Newsletter
REGULATIONS ON APPOR-TIONMENT OF COSTS TO TAX-EXEMPT INCOME
On 26 April 2007 the Ministry of Finance (MOF) announced its Regulations Governing the Ap-portionment of Costs, Expenditures, and Losses Associated with Tax-Exempt Income of Profit-seeking Enterprises, which took effect beginning with the 2007 income tax returns.
In the future, an enterprise specializing in the purchase and sale of real estate, securities, or futures, will be required to distinguish between costs attributable to their taxable income and those attributable to their tax-exempt income. If such enterprise has tax-exempt income, the costs associated with such income will be deductible only from items of tax-exempt income, and may not be deducted from taxable income, as this would improperly reduce the enterprises' tax burden. The provisions of the Regulations are outlined below.
I.Provisions based on previous MOF inter-pretations:
Past MOF rulings stated that if a profit-seeking enterprise has both taxable and tax-exempt in-come, then costs, expenditures, and losses that are directly and clearly attributable to the tax-exempt portion of its income should be di-rectly deducted from tax-exempt revenue alone, and cannot be deducted from taxable revenue. In the case of costs, expenditures, and losses that cannot be clearly attributed, a reasonable ratio should be calculated in which to apportion them between taxable and tax-exempt income. The formulae for such apportionment in principle remain unchanged under the Regulations, and are set out below:
‧Operating expenses: In principle, operating expenses should be apportioned in the ratio of the enterprise's non-taxable revenue to its aggregate revenue（including net operating revenue and non-operating revenue）. But when apportioning costs between different divisions, the enterprise may elect to apportion them according to a different ratio, such as the ratio of office space, or number of personnel, of the divisions concerned.
‧Interest payments: In respect of any amount by which interest payments exceed interest revenue, apportionment should be individu-ally calculated for land, securities, and futures according to the proportion of total available funds accounted for by the funds employed for each.
II.Types of enterprises exempt from the Regulations:
Any enterprise not specializing in trade in secu-rities, futures or real estate need only deduct from its tax-exempt income those costs and losses that can reasonably be directly attributed to such income. It need not further apportion to its tax-exempt income a portion of those costs and losses that are not clearly attributable. In current practice, an enterprise whose tax-exempt revenue accounts for less than 50% of its total operating revenues is considered not to be spe-cializing in such business.
III.New rules not included in previous MOF interpretations:
‧Definition of tax-exempt income:
Previous MOF interpretations have referred to only four types of income exempted from in-come tax: income from land transactions; in-come from securities transactions; income from futures transactions; and net share divi-dend or net earnings (not including investment income declared according to the equity method). In addition to these four categories, the Regulations also refer to "other tax-exempt income". Thus, other types of tax-exempt income, such as that during the five-year tax holiday, or generated by a company's opera-tional headquarters, will all be subject to the requirement of reasonable apportionment of costs, expenditures, or losses.
‧Conditions for different basis for apportion-ment between divisions:
The Regulations provide that for an enterprise to be allowed to choose a basis other than the ratio of non-taxable revenue to aggregate revenue for apportioning costs between its different divisions, it must fulfill both of the following conditions:
1.It must have separate divisions under the regulatory framework prescribed by the competent authority for the industry con-cerned.
2.The enterprise must maintain separate profit and loss accounts for each individual division.
‧Deferred declaration of costs associated with unsold sources of tax-exempt income:
If an enterprise holds a source of tax-exempt income such as land, securities, or futures, and in a given accounting period it sells only part of such an income source, or sells none of it, then when filing its tax return for that year the enterprise may not yet declare the costs or losses associated with the unsold portion (in-cluding costs, expenditures, interest, or losses that can directly be reasonably and clearly at-tributed to the income source, and interest payments that cannot be clearly attributed and are therefore required to be apportioned be-tween taxable and tax-exempt income). The costs and losses that should be attributed to the tax-exempt income may not be deducted until the asset is sold.
The Regulations provide that an enterprise may not apportion and declare the costs, ex-penditures, and losses associated with a source of tax-exempt income until it has sold the asset concerned, and in any year in which the en-terprise has not sold such assets it may not apportion and declare related costs. By this method of using the ratio of costs associated with assets already sold to those associated with assets not yet sold, the tax authorities can monitor the unsold sources of tax-exempt in-come held by an enterprise, and thus can clearly identify and attribute tax-exempt in-come and its related expenditures and costs, and require the apportionment of those that are not directly attributable.
For example: in 2006 Company A purchases 10 shares in Company X, thereby incurring clearly attributable costs of NT$90,000 to the shares purchase, as well as interest payments of NT$10,000 that cannot be clearly attributed to the share purchase and require apportion-ment, giving a total cost of NT$100,000. In 2006, A does not sell any of the shares, while in 2007 it sells four shares, and retains six unsold. When A files its business income tax return for 2006, because it sold none of the 10 shares in that year, the NT$100,000 must be carried over in full to the year of sale. In 2007, because A has sold four of the shares, the cost of the four shares, totaling NT$40,000, should be declared as costs associated with tax-exempt income arising in 2007. It will change the costs and the gains derived from the securities transactions in 2006 and 2007 so the calculation of Alternative Minimum Tax（AMT）will be affected. As to the six re-tained shares, the cost of these shares, totaling NT$60,000, must again be carried over, and cannot be declared as costs associated with tax-exempt income arising in 2007.
‧Purchase of land other than as fixed assets by enterprises not specializing in real estate:
With regard to tax-exempt income from land, the Regulations include an additional provi-sion that if an enterprise not specializing in land investment holds land that is not entered in its accounts as a fixed asset, and it neither uses the land in the operation of its business nor has a clear plan for the sale of the land, then the costs associated with future tax-exempt income from the land cannot be included in the enterprise's costs for the ac-counting period in which such costs arise, but must be carried over to the year of sale. For enterprises that have invested in land but do not have a specific plan for its use, this provi-sion will reduce their declarable costs and thus increase their tax liability.
‧Taxable income from unsold sources of tax-exempt income:
If an enterprise's use of unsold sources of tax-exempt income, i.e., land, securities, or futures, gives rise to taxable income (e.g., rental income from land, or lending fees from securities lending), then interest payments at-tributable to the individual income source may be declared as expenditures for the year in which the taxable income arises, up to the amount of such taxable income, and may be deducted from the enterprise's taxable income for that year.