In an effort to safeguard its tax base and align with global standards, Taiwan implemented Controlled Foreign Corporation (CFC) rules effective January 1, 2023. These regulations aim to curb tax avoidance strategies that exploit offshore entities in low-tax jurisdictions.
Defining a Controlled Foreign Corporation (CFC)
Under Taiwan’s framework, a CFC is characterized as a foreign entity registered in a low-tax jurisdiction where:
1.Ownership Threshold:
- A Taiwan tax resident individual, along with related parties, directly or indirectly holds over 50% of the entity’s paid-in capital.
- A Taiwan legal entity, together with its related parties, directly or indirectly owns more than 50% of the entity’s paid-in capital.
2. Effective Control:
- Even if the ownership is below 50%, the foreign entity is considered a CFC if it is effectively controlled by a Taiwan tax resident individual or legal entity, along with their related parties, either directly or indirectly.
A low-tax jurisdiction is identified by one of the following criteria:
- The jurisdiction’s corporate income tax rate does not exceed 70% of Taiwan’s tax rate (i.e., 14%).
- The jurisdiction operates on a territorial tax system, taxing only income sourced within its borders and exempting offshore income unless repatriated.
The Ministry of Finance has published a list of jurisdictions meeting these criteria.
Identifying Related Parties
The term “related parties” encompasses a broad spectrum of relationships, including:
- Entities where a profit-seeking enterprise directly or indirectly holds 20% or more of the voting shares or capital.
- Enterprises where 20% or more of the voting shares or capital are owned or controlled by the same person.
- Situations where a profit-seeking enterprise holds the largest percentage of voting shares or capital in another enterprise, amounting to 10% or more.
- Cases where over half of the executive shareholders or directors are identical between two enterprises.
- Scenarios where a profit-seeking enterprise directly or indirectly controls the personnel, finance, or business operations of another enterprise.
A comprehensive definition is detailed in Article 3 of the “Regulations Governing Application of Accrued Income from Controlled Foreign Company for Profit-Seeking Enterprises.”
Scope and Applicability
Article 43-3 of the Income Tax Act mandates that profit-seeking enterprises include the profits earned from CFCs when calculating taxable income for the year. However, for interim corporate income tax computations, CFC income is excluded.
It’s important to note that if both CFC and Place of Effective Management (PEM) rules apply, PEM takes precedence. Additionally, a substance-over-form principle is enforced, meaning shares owned through nominees must be considered.
General Exemptions
CFC rules provide exemptions under specific conditions:
- Substantial Operating Activities: The CFC must have a fixed place of business in its registered location with employees conducting genuine business operations. Furthermore, passive income (e.g., rent, royalties, interest) should constitute less than 10% of the total operating and non-operating income.
- Earnings Threshold: If the CFC’s current-year earnings are below TWD 7 million, the income need not be reported. However, if multiple CFCs collectively exceed this threshold for a tax filing household, full reporting is required.
It’s also pertinent that if income has been recognized under PEM rules, there’s no necessity to report the same income under CFC regulations.
Tax Computation for Individuals
For individual taxpayers, CFC income is calculated as:
CFC Income = (Current-year earnings of the CFC – Required legal reserve – Prior year losses) × Direct holding ratio × Holding period
Key considerations include:
- Reporting Threshold: If the total computed CFC income for a tax filing household is less than TWD 1 million, reporting isn’t mandatory.
- Loss Carryforward: Documented CFC losses, verified by a Certified Public Accountant (CPA), can be carried forward for up to 10 years. These losses can only offset future CFC income.
Avoidance of Double Taxation
- Once dividends or earnings are actually received, they aren’t included in the basic income again.
- Foreign tax credits may be applicable, allowing taxpayers to offset taxes paid overseas against their Taiwan tax liability.
- When an individual sells CFC shares and calculates capital gains, previously included CFC income can be deducted based on the transaction ratio of the shares.
Implications for Offshore Trusts
The introduction of CFC rules has significant implications for offshore trusts:
- Discretionary Trusts: Beneficiaries of discretionary trusts often lack knowledge of their exact entitlements. The Ministry of Finance issued a ruling on January 4, 2024, stating that CFC income should be allocated equally among beneficiaries. This approach doesn’t account for potential discrepancies between reported CFC income and actual future distributions.
- Trustee Obligations: A subsequent ruling on July 10, 2024, requires offshore trustees to register with Taiwan’s tax authorities if a Taiwan tax resident settlor transfers shares or capital of a CFC in a low-tax jurisdiction into the trust. These trustees must maintain detailed records of all trust assets and appoint a responsible tax agent in Taiwan to handle tax filings and communications with the tax authorities.
Conclusion
Taiwan’s implementation of Controlled Foreign Corporation (CFC) rules marks a significant shift in its tax regulatory framework, aimed at preventing tax avoidance through offshore entities in low-tax jurisdictions. By requiring Taiwan tax residents to report and pay taxes on undistributed earnings from foreign-controlled entities, the government is strengthening tax transparency and compliance in line with global anti-tax avoidance initiatives.
For individuals and profit-seeking enterprises, understanding CFC rules is essential to ensure proper compliance and avoid penalties. The tax computation thresholds, exemptions, and loss carryforward mechanisms offer some flexibility, but taxpayers must maintain detailed records of their offshore holdings and related transactions.
Furthermore, offshore trusts are now under increased scrutiny. Trustees managing assets that include CFC shares or capital must adhere to new regulatory requirements, including registering with Taiwan’s tax authorities and maintaining detailed documentation. These additional compliance measures reinforce Taiwan’s commitment to international tax standards while increasing oversight on offshore wealth management structures.
To navigate these complexities, taxpayers should conduct a thorough review of their foreign investments, assess potential CFC reporting obligations, and seek professional tax guidance when necessary. Staying proactive will help individuals and businesses adapt to the evolving regulatory landscape while ensuring compliance with Taiwan’s tax laws.
