Article 24, Paragraph 1 of Taiwan’s Income Tax Act stipulates that “The amount of income of a profit-seeking enterprise shall be the net income, i.e., the gross yearly income after deduction of all costs, expenses, losses, and taxes.” Therefore, calculation of income will affect amount of income tax. Since high-tech industries usually have high research and development expenses (“R&D expenses”), more attention should be given to how to recognize R&D expense.
In 108 Shang Zi No. 1130 Judgment (“this Judgment”) rendered by the Supreme Administrative Court last year (2021), it set a basic standard on how to recognize R&D expense, and overturned the previous judgment (Taipei High Administrative Court’s 107 Su Zi No. 1374 Judgment, “Original Judgment”).
- Fact:
Company A in Taiwan (“Appellant”) reported a “Technical Information Provision Fee”1 of NT$198,882,190 as its expense in 2011. Said “Technical Information Provision Fee” was paid by Appellant to its Grandparent Company, a Japanese Company C. However, Tax Bureau excluded said fee as Appellant’s expense. Tax Bureau’s reasons were that Appellant had already paid “Technical Remuneration” to Appellant’s Parent Company, a Japanese Company B, in the same year (2011), and the Appellant had failed to explain about substantial contribution attributed from “Technical Information Provision Fee”. Appellant was dissatisfied with Tax Bureau’s decision and filed an administrative lawsuit, and further appealed to the Supreme Administrative Court after losing the lawsuit as shown in the Original Judgment. The Supreme Administrative Court made its Judgment and nullified and remanded the Original Judgment.
- Opinions held by Original Judgement:
(1) In Appellant’s balance sheet, the Appellant did not obtain any intangible assets or patent rights from said “Technical Information Provision Fee”. Accordingly, “Technical Information Provision Fee” should be determined as a “Production Expense”, not as “Purchase Expense”, “Sales Expense”, and not as Appellant’s assets.
(2) In 2011, Appellant generated revenue of 80.78% from selling, and 19.22% from manufacturing.
(3) Since manufacturing accounts for 19.22% of Appellant’s revenue in 2011 and the “Technical Information Provision Fee” should be determined as “Production Expense”, only 19.22% of “Technical Information Provision Fee” (NTD $198,882,190) at NT$ 37,071,956 could be recognized as expense.
- However, this Judgment opines:
(1) Appellant argued that one of its business is to provide customized products to customers, and only Company C has the ability to engage in said customized product development. Accordingly, the R&D expenses of Company C should be paid by Appellant and Company B, and “Technical Information Provision Fee” was Appellant’s payment for R&D service from Company C.
(2) Appellant submitted the customized R&D projects’ details and letters between Appellant and TSMC (one of Appellant’s clients) to support Appellant’s arguments that Appellant did entrust Company C to conduct research on customized product; thus, the Original Judgment should investigate whether Appellant’s evidence proves that there is a double entry between “Technical Information Provision Fee” and “Technical Remuneration” , and decide if Appellant can apply “Technical Information Provision Fee” as expense.
(3) Further, while Article 31 of Enforcement Rules of the Income Tax Act lists the titles of expense of various industries (trading industry, manufacturing industry, etc.,) as examples, an enterprise can apply special technical service payment and recognize the same as an expense if said payment is truthful, reasonable and necessary, regardless of how an enterprise uses accounting title for such expense.
Based on this Judgment, it can be seen that even if an enterprise does not get patent rights or list intangible assets in balance sheet, the expenses for R&D can still be recognized as expense so long as they are “true, reasonable and necessary” in nature. In addition, the recognition of costs and expenses has nothing to do with title of accounting, or the ratio of sales and current annual operating revenue.
Finally, it is advisable that a company record the R&D process in details, such as keeping research-related correspondences between the company and its customers, and recording modification and acceptance of R&D samples, etc., so that it could be useful to prove that the R&D expense is indeed “true, reasonable, and necessary,” if necessary.
1 “Technical Information Provision Fee” is the allocated R&D expenses of Company C. Company C first calculates the R&D expenses that should be apportioned by each of its subsidiary companies based on the revenue ration of each product of each subsidiary company within the company group per the R&D expenses of the current year. Then each subsidiary company, and each sub-company controlled by each subsidiary company, calculates the R&D expenses that should be shared by the subsidiary company and the sub-company according to the revenue ration of each product. According to OECD’s Transfer Pricing Guidelines, the amount or ration of allocation of R&D cost between parent company and subsidiary could be decided based on the ownership of intellectual property developed from R&D, the amount of R&D expenses of each legal entity, and the risk of each legal entity.