Business Conversion Tax Incentives

4 Apr 2018 at
04:00 / NEWSPAPER SECTION: BUSINESS

Business Conversion
Tax Incentives

Decree encouraging
individuals to adopt company structures raises questions and problems that are
still being resolved

Tax incentives often
appear attractive in theory, but the reality of attempting to claim them can
often cause difficulties for taxpayers.

Such has been the case
with attempts to promote the conversion of businesses traditionally operated by
those liable only for personal income tax (PIT) — individuals, non-juristic
ordinary partnerships and groups of persons — into corporate entities such as
a company limited or registered partnership. The ultimate goal is to encourage
and better monitor tax compliance.

To this end, the
government issued Royal Decree No.630 (RD 630) to exempt PIT, value added-tax
(VAT), specific business tax (SBT) and stamp duties for individuals who made
the conversion by means of transferring assets and goods used in their
businesses to a newly incorporated company or registered partnership. The
transactions otherwise would have been subject to taxes as for a sale.

The decree has now
expired, although there are reports that an extension to the end of this year
is being considered to give individuals one last chance before possibly facing
a tough tax audit.

The notification of
the Revenue Department director-general issued under the decree requires that,
in order for tax incentives to apply, the assets transferred must have been
utilised in the individual's business, and the transfer must be made in exchange
for new shares issued by the new company.

Further, the
individual undertaking the transfer must receive the shares with a value that
is not less than the transferred assets. In the case of immovable properties,
the value of the shares must be equal to the value of the properties appraised
by the Land Department, or the cost price, whichever is greater. In claiming
the tax incentives, the individual and the new company had to submit
declaration forms to the Revenue and Land departments.

This type of business
transfer often involves not only the two main parties to the transaction,
namely the transferor and the transferee, but also other stakeholders through
contracts with trade partners. Some properties may be subject to mortgages or
held as loan collateral, in which case the financial institution may demand
early repayment in exchange for the release from encumbrances before the
transfer can be registered.

Difficulties could
also arise with immovable properties owned by several individuals if some wish
to convert the joint business into a new company while others would prefer to
maintain the status quo. The transformation under this scenario may not be
entirely tax-free, so one must consider which parts of the properties are
eligible for privileges. For the portion that is not qualified, there may be a
recapture of the taxes. In this regard, the Revenue Department advised in a
recent ruling as follows:

n Where all co-owners of immovable properties transfer all
of their ownership interest in exchange for the registered capital of a new
company, they would be entitled to the tax exemptions granted under RD 630.

n Where only one co-owner transfers ownership, in order for
such individual to benefit from the tax exemption, "his ownership portion
of immovable property must firstly be separated from the common ownership
before the transfer to the new company".

The trouble here is
that this interpretation was issued after the deadline for transfers expired,
and imposes a new requirement that was not mentioned in RD 630 or in any
notification.

Such a requirement is
impractical because, in order to separate the co-owned properties at the Land
Department, the official must conduct a cadastral survey to divide the
properties, which normally takes around three months. In any case, settlement
among the co-owners could take forever.

It is understandable
that the Revenue Department may not want a newly set-up company to become a
co-owner of such properties with the remaining individuals, since co-ownership
and joint use could constitute an unincorporated joint venture between the new
company and the remaining individuals — similar to a non-juristic ordinary
partnership from a tax aspect. But what else could taxpayers do to solve this
problem if the properties have already been transferred and this condition just
came out recently?

Further, another
revenue ruling dealt with an interesting question from an individual: if an
asset was utilised in a business before the transfer, must the new company
carry on the same line of business, or could it operate other businesses? The
department responded: "In order for the individual taxpayer to be entitled
to the exemptions for the transfer of assets and goods under RD 630, the new
company must carry on the same line of business that had been operated by the
individual before the conversion." In short, business continuity is the
key to the tax privileges.

Theoretically, this is
a rational requirement so that the tax exemptions will be granted only for a
genuine business conversion. However, as it was never mentioned in RD 630 and
in the subsequent notification, a few taxpayers may have missed it and an audit
could be catastrophic for the taxpayer.

Most importantly, the
department has never made it clear how long the original business must be
maintained, as the business in the hands of the new company may need to be
changed, depending on commercial needs.

If indeed the
government follows through and extends the deadline for business conversions,
it should certainly use this opportunity to clear up these problems.

By Rachanee Prasongprasit and
Professor Piphob Veraphong of LawAlliance Limited. They can be reached at [email protected]