Taxpayers and the Revenue Department have been locked in endless disputes over the nature of fees paid to offshore service providers. Should such fees be classified as "royalties" or "service fees" under an agreement for avoidance of double taxation, more commonly known as a tax treaty?
If any fee is regarded as a "royalty", it continues to be subject to 15% withholding tax without regard to the application of a tax treaty (a reduced tax rate of 5%, 8% or 10% may be available under some treaties). Yet, if the service fee is regarded as "business profit", it will be eligible for withholding tax exemption in Thailand, provided the foreign company has no "permanent establishment" in the country.
As the interpretation of this matter could give rise to 15% withholding tax, the term "royalty" needs to be considered carefully. Basically, it includes "consideration for information concerning industrial, commercial and scientific information", but most assessment officers broaden the interpretation. Their view is that if, in the relevant service agreement, the foreign company represented that "it has expertise or experience and it is qualified to provide certain technical services" to the Thai company, they would treat it as "information concerning industrial, commercial or scientific experience" and the fee would be considered a "royalty" for withholding tax purposes.
Taxpayers are likely to argue that such an interpretation is erroneous and contrary to the OECD commentary that guides interpretations. In reality, there is no good reason for a taxpayer to enter into a contract with a foreign contractor who lacks experience or expertise or who is not qualified to perform work.
In an extreme case, if a foreign company enters into a licensing agreement to grant the right to use intellectual property to a Thai company and, at the same time, enters into an offshore service agreement to provide the same party with certain services not related to the use of such intellectual property (i.e. management and administration), tax authorities will not hesitate to consider the fees under both agreements as royalties and impose 15% tax. This raises an issue as to the legal basis and tax policy that would require a foreign company acting as a licensor and, at the same time, providing general services, to pay such withholding tax.
This very unusual perception has been haunting Thai taxpayers for a long time. To avoid unnecessary disputes with the taxman, the use of two separate foreign companies and two separate agreements is normally advisable, which in turn creates unnecessary contractual complications. In any case, the Revenue Department usually assumes that anyone taking this approach is trying to avoid tax and will attack the arrangement.
It is also unfortunate that in some cases, judicial review tends to sympathise with the government and the primacy of tax collection, instead of adopting a neutral interpretation of the royalty definition and tax treaty principles. This has occurred even when tax authorities have failed to exercise due effort to prove such tax avoidance attempts and the genuine nature of such general services.
In a notable case that was finally resolved last month, a reputable Thai company entered into an intellectual property agreement, e.g. use of trademark, and an offshore service agreement with a Dutch company, which did not come to perform services in Thailand. The payments were divided into two portions: a fixed amount and a variable fee, based upon the gross revenue.
As the Thai company was obligated to pay the fixed fee even though it did not obtain any service in that relevant month, the fixed fee was regarded as a royalty for withholding tax purposes while the tax authorities agreed to apply the business profit treatment to the variable fee.
The Thai company strongly argued that the assessment was not correct as it was impossible, for the same services, that one payment was regarded as a business profit while the other was regarded as royalty.
Surprisingly, the Taxation Court ruled in favour of the Revenue Department based on the personal view of the assessment officer and ignored evidence and proofs presented by the Thai company on the general nature of services. The case was under consideration by the Supreme Court for more than seven years. The Supreme Court reversed the tax court's decision last month and, significantly, set out one good precedent under the tax treaty principle. That is:
" ... [A] royalty, being consideration for information concerning industrial, commercial or scientific experience, must be for proprietary information or expertise of the grantor. That said, the grantor who is the owner must have proprietary right over the information so granted. It is widely accepted that a royalty is not service fee, but consideration for the right to use or for the transfer of intellectual property; for example, licensing of copyright or a patent or trademark or service mark.
"Unlike a royalty, a professional service fee is consideration for an application of knowledge, expertise, or experience to create work or production for an employer. For example, an engineer applies his knowledge or expertise and experience to design a factory for his employer. Therefore, if it can be proven that all services are not related to any transfer of technology or expertise or experience, it is regarded as 'business profit' eligible for withholding tax exemption in Thailand pursuant to the double taxation agreement entered into between Thailand and the Netherlands..."
Interestingly, the Supreme Court also stated that "it was personal view of the assessment officer and such interpretation (remark: different tax treatments for the fixed fees and the variable fees) for tax collection under the same agreement is groundless under the law or under the tax treaty".
We are thankful for the Supreme Court's judgement in setting out perhaps the clearest interpretation on the "royalty" definition ever, and for respecting the principle of the tax treaties that Thailand has entered into with around 55 countries so far.
From now on, the tax authorities should carefully study the tax treaty guidelines and the Supreme Court's judgement and start to accept more accurate interpretations in the same way that a prudent nation is supposed to.
Prepared by Thanasak Chanyapoon and Piphob Veraphong, they can be reached at 02-677-6300 or admin@lawalliance.co.th