Newsletter
MOF Promulgates the Drafts of CFC Application Rules and PEM Application Rules
On 12 July 2016, the Legislative Yuan completed the three readings of Article 43-3, the Controlled Foreign Corporation ("CFC") rule, and Article 43-4, the Place of Effective Management ("PEM") rule, under the Income Tax Act ("ITA"), and the President promulgated the CFC rule and the PEM rule on 27 July 2016.
In order to give profit-seeking enterprises ("PSEs") time to make the necessary adjustments after the promulgation of the CFC rule and the PEM rule, the Executive Yuan was authorized to determine the effective date of these two rules. According to the Executive Yuan, the CFC rule and the PEM rule would unlikely be enacted before 2018.
The draft Controlled Foreign Corporation Application Rules ("CFC Application Rules") and the draft Place of Effective Management Application Rules ("PEM Application Rules") prepared by the Ministry of Finance (MOF) were published in the Executive Yuan Gazette dated on 14 November 2016 for the general public’s review and comments in 30 days. Part of the provisions in the two drafts are the same as the CFC rule and the PEM rule stipulated in the ITA. We summarize the major contents of the two drafts which are made in furtherance to the ITA provisions as below:
I. Major Contents of the Draft of CFC Application Rules
(I) Regarding the "more than 50% owned (directly or indirectly) or controlled" requirement
1. The draft of CFC Application Rules provides that, if a PSE, through its affiliate, owns an offshore enterprise in low-tax jurisdictions, and the PSE owns more than 50% of the affiliate, then the percentages of the offshore enterprise owned by the PSE's affiliate shall be added onto the percentages of the offshore enterprise owned by the PSE. If the PSE owns less than 50% of its affiliate, then the percentages of the offshore enterprise owned by the PSE's affiliate shall be multiplied by the percentages of the PSE's affiliate owned by the PSE, and then added onto the percentages of the offshore enterprise owned by the PSE.
2. If the PSE, through multiple layers of its affiliates, owns an offshore enterprise in low-tax jurisdictions, and the PSE owns more than 50% of its affiliates in each layer, then the percentages of the offshore enterprise owned by the PSE should be calculated by the same methodology stipulated in 1. above. Where there is double counting of the percentages of the offshore enterprise owned by the PSE, only the higher percentage should be counted.
(II) Regarding the "significant influence" requirement
The draft of CFC Application Rules provides that, a PSE has a significant influence over the offshore enterprise if the PSE, together with its related parties, controls the offshore enterprise, or has a significant influence over the offshore enterprise’s decision making in its personnel, finance, business operation, and management policy.
(III) Regarding the two exemptions of "substantial operating activities" and "earning standard"
According to Article 43-3 of the ITA, if the offshore enterprise has "substantial operating activities" in the country or jurisdiction where it is located or the offshore enterprise's annual surplus earnings are below a certain standard, the CFC rule does not apply to the offshore enterprise. The draft of CFC Application Rules provides that, an offshore enterprise has substantial operating activities in the country or jurisdiction where it is located if the following two conditions are met:
1. The offshore enterprise has a fixed place of business and it hires employees to conduct business in the place where it is registered.
2. The aggregate amount of the passive income, such as dividends, interests, royalties, rents, and income from disposal of assets, is less than 10% of the sum of the offshore enterprise’s net business income and its gross non-business income, which sum does not include the income from the offshore enterprise’s branches in third countries. Furthermore, the interests earned by the offshore enterprise whose principal business is banking or insurance in the course of its principal business, and the royalties earned from the licensing of intangible assets which are developed by the offshore enterprise in the place where it is registered and the income from the disposal of such intangible assets, should not be included in the calculation.
Furthermore, the draft of CFC Application Rules also provides that, the "annual surplus earnings are below a certain standard" means that all the earning of all the offshore affiliates of a PSE collectively amount to no more than NT$7,00,000.
(IV) Proportionally Including in the PSE’s investment income
When an offshore enterprise is deemed to be a CFC controlled by a PSE, the annual earnings of the offshore enterprise, after deduction of items that are restricted form being distributed and losses, shall be multiplied by the percentages of the offshore enterprise owned by the PSE and by the percentage of the PSE’s holding period in a year. The PSE shall recognize the amount as its investment income and include such investment income in its annual income tax return.
II. Major Contents of the Draft of PEM Application Rules
(I) Regarding the "decision maker or the decision-making place is within the territories of the ROC" requirement
Article 43-4 of the ITA stipulates that, the first requirement for the PEM rule to apply is that the decision maker who makes significant decisions in the business management, financial management, and personnel management (collectively the "Significant Management Decisions") of an overseas PSE is an individual resident of the Republic of China ("ROC") (a "ROC Resident Individual") or is a PSE having its head office located within the territories of the ROC, or the place where the Significant Management Decisions are made is located within the territories of the ROC.
The draft of the PEM Application Rules further explains that, the decision maker of the Significant Management Decisions of an overseas PSE is a ROC Resident Individual or is a PSE having its head office within the territories of the ROC if one of the following conditions is met:
1. Half or more than half of the directors or the shareholders operating the business of the overseas PSE who make Significant Management Decisions are ROC Resident Individuals or are individuals delegated or commanded by a ROC Resident Individual or by a PSE having its head office within the territories of the ROC.
2. The Chairman or the General Manager or the person at a higher managerial level who makes Significant Management Decisions is a ROC Resident Individual or is a PSE having its head office located within the territories of the ROC.
3. There are other situations showing that the decision maker of the Significant Management Decisions is a ROC Resident Individual or is a PSE having its head office located within the territories of the ROC.
4. Please note that, a PSE having its head office within the territories of the ROC includes an overseas PSE which, after the application of the PEM rule, is deemed to have its head office located within the territories of the ROC.
In addition, the draft of the PEM Application Rules also explains that, in recognizing whether the place of the making of Significant Management Decisions is located within the territories of the ROC, the MOF should consider the following facts:
1. The place where the meeting of the Board of Directors or of the organization with similar functions is held;
2. The place where the Chairman or the General Manager or the person at a higher managerial level usually carries out his or her duties;
3. The place where the actual headquarters of the PSE are located;
4. The place where the management which is economically and functionally significant is executed; and
5. Other situations indicating the place where the decision makers of the Significant Management Decisions usually carry out their duties.
(II) Regarding the "major business activities carried out in the ROC" requirement
Article 43-4 of the ITA stipulates that, the second requirement for the PEM rule to apply is that the financial statements, records of accounting books, minutes of meetings of the Board of Directors or minutes of meetings of the shareholders are prepared or stored within the territories of the ROC. The draft of the PEM Application Rules simply reiterates the second requirement. However, regarding the third requirement for the PEM rule to apply, which is the PSE has "major business activities carried out within the territories of the ROC," the draft of the PEM Application Rules further explain as follows:
1. A PSE has major business activities carried out within the territories of the ROC if: (1) the PSE does not conduct major business activities in the place where it is registered; and (2) the execution of the PSE's major business activities is carried out within the territories of the ROC.
2. In recognizing an overseas PSE's major business activities, the major business activities carries out by the affiliates of the overseas PSE or by the businesses invested by the overseas PSE should not be taken into consideration.