Double taxation in the AEC and tax credits in Thailand

The long-awaited formation of the Asean Economic Community (AEC) is just over five months away. Drawn by the promise of a freer flow of goods, services, investment, capital and skilled labour, many businesses need to study how to prevent or reduce the effects of double taxation.

Double taxation results from differences between the tax jurisdictions of different countries. For example, corporate income tax in Thailand is based on worldwide income, whereby net profits derived from all sources, whether in Thailand or abroad, are included in the tax base in Thailand. As the income that a Thai company derives from abroad is likely to be subject to tax in the source country, the same amount of profit is being taxed twice.

This “juridical” double-taxation effect can be minimised under the law. A company or juristic partnership incorporated under Thai laws and deriving income from a foreign country may be entitled to use the tax paid to the source country as a tax credit in Thailand, subject to the following conditions:

(i) The foreign tax must have already been paid. Where the foreign tax is actually paid in a subsequent accounting year, it may result in an adjustment to the Thai corporate income tax (CIT) return if is filed before the actual payment of the foreign tax.

(ii) The maximum amount of foreign tax that can be credited is limited to the amount of Thai CIT imposed on that foreign-sourced income.

(iii) For income derived from a business in a foreign country, the tax credit amount is limited to Thai CIT imposed on net profits computed under the conditions laid down in the Thai Revenue Code. For income derived from a foreign source without any business operation in the foreign country, the tax credit limit is computed by applying the Thai tax rate to that amount of foreign-sourced income — regardless of the actual amount of net profit.

(iv) The company must not deduct as a tax expense the foreign tax amount that is allowable as a foreign tax credit in (ii).

(v) The company must be able to produce documentation issued by the relevant country’s tax authority as evidence of payment of foreign tax.

Thailand has double-taxation treaties with every Asean country except Cambodia and Brunei, so the double-taxation effect can also be eliminated via these treaties if they are more favourable. For example, the Thailand-Laos treaty grants an underlying tax credit and a tax-sparing credit. In such a case, a company may opt to apply the foreign tax credit rule under a treaty, but the basic conditions of domestic law related to calculating limits may continue to apply.

Where the foreign tax amount exceeds the limit, the excess portion can be used as a tax expense for CIT purposes. For instance, a Thai company with a Myanmar branch would face a 35% tax rate, higher than the Thai CIT rate. The excess Myanmar tax can be deducted in computing net profits in Thailand. Although Section 65 ter of the Revenue Code disallows the deduction of “penalties, surcharges, fines, income tax”, the Revenue Department has ruled consistently that the foreign tax does not fall afoul of this provision.

Further, while foreign tax credits under domestic law are limited to a company or juridical partnership incorporated under Thai law, double tax elimination methods under tax treaties apply to any entity that qualifies as a “Thai tax resident”. This also makes it possible for a foreign individual who stays in Thailand for at least 180 days in a calendar year to claim tax treaty privileges if he or she pays taxes in other Asean member countries as a “Thai tax resident”.

Most Asean countries also impose indirect taxes in significant amounts. Indonesia, Vietnam and Cambodia impose 10% indirect taxes similar to VAT, and the Philippines has a 12% indirect tax. Unfortunately,there is no foreign tax credit for such taxes, so the only way to reduce the extra tax burden is to deduct such indirect tax as a tax expense. This is possible as Section 65 bis (6 bis) of the Revenue Code prohibits only the deduction of VAT payable under Thai law.

The Revenue Department ruled recently in the case of a Thai company that provided management services to hotels in Laos, where the service fees the company received were subject to indirect tax of 10%. It advised that, since the deduction of indirect taxes paid in a foreign country was not prohibited, and such taxes were qualified as expenses for the business in Thailand, the Laos indirect tax was deductible as a tax expense in computing Thai CIT.

However, as the Laos indirect tax was in fact borne by the Lao hotel, so if the service fee was 100, it paid 10 to the Vientiane government. The Revenue Department required the Thai company to gross up the tax (10) as additional income in computing CIT in Thailand (100+10=110).

This is because the law defines “taxable income” to include “any other benefits that are of money worth, including taxes borne by other persons…”. After deducting the indirect tax of 10, the Thai company was left with the gross service fee of 100 for CIT purposes.

Also note that the government is still working to revise Royal Decree No. 442 concerning offshore dividend exemption. To be eligible for a tax exemption, the offshore dividend must be paid out of profits that are subject to corporate income tax at a rate of not less than 10% (currently set at 15%).

The revised legislation will also allow a parent company in Thailand to set up a holding company in a tax haven jurisdiction as long as the underlying operating company is paying at least 10% corporate income tax. However, the parent company in Thailand must hold not less than 25% in the overseas company.