By Al Chang

Parties to a corporate acquisition may be subject to a 25% tax on certain mergers that were previously held to be tax-free, according to a ruling issued by the Taiwan Ministry of Finance (MOF) on 4 January 2008 (Ruling No. 9604558950). Accordingly, for mergers concluded on or after 1 January 2008, the ruling requires that target corporations realize gains derived from the disposition of fixed assets where the acquiring corporation utilizes the purchase method of accounting.

The ruling sets forth the manner in which recognition of the gain or loss on the disposal of fixed assets in a merger is to be reported. The ruling provides that certain documentation (a valuation report, the merger contract and the board-approved merger resolution) are to be inspected and approved by the tax authorities. An acquiring company using the purchase method of accounting with respect to a merger is to record the fixed assets acquired in the merger in its books at fair market value. Thereafter, the acquiring company may depreciate the costs associated with the fixed assets and claim a corresponding deduction. For mergers concluded on or after 1 January 2008, the dissolved company is required to realize gain or loss derived from disposal of fixed assets when filing its final income tax return in accordance with article 75 of the Taiwan Income Tax Act (ITA).

Article 65 of the ITA provides that, for merger purposes, the valuation of assets should be based on fair market value or the actual price of the transaction. Prior to the 4 January ruling, when the current value of the assets exceeded book value, the dissolved company was not required to recognize the step-up as gain arising from the merger and the tax office generally did not challenge this treatment.

As a result of the new ruling, a target company will be exposed to a 25% corporate income tax on capital gains derived from the disposal of its fixed assets in a merger, whereas previously such gains were exempt. Of course, even though this income tax is imposed on the target company, it will ultimately be the acquiring company that bears the burden of the tax liability, which may be substantial, since, in such a merger, the acquiring company takes over all the assets and liabilities of the target. It is therefore expected that the potential tax exposure resulting from the ruling will be a major issue in future merger negotiations.

Notably, the ruling uses the terms “fair market value of fixed assets” and should only apply to fixed assets; however, whether the ruling also applies to other assets such as intangible assets, long-term investment and depletable assets is still subject to further explanation by the MOF.

During unofficial discussions with the MOF, an official indicated that the ruling applies to the direct merger of two entities and not to two-step mergers, such as upstream/downstream mergers. The MOF has not yet issued guidance to clarify issues relating upstream/downstream mergers, so the issue remains open.

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