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Changing rules for applying foreign tax credits

12 Jul 2017 at 04:00 / NEWSPAPER SECTION: BUSINESS

>Changing rules for applying foreign tax credits

One of the original principles outlined in the OECD Model Tax Convention is that no taxpayer should be taxed repeatedly on the same amount of income earned from a cross-border transaction. This situation is referred to as "juridical double taxation" -- where income is subject to taxes under the jurisdictions of more than one state.

Though an increasing number of states, including Thailand, have recently started to circumvent tax treaty principles in an attempt to collect more taxes from major e-commerce operators that earn substantial sums without paying sufficient tax in the source country, eliminating double taxation continues to be the main purpose for entering into tax treaties.

Since the law does not provide individual taxpayers with a method to eliminate juridical double taxation, the Revenue Department often relies on mechanisms granted under tax treaties where relevant.

Two principles apply in dealing with taxation of an individual under Thai law. The first is the "source rule", whereby income derived from the Thai source will be taxed regardless of the individual's nationality or residence(s). The second is the "resident rule", whereby a Thai tax resident -- a person who stays in Thailand for the aggregate period(s) at least 180 days -- derives income from a foreign source and brings it back to Thailand during the same calendar year.

For example, let's look at the case of an employee of a Thai company who is assigned to work offshore temporarily by his employer in Thailand. The Revenue Department considers him subject to Thai tax under the "source rule" as the Thai employer pays his salary. However, if he is also required to pay taxes to a foreign government, he may be allowed to use the foreign tax as a credit against Thai personal income tax by virtue of a tax treaty of one exists.

In applying the foreign tax credit (FTC) method, the Revenue Department has never challenged the eligibility of the taxpayer beyond the basics: the employee must be a Thai tax resident and the credit amount must not exceed Thai tax imposed on such income.

The consequence of applying the FTC to eliminate juridical double taxation is that one state, in this case Thailand, must surrender its taxing right to the other. Lately, however, it appears that the Revenue Department has decided to assert itself in this regard and will not allow some states to take advantage of tax treaties any more.

In a recent revenue ruling, a Thai company was hired by a Singaporean customer and sent its employee to work in Malaysia for one year, during which the employee had to travel back and forth. As his aggregate stays in Thailand reached 180 days, the employee was considered a Thai tax resident, but it turned out that he was also treated as a Malaysian tax resident and subject to Malaysian tax.

Salaries were paid to the employee's bank account in Thailand by the Thai employer, which withheld tax and filed a return to the Revenue Department. The employee asked the department if he was entitled to claim the FTC by using the Malaysian tax paid as a credit against Thai tax pursuant to the Thailand-Malaysia tax treaty.

According to tax treaty principles, the country required to grant the FTC must be the state of residence. Since the employee in this case had double tax residence status, the Revenue Department applied a "tie-breaker rule" under Article 4 of the treaty to determine the employee's residency.

The department held that the employee "must be treated as a resident of the state in which he had a permanent home". Since his family and the bank account to which his Thai employer made salary payments were in Thailand, Thailand was regarded as the "permanent home". The department further pressed its case by stating: "If the employee had permanent homes available in both countries, Thailand must be the country where he had closer personal and economic relations."

The department did not stop there. For the first time in history, it investigated the legitimacy of the Malaysian tax to be allowed as a credit by reviewing the Malaysian government's taxing authority under Article 14 ("Personal Services") of the treaty. Basically, it states that the Malaysian government cannot tax the employee if all of the following conditions are fulfilled:

The employee stayed in Malaysia for aggregate period(s) not exceeding 183 days during the relevant calendar year;

The services were rendered in name of the person in Thailand; and

The salaries were not borne by the payer's permanent establishment in Malaysia.

Since the first condition was not fulfilled, the Malaysian tax was deemed to be legitimate pursuant to Article 14 and could be credited against Thai tax. The ruling concluded: "Since both Thailand and Malaysia had taxing authorities on the salaries received by the employee, double taxation took place. Thus, Thailand, as the country of residency had liability to eliminate such double taxation by granting the FTC to the employee."

Of course, the department required that the amount of tax to be credited must not exceed Thai tax payable under the Revenue Code.

In fact, the way it approached the above ruling is something the Revenue Department should have done many decades ago. From now on, individuals who are Thai tax residents should not jump to the conclusion they will always be allowed the FTC without proving the legitimacy of foreign tax first.

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

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