Taiwan has since 1 January 2023 implemented controlled foreign corporation (CFC) rules to prevent tax avoidance by taxing income earned by foreign entities controlled by Taiwanese residents.
What is a CFC?
A CFC is defined as a foreign entity registered in a jurisdiction of low tax rate, with more than 50% of paid-up shares directly or indirectly held by a Taiwan tax resident person or corporate (individually and/or together with related parties). Alternatively, even if the above is not satisfied but the foreign entity in question is effectively controlled directly or indirectly by a Taiwan tax resident person or corporate (individually and/or together with related parties), the foreign entity can also be deemed as a CFC.
The definition of a CFC seems to be quite broad, and so is the definition of "related parties"1 (set out below).
Under the CFC rules, low tax rate jurisdiction refers to a jurisdiction where:
- corporate income tax is no more than 14%; or
- income taxes are imposed on a territorial basis (i.e. foreign-sourced income are not subject to income tax).
Difficulty of implementing CFC rules in the context of a discretionary trust
With introduction of the CFC regime in 2023, Taiwan will see its first CFC reporting this May, the month of income tax filing. However, the rules and CFC reporting requirement are raising concerns with respect to discretionary trusts.
It has never been a problem in the past when Taiwan taxpayers are only subject to tax on receiving distributions from offshore trust. The CFC rules if applicable will now mean taxpayers will have to pay tax before they receive the actual distributions, and it is unclear how any taxable income should be reported and tax paid. In the case of discretionary trusts, the beneficiaries will often not know how much they will receive from the trust, or even whether any interest has vested or materialized, but the tax office has insisted that someone needs to account for the income tax related to the CFC income in each financial year. This could lead to mismatch of CFC income between what is reported and taxed now, and what would be actually distributed subsequently.
The Taiwan Ministry of Finance (MOF) issued a tax ruling (the Ruling) on 4 January, 2024 to provide guidance on CFC reporting. There are two issues that we believe deserve special attention.
- In the case of discretionary trust, the Ruling stipulated that CFC income should be allocated on average basis based on number of beneficiaries with the issue of the potential differences between CFC income reported now and actual distributions received in the future is not addressed. It is also of concern that the Ruling proposes equal allocation regardless whether all beneficiaries have actual interest or that the level or percentage of interest could vary greatly or not decided. It also appears to be irrelevant whether any such beneficiary has effective control directly or indirectly over the CFC.
- The Ruling places reporting obligations on the trustees by reference to Article 92-1 of the Taiwan Income Tax Act. Again, this could be problematic in practice. The said article covers domestic trustees and domestic withholding with specific forms to follow. Consequence for non-compliance with this reporting requirement is unknown too.
Effect of CFC rules on international wealth planning
With Taiwanese diaspora and strong entrepreneurship, internationally there are many Taiwanese-owned businesses. At the same time, as with most private wealth or ultra-high net worth (UHNW) families, there are necessarily a certain level of international wealth planning for family legacy and succession, family governance and structures, especially for multi-generational and often multi-jurisdictional families. In recent years, there have also been many family offices set up by UHNW families with Taiwan nexus.
Within such corporate or private wealth holding structures, there would commonly be companies incorporated in offshore jurisdictions, whereas under the CFC rules, popular jurisdictions such as Singapore and Hong Kong are considered as low tax jurisdictions under the Taiwan CFC rules. Although the corporate income tax rate is above 14% in both jurisdictions, under the territorial income tax regime, foreign-sourced income are generally not subjected to income tax. However, there have been changes to the respective foreign sourced income exemption schemes in Hong Kong and Singapore, such that foreign-sourced capital gains are subjected to taxes. Could this potentially affect the assessment of whether Hong Kong and Singapore continue to fall within the definition of low tax jurisdictions under the Taiwan CFC rules? Also, we note that to date, Pillar 2 global minimum tax framework has not been taken into account in CFC rulings.
As private wealth centres and family offices hub in the region, this is of concern where UNHW increasingly having family offices, asset holding or fund companies set up in Singapore or Hong Kong. This is specifically envisaged under the Singapore tax incentives for family offices, section 13O or 13U of the Income Tax Act, where the fund management company has to be resident in Singapore and fund management activities are required to be carried out in Singapore. Further, it is common for legitimate asset protection or succession planning over generations that UHNW establish trust structures providing transfer of wealth, inheritance or distributions to next generation beneficiaries over time, often subject to trustee discretion on vesting and/or distributions. Under Hong Kong's framework for family offices tax concession, the tax regulations refer to private wealth structures involving direct or indirect beneficial interest of family members held through different levels of investment holding companies, and which may be under family trust arrangements. "Family Investment Holding Vehicle" may be "a body of persons (corporate or unincorporate) or a legal arrangement and includes a corporation, partnership and trust (including a discretionary trust)".
The Taiwan CFC rules and the Ruling would be problematic if Singapore or Hong Kong were to be considered as "low tax jurisdiction" and there are Taiwanese with direct or indirect interest in Singapore or Hong Kong entities as to be potentially caught. Even if this may not be the intention of the CFC rules, as the Ruling imposes reporting obligations on domestic trustees as noted above, foreign trustees in Singapore and Hong Kong are concerned with the uncertainty, in particular whether Taiwan regulators may enforce the CFC rules against any foreign trustees who are holding such assets with underlying Taiwanese beneficiaries. This also leads to the issue we discussed above on the difficulty of implementation of CFC rules on discretionary trusts.
With these concerns, although it is unclear how the CFC rules and the Ruling would actually apply in practice, we suggest foreign trustees and wealth planners of Taiwanese families take special care to review and consider the following:
- whether any company in the wealth holding structure is or may be considered as being in a "low tax jurisdiction" (including any entities in other jurisdictions besides Singapore or Hong Kong discussed above);
- whether any such company is or may risk being considered as "effectively controlled directly or indirectly by a Taiwan tax resident person or corporate (individually and/or together with related parties)";
- whether the Ruling may apply to require allocation of income of any such entity to beneficiaries with interest (actual or potential) in such entity, and do these include any Taiwanese beneficiaries (or are beneficiaries unknown or unidentified).
Further advice should be obtained on any tax reporting obligations under Taiwan law if the answers above are "yes", or if assistance is required to assess any of the questions.
Conclusion
As illustrated above, there remains several areas of uncertainty. We expect the Taiwan MOF to publish further rulings or clarifications, especially after this first reporting season in May 2024.
Footnote
1. https://law.moj.gov.tw/ENG/LawClass/LawAll.aspx?pcode=G0340146 ↩
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
