Farewell to the subcontract technique for foreign entities

The atmosphere is deteriorating for foreign enterprises doing business in Thailand. Developments that have sapped confidence include the 30% reserve requirement imposed by the Bank of Thailand in December to maintain baht stability, controversy over the amendment of the Foreign Business Act to eliminate the use of nominees, and the shocking attempt by the National Legislative Assembly to adopt a harsher approach by including economic interest and foreign management control to test foreign ownership. Thankfully, the draft has been withdrawn temporarily. In any case, it is getting more difficult for foreign entities to survive when it comes to tax.

For a number of years, there were questions as to whether a foreign entity that won a contract in Thailand could avoid Thai corporate income tax by using a sub-contract approach, so that it would not be deemed as doing business in Thailand. A few different interpretations of this clause led to confusion for more than a decade. Some said that a subcontract never triggered Thai corporate income tax _ as the foreign entity itself was not doing business in Thailand. Some disagreed. Some applied a double-taxation treaty (DTT) to the case.

Just recently, the Revenue Department set a guideline stating that, where a foreign contractor subcontracted work that it undertook from a customer in Thailand, even though it did not carry out any activity in Thailand by itself, it was deemed to carry on the business in Thailand if the activities of the subcontractor took place in Thailand. As a result, the foreign contractor in such a situation was obliged to pay corporate income tax.

Where a foreign contractor is a resident of the country that has a DTT with Thailand, the ''doing business in Thailand'' test would generally be replaced by the ''permanent establishment'' or PE test. It means that the foreign contractor pays corporate income tax only if it has a PE in Thailand. In most cases, a PE is deemed to exist if the foreign contractor has had activities for more than six months in Thailand.

For example, a parent in Singapore was engaged by its Thai subsidiary to plan and decorate an IT fair held in Bangkok. The Singapore parent then subcontracted work to another Singapore entity, which did not usually have a PE in Thailand. The Singapore subcontractor sent its employees to decorate the booths at the site. The Singapore subcontractor charged the fees to the Singapore parent, which in turn sought reimbursement from its Thai subsidiary.

Since employees of the Singapore subcontractor provided services in Thailand, the Singapore parent was deemed to be doing business in Thailand indirectly. However, by sheer luck, as the Singapore subcontractor's employees did not stay long enough to constitute a PE under the Thailand-Singapore DTT, so the Singapore parent was exempted from tax.

Although the Singapore parent managed to get away without having to pay corporate income tax, the ruling does trigger a number of issues. First of all, what if another contractor is not lucky enough _ say, the employees stayed in Thailand for a long term? What will happen if the subcontractor is a Thai entity? If the subcontractor is also a foreign entity, what will be the tax implications of such a subcontractor?

This new position of the Revenue Department is different from past treatment where work was subcontracted. Because each tier of the contract represented a separate legal transaction, the activities carried out by the subcontractor did not affect the tax status of the foreign contractor and did not cause the foreign contractor to have a PE. This rationale was accepted by the department in many cases, even in an extreme scenario whereby the subcontractor is a Thai company.

For instance, in 1990 a French company undertook to install and control telecommunication equipment for a Thai entity. To avoid Thai tax, it subcontracted work in Thailand to one of its own subsidiaries and expatriates were seconded to work in Thailand under the umbrella of the Thai subsidiary.

The Revenue Department generously ruled that, although work was carried out by the Thai subcontractor for years, as it was done on an independent basis and not in the name of the French company, the Thai subcontractor was not deemed as the French company's agent or go-between in Thailand. Thus, the French company was not subject to Thai corporate income tax.

Obviously, if the old rationale still applies, the foreign contractor would be free from the PE concern merely by subcontracting work to its own entity in Thailand. Funny, isn't it? From now on, you won't be able to use that kind of silly trick.

By Rachanee Prasongprasit and Piphob Veraphong. They can be reached at admin

Source: Bangkok Post 28.08.2007