TIGHT & TIGHTER
As the tax man squeezes harder, CFOs are expanding their strategies to find the best breaks.
By Lotte Chow

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Wai-kit Lau, CFO of Hong Kong's Asia2B, has a reason to be cheerful. In January, his B2B portal completed a no-cash, all-stock merger with Singapore's Sesami.com to create Sesami Inc, a regional e-commerce hub. The deal means more than survival for Asia2B. Lau says the combined group, with annual sales of US$25 million, will break even next year and start producing profits as early as the next.

So where did Lau and CFO Moh-gin Teo of Sesami.com decide to incorporate the new company for tax purposes - low-tax Hong Kong, or Singapore, with its comprehensive network of bilateral tax treaties offering advantages for cross-border transactions?

Neither is the correct answer. As Teo explains, the Cayman Islands was the best choice for Sesami. "Besides offering a favorable tax base," he says, "the Caymans also offers enough legal and taxation flexibility for a future IPO." And, of course, a corporate tax rate of zip.

It's CFOs like Lau and Teo that make government officials across Asia wince. Facing a gloomy economic outlook, fast-breaking technological change and increasing pressure from the West to cut tariffs and liberalize markets, Asian civil servants this year are working hard to keep tax dollars at home.

While tax rates aren't moving much, enforcement of those rates is getting stricter. Last year, only Singapore and the Philippines cut their corporate tax rates. But in Indonesia, Malaysia, Thailand, South Korea and China, finance ministries tightened up on collection, especially in the area of transfer pricing. "Even Singapore, in terms of the questions tax authorities ask," says Chong Lee Siang, Arthur Andersen's Singapore-based tax coordinator, "is looking at this area. But in still-developing areas," she adds, "the trend is clear: the more they open up, the more they have to tighten their enforcement."

Grand Plans

For CFOs without the option of relocating to the Caymans, the next best way to cope with Asia's zealous tax authorities is simply a matter of planning. Good tax planning, in fact, should do more than simply keep the tax bill low. Consider M&A. Although the number of deals may decline from last year's high levels, the need to extract maximum value from each one has risen.

David Toh, Asian leader for M&A tax services for PricewaterhouseCoopers (PwC) in Singapore, explains: "Taxes can play a large part in adding value to a deal if managed properly, and conversely, destroy a deal if not handled with care." Careful tax planning, he says, can save as much as 10 percent of a purchase price. This margin, in turn, can give the bidder a chance to improve his offer at no real cost if the competition gets intense.

No CFO worth his salt, of course, would say that tax considerations determine how a deal will ultimately proceed, and the best tax structure may not always be the basis for a commercial decision. Indeed, there are many ways for efficient tax planning even after a deal, according to the experts. In merging two companies - one profitable and one loss-making, for example, the assets of the profitable entity, with the higher tax bill, can be injected into the loss-making one to minimize the group's tax liability, says Toh.

For most deals, tax planning begins once the financial structure of the transaction - share-based or assets-based - is set. In Asia, the preferred method is share-based transactions where the tax liability is usually lower and less complex. "The problem with assets sales," says Deloitte Touche Tohmatsu partner Anthony Tam, "is that they are often complicated by family ownership and cross-shareholding structures. As such, they are preferred only when they can be written off on the balance sheets."

Michael Healy, the Hong Kong-based chief operating officer at US$1.4 billion-a-year First Pacific agrees. "The sale of shares over the sale of assets is preferable to minimize the tax bill," he explains, "because in many countries where the group has investments, high rates of indirect tax may arise from asset sales." When in November last year, the conglomerate sold its banking subsidiary, First Pacific Bank, to the Bank of East Asia of Hong Kong, it found the dollars were in the tax details.

The bank's flexible holding structure, which can be changed to meet different regulatory and tax requirements, allowed for several choices. Healy chose a preferred disposal option for tax purposes, in other words, the sale of the share capital, rather than the assets, of the bank. Under this scheme, tax considerations weren't a concern because Hong Kong has no capital gains tax. The only significant issue was the stamp duty. "The tax paid as a result of the disposal generally comprised the Hong Kong stamp duty payable on Hong Kong share transfers of 0.125 percent," Healy says.

For Healy, this kind of efficient tax planning begins with the structuring of a corporate tax function. First Pacific has a centralized tax unit to oversee its tax exposures in its operating subsidiaries. That means that separate tax teams at the larger operating subsidiaries manage the domestic tax issues, while the head office team works to ensure the group's investments are held tax efficiently at the top level.

The head office also provides assistance and advice to subsidiaries on any tax-related issues. "Tax considerations are always present in any deal the group undertakes," says Healy. "Whether it be an acquisition or disposal of an investment, the tax team is involved from an early stage to determine the best or preferred tax structure for the group."

First Pac's COO believes tax planning adds important support to overall business strategies but is not the driving force. "Tax planning in a vacuum is a waste of time and money," says Healy. "To be effective, it requires a good understanding of the business processes and commercial issues involved. The tax tail," he adds, "should never wag the commercial dog."

Fun in the Sun

Another key to handling taxation effectively is to have a tax structure that suits the company's business model and market reach. For example, if the company's revenue is generated from countries such as China and India, it makes sense to choose a tax base that has favorable tax treaties with both countries. In looking at tax havens, Asia2B's Lau discovered that Mauritius, for example, has extensive tax treaties with China and India whereas the Cayman Islands has a minimal tax network with China. "However, in strategic terms," Lau points out, "a company's tax structure doesn't have to look like its corporate structure as the two serve different purposes. The goal is to adapt our business structure, including tax planning considerations, from time to time, to make it most effective in the ever-changing e-commerce legal and taxation environment."

For Chris Leahy, tax treaties are equally important. "When doing cross-border deals, avoiding double taxation is paramount," says the CFO of Hong Kong-based financial services provider techpacific.com. In November last year, techpacific bought a 51 percent stake in Australia's digital services provider Cyberworks Spike, which operates in Australia, Japan and Hong Kong. Although the company is not now profitable, techpacific is busy planning for the future. This means charging the costs of doing business and operating profits to the lowest-tax jurisdiction - Hong Kong. Potential tax savings can be huge: the corporate tax rate of Australia is close to 50 percent; Japan's between 30 and 40 percent; and Hong Kong's 16 percent.

Typically, in cross border deals between a low-tax jurisdiction like Hong Kong, and a high-tax jurisdiction like Thailand, participants can transfer sales profits and other service fees to Hong Kong to reduce their tax bills. "A few tax-efficient moves can go a long way to helping a group save hundreds of thousands of dollars in taxes," says PwC's Toh. He cautions, however, that when implementing tax savings strategies, a company must be careful of local anti-avoidance rules and practices. "Proper documentation and meeting commercial requirements to restructure the group operations are essential," he says.

Caution is even more crucial in the Internet arena. This is because the traditional concept of paying taxes on activities occurring in a physical location doesn't yet apply to e-business. As a result, there are few clear rules on who must pay what and where.

No Asian country has yet introduced tax legislation on e-commerce. The reason is simply that authorities fear that harsh tax legislation would push companies to relocate to low-tax jurisdictions, while lenient tax laws could cost them revenue. "The result is that many jurisdictions are applying their existing tax laws to cover e-commerce transactions," says KPMG tax partner Ayesha Macpherson in Hong Kong. In the meantime, companies like Sesami are departing for tax havens.

Feeding the Dragon

For some companies the stricter enforcement of tax laws may be such a burden that they'll simply pack up and shift their entire business to more tax-favorable environments. For others, when the going gets tough, they fight back. The one country in Asia that inspires this kind of spirit is China.

Like many other countries in the region with increasingly stretched budgets, China is tightening tax laws to boost its public coffers. But the country also offers some of the best economic growth prospects in the region. This potential has not been lost on Kelvin Yiu, finance director at Hong Kong-based footwear chain Le Saunda.

Yiu says China's recent increase in transfer pricing audit, for example, simply means forming new tax strategies to counteract the potential effect on the bottom line. But bowing out of the China market isn't an option. "The new enforcement policy could mean a big difference in our tax bill," says Yiu. "As a result, we'll look for tax planning alternatives to reduce our tax liability, but we won't leave the country because the business opportunities are still there."

In the past, Yiu says his company took advantage of transfer pricing policies to lower its corporate tax bill in China, which at 33 percent, is twice Hong Kong's 16 percent. Until recently, China's loose approach in this area meant companies operating in the country were free to shift profits to lower tax jurisdictions such as Hong Kong or other off-shore sites like Mauritius. China-based factories would then sell the products to their off-shore parent companies at a relatively low price to avoid higher taxes.

No more. Most Asian jurisdictions, including China, once lagged behind their US and European counterparts in transfer pricing enforcement. And consequently, profits were exported. "But with increased inward investment," says John Reid, partner, tax services at Ernst & Young, "China doesn't want to continue to lose out on taxes."

Even so, with stricter enforcement in transfer pricing, Reid points out that companies can still reduce their tax liability by transferring some of their service fees such as license fees, management fees and interest charges out of China to low-tax jurisdictions. In addition, they can relocate non-core operations such as service centers, and goods pick-up and distribution centers.

Another alternative, says Yiu, is setting up factories in one of China's ever-multiplying reduced-tax-rate zones. China offers lower tax rates, tax holidays and other incentives to companies investing in special economic zones, high-tech development zones, remote and economically under-developed rural areas and the central western district.

One Chinese directive offers up to eight years of 50 percent tax reduction to foreign companies investing in designated areas. Dutch electronics manufacturer, Philips, which has been operating in China for more than ten years and outsources much of its production to local contractors, has learned to love the generous tax concessions it's been enjoying. "Our biggest concern," says Shanghai-based Egbert Ausems, chief controller for east Asia, "is what happens after the company's tax holiday expires."

Philips already has operations in Nanjing, Shanghai, Guangzhou and Shenzhen, says Ausems, and could look for new economic zones and reduced tax rate areas to invest. "The problem," he says, "is that we can't increase our production capacity just like that. Nor can we close existing operations when tax holidays expire because of existing, unfinished projects." A less-taxing solution, says Ausems, could come in the form of a merger, especially if a profitable business is merged with a loss-making one. Alternatively, by retaining the group's dividends in China for future investments, Philips can also reap tax benefits.

Either way, it won't be easy. "Tax planning in China is complicated," says Hong Kong-based Marcellus Wong, partner for tax services at Arthur Andersen, "but companies can maximize efficiency by reorganizing the structure of their operations." Complicated, sure, but less painful then getting squeezed by the taxman.

Lotte Chow is a contributing editor to CFO Asia based in Hong Kong.