Tax trends in the Asia–Pacific regionApril 11, 2012
In the wake of the global financial crisis, many Asia–Pacific leaders who saw robust economic growth return in 2010 have continued the switch from fiscal stimulus to fiscal consolidation, with an emphasis on increasing tax collections and restraining spending growth.
The goal was to eliminate budget deficits (or increase existing surpluses) and reduce the debt they had taken on during 2009. The figures shown in Table 3 demonstrate that many are succeeding in this endeavor.
Singapore, Korea and Hong Kong are projected to run budget surpluses in 2012, and every other nation except Thailand shows a trend toward lower projected deficits between 2011 and 2013, even Japan (see Table 3).
In Thailand, the budget deficit is trending slowly upward but not alarmingly so, considering its modest debt.
This may be largely the result of disastrous flooding in late 2011 that knocked at least two percentage points off Thai GDP growth.
With a recent flood–related stimulus package passed in Thailand and a very significant corporate income tax rate cut from 30% to 23% for 2012 (and a further temporary reduction to 20% for the next two tax years), it will be interesting to see how these figures change over time.
South Korea, meanwhile, reports a strong shift in stance towards consolidation, both raising headline personal income tax rates and also repealing a previously planned reduction of the marginal corporate income tax rate (from 24.2% to 22%) effective from the fiscal year commencing on or after 1 January 2012.
The successful transition from fiscal stimulus to fiscal consolidation in many of the region’s governments has justifiably built confidence in Asia–Pacific economic policy.
Leaders there have many reasons to believe that their nations have promising economic prospects and some of the soundest budgets in the world.
This should make it even more likely that strong capital flows will continue in their direction.
Growth is projected to be strong in 2012, surpassing that of many emerging markets in the Americas, and the tax policies Asia–Pacific nations choose will play a significant role in helping them fulfill hopes for economic growth.
Lowering statutory corporate tax rates to compete for investment
There are short–term and long–term strategies to raise government revenue, and most governments in the Asia–Pacific region have been pursuing both.
The long–term strategy is focused on attracting investment because the jobs and infrastructure created by companies locating there will increase wealth, grow the tax base and enable growth in tax revenue.
Usually, the legislative and administrative measures that attract investment in the long term have the short–term effect of diminishing tax revenue.
However, if those short–term revenues can be collected through other means, then both short– and long–term revenue goals can be met.
A longstanding tactic that nations around the world have been using to compete for economic development, assuring a healthy tax base in the long term, is lowering the statutory corporate tax rate.
Over the past few decades, that trend has intermittently slowed and accelerated, but it has never entirely stopped.
Recently, the strategy of lowering corporate rates received academic support from the influential Organisation for Economic Co-operation and Development (OECD), which ranked corporate income taxes as the most damaging type of tax, followed by personal income taxes, indirect taxes and property taxes.
An Ernst & Young survey of tax executives of global companies shows most agree with the OECD position.
Our survey asked what factors make them more likely to invest in a particular location, and senior executives cited a low corporate tax rate more frequently than any factor except the projected rate of economic growth.
Many countries seem to have taken the words of the OECD to heart and as a result, many commentators have talked of the “race to the bottom.”
After many mature markets in Europe and Canada saw stimulus as a useful way to fast–track reductions in headline corporate tax rates in 2009–10, many countries in the Asia–Pacific region are starting to react, putting in place a series of significant moves that may continue in 2012 and beyond.
Statutory corporate rates in Asia–Pacific currently range from 16.5% in Hong Kong to 41% in Japan, although that figure will soon fall as Japan has successfully enacted a long–delayed plan to cut its corporate tax rate by 4.5 percentage points, effective 1 April 2012.
Although the Japanese rate cut became law in December 2011, the disasters of 2011 have been so costly that legislators ended up giving the cut with one hand, only to claw back a substantial part of it with the other.
A 10%, three–year corporate surtax was enacted along with the statutory rate cut, which will result in an effective tax rate of 38.01% in 2012, 2013 and 2014, before falling to 35.64% in 2015.
This reduction will give Japan a tax rate lower than the current United States effective rate of 39.2%. Still, Japan will continue to have the highest rates in the Asia–Pacific region.
It is also worth noting that Japan’s headline rate cut, in common with the overall trend for headline rate reductions, is accompanied by base–broadening measures such as disallowing the deduction of excess interest.
Wishing to collect more revenue despite the corporate rate cut, Japan has not only enacted the three–year temporary corporate surtax but also a “temporary” personal surtax of 2.1% (that is set to expire in 2037) and a politically sensitive proposed doubling of its consumption tax, from 5% to 10%.
In 2008, China cut its headline enterprise tax rate to 25% from 33%. In the interim, China has sought to make the policies consistent and fair for its domestic companies by removing most of the incentives and deductions enjoyed by foreign companies.
This phase was perhaps most recently illustrated by the imposition of social insurance charges on foreign nationals working in China.
Rates vary by local government policy and in some cases could be as much as 20% to 40% of an average salary in a given location for an employee and employer, respectively.
Three nearby jurisdictions have established corporate tax rates significantly lower than China’s, and a fourth is just joining them this year.
Singapore cut its rate to 18% in 2008, and after Hong Kong lowered its rate to 16.5%, Singapore reduced its rate to 17% in 2010.
Taiwan competes in this cluster of ultra–low corporate tax rates, having cut its statutory rate from 25% to 17%, effective in 2010. Thailand is the newest entrant into this club.
While it maintained a comparatively high rate of 30% for several years, it has just announced a bold, politically controversial move.
The government will cut the headline corporate tax rate permanently to 23% effective in 2012, with another reduction to 20% that applies to tax years 2013 and 2014, even as the country copes with serious short–term fiscal pressures related to devastating floods in late 2011 that depressed agricultural, manufacturing and mining output.
The scope of the economic damage is immense, with many important facilities having spent several weeks underwater and government revenue reduced. As with all such calamities, criticism is intense.
Yet to the distressed business community, the government offers a huge incentive to profitable corporate facilities.
Thailand is also motivated by its need to conform its taxes more closely to the other members of the ASEAN Economic Community, which is aiming to create a free trade zone among its 10 members by 2015, the same year the organization convenes in Thailand.
Other Asia–Pacific nations have declined to cut their rates to 20% or less but have still followed the general downward trend.
Three have matched China at 25%. Indonesia’s rate had been 30%, but it dropped to 28% in 2009 and then to 25%. Similarly, Malaysia cut its rate in increments from 28% in 2006 to 25% in 2010.
Vietnam’s rate has been stable at 25%, though it offers a concession to small– and medium–sized enterprises. The Philippines lowered its corporate rate to 30%, effective 2010.
A new rate this year is New Zealand’s 28% rate, a cut of two percentage points. Australia has announced that it will cut its corporate rate from 30% to 29% effective 2013.
Keen to stay in the tax competition race, the Australian Government would have preferred to provide a larger reduction to business but was stopped from doing so by the need to narrow the scope of the controversial Minerals Resource Rent Tax (MRRT).
Finally, as noted, Korea lowered its headline corporate rate in 2009 to 22% (24.2% including surtax) and promised a 20% rate to be effective in 2012.
However, in November 2011, the government announced that it would apply the new, lower rate only to medium–sized firms, maintaining the current rate for large corporations.
Doing well by doing good? Pursuing a revenue–raising environmental policy
We have chronicled the downward trend in statutory corporate tax rates across the Asia–Pacific region and attributed the low indebtedness of the region’s governments to robust growth and fiscal consolidation.
But because Asia–Pacific governments are still increasing spending, they must collect revenue in other areas of the tax base. The green economy is proving to be one driver of tax policy is this area.
The world’s governments increasingly are labeling industries as “green” or “clean” versus “dirty.”
Companies that manufacture products that have a pro–environment reputation, such as those making high–tech batteries, wind turbines, solar panels or any product that consumes less power than its competitors, are deemed to be “green” and perhaps worthy of a tax concession.
On the other hand, mining companies, energy companies, power companies and any industries that use a relatively large amount of power and natural resources are “dirty” and targeted for additional taxes.
We have identified four basic ways in which the green movement is changing tax policy: higher taxes on mineral resources, higher taxes on all carbon emitted into the atmosphere, lower taxes on green industries and higher taxes to pay for recovery after natural disasters.
Raising taxes on mineral resources
During 2012, Asia–Pacific nations will continue to raise additional revenue from their natural resources. The method can be a straightforward legislative action raising the income tax rate or the amount per ton of mineral extracted.
For example, Vietnam’s 25% corporate tax rate does not apply to oil companies or other extractive industries; the rate on them varies from 32% to 50%. In China, the five–year plan states calls for tax measures to be used as a macroeconomic policy tool to control pollution and resource exploration to achieve a greener environment.
Measures could include increasing the tax burden on high resource–consuming products and reducing and/or suspending export refunds for such products.
Since 1 November 2011, companies extracting natural resources have been paying a tax based on value or weight. For example, the coal tax will vary from RMB2.5 to RMB8 per ton, depending on the type of coal and the location of the mine.
The tax on crude oil and natural gas will be 5% of the value. Foreign contractual companies exploring for oil on shore are included.
Further, a 5% tax plus local levies will be imposed for the transfer of resources in China by way of adding a new taxable item of “resources” to the existing list of intangibles subject to business tax (BT), effective 1 February 2012.
The taxable transactions include transferring the right of resources in exploration, exploitation or the right to the use of the resources on land and ocean.
The green effect is evident in consumption tax policy, too.
China plans to apply its VAT to all products that are resource– consuming or deemed as environmentally damaging. But revenue can be raised without new statutory tax rates.
For example, in Australia tax authorities have declared their intention to re–examine how generously mining companies’ expenses in exploration should be treated. And in Indonesia, transfer pricing audits are focused on mining, especially coal, oil and gas.
Despite widespread debate over carbon taxes and other carbon pricing regimes, few nations have enacted one. However, due to a remarkably even split between the two major parties in Australia, the minority Greens were able to enact their agenda, a new carbon tax.
Other nations in Asia–Pacific and around the world will be observing the Australian experience, including China, whose State Council has announced that it is considering a “green tax” and gradual expansion of the tax bases to preserve the environment and reduce carbon emissions.
In addition, China intends to pilot a number of carbon trading schemes. Korea and Japan have announced that they are working on introducing carbon trading schemes, and New Zealand has a limited carbon trading system already in place.
Taiwan, too, has declared its intent to promote a sustainable environment with its tax code and expresses interest in a “green taxation system,” and a proposal is pending in the Vietnamese legislature to enact an environmental protection tax.
Enacting tax breaks for green industries
Not all green tax policies raise revenue, and examples of special tax concessions abound. In China, green technology firms can qualify for an exemption from the BT and VAT.
One program offers a “3+3 CIT holiday,” which means that beginning with the first year that a green firm generates business–related revenue, it can claim a full corporate income tax exemption for three years, followed by three years of a 50% exemption.
Last year, Thailand enacted targeted tax breaks to encourage foreign investment in specific green and high–tech industries, and Japan has introduced an immediate deduction for investments companies make in energy–saving facilities or in developing energy–saving appliances.
In the Philippines, a tax subsidy for the manufacture, importation and development of hybrid and e–vehicles progressed in the legislature during October 2011 and is expected to be enacted in 2012.
The incentives include exemptions from VAT, excise tax and duties for nine years. Originally scheduled to take effect in 2011, Australia’s green buildings tax credit will now take effect in July 2012. It offers a bonus tax deduction of up to 50% of the money companies spend on improving their existing buildings’ energy efficiency.
Recovering from natural disasters
Environmental disasters profoundly affected tax and spending policies in Australia, New Zealand, Japan and Thailand in 2011.
It is routine for tax administrators or legislators to offer some concessions after natural disasters. The series of earthquakes in New Zealand, for example, imposed the huge cost of rebuilding the Canterbury region.
Part of that assistance was delivered by the tax system as earthquake– affected businesses received concessions, particularly around the treatment of insurance proceeds and the destruction of depreciable assets.
Earlier in 2011, Australia announced a one–time flood levy to fund lost infrastructure in the wake of the Queensland floods.
The impact of the Great East earthquake on the Japanese people has been profound, affecting every aspect of life including the tax system. A corporate tax rate reduction that had been scheduled to take effect in the spring of 2011 was postponed when the devastating tsunami struck.
When finally amended by the addition of the Restoration Funding Bill and enacted in December 2011, the new law cut the national corporate tax rate to 25.5% but also imposed a 10% surtax on corporate income for 2012–14 and a 2.1% personal income surtax for 25 years, also starting in 2012.
Some climate change forecasters predict that natural disasters will become increasingly frequent and catastrophic, implying that governments should leave room in their budgets for more disaster relief and adjust their tax codes accordingly.
Targeting tax incentives more narrowly
Not long ago, many tax opportunities existed in Asia–Pacific, especially China, for all kinds of companies. Now the sought– after industries are fewer.
Vietnam is still offering some of the manufacturing incentives that China formerly offered and recently reduced its interest withholding tax to 5%, effective 1 March 2012, from current rates of at least twice that level.
Large infrastructure projects will gain significantly. The withholding tax reduction is accompanied by several other pro–business changes enacted on 27 December 2011. More commonly, though, incentives are industry–specific, with the financial services industry a major beneficiary.
Highly mobile and tax sensitive, that industry generates substantial incomes for workers and plays a very useful role in the promotion of economic growth more generally. In other words, the financial services industry is in an excellent position to play nations off against each other.
Hong Kong is the established leader in this field and during 2012 will focus on:
- Being the premier offshore provider of renminbi services, which is not a new distinction for Hong Kong but is more important with the rise of the renminbi as a major world currency
- Attracting overseas companies, especially from emerging markets, to list on Hong Kong’s stock exchange
- Seeking agreements on the avoidance of double taxation with more trading and investment partners to foster the growth of the asset management business
Malaysia, Singapore, New Zealand and Australia have all enacted advantageous tax provisions to attract high value–added financial services to compete with Hong Kong.
Vehicles to raise revenue: aggressive tax administration and higher indirect taxes
Higher taxes on “dirty” industries are probably not capable of raising the amounts of new revenue that governments want for spending initiatives.
For the bulk of their new revenue, governments have increasingly turned to stricter tax enforcement on international taxpayers and higher consumption taxes, and during 2012 we expect both trends to accelerate.
Increasing levels of tax enforcement: rejection of traditional holding company arrangements
China’s Circular 698 has been a source of consternation for taxpayers who depend on the traditional tax treatment of holding companies.
Repeatedly in 2011, when China’s tax authorities learned of indirect disposals of holding companies that were resident in tax–advantaged countries such as Mauritius or the British Virgin Islands, they ignored the holding company structures and imposed tax on the seller.
Counting both direct and indirect disposals, tax adjustments are up by nearly 500%, from RMB0.46 billion (US$72 million) to RMB2.66 billion (US$419 million) during the past five years.
In some cases, China’s tax authorities learned of indirect disposals during discussions with the taxpayer, but often a newspaper article or web posting was the original source.
As highlighted in Ernst & Young’s 2011–2012 Tax risk and controversy survey, media exposure is having a much greater effect on tax administration than in years past, and we expect the growing scrutiny of business tax affairs by news organizations and activist groups around the world to play an even greater role in 2012 and beyond.
From 2011 to 2016, China’s State Administration of Taxation (SAT) plans to improve its prevention of tax avoidance in five areas:
- Enterprises — extending to parent companies of domestic enterprises going overseas
- Industries — extending to financial services, trading and other service industries
- Transactions — extending to transfers of equities or intangibles and financial arrangements between related parties
- Locations — extending to central and western China
- Measures — extending to cost–sharing agreements, controlled foreign companies, thin capitalization and tax–planning activities involving overseas cost allocation or the use of intermediate holding structures and tax havens
Increasing levels of tax enforcement: other initiatives
In Australia, the tax authority has established a reputation for robust enforcement.
That will not change during 2012 as it intends to perform more tax audits, continue requiring pre–lodgement reviews from the top 120 companies and continue targeting those large companies who fall into their “high risk” definition.
New legislation will be enacted in 2012 to amend transfer pricing laws, giving the Tax Commissioner greater power to reconstruct or ignore legal transactions.
The new law promises additional contemporaneous documentation obligations and stronger penalties. Most controversially, it will authorize the tax authority to reinterpret transactions back to 1 July 2004.
In addition to surprising taxpayers who thought past years’ transactions were a settled matter, Australia’s retroactive changes might also encourage other countries, with weaker fiscal positions than Australia’s, to consider the same approach during 2012.
Philippine tax authorities continue to employ aggressive tax administration and enforcement measures to increase tax collection, such as specialized tax audits on conglomerates and professional individuals, close tax compliance monitoring of large taxpayers, and regular performance evaluations of revenue examiners and officers.
Increasing levels of tax enforcement: using the media
The Philippines may have strict audits, but it is best known for Run After Tax Evaders (RATE) and Run After The Smugglers (RATS), two publicity campaigns that have produced many civil and criminal charges against suspected tax evaders, smugglers and corrupt tax officials.
This is the type of media–related tax administration that we expect to see more often during 2012. Similarly, Singapore’s tax authority publishes the names of non– compliant taxpayers as a deterrent measure.
Increasing levels of tax enforcement: Asia–Pacific region confirms trend toward disclosure and transparency
The trend towards increased disclosure and transparency requirements was certainly illustrated in the region in 2011 and will likely continue to grow in 2012.
During 2011, Australia unveiled its Reportable Tax Position (RTP) strategy, which was broadly similar to the US’ Uncertain Tax Position requirements. Both programs require corporations to explain their reasoning, or “position,” whenever a tax calculation is not very likely to be correct.
Countries such as Malaysia and the Philippines, meanwhile, have sent large taxpayer forms requesting detailed information about cross–border transactions with related parties.
While many countries in the region are not part of the OECD (and its Forum on Tax Administration, in particular), it will be interesting to see to what extent similar requirements are unveiled in 2012.
After extracting more information from taxpayers than they had previously, tax authorities take transparency another step by sharing their taxpayers’ data with other tax authorities.
Governments have signed hundreds of bilateral and some multilateral tax information exchange agreements (TIEAs) during the past year, and the nations that were slow adopters are quickly catching up.
In addition to sharing data, some governments have tentatively begun combining their forces in a simultaneous audit. However, those have not become as popular as we thought a year ago that they might.
This article was first published in the Ernst & Young Tax Policy and Controversy Outlook publication which can be accessed using the link below: