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Tax Avoidance in Thailand
Background of The Problem
In the globalization, international business transactions have increased rapidly over the years. This is because the world economy has become increasingly integrated. Trade flows have grown as a proportion of national income and there is now a global capital market. Investment has increasingly expanded at an unprecedented rate in many states. These international business activities have led to the formation of groups of companies with mutual interests.
Commonly, the goal of business enterprise is to create profit. In practice, companies will make profit by generating and continuing the growth of business expansion. It can be enhanced through transfer pricing. Transfer pricing is about shifting profits from one business to a related business by charging transfer prices which may deviate from the market price. It operates by substituting the arm’s length price, for the purposes of calculating taxable profits, which can be either higher or lower than the world market prices in place of the actual terms of transactions between associated parties in order to reduce income and gain overall profit within the group.
Currently, since Thailand is a source income country and needs capital inflow and high technologies, multinational companies have influenced the development of Thailand through their investment. The problem of transfer pricing has existed since then but it is hard to clearly identify the matter. This is because of a lack of information and the nature of trans-border business transactions of multinational companies. Information and documentation are also often kept in the parent corporations established in other countries.
In general, purchase or sale of goods always occur within the group of companies whereby the parent companies, typically developed countries, sell and ship raw and processed materials, manufactured products as well as mass-produced goods from their countries to Thailand, developing country, for manufacturing of the finished products. Prices of products charged under these transactions are likely to be lower or higher than prices charged among independent parties.
Moreover, machines have often been used in head offices or parent corporations for several years and then later on they will be sold to subsidiaries or branches in Thailand for investment with high prices. Parent companies can then draw money back from Thailand where they invested at the beginning. They receive disguised dividend without paying tax to Thai government—corporate income tax or dividend withholding tax.
After that Thai subsidiaries or Thai branches will export finished goods to their parents or other affiliated companies that situate in tax havens or countries which have a lower corporate tax rate than that in Thailand. This method is an ordinary practice in trans-border trading of multinationals for the movement of goods and tends to avoid tax in Thailand, a host country. This technique also creates inequitable treatment for tax sharing between developing and developed states.
The Thai Revenue Department has no specific rule for controlling the manipulations employed by these multinationals. Tax authorities must use their own discretions and judgments which may create uncertainty, a lack of consistency, and unfairness for all taxpayers. This loophole would damage the country in the long term.
Increased cross border intercompany transactions
Manipulation of transfer prices in order to reduce the tax liability
Tax authorities should regulate transfer prices
Thailand lose a huge amount of tax revenue
Aim of the Dissertation
The objective of this dissertation is to seek the clarification to the problem of transactions concerning transfer pricing issue and to find a proper solution to be adopted in Thai tax system by observing approaches used in many jurisdictions. This paper will mainly study and analyse the relevant provisions in relation to transfer pricing under Thai law. Then, the rules dealing against transfer pricing of the model tax conventions and other selected jurisdictions will be discussed in order to find out which approaches should be adopted in Thai tax regime to prevent and solve the manipulative transfer pricing in Thailand.
Under the Thai tax law, there is no specific rule to counter the manipulative transfer pricing; therefore, Thailand should introduce specific provisions and other supported mechanisms regarding transfer pricing into Thai legal system.
This dissertation was consummated by means of a documentary research by studying and gathering information, analysing legal provisions, legal orthodoxy, textbooks, cases, and journals including Thai and English journals. The process additionally includes discussion among people and academic in the regarded field.
Scope of the study
To establish conceptual framework on transfer pricing, this dissertation will focus only on the transfer pricing transaction on a purchase and sale of goods of the cross-border transaction of multinational enterprises. The price transferred between local corporations in Thailand will not be in the scope of the study. Besides, it will focus only on a sale of tangible properties. The transfer or sale of immovable intangible properties such as intellectual properties and transfer of technology will not be discussed in this dissertation. Other related issues and aspects of the problems will be briefly discussed when it is deemed necessary.
Structure of the Dissertation
To address the problems, the dissertation consists of 6 chapters. To help the reader understand the concept of this paper, introduction will be provided first in Chapter I. This chapter will contain a brief description of background of the problem, which will present the reason of this study, the purposes of the paper, and also the structure of the dissertation. Then chapter II will demonstrate how companies avoid tax through transfer pricing. The terms ‘transfer pricing’ and ‘associated multinational corporations’ will be defined to provide the reader with the basic understanding of the issue. The general rationales and methods of the abusive transfer pricing will also be mentioned in this chapter.
Chapter III will discuss about the nature of the transfer pricing problem on sale of goods and its impacts in Thailand which will demonstrate why the issue of transfer pricing has gradually become an essential problem in Thailand. Next, Chapter IV is ‘approaches under Thai tax system and the applicability to prevent the abusive transfer pricing on sale of goods’. This chapter aims to assist the reader to have the basic essential understanding of the in-depth view of taxation system related to transfer pricing in Thai tax law, including tax implication on transfer pricing of the Thai Revenue Department, Thai Customs Law, and double tax treaties.
After that it will study the current action of Thai tax authorities and the contemporary problems to Thai legal framework which obstruct the application of the said provisions in practice. Subsequently, chapter V will research approaches under model tax conventions as well as other selected jurisdictions to the problem of transfer pricing which lead to suggestions at the end of this dissertation—chapter VI. The last chapter will conclude all issues occurred in Thailand and finally will seek to find the best solution which would be appropriate to the Thai tax system. The findings will also be discussed to meet with the dissertation’s objectives.
How Companies Avoid Tax Through Transfer Pricing
The tax rates and tax systems differ from country to country which may lead to the distortions in the pattern of production and trade. It may influence the countries in which goods or products are manufactured, and the countries from which saving are derived and in which investment takes place. The existing differences between effective taxation burdens in various countries give rise to great difficulties for the assessment officers in each country who tax multinationals.
Moreover, these corporations themselves put substantial endeavour into reducing overall tax burden by transferring capital and profits around the world. This is because most countries do not tax company groups as a single entity. Therefore transfer pricing becomes a problem for tax purposes due to the need to establish the amount of taxable profit for each taxable entity to reduce the tax burden of company groups as a whole. Furthermore, it is important when computing how much profit belongs to a part of a company which is located in another tax jurisdiction such as a permanent establishment.
For the above reasons, most jurisdictions have legislation that aim to protect their tax base from manipulative transfer pricing practices by deeming that intra-group transactions must calculate taxable profits, for tax purposes, at market value using the ‘arm’s-length principle’. Though, establishing market value is not that simple because it is difficult to determine what arm’s length prices between connected parties should be since information on comparable transactions in the open market is unavailable. Besides, governments are concerned to ensure that the profits reported by related companies reflect a fair commercial level of profit. However, they do not want to be so harsh that they fail to attract investment from multinational groups. This is a particular problem for developing countries.
2.2 Definition of Transfer Pricing
Black’s Law Dictionary defines the term ‘Transfer price’ as follow.
‘The price charged by one segment of an organization for a product or service supplied to another segment of the same organization; esp., the charge assigned to an exchange of goods or services between a corporation’s organizational units.’
According to the above definition, transfer pricing simply means pricing of business transactions between related corporations. It governs the way in which group companies charge each other for intra-group goods or services. However, the definition does not mention taxation but when discussing about transfer pricing in an international tax context it usually means the artificial manipulation of internal transfer prices within a multinational group, with the intention of creating a tax advantage.
Therefore, transfer pricing is about shifting profits from one business to a related business by charging transfer prices, such as prices which do not conform to an arm’s length standard. It operates by substituting arm’s length terms in place of actual terms of transactions between connected parties. Normally, arm’s length price is the price that would be charged in an uncontrollable transaction, for instance, when parties are unrelated.
There are two most common methods to find an arm’s length standard: first, checking the price in a similar transaction between two totally different parties (for example, AàB vs. CàD); and second, checking the price in a similar transaction between one of the involved parties and one unrelated party (for example, AàB vs. AàC). Arm’s length price also has the meaning attached to it under OECD Model Convention, Article 9(1). It specifically provides that the transfer-pricing rules are to be interpreted in accordance with Article 9 of the OECD Model Convention and the OECD Transfer Pricing Guidelines of 1995.
Under Thai law, there is no definition of the market price provided in the Revenue Code. Such definition however exists in the Departmental Instruction No.Paw.113/2545. Market price under the instruction means the price of remuneration, service fee or interest, which is fixed in commerce between independent contractual parties in good faith, for the transfer of property, rendering of service, or lending of money, of the identical character, type, or kind, on the date that the transfer of property, rendering of service, or lending of money, is conducted.
2.3 Definition of the Associated Multinational Corporations
Associated corporations generally mean at least two entities that are owned or controlled either directly or indirectly by the same interest which are so-called ‘a group of companies’. A group of companies will comprise at least a parent company which controls another company known as a subsidiary. Therefore, if two companies form a group, they are then free to set price within the business group in a way which minimises the tax payable.
Section 1(a) of The Code of Conduct on Transnational Corporations provides the definition of multinational corporations. Multinational corporations mean companies that have the same decision making system and perform their businesses in more than one country.
‘Article 9 - Associated enterprises (1) Where
a) an enterprise of a Contracting State participates directly or indirectly in the management, control or capital of an enterprise of the other Contracting State, or
b) the same persons participate directly or indirectly in the management, control or capital of an enterprise of a Contracting State and an enterprise of the other Contracting State,
and in either case conditions are made or imposed between the two enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which would, but for those conditions, have accrued to one of the enterprises, but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly.’
Article 9 of the OECD Model treaty is the main provision which provides the interpretation of the associated companies’ relationship for the transfer pricing aspect. Under this article, the adjustment will be made in case transactions have been made between parent and subsidiary companies and companies under common control. Associated multinational corporations under this Article are therefore implied mean companies that have the same common control.
Under the Departmental Instruction No.Paw.113/2545, the term ‘independent contractual parties’ means any contracting parties which have no relationship of management, control, or joint investment, between them, whether directly or indirectly. Therefore, associated multinational corporations would mean on the contrary to this definition which are companies that have relationship whether directly or indirectly of management, control, or joint investment between them. This implied definition is also consistent with the concept of ‘associated enterprises’ in the OECD’s transfer pricing guidelines.
2.4 Rationales of Transfer Pricing Between Multinational Corporations
Normally, the purpose of business enterprise is to maximise profit. Practically, purposes of companies are creating profit, generating growth of business expansion as well as continuing the business corporation. In fact, transfer pricing is not the purpose in itself but the matter will lead to the rationales of multinational enterprises. Those rationales include the reduction of tax expenses, the avoidance of host country’s limitation, the maximization of profit, the allocation of profit, and the start up the market.
2.4.1 Reduce Tax Expenses
Multinational companies often apply transfer pricing to decrease their worldwide tax. They want to pay tax as least as possible, so they reduce profits by adding expenses through a higher transfer price. Commonly, prices of goods or raw materials charged between related companies are habitually different from prices charged between independent parties. The latter price is always the price set up in the actual market dictated by the free market competitiveness. In contrast, prices between related companies tend to disguise the free market price. This mechanism is an artificial transfer pricing so as to pay no or less corporate income tax.
For example, the parent company or head office often exports raw materials with the high price to its subsidiary or branch in a host country for manufacturing finished goods. The finished goods will later be sent back to the head office with the lower price. If the host country has the higher effective tax rate than that in the home country, then the multinational corporation can save overall tax burden.
In contrast, in case the host country has lower effective tax rate than that in the home country, the head office in the home country will then control and set the exported price charging to its subsidiary or branch in the host country in an excessively low price and set the exported price charging to the parent corporation in an overly high price. By this way the multinational corporation will also save more tax.
Avoid Host country’s Limitation
The transfer price can be utilised to avoid the impact of the limitation policy of the host country when multinationals in the host country remits money back to their parent in the home country. Money remittance can be in the form of management or royalty fees.
Create Profit on Variation of Currency
Transfer pricing method is also an efficient tool for multinational enterprises in order to create profit on variation of currency in other countries.
The key objective of a company is to make money and maximise profits. This goal can be achieved through transfer pricing method which creates tax advantages to multinationals much more than expected. The international transfer pricing helps multinational companies to make the right decision to maximise their own profits and at the same time the global profits of the multinational enterprises as a whole. This mechanism can be employed by promoting business in the host country. In some specific kind of businesses, the government in particular host countries will grant tax incentives and other privileges to draw investment, capital, and technologies from developed countries.
Generate an Allocation of Profit
Transfer pricing techniques can be exploited in order to allocate proper income within the group. Moreover, multinational companies can transfer profits out one the country in case they consider that the political circumstance in that country is not stable or there is a strict policy in controlling their business segments.
2.4.6 Open Up the New Market
This is the temporary purpose of multinational companies. The strategy of these corporations is that, for example, the parent company will sell products to its subsidiary in the host country with the cost lower than the normal market value so that the subsidiary has the opportunity and is capable to access the new market. The subsidiary can then amplify its market share in the host country, bring in new merchandises into the market, and discourage the growing competition from other companies.
2.5 Methods of Transfer Pricing of International Business Transactions
The techniques or methods of transfer pricing of international business transactions of connected multinational companies will be discussed in this part. These methods are purchase and sale of goods, transfer of intellectual property knowledge, certain intra-group services, and debt finance.
2.5.1 Purchase and Sale of Goods
This dissertation will mainly concentrate on the method of transfer price on the purchase and sale of goods by connected companies so as to decrease their overall tax liability within the group. However, this method will be independently discussed in Chapter III.
2.5.2 Transfer of Intellectual Property Knowledge
This method is often used by developed countries investing in developing countries since developing countries as host countries need high technologies for developing their infrastructure projects. These technologies include know-how, patents, trademarks, technical assistance and trade name. For this reason, parent corporations in developed countries, the owner of these technologies, will charge at whatever amount that unrelated companies would be charged for the use of the said technologies in similar circumstances.
Moreover, this transfer of technology transaction between connected parties is regularly conducted in the form of licensing agreement for the use of technologies. The royalty fees charged under the agreement will normally be extremely high and these fees are to be transferred out of affiliated companies in developing countries to their parents in developed countries.
Most countries normally impose tax on royalty; nevertheless, the tax rate for royalty is often lower than corporate income tax and dividend tax. This encourages companies (subsidiaries and affiliated companies) to be imposed excessive royalty fees by their parents in order to transfer money back in the form of royalty rather than in the form of dividend. Hence, a group of companies can save overall tax.
Certain Intra-Group Services
Parent corporations always provide a wide range of services to their subsidiaries in the related business field. These services include administrative, technical and commercial services. The service charge among these multinationals is various according to the type of services. Besides, profits of these multinational corporations can be moved from country to country by transferring profits from one country to another in the form of service fees. For instance, the company in the low tax jurisdiction will charge the huge amount of service fees from the company located in the high tax jurisdiction, for tax purposes, in order to minimise the overall tax liability of the group.
Capital is the fundamental nature of investment. Capital can come from either equity or loan. The returns of equity and loan (debt capital) are treated differently for tax purposes. The returns to shareholders on equity investment are disallowed as a tax deduction for the paying company, being distributions of profits rather than expenses of earning profits. By contrast, the returns to lenders on debt, usually in the form of interest, are generally deductible for tax purposes for the payer in arriving at income assessable to corporation tax.
This financial strategy is important for the group since the tax cost of debt financing is normally less than the tax cost of equity finance while the interest rate charged for loan among associated enterprises is usually higher than unconnected enterprises. This can then result in endeavours by multinational enterprises to present what is in essence equity investment in a company in the form of debt and thereby to attain a more constructive tax treatment. In some situations, parent company may establish an entity in countries where treaties provide more tax benefits such as deduction of interest tax.
It should be highlighted that in most cases these methods tend to manipulate the transfer price within the group; however, it does not mean that all cases have to be an abusive transfer price. Multinational companies may apply these methods to allocate their management fund without reducing or avoiding tax liability. Further, associated companies related to the transfer pricing case are usually located in high tax jurisdictions.
Nature of the Transfer Pricing Problem On Sales of Goods And Its Impacts In Thailand
3.1 Nature of the Transfer Pricing Problem on Sale of Goods
Regularly, tax will be imposed on profits of companies that arise in the relevant period. Profits may be calculated differently in each particular country according to the tax system in that jurisdiction. However, purchase or sale of goods always occurred within multinational corporations. The subsidiaries or branches in developing countries like Thailand normally import raw materials from their parent companies located in developed countries, for manufacturing the finished goods. After that those subsidiaries or branches in Thailand will export such manufactured products back to either parents or other affiliated companies established in the tax havens or other countries where there is little or no corporate income tax.
This method is a common practice for the movement of goods in international trading within associated multinational corporations. Parent corporations usually provide raw materials along with other processed materials to their subsidiaries or branches located in other jurisdictions. Prices of these materials charged under these transactions are likely to be lower or higher than the price charged between unconnected companies. Frequently, parent corporations have used machines for many years before selling and shipping to source income countries for investment with an excessively high price, for tax purposes.
These prices are controlled by parent companies and obviously tax benefits will be obtained in the group of these multinational companies as a whole. Parent companies can then receive their money back from countries they invested at the beginning without paying tax, such as corporate income tax and dividend withholding tax, to those source income countries. Such income is so-called ‘disguised dividend’. This kind of transfer price method is likely to avoid tax of the host country—Thailand. It also creates inequitable treatment for allocating of tax revenue between developing and developed countries.
For example, assume that Thai Co., a Thai subsidiary, conduct its business in manufacturing a transformer. The processed materials are composed of copper coil and iron core. Frequently, Thai Co. purchases copper coil from local company in Thailand but imports the iron core from its parent company or other affiliated companies within the group, Foreign Co.
In computing profits, Thai Co. will deduct the costs of copper coil, iron core, and all costs incurred in mixing and packaging the feed from its sale proceeds. As a consequence, a simple balance sheet may be as follow.
Sale Proceeds : 200,000 Baht
Cost of Copper Coil : 100,000 Baht
Manufacturing : 20,000 Baht
Cost of Iron Core : X
Profit on Sale : 200,000-(10,000+20,000+X) Baht
Noticeably, the amount of profits subject to tax in the hands of Thai Co. will vary according to the price charged to X.
In case Thai corporate tax rate is higher than that where Foreign Co. is located, then it is likely that a high value will be charged to X irrespective of the manufactured cost of the iron core. This way will reduce the total amount of tax borne by the group.
In contrast if Thai corporate tax rate is lower than the corporate tax rate in the jurisdiction of the Foreign Co., then the price charged to X may be lower than the market price. This procedure will assist the group of companies in saving its overall tax. This method will be even more efficient where the company is granted an investment promotion through the Board of Investment of Thailand since the corporate tax would be exempted in such case.
3.2 Impacts of a Manipulative Transfer Pricing On Sale of Goods In Thailand
An abusive transfer pricing always generates an inequitable share of tax revenue between countries, especially between developed and developing countries. Thailand is also considered as a developing country and it is likely that Thailand has been impacted by an abusive transfer pricing. Normally, Thai subsidiary or Thai branch would purchase raw materials from its overseas parent company.
The price set between overseas parent company and Thai subsidiary or Thai branch is often higher than the real market price. Thai subsidiary or Thai branch then attain a lower profit than actual which finally minimise the corporate tax burden to be paid to the Government of Thailand. Taxation on dividend and taxation on remittance profit will also be reduced accordingly.
Later on, the Thai subsidiary company and Thai branch office would sell, at the discretion of the parent company, manufactured products back to the parent or other affiliated companies established in other countries with the intention so as to reduce their overall tax burden. The price in this transaction is likely to be lower than normal. Consequently, Thai subsidiary or Thai branch can reduce its profit to zero so that little or no corporate income tax is imposed and collected by the government of Thailand. Not only is there a loss of huge amount of tax revenue of the country, the government of Thailand will also lose foreign currency. These transactions demonstrate that the revenue is likely to leaving out of the country rather than coming in.
Thailand has no specific provision dealing with transfer pricing issue engaged by these multinational corporations. In most cases, tax authorities use their own discretion and judgment which then creates uncertainty, a lack of consistency, and hence potential for unfairness for all Thai taxpayers. The system of tax collection in Thailand can be further exploited by this loophole.
Moreover, Thai government has been promoted incentives to foreign companies to run business in Thailand through the Board of Investment in order to attract the flow of investment and know-how to Thailand. Thai government claims that these foreign investments create a number of jobs for Thai people in the country and also high technologies will be transferred to Thailand. However, the investment promotion policy has been granted to these foreign companies without taking into consideration of the transfer pricing issue. Multinational corporations may take this chance to manipulate the transfer price within the group in order to save their global tax liability.
For example, the exemption of the corporate tax for eight years is one of promotion incentives granted to foreign corporations. Within this period and thereafter the promotion expired, these companies may also import raw materials without any requirement to report or disclose the price of goods imported. Similarly, there is also no need to report or disclose the price of goods exported. By this way, those multinational enterprises could reduce their overall tax burden. It can be said that the investment promotion through the Board of Investment of Thailand may not be at all beneficial to the country since there is a lack of such information appeared in the Thai tax system.
To sum up, the impacts of transfer pricing transactions of multinational enterprises are that (1) Thailand loses an enormous sum of tax revenue. (2) There is no actual technology transfer to Thailand as well as no actual technology trained by Thai workers. (3) Trade balance problem and monetary payment balance problems may occur in Thailand. (4) The policy of investment promotion of Thai government through the Board of investment would be ineffective and may not be at all beneficial to Thailand as for the primary objective. (5) Other instruments with the purpose to control prices of goods, exchange control or correct the trade balance might not be applicable in practice if multinational companies continue to manipulate the transfer price.
Approaches Under Thai Tax System and The Applicability To Prevent Abusive Transfer Pricing On Sale of Goods
The sole purpose of transfer pricing rules is to prevent tax loss by the charge of transfer prices. The rules require that the price of the goods or services is deemed to be a market rate price or an arm’s length price. Accordingly, it can be said that these rules exist to prevent groups, particularly multinational companies, being able to manipulate profits or losses generated within group companies often to transfer profits from high tax to low tax territories. This is only likely to occur between enterprises which are commercially linked. For this reason, transfer pricing adjustments only apply in a limited range of circumstances.
4.1 General Tax Structure In Thailand
The general Thai tax structure on corporate income tax will be outlined at the beginning of this part to provide the general idea of Thai tax structure. Then it will examine the current legal measures, legislation dealing with transfer pricing. Thai Revenue Code and the interpretation perspective of Thai tax authority, the Revenue Department including other related legislations will be considered. Current action of Thai tax authority and its problems will also be discussed in this part.
Taxation is the major source of government's revenue. A large part of tax collection comes from corporate income tax as evidenced by the corporate income tax collection of the Revenue Department in the fiscal year 2007—the approximately 34.37 per cent (384,618 Baht from the total of 1,119,203 Baht of tax collection) has been collected. However, it should be noted that corporate income tax is one of the main factors that enterprises take into account of how to transfer the price to minimise the overall tax burden within the group. Pricing arrangement at arm’s length between related companies is a fundamental prerequisite of international tax planning.
If, for example, Thai Co. develops Indian Co., a branch, for research and development work, the branch needs to recharge its costs to the group and make a profit. This profit could be based on, say, 3 per cent of costs or 30 per cent of costs. Since the parent company of the group has controlled over the agreement that is entered into with Indian Co., it may naturally wish to restrict the taxable profits to a minimum. Such control means that the inter-company pricing arrangement is not at arm’s length, and it is fundamental to tax planning that all transactions, which are not entered into at arm’s length, are effected at their full market value.
Corporate Income Tax and Taxation on Multinational Corporations
220.127.116.11 Corporate Income Tax
Corporate income tax is a tax imposed on a juristic company or partnership registered under Thai or foreign law and carries on business in Thailand or derives certain types of income from Thailand. Generally, the corporate income tax rate is 30 per cent. Company residence is determined by the place of incorporation. A Thai company is subject to corporate income tax in Thailand on its worldwide net profits.
On the other hand, a foreign company carrying on business in Thailand is subject to corporate income tax only for net profit arising from or in consequence of business carried on in Thailand. A foreign company that does not carry on business in Thailand will be subject to withholding tax on certain categories of income derived from Thailand. The withholding tax rates may be further reduced or exempted depending on types of income under the provision of Double Taxation Agreement.
In the calculation of corporate income tax of a company carrying on business in Thailand, it is calculated from the net profit of the company on the accrual basis. A company shall consider all revenue arising from or in consequence of the business carried on in an accounting period and deducting therefrom all expenses that have been incurred during an accounting period in accordance with the conditions prescribed by the Revenue Code.
18.104.22.168 Taxation on Multinational Corporations
Multinational Corporations can be classified into two types—onshore and offshore companies. They will be taxed differently according to their types.
i. Onshore Companies
Onshore companies are companies that established under Thai corporate laws. They also include companies that incorporated with respect to foreign laws but carrying on business in Thailand. The term ‘carrying on business in Thailand’ provided in the Thai Revenue Code is very broad. For example, if the company is registered as a Thai subsidiary, its worldwide net profits are then taxable in Thailand.
In contrast, if it is registered under other countries’ laws but carrying on business as a branch in Thailand, in this case Thai tax will only be imposed on income derived from doing business in Thailand. By all means, these onshore companies are normally subject to pay corporate income tax at a rate of 30 per cent of their net profits.
Moreover, when a subsidiary remits dividend to its parent company located overseas, it is then subject to pay dividend tax at the rate of 10 per cent. Likewise, when a branch office in Thailand remits its profits which arise from the business carried on in Thailand to other overseas associated corporations, it must pay a profit remittance tax at a rate of 10 per cent of the amount remitted. Nonetheless, it should be noted that the tax of dividend and profit remittance is supplementary to the corporate income tax.
ii. Offshore Companies
Offshore companies mean companies that incorporated under foreign laws but do not conduct substantial business in their country. These companies are subject to pay income tax only income derived from source in the country. When these offshore foreign corporations receive income from Thailand, they will only be subject to pay withholding tax at a fixed percentage of gross income. Tax will be withheld at source by the party in Thailand who pays such income.
Normally, when loan interests are paid to banks, insurance companies and financial institutions, the withholding tax rate is 15 per cent. However, if the Government or Thai financial institution under the law to lend money to promote agriculture, commerce or industry is the one who pay such interests, withholding tax, tax will be exempted. Other interest, dividends, lease payments, rental payments, royalty fees, professional fees, management fees, and income derived from a previous employment and or service rendered are all subject to tax at the rate of 15 per cent respectively.
Taxing Incomes from Foreign Direct Investment
Subsidiary's Profits (1)
Branch office’s Profits (2)
Worldwide Income (6)
Flows of Incomes
-Interest, Royalties (5)
Dhirapharbwongse (2007), p.37
It should be noted that in some cases the withholding tax may be wholly or partially exempted or reduced under the applicable double taxation agreements. Currently, Thailand has concluded tax treaties with 52 countries. The rate of withholding tax on interest may be reduced to 10 per cent if paid to a foreign financial institution.
On the other hand, no double taxation agreement reduces the rate of withholding tax on dividends to below the domestic tax rate of 10 per cent; however, dividends may be exemptd from withholding tax if paid by a ROH to a foreign company or partnership (provided that the dividend is paid out of qualifying income); or a promoted business by the Board of Investment during tax holiday.
4.2 Tax Implication On Transfer Pricing On Sales of Goods In Thailand
This part will examine all relevant provisions under Thai legal system in relation to transfer pricing on the sale of goods. Then it will discuss the recent position of Thai tax authority in order to deal with the transfer pricing of multinational corporations. The last part will also consider what the obstacles under Thai law which cannot practically take the transfer pricing situation be into force.
4.2.1 Legal Framework
At present, Thailand has no specific direct legislation preventing the abusive transfer pricing of multinational corporations operating business in Thailand. To prevent the avoidance of taxation caused by this matter, tax authorities can apply some indirect legal provisions. These provisions are contained in the Thai Revenue Code, the Customs Act, and Double Tax Agreements between Thailand and other countries.
22.214.171.124 The Revenue Code
Although Thailand has not yet codified any particular legislation counteracting the manipulative transfer pricing of multinational companies, there are some related provisions contained in the Thai Revenue Code dealing against an abusive transfer pricing corresponding to the sale of goods of multinational companies. Those provisions are Section 65bis(4) and (7) and Section 65ter(3), (13), (14) and (15), and Section 70ter. They also include Departmental Instruction No.Paw.113/2545 (2002).
i. Section 65bis(4)
‘Section 65bis Computation of net profits or net loss under this Division shall be subject to the following conditions:
(4) In the case where, without justifiable ground, a property is transferred, service is rendered, or money is lent without any remuneration, service charge or interest, or with a compensation, service charge or interest in an amount lower than the market value, the assessment officer has the power to assess the remuneration, service charge or interest at the market value on the date of transfer, rendering service or lending’
This provision is a general anti-avoidance provision under Thai tax law which is applicable to juristic companies or partnerships. It simply requires a transaction, whether between related or unrelated parties, to be executed at a market price unless there is a justifiable ground. It also empowers the tax authority to consider properties’ value that is transferred to other business sectors with no payment or such payment is lesser than the actual market price without justifiable ground.
Properties in this section include products, processed or raw materials imported from other countries for manufacturing in Thailand. This legal instrument is proposed to prevent these juristic persons transferring properties to other corporations with unreasonable price. This provision is applicable to local companies as well as to connected multinational companies in case where transferred price is paid lower than the actual market value to minimise their overall tax burden within the group of companies.
However, if there is a justifiable ground to the said transfer of properties, then tax authorities have no power to assess the value of properties. Therefore, it is important to clearly understand the scope of what the ‘justifiable ground’ contained in Section 65bis(4) means. Normally, only the fact that parties to the transaction are related in terms of management or shareholding does not necessarily make the transaction justifiable under this provision. However, in practice, there is an unclear guideline to the definition of this term. This creates problem and the most difficulty to tax authorities and all taxpayers to comply with. For this reason, following the precedent application of laws of the Supreme Court case, the interpretation of the tax authority, and the rulings of the Revenue Department is probably the solution to the said problem.
According to Thai Supreme Court case No.1259/2520 (1977), the plaintiff made a hire purchase of 222 cars at 17,500 Baht for each. However, the actual value of such transaction in the market was from 47,000 Baht to 50,000 Baht. The court decided that the value in this transaction was lower than the actual market price without justifiable ground and therefore the tax authority authorised to assess the hire purchase at the market value according to Section 65bis(4).
The ruling of the Revenue Department No. Gor.Kor.0802/1193 Lor.Wor.26 January 2530(1987) ruled on the fact that a contractor settled the construction contract with the hirer for the expansion of oil refinery. A contractor agreed to make maintenance of the machine and equipment for the construction of the hirer on behalf of the foreign lenders without any remuneration. This transaction was deemed that there was a justifiable ground because a contractor had received benefit under the contract. Hence, the tax authority did not have assessment authority as per Section 65bis(4).
By all means, it should be noted that tax officers have limitation to authorise the assessment to the transfer of property, provision of service and money lent. If the case is beyond the scope of such three transactions, tax officers have no assessment power. For instance, lease of property does not fall within the scope of any transactions described above. Then, tax authority has no authority to assess a lease of property. Finally, Thailand will lose the revenue sharing to other countries accordingly.
‘What is the market price?’ is another essential topic for this provision. Thai Revenue Code does not specify the definition of the market price. However according to Thai legal practice, precedent cases of the Supreme Court’s decisions are usually considered to be the first source in order to apply the market price’s definition for certain kind of business transaction. Nevertheless in many particular situations, the market price cannot be found in precedent Supreme Court cases. As a result, tax authorities must use their own discretions to justify the meaning of the term in such case. This situation then creates uncertainties for taxpayers, and finally forms a crucial loophole for corruption.
In case of rendering of service with no charge of service fee or the fee lower than the actual market rate, the tax officer also authorises to adjust such chargeable service fee to be the market price. Further than that, when loan is made among associated companies with no interest or the interest is lower than the market rate, the assessment shall be made. The new interest rate will be charged instead and then such interest is deemed as income, for tax purposes, in calculating the net profits in order to find out the new tax amount to be paid. However, this dissertation will not study these issues and its preventions.
ii. Section 65bis(7)
‘The assessment officer shall have the power to assess cost prices of imported goods by comparison with the cost price of the goods of the same category and type which are delivered to another country.’
The intention of this paragraph is to prevent corporations importing goods from overseas in an irregularly high price. In practice, Thai corporation often imports goods from its affiliated companies established in other countries in exchange of a high price in order to draw money out of Thailand to those overseas affiliated companies. This mechanism will significantly decrease the net profit of the entity in Thailand and finally the company tax liability will be effectively reduced accordingly. Section 65bis(7) can then be applied to prevent such transaction.
The tax officer is entitled to reassess the cost of goods imported by associated companies in foreign countries if the price is higher than the actual market price. If, for example, the price of the same or similar kinds of goods imported to other nations is lower than the price of goods imported to Thailand, the assessment officer is able to adjust the price equivalent to the price imported to other countries for tax purposes. However, the obstacle in practice is, for instance, in many cases the imported goods and products are unique since the multinational corporation just commences its particular kind of business in Thailand; therefore, comparable prices cannot be found in the market.
iii. Section 65ter(3)
‘Section 65ter For the purpose of computing net profits, none of the following items shall be allowed as expenses:
(3) Any private expenses, gifts or charitable donations except a sum donated for public charity or for such public benefit as designated by the Director-General with the approval of the Minister for which deduction may be made to the extent not exceeding 2 per cent of net profits, and a sum paid for the purpose of education or athletics as designed by the Director-Genera with the approval of the Minister for which deduction may also be made to the extent not exceeding 2 per cent of net profits.’
Normally, the tax imposed on legal entities is calculated from net profits less deductible expenditure. In terms of expenses, the Thai Revenue Code does not have any special provisions that deal with transfer pricing arrangements, other than the requirement under Section 65ter. The expenditure that can be deductible against profits of the companies, however, is not specified in Thai Revenue Code. Instead, section 65ter provides certain items of expenses that cannot be deductible.
This section is intended to prevent corporations decreasing their corporate tax liability by producing a huge amount of expenses. Moreover, paragraph (3) of this section can also be applied as an anti-avoidance method for transfer pricing contained in Thai tax law. The Revenue Department do apply this paragraph to disallow the deduction of the expense which is seemed to be private expense, gift or charity donation against profits except for some specific permissions.
iv. Section 65ter(13)
‘Any expenses not exclusively expended for the purpose of acquisition profits or for the purpose of business.’
This paragraph provides that any expenses not exclusively expended for the purpose of acquiring profits or for the purpose of business shall not be allowed as an expense or to be deductible. This condition disallows expenses which are not solely connected to the business or not associated in acquiring profits to be deductible for the calculation of corporate income tax. This provision can be used to prevent multinational enterprises to decrease their corporate income tax by transferring the price of goods within the group if it is not related to the business of the company.
However, allowable expenses shall be considered from and depended on the necessity, appropriation, evidence, facts and circumstances including nature of each business on a case by case basis. In other words, the Revenue Department do apply ‘business purposes’ to decide whether the expense of companies should be deductible or not. If the expenditure is for the purpose of the business of the company, it is then deductible for tax purposes. Additionally, if the tax officers cannot prove with evidence that company spend money for any other purpose rather than for business purposes of the company itself, such expense is therefore considered as the expense for the purpose of the business of the company and then shall also be deductible.
However, this paragraph has been interpreted in a broader sense; otherwise, certain expenses such as expenses for public relations purpose may not be deductible. For this reason, multinational corporations in Thailand may still take advantages of this loophole to allocate expenses for public relation purposes within the group around the world.
v. Section 65ter(14)
‘Any expense not exclusively expended for the purpose of the business in Thailand’
According to this paragraph, it implies that expenses must be spent exclusively for business purposes. The condition of this paragraph is the same as in section 65ter(13), which is that expenses of a parent company or other companies within a group, such as affiliated companies, are not allowed to be deductible for the business of companies in Thailand. Nonetheless, the companies shall be classified into two types—(1) a branch office of a foreign entity and (2) a subsidiary of a foreign entity—in order to consider this paragraph.
For a branch office of a foreign entity, if expenses of the parent company or other branch offices paid in or for other countries, such expenses can be deductible in Thailand only in case that they relate to the business of a branch office in Thailand. On the contrary, if it is not so, those expenses shall not be deemed as expenses for the business and therefore cannot be deductible for tax purpose in Thailand. Moreover, the Revenue Department issued the Departmental Instructions which provides that expenses of a branch doing business in Thailand paid to its parent company are deductible for tax calculation purpose.
For a subsidiary of a foreign entity, since it is established under Thai law, it is a Thai company and is legally a separate company from its parent corporation. Practically, expenses paid out of the subsidiary to its parent are subject to withholding tax according to section 70 of the Thai Revenue Code. If those expenses are related to the business of the subsidiary, then it is deductible. However, the withholding tax payable to the Government of Thailand may be exempted where there is a double tax treaty.
Furthermore, there is a Ruling No. 13/2529 (1986) of Tax Decision Making Committee regarding income tax on expenses paid in Thailand according to section 65ter(14) which sets some guidelines for the deductible expenditure. The expenditure is allowed to be deducted if it falls within the following descriptions:
‘(a) The expenses are made in connection with the assistances or services given or rendered by the parent company or branch office relating to the business of Thai Branch;
(b) The research and development expenses are made for Thai branch, or the results of such research and development are actually for the benefit of the business of Thai branch;
(c) Any expenses which have already been treated as expenses in the computation of net profits of the parent company or other branches shall not be treated as expenses of Thai branch;
(d) The allocation of the expenses made by the parent company or other branches to Thai branch must comply with the generally accepted rules and methods, and must also be consistently applied to the branches in other countries;
(e) The expenses do not belong particularly to the parent company or other branches, such as office rentals, water and electricity charges, stationary expenses, cots of appliances, wear and tear and depreciation of appliances or equipment.’
vi. Section 65ter(15)
‘The portion of the purchase price of properties and of the expenses in connection with purchase or sale of properties which exceeds a normal amount without justification.’
The objective of this paragraph is to prevent the deductibility of expenses which exceed the normal amount of expenses for the purchase or sale of properties without justification. This means that if the sale of goods is within the normal amount, then it is deductible as for the expense of the company. However, in case the sale of goods exceeds the normal amount, the expense deduction will not be allowed where there is no justification. This is because such expense will be added to the cost price and finally more expenses will be claimed. It will then reduce the taxable income and amount of tax to be collected by the government. Furthermore, the properties under Section 65ter(15) include the goods purchased and imported to Thailand by branches or subsidiaries of the overseas parent corporation.
However, the difficulty arises since there is no guideline definition and interpretation of what ‘normal exceed amount’ should be interpreted. Similarly, the meaning of ‘justification’ is not clearly identified. Then, there is no certainty of what situation the expenses are in excess of the normal amount with justification.
vii. Section 70ter
‘Export of goods made by any juristic company or partnership to or under the instruction of its head office, branch, affiliated company or juristic partnership, principal, agent, employer, or employee shall be deemed sale made in Thailand, and the market price of the goods ruling on the date of export shall be deemed revenue of the accounting period in which the export is made.’
The purpose of this section is to prevent the transfer of goods out of Thailand without sale. The provision provides that the price of goods shall be according to the market price as on the date of the exportation. Goods deliver to overseas companies according to the instruction of the parent or affiliated corporations which are not for sale shall, for tax purpose, be deemed that they are for sale in Thailand. As a result, a company or partnership exported such goods must declare such transaction and recognise income from such sale in order to calculate the net profit for the purpose of tax payment in Thailand. Nevertheless, there are some exceptions as stated in section 70ter(1), (2), (3), and (4).
viii. Departmental Instruction No. Paw. 113/2545 (‘D.I.Paw.113/2545’)
16th May 2002, the Revenue Department issued the Departmental Instruction No. Paw. 113/2545 on Determination of Transfer Price based on the Market Price which provides a standard guideline for the tax officers to determine whether the transfer price is based on the market price. The release of these guidelines assembles a vital action in the Revenue Department’s plan to concentrate on the perceived loss of tax revenue through manipulative transfer pricing practices by multinational enterprises.
While D.I.Paw.113/2545 has not yet codified into law, it could be invoked along with other provisions contained in Thai Revenue Code. Where there is no justification of the transfer price for business purposes, in practice tax officers can and do attack such structures. D.I.Paw.113/2545 empowers tax officers to adjust the revenue and expenses for Thai subsidiaries and Thai branches and determine the market price of cross-border transaction between related parties when calculating corporate income tax if a company receives no compensation or receives at the amount less than market price without justifiable reasons or pays expenses at the amount more than market price without justifiable reasons.
Also, D.I.Paw.113/2545 provides a definition of market price or arm’s length price which is consistent with Arm's Length principle under OECD's transfer pricing guidelines. Market price under D.I.Paw.113/2545 means the price of consideration, service fee, or interest that would be charged in a commercial manner between independent parties acting in good faith at the date of transaction for the sale of assets, provision of services or lending of funds under the same circumstances.
Pricing methods that the Revenue Department accepts are comparable uncontrolled price method, resale price method, cost method, and other methods if the said three methods cannot be applied, including profit based methods adopted by OECD such as profit-split method, transactional net margin method and any other methods that are internationally accepted. The application of the above methods relies on a comparison of prices or profits for transactions between related parties with the prices or profits or transactions between independent contracting parties in the same or similar circumstances. Further than that, the acceptance to consider the request for an advance pricing agreement (‘APA’) is also provided in D.I.Paw.113/2545. An APA is an agreement that determines the transfer pricing methodology to be used in future transactions between connected companies.
The issuance of D.I.Paw.113/2545 clearly assists the operation of assessment officers to identify the market price in order to assess the corporate income tax of multinational corporations. However, since D.I.Paw.113/2545 has not yet codified into law and it is only the guideline for assessment officers, it does not have force of law and tax authorities and the courts are not bound to follow these instructions. The uncertainty of tax assessments might occur depending on the fact of each particular case together with the discretion of officers at that time. Therefore, there is no actual numerical amount that represents the market price that is acceptable by the Revenue Department. In addition, the company will need a proper and good negotiation approach as an additional tool to assist in the Revenue Department’s decision to accept the price which it has determined and used. Therefore, even the transfer price is not in line with market rates, they could still argue against the action of tax officers that such action does not breach any laws in case where the activity has justifiable reasons for business purposes.
The Customs Law
‘True Market Value’ or ‘Value’ of any goods has its definition set forth in Section 2 of the Customs Act B.E.2469 (1926) as amended by the Customs Act (No.17) B.E.2543 (2000) as demonstrated below.
‘CUSTOMS VALUE or VALUE of any goods in case of exportation, shall mean the wholesale cash price without deduction or abatement for which goods of the same class and kind quality would be sold without loss at the time and place of exportation; or
In case of importation, shall mean the value of goods for the purposes of levying and valorem duties of customs according to any of;
the transaction value of imported goods,
the transaction value of identical goods,
the transaction value of similar goods,
the deductive value,
the computed value,
the fall-back value.
The rules, procedures and conditions on the application and the valuation of the customs value under (a) (b) (c) (d) (e) and (f) shall be in accordance with the Ministerial Regulation.’
In case the importers or exporters of goods do not satisfied with the valuation of the officer, they can appeal to the committee. Nonetheless, they are responsible to keep books of accounts, documents, relevant evidence on importation and exportation for inspection.
Furthermore, the competent authority is entitled to take action if there is a breach, or an act that is incompatible with the Customs Law, or a finding that there is an offence.
Moreover, section 10bis of the Thai Customs Act expresses the tax point at the time of importation and that price of goods is crucial because custom duty collection is based on such price.
126.96.36.199 Double Tax Treaties
Since the nature of transfer pricing of multinational corporations involves with two or more jurisdictions, double taxation agreements will then take the crucial role in order to deal with this manipulative transfer pricing. This is because the double tax treaty is very flexible for both trading partner countries of the treaty since the treaty concluded from the final negotiation of both parties. The context of the double tax treaty will therefore support the provisions and policy of the tax system of those two countries.
The legal action of the contracting partners will then be applicable in practice. Up until now, Thailand has concluded treaties for double taxation with many trading partners. There are now 52 treaties made between Thailand and other nations. The contents of the treaties are according to the OECD Model Convention. Article 9 of the OECD Model Convention is specifically outlined the method to find out the actual market price of goods or arm’s length price. This method will be utilised to assess taxable income and profit for the calculation of tax. There are also other relevant provisions—Article 7 (Business Profits), Article 11 (Interest), Article 12 (Royalties), Article 25 (Mutual Agreement Procedure) and Article 26 (Exchange of Information)—in connection with transfer pricing between parties of the treaty. However, since exchange of information ordinarily occurs only in the context of a tax treaty, and there are relatively few treaties between developed countries and developing countries, there is little such cooperation.
4.3 Current Action of Thai Tax Authority
The Large Business Tax Administration (the ‘LTO’) was established in May 25th, 1999 by Thai Revenue Department. The core objective of the LTO is to specifically deal with taxpayers who in the large business sector. A large business sector as classified by the LTO is an entity with its turnover at least 500 million Baht per annum. The LTO’s duty is to monitor and increase the efficiency of tax collection from such taxpayers in filing tax return, applying for tax ruling and tax appeal. Tax investigation and tax return claim are also its responsibilities. The LTO has to ensure proper compliance of those taxpayers. Moreover, the LTO is in the process of profoundly study on transfer pricing issue such as profit shifting by considering the issuance of new regulations so as to broaden the scope of the current provisions and the authority of tax officers. The study, in addition, includes procedures on information and documentation and also educational and training program to form a team of specialists in the field of transfer pricing.
4.4 Contemporary Problems To Thai Legal Framework
Normally, the tax policies and objectives of developing countries may be different from those of developed countries. The developing countries consider corporate income tax less as a means for financial tool for the government in order to achieve higher economic growth. Tax levels may be kept low through incentives to raise their competitiveness for capital, markets and technology. The lack of anti-avoidance mechanisms, such as transfer pricing regulation, may be acceptable and may be deemed as tax incentives.
Currently, Thailand is a developing country and a source income country, and needs capital inflows and high technologies from other developed nations to effectively run the economic of the country. For such reason, multinationals have influenced the development of the country through their investment. The government’s perspective is that transfer pricing is a tax incentive to induce foreign investment into Thailand and increase the tax base of the country. It believes that transfer pricing is a policy tool to achieve higher economic growth. It is also unarguable that the government’s policy to encourage the establishment of companies has proven good to the economic; jobs were created and finally consumers will benefit from this policy. That is to say, it creates a boost to a country’s economic situation.
There is no doubt that it has created benefits. Moreover, the government also concerns that if there is an introduction of the specific legislation to prevent transfer pricing, it would reduce the foreign investment and then decrease the tax base. Therefore, it believes that the manipulative transfer pricing of multinationals is not a serious trouble in Thailand. However, it is still doubtful that the government’s perspective is right since the amount of tax lost is so high (The corporate income tax in Thailand is approximately 34.37 per cent of the total tax collection of the country.) and the government depends very much on corporate income tax.
Moreover, the mechanisms under Thai legal framework as discussed in 4.2.1 are not enough to prevent and deal with the problem of transfer pricing. This is because (1) these legislations are not designed to deal specifically against transfer pricing matter of those multinationals. (2) Before 16th May 2002, there is no guideline to find the actual market price in Thai tax regime. After 16th May 2002 although there is an issuance of D.I.Paw.113/2545 which provides a guideline of the market price, it is still not a law and need no compliance. (3) The tax authority generally focuses only on the consideration of the allocation of expenses within the group. On the contrary, other legal terms available to deal with the transfer pricing problem have not been employed. This is because there is a lack of information of those multinational companies and no any further study on this specific issue. (4) The transfer pricing issue has not been seriously considered by Thai tax authority and Thai government. (5) There is no exchange of information between double tax treaty partner countries in practice.
Model Tax Treaties' and Other Countries' Approaches
Transfer pricing may involve with cross-border transactions in various tax jurisdictions. It can be regarded as a tax planning. The main objective of the planning is to minimise or defer global taxes lawfully to meet the desired business.
Generally, income that crosses international borders could be taxed by the country where it originates (source country) or by the country of residence of the recipients of such income. Transfer pricing issue creates inequitable tax share among countries. If there is no any mechanism adopted by national governments to handle an abusive transfer pricing within multinational corporations, the conflict of trading countries may occur since each jurisdiction has its own sovereignty to impose tax to companies that have nexus with the country. Those countries all authorise to reassess the transfer prices of the affiliated corporations.
As a result, these corporations may at the same time be subject to double taxation. However, since the methods of transfer price of multinational enterprises are complicated and hard to scrutinize and control, the co-operation in the international level should be conducted in order to prevent this matter. Moreover, the arm’s length standard adopted by many countries to deal with transfer pricing situation has been criticized from many groups of people such as academic commentators, taxpayers directly affected by the standard, and tax administrators.
Although there is a lot of criticism to this standard, it tends to be widely accepted in various countries in order to resolve transfer pricing matter. Many jurisdictions, mostly developed countries, specify rules to be used in establishing and monitoring transfer prices. In general, the objective is to evaluate prices that would be charged in arm’s length transactions with independent parties such as between unconnected buyer and seller. This part will then describe the measures of the UN, the OECD, and other selected jurisdictions that can deal with this problem.
5.2 Model Tax Treatie's Approach
‘Article 33 of UN Code of Conduct provides that in respect of their inter-corporate transactions, transnational corporations should shall not use pricing policies that are not based on relevant market prices, or in the absence of such prices, the arm’s length principle, which have the effect of modifying the tax base on which their entities are assessed or of evading exchange control measures or customs valuation regulations or which contrary to national law and regulations adversely affect economic and social conditions of the countries in which they operate.’
The Commission on the Code of Conduct of the United Nation outlines the scope and guidance for transnational corporations and also supports the negotiation of the host countries. Article 33 is the only provision in the Code of Conduct that deal with transfer pricing matter. It provides that the related transnational corporations shall follow the transfer price according to the related market price. Nonetheless, if the market price cannot be found, an arm’s length price (the price set among independent parties) will then be applied.
The Organization for Economic Co-operation and Development (the ‘OECD’) has realised and has been working for several years to come up with an international consensus on transfer-pricing rules. The OECD in 1979 issued the report ‘Transfer Pricing Guideline for Multinational Enterprises and Tax Administrations’, which advocated the implementation of the arm’s length rule to establish the prices of transactions between related enterprises. The OECD has firmly rejected global methods of profit allocation or the use of predetermined formula to allocate the profits of multinational between the various host countries in which they operate.
In other words, prices paid for goods transferred between related companies should be those which would have been paid between independent parties for the same or similar goods under the same or similar circumstances for tax purpose. Therefore, when transfer pricing is not according to market forces and the arm’s length term, the tax burden of connected parties and tax revenues of host countries could be distorted.
According to Article 9 of the OECD Model Treaty, it provides that transfer prices should be adjusted in order that they will be according to prices that would have been set between unconnected parties acting independently. Also, since most multinationals have concerned that the same amount of income should not be taxed twice in two different countries only because a transfer pricing attack by one jurisdiction is made too late for the corresponding adjustment to be made in the other jurisdiction, the OECD provides Article 9(2) and Article 25 regarding to such concern. They implies that most countries entering into any tax treaties have bound themselves to make adjustments to transfer prices, for tax purposes, to compute taxable income of their taxpayers in case those prices have been adjusted by a treaty partner according to the arm’s length standard.
The arm’s length standard is an appropriate transfer pricing in accordance with international custom and is met if a taxpayer sets transfer prices when dealing with connected persons so that the income is reported, for tax purposes as if it has engaged in comparable dealings with unconnected parties.
The goal of the arm’s length standard is to provide guidance and methods for determining transfer price in concrete situations. Historically, the OECD has recommended the five following methods that have been widely used in many countries in order to determine transfer prices at the arm’s length price.
i. Comparable Uncontrolled Price (the ‘CUP’)
Under the CUP method, it involves investigating the uncontrolled price in relation to the sale of a product or a transfer of services between unrelated parties by reference to sales of similar products in similar circumstances. The CUP method compares the price charged in a controlled transaction to the price charged in a comparable uncontrolled transaction in comparable circumstances.
ii. Resale Price (the ‘RP’)
The RP method sets the arm’s length price by starting from the final selling price and subtracts an appropriate gross margin to arrive at a purchase price. This method is suitable where the reseller has not made substantial modifications to a product and where a seller performs all the functions a distributor would be expected to perform.
iii. Cost Plus (the ‘CP’)
The arm’s length price for the CP method starts by computing the cost of the goods and adds a mark-up that is deemed appropriate determined from comparable uncontrolled transactions. The CP method is suitable and most often used in the manufacture and sale of goods. The size of the mark-up and the margin that tax authorities would want to see left within their taxing authority depends, for instance, on the nature and complexity of the services rendered—the greater the complexity, the greater the mark-up required.
iv. Comparable Profits (the ‘CPM’)
According to the CPM method, the taxpayer must establish an arm’s length range of profit for itself or a connected party (the tested party). If the reported profits of the tested party are in that range, its transfer prices will then be accepted by tax assessment authorities. On the other hand, if its profits are not within that range, then assessment officers may revalue transfer prices in order that profits fall within the range.
v. Profit Split (the ‘PS’)
The PS method outlines the way to compute the worldwide taxable income of associated transnational company engaging in a common corporation. It examines the profit that has been allocated to each transaction corresponding to the value of a given company’s real economic contribution to the overall profit on a product.
This method will be applicable in case CUP, RP, CP methods cannot apply. If there is more than one products line within the group, the PS method may apply separately to each product line.
To sum up, the first three methods—CUP, RP, and CP—are internationally accepted by many jurisdictions while the other two methods of CPM and PS are less widely accepted.
However, there is a common criticism of the OECD materials that they are too general. Therefore, many taxpayers and tax administrations often prefer the US legislation as it allegedly provides more certainty since the US has always taken responsibility for developing its own rules rather than relying on the OECD Guidelines and its regulations have more detail than the OECD materials.
5.3 Other Countries' Approaches
5.3.1 United States (the ‘US’)
Multinational corporations with business operations in the US need to pay careful attention to the US transfer pricing rules because the US Internal Revenue Service (the ‘IRS’) has been very aggressive in its examination of the allocation of income between US and foreign operations. Besides, the US has always been developing its techniques to be dealing against an abusive transfer pricing. It contains more details in its text and explanations than those in the OECD, incorporates several provisions of the OECD Commentaries in the treaty text itself. Extensive technical explanation is also included in the text in order to provide further insight into the US treaty policy, the definition of terms and other provisions. While these explanations are not part of the treaty text, they give constructive interpretations and clarification.
In accordance with section 482 of the Internal Revenue Code (the ‘IRC’) of 1986, it authorises the IRS to reallocate income between associated parties to prevent tax evasion or to reflect an actual income of companies in case the IRS determines that the transaction is not commercially acceptable. This section applies even if the companies involved are either both resident in the US or both non-residents. The IRS would evaluate the transfer price by considering the price transferred between unrelated companies or the arm’s length price.
The arm’s length price has the meaning set forth in section 482 of the IRC of 1986. Moreover, regulations under section 482 lays down three specific rules to establish the arm’s length price with regard to the transaction between connected parties—(1) the CUP method, (2) the RP method, and (3) the CP method. However, if none of these methods can apply in a particular case, the Regulation provides that the IRS or taxpayers can reserve a fourth method that is wide in its scope and perhaps subjective in its view.
A number of court’s decisions have held that the PS method is an appropriate method for the fourth method. Moreover, even where reallocation is made but payment of the reallocated amount by a foreign corporation is impossible because of local restrictions, Revenue Ruling 82-45 still entitles the IRS to tax the reallocated amount, although there is still substantial case law authority to the contrary. In addition, the penalties range from 20-40 per cent of the amount of the taxes in dispute. It can be said that the threat of transfer pricing adjustments by the IRS certainly should be a source of concern for multinational enterprises with operations in the US.
5.3.2 United Kingdom
TA 1988 section 77A and Schedule 28AA apply where any sale takes place between parties who are connected with each other and the price is less than the open market value of the goods. These provisions specifically control pricing policies between non-arm’s length companies and allow the Revenue to disallow certain prices between related parties. Therefore, in calculating the tax liability on the trading income of the seller company, the sales proceeds must be adjusted to the actual value of the goods if the Revenue so direct. Moreover, a similar adjustment must also be made for the buyer company if the price is more than the open market value of the goods.
Moreover, advance pricing agreements may also be made between taxpayers and the Inland Revenue from August 1999. These methods enable problems to be cleared in advance in order to remove the risk of extra tax being imposed.
Section 1 of the Aussensteuergesetz provides that proceeds of internationally connected companies may be adjusted for German taxation to reflect the sum that would have been produced through dealing with independent parties. In case there are two countries involved, Article 9 of the OECD Model Treaty will regularly authorise the German tax administration to adjust the profits of the German company if trading transaction has not been according to a commercially justifiable ground.
Though, section 1 gives power to the tax officer to effect the gain of profit in the absence of business-related transactions, since it is unlikely that a low-tax regime will have a tax treaty with Germany. Payment of certain items which does not follow an arm’s length standard are also treated as a hidden distribution of profits under another provision of German law.
The Income Tax Act 1967 section 140 empowers the Director-General to vary or disregard any agreement or arrangement and adjust the transfer price that aim to decrease or avoid taxes. Generally, where a transaction has no business substance and has the purpose of obtaining tax benefit, the transaction would be challenged by the assessment officer.
There is a general anti-avoidance provision—The Income Tax Act section 33—which allows the Comptroller to disregard or vary any arrangement which is intended to vary, decrease or avoid tax burden in Singapore. Apart from this general anti-avoidance provision, the Income Tax Act section 53(2) and (3) can also be applied against an artificial transfer pricing arising from transactions between local company and its overseas connected corporation. In this situation, the Comptroller can determine the real profits that should have grown and calculate them on the foreign related company in the name of the local company as agent of the foreign company. Where actual profits cannot be established, the Comptroller can use a reasonable percentage of turnover of transactions as a substitute.
Moreover, the Inland Revenue Authority of Singapore (the ‘IRAS’) has released a new circular on Transfer Pricing Consultation (the ‘TP Consultation’) on 30 July 2008. The IRAS will perform the TP Consultation by have a discussion with the taxpayer to enhance the IRAS’ understanding of the business of the taxpayer and assist a physical assessment of the taxpayer’s documentation if needed. The taxpayer is required to keep adequate and timely transfer pricing documentation to reveal compliance with the arm’s length standard.
The State Administration of Taxation of China (the ‘SAT’) has recently enacted the new transfer pricing rules which take effect from 1 January 2008. The rules are contained in Chapter 6 of China’s Corporate Income Tax Law and in the implementation rules. They considerably enhance the power of tax authorities to investigate the transfer pricing matter. Thx authorities empower to examine companies that tend to have several types of related party transactions, lower profitability than the average of industry standards, business activities with companies located in tax havens and absent or incomplete transfer pricing documentation, for instance. Also, foreign investment corporations engaged in transactions with related companies either within or outside China should be subject to the same investigation. However, the investigation is most likely to focus on transactions with overseas associated parties involving with tangible property.
Moreover, foreign companies that conduct business activity in China must obtain relevant transfer pricing documentation. The information in the documentation includes five basic categories—(1) organizational structure, (2) description of business operations, (3) description of related party transactions, (4) comparability analysis, and (5) selection and application of transfer pricing method. Although the burden of proof is on the company to justify its transfer pricing policies, tax authorities still have the power to adjust the price in case they consider that the price does not comply with the real market price. The methods to adjust the transfer price are also specified in the implementation rules which are the CUP, RP, CP, PS, Transactional Net Margin Methods and other methods consistent with the arm’s length rule. If the transfer price charged among the group does not comply with the arm’s length standard, those companies will be subject to penalties and interest.
Conclusion and Further Recommendations
Currently taxation has played an important role when multinational companies plan and conduct businesses in the contemporary integrated world. They always seek to minimise expenses of the companies. The price transferred on the sale of goods from corporation in one country to related corporations in other countries normally does not comply with the market price which is the price set between independent parties. The price charged for these goods between associated corporations is called ‘transfer price’. The techniques of transfer price can be set at a level which reduces or even eliminates the total tax which has to be paid by multinational companies.
These transfer pricing techniques create unfair share of the tax revenue among countries related to those multinational corporations especially developing countries, including Thailand. For this reason, many jurisdictions created rules to prevent this situation. The rules are usually complicated and always based on the arm’s length standard so as to adjust the transfer price and to discourage the manipulative transfer pricing matter.
However, in practice it is very difficult to determine methods which are suitable for the transfer pricing transaction on the sale of goods to find the suitable arm’s length price. In general, methods that are widely accepted by many countries and the international tax community are the CUP, RP, and CP methods. The PS and CPM methods on the other hand are less widely accepted.
At present, Thailand is considered as a developing country and still needs foreign investment to run business in Thailand in order to attract high technologies and provide jobs to Thai people. Thailand also has been facing the economic crisis for the past decades. For these reasons, Thai government therefore established the policy to give incentive to foreign corporations to further come invest in Thailand to draw capital as well as new technologies, and to generate jobs. It can be said that Thailand is much more open to attract foreign investment through such policy. As a result, many multinational companies appear to set off their businesses in Thailand.
However, since the only goal of these multinational companies is to make money and the transfer pricing techniques are habitually used by multinational corporations for the purpose of reducing their overall tax burden, there is strongly no doubt that those corporations will also use these techniques in Thailand and finally Thailand will lose a huge amount of tax revenue. The investment of multinational companies through the government’s policy does not mean however that they should be allowed to utilise any means possible to reach their goal. It is now therefore the time to concern the transfer pricing techniques of multinational corporations and how those corporations take advantage via these techniques from Thailand in order to seek an appropriate mechanism to prevent transfer pricing problem.
Whilst many countries have transfer pricing rules to handle with the transfer price of multinational enterprises doing cross border business transactions, Thailand has not yet enacted any specific provisions in Thai Revenue Code dealing particularly with this matter. Although there is the guideline for the tax assessment issued in D.I.Paw.113/2545, it is still not a law and does not need compliance from both taxpayers and tax officers. Even though it cannot be rejected that D.I.Paw.113/2545 is very useful for tax officers because it provides directions and methods to calculate tax, but the uncertainty of the tax assessment may still arise due to the discretion of each tax officer and the fact of each case.
Therefore, it can be said that Thai legal framework seems to be ineffective and pose an element of uncertainty to the Thai tax system to deal with transfer pricing techniques employed by multinational corporations. However, Thai government has realised the effect of transfer pricing problems in Thailand. Consequently, the Revenue Department established the LTO to improve the efficiency of tax collection from large taxpayers with the turnover more than 500 million baht. The LTO can also be further developed to be a powerful and special tax authority to control the transfer pricing situation of multinational enterprises in the future.
6.2 Further Recommendations
Thai tax system is not sufficient to deal against transfer pricing matter which lead to the loss of huge amount of tax revenue from multinational corporations. Hence, Thailand should profoundly study the tax system regarding transfer pricing of other countries and adopt the provisions which are considered to be suitable and useful to Thai legal system to develop the legal framework in Thailand. As earlier described the mechanisms of Model Tax Conventions and other countries in Chapter 5, the mechanisms that the author would propose Thai tax authorities to adopt the use and take actions to prevent the manipulative transfer pricing issue are accordingly.
First, Thailand should enact the new specific legislation in relation to the manipulative transfer pricing on the sale of goods of the multinational enterprises in order to stop or prevent an artificial transfer price with either high or low price to various jurisdictions. Although, there are some indirect provisions to prevent the abusive transfer pricing of a group companies contained in Thai Revenue Code, those provisions are only general provisions, not specific anti-avoidance provisions to deal specifically with transfer pricing on the sale of goods. So, they cannot deal with the very complicated issue like transfer pricing issue.
Besides, tax authority has no or little information regarding to the price transferred among multinational corporations, such as market price of raw materials and manufactured products, since there is no supported legislation to give the power to the tax authority to obtain such information from those multinational companies and other relevant third parties.
Moreover, since D.I.Paw.113/2545 is not a law and has no enforcement, the promulgation of a new legislation in Thai Revenue Code should provide suitable methods (which need compliance from both tax offices and taxpayers to follow steps by steps) to find an arm’s length price of the goods transferred between related parties. The new legislation should be according to D.I.Paw.113/2545 which provides the definition of the market price, the definition of associated companies, and the methods to find an arm’s length standard.
Thai tax authorities should also have authority to reassess the transfer prices in case they consider that the transaction is made with the purpose of obtaining tax benefit when one corporation shifts income to other connected companies organized in other countries especially in tax haven countries. The power should incorporate the power to allocate deductible expenses, credits, and other allowances among associated companies. This suggested mechanism would increase the ability of tax officers to collect tax from those companies doing this abusive transaction and therefore Thailand would be able to collect reasonable amount of tax revenue from business activities of multinational companies conducted within Thailand.
Second, Thailand should codify the enforcement regulations in order to support the issuance of transfer pricing provisions to be able to be implemented in practice. The regulations should give the power to the Revenue Department to investigate and audit associated companies. For instance, if the associated foreign company reports little profit after the expiration of the promotions of the Board of Investments, tax officers empower to precede the tax audit. Moreover, penalties and interest should be imposed where there is no compliance to the new transfer pricing legislation.
Third, the disclosure rules should also be adopted so that the Revenue Department can obtain more accurate information about transfer pricing of multinational corporations. This is one of the important mechanisms that would make the new transfer pricing legislation be effective in practice. These rules would help the tax assessment to examine whether or not the transaction is according to an arm’s length standard.
However, it might be difficult to collect information from those subsidiaries established in Thailand since their foreign parent company is the one to control those documents; so they do not have the power to generate their own documents and tax authorities do not have the power to investigate over foreign company. Therefore, the new disclosure rules should also support the right and provide the authority to tax officers to acquire all documentation relating to transfer pricing transactions in such case.
Fourth, the policy of Thai government granted to foreign corporations to promote investment in Thailand should be once again seriously considered and carefully reviewed. This is because in the past some government’s policies to promote foreign investment were granted without the awareness of tax avoidance activity through transfer pricing; then, the manipulative transfer pricing can be implemented once those corporations have opportunities. The revision would help the government to figure out the weak points of the policy and then find out the way to close those loopholes. Moreover, there should be statistics to compare transfer prices of multinational corporations conducting their business in Thailand so that there could be comparable price list available in Thailand. These information possibly will help relevant Thai authorities to deal with this matter.
Last but not least, the LTO should be further developed to be specific tax agency dealing specifically against transfer pricing problems. It should study and investigate the price transferred between connected corporations. Additionally since the techniques of the transfer pricing transaction are always complicated, the staffs in the LTO should be well educated and trained so that they will have the ability to deal with the very complicated issues. Moreover, educational co-operation among various countries should also be preceded for further training on the transfer pricing issue.
From all above suggestions, it seems that some actions should be taken before the weakness of the Thai tax system is to be further exploited. However, not only are the tax legislation needed for radical changes, but also the entire system that Thai tax authorities must profoundly possess real comprehension and wide understanding of the policy and fundamental functions of the tax law as it is the mechanism driving the tax system as a whole to function properly.
Nonetheless, these suggestions cannot be successful without the co-ordination both in the domestic and in the international levels. This is because these co-ordinations would assist the tax authority to control the manipulative transfer pricing and obtain more accurate information of companies since these multinational companies involves with many government agencies and many countries.
For the domestic level, the related government agencies should co-ordinate with each other to handle transfer pricing issue. Likewise, for the international level, Thai government should co-ordinate with other countries. This could be achieved through the application of the tax treaty. At the very least there should be an ‘exchange of information’ provision regarding transfer prices, to assure that the same transfer pricing were being reported to both source and residence countries.
However, it is hard to conclude that to what extent the Thai government should adopt the approaches to deal with transfer pricing schemes due to the differentiation between the structure of Thai legal system and other countries. However, it is certain to conclude that the other countries’ approaches to the problem of transfer pricing are the very useful and valuable lessons to be profoundly study and observed by the government, court, Revenue, and law students in Thailand.
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