Amid rising trade and technology disputes between the US and China, Taiwanese companies with subsidiaries in China are undergoing a significant wave of capital reduction, as indicated by tax service experts. US Secretary of Commerce Gina Raimondo's recent remarks on China being the greatest US threat and criticisms of Nvidia skirting the gray area of chip trade curbs compound the complex landscape, while Taiwan's recent official announcement of a national list restricting the exports of 22 key technologies to China also further underscores the challenges faced by entities including the government-subsided Industrial Technology Research Institute (ITRI).
PwC Taiwan's tax service experts, including CY Hsu, noted a decline in direct investments based on China's international balance of payments data. The statistical trends, along with increased capital reduction announcements for 2023, reveal the impact on Taiwanese companies operating in both Taiwan and China.
PwC's market development director, Hsu Ming-chuan, attributed the increased capital reductions by Taiwanese companies for their subsidiaries in China to client demands. But he also emphasized that it remains uncertain whether they will continue to scale down operations in China, given China's strenuous efforts to retain manufacturing through incentives.
PwC Taiwan noted that in recent years, the most common challenge faced by Taiwanese companies operating on both sides of the Taiwan Strait is the supply chain adjustment. Some Taiwanese businesses have chosen direct exits from China and cease further investments in China. For those opting to retain a presence, reducing the capital of their Chinese subsidiaries has become a popular strategy.
Capital reduction tactics
PwC Taiwan advised that corporate shareholders' capital reduction is treated in a phased manner, with the funds remitted back to Taiwan being tax-free as a return of original investment; the portion attributable to profits is calculated proportionally as dividend income; and the remainder is treated as income from asset transfer. If properly planned, the capital reduction and remittance back to Taiwan may be claimed as a return of capital and will not be subject to tax.
However, PwC Taiwan warned, if there were controversial aspects in the Chinese company's shareholder equity account, such as capitalization of retained earnings, equipment valuation, or accumulated losses, the handling may be more challenging. In addition, attention must be paid to whether the accounting treatment will generate controlled foreign company (CFC) income recognized in Taiwan, which requires advance tax payment.
CY Hsu also noted that if Taiwanese companies' subsidiaries in China that are directly invested by individuals reduce their capital, they generally prefer to distribute profits before capital reduction. This is because foreign individuals can claim a temporary exemption from withholding tax on dividends obtained from foreign-invested enterprises. However, Hsu believes that this claim is still controversial in practice, mainly because tax authorities in different regions of China have varying opinions on whether Taiwanese individuals are equivalent to foreign individuals. Additionally, tax authorities still have the right to determine whether the reduction amount is at a fair market value.
In addition, the evolving tax environment in China, marked by the recruitment of young tax professionals and the use of digital dashboards, highlights the need for careful consideration. Relying solely on personal connections may now pose more challenges than benefits in this changing landscape.