Withholding Tax for Electronic Services and Royalties: Key Regulations and Compliance in Taiwan 

With the increasing frequency and diversity of cross-border transactions, the demand for procuring electronic services from abroad has only surged, particularly due to the acceleration of digital transformation during the COVID-19 pandemic. Payments made to foreign companies for services provided to Taiwanese businesses via the internet or other electronic methods are generally regarded as Taiwan-sourced income and are therefore subject to tax withholding. 

Foreign companies earning income from providing services through online or other electronic methods may apply to the tax authority for approval of the applicable net profit ratio and the domestic contribution percentage, then used to calculate taxable income and withholding tax. If the applicable net profit ratio multiplied by the domestic contribution percentage exceeds 15%, and the provided services meet the criteria of Article 25 of the Income Tax Act regarding technical services, the foreign companies may also apply to calculate withholding tax based on 15% of revenue from Taiwan. 

Furthermore, if the foreign company’s country has signed a Tax Treaty with Taiwan, the income derived from such services may, under qualifying conditions, be eligible for exemption as business profits. These are currently common methods to effectively reduce the actual withholding rate for cross-border electronic services. 

Regulations on the Identification of Royalties under the Taxation Rules for Cross-Border Sales of Electronic Services

The term “electronic services” has been clearly defined as follows: 

  • Services transmitted via the internet and downloaded for use on computers or mobile devices.
  • Services used directly over the internet without requiring download or storage on any device.
  • Other services provided via the internet or electronic means.


The sales models can be broadly classified into two types: “platform-based electronic services” and “non-platform-based electronic services.” Examples of non-platform-based electronic services include the sale of e-books, standardized software, online games, music and videos, and online courses. Whether such services constitute Taiwan-sourced income depends on their economic connection to Taiwan.
 

For instance, if standalone software, e-books, or similar products are produced and completed overseas by a foreign company and transmitted via the internet or other electronic means for download and use by buyers in Taiwan, and if the process does not involve participation or assistance from any individuals or businesses within Taiwan, the revenue are not considered Taiwan-sourced income. 

Furthermore, under the taxation rules and related operational guidelines for cross-border sales of electronic services, it is clearly stated that “payments received by foreign companies for transmitting patents, trademarks, copyrights, trade secrets, and other licensed rights via the internet or electronic means for use in Taiwan” are considered royalties. In other words, under cross-border e-commerce regulations, if the electronic services provided by foreign companies via the internet or electronic means include the use of the rights defined above, such income must be excluded from the scope of electronic services.  

Principles for Identifying Royalties in the Review of Technical Services under Article 25 of the Income Tax Act

When foreign companies provide “technical services” and receive compensation while applying for the preferential tax rate under Article 25 of the Income Tax Act, tax authorities often inquire whether the compensation contains elements of “royalty” income during the review process. If part of the compensation is determined to constitute royalty income, it must be separated from the contract price and excluded from the preferential tax rate. 

The scope of royalty determination includes not only the general definition, which refers to compensation for allowing others to use business rights, copyrights, patents, trademarks, business names, brand names, designs or models, plans, secret methods, trade secrets, as well as various franchise rights, marketing networks, customer data, and other rights with property value, but also revenues derived from providing technical services via the internet or other electronic transmission methods. The following situations are specifically mentioned in the review principles as standards for tax authorities to determine royalty income: 

  • During electronic data processing and storage, if customer lists, business information, or other proprietary data are provided, the compensation for such components constitutes royalty income.
  • System and application software licensing, including licensing of source code, constitutes royalty income.
  • For customized system development, if ownership of the system remains with the seller, or compensation is based on production quantity or sales revenue, the income is classified as royalty income.
  • For reports or documents generated as part of the service, where the copyright belongs to the author, compensation related to the use of such reports or documents must be separated from the contract price as royalty income.
  • For program signal transmission, uplink, and download services, if the content involves the use of program tapes or video licenses, the related compensation is treated as royalty income.
  • For market research services, if the models or software used to create the research report are provided to the service purchaser, the compensation related to these components constitutes royalty income.
  • For educational training services, if the course materials or content involve proprietary technical information or secret methods, the corresponding compensation must be identified as royalty income and separated from the contract price.

Standards for Determining Royalties under the Guidelines for Applying Income Tax Treaties

Royalties under income tax treaties are generally determined based on the following standards: 

  • Purpose of Use by the User:
    Authorizing others to use or have the right to use computer program works includes the right to use or reproduce the software to produce specific results from a set of instructions. However, for personal (non-commercial) use, operation, or reproduction of the software for backup purposes, it does not constitute royalties under the treaty.
  • Activities Conducted by the Provider:
    The revenue obtained for authorizing others to use “industrial, commercial, or scientific experience or information” applies when the information provided is pre-existing, not publicly available, and requires confidentiality. Additionally, the provider does not need to engage in further activities for customization purposes and does not guarantee any outcomes from the use of the information. Such income for providing “industrial, commercial, or scientific experience or information” can be further divided into:

(1) Passive Activities: Income for authorizing others to use pre-existing but undisclosed specialized knowledge or technical know-how. These payments are classified as royalties under the tax treaty. 

(2) Active Activities: income for using specialized knowledge or technical know-how to provide services to others. Such compensation is classified as technical service income and should be handled in accordance with the provisions for business profits or technical service fees under the tax treaty. 

Conclusion

In practice, when dividing electronic services and royalties for cross-border sales via the internet or other electronic means, it is common for tax authorities and taxpayers to have differing interpretations. During the review process, further clarification and breakdown of the services provided are often required to determine whether royalties are involved, which can be complex. There may also be cases where the taxpayer’s claims during the application process do not align with the final decision by the tax authorities. 

For the various types of transaction models, the outcome may differ depending on the specific terms of the contract. Foreign companies must determine whether their revenue arises from cross-border sales of electronic services or from royalty payments for licensing. To reduce the applicable withholding tax rate, buyers should refer to relevant legal regulations at the time of contract signing. This will help minimize the risk of the income being categorized as royalties by tax authorities. Prior to submitting an application, taxpayers should re-evaluate their case from the perspective of the tax authorities to avoid significant discrepancies between their claims and the final review results, which could lead to additional tax burdens. 

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