Local taxes
disclosures. Ideally, recording the property as “capital asset”
■ Any local taxes levied by any local municipal authority in during construction phase and prior to disposal would assist in
respect of the property. strengthening this claim.
102
102
India: Real estate investment: Key regulatory and tax aspects
If the surplus is taxable as capital gains then the tax liability III. Conclusion
would depend upon the length of time for which the “capital
asset” was held.
It is evident from the above analysis that the regulatory regime
■ Disposal of short-term capital asset (if the capital asset is and taxation of real estate in India is complicated. Therefore,
held of a period less than 36 months) is taxable at the there is a need for advance planning and structuring at the
rate of 33.99 percent. point of acquisition of properties. Usually, taxation can only be
■ Disposal of long-term capital asset (if the capital asset is optimised through appropriate holding company structures
held of a period more than 36 months) is taxable at the from tax friendly jurisdictions. In such cases the disposals are
rate of 22.66 percent. In case of long-term capital asset, structured through sale of shares of special purpose vehicle
a step-up in the cost of acquisition is available based on holding properties in India.
inflation index.
Further, Finance Bill 2009 has amended the provisions relating Amarjeet Singh is a Tax Partner with KPMG’s Indian firm,
to deemed valuation to include transactions (transfer of capital currently seconded to KPMG LLP in London. For further
information, please contact the author by email at:
assets, being land or building or both) which are not registered
with stamp authorities and are executed through agreement to
sell or power of attorney. © KPMG LLP 2009
103
103
104
2
Growing Markets in E. and S. Asia
Growing Markets in
38 Threadneedle Street
London
EC2R 8AY East and South Asia
Tel +44 (0)20 7847 5801
www.bnai.com
August 2009
ISBN: 978-0906524-98-5
BNA International
9 780906 524985 Tax Planning International Special Report
A3TemplateCover_Final_1.indd 1 10/10/06 19:38:01

Growing Mkts of East South Asia

Diunggah oleh

Informasi Dokumen

Deskripsi Asli:

Hak Cipta

Format Tersedia

Bagikan dokumen Ini

Bagikan atau Tanam Dokumen

Opsi Berbagi

Apakah menurut Anda dokumen ini bermanfaat?

Apakah konten ini tidak pantas?

Hak Cipta:

Format Tersedia

Growing Mkts of East South Asia

Diunggah oleh

Hak Cipta:

Format Tersedia

Growing Markets

Tax Planning International: Special Report

Tax-TPD.indd 1 8/5/06 23:38:24

Growing Markets in East and South Asia

Outline of the corporate tax regime . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51

The tax and legal framework. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67

The tax and legal framework. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77

The tax and legal system . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91

The tax and legal framework

C. Tax rates F. Anti-avoidance

withholding tax of up to the maximum rate prescribed by a Table

subjected to Indonesian tax. Pakistan Yes – 15% 3 months No

Foreign exchange differences on borrowings, whether realised III. Conclusion

operating licenses in Indonesia. China Yesb 10 10

In principle, a “back to back” arrangement could be entered UAE Yes 10 5

into with an international bank whereby an IDR loan to the UK Yes 10 10

Indonesian subsidiary is granted by an Indonesian branch of USA Yes 10 10

IV. Structuring the investment VI. Conclusion

The tax and legal framework

I. Applicable company law Foreign companies in certain industries such as banking,

D. Withholding taxes H. Transfer pricing

Under the new Corporate Income Tax Law (“CITL”) enacted

A foreign direct investment into any country requires planning on:

Austria No 7% Exemption Exemption

The tax and legal framework

■ Any identifiable portion of the main contract V. Conclusion

I. Holding company strategies II. Financing strategies

maximum interest withholding tax rate that is equal to or III. Conclusion

I. The legal framework be given for up to 30 percent foreign ownership. This

The tax and legal framework

A Chusik Hoesa, established with KRW50 million of minimum

B. Tax reform and development activities (“R&D”) is increased to 10 percent

I. Establishment of PE C. Deemed PE (dependent agent)

I. Holding strategy However, when the holding company is in a location included

I. Acquisition stage When a foreign investor establishes the company, 0.48

Outline of the corporate tax regime

On the other hand, a Representative Office is not required to

2. Investment Tax Allowance (“ITA”) VI. Exchange control measures

A non-resident could render services to Malaysia in a number B. Malaysian withholding tax

Control regime allows, amongst others, a Malaysian IV. Conclusion

The tax and legal framework

Representative office of a foreign corporation organised and A. Fundamental principles

■ Dividends received by a domestic company or by a of production, in case of Filipino-owned enterprises, or 70

I. Territorial scope ■ The foreign enterprise furnishes services in the

I. The legal framework A resident Philippine real estate company, or registered

The tax and legal framework

I. Applicable company law Foreign companies in certain industries including banking,

Protection) Act 1976 provides guarantees for repatriation of B. Repatriable basis

A. Non-repatriable basis 1. Normal tax regime

from July 1, 2008, first year allowances at 90 percent, in lieu of Dividend 10

machinery and equipment installed and used by any industrial Royalty 15

undertaking set up in specified rural and underdeveloped Supply of goods by a PE 3.5

areas. Services rendered by PE 6

I. Introduction c. A contract for advertisement services rendered by tv

Austria 10 10 No Yes - 6 months

Bosnia-Herzegovina 15 –b No Yes - 6 months

Finland 10 10 Yes - 6 months Yes - 6 months

Iran 10 –b No Yes - 12 months

Kazakhstan 15 –b Yes - 6 months Yes - 6 months

Malaysia 15 –b No Yes - 6 months

Norway 12 12 No Yes - 6 months

Qatar 10 10 No Yes - 6 months

South Africa 10 10 Yes - 6 months Yes - 6 months