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Future Focus

Tax and Transformation in Asia Pacific’s New

Business Reality

November 2011

kpmg.com

http://www.kpmg.com

© 2011 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved.

07 19 29KPMG Corporate and

Indirect Tax Survey (2011)KPMG Global Transfer Pricing

Review (2011)Good, Better, Best: The race

to set global standards in tax management

Welcome to the new business reality 3

Rising development and regional trade drive complexity and change 4

In brief 7

Global shift from corporate to indirect taxes: 7 ASPAC on trend

Investing beyond borders: 10 Regional variety yields advantages

Australia, China and India: Tax uncertainty 12 rattles M&A markets

China’s Five-Year Plan: Five steps 16 for managing the impact

Transfer pricing: Diversity, dynamism and scrutiny 19

Road to recovery: 21 Japan’s 2011 disaster relief and tax reforms

Australia pursues sovereign wealth fund investment 23

Energy needs and green agenda fuel resource tax changes 24

Achieving a world-class tax function: Changing regulatory 28 landscape opens the door

Leap ahead 32

Keeping tabs on short-term business travellers 33

Managing rising VAT/GST compliance burdens 37

Cloud computing: Clearing up the tax risks 40

Transfer pricing issues on business restructurings 42

Shared service centres: More complex functions = more tax complexity 44

Contents


ContributorsMany KPMG member firm partners and practitioners contributed to the production of this magazine. In particular, we would like to thank:

Warrick CleineKPMG’s Head of Tax for Asia PacificKPMG in Vietnam

Chris AbbissASPAC Regional Lead PartnerFinancial Services – TaxationKPMG in Hong Kong

Rick AsquiniPartner KPMG in Australia

Vaughn BarberAsia Pacific Regional Leader, Mergers & Acquisitions TaxHead of China OutboundTax PartnerKPMG in China

David DrummondNational Leader, Tax Management ServicesKPMG in Australia

Steven EconomidesASPAC Lead Partner, International Corporate TaxKPMG in Australia

David GelbGlobal Head of R&D Tax IncentivesKPMG in Australia

James GordonManager, Tax Management ServicesKPMG in Australia

John GuTax PartnerKPMG in China

Rod HendersonAsia Pacific Regional Tax Leader, Energy & Natural ResourcesTax PartnerKPMG in Australia

Khoonming HoPartner in Charge, TaxChina and Hong Kong SARKPMG in China

Tay Hong BengPartner, Head of TaxKPMG in Singapore

Andy W. HuttTax Partner, International Executive ServicesKPMG in Australia

Glenn JacksonSenior Manager, Tax Management ServicesKPMG in Australia

Deborah JenkinsIndirect Tax PartnerIndirect Tax Asia Pacific Regional Co-LeaderKPMG in Australia

Holger LampeAsia Pacific COO, Mergers & Acquisitions TaxSenior ManagerKPMG in China

David LinkeTax PartnerKPMG in Australia

Dennis McEvoyPartner, International Executive Services (IES)ASPAC Regional Leader, IESKPMG in Singapore

Miyuki MurataTax Technical CenterKPMG in Japan

Kari PahlmanKPMG’s Regional Head of Transfer Pricing ServicesKPMG in Hong Kong

Graeme M. ReidASPAC Regional Tax PartnerKPMG in Singapore

Girish VanvariExecutive DirectorKPMG in India

Garry VoigtPartner KPMG in Australia

Grant Wardell-JohnsonTax PartnerKPMG in Australia


Welcome to the new business reality

Economic uncertainty, technological innovation, climate change, tax and regulatory reform: Faced with these complex challenges, tax directors need to take forward-thinking approaches to re-imagine their operations and re-shape their long-term strategies in response.

As many of the articles in these pages show, companies doing business in the Asia Pacific region need to make transformation and innovation their highest priorities, and KPMG can help guide the way. For example, KPMG’s web-enabled collaboration and reporting tool, the Global Tax Management System (see page 11), was developed in light of KPMG member firms’ experience of the functionality businesses need while working in a complex global tax and compliance environment. The system provides a secure, collaborative platform, allowing real-time visibility over the entire compliance program – across multiple entities in multiple jurisdictions. With this system, companies can follow progress and have access to key data and documents at any time.

Similarly, we have developed solutions to help leading international organisations with far-flung operations win control over compliance problems and take advantage of opportunities. We help your company put in place centralised, automated mechanisms for managing global programs in specialty tax areas such as VAT/GST (page 37), transfer pricing (page 42), and short-term employee business travel (page 33), among others.

KPMG member firms aim to help you adapt and respond quickly to new risks and opportunities – and help give you a competitive edge. Our member firms’ goal is to cut through the complexity of the new business and economic reality and deliver practical ideas and forward-thinking approaches to help you position your business for future success.

Greg WiebeGlobal Head of TaxKPMG International


Future Focus 3

Rising development and regional trade drive complexity and change

Businesses in the region are increasingly challenged to keep

pace with the speed and complexity of change.

Across the Asia Pacific region, development is proceeding at a rapid pace. As China and India step into higher end manufacturing and service sectors, developing countries like Indonesia and Vietnam are stepping up their manufacturing capabilities at the lower end. The Southeast Asian free trade zone, with its huge consumer market and a rapidly expanding middle class, is becoming more important as a centre for economic activity. Businesses are taking advantage of this diversity by taking a more regional approach to where they locate their various activities and functions.


4 Future Focus

Warrick CleineRegional Leader, Asia Pacific Tax

The focus on tax risk continues to climb in an environment where non-compliance can threaten an organisation’s reputation and its prospects for future success.

All this activity is straining infrastructure, and countries like India, China and Australia are investing heavily in upgrading their transportation systems, utilities and

other facilities. These investments, combined with rising populations and living standards, are creating more demand for raw materials and power.

Regional trade in these commodities is increasing, and countries like Australia and China are imposing higher taxes on resource profits. At the same time, governments are adopting tax policies that encourage investment in sustainability projects to decrease energy use and harmful emissions. A generous array of grants and tax incentives is becoming available for innovations in renewable energy, energy efficiency and low pollution technologies.

The cross-border activity is catching the eye of tax authorities in the region. From transfer pricing audits to short-term

business travellers to challenges of offshore holding structures, tax authorities are looking at taxpayers’ cross-border activities to shore up their governments’ finances and prevent revenue leakage. The focus on tax risk continues to climb in an environment where non-compliance can threaten an organisation’s reputation and its prospects for future success.

Businesses in the region are increasingly challenged to keep pace with the speed and complexity of change. The articles in the following pages highlight some of the most dynamic tax and business issues facing tax directors of enterprises that are located or have investments in the region – identifying new risks, highlighting opportunities, and bringing the new business reality into focus.


Future Focus 5

INTERNATIONAL TAX.UNDERSTOOD.

INTERNATIONAL CORPORATE TAX Global tax planning is complex and must be managed tightly.

At KPMG, our global network of dedicated professionals have years of experience in working with global companies

in multiple jurisdictions. We use our depth of knowledge to help solve global tax problems every day.

For more information visit kpmg.com/internationalcorporatetax


IN BRIEFGLOBAL SHIFT

FROM CORPORATE TO INDIRECT TAXES:

ASPAC ON TREND

Our 2011 survey of the world’s corporate and indirect tax rates continues the story told in earlier years. Corporate tax rates have been steadily falling for a decade, while indirect tax (VAT/GST) systems have proliferated across the globe, rising to higher rates and applying to more items as these systems mature.

Corporate and indirect tax rates in the Asia Pacific region are generally on trend. Many countries in the region are emerging economies that need foreign investment

to grow. In deciding amongst locations, potential investors tend to focus on income taxes and neglect the potentially high but often less visible costs of other taxes. Recognising this tendency, many investment-seeking countries impose lower direct income taxes and make up the reduced revenues through relatively higher indirect taxes, such as customs duties and VAT/GSTs.

Looking beyond headline corporate tax ratesIn comparing income tax costs between countries, headline corporate tax rates should be just the starting point. More than most regions, headline corporate tax rates and effective rates in the Asia Pacific region differ greatly. Asia Pacific countries make liberal use of targeted tax incentives, such as tax exemptions, credits and tax holidays, to influence capital and investment flows and achieve economic or socio-political

ends. These preferences can reduce a company’s effective tax rate significantly. For example:

• SingaporeandAustraliahaveintroducedtargetedtaxincentives for fund managers in order to encourage domestic growth in this sector and decrease reliance on European fund managers.

• Japanhasreplaceditsforeigntaxcreditregimewithanewsystem for taxing foreign dividends in order to encourage the repatriation of earnings from outbound investments.

• China,Indiaandothercountriesoffergeneroustaxpreferences for certain labour-intensive and high technology industries and for establishing operations in special economic and industrial zones.

Additionally, tax systems in some of the region’s developing countries tend to be simplistic, taking a form-over-substance approach. This produces greater differences between tax accounting and financial reporting rules, which can cause

KPMG Corporate and Indirect Tax Survey (2011)


Future Focus 7

unexpected tax results. Tax authorities in countries like Indonesia, Australia, China and India have also taken action under specific or general tax avoidance provisions to attack structures that seek to artificially take advantage of tax concessions or tax treaties.

Indirect tax reform – Back on track?Until the financial downturn, indirect tax reform was set to spread across the region. The trend has stalled as Asia Pacific countries wait for the world’s economy to recover. Political concerns drive tax policy as much or even more than economic ones, and few governments will risk the backlash that could result from raising taxes in a troubled economy. For example:

• MalaysiaandIndiahaveannouncedplans to introduce new indirect tax systems, but political opposition has caused their governments to put them on hold.

• Japanlookedsettoincreaseitsconsumption tax (VAT) rate but those plans appear to have stalled in the aftermath of the March 2011 earthquake, nuclear accident, and continued economic and political uncertainty.

• Australiaiscurrentlyundertakinga major tax reform initiative, but a GST base and rate are not being considered.

The appropriateness and stability of all taxes should be considered in any tax reform exercise. Compared to income taxes, indirect taxes are less affected by economic ups and downs and so they are more stable, their revenue bases are less mobile, and their real-time collection provides a steadier revenue stream. Asia Pacific countries that already have efficient tax regimes in place are doing well by them, especially those countries with rapidly expanding consumer markets.

There are signs that the current deferment of new indirect tax systems is starting to ease. Malaysia seems poised to finally put its GST in place, potentially next year, if its current government is re-elected and wins the mandate to do so. China will likely begin piloting a new national VAT for its service sector, starting in Shanghai (see page 17) early in 2012. Other Asia Pacific countries are expected to follow this trend over the next few years.

Further, as more countries in the region enter free trade zones and economic alliances, they will need to reduce trade barriers. Those countries that have opted to impose higher customs charges to

maintain attractive headline corporate tax rates may look to GST/VATs to help replace their customs revenues.

Factor rising indirect tax rates into business decisionsBusinesses in the Asia Pacific region should keep the coming indirect tax changes in mind in their strategic planning. For example, you should be sure to accommodate new and changing GST/VAT rates when negotiating long-term contracts with suppliers and when implementing new IT systems. You should also make sure your business has the right mix of income tax and GST/VAT management resources in place – like those featured in this magazine’s ‘Leap Ahead’ section – to stay ahead of this long-term trend.

The big pictureCompanies looking to invest or locate operations in Asia Pacific need to consider the whole picture. The region is incredibly diverse, and different countries have different advantages, depending on the nature and objectives of the business. Potential investment destinations should be assessed with an eye to your overall strategy, with particular attention to:

• proximitytotargetmarkets

• suitabilityoflabourmarket

• accesstosuppliersandmanufacturing inputs

• costsassociatedwithacountry’sinfrastructure, such as utilities, water supplies, and transportation networks

• revenueauthorities’attitudes

• politicalclimateandtradepolicies.

These factors can be just as crucial as direct income and indirect tax costs to potential success in the region.

Trends in tax rates – Global versus Asia Pacific

The world’s average corporate tax rate has fallen in each of the past 11 years, from 29.03 per cent in 2000 to 22.96 per cent in 2011. In Asia the average corporate tax rate went from 23.96 per cent in 2010 to 22.78 per cent in 2011, while rates in Oceania countries went from 24.17 per cent in 2010 to 23.83 per cent in 2011.

Meanwhile, average indirect tax rates at the global level have been stable, hovering at or near the 2011 average of 15.41 per cent for the past six years. Oceania’s average VAT/GST rate rose from 12 per cent in 2010 to 12.5 per cent in 2011. The average rate in Asia rose from 11.64 per cent in 2010 to 11.93 per cent in 2011.


8 Future Focus

IT’S A DONE

DEAL.MERGERS & ACQUISITIONS

Winning the deal is easier when you hold all the cards. At KPMG, our network of mergers and acquisitions tax professionals

possess the experience and forward thinking necessary to help you meet the time constraints of the deal.

For more information visit kpmg.com/mergers-and-acquisitions


Investingbeyond borders: Regional variety yields advantages

While Asia has traditionally relied on foreign direct investment from North America and Europe for its economic growth, the global financial crisis has prompted Asian nations to build up their economies and seek growth opportunities closer to home. Companies in the region are increasingly looking beyond their countries’ borders to access the burgeoning consumer markets of Southeast Asia and to reduce costs across their supply chains.

Shifting activities and functionsFour or five years ago, China’s low labour costs and skilled workforce helped make it the chief focus of foreign investment in the region. Investors often followed the ‘China + One’ philosophy to guide their Asian investments. This notion held that a foreign company seeking to invest in China should also invest in at least one other Asian country to diversify supply chain and market risk.

Whilst this notion is still relevant, Chinese companies have been moving up the value chain to focus on high-end manufacturing and technology. At the same time, rising labour costs are diminishing China’s attraction for certain industries. Meanwhile, Southeast Asian countries like Thailand, Vietnam and Indonesia have stepped in as destinations for low-end manufacturing activities. Investors in the region now

enjoy a much wider range of options for locating these functions as a result.

Southeast Asian markets gain more cloutWith about 1.5 billion people and a quickly expanding middle class, the free trade zone of the Association of Southeast Asian Nations (ASEAN) offers a growing and potentially lucrative consumer market. Developed Eastern countries like Japan and Korea are increasingly focused on selling into this market. Western companies that have been shifting their production east to take advantage of lower labour costs are now selling their products in these markets as well. As consumer purchasing power among the region’s middle classes continues to rise, we expect the ASEAN market to become even more important over the next few years.

More engagement across regionsEast to west investment is also rising. As countries like Japan and Korea continue to develop more sophisticated products and business models, they have been buying up more Western brands and companies and selling more products into Western markets. China and some Southeast Asian nations are starting to follow suit. As China invests in developing its domestic economy, it is increasingly importing goods, such as capital equipment and automobiles, from Western producers.

The Western liberal democracies of Australia and New Zealand are becoming increasingly engaged in the region. Looking to secure energy supplies, companies from China and Thailand are purchasing Australia’s resources, such as coal and iron. They have also begun buying assets, such as mining and processing facilities, directly. Australia and New Zealand are becoming increasingly relevant markets for Southeast Asian products, while Southeast Asian demand is rising for professional services of Australian and New Zealand firms in areas such as civil engineering, law and insurance.

Ideal conditions for regional operations and supply chainsWith rising cross-border activity and a range of players spanning the entire continuum of enterprises, from start-ups to growth stage companies to multinationals, Southeast Asia offers an incredible diversity of cost structures. Such regional diversity creates an ideal breeding ground for cost-efficient regional operations and effective supply chains:

• DevelopedjurisdictionssuchasSingapore and Hong Kong are well suited for financial services and head office functions.

• EmergingeconomiesinMalaysiaand Thailand are gaining ground as destinations for mid-range functions such as engineering and logistics.

With rising cross-border activity and a range of players spanning the entire

continuum of enterprises, from start-ups to growth stage companies to multinationals, Southeast Asia offers an incredible diversity of cost structures.


10 Future Focus

• DevelopingcountriessuchasIndonesia and Vietnam have low-cost, highly skilled workforces suitable for lower-end manufacturing activities.

With so many options, it no longer makes sense to put all activities in one location. The better value proposition is to look at the range of supply chain functions required to achieve the company’s objectives and to spread those functions across the region advantageously.

Demise of traditional holding structuresJust as business models in the region are changing, rising tax authority interest is challenging traditional treaty-based holding company models. As discussed on page 12, the Indian Vodafone case is an example of a number of substance-over-form challenges to offshore holding structures from tax authorities in China, Indonesia, Australia and Korea. Where the tax authorities determine that a holding company in a favourable tax jurisdiction lacks business

substance, they will look through the company and impose capital gains tax (or a higher rate of withholding tax on dividends and interest) on its beneficial owner.

As a result, regional holding company structures are being revisited.

Regional management hubs – Hong Kong and Singapore Hong Kong and Singapore are emerging as the most prominent management holding company locations for investments in the region, and not just because of the ease of establishing management operations there with sufficient substance.

Singapore is strategically located in Asia and well supported by an excellent financial infrastructure and pro-business environment. Singapore’s simple and business-friendly tax system, coupled with an open immigration policy that facilitates the relocation of foreign talent to Singapore, attracts significant foreign investment.

Singapore also offers over 100 tax incentives to attract business, including regional management or holding companies, to the country. Singapore offers particularly generous tax preferences for research and development, which are a good draw for high technology companies. Singapore also has over 60 tax treaties, including 20 agreements with other Asian countries covering developed markets such as Japan and South Korea and major emerging markets such as India, China, Vietnam and Indonesia. Coupled with its quasi-territorial basis of taxation, Singapore has traditionally been viewed as a gateway for investors into Asia.

Hong Kong has long been regarded as a preferred jurisdiction for multinationals to headquarter their Asian operations. Geographically, Hong Kong is somewhat better situated than Singapore for investments in China, Korea and Japan. Its free market economy, favourable location and competitive tax regime have been major contributing factors to its success.

Hong Kong has a relatively simple territorial tax system that only taxes business income earned through a business carried on in the country. Although its treaty network is much smaller than Singapore’s, Hong Kong is working hard to catch up and now has more than 20 treaties, including recently signed double tax treaties with Japan and Indonesia. Hong Kong does not offer incentives to businesses establishing regional management or holding companies. Even still, these businesses can often structure their operations to reduce or eliminate Hong Kong taxes under Hong Kong’s territorial tax system.

Weighing the optionsMany potential investors in the region start examining their options by focusing on applicable tax rates, incentives and planning opportunities. Proximity to markets, appropriately skilled workforces, access to production inputs, and knowledge of the competitive landscape are also key. Language barriers, cultural differences and a lack of reliable government data can create challenges in gathering this information. For potential investors in Southeast Asia, it’s particularly important to get advice from professional advisers with extensive knowledge and practical experience in the region.

Hong Kong and Singapore are emerging as the most prominent management holding company locations for investments in the region, and not just because of the ease of establishing management operations there with sufficient substance.


11Future Focus

Australia, China and India:Tax uncertainty rattles M&A markets

Now, more than ever, businesses must fully understand the tax implications of their M&A activity, particularly when dealing with emerging markets and the developing world. From increasing cooperation between national tax authorities to the emergence of new buyers, organisations must clearly understand the unique tax implications of each deal on a global, state and local tax level.

Within the Asia Pacific region, Australia, China and India continue to be major locations

for M&A deals based on value, with real estate, financial services, materials and energy and natural resources transactions seeing the most activity. However, changing tax policies and tightened enforcement activities in these countries are creating on-going and significant tax uncertainties.

Tax issues on exitOne of the biggest areas of concern for potential investors in these three countries is the tax outcomes on offshore exits by non-resident investors.

India – Vodafone’s ripple effect continuesThe proceedings of the Vodafone case are now underway before the Supreme Court. The case is significant for cross-border M&A deals that involve an indirect sale of shares in an Indian company, as it would test

the offshore sales of shares in targets with controlling interests in Indian companies from a ‘substance over form’ perspective and could potentially influence the resultant Indian income tax implications (including withholding requirements). When the court will make its decision is unknown.

India’s more recent E* Trade Ruling was pronounced in the assessee’s favour, but the Revenue authorities have challenged the Ruling before the Supreme Court. Further, apprehensions remain on the impact of these decisions on Mauritius holding companies. These companies are commonly used to make direct investments into India because the existing India-Mauritius tax treaty allocates the right to tax capital gains to Mauritius (which does not tax capital gains). In deciding whether a Mauritius holding company had sufficient substance to achieve treaty benefits, the Indian Supreme Court had earlier ruled that a Mauritius tax residence

In deciding whether a Mauritius holding company had sufficient substance to achieve treaty benefits, the Indian Supreme Court had earlier ruled that a Mauritius tax residence certificate should be sufficient for claiming tax treaty benefits.


12 Future Focus

certificate should be sufficient for claiming tax treaty benefits.

In addition to such concerns, India has announced that it is renegotiating its treaty with Mauritius. India is also introducing a general anti-avoidance rule with prospective effect, which is proposed to be enforced from April 2012. In light of this uncertainty, companies with Mauritius holding structures may need to reconsider their corporate structures.

China – Look-through approach for disposals of offshore holding companiesIn December 2009, China’s State Administration of Taxation (SAT) issued Circular 698. Where an equity interest in Chinese resident company is indirectly transferred, Circular 698 requires the seller to report the transfer to the SAT if the effective tax rate to the seller of a company in the offshore holding jurisdiction is less than 12.5 per cent or offshore income is tax-exempt in that jurisdiction. If the SAT finds the structure lacks business substance or commercial purpose, the SAT may

look through it. The seller then may be deemed to have a Chinese-sourced capital gain taxable at 10 per cent, and withholding tax will apply.

Whilst Circular 698 obliges the seller to report the deal, in practice, the seller’s failure to report the offshore transaction may shift the risk to the buyer. In that case, the tax authorities may not allow the tax basis of the shares to be stepped up to the transaction value.

Australia – TPG’s Myer Group disposal triggers scrutiny of offshore exitsGenerally, non-Australian residents disposing of shares in Australian companies whose value is not principally attributable to Taxable Australian Real Property do not pay Australian tax on the gain where that gain is on capital account. However, tax can apply to onshore and offshore disposals if the shares are land-rich and the seller owns 10 per cent or more of the equity interests in the company being sold.

However, the Australia Taxation Office (ATO) recently issued a set of tax

determinations that gains arising on disposal of shares in private equity portfolio companies are on revenue account unless specific facts indicate otherwise. As a result, under Australian law, revenue gains derived by a foreign private equity fund will be taxable if they are Australian sourced, unless the seller can validly claim treaty protection under the business profits article of an applicable treaty. The ATO will also seek to apply Australia’s general anti-avoidance rules to situations where interposed entities in investment structures have limited commercial substance.

The ATO has been reviewing recent and anticipated exits in the lead up to issuing these determinations. Potential investors in offshore holding companies should ensure there is commercial substance in the non-resident holding location. They should also seek to incorporate sufficient flexibility into the structure for exit.

The ATO will also seek to apply Australia’s general anti-avoidance rules to situations where interposed entities in investment structures have limited commercial substance.


13Future Focus

Top due diligence issuesFor potential investors in China, India and Australia, conducting thorough tax due diligence on potential acquisition targets is critical. Below we highlight some of the top due diligence concerns for potential investors in China, India and Australia today.

China – Pay special attention to tax invoicesA persistent due diligence issue in China involves the country’s unique system of tax invoices (fa piao). When these tax invoices are not issued correctly or no valid tax invoices are obtained when an asset is purchased, taxpayers may be unable to deduct the asset’s cost base on its sale, resulting in significant property tax and corporate income tax exposures.

India – Anti-trust regulationsUnder a major regulatory change, India has introduced a new anti-trust law based on European models. The rules apply to both domestic and foreign transactions that may affect competition in India. Under the rules, if an acquisition causes certain thresholds to be exceeded, an application must be filed with the new Competition Commission

of India. The Commission will then determine whether or not competition is adversely affected.

How the rules will be applied in practice remains to be seen, but early signs are positive. Initial rulings issued by the Commission so far have been favourable.

Australia – Watch for subordinated debt reclassified as equityOn-going financial uncertainty continues to affect funding arrangements, especially subordinated debt instruments, which were used extensively before 2008. Debt/equity classification rules allow the ATO to re-characterise these instruments based on substance rather than legal form. In a number of transactions, the ATO has used these rules to characterise such instruments as equity, making the interest on the instruments non-deductible.

Australia – Trapped franking creditsRecent changes in Australian corporation laws have raised questions on the ability for companies to pay a franked dividend where the company has accumulated accounting losses. The ATO has released draft guidance on this topic suggesting

that dividends may be viewed as being sourced from share capital and thus unfrankable. There is much anticipation on the final tax outcome on this matter, given it could mean in certain cases that the distribution of franking credits becomes difficult.

Australia – Potential changes to tax consolidation rulesMedia reports suggest that the Australian Government is considering amending the tax consolidation rules, in particular the ‘rights to future income’ rules (‘RTFI rules’).1 These rules took effect in 2010 and allow an acquirer of a company that has valuable customer contracts (i.e. a right to a future income stream) to deduct the market value of those contracts in future years. Apparently, the revenue impact of the RTFI rules has been much higher than expected, and Australia’s government is seeking to stem the tax revenue losses in its efforts to reduce its budget deficit.

The spectre of such retroactive change can create the sort of tax uncertainty and risk that many large, risk-averse offshore investors seek to avoid.

Looking aheadChina, India and Australia have each announced plans for significant tax reforms that will take effect over the next few years. In some cases, these reforms will dramatically affect the tax liabilities of foreign investors in these countries. Going forward, investors in the Asia Pacific M&A market should pay close attention to the impact of these changes on the taxation of potential targets.

China’s 12th Five-Year PlanAs discussed in more detail on page 16, China’s 12th Five-Year Plan introduces a number of measures to help the country move from a manufacturing based economy to a service economy. Among changes affecting the M&A market are proposals to encourage energy efficiency through a new environmental tax and amendments to China’s existing resource tax.

India’s new Direct Tax CodeIndia’s new Direct Tax Code, expected to take effect from April 2012, aims to simplify tax laws. However, the new code will introduce:

• ageneralanti-avoidancerule,asnoted above

• strictnewcontrolledforeigncorporation rules

1. See, for example, ‘Tax Change Blows a Hole in Budget as Billions of Dollars are At Risk’, The Australian, October 4, 2011.


14 Future Focus

• taxabilityofindirecttransfersofshares in a foreign company in proportion to the market value of assets located in India

• anewconceptof‘placeofeffectivemanagement’ that could bring more Indian multinationals into India’s tax net.

The new Direct Tax Code will also impact Indian tax holidays. India’s current profit-based tax holidays based on location will be converted to tax holidays linked to investment, affecting future valuations.

Australia’s Henry Review ReportIn 2008, the Australian government established the Australia’s Future Tax System Review (also known as the Henry Review). Tasked with examining Australia’s tax transfer system, the Panel made 138 recommendations with the aim of positioning Australia to deal with future demographic, social, economic and environmental challenges.

Among the recommendations that the government has decided to (along with some of its own reforms), the following measures will particularly affect the M&A market.

• Australia’scorporatetaxrateforlargebusinesses will drop to 29 per cent (from 30 per cent), as of 1 July 2013.

• AproposednewMineralsResourceRent Tax will apply to profits from coal and iron ore mining, starting 1 July 2012 (see page 25).

• Acarbonpricewillapplytothetop500 carbon emitters from 1 July 2012 starting at a fixed AUD23 a tonne for carbon dioxide before ultimately moving to a market based pricing mechanism.

India’s current profit-based tax holidays based on location will be converted to tax holidays linked to investment, affecting future valuations.

• Theinterestwithholdingtaxoninterest paid by financial institutions on most offshore borrowings will be reduced in stages to an aspirational goal of 0 per cent.

Examine all the optionsDespite the challenges for investment holding structures discussed above, many upcoming tax reforms are positive. M&A investors still have plenty of scope for tax planning to help

reduce costs and improve their after-tax investment returns.

Potential investors should be sure to examine their options and structure their investment holdings in ways that will withstand the tax authorities’ scrutiny. Investors should also identify the range of potential outcomes and make sure these are reflected in any valuation, price adjustment mechanisms, indemnities and other transaction terms.


15Future Focus

China’sFive-Year Plan – Five steps for managing the impact

China’s 12th Five-Year Plan lays out an ambitious blueprint for transforming the

country’s economy and achieving its development goals from 2011 to 2015. Along with other preferential policies, tax changes are an important part of achieving this Plan. These changes will have far-reaching implications for companies doing business in China.

Having approved the Plan in March 2011, China’s government is now drafting detailed tax law changes to help achieve the Plan’s key goals:

• todistributewealthmoreevenlyandencourage domestic consumption

• toprotecttheenvironmentandpromote energy efficiency

• tofostertheeconomicdevelopmentof China’s Western and Central regions

• toshiftthecountry’seconomyawayfrom export-driven manufacturing and toward a more service-based economy.

The impact of these changes will differ greatly depending on your industry and the location of your activities. For any business with investments or operations in China, the five steps below are crucial for avoiding adverse

effects and benefiting from the opportunities created by China’s latest Five-Year Plan.

1 Review your company’s business plan to factor

in a potential environmental tax. China proposes to introduce an environmental tax based on a ‘polluter pays’ principle. This green tax could be levied, for example, on carbon emissions from fossil fuels and discharges of polluted water. The tax is expected to be particularly harsh for companies that operate in or have significant inputs from sectors such as steel, cement and mining. Companies should factor this proposed new tax into their business planning and consider changing their operations to reduce environmentally harmful effects.

2 If your company operates in resource-

intensive sectors such as oil or natural gas, monitor and plan for changes in China’s resource taxes.China plans to overhaul its resource tax regime in the next five years, replacing its current tax based on production output with a new tax

based on sales value. The new tax will apply at the rate of 5 per cent on the sales price of resources such as oil, gas and rare earths, allowing the tax to track rising commodity prices. The tax was introduced in a pilot program in 2010 in China’s Northwestern region and later expanded to 12 other provinces. The nationwide version of the tax will not only affect the profits of oil and gas companies but also of related industries. The tax is designed to discourage resource consumption through higher downstream prices assuming the tax cost will be passed on to end users.

3 Revisit your China tax strategy for the next

five years with a view to optimising your ability to leverage tax incentives for specific investments.China’s Five-Year Plan will introduce new tax incentives to encourage investments in specific industries, such as the biotechnology, IT, aerospace and telecom sectors. Incentives will also be available for companies involved in developing methods and products for conserving energy, reducing emissions, and protecting the environment.


16 Future Focus

To help make the most of these incentives, investigate and monitor what incentives may be available to your company, incorporate them in your business and financial plans, and factor them into your business decision-making processes.

4 If your company operates in the service

sector, get ready to manage the impact of China’s new VAT regime.For companies in China’s service sector, the country’s current parallel business tax and indirect tax systems will be replaced with an expanded value-added tax. This is good news for Chinese services businesses, as it will allow them to recover more

tax on their business inputs, lighten their overall tax burden, and improve their international competitiveness. This change could also affect how you structure your business, and whether you concentrate service or other functions within a single entity or location.

5 Consider reconfiguring your operations in China

to take into account location-based incentives.China’s Five-Year Plan would introduce incentives to attract businesses west, away from the country’s well-developed coastal areas. The aim is to carry economic momentum from the coastal cities inland to China’s Central and Western regions. Reduced

corporate income tax will continue to apply for the next ten years to companies in targeted business categories in Western regions of China. Review the location of your company’s activities within China to help optimise your access to these incentives, in line with your overall tax and business goals.

Finally, keep in mind that China’s tax policy makers are still working out the rules to effect these sweeping tax changes. If aspects of the Five-Year Plan raise specific concerns for your business, you still have plenty of opportunity to offer input and ideas to help the government shape the implementation details.

If aspects of the Five-Year Plan raise specific concerns for your business, you still have plenty of opportunity to offer input and ideas to help the government shape the implementation details.

China’s 12th Five-Year Plan: Tax (KPMG in China)


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SLEEPTIGHT.

GLOBAL TRANSFER PRICING If change is inevitable, foresight is key. KPMG’s Global Transfer

Pricing professionals develop value-adding approaches and help ensure compliance with increasingly complex

local country regulations. When there is no margin for error, it pays to know that the details have been covered.

For more information email us at [email protected]


TRANSFER PRICING: DIVERSITY, DYNAMISM

AND SCRUTINY

Transfer pricing has been a hot button issue in the Asia Pacific region for the past several years, and the focus on intercompany charges seems bound to intensify. Asia Pacific countries are spawning new multinationals through expansion outside of their own countries, including a multitude of Chinese companies now expanding overseas. These structures are increasingly international, with supply chains branching across countries and continents. As cross-border economic activity rises, tax authorities are sharpening their focus on transfer pricing issues, with new compliance initiatives and growing budgets for investigations.

In this environment, companies operating in the region face unique challenges related to the diversity of

regimes, the speed of change, and the increase of audit scrutiny.

Coping with diverse regimesCompanies in the region need to cope with diverse transfer pricing regimes at varying stages of development, from the mature regimes of Japan and Australia to the newer, relatively less developed regimes of Southeast Asian countries like Malaysia, Indonesia and Vietnam. These differences can frustrate efforts to establish consistent company-wide transfer pricing policies. Dealing with newer regimes can also be risky. Even though a company’s transfer prices may be sound, the tax authority’s field team may lack technical experience,

which can complicate audits and create disputes. Even in mature regimes, new developments like the Full Federal Court of Australia’s ruling in SNF can alter the landscape dramatically.

There are also rumblings that the transfer pricing guidelines set by the Organisation for Economic Co-operation and Development (OECD) and followed by most countries do not suit the needs of emerging economies, especially as they relate to intellectual property, brand values and royalties. For example, China has developed novel approaches to challenge transfer prices for certain luxury products and other imported brands. Because the prices of these brands in China may be higher than they are in other parts of the world, the State Administration of Taxation

(SAT) believes that a higher proportion of profit arises due to unique conditions in the country. Transfer pricing analyses should thus consider a ‘China market premium’ and allocate more substantial profits to China at the expense of the jurisdiction in which the global brand intangible is held.

Speed of changeTransfer pricing in the region has been swiftly evolving, and the landscape could further transform within the next five years. China and India have put in place transfer pricing rules, policies and procedures and have achieved in five years the same level of activity that took European and North American countries over 15 years to accomplish. We expect other Asia Pacific countries to follow suit by incorporating more

KPMG Global Transfer Pricing Review (2011)


19Future Focus

complex regulations that address specific transactions and situations. In turn, this added complexity could spur a rise in transfer pricing audits and disputes.

Rising scrutiny

The Asia Pacific region is already seeing higher levels of scrutiny over transfer prices. In China, for example, although the overall number of cases has remained similar over the past five years, the average value of each adjustment has risen rapidly: The total value of adjustments has increased from less than RMB500 million in 2005 to over RMB2 billion in 2009, a 354 percent increase.

There are signs that this trend will

accelerate. The increase in transfer pricing regulations within the Asia Pacific region and the corresponding documentation has provided tax authorities with a wealth of data they can use to select audit targets. Thanks to database technology, tax authorities are able to use this information to target industries, groups or even companies with abnormal results and thus focus their search on transactions within these areas.

Compliance focus by transfer pricing authoritiesFurther, tax authorities have spoken openly about increasing compliance activities. Australia’s Strategic Compliance Initiative, launched in 2009, has a budget of AUD300

million over four years and includes a dedicated staff of around 50 people focusing exclusively on transfer pricing compliance. China’s SAT continues to emphasise investigations and says that it will increase the number of transfer pricing specialists to 500 nationwide. The Indian tax authorities are also increasing the number of transfer pricing specialists, and the Indonesian and Philippine tax authorities have announced new audit initiatives.

Given this activity, it was not surprising that authorities from the Asia Pacific region topped the list of aggressive transfer pricing authorities in a poll by TP Week. According to this poll, the top three most aggressive transfer pricing authorities were Japan, India and China; Australia and Korea also made the top ten.

Australia’s SNF decision – Good news for loss companies

The Full Federal Court of Australia’s landmark decision in Commissioner of Taxation v SNF Australia Pty Ltd. has far-reaching implications for the Australian Taxation Office (ATO) and Australian taxpayers in how they should approach international transfer pricing matters going forward.

As a result of this decision, where Australian companies have poor profits or losses and are thus likely to pay minimal tax, there is now support that in a transfer pricing context these losses may be defendable in the eyes of the court and not necessarily in conflict with Australian tax law. The case will also be relevant for profitable taxpayers where the taxpayer group has entered into transactions with independent distribution entities.

Facts and findingsThe taxpayer distributed products sourced from foreign related parties in the Australian market. The taxpayer sustained losses for over 10 years that the Commissioner

claimed were caused by transfer pricing. The Commissioner argued that the Australian subsidiary was purchasing the chemicals used in the products at inflated prices compared to market prices by focusing on the profile of losses incurred – in other words, the company was assumed to be generating losses via bad transfer pricing.

The court supported the taxpayer’s claim that the chemical purchase prices were reasonably comparable to global prices charged to unrelated parties and that the losses were due to commercial factors. The court went on to explain that although continued losses might indicate a possible transfer pricing misuse, they are not proof in themselves of a problem.

Impact on ATO’s approachAt the time of writing, the ATO had not yet issued a Decision Impact Statement to outline its views on how SNF will affect the ATO’s transfer pricing assessing practices. We expect that, in the future, the ATO will incorporate a greater focus on specific transactions rather than the overall profits of subsidiaries.

Although the SNF case has dealt a blow to the ATO, we expect that it will continue to focus on transfer pricing as a key risk and keep up the pressure on taxpayers who push the boundaries.

Postscript: In November 2011, the Australian government announced it is proposing to reform the transfer pricing rules in the income tax laws.

The government suggested that recent court decisions such as SNF have highlighted difficulties with Australia’s current transfer pricing rules and the rules need to be modernised to maintain the integrity of the corporate tax base.

The Australian government also indicated it is considering introducing amendments to clarify that the transfer pricing rules in Australia’s tax treaties operate as an alternative to the domestic transfer pricing rules in providing a power to make transfer pricing adjustments.

Moreover, the government is considering whether this amendment should apply from income years commencing on or after 1 July 2004 in treaty cases.


20 Future Focus

Road to recovery:

Japan’s 2011disaster relief and tax reforms


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The March 2011 earthquake caused Japan to postpone a number of tax reform proposals announced

in December 2010. Some of these measures – such as a proposed five per cent reduction in Japan’s corporate tax rate – have been set aside for further consideration by the Diet. Other measures were enacted in a separate bill on 30 June 2011. These include a set of tax incentives designed to attract international foreign companies to the country and other measures affecting the country’s controlled foreign affiliate and foreign tax credit regimes.

To increase tax revenue and help finance recovery from the earthquake, the Japanese government plans to submit another tax bill to an extraordinary Diet in late October or early November. This bill would impose a 10 per cent surtax on the corporation tax due for three years. If the Diet passes both this bill and the 2011 tax reform measures that were not enacted in June 2011, the Japanese effective corporate tax rate will drop to 38.01 per cent (from 40.69 per cent) for the next three years and then to 35.64 per cent in the following years.

Japan also introduced a series of tax proposals in April to provide relief for individuals and businesses from the impact of the earthquake.

Tax incentivesAmong incentives to attract international foreign companies enacted in June 2011, Japan has introduced incentives for Comprehensive International Strategic Special Districts and for research and development (R&D) centres and Asian regional headquarter companies.

Other new incentives include a special depreciation and tax credit regime for specified assets for advanced low-carbon and energy saving equipment. Other temporary incentives were extended, including special depreciation and tax credit for specified assets for energy rationalisation and the temporary increase to maximum tax credits for R&D costs.

Controlled foreign corporationsThe June 2011 bill made a series of changes to Japan’s controlled foreign corporation (CFC) rules. These rules

apply to a specified foreign subsidiary that has its main or head office in a country that imposes no tax or an effective income tax rate of less than 20 per cent. Income of such subsidiaries is aggregated with the parent’s and subject to Japanese tax under certain circumstances.

Among other things, the changes clarify that if the related foreign subsidiary’s income is zero, the headline income tax rate of the foreign country will be deemed as the effective income tax rate for the subsidiary. Further, exempt dividends received by a foreign related company from a foreign subsidiary no longer need to be added back to income in computing the company’s effective tax rate.

Foreign tax creditsJapan’s June 2011 tax reform bill changes the scope of foreign income eligible for foreign tax credit. If a tax rate may be selected from among various tax rates by mutual agreement of the taxpayer and the foreign tax authority, then the foreign taxes over the lowest rate are excluded from income eligible for the credit. The new rules also

Japan extends special disaster relief for businesses

In April 2011, Japan’s government announced a package of tax relief to support people and companies affected by the March 2011 earthquake. Proposals to help Japanese businesses include the following measures.

• Corporationswillbeallowedtocarrybackspecifieddisasterlossesresultingfrom the earthquake to apply them against profits in the previous two years (subject to certain conditions).

• Corporationsthatincurredaspecifieddisasterlossoninventoriesandfixedassets can apply for withholding tax refunds for interim tax paid to the extent of such losses.

• Accelerateddepreciationisavailableforcertainassetsacquiredtoreplacecapital assets destroyed by the earthquake (e.g. buildings, machinery, vehicles).

• Fullcapitalgainstaxrolloverisavailableforassetsacquiredtoreplacedestroyed assets (including real estate and depreciable assets).

contain a re-sourcing provision that treats income as foreign source income where that income is subject to tax in a foreign country that has entered into a tax treaty with Japan.

Tax measures on holdThe Diet is still considering other measures that were announced in December 2010 but not enacted in the June 2011 bill. As a result, more

tax reform measures may be enacted over the next while. Along with the five per cent corporate tax rate cut, these items include changes that would reduce the threshold of tax rate in determining creditable foreign taxes from 50 per cent to 35 per cent for foreign tax credit purposes; and abolition of the two-thirds rule for non-taxed foreign source income in determining the creditable limit.

The Diet is still considering other measures that were announced in December 2010 but not enacted in the June 2011 bill. As a result, more tax reform measures may be enacted over the next while.


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Australia pursues sovereign wealth fund investment

As countries across the Asia Pacific region look for ways to finance extensive infrastructure improvement projects, sovereign wealth funds (SWF) can offer reliable, long-term sources of foreign investment. With competition for SWF dollars expected to intensify, Australia is leading the way in creating an attractive tax environment for these funds.

ASWF is a fund owned by a sovereign state, rather than by a regional or local state

entity. SWFs can include a fund set up for intergenerational movement of capital or to meet specific government unfunded liabilities. Thus, many of these funds tend to seek investments in long-term asset holdings that have relatively low risk. Australia, Singapore, Malaysia, China, New Zealand, Brunei and Korea have substantial SWFs that are active in the Asia Pacific and global investment markets.

SWFs offer steady sources of long-term investment

SWFs are usually exempt from tax in their home countries. But, as with any investor, these funds generally seek to diversify their risk and improve their returns by investing in other markets. Most SWFs seek to invest globally in:

• realproperty

• infrastructure

• privateequity

• non-portfolioequityanddebt

• publicmarkets.

SWFs are generally long-term, non-speculative investors, and so they provide stable sources of funds that tend not to disrupt local economies. As a result, countries like Singapore, Hong Kong and Australia have developed strategies and incentives to attract more foreign SWF investment dollars.

Relief from foreign taxesBecause SWFs are tax-exempt in their home countries, they are particularly sensitive to the impact of foreign taxes. Every foreign tax dollar paid directly reduces the fund’s yield. SWFs can often achieve some form of exemption from foreign taxes on their returns, such as interest, dividends or capital gains, from investments in the foreign country, either through sovereign immunity laws, a special exemption, or a tax treaty. Where the SWF invests into a market that does not have a favourable tax treaty or other form of exemption, it is important for the fund to look at how the investment is structured.

Australia’s tax-friendly policies for SWFs

Among Asia Pacific countries, Australia has in place what is likely the most sophisticated tax regime for attracting SWFs. The country has a limited form of sovereign immunity exemption for foreign government investments. As with any other tax exemption, the sovereign immunity exemption is subject to various limitations and restrictions, particularly on eligibility. If a SWF holds an interest of less than 10 per cent of an entity, all of the SWF’s income from the investment is tax-exempt.

Australia’s federal government has also introduced a ‘managed investment trust’ (MIT) regime to improve the competitiveness of the Australian funds

management industry. If the SWF investment is in Australian investment property or infrastructure projects, the fund may qualify as a MIT. This special class of trusts is subject to a reduced tax rate of 7.5 per cent for foreign investors resident in certain countries (compared with the general corporate income tax rate of 30 per cent). MITs may also elect to have capital gains treatment on gains and losses arising on the disposal of certain assets, allowing SWFs to enjoy preferential tax treatment on the underlying investment income.

These tax preferences greatly increase the SWF’s after-tax yield and have attracted significant SWF investment to the country. Since the MIT regime was introduced in 2008, SWFs from Singapore, New Zealand, Korea, Europe and North America have all invested heavily in Australia.

Stability in all areas is paramount

Of course, effective tax rates are one of many factors influencing SWF investment choices. SWFs investing in foreign markets also look for stability in the local currency, political regime, and taxation laws and administration. Given Australia’s success in attracting investment, especially in infrastructure, other countries in the Asia Pacific may consider introducing similar tax preferences to help them compete for SWF investments.


23Future Focus

Energy needs and green agenda fuel resource tax changes

Many countries are looking to secure long-term supplies of energy and raw materials to fuel economic development. This has sparked a boom in cross-border investment in energy and natural resources, with a particular focus on the Asia Pacific region. Combined with strong commodity prices, all this activity is attracting the eyes of governments seeking more tax revenues. At the same time, these governments are under rising pressure to shift their consumption toward more clean energy and promote the green agenda.

For Asia Pacific companies in the energy and natural resources sector, these factors are driving

three taxation trends.

1. Resource-rich countries, like Australia and China, are imposing new taxes to boost their revenues from resource extraction activities.

2. Governments are moving to put in place regimes, like Australia’s proposed carbon price, to discourage carbon emissions and other practices and products that can cause environmental harm.

3. Countries are also introducing tax incentives to promote environmentally friendly activities, practices and products.

Extracting more revenues from resource taxesTraditional resource companies and new investors are reaching out to new

locations in pursuit of coal, iron ore, liquefied natural gas (LNG), oil & gas, metals and other commodities. India, China, Japan and Korea are seeking to secure coal supplies to meet their rising power generation needs, whilst Australia and Indonesia are boosting coal and liquefied natural gas exports in response.

Many countries in the region are investing in huge infrastructure upgrades to accommodate the rising cross-border economic activity. New roads, pipelines, power plants and rail and port facilities are being built at a rapid pace, creating demand for iron ore and coal. Both coking coal for steel and thermal coal for power stations are in high demand, as are copper, uranium, and other resources used in new buildings.

With strong commodity prices, fiscally challenged governments are reviewing their resource taxation arrangements, including the level of royalties, the use

Many countries in the region are investing in huge infrastructure upgrades to accommodate the rising cross-border economic activity.


24 Future Focus

Energy needs and green agenda fuel resource tax changes

A new wave of carbon trading plans

seems set to spread across the Asia Pacific

region, with Australia at the front of the curve.

of profits-based rent taxes and so-called ‘super profits taxes’. As noted on page 16, China plans to impose a new green tax and to overhaul its resource taxation system within the next five years.

Australia’s expanded resource tax regimeAustralia has proposed the following measures.

• AnewproposedFederalMineralsResource Rent Tax (MRRT) will be imposed on the profits from coal and iron ore mining. MRRT will apply at a headline rate of 30 per cent on resource profits, reduced to an effective rate of 22.5 per cent by an extraction allowance. A credit will be given for state resource royalties.

• The40percentPetroleumResourceRent Tax (PRRT) currently imposed on offshore projects will be expanded to include all petroleum projects (other than those in the Timor Sea Joint Petroleum Development Area), including coal seam gas projects. State petroleum royalties will continue to apply to projects within state jurisdictions; however, these royalties will be fully creditable against PRRT liabilities.

Although these taxes do not take effect until July 2012, affected resources companies (coal, iron ore, oil and gas) in Australia should start taking steps now to fully understand the proposed changes

and assess the implications for their organisations. Companies across the region should monitor the imposition of such new resource taxes and consider their potential impact on long-term projects.

Carbon pricing – The centrepiece of Australia’s climate change planAround the world, carbon pricing schemes are emerging as one of the dominant government policy tools for helping to reduce a nation’s overall carbon footprint. From the European Union to North America and South Africa, jurisdictions are using these plans to monitor and meet their greenhouse reduction targets. A new wave of carbon trading plans seems set to spread across the Asia Pacific region, with Australia at the front of the curve.

Australia’s new carbon pricing is the centrepiece of its Climate Change Plan. The scheme is not technically a tax – it is a price mechanism that will apply to all companies producing at least 25,000 tons of certain carbon dioxide emissions per year (excluding electricity and fuels used for transportation), starting on 1 July 2012. The mechanism will directly affect 500 companies, with knock-on effects for many more businesses as the scheme’s impact on electricity costs spreads through the supply chain.

Phased-in emissions trading systemCentral to these measures is an emissions trading system that will be phased in with permit prices fixed at AUD23 and rising to AUD25. The number of permits issued during this phase will be uncapped. After three years, the number of permits will be subject to annual caps (to be announced for 2015–20 in 2014), and the price will then be determined by supply and demand.

The proposed prices during the phase-in period are higher than current prices in comparable global markets. Given Australia’s heavy reliance on coal, the phase-in prices were set intentionally high to help drive investment into the renewable energy sector. While the phase-in prices are comparable with the forward prices for the European Union’s emissions trading scheme, many analysts predict Australian carbon credit prices will drop significantly when market-based pricing takes effect after the first three years.

To prepare for the carbon price, affected companies should evaluate the system’s potential impact on their direct and indirect costs, develop accurate and reliable systems to capture and report emissions data, and begin establishing their carbon trading strategy.

Other countries in the area are also looking to carbon pricing mechanisms to help them reduce harmful emissions. For example:


25Future Focus

• NewZealandalreadyhasalimitedcarbon trading system in place, although the carbon price is currently too low to have any noticeable impact.

• Chinaintendstopilot-testdifferentcarbon trading schemes in various locations, though the details of these plans are still in the works.

• Koreahasannouncedplanstointroduce an EU-style emissions trading system in 2015.

• Japanhadplannedtoadoptanemissions trading system, but suspended these plans in 2010 and faces difficult decisions on its energy policy in the aftermath of the March 2011 earthquake, tsunami and nuclear disaster.

Since all of these plans, including Australia’s, are grounded in the same concepts as the European Union system, the next decade could see the rise of international trade in carbon credits.

Subsidising the transition To lay the ground for transformation of a country’s energy production and usage, punitive measures like imposing carbon taxes and banning polluting materials and practices can only go so far. Other steps need to be taken to feed rising energy demands. Countries will increasingly rely on renewable sources such as solar, wind, tidal and geothermal energy, but the underlying technology is not yet economically viable on a large scale.

To meet their climate change goals and transition to a clean energy future,

countries need to make significant investments in fostering innovations in renewable energy, energy efficiency and low pollution technologies.

Australia’s plan includes array of grants and tax incentivesFor example, Australia’s Climate Change Plan recognises that businesses will need a variety of different types of incentives to support to make the transition. The carbon pricing mechanism is expected to drive innovation and investment into clean technology research, development and implementation. The Plan allocates significant funding to help encourage this activity in a variety of different packages, including grants, loans, tax deductions, and other incentives.

The plan also includes significant compensation packages targeted toward a number of different sectors to ease the impact of the carbon price and support jobs in exposed sectors (e.g. steel, aluminium and coal, manufacturing and electricity generation).

Similarly, China’s 12th Five-Year Plan (see page 16) includes incentives for companies involved in developing methods and products for conserving energy, reducing emissions and protecting the environment.

Grants versus tax creditsIn assessing the assistance available, bear in mind that government grants are usually allocated in set amounts and the application process is competitive, requiring a strong business case for success. Once

the grant is approved, the company typically has certainty over the funds (subject to compliance with agreed conditions). In contrast, tax incentives, such as credits for research and development, are usually open to anyone who has met the criteria. However, eligibility is generally not approved until after the costs related to the activities have been incurred, and so the funding may be less certain.

Plan ahead to optimise government assistanceWhether the assistance takes the form of a grant, tax preference or otherwise, companies can optimise the assistance they receive by taking a business-wide, forward-thinking approach to their innovative activities and establishing automated systems for tracking their activities and costs. Steps that your company can take to help optimise your Climate Change and Sustainability incentives are as follows:

• Investigatewhatgrantsandtaxpreferences are available when determining where to locate investments and activities.

• Incorporatethepossibleavailabilityofthese incentives in your business and financial planning, and factor them into your decision-making processes.

• Involvescientificresearchers,engineers and other technical staff in the process of identifying activities eligible for government support and preparing support documents.

• Establishautomatedprocessesfor tracking eligible activities and capturing related costs.

Above all, try to instil awareness about government grants and tax concessions throughout your company so that financial executives are aware of the added value and employees are on the lookout for eligible activities.

To lay the ground for transformation of a country’s energy production and usage, punitive measures like imposing carbon taxes and banning polluting materials and practices can only go so far.


26 Future Focus

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Achieving a world-class

tax function:Changing regulatory landscape opens the door

Over the past several years, KPMG member firms have observed a changing landscape for tax departments. Boards are more inquisitive toward tax risk management frameworks, while the world’s tax authorities are employing more innovative techniques to replenish diminishing tax revenues caused by the global economic downturn.

The globalisation of multinational organisations is also magnifying potential tax exposures through

lack of visibility and control over offshore compliance activities, missed filing deadlines, and corresponding audit activity. In responding to these pressures, both internally and externally, organisations have the opportunity to:

• aligntheirtaxstrategieswiththeirbroader organisational goals

• adoptrobusttechnologyplatformstoautomate and standardise processes

• re-thinktheircurrentapproachestoward tax compliance activities by outsourcing or off-shoring certain tax activities.

Stakeholder pressures on tax governanceIn 2009, KPMG International commissioned a study of how tax departments were adapting to increasing stakeholder pressure to deliver more in less time.2

Not surprisingly, respondents expressed frustration that senior executives were looking to tax departments to contribute more to the bottom line through

better management of tax cash flows and tax planning without providing appropriate guidance as to the role of tax departments within the broader enterprise risk management framework.

With tax authorities adopting a more cooperative model toward sharing information across borders and developing more sophisticated risk profiling techniques, there has been a surge of activity around tax governance. Working together through the Organisation for Economic Co-operation and Development’s (OECD) Forum of Tax Administrators,3 the Australian Tax Office (ATO) and tax authorities around the world are assessing the robustness of tax governance frameworks to set the tone for future engagements and interaction with organisations. Australia, along with the United States, the United Kingdom and Canada, is at the forefront of this trend.

So far, Australia is the only Asia Pacific country to embark on a full-scale taxpayer risk-profiling project that explicitly rewards taxpayers that have a robust approach to tax governance. Other countries, however, have noticed its lead.

China introduced voluntary provisions on tax risk management for large business in 2009. The Chinese authorities appear keen to continue to expand this approach of appraising taxpayers on their internal control frameworks and how they deal with tax.

In countries such as Japan and Korea, where taxpayers are traditionally more conservative, there is less tax authority pressure to address tax governance. Internal pressure persists to ensure the company does not make errors or enter into dealings that may damage their reputation.

Risk differentiation framework: ATO’s risk profiling toolIn 2010, the ATO introduced a new risk-based approach to achieve further voluntary compliance by approximately 1,200 large business taxpayers and aid in the differentiation of their compliance activities regarding the consequence and risk of non-compliance.

Under this program, large taxpayer groups are slotted into one of four quadrants associated with their

2. KPMG International, Good, Better, Best: The race to set global standards in tax management, 2010.3. See, for example, OECD Forum on Tax Administration, General Administrative Principles: Corporate Governance and

Risk Management (Information Note, July 2009).


28 Future Focus

relative consequence and risk of non-compliance assessed from both a quantitative and qualitative perspective.

• Organisationsthatdemonstrateastrong tax governance structure and a history of cooperation with the ATO are perceived to be lower risk and are more often included in Quadrant Q2 and 4. These organisations in theory experience more limited compliance activity.

• HigherriskgroupsinQuadrantQ1 and 3 may experience relatively more rigorous compliance activity with a real-time focus and more demands for information. Pre-lodgement compliance reviews give the ATO real-time visibility of risk areas in a supposedly self-assessment environment and disclosure of ‘contestable’ tax positions by way of tax return schedule disclosure.

This approach is intended to level the playing field for those large businesses that have signed up for the ATO flagship product for voluntary compliance, the Annual Compliance Arrangement.

For organisations in higher-risk quadrants, ATO auditors are going beyond querying the data filed in tax returns. Auditors are expressing interest in the details of taxpayers’ corporate governance and asking questions about the robustness of the framework of people, policies,

processes, controls and systems by which tax and the related risks are managed. The ATO is seeking to obtain an intimate understanding of organisations’ corporate governance frameworks, and then attempting to test the effectiveness of the framework by retracing how a series of actual transactions progressed through the governance framework in practice.

This insight is enabling the ATO to be more proactive in using its powers to review uncertain tax positions in real time and in using this data to refine its approach to risk reviews and audits. The insights gained are also enabling the ATO to understand and direct its attention to areas of weakness in the underlying information systems and processes. Systematic failures may uncover repeated errors for tax and help the ATO raise more revenue through adjustments, penalties and interest.

Benefits of tax governance go beyond a risk management frameworkConversations about tax governance typically focus on how to respond to a tax authority’s inquiry for a risk framework presentation; how to satisfy an overseas parent initiative; or how to prepare for an audit risk committee presentation.

This risk-based attitude toward developing a tax governance framework

is unfortunate as it only achieves a narrow set of outcomes. There is an opportunity to shape the conversation more broadly to encompass the risk management and value creation benefits associated with the articulation of a tax governance framework.

As groups in the Asia Pacific region continue to expand, their need will increase for resources to manage overseas compliance and the amount of financial data needed for tax reporting. At the same time, data storage may become decentralised on inconsistent systems and make information harder to retrieve. In this environment, adopting a consistent tax governance framework prospectively can help companies achieve commercial benefits in terms of identifying risk areas and potential opportunities in a timely manner that supports the business as it grows.

Analysis of the area of tax management shows that there is no one-fit-all solution. Organisations have different expectations about how to allocate resources between risk and value. KPMG member firms have also observed that organisations are at different points along the tax function transformation timetable. Inevitably, all organisations converge towards the same objective – a tax function that aligns with the business, meets stakeholder requirements, and is embedded into the organisation’s mainstream.

Good, Better, Best: The race to set global standards in tax management


29Future Focus

Creating a tax governance frameworkIn developing a tax governance framework, it is important to engage widely across all parts of the business – including boards, senior executives and finance professionals. To help achieve buy-in, experience shows that the strategy needs to remain focused on generating value for the business.

Through our work with and analysis of leading organisations worldwide, KPMG member firms have observed that companies that are developing a tax governance framework need to take into account a broad spectrum of matters, including:

• Common purpose. Aligning the tax strategy with the commercial objectives of the organisation.

• Embedded processes. Identifying the coverage of taxes for an organisation and then allocating roles and responsibilities across finance, tax and other departments to ensure the effective and efficient use of resources within the company.

• Timely and accurate information. Producing, exchanging and distributing data to the right people, at the right time, and in the right format.

• One view of performance. Monitoring effective tax management by clarifying what is required and how performance is measured, through agreed-upon key performance indicators (KPI) that are consistent with the business.

• Enabling technologies. Automating labour-intensive processes that consume resources and increase risk through the use of enabling technologies.

• High-performing teams. Ensuring the tax function comprises the right number of tax professionals with the right mix of training, skills and experience.

Supporting tax governance with technologyHow can technology help? Automation and standardisation eases the management of complex data flows, streamlines the performance of routine tasks, and increases the accuracy of tax data and related filings. Greater efficiency results, allowing in-house tax teams to spend less time on compliance and more time adding value through proactive tax planning activities and engagement with the business units. Investments in tax technology – such as KPMG’s Global Tax Management

System (see sidebar) – can reward an organisation by:

• providingasingleplatformforstaff and professional advisors and ensuring transparency over every aspect of tax management

• offeringasinglelocationtostoredata,protected by an audit trail that tracks changes and provides version control

• providingvisibilityovertaxcashflows, thereby allowing users to track and control payments and credits

• providingacentralplatformformanaging complex international tax issues, such as a company’s transfer pricing policies, employee relocations, and VAT/GST obligations, in each of the company’s locations.

The role of technology in supporting outsourcingIn an emerging trend, tax departments are being asked to juggle the demands of compliance deadlines, tax planning initiatives, and driving value across the business with fewer resources. Responding to these pressures, organisations are increasingly reviewing the benefits of outsourcing tax compliance tasks to a third-party service provider.

In developing a tax governance framework, it is important to engage widely across all parts of the business – including boards, senior executives and finance professionals.


30 Future Focus

Through outsourcing, companies can efficiently manage the use of internal tax resources while engaging a service provider to be the organisation’s ‘eyes and ears’ across the globe. As the sidebar shows, technology to support an outsourcing model can offer particular benefits for companies that need to get visibility over local tax obligations as they expand into different countries.

Getting the balance right between managing risk and driving value

Until recently, tax has rarely registered at the board level or on the agendas of senior executive meetings. This is either due to the perception of tax’s specialised nature, a lack of understanding or an inability to achieve alignment with the business. Recently, stakeholder expectations have elevated tax governance priorities within the organisation, largely driven by regulators. For tax departments, the challenge is to manage expectations regarding the risk framework while demonstrating the opportunities of embedding tax within the business to drive value. At KPMG, we call this ‘Driving Tax Performance’.

Tap into technology’s benefits by outsourcing

I n-house tax professionals in the Asia Pacific region are striving to balance

rising regulatory demands with the need to add value to rapidly growing businesses. Outsourcing (or co-sourcing) can be a versatile, scalable and cost-effective way of moving beyond current constraints and better meeting the company’s compliance needs.

Getting transparency and control over business process is critical, especially in an outsourcing environment. Tax and finance departments must be able to share information and collaborate on global projects. Technology plays an important part in

providing real-time visibility over the compliance project – across multiple entities in multiple jurisdictions.

Organisations are seeking a coordinated and consistent approach to global compliance to ensure access to leading practices and effective tax risk management. An outsourcing framework establishes a core team to provide a single point of contact to deliver the services. The technology provides a bridge between people using different systems in different locations. It provides a secure, structured and efficient way to assist with the coordination and delivery of outsourced activities.

KPMG’s Global Tax Management System

In the increasingly complex and demanding world of compliance

and reporting, having visibility over your global tax processes and data is essential. Locally, it enables your teams around the world to operate with consistent standards. Centrally, it gives you effective monitoring and control and demonstrates strong corporate governance to auditors, tax authorities, investors and other stakeholders.

KPMG’s GTMS is a web-based information hub that helps you capture and maintain visibility over your tax processes, document files, and data wherever they are managed or originated. Among its many benefits, GTMS offers:

• Theabilitytobetterdefineandstructure data gathering across

your business in advance, improving efficiency for service providers and users all-round.

• Theflexibilitytotailoroutputstomeet the specific reporting needs of multiple interest groups.

• Amodularapproach,allowingGTMS to respond to change and align the tax function more closely with the developing shape of your business.

By providing a single platform accessible to your staff and third-party service providers, GTMS gives transparency over your tax management processes and access to information and data files when you need them.

This is either due to the perception of tax’s specialised nature, a lack of understanding, or an inability to achieve alignment with the business.


31Future Focus

Short-term business travel, rising VAT/GST costs, cloud computing, aggressive transfer pricing audits:

as companies in Asia Pacific countries grow and expand into new markets, their tax teams will need to find ways to cope with complex global issues like

these while adding value to their organisations.

Luckily, solutions to many of these issues have already been forged over time and with much

difficulty by leading organisations in Europe, North America and around the world.

Asia Pacific companies can bypass these development phases by adopting systems,

processes and technologies that are already proven and tested. In this section, we offer some ideas that Asia Pacific companies can employ to leap ahead.

Leap


32 Future Focus

Short-term international business travel is rising across the Asia Pacific region as companies take up more opportunities to

exchange ideas and get their employees working together in global teams. But unmonitored and unplanned, such travel can create a host of income tax, immigration and other exposures.

High costs are the key issue related to international assignments for companies worldwide. Among Asia Pacific countries, unplanned employee travel is one of the biggest factors increasing assignment costs – and heightened enforcement is making these risks even greater.

In developed countries, such as Australia and Singapore, tax and immigration authorities are growing much more sophisticated in collaborating and sharing information, improving their ability to enforce tax and immigration laws. Tax regimes in developing countries are catching up to their more sophisticated neighbours, building up resources and strengthening their ability to track business travellers and ensure tax compliance.

Most jurisdictions have well-developed treaty networks that should protect cross-border workers from double taxation. Inconsistent

interpretations and administrative practices, however, can frustrate access to treaty benefits. Social security tax regimes in the Asia Pacific region are less developed than in other parts of the world, and so significant issues can arise in countries that do impose them due to the lack of totalisation agreements. Recently, China and India have taken steps to bring foreign nationals into their social security nets. Assignees in India, as well as their employers, can bear significant social security costs, with no relief or ability to retrieve the funds before retirement.

Planning can prevent tax problems before they ariseInternational assignment planning is fundamental to avoid double taxation and other exposures that may arise from employee travel. One of the more common tax issues arises when the assignee’s salary is paid by the host country, which often occurs because the assignment is for host country entity’s benefit.

These issues can be easily avoided through upfront planning between the home and host countries regarding the employee’s remuneration. Examples of other common

Keeping tabs on short-term

business travellers

High costs are the key issue related to international assignments for companies worldwide.

Thinking Beyond Borders:

Management of Extended Business Travellers (2011)


33Future Focus

issues that unplanned employee travel can create are as follows.

• Dependingonhowmanydaystheemployeespendsworking in a foreign country – in aggregate and often over more than one year – the travel could create income tax and social security obligations for the employee in that country, along with payroll tax and withholding obligations for the employer.

• Employeesenteringacountryonbusinesswithouttheright immigration documents – or staying in the country for longer than the documents allow – could expose themselves and their employers to fines, penalties and future travel restrictions.

• Anemployee’sactivitiesinaforeigncountry,suchasconcluding contracts on the employer’s behalf, could be construed as creating a permanent establishment there, opening the company to taxation as a resident in that country.

Proper planning that takes into account domestic laws, administrative policies, and potential tax treaty relief can help a company manage and mitigate such exposures before the employee heads out.

Keeping your employees safeJapan’s earthquake in March 2011 and its aftermath highlight the importance of having a robust system in place for

tracking and planning employee travel. Emergencies like these strike without warning, creating a need to move employees out of the danger zone for uncertain lengths of time or marooning them in a foreign country for longer than intended.

Whether due to environmental disaster, political unrest or other emergency, such moves can cause the same tax exposures as other employee travel. In fact, these situations could entail even more risk, for example, when the relocation of key decision-makers from one country to another constitutes a shift in business functions with transfer pricing or permanent establishment implications. When such events occur, quick access to data about your employees’ whereabouts and options for relocating them safely and economically could be crucial.

More risks for financial services employeesFor regulated financial services companies, keeping tabs on the activities of their employee travellers is a top priority. To avoid running afoul of financial services regulations, these companies need to make sure their employees do not undertake activities requiring a license, approval or government sanction that the company itself has not yet obtained. The best way to manage this risk is to have a system in place to allow risk and compliance officers to clear the employee’s proposed activities and objectives in advance of the travel.

Leap aheadLeading organisations are getting control of their short-term travel programs by taking a global approach and putting in place centralised, automated mechanisms for assessing future business trips. These systems can help mitigate tax compliance and other risks before any travel can be booked. Such a system would:

• quantifyhowmuchtimetheemployeehasalreadyspent in a foreign jurisdiction in the past and how much more time he or she can spend there without creating a taxable presence

• enumerateanysocialsecurity,payrolltaxorwithholdingtax implications that could arise from extended business travel in the proposed host country

• advisewhethertheemployee’splannedactivities(e.g.obtaining licenses, meeting suppliers, negotiating sales) could create tax, financial services regulatory or other consequences

• specifywhatvisasorotherimmigrationdocumentsarerequired by business travellers in the foreign country

• listanyotherrequirementsorobligationsthatshouldbetaken into account by people travelling to the particular country.

Such systems should also track employees on international assignments in the event that natural disasters or political developments make it necessary to find and relocate them quickly.


34 Future Focus

MAKING YOURBUSINESS WORK

ABROAD.

INTERNATIONAL EXECUTIVE SERVICES Mobilising a global workforce takes balance and foresight.

KPMG provides guidance to allow companies to focus on the highest value aspects of their programs – their people.

For more information visit kpmg.com/ies


RISK.LOWERED.

Guiding you to the right side of risk and reward. KPMG’s Global Indirect Tax Services: Global insights delivered locally.

For more information visit kpmg.com/indirecttax


Managing rising VAT/GST compliance burdens

The KPMG Benchmark Study on VAT/GST (2011)

With many Asia Pacific countries on the brink of significant VAT/GST reform (see page 7), businesses in the region will see more challenges in achieving full VAT/GST compliance. As export manufacturing operations continue to expand in South-east Asia and as the region continues to attract more outsourced compliance activities, VAT/GST issues will put more pressure on resources and cash flow. These companies need to achieve a difficult balance between managing their indirect tax risks and creating value. Asia Pacific companies that get the balance right stand to reduce their risk, add more value and gain competitive advantage.

Current indirect tax systems in the region differ widely from each other and generally even more so from more established regimes around the world. Asia

Pacific tax authorities typically prefer to deal with local professionals who know the rules and how they are applied in practice. However, indirect tax compliance is often managed out of parent companies in foreign countries that have different VAT/GST rules and administrative practices. Few large multinational groups in the region have a head of VAT/GST.

As in many other regions around the world, Asia Pacific tax authorities are becoming increasingly active in their VAT/GST audits. Despite this increasing audit focus, results of The KPMG Benchmark Survey on VAT/GST show that, around the world, the indirect tax function remains under-resourced, under-measured and under-managed in most organisations. Given the huge number of VAT/GST transactions that global companies need to handle, there is no doubt that businesses are missing significant opportunities – to improve cash flow, reduce costs, improve business processes and enhance the bottom line.

Given the huge number of VAT/GST transactions that global companies need to handle, there is no doubt that businesses are missing significant opportunities – to improve cash flow, reduce costs, improve business processes, and enhance the bottom line.


37Future Focus

Leap aheadAsia Pacific enterprises can guard against the growing risk of indirect tax audits by adopting a company-wide strategy of prevention, planning and management. Such a strategy should establish risk management and corporate governance processes of indirect taxes with clearly defined goals that measure such indicators as tax savings, management efficiency and reductions in assessments and errors.

In the Asia Pacific context, care should be taken to ensure key performance indicators (KPIs) are relevant for the region and comparable across jurisdictions. For example,

turnaround times for receiving tax refunds may be a reliable KPI for companies in Europe. However, in many cases, Asia Pacific operations are likely to wait much longer to receive refunds (if indeed applicable) from the region’s less developed tax administrations.

Further, KPIs should not be designed in ways that might distort good business practices. For example, setting a limit on the amount of spend on external consultants as a KPI may be a valid benchmark in some cases – but it could also discourage the use of third-party VAT/GST advisers where they could add significant value.

Global strategy, local knowledgeAmong other things, a company’s VAT/GST strategy should identify items that local tax authorities are scrutinising when generating assessments. Companies need to ensure that their tax functions include professionals with the right level of local VAT/GST expertise to manage these challenges. Leading global organisations are increasingly appointing Asia Pacific tax managers to give local indirect tax matters more visibility and priority within the company.

Technology can play a crucial roleWith VAT/GST reform expected across many countries in the Asia Pacific region, the strategy should be adaptable to possible future changes and new trends in tax practice, while focusing on immediate points of realisation of short-term goals. In designing a global indirect tax management framework, effective

use of technology can play a crucial role in:

• designingtheprocessandmakeits control viable

• quantifyingandmeasuringtheeffectiveness of the process and revealing opportunities for optimisation

• providingaglobalplatformformanaging tax risks in multinational environments.

Given the huge volumes of transactions that must be processed, technology can help the company’s tax function create business value by reducing errors and increasing tax savings, thereby reducing the cash flow problems that can be caused by indirect tax mismanagement. Through automation and standardisation, the company also stands to gain better control over indirect tax issues arising in billing procedures, which create indirect tax obligations, and procurement processes, which create indirect tax recoveries.


38 Future Focus

KPMG’s framework for managing VAT/GST

Through our work with leading organisations worldwide, along with our benchmarking studies and analysis, KPMG International

has developed a framework for effective and efficient VAT/GST management. The framework entails developing a set of clear, commonly understood policies that identify the key tax risks throughout the organisation and offer insight for their mitigation and management. Applying these principles, it is possible to implement a continuous VAT/GST performance benchmarking process through the five steps described below.

1. Engage widely within the organisation to identify key business objectives and future direction. Effective VAT/GST management should be founded on a set of clear, commonly understood policies that identify the key tax risks throughout the organisation and offer insight on how they should be managed.

2. Assess the extent, quality, and usage of VAT/GST Key Performance Indicators (KPIs) currently in operation in your organisation. Most companies have well-established metrics for corporate tax performance, but only a minority have specific VAT/GST performance goals visible to the CFO. The VAT/GST metrics that do exist mostly focus on cash flow and compliance management. Additional KPIs could track and measure:

• reductioninVAT/GSTpayableonincome

• reductioninVAT/GSTpayableonexpenditure

• minimisationofinterestandpenalties

• relationshipswithtaxauthorities.

3. Build a strong business case for investing in people, process improvement and technology, emphasising where these investments will deliver value. Many organisations have scope to improve their GST/VAT performance and deliver more value by increasing their investments in people, process improvement and technology.

4. Determine appropriate VAT/GST performance benchmarks/KPIs for the organisation. Multinational businesses should consider what are the most appropriate qualitative and quantitative measures for their business, put in place a program of continuous improvement, and demonstrate over time how real business value can be generated through better indirect tax management.

5. Continuously review and update VAT/GST benchmarks in light of changing business, legislative and other variables changes. Given the scale of VAT/GST throughput being handled by multinational organisations, there is no doubt that businesses are missing significant opportunities to improve cash flow, reduce costs, improve business processes, and enhance the bottom line. Realising this value will require a clear focus on the most critical KPIs and how they can be improved within the business over time.


39Future Focus

Cloud computing: Clearing up the tax risks

As an easy and cost-effective way to resolve costly technology and computing tasks, ‘cloud computing’ is becoming an attractive solution to manage information technology. Around the world and across the Asia Pacific region, technology start-ups and established players are rolling out cloud services at a rapid pace, and businesses have been quick to embrace the technology’s benefits.

However, the cloud network’s lack of any fixed location confounds usual tax concepts based on the source and nature of various payments. Determining the tax treatment of transactions that occur in the cloud can be complex, and most tax authorities in the Asia Pacific region have yet to develop consistent rules and policies in response. Even without well-defined policies, some countries, such as Korea and Taiwan, have become bolder

in classifying outbound payments for some cloud services as royalties and asserting their right to impose withholding taxes on them.

Given this lack of clarity, users and providers of cloud computing services need to plan their operations and activities carefully to manage their exposure and gain the full extent of cloud computing’s benefits.

What is ‘cloud computing’?The virtual ‘cloud’ is a metaphor for externally managed or outsourced IT resources, information, software and hardware. In cloud computing, a company’s computing needs are managed in the cloud by the third parties so that the company has no need to manage the architecture’s back end. This way, companies (users) can perform sophisticated IT functions without the need to own, manage – or even to know

the detailed physical location of – the servers, routers and other technical data storage devices in the network.

These characteristics are particularly beneficial in developing countries. Using the cloud, Asia Pacific companies can approach their IT needs on a ‘pay-as-you-go’ basis rather than investing in developing and staffing and IT infrastructure in-house.

Tax issues up in the airMost domestic tax laws and treaty provisions that apply to cross-border transactions were designed for bricks-and-mortar companies. Many rules apply based on physical location to determine whether a payment is from a domestic or foreign source. The source of income can affect whether foreign tax credits are available to offset foreign taxes paid. It can also affect whether withholding taxes are imposed on payments received from cloud computing transactions and whether tax treaty relief is available on that income.

But device and location independence are two of the cloud’s key features. In any given cloud network, the cloud service provider may own or manage many servers, routers and other technical data storage devices off-site, possibly located across multiple systems and countries around the world. Some of the specific tax complexities that can result are as follows.

The source of income can affect whether foreign tax credits are available to offset foreign taxes paid. It can also affect whether withholding taxes are imposed on payments received from cloud computing transactions and whether tax treaty relief is available on that income.


Nature of paymentThe tax treatment of a cloud user’s payments for cloud computing services depends on the extent of the user’s rights to use the cloud computing software. Whether the payment is characterised as sales income, service income or royalty can dramatically affect how and where the income is taxed, and whether withholding taxes or tax treaty relief will apply.

• Sales income – A computer program is sold when the transfer includes all substantial rights and burdens of ownership. Sales income is generally sourced to where the property is produced and/or to where the sale takes place (e.g., where title and benefits and burdens of ownership pass to the buyer). In the cloud computing context, all production activities are rarely conducted in one location, and so pinpointing the payment’s source may not be straightforward.

• Service income – Generally, income derived from the provision of services is sourced to where the services are performed. Like sales transactions, all of the inputs that make up a cloud service offering are rarely conducted in a single jurisdiction.

• Royalties – If the cloud user gains the right to exploit intellectual property, the payment is a royalty. These payments are sourced to where the intangible property is used (exploited)

and, unlike payments for services, they may attract withholding taxes in the payer’s jurisdiction.

Value-added taxesProviding cloud computing services can create VAT registration, collection and reporting obligations in the jurisdictions where the services are consumed. A number of countries offer relief for electronically delivered services or the possibility of exempting certain forms of software services in their entirety.

Permanent establishmentCloud service users and providers need to determine whether their activities or operations are substantial enough to create a taxable presence in a foreign jurisdiction. If so, they may become liable for tax in the foreign country. Relief may be available under an applicable income tax treaty.

Transfer pricingCloud computing businesses face transfer pricing issues raised by how the value of the business is distributed among the intellectual property, cloud computing infrastructure, and supporting personnel. Where more than one entity combine efforts to provide a cloud computing offering to customers, the business will need to evaluate each entity’s economic contribution to the effort and compensate each entity according to arm’s-length principles.

Developing your tax strategy for cloud computingClearly, with the high degree of tax uncertainties involved and the current lack of administrative guidelines, it is vital for organisations engaged in cloud computing – whether as providers or customers – to put in place comprehensive tax strategies for undertaking cloud computing projects.

In developing this strategy, organisations should begin by mapping out the project’s system of international payments and services, including their location, direction, risk and beneficiaries. Project managers should then work with their tax teams or independent tax advisers to take a position on the nature of payments and permanent establishment and withholding tax risks inherent in their system. From there, project managers can adjust their systems and take other mitigating steps, such as entering discussions with tax authorities or obtaining advanced rulings, to put the organisations in the best tax position possible.

Organisations that do this from the outset will gain a significant long-term advantage over any competitors who fail to comprehensively address the tax risks and opportunities arising from the burgeoning new cloud computing industry.

In the cloud computing context, all production activities are rarely conducted in one location, and so pinpointing the payment’s source may not be straightforward.


41Future Focus

Transfer pricingissues on businessrestructurings

As Asia Pacific businesses continue to grow and shift their activities within the value chain, they will move more functions and activities among locations in the region or rationalise their existing structures to compete. In doing so, these companies should be prepared to manage complexities arising from new transfer pricing guidance on business restructurings from the Organisation for Economic Cooperation and Development (OECD).

So far, Australia’s tax authority is the only one in the region to formally set its sights on

these transfer pricing issues. Other tax authorities are expected to take more interest as outbound business restructurings in their jurisdictions become more common.

OECD defines ‘business restructuring’ broadlyIn 2010, the OECD formally incorporated business restructuring issues in its Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations. The new guidelines effectively treat a wide range of non-tax business decisions as transfer pricing issues. Business restructuring is defined to include: ‘… the cross border re-deployment by a multinational enterprise of functions, assets and/or risks’. In essence, a business restructuring can involve almost any

substantive change in a business relationship, including:

• achangeinthenatureorscopeof transactions among controlled entities

• ashiftintheallocationofrisks

• achangeintheownershipofassets,including intangibles

• achangeinresponsibilityforspecificfunctions

• terminationoftherelationship.

Importantly, the OECD guidelines state that the arm’s length principle should not apply differently in the case of restructuring than in other transfer pricing contexts.

ATO ruling embraces OECD guidelinesIn February 2011, the ATO released a taxation ruling (TR 2011/1), which

provides its views on how Australia’s transfer pricing rules apply to multinational business restructurings. The ruling closely aligns with the OECD guidelines but places more emphasis on the commercial reasons for the restructure, including alternative options available to the taxpayer. The ATO is expected to increase its compliance activity in this area.

Other jurisdictions – Getting on boardMany Asia Pacific countries still currently see fewer outbound business restructurings, but we expect these transactions to increase in the future. Japan and Korea, for example, are looking into adopting the revised OECD guidelines, and they are expected to pursue business restructurings accordingly.


42 Future Focus

The guidelines stress the importance of clearly defining the structure of the transaction in terms of functions, assets and risks, both before and after restructuring.

We expect this situation to change across the region in the next several years as transfer pricing regimes become more mature and countries such as China continue to expand

and shift certain activities and assets, such as manufacturing or intellectual property, to other Asia Pacific jurisdictions. However, jurisdictions like Hong Kong and Singapore – which

are typically on the receiving end of economic activity and/or capital on business restructurings – may remain less aggressive in their related transfer pricing policies.

Leap aheadThe new OECD guidelines and the expected increase in business restructurings mean that international organisations in the Asia Pacific region need to put in place processes to document a much broader range of changes in their business operations than in the past. Under the guidelines, organisations thinking about a change in business structure or intercompany relationships should consider – and document – how the arm’s length standard applies in terms of:

• theirinitialstructure

• theirnewstructure

• thepayments(ifany)thatwouldbeexpectedatarm’slength on converting from one structure to the other

• theimplications(ifany)ofthepriorstructureandthenature of the restructuring for prices under the new structure.

The guidelines stress the importance of clearly defining the structure of the transaction in terms of functions, assets and risks, both before and after restructuring.

Written agreements that specify these terms are recommended. Regarding financing arrangements, documentation should include an analysis showing that the interest payments are commercially realistic.

In addition to documenting the business reasons for moving people and functions, taxpayers need to be prepared to demonstrate that the contractual allocation of risk is arm’s length. This can be done by pointing to third-party arrangements with the same risk allocation or by showing that the allocation of risk is what one could expect among unrelated parties. In the latter case, you should be able to demonstrate:

• controloverrisk,whichrequiresthepresenceofemployees or directors with the authority to perform control functions

• financialcapacitytoassumetherisk.

Companies should also set up and monitor processes to ensure that their transfer pricing policies continue to support the business purpose of the restructuring.

KPMG’s A World in Transition: Managing the Transfer Pricing Implications of Complex Supply Chains (2011)


43Future Focus

Shared service centres – more complex functions = more tax complexityThe use of in-house shared service centres has become increasingly common among large multinational companies. These centres allow for the centralised processing of back-office functions within a single location, creating opportunities for rationalisation, concentration of expertise and cost savings. Despite their advantages, shared service centres need to be structured carefully to secure the intended benefits, especially where transfer pricing and related indirect tax (VAT/GST) issues are concerned.

Shared service centres taking on more complex functionsTraditionally, large European and US companies chose to locate shared service centres in the Asian sub-continent, attracted by the combination of low labour costs and highly educated populations. Shared service centres were set up in the Asia Pacific region primarily to perform routine administrative and support operations, such as IT support and call centres.

As the economies of these countries have grown more diverse and complex, shared service centres are being used to centralise activities of more substantial, value-added functions, such as marketing, distribution and logistics. Growing local companies are taking up this business model, and new offshoring destinations are becoming popular due to incentives to attract these operations offered by countries like India, the Philippines, Thailand and Malaysia.

As the functions of shared service centres have grown more complex, the complexity of their tax obligations has grown in pace. In deciding where to locate a shared service centre, companies should be sure to examine the impact on their transfer pricing

policies and other taxes such as VAT/GST. Getting these wrong can lead to excess costs, poor cash flow, lost tax advantages and, in extreme cases, disputes with authorities and fines and penalties.

Transfer pricing disputes on the riseWith different tax regimes, different regulations and different tax rates in different jurisdictions, transfer pricing decisions can significantly affect both the total level of tax liability and where the tax is due. As noted on page 19, tax authorities in the Asia Pacific region are considered to be relatively aggressive when it comes to transfer pricing. However, their field teams often lack the level of technical experience required to assess related-party transactions adequately, and transfer pricing disputes are unfortunately common. Companies establishing shared service centres in the region need to develop a strong transfer pricing framework that meets the compliance needs of all relevant jurisdictions. Companies should also focus on ensuring the framework is properly implemented, documented and monitored.

Advance pricing arrangements (APAs) can help prevent these disputes. An APA is an arrangement between a multinational enterprise and one or more tax authorities confirming, in advance, an appropriate transfer pricing methodology to be applied to specific intercompany transactions for a specified term. The past decade has seen an increasing number of Asian tax authorities join Japan, Korea, and Australia in offering APAs. For example:

• Chinare-introduceditsAPAprogramin 2009 and has been giving APAs greater emphasis.

• ThailandupgradeditsAPAprogramwith its release of new guidance for taxpayers on procedures, timing and application documents.

• Malaysia,IndiaandIndonesiaaretaking steps towards comprehensive APA programs.

One of the key benefits of APAs is that they can reduce the risk of future income assessment adjustments. They can also provide a forum to engage in more constructive discussions with tax authorities about transfer pricing issues.

Potential VAT/GST on transfer prices adds more complexityThe VAT/GST implications of transfer pricing between a shared service centre and the operating companies or branches it serves can be as significant as the corporate tax consequences. Companies should be sure to consider the potential indirect tax issues when structuring these arrangements; otherwise, they could wind up with unexpected indirect tax costs that cannot be recovered. They could also end up increasing their ultimate underlying costs by charging VAT/GST to their external customers incorrectly.

One key technical issue arises from the principle underlying many VAT/GST regimes. By this principle, the provision of services generally is only liable to tax if it falls within the category of supply for a consideration. Many shared service centre arrangements do not have traditional ‘fees’ charged for these services and such transactions are not picked up by traditional accounting systems. As a result, a taxable supply of services may occur even when there is apparently no financial consideration payable but only a ‘transfer pricing payment’.


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Double taxation issues on re-charging across bordersIn practice, most tax authorities seek to tax services supplied by shared service centres to in-house recipients. The situation is further complicated by the lack of symmetry between indirect tax systems both within the Asia Pacific region and with European models. Further, since tax treaties do not cover indirect tax obligations, double taxation is a constant threat. In the financial services arena, depending on where the service is actually provided, this situation can lead to significant above-the-line costs for business. The excess costs may be high enough to wipe out the shared service centre’s intended economic benefits entirely.

GST advance compliance programs

As with transfer pricing, tax authorities in the region are increasing their audit

scrutiny of indirect taxes. In countries with more developed tax regimes, VAT/GST compliance is high on the tax authorities’ radar, particularly in Australia and Singapore. In both countries, the tax authorities offer versions of advance compliance programs that offer reduced (or more favourable) audit coverage for companies whose GST controls meet certain criteria.

For example, Singapore’s GST Assisted Compliance Assurance Program (ACAP), introduced in April 2011, offers successful applicants the following benefits:

• astep-downofGSTauditactivityforthree to five years

• fasterissuanceofrefundsandrulings

• auto-renewalofGSTschemes

• fullwaiverofpenaltiesfor non-fraud GST errors voluntarily disclosed.

Singapore’s tax authority requires the ACAP reviewer to be accredited with the Singapore Institute of Accredited Tax Professionals. KPMG’s tax team in Singapore includes appropriately accredited advisers. Based on our experience assisting clients with Singapore’s previous advance compliance program and our strong working relationship with Singapore’s tax authority, we can work with companies to prepare and apply to access the benefits of Singapore’s ACAP program.

Leap aheadShared service centres can bring clear operational and financial benefits to multinational companies. However, these centres raise complex issues of transfer pricing and indirect tax liability that need to be considered to help maximise the financial benefits to the group and avoid financial penalties.

Before establishing a shared service centre, be sure to consider the following issues to help maximise value, minimise cost and control risk.

Transfer pricing issues VAT/GST issues

• Developastrongtransferpricingframeworkthat meets the compliance needs of all relevant jurisdictions, and make sure it is properly implemented, documented and followed.

• Fullydocumentyourtransferpricingpolicies,includingyour choice of transfer pricing method and the inapplicability of other methods.

• Bepreparedtoengageintaxdisputeswithlocalauthorities, and develop your strategy for driving audits and disputes in advance.

• Gainmorecertaintythatyourtransferpriceswillbeaccepted by entering into APAs with the relevant tax authorities.

• SeeklocalprofessionaladviceregardingtheVAT/GST base and any available exemptions to ensure compliance and avoid added costs.

• ConsiderthelevelofsymmetryamongtheVAT/GSTsystems in the countries covered by your shared service centre, particularly those involving centralised procurement functions.

• ThinkabouttakingadvantageofVAT/GSTassistedcompliance assurance programs offered by the tax authorities.

• LookintooutsourcingyourregionalorworldwideVAT/GST compliance to a single service provider to access economies of scale, specialised local knowledge and industry best practices (see page 31).

Singapore’s tax authority requires the ACAP reviewer to be accredited with the Singapore Institute of Accredited Tax Professionals.


45Future Focus

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

© 2011 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International.

Designed by Evalueserve.Publication name: Future Focus: Tax and Transformation in Asia Pacific’s New Business RealityPublication number: 111102 Publication date: November 2011

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