32nd annual asia pacific tax conference

32nd Annual Asia Pacific Tax

Conference

10 – 11 November 2016

JW Marriott Hotel Hong Kong

Alternative A: Source country

taxation, evolving PE rules and

unilateral measures

Chair: Gary Sprague, Palo Alto

John Walker, Australia

Sanjiv Malhotra, India

Yi Lyn Tan, Malaysia

James Choo, Singapore

Sai Ree Yun, Yulchon LLC, South Korea

Jane Tang, China

Ponti Partogi, Indonesia

© 2016 Baker & McKenzie

Mechanisms for Enhancing Source Based

Taxation

‒ Treaty PE threshold

Dependent person “the principal role” standard

Service PE

Limits on preparatory or auxiliary exceptions

Profit attribution framework

‒ Withholding taxes

Rents and royalties

Technical or other services

Software

UN paper

3



Taxation

‒ Transfer pricing

Accurate delineation of the contract

Risk assumption, management and control

Marketing intangibles

Transactional profit split method

Use (and misuse) of Value Chain Analysis

Other theories

Market premium

Location specific advantages

4



Taxation

‒ Deemed PE

MAAL

DPT

DPT2

Attribution of royalty to PE

‒ Capital gains

Indirect stock transfer rules

5



Taxation

‒ Market access conditions

Indonesia OTT Regulation requiring PE

Italy virtual PE proposal

‒ Anti-haven measures

Higher WHT rates for transactions with noncooperative tax

jurisdictions

Disallowance of royalty deduction for payments to havens

‒ Task Force on the Digital Economy

Phase one – VAT

Phase two - ?

6



Taxation

‒ Business model targeted withholding tax

India equalization levy

‒ Treaty disregard

LOB / “a principal purpose” condition

Anti-abuse justification

Definitional justification

‒ Deduction disallowance

Intercompany service fees

7


Policy Justifications

‒ Existence of market creates value

‒ “Fair share” of tax

‒ “Level playing field” for domestic sellers

‒ Nonreciprocal trade flows

‒ Prevent corporate tax base erosion

‒ Exchange of user data creates value

‒ Stamp out nowhere taxed income structures

8


India


India

‒ Has been a strong advocate of “source-based” taxation

‒ Transfer Pricing

IRA advocates use of locational savings / locational specific

advantages

IRA has been making large adjustments on account of

marketing intangibles

‒ Royalties / fee for technical services

Disputes on definition of royalty and fee for technical services

Matters pending at the Federal court

Amendments made to the domestic law to increase the scope

of royalty

10


India

‒ Permanent Establishment

Indian DTAAs have the concept of Service PEs

Secondment of personnel may create PE in India

‒ Unilateral measures – Equalization Levy

IRA views such a levy to be consistent with BEPS Action 1

Value created by getting access to data of the Indian market

not getting taxed

‒ India working closely at UN on software related taxation

‒ India reserves the right to impose higher withholding taxes

for transactions with “notified jurisdictions”

‒ Rules on indirect transfer tax enacted retrospectively

11


China


Treaty PE Taxation

‒ Stepped up enforcement of service PE provision

Income tax and turnover tax on PE

Revenue and profit determined based on deemed profit rate and

split of onshore / offshore services

Reject actual attributable profit arguments on basis of no

accurate and proper books and records

Individual income tax on employees

Remuneration deemed to be borne by PE, loses treaty

exemption

‒ General anti-avoidance rule and procedural guidance can

achieve anti-fragmentation of complementary functions

forming part of a cohesive business


Withholding Tax

‒ Technical service fees vs. royalties

‒ Rent vs. royalties

‒ Deemed…

Dividend for long term interest-free loan

Interest for guarantee fees

Royalty for use of IP

Rental for provision of free equipment?

‒ Can impose withholding tax with late payment surcharges

and not allow corresponding deduction

14


Withholding Tax (cont’d)

‒ Domestic interpretation of “beneficial ownership”

requirement for dividends, interest and royalties

Economic substance and not a conduit

‒ “Beneficial ownership” requirement effectively extended to

capital gains exemption

‒ Domestic interpretation of conditions for capital gains

exemption

Direct and indirect shareholding covers the entire group

No expressed look back period for 25% shareholding means

unlimited look back period

‒ Affects ability to rely on treaty safe harbor for indirect

transfers 15


Indirect Transfers

‒ Indirect transfers of “Chinese taxable property”

Chinese company, Chinese real estate, Chinese taxable

establishment

‒ Specific anti-avoidance rules, taxability depends on

“reasonable commercial purpose”

‒ Blacklist

Target company with insufficient economic substance deriving

vast majority of value, assets and revenue directly or

indirectly from China

‒ Safe harbor

Public trading, treaty exemption, intragroup restructuring

‒ Voluntary reporting of indirect transfers 16


Deduction Disallowance / Anti-haven Measures

‒ Non-deductible outbound payments to affiliates

All payments to affiliate with no economic substance

Service fees that give China no economic benefit

Royalties to affiliate with no economic ownership of

intangibles

Royalties to listed affiliate for incidental benefits from listing

activities

‒ Transfer pricing rule or deduction rule?

‒ Impacts group IP structures, group expense recharging

structures, headquarters management fees charge-out

17


Transfer Pricing

‒ Marketing intangibles from brand-building activities

‒ Location specific advantages

Location savings - Existence of talents and infrastructure that

lowers cost

Market premium - Existence of market that gives

disproportionately high return

Intrinsic value of in-country functions?

‒ Emphasize value chain analysis

18


Policy Justifications

‒ Protecting China’s taxation rights

‒ Combating international tax evasion and avoidance

‒ Preventing corporate base erosion

‒ Aligning tax with economic activities

19


Malaysia


Amendments to “Royalty” Definition

‒ Finance Bill 2016 (“Bill”): proposed amendment to the

“royalty” definition to include consideration for the use of, or

the right to use software and other like property or rights

‒ Issues:

Conflict with the Guidelines on Taxation of E-Commerce,

which states that payments for purchase of a product are not

royalties

Current application of the rights-based approach by the

Malaysian courts

Scope of “software” – does it include SaaS products?

21


Deemed Derivation Rules for Services

‒ Special classes of income (in section 4A), including service

fees, are subject to withholding tax if derived from Malaysia

‒ Current position under Section 15A : S4A Income shall be

deemed derived from Malaysia if -

responsibility for the payment lies with the government, state

government, local authority or a person who is resident in

Malaysia; or

the payment is charged as an outgoing or expense in the

accounts of a business carried on in Malaysia,

provided that this section shall apply to the amount

attributable to services which are performed in Malaysia.

22


Deemed Derivation Rules for Services (cont’d)

‒ Proposed amendment to remove the proviso which limits

the deemed derivation provisions to only services which are

performed in Malaysia

‒ Issues:

Service fees paid by Malaysian resident to a non-resident

deemed to be derived from Malaysia even if services are

performed outside Malaysia?

Can the non-resident rely on the business profits article in

double tax agreement?

23


Proposal on New Tax for Online Businesses

‒ Various announcements by the Ministry of Finance (“MOF”)

on the intention to tax “online businesses”

‒ Special digital economy committee has been set up within

the IRB to evaluate the current income tax regime and put

forward recommendations

‒ No indication thus far on changes to the GST regime to

implement the BEPS Action 1 recommendations

24


Singapore


General Remarks

‒ Singapore is in a unique position because it has to “balance

both sides”

‒ Policy interests in protecting Singapore’s tax base:

Ensuring “fair share” of taxation

BEPS Associate

Maintaining an open economy and encouraging cross border

investment

‒ Typical regional principal in an APAC supply / value chain

Not as aggressive on source-based taxation compared to

jurisdictions with large markets

26



Taxation


Rent: 15%

Royalties / license fee: 10%

payments for the right to use moveable property

payments for the use of or the right to use scientific,

technical, industrial or commercial knowledge or

information

Service fee: 17%

applies generally only to services provided in Singapore

(subject to other conditions)

27



Taxation


Software – rights based approach adopted

characterisation of payments depend on whether payer

acquired a “copyrighted article” or “copyright right”

copyright right: payer is allowed to commercially exploit

the copyright

copyrighted article: rights acquired are limited to those

necessary to enable the payer to operate the software

28



Taxation

‒ Treaty PE threshold

Some existing treaties have Service PE thresholds

Practical issues in interpreting this threshold creates uncertainty

Method in counting time in Singapore

Subcontracting of work to a local party counted?

Singapore has not committed to implementing BEPS Action 7 which

introduced the concept of “the principal role” standard etc

Singapore is currently part of a working group that is developing a

multilateral instrument for incorporating BEPS measures into existing

bilateral treaties to counter treaty abuse. The changes to the definition

of permanent establishment will likely be among the changes proposed

for inclusion in the multilateral instrument. It is unclear whether

Singapore will be a signatory to the multilateral instrument.

29



Taxation

‒ Treaty abuse

Domestic general anti-avoidance rule available

Anti-abuse provision in some treaties – E.g., PPT in new

France treaty

Limitation of relief / benefit clause in double tax treaties which

requires that the Singapore resident taxpayer receives the

payment in Singapore in order to enjoy treaty benefits

Singapore has committed to implementing BEPS Action 6 and

confirmed that it does not condone treaty shopping

30



Taxation

‒ Transfer pricing

Singapore follows current OECD’s guidelines for transfer pricing

Historically not aggressive but evidence points to a changing trend

Many companies now under TP audits, including those that

have significant substance and have tax incentives

Audits both on incomings and outgoings to ensure integrity of

tax base

Uncertain whether Singapore will adopt measures to implement the

recommendations made by the OECD in BEPS Actions 8, 9 and 10

– This is not a minimum standard that Singapore signed up for.

31


Policy Considerations

‒ IRAS is aware that BEPS is being used by some jurisdictions to

strengthen source-based taxation in source states

‒ As a principal location, likely that Singapore will face challenges from

market jurisdictions

‒ Actions taken by Singapore

improve its treaty network

ramp up transfer pricing capabilities

strengthen competent authority’s capabilities

‒ Objectives for Singapore

committed to implementing minimum standards as a BEPS associate and is

on board in stamping out “nowhere taxed income”

also supports tax planning by MNCs in a fair and appropriate manner – the

“fair share of tax” argument

Protect Singapore’s tax base from overly aggressive foreign tax authorities

while ensuring that businesses do not suffer double taxation costs

32


Indonesia


Mechanisms for enhancing source based

taxation

Indonesia ‒ There is still no (legal/tax) specific regulation for digital economy groups

‒ Draft OTT Regulation requiring the registration of PE

‒ The Income Tax Law describes that a PE contains the concept of the

existence of place of business, namely facilities that may be in the form

of computer or automated equipment owned, leased or used by

electronic transaction operator to conduct business activities

through internet.

‒ In April 2016, the Indonesian tax authority started to audit 4 big digital

economy companies and deemed that these companies to have a PE in

Indonesia.

34


South Korea

© 2016 Baker & McKenzie 36

‒ Domestic PE rules

Already reflects most BEPS recommendations in Action 7

(e.g., “principal role” standard)

‒ Recent trend: Aggressive taxation based on finding of PE

by the Supreme Court (Holiday Case in July 2016)


‒ Withholding tax (I)

Proposed bill (2016): to strengthen taxation of multilateral IT

companies under domestic corporate income tax law

Expands the scope of Korean source royalties by including

royalties arising from “overseas computer program rights” in

Korean source income

Should not affect treaty jurisdictions: Under Korean law, treaty

law supersedes domestic law

Caveat: if the bill is passed, Korea may seek to amend

treaties in order to give effect to the revised domestic rules


‒ Withholding tax (II)

Supreme Court decisions (2014 – 2016) on royalties arising

from patents

Common facts

Korean company paid royalties to U.S. company for use of U.S.

company’s U.S. patents in Korea (no registration in Korea)

Korean company withheld 16.5% under Korea-U.S. Tax Treaty

Holding: Royalties are not Korean source income

Domestic law: patents registered abroad and used for

manufacture/sale in Korea are considered to have been used in

Korea without regard to whether they are registered in Korea

Korea-U.S. Tax Treaty: Korean source income “only if paid for

the use of, or the right to use, such property in Korea”

Rationale: Patents not registered in Korea are not patents for

Korean tax purposes → no royalty at all?


‒ Legislative action relating to Digital Economy

Amendment of Korean VAT Law (in effect since July 2015)

The amendments benchmarked BEPS Action 1

Non-residents/foreign companies engaged in e-commerce with

customers in Korea: required to effect simplified online VAT

registration system

E-commerce is defined to include services such as providing

games, sounds, video files, software, etc.

VAT registration must be made even if no PE in Korea


‒ Disallowance of deduction for intercompany service fees

Conditions for deductibility under domestic law

Execution of an agreement in advance

Actual provision of services

Expectation of additional revenues or cost savings

Service fees must be arm’s length prices

Extremely detailed and objective evidence required by Korean

tax authorities to meet the above conditions

Virtually no taxpayer has successfully met the conditions at the

audit and pre-trial appeal levels

Korean courts may require relatively lower standards

A court has recently accepted the evidence proffered by the

taxpayer at least in one case (Busan Regional Court Decision

2013Guhap21114 dated July 11, 2014)

Alternative A: Source country

taxation, evolving PE rules and

unilateral measures

Chair: Gary Sprague, Palo Alto

John Walker, Australia

Sanjiv Malhotra, India

Yi Lyn Tan, Malaysia

James Choo, Singapore

Sai Ree Yun, Yulchon LLC, South Korea

Jane Tang, China

Ponti Partogi, Indonesia

32nd annual asia pacific tax conference

Documents