By Al Chang and Arthur Chen
On 20 February 2008, Taiwan’s Ministry of Finance (MOF) issued Ruling 9704510660 addressing the tax treatment of individual shareholders in the absorbed company in a cash merger. The ruling was issued in response to the controversial tax treatment under MOF Ruling 9304538300 issued in 2004.
2004 Ruling
Under article 4-1 of the Taiwan Income Tax Act, capital gains realized from a qualified security transaction are exempt from income tax. The article thus provides an incentive for taxpayers to arrange cash merger transactions so that the shareholders of a profitable company can extract cash from a company while avoiding the income tax liability that would have arisen on a dividend distribution had the merger not taken place.
The 2004 ruling was introduced to combat such schemes. Under this ruling, if the consideration received by the shareholders of the absorbed company in a merger transaction exceeds the total contributed capital, including share capital and additional paid-in capital, held by all of the shareholders of the absorbed company (irrespective of whether the shareholders are individuals or corporations, and whether resident or nonresident), and that excess is paid in cash, the excess portion distributed to the shareholders is considered a dividend and is subject to income tax under the relevant rules. In essence, the 2004 ruling treats the portion of a cash merger payment that exceeds the contributed capital of an absorbed company as a dividend distributed by the absorbed company.
Although the 2004 ruling may have achieved its intended purpose, it has been beset by a number of problems. The most controversial issue is that the “dividend” provided for by the ruling is calculated by subtracting from the consideration paid in a cash merger transaction the recorded capital per the accounting books of the absorbed company. In other words, the ruling disregards the possibility of share transfers, with the result that the share capital and additional paid-in capital recorded in the accounting books of the absorbed company might not necessarily represent the true acquisition costs for the new shareholders in the absorbed company, particularly when such company was profitable and had undistributed earnings.
2008 Ruling
In light of the above issues, the new ruling provides individual resident and nonresident shareholders of the absorbed company in a cash merger an opportunity to substantiate their true acquisition costs by providing supporting documents, and to calculate the dividend portion accordingly. The ruling confirms that if the acquisition costs of the individual shareholders do exceed the total consideration received in a cash merger transaction, the dividend will be zero. The MOF also confirms that individual shareholders that received the dividend certificate calculated under the 2004 ruling and that can support the investment costs may apply for a refund.
Uncertainty and Opportunities
To avoid double taxation, current Taiwan income tax rules provide that dividends distributed by Taiwan companies to other Taiwan companies are exempt from income tax; such dividends are taxable only when eventually distributed to resident individual shareholders or nonresident (individual and corporate) shareholders under the imputation system. Based on the literal wording of the 2008 ruling, however, only individual shareholders are allowed to provide supporting evidence of their acquisition costs. The ruling may have overlooked the fact that certain overseas corporate shareholders may have been subject to tax treatment under the 2004 ruling. It is unclear whether the MOF will provide further clarification. Resident individual shareholders that have paid income tax on dividends calculated under the 2004 ruling, however, should reassess their position and determine whether the year of assessment concerned is still within the statute of limitations. It should be noted, however, that unless an individual shareholder can provide supporting documentation to demonstrate his/her actual costs, the dividend still must be calculated based on the 2004 ruling.
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