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TaxCORNER
LAWALLIANCELIMITED
The old expression, "Income tax returns are the most imaginative fiction being written" seems to be true when we look at the history of taxation.
One traditional tax planning technique that is drawing more reproaches from the Revenue Department involves transactions with a "circular" characteristic. This means that the parties usually enter into this type of transaction with a single or main purpose to carry out a series of transactions that will eventually generate tax expenditure.
Although Thailand does not have a specific anti-tax avoidance rule to prohibit the tax deduction, if the expenditure so generated lacks the characteristics required in the Revenue Code, i.e. it is spent exclusively for the profit-seeking or business purposes, it will not be deductible in computing corporate income tax.
For instance, where the price of subsidiary's shares deteriorates, a parent company will be allowed to deduct the capital loss upon the sale of such shares as long as they are sold at the price not lower than the market value. If the shares are sold at a low price, the law authorises the Revenue Department to assess the price up to the level of the market value. Until recently, no one really took into account the parent company's genuine motivation for its investment in such loss-making shares of subsidiaries.
In a revenue ruling, a parent company subscribed to the first lot of shares issued by a subsidiary when it was established to run a shopping mall. During the 1997-98 economic crisis, the subsidiary's business became dormant and it owed service fees to the parent company. In order to repay the debts to the parent company, the subsidiary increased its capital, on which the parent company subscribed to the second lot of the shares. Immediately after the subsidiary repaid the debts, the parent company sold both lots of shares in the subsidiary to others at a loss of 21,150,300 baht.
Even if the price at which the parent company sold the subsidiary's shares was at the market level, the Revenue Department considered tax deductibility of the losses between these two lots of the shares differently. While it advised that the capital loss attributable to the first lot of shares was deductible, that attributable to the second lot was disallowed.
The reason was that the parent company's motivation for investing in the second lot of shares was not for genuine investment purposes but with an intention to convert bad debt into an investment loss. Thus, such a loss did not constitute an expenditure that was exclusively spent for the profit-seeking or business purposes as required in the Revenue Code.
The above ruling may raise a question: would the parent company have been allowed the tax deduction had it sold the shares some time after it had received the repayment of debts from the subsidiary? Of course, the parent company's hasty sale of the shares made it too explicit that it had no commercial motivation in investing in the second lot of shares. However, holding the shares for longer may not be very helpful from the point of view of the Revenue Department if the subsidiary does not carry on further business.
Another issue may arise whether the same approach would have applied had the parent company incurred capital loss from the subsidiary's liquidation, rather than from the sale of the shares? Well, the answer from the Revenue Department probably remains the same as long as no business activities are carried out by the subsidiary.
In fact, the parent company can simply deduct the same amount of expense by following the procedures for bad debt write-offs pursuant to the relevant regulation, i.e. taking civil action against the subsidiary and obtaining a court order for debt repayment. Nevertheless, it is understandable that such a procedure would be time-consuming and harmful to the reputation of the group company.
Currently, there has been a move within the Revenue Department to issue a new regulation that would allow a parent company to convert debts owing to it by its own subsidiary into equity and to deduct such amount as an investment loss upon subsequent liquidation of the subsidiary. This draft regulation, if successfully issued, will allow intercompany bad debts to be written off easily without the need to go through court action as a prerequisite. On the other side of the coin, it could give a big tax loophole to taxpayers to play around with this deductibility rule.
At any rate, before the draft regulation becomes reality, the above ruling is a good warning that the Revenue Department will take the motivation of a taxpayer into consideration in determining the legality of tax treatment.
By Rachanee Prasongprasit and Piphob Veraphong. They can be reached at admin@lawalliance.co.th
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