Firms must distinguish between ‘trick’ and ‘treat’ with tax

Taxpayers should not expect the department to continue applying the “form over substance” approach – unless that yields more tax revenues.
A case in point is the department’s attempt to re-characterise share premiums as taxable income when it believes the shares were issued at a premium to evade tax. 
The rather puzzling consequence is that actions taken by a shareholder to avoid potential bankruptcy proceedings – a capital increase to raise funds to repay creditors – result in a taxable transaction.
This position was reflected in a Supreme Court judgement last year. 
A Thai company with substantial debts and operating losses raised capital by issuing one new share at Bt1,000 par value with a premium of about Bt400 million. The company claimed that the significant premium resulted from the foreign-shareholding restriction. The one preference share was entitled to receive 95-99 per cent of all dividends. In the event of liquidation, the preference shareholder had priority in receiving capital up to the share premium. 
The company presented a business plan to the foreign shareholder on the use of the funds from the premium to turn around the loss position and expand the business, which would ultimately result in returns to the shareholder. 
All of this seems commercially reasonable. 
The company ultimately used 78 per cent of the capital-increase funds to deleverage itself and repay debts, but did not proceed with the business expansion. Instead, it converted itself into a holding company by transferring the operating business to an affiliate. 
It placed the remaining money in short-term deposits or used it to buy bills/debentures earning interest income.
The Supreme Court argued that the share premium was a taxable “subsidy” to the company. 
The court appears to have been influenced by the facts that the premium was unjustified considering the company’s past performance, the company did not use the proceeds to revive/expand the business (which was sold), and the foreign shareholder did not receive a reasonable return on its investment. 
It is interesting to note that, in this case, there was no obvious tax-avoidance motive in the steps taken by the shareholder, other than to use a share premium instead of “gifting” the funds to company.
In another 2015 case, two days before putting itself into dissolution, a company spent its cash to pay “subsidies” to its affiliates, while reducing its retained earnings. The affiliates used the cash received to repay debts owed to the foreign parent company. The result was that the foreign parent company received cash from the company through debt repayments from the affiliates without any withholding tax. The Revenue Department imposed a withholding tax on the company by deeming the subsidies (paid to the affiliates) as dividends paid to the foreign parent.
The Supreme Court agreed with the department’s position, taking the view that these subsidies were just arranged to evade dividend withholding tax. It made no sense that the parent would enter a complicated arrangement of subsidies instead of making a dividend distribution.
From these cases, it is apparent that the department and the courts are now increasingly looking into the substance rather than the form of transactions. 
Taxpayers need to pay more attention to substantiating their transactions with appropriate and reasonable grounds to ensure that a tax-saving “treat” is not considered as a tax-avoidance “trick”.

Contributed by CHINDANAI SANGKAKUN, tax and legal manager at PwC Thailand, and PREMA RAO, associate partner.