Taiwan Tax Alert: Legislative Yuan passes Industry Innovation Act and approves corporate tax rate reduction

The Taiwan Legislative Yuan passed the Industry Innovation Act (Act) on 16 April 2010, a law designed to attract capital investment in Taiwan for research and development (R&D), innovation and industry upgrading projects. The provisions of the Act, which apply retroactively as from 1 January 2010, are intended to replace the Statute for Upgrading Industries (SUI), which expired at the end of 2009. The Legislative Yuan simultaneously reached a consensus to amend the Income Tax Act to reduce the corporate income tax rate.


Tax incentives for innovation activities

The Act provides an income tax credit for innovation-related R&D expenses incurred by Taiwan-based enterprises at their facilities located in Taiwan. The Act allows a company to take a credit against its tax payable up to 15% of its total R&D expenditure for the current year. The tax credit is capped at 30% of the taxpayer's corporate income tax payable for the current year and cannot be carried forward.

The R&D tax credit provision is scheduled to sunset after 2020. The term "innovation activity" is not specifically defined under the Act, but further details and guidance will be provided in implementing regulations to be promulgated in the coming months. Taxpayers wishing to claim the tax credit for R&D expenditure should proceed with caution, however, until they can be sure that the R&D activities they have undertaken will be treated as qualifying "innovation activities" under the Act. Obtaining an R&D tax credit under the Act could ultimately be more difficult than claims for the various R&D tax credits that were available under the expired SUI, because Taiwan's tax authorities may scrutinize R&D-related expenses more closely to determine whether they are actually for innovation purposes as defined under the Act.

The Act also includes incentives for small and medium-sized enterprises, including a NTD 10,000 stipend for enterprises that hire new employees.

While the original draft of the Act included a number of additional tax incentives, such as provisions relating to the creation of logistics and distribution centers and operation headquarters, these incentives were eliminated in the final version.

Proponents of the Act contend that granting an R&D tax credit is critical during the economic downturn because companies may otherwise seek to reduce their R&D or industry upgrade transition expenses, which would severely damage Taiwan's overall competitiveness in the long term. Critics argue that the tax provisions in the Act unfairly benefit the interests of large corporations, instead of providing assistance to the multitude of small and medium-sized enterprises that employ the majority of workers in Taiwan.


Establishment of industrial parks

The Act also modifies the rules regarding the establishment of industrial parks by allowing central and local government entities, public enterprises and private individuals to submit development plan applications for the creation and operation of industrial parks to promote new industries and create new jobs outside of Taiwan's prominent high-tech sector.


Reduction of corporate income tax rate

In conjunction with the establishment of Industry Innovation Act, the Legislative Yuan has reached a consensus and plans to act in the near future to amend the Income Tax Act to reduce the corporate income tax rate from the current 20% to 17%. The expected lower rate is intended to boost Taiwan's competitiveness by bringing its corporate income tax rate in line with other countries in the Asia-Pacific region.

Taiwan Ministry of Finance explained that the corporate tax cut could create a short-term tax loss, but that it expected enterprises to use the tax savings for investments that will in turn drive innovation and create future tax revenue.

Lawmakers are hoping that the reduced rate will help attract foreign enterprises and lure overseas Taiwan entrepreneurs back to Taiwan to establish their Asia-Pacific operation headquarters and innovation operations.


Going forward

The recently expired SUI included tax incentives related to the establishment of a company's operation headquarters and logistics and distribution centers in Taiwan. Because similar provisions are not included in the Industry Innovation Act, companies that had relied on the SUI tax incentives in the past may need to reevaluate their positions going forward.

Foreign enterprises that have already established a logistics and distribution center in Taiwan may be able to apply the provisions of the Taiwan Free Trade Zone Act to mitigate their corporate income tax exposure for Taiwan-source income. Foreign enterprises also may be able to reduce their Taiwan corporate income tax payable by submitting an application to the Taiwan tax authorities requesting approval of their contribution ratio to determine their Taiwan-source income.

Without the SUI tax provisions, companies that have set up their operation headquarters in Taiwan will face taxation for dividends remitted to the headquarters from their foreign affiliates. Companies in this position will want to reevaluate their dividend distribution plans and/or corporate structures to determine whether an alternative model would provide a more efficient tax result.

Taxpayers that are uncertain how their tax position will be impacted by the new tax provisions should consult with their tax advisors to discuss these issues.