THE BIG SQUEEZE
With Asia's economic crisis now just a bad memory in most of the region, governments want a bigger slice of corporate profitability.
By Lynne Curry

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The party's over. Those generous tax holidays and rebates aimed at helping companies negotiate the financial crisis of 1997-98 are now pretty much history. In a sweeping about-face, governments have abandoned their flexible, sympathetic posture toward companies hit by the downturn. With economic growth once again on the rise in Asia, governments are working hard at broadening their tax bases and turning up the heat on tax collection.

Why the big tax squeeze if growth is back? Look no further than the swelling fiscal deficits in the region. Governments spent heavily to lift their economies out of the crisis and are now paying the price. As raising personal or sales taxes remains fiendishly unpopular, most governments would rather shake down the business sector instead. Further, Asian governments are now under pressure to bring their tax codes more into line with Western practices. For example, as members and would-be members of the World Trade Organization (WTO), India, Thailand and China need to reduce their protectionist customs duties which are designed to keep foreign goods out. Once these duties fall, the governments need to compensate for the drop in revenue. Few doubt that these governments plan to look hard at the corporate sector to make up the difference.

While direct tax rates aren't going up - yet - new taxes are cropping up, multinationals are getting painfully pinched and tax collectors are getting a lot meaner. In South Korea, for example, managers who take a client out to dinner are now obliged to pay by credit card. The reason? According to a new government ruling, companies that hope to get tax exemptions for business entertainment expenses must back up their claims with credit card receipts or face rejection. In the Philippines, US multinationals now pay a 25 percent withholding tax on royalty payments to their parent companies, compared to just 10 percent last year. In Thailand, China and India, governments are starting to clamp down on the practice of transfer pricing, which allows a company to artificially set prices and transfer profits from a subsidiary to a parent company, instead of keeping them in the country where the goods are produced. "If a company can't prove how it set up its transfer pricing and there is no documentation, that company will have a problem when an audit is done several years later," warns Janchai Chonlavorn, financial controller at Ford Operations (Thailand) in Bangkok.

At the same time, tax authorities are winding back tax rebates and incentives. For example, governments have become fussy about the kinds of businesses that qualify for tax breaks and this fussiness means that fewer companies qualify. In most countries, however, tax authorities will reward companies that spend research and development money on IT products for their own market. In China, companies that meet certain R&D conditions required by the government can claim generous tax deductions. These deductions, however, now come with strings attached. Companies must commit to several years of investment to reap the tax benefits.

Still, not every recession-inspired incentive is disappearing. Singapore's property companies are still receiving tax rebates, while Thai and Indonesian firms involved in mergers stemming from debt restructuring deals don't have to pay property transfer fees. In South Korea, a similar ruling provided a welcome boost to companies like Hyosung Corp., an industrial conglomerate that restructured its operations after falling deeply in debt two years ago. "This regulation was a very useful instrument," says Choong Suk Pyun, an auditor at Hyosung. "We sold our subsidiary to a German petrochemical company. We reduced our debt, have cash in the account, and our subsidiary merged into a single company without the additional cost of property transfer taxes."

Asian governments are also getting smarter about tax collection. Computerization, tax record centralization and transparent registration procedures are becoming the new standards. India, for example, now requires companies to have a tax registration number or risk having their applications rejected. Chinese tax bureaus now allow for computerized filing. For CFOs, this should make paying taxes easier, if not more welcome. In the following pages, CFO Asia takes a closer look at the recent changes to the tax regimes around Asia.

China

Faced with the prospect of a record budget deficit this year, China is working overtime to increase tax revenues, particularly from foreign companies. In a recent directive, Beijing cancelled special tax treatment given to foreign companies by local governments. Previously, local authorities seeking to woo foreign investors had offered flexible tax incentives, such as giving companies 25 percent value-added tax (VAT) refunds. However, "there are different opinions on this ruling," says Julia Zhu, tax manager at Kodak China in Shanghai. "Some say refunds from local government are acceptable, because they are local [and not central] government revenue." Kodak currently doesn't receive a VAT refund, but believes the new ruling could affect future projects. Before accepting preferential tax treatment from a local authority for a new deal, the company would seek an endorsement or approval in writing from the central government.

Further, a Beijing ruling on royalty tax payments has meant even more pain for foreign-owned companies. Taxes on royalty payments made to a parent company must now be paid whenever they accrue in the financial statement, according to the new regulation, regardless of whether or not the money is remitted to the parent. "We normally wouldn't make royalty payments until much later, but we are required to pay the tax whether or not we send the money," complains one CFO in Shanghai. "It's a killer on our working capital."

China's imminent membership in the World Trade Organization will present yet another blow to foreign companies - most CFOs expect that WTO membership will most likely end what's left of the mainland's preferential tax treatment for foreign companies. "Tax incentives originally given to foreign-invested enterprises will probably be phased out or cancelled," says Zhu. WTO membership is a "big disadvantage for foreign companies," says James Boyle, deputy general manager and acting CFO at Dura-Line Shanghai Plastics, a Sino-US telecommunications duct manufacturer in Shanghai. "Most Western companies have no funny books and keep only a real set, whereas most Chinese have two sets," he says, which means they can often afford to play a bit looser with the rules. As foreign companies don't have that kind of leeway, "paying taxes will be more expensive for foreign companies," he predicts. Despite this view, experts cite growing transparency in many Chinese companies.

Still, China has not rolled back its tax breaks for exporters - whether they are foreign owned or domestic. Companies that sell overseas are still receiving an increased refund rate of VAT, which has gradually risen from the normal 9 percent rate to 13 to 15 percent. In some cases, it reaches 17 percent. This move by China's authorities has been "a big help to companies," says Boyle. "It allowed companies to keep exporting during the financial crisis. It was a tricky way to devalue," he says.

Further, Beijing has also increased its tax incentives for the high-technology sector. One of the latest rulings enables a company to apply for a tax exemption from the 5 percent business tax on imports if it is importing high-tech equipment.

Hong Kong

Hong Kong dodged a bullet last month when Financial Secretary Donald Tsang did not include a sales tax or raise direct taxes in his annual budget speech. However, with the Special Administrative Region likely to chalk up its third fiscal deficit in a row this year, CFOs are still expecting trouble ahead.

CFOs still fear the government may adopt a sales tax down the road, a move that could seriously damage Hong Kong's attractiveness to business, they argue. "It would increase the cost of doing business and dampen the economy," says Stephen Lo, group financial controller at Chen Hsong, a manufacturer of plastic injection mold equipment. Others point out that a sales tax plus the new fees for the Mandatory Provident Fund, the government's compulsory retirement scheme, would put a punishing burden on small businesses in particular. "By introducing a sales tax and the MPF, the government is creating a big bureaucracy and an additional burden," says Alfred Chow, CFO at Hong Kong-based Karrie Industrial, maker of computer casings for US companies IBM and Compaq.

Not surprisingly, Hong Kong's legislators are equally set against a sales tax. Nonetheless, tax experts believe the government has little choice but to introduce new taxes sooner rather than later. While Hong Kong has retained its preeminent position in Asia as having the lowest corporate income tax rate of 16 percent, its tax base remains precariously narrow. About 5 percent of corporate taxpayers pay 80 percent of corporate tax. Much of those big taxpayers are property companies that have been hit hard by the recent slump in land prices and the volume of transactions. This, in turn, has given rise to tremendous swings in revenue growth. Further, as more companies transfer operations to China, revenue from profits tax continues to shrink. And the Basic Law, Hong Kong's mini-constitution, requires a balanced budget.

In the short term, Tsang plans to raise indirect taxes, such as instituting licensing fees for factories that produce chemical waste, as well as raising charges for water, education and medical services. Further, Tsang has established a task force to consider other means for broadening the tax base. "The government has to find another source of revenue," says Anthony Tam, a partner at Deloitte Touche Tohmatsu (DTT), "and the sales tax is a big possibility."

India

Domestic finance managers in India expect that the 10 percent surcharge on the basic 35 percent corporate income tax, reintroduced on a temporary basis in April 1999, no longer looks so temporary. "The 10 percent surcharge won't be removed," asserts S. Gopalakrishnan, general manager of finance at Bush Boak Allen India, a subsidiary of the US-based Bush Boak Allen which manufactures flavoring essences in Madras. For a reason, look no further than India's staggering budget deficit, he says. But while Delhi needs to broaden its tax base, increase revenue and scrutinize companies more closely, it's also under political pressure to woo business and reduce taxes.

Thus, there is good news for CFOs in India - the government is making big strides in liberalizing the tax environment. Over the past three years, Delhi has cut import duties from a peak of 300 percent to a top rate of 40 percent and last year, it slashed some duties even further to comply with WTO standards. "Over the past five or six years, the changes have been encouraging as the government rationalizes and simplifies the tax structure," says a CFO from a Mumbai-based engineering firm. The central government has recently unified the sales tax levied by different states and has standardized the excise tax on the production of goods. Indian tax authorities have also begun streamlining and centralizing control of direct taxes. Ultimately, a company based in one city will be able to file taxes anywhere in India. The government is also now requiring both companies and individuals to provide bank account and tax numbers for easy identification. "When you do a transaction, the first thing they ask for is the tax number or you can't do the transaction," says the Mumbai-based CFO. That makes the system more transparent and harder for companies to evade taxes, he says.

Despite these liberalizations, Indian executives are still suffering at the hands of the country's notorious court system. "We've had [tax] appeals pending for the last six years," says Gopalakrishnan. "Most companies have appeals. The tax rules are not clearly defined and disputes revolve around the interpretation of sales and the terms of sales." Aware of its cumbersome judicial process, the government is moving to reduce the case backlog.

Indonesia

Following Indonesia's agreement with the IMF to improve its tax collection, most CFOs expect tougher times ahead. "Soon there will be tax reform and the government will broaden the tax base," says Andrew Makmuri, finance manager at Upjohn Indonesia, a pharmaceutical manufacturer. "This will mean higher taxes for companies." Some multinationals believe the government will target them first, a practice a foreign diplomat calls "hunting in the zoo". He explains: "The government's attitude could well be, 'Let's go and get them, because they are relatively transparent and don't keep double books.'"

At the same time, Jakarta is taking a tough approach to the tax holidays it launched during the worst of the downturn. So tough, in fact, that some say the country's tax holiday regulations have become close to meaningless. "Tax holidays may apply to certain companies, but the government doesn't approve of them, although the regulations allow them," says Samin Tan, a partner at Hans Tuanakotta and Mustofa, a DTT-affiliated organization in Jakarta. "There is a lot of debate whether this policy still needs to be offered," he says. Indeed, the government is now considering the replacement of tax holidays with other types of incentives, including providing investment allowances and accelerated tax depreciation rates.

Meanwhile, Jakarta is continuing to support corporate debt restructuring with tax incentives. In addition to allowing tax-free mergers, borrowers that can't repay loans are given an extension on their tax payments for the bad loans (which are classified as income), while others continued to amortize or extend their foreign exchange losses suffered in 1997. "Most companies suffered losses because of currency depreciation," said R. Gururajan, finance manager at Texmaco Jaya, a textile chemical manufacturer. "For domestic Indonesian companies, taxation was a theoretical proposition. For those who didn't borrow in foreign currency, they will pay taxes, but for others, it's a problem," he says. Others took advantage of the weak rupiah. Upjohn's Makmuri says: "During the crisis, our company booked a foreign exchange gain and wanted to take it out, but we paid a huge amount of corporate income tax on it. This affected cash flow. [But] as a multinational, we can't ask for special treatment."

Malaysia

Malaysian finance managers enjoyed a tax-free year last year, but this year it's time to pay up. Moving to a self-assessment system for 2001, the Malaysian authorities are requiring companies to estimate the annual profit for the current year, calculate the tax and pay in monthly instalments on a current year basis. They have one chance to submit revised estimates of profits in June. If their calculations deviate significantly, they pay a fine. "The government is trying to pass the burden back to the individual," says Soon Wing Chong, finance manager at Western Digital, a computer hard disc drive manufacturer in Kuala Lumpur. "It will [mean] more bookkeeping for companies," says a financial manager at a plastics manufacturer in Kuala Lumpur. "The first few years it will be difficult. The cost of the tax accountants and consultants will be higher, and more responsibilities and penalties will be imposed on the client."

Like other governments, Malaysian tax authorities are trying to widen the tax net. Over the last three years, the corporate tax rate has fallen to 28 percent with the ultimate goal of reaching 25 or 26 percent. The government is moving towards adopting a VAT or consumption tax in an effort to reduce direct income tax, while taxing those who spend. "If you don't spend, you don't pay," says Patrick Yeoh, a partner at DTT in Kuala Lumpur. "Those who earn a lot, pay a lot." Malaysia already has a limited 5 percent service tax, which primarily applies to restaurants and other food establishments. The government has also continued to lower or abolish duties on fabrics, sewing machines, some clothing items, furniture, leather-based products and electronic motor parts to help stabilize inflation.

Meanwhile, even in a tax squeeze, Malaysia remains keen on nurturing its high-tech businesses - tax incentives for the IT industry are still in place. This pleases companies like Western Digital. "We save a lot of taxes because of the pioneer status they give," says Soon. "It's renewable every five years as long as your company brings in high-tech products."

Philippines

On top of a growing fiscal deficit, the Philippine tax authorities have a major debt collection problem. According to various estimates, about 40 percent of corporate income tax escapes collection. It's no surprise, then, tax decisions are getting tougher. The Philippine Supreme Court recently ruled that royalties and fees remitted by a US subsidiary based in the Philippines to its parent company are subject to a 25 percent withholding tax. A controversial decision, it is a "classic example of the flip-flopping of tax policy," says Homer Nuqui, vice-president of finance at California Manufacturing, a unit of American food manufacturer Best Foods, in Manila. Nuqui's bitterness is understandable. The decision reverses an earlier ruling by the Court of Tax Appeals that decreed withholding tax for US subsidiaries should be 10 percent.

Different Philippine commissions have considered this issue over the years, but this Supreme Court decision is seen as final. Still, Nuqui isn't convinced. "The different rulings have made it difficult for tax planning - you don't know the position of the government or what other policies will be changed," Nuqui says.

Still, Manila has been steadily lowering corporate income tax, from 34 percent in 1998 to 32 percent this year. Seeking to woo foreign businesses, the government has given tax incentives to MNCs that establish regional operating headquarters there. Previously, MNC regional headquarters weren't allowed to do business in the Philippines. Now, tax authorities charge MNCs 10 percent of the corporate income tax rate. Procter & Gamble and Shell have recently opened regional offices in the country, and California Manufacturing plans to set up its regional office there.

Singapore

In step with the trend elsewhere in the region, Singapore is cutting back on tax holidays. For example, Singapore's real estate companies, which were among the hardest hit in the financial crisis, enjoyed a 55 percent property tax rebate on commercial and industrial properties last year. In his latest budget, the city-state's finance minister said that the property tax rebate is being reduced to 25 percent beginning this July. As a sweetener, the government has reduced corporate tax to 25.5 percent from 26 percent, but the withdrawal of tax rebates packs a greater punch than the benefits of the marginal reduction in corporate tax.

"These tax rebates have helped," says Chong Yeu Liong, a treasurer at retail mall and service apartment investor Somerset Holdings, which is based in Singapore. "We managed to pass them on to the tenants. The rebates have helped landlords cope with depressed demand over the last 18 months." Still, companies have benefited from the liberalization of the financial market. Somerset was able to take advantage of tax incentives provided for purchasers of local currency bonds. Singapore dollar-denominated bonds, arranged by approved Singapore-based banks or intermediaries, are taxed at 10 percent interest, not the standard corporate rate of 26 percent. These bonds must be issued in a fixed period between February 1998 and February 2003. "This tax measure enables local companies like us to improve the yield on bonds," says Chong.

South Korea

Evenings on the town, paid for in cash, are out. Pens and umbrellas bearing the corporate logo are in. The Korean tax authorities are cracking down on business entertainment tax cheats. Finance managers wooing a client must now charge their food and drink on a credit card instead of paying cash for it. This system creates a dependable paper trail, allowing tax authorities to separate companies' legitimate expenses from the illegitimate ones. "Expenditures without credit cards cannot be recognized as deductions," said Keun Kil Paek, a partner at Ahn, Kwon & Company, a DTT affiliate in Seoul. "Companies don't like to spend at shops where there is no acceptance of credit cards. They try to use them as much as possible." Tax authorities have also shrunk the amount allowed for entertainment expenses. The amount is now based on a percentage of sales and capital, thus the bigger you are, the more you can spend.

This has had a big effect on small- to medium-sized Korean companies. "We changed from having dinners with customers to giving away promotional items," says Sun Koo Cho, controller at Grundfos Pumps, a subsidiary of Danish water pump manufacturer Grundfos. "If we have entertainment expenses higher than the limit, it's not deductible." Ms Cho adds that "confidential" fees, such as cash given at weddings and on other social occasions, are no longer accepted by the authorities without a receipt.

Still, Korean authorities are supporting the country's corporate restructuring by waiving the capital gains tax on real estate transferred in a merger. Further, they are open to negotiation over VAT payments with a foreign investor who believes its VAT payment is too high. They can negotiate to lower the amount, and sometimes, this tactic is successful. The moral: negotiation pays.

Taiwan

Although it was hardly hit by the economic turmoil in the region, Taipei is still giving fewer tax concessions these days. One of the reasons - revenues have fallen since Taiwan abolished the "two in one" dividend tax in 1998. Under that scheme, a company's earnings were taxed twice: they were subject to corporate tax, and after the earnings were distributed to shareholders they were again subject to individual income tax. Now, after the corporate tax is paid, shareholders are eligible to claim a tax credit against their individual income tax. "Since the total tax was reduced, it makes no sense to give tax holidays," says Al Chang, partner at Deloitte & Touche in Taipei.

The government is also scaling back on tax concessions in the stock market. Tax credits for shareholders investing in new strategic industries when shareholders hold the stock for more than three years are being reduced. After initially claiming 20 percent of the value of the stock for three years, corporate shareholders can claim one percentage point less every two years. Another move that put more money into the pockets of the tax authorities is the lifting of tax deferrals on cash bonuses given to employees. No longer can employees apply for tax deferrals with cash bonuses; they have no choice but to pay the tax at once.

While the government is withdrawing tax breaks, high-tech companies remain the darlings of Taiwanese industry. Last year, the government increased the amount high-tech companies could claim against their taxes on R&D expenses, specifically up to 25 percent from approximately 20 percent the previous year. Companies can also claim depreciation on the equipment. For Taiwan Semiconductor Manufacturing Corporation (TSMC), this ruling was a big help. "Normally, R&D equipment is very expensive, and in our case, isn't commercial," says Norman Shen, director of finance at TSMC. "It is designed solely for our company. Equipment is quite a big portion of our R&D. This enables us to decrease our tax burden."

Thailand

Greater scrutiny is the new mantra among tax authorities in Bangkok. Although no change in the tax law has occurred, Thai tax authorities are working harder at collecting the tax owed to them. To this end, the government recently created a special group called the Large Tax Organization. Trained by the Australian Tax Office, it has added teeth to the traditional Thai audit style. The new audits focus less on individual transactions, and more on the broad picture of how companies actually operate and transfer their profits out of the country. Organizations that qualify for this kind of scrutiny must have gross income of 500 million baht (US$13.5 million). "Thai tax authorities are looking to make sure Thailand gets its tax," says John Cifor, partner at Deloitte Touche Tohmatsu Jaiyos in Bangkok. "Companies should be more conscious when coming into the market that they face potentially more audits," adds Janchai Chonlavorn, financial controller at Ford Operations in Bangkok. "Companies need more documentation. The government is becoming more shrewd."

In order to help Thai companies still undergoing debt restructuring, the government has reduced VAT to 7 percent from 10 percent on the majority of goods and services until April next year when it automatically reverts back to 10 percent. However, this incentive has been a mixed blessing. Concern about widespread fraudulent VAT refunds and budget deficits have prompted the Thai revenue department to substantially slow the speed of these refunds.

Lynne Curry is a contributing editor to CFO Asia.