Taiwan Tax Alert: Calculation of creditable tax on dividends paid to nonresidents revised

On 30 March 2010, Taiwan's Ministry of Finance finalized a form required for tracing components of the new formula that applies to calculate the surtax credit that can be offset against withholding tax on dividends paid by Taiwan companies to nonresident shareholders.

Under the revised calculation methodology, which was included in amended article 61-1 of the Enforcement Rules to the Income Tax Act issued on 18 November 2009 and is effective for dividend distributions after 1 January 2010, the 10% surtax on undistributed retained earnings paid by Taiwan companies may be credited against the withholding tax on dividends distributed to nonresident shareholders.

Taiwan generally operates an imputation system to avoid double taxation of dividends. Under this system, where a Taiwan company distributes after-tax profits as dividends to resident shareholders, the distributing company also allocates the company's income tax paid on the dividends to the shareholders as an imputed tax credit. The imputation credit, however, is not extended to nonresidents. To mitigate the tax burden on nonresident shareholders, the 10% surtax (levied on a Taiwan company's current year earnings if they are not distributed to shareholders) paid at the corporate level may be used as an offset against the withholding tax on dividends distributed to nonresident shareholders.

The revised formula for calculating the amount of creditable tax for nonresident shareholders is as follows:

- Amount of creditable tax = Balance amount of 10% surtax actually paid in previous year as of dividend declaration date × [Amount of distributed dividends paid out of accumulated undistributed earnings that were subject to 10% surtax/Accumulated undistributed earnings that were subject to 10% advance tax] × % of shares held by nonresident shareholders as of the dividend declaration date.

- Maximum amount of creditable tax = 10% × Amount of dividends distributed to nonresident shareholders out of accumulated undistributed earnings that were subject to the 10% surtax.

Under the revised formula, only the portion of dividends distributed from accumulated undistributed earnings on which the 10% surtax was paid can give rise to creditable tax for nonresident shareholders. Thus, the greater the amount of dividends distributed from accumulated undistributed earnings on which the surtax was levied, the more creditable tax is available for nonresident shareholders to set against the withholding tax on dividends.

To calculate the balance amount of the 10% surtax actually paid in previous years as of the dividend declaration date, the payer company must trace back the requisite information in its Imputation Credit Account (ICA) from 1998 and include this on a new form filed with its FY 2009 income tax return.


Previous rules

Before the November 2009 change to the calculation method, the calculation of nonresident shareholders' creditable tax was governed by a 2007 ruling (No. 9604545780) issued by the Ministry of Finance. Under this ruling, if all dividends of a Taiwan company were distributed out of current year retained earnings, an advance tax credit was not available to foreign shareholders to offset dividend withholding tax. This rule also applies under the revised calculation method issued on 18 November 2009.

Under the 2007 ruling, if dividends distributed to shareholders included accumulated undistributed earnings that were subject to the 10% surtax, the Taiwan company could calculate the creditable tax and distribute it to nonresident shareholders in accordance with a specified formula. Again, the concept that the Taiwan company could distribute a creditable tax to nonresident shareholders only if distributed dividends are paid out of accumulated undistributed earnings that were subject to the 10% surtax is retained under the new calculation method.

The main difference between the calculation formula under the old and the revised regulation is that the new formula limits the creditable tax to the percentage of accumulated undistributed earnings that were subject to the 10% surtax that are being distributed, while the old formula did not. Thus, if a Taiwan company only distributes a small portion of dividends from accumulated undistributed earnings that were subject to the 10% surtax, the creditable tax available to nonresident shareholders likely will be less than it would have been under the old formula.


Conclusion

If dividends received by nonresident shareholders after 1 January 2010 are all from current year distributable earnings (on which the 10% surtax has not yet been levied), a surtax credit against withholding tax will not be available. By making such distributions, a Taiwan company could reduce its 10% surtax in the current year. Therefore, if a Taiwan company has a significant percentage of nonresident shareholders, it will have to decide whether to distribute dividends only out of current year's earnings, which could reduce its liability for the 10% surtax, or to distribute dividends out of previous years' earnings that were subject to the 10% surtax and thus afford creditable tax to the nonresident shareholders, but potentially increase its liability to the 10% surtax in the current year.

The revised calculation formula has no direct effect on resident shareholders because the Taiwan company can allocate income tax paid on the dividends for resident shareholders as an imputed tax credit, whether the company distributes dividends from current year earnings or accumulated retained earnings.

For nonresident shareholders, the more dividends distributed from accumulated retained earnings, the more net dividends nonresident shareholders will receive (after the credit against withholding tax). However, the Taiwan company's tax expense in the current year will increase by the 10% surtax on undistributed earnings, decreasing the distributable earnings in following years.