Over the last couple of years, tax practitioners have become increasingly aware of suspicious or shady transactions, especially those without a genuine intention, being challenged more frequently by the Revenue Department.
Such challenges usually end in bitter disappointment for taxpayers. They include cases involving a "body of persons" structure set up by high-income earners or a divorce (before the applicable law was declared unconstitutional) arranged merely for tax-saving purposes.
In the spirit of greater scrutiny, tax auditors have been paying more attention to capital-increase transactions that result in unnecessary interest costs to a parent company or eventually create losses. Sometimes there is only a marginal difference between a transaction that tax authorities consider legally valid and one they consider a sham.
Last year, the Supreme Court shocked the financial industry by overruling an appeal by a taxpayer on the grounds that a subscription to capital-increase shares by a parent company constituted a subsidy (a free gift, in other words) that was taxable to its subsidiary.
The case involved a subsidiary that had been unable to repay a loan to a financial institution, as it had sustained consecutive losses from operations. To maintain the good financial reputation of the group, the foreign parent decided to save the subsidiary from bankruptcy by way of a capital increase so that the subsidiary could pay off the loan and then liquidate itself.
Because of limitations under the Foreign Business Act, the subsidiary could issue new shares only to the foreign parent with a total par value of less than 200,000 baht but with a premium of about 900 million. The transaction was driven by a genuine business intention to clean up the failing operation smoothly. Many of you would probably do the same in a similar situation.
The court saw things differently. It ruled that since the subsidiary was dissolved immediately after the capital increase, there was no genuine intention for new capital to be used in its business operations. The parent could also have paid off the loan simply by paying cash directly to the financial institution on the subsidiary's behalf — in which case the subsidiary would have had to realise the subsidy as taxable revenue. Thus, arranging for a capital increase to achieve the same result was ruled a means to avoid corporate income tax on a free subsidy.
Thailand's judicial system seems to take the attitude that in solving business problems, the private sector should adopt a transaction that will result in the most tax costs. Structuring the transaction in a different way to alleviate such costs could be viewed as an act of tax avoidance rather than normal tax mitigation, which everyone should have the right to choose.
In a similar transaction, a parent company entered into a capital increase arrangement with its subsidiary at a high premium of about 2 billion baht in total. The real intention of the parties was unclear but was believed to be an attempt to create an internal debt to prevent other creditors from reaching the assets. The transaction steps can be summarised as follows:
Parent Co borrows 5,000 from Subsidiary, to be used to purchase Subsidiary's own capital-increase shares. The cash for the loan principal is never transferred from Subsidiary. On the balance sheet of Parent Co, this creates debt of 5,000.
Parent Co subscribes to the new shares of Subsidiary at 5,000, although the shares have a par value of 100 and a net book value of about 200.
After the capital increase is registered with the Commerce Ministry, Subsidiary's balance sheet indicates paid-up registered capital of 100 and a share premium of 4,900.
When the Revenue Department auditors first heard of this transaction, mindful of the first Supreme Court case, they considered assessing both parties at the same.
First, they wanted to assess Subsidiary for receiving a cash subsidy (free gift) from Parent Co, equal to the premium amount that Parent Co paid for the shares, as it was far higher than the net book value of Subsidiary.
Second, the auditors wanted to assess Parent Co for deducting interest costs for tax purposes and to prohibit it from booking the entire premium as the tax cost base in such newly issued shares. Had this tax investigation gone ahead, it would have resulted in the Revenue Department collecting twice the amount of tax.
Fortunately, creditors protested, and the capital increase and loan transactions were declared null and void under Section 155 of the Civil and Commercial Code as if they had never taken place. This forced the tax auditors finally to accept that no actual loan existed and no cash gift was ever made from Parent Co to Subsidiary. Hence, the assessment was restricted to Parent Co for non-deductibility of interest expenses and the excessive tax cost base of the subscribed shares — but the Subsidiary faced no assessment for a taxable gift.
These cases are proof, however, that the Revenue Department is keeping a close eye on share premium transactions. The lesson here is to be careful when structuring a capital increase and ensure the relevant ratio of par to the share premium does not go beyond industry standards and, more importantly, the financial status of the subsidiary itself.
This column was prepared by Rachanee Prasongprasit and Prof Piphob Veraphong. They can be reached at admin@lawalliance.co.th