Can a feasibility study lead to unwanted bills?
For a cross-border transaction, the question of whether or not a foreign counterparty has a so-called permanent establishment (PE) is always a crucial one. It can tell you the hidden costs of a project due to the tax liability of the foreign counterparty. Even if the foreign counterparty may not have any activities in Thailand for almost the entire project, some activities in the country could be sufficient to result in tax costs.
Where a tax treaty between Thailand and another country applies, a foreign entity will be obliged to pay income tax on business profits derived from the Thai source, only if it has a PE in Thailand. The PE is deemed to exist under a variety of circumstances. One of them is the performance of services in Thailand for a period(s) that is longer than the threshold period as specified in the relevant tax treaty. In most cases, such periods of time tend to be six months.
If a foreign entity merely carries out a feasibility study in Thailand for longer than the threshold period, should it be treated as having a PE in Thailand? Mind you, this question is not directed to the situation in which a foreign entity is hired by a Thai employer to render a feasibility study.
However, it concerns a situation in which the foreign entity carries out a feasibility study for its own contemplated service to be provided to the Thai employer.
In one Revenue Department ruling, a Canadian company entered into a memorandum of understanding (MoU) to provide a Thai bank with foreign currency remittance services via an internet system. Before beginning the services, the Canadian company needed to carry out a feasibility study in Thailand for seven-and-a-half months (which exceeded the threshold period of time under the Thai-Canadian tax treaty).
The Canadian company did not charge a fee for the feasibility study but subsequently charged fees for currency remittance services, commissions for currency exchange and interest on the deferred payments. In rendering these services, it did not have any office in Thailand.
The Revenue Department made a dubious clarification of the above issue that if the Thai bank was bound by the terms of the MoU to use the Canadian company's services, the Canadian company would be considered as having a PE in Thailand _ due to the feasibility study. In such event, it would be obliged to pay tax on all types of incomes described above.
Nevertheless, if the MoU did not have such binding effect, the Canadian company was not considered as having a PE in Thailand and was exempt from income tax according to the tax treaty on the fees from the currency exchange and remittance services. As for the interest on deferred payments, it was subject to withholding tax at a reduced tax rate.
An interesting issue that raises a concern for most cross-border transactions is that the above conclusion was based on the fact that the Thai company must not be bound to hire the foreign company at the time that the feasibility study was carried out. Otherwise, income tax would apply to the foreign company, which would definitely increase the project costs.
In reality, most documents signed by the parties are likely to have binding effect one way or another.
If this were the case, then the mere fact that the feasibility study is made in Thailand by a foreign entity _ even if the services are performed outside Thailand _ will be sufficient to create a PE.
This consequence is a bit unusual, as the tax treaty in fact forbids Thailand to tax a foreign company if it merely carries out activities in Thailand with a preparatory or auxiliary character, such as collecting information for itself. As such, the Canadian entity in the above case should not be considered as having a PE in Thailand even if the MoU would have had a binding effect.
Although the ruling was in fact made in favour of the taxpayer due to the non-binding effect of the MoU, the Revenue Department seemed to take a discreet approach by ignoring the fact that the feasibility study actually had preparatory and auxiliary characteristics. Since most tax treaties of Thailand include a provision similar to the above, this position could also be applied to other countries as well.
It would have been pleasant if the guideline had simply stated that no tax was applied as the services were performed outside Thailand. It is hoped that someone at the Revenue Department will try to clarify this position in the near future.
By Rachanee Prasongprasit and Piphob Veraphong. They can be reached at admin