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Turning Entrepreneurs into Corporate Entities

March 2017 - Tax & Private Client. Legal Developments by LawAlliance Limited.

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7 Mar 2017 at 04:00 / Newspaper section:Business

Turning Entrepreneurs into Corporate Entities

February was a busy month in terms of new tax legislation. But this is just the beginning, as the director-general of the Revenue Department has also announced an ambitious plan to study extending Thailand's tax jurisdiction to overseas traders in cross-border e-commerce transactions. The idea is to generate tax revenue from online businesses, as the current legislation does not allow Thailand to tax foreign traders not doing business within the country.

While the director-general's plan is well-intentioned and could benefit the country, the idea is in conflict with international taxation policy. A source country such as Thailand can tax trading income only when foreign traders conduct business, or have a permanent establishment, within Thailand.

Amending the Revenue Code in the current National Legislative Assembly under a military government would not be difficult, but renegotiating tax treaties with 60 countries, plus a number of trade agreements, is a different story.

Of greater concern is the potential response from other countries, which might seek to retaliate against Thai conglomerates or online shops based in Thailand. So much for the prime minister's policy to drive the country towards a digital economy. Imagine what kind of world order we would have if countries ignored international taxation rules and simply taxed traders from other countries, who have never set foot in their jurisdictions physically but simply trade online with their nationals.

In short, whether or not Thailand can carry out this ambitious policy definitely requires a lot more thinking beyond the level of what bean counters typically do.

Back in the real world, one new piece of legislation we'd like to draw to your attention has been in effect since Jan 28. Royal Decree 630 reflects the Revenue Department's attempt to persuade individual taxpayers who run businesses to carry on the business in corporate form, rather than as entrepreneurs.

The change reflects a belief that tax avoidance occurs more at the individual taxpayer level among the likes of goldsmiths, clinics and pharmacies. If these were corporate entities, at least their books and records would need to be scrutinised by a licensed third-party auditor.

To entice individual taxpayers to convert their entrepreneurial businesses into corporate form, changes have been made to the Revenue Code.

First, effective from Jan 28, nominal expenses deductible by businesses operated by individuals (other than employment) have been reduced from the original 60-85% of gross income to a new rate of only 60%. At the same time, the employees' standard deduction is increased to 50% with a ceiling of 100,000 baht.

An entrepreneurial business can still deduct actual expenses that are greater than nominal expenses, if the individual taxpayer can produce evidence and comply with the rules for deductions. Nonetheless, the tax saving is optimised if the business is conducted in corporate form, given the lower effective tax rates as well as broader scope to deduct actual expenses.

Second, since converting a business into corporate form will involve transfers of assets, rights, stocks of goods and possibly licences owned by an individual taxpayer to a company, tax leakage will occur in the course of the restructuring. For this reason, RD 630 will exempt personal income tax, value-added tax, specific business tax and stamp duty for individuals receiving income from such transfers or execution of documents in relation to the conversion to a new company or juristic partnership, if it is incorporated between Aug 10, 2016 and Dec 31, 2017.

In order for the exemptions to apply, the individual must receive consideration for the transfer in the form of "ordinary shares" issued by the company or juristic partnership.

Also, the 2% registration fee at the Land Department will be reduced to 0.01% for restructuring carried out from Aug 30, 2016 to Dec 31, 2017.

While a notification from the director-general of the Revenue Department will be needed to provide more detailed instructions regarding the above privileges, it is noteworthy that individual taxpayers seeking the exemptions outlined above must receive only "ordinary shares" from a newly set up company, and not shares with special privileges or limited privileges as they relate to the likes of dividends and/or voting rights.

Perhaps this is intended to prevent the individual taxpayer from selling a business to a third party without a genuine intention to convert the business. Currently, it seems that an individual taxpayer is not prohibited from selling the shares on to other third parties, but we will need to wait for the notification for confirmation.

In addition, the government has granted sweeteners by exempting tax on income equal to 100% of the expenses incurred from the establishment of the aforesaid new company or juristic partnership, accounting and audit expenses, for five consecutive accounting years.

All in all, some entrepreneurial businesses are better off entering into the corporate income tax (CIT) system, as the CIT rate has been reduced to 20% of net profits since 2013 (from the 30% rate that applied until 2011), while the personal income tax regime applies progressive tax rates of 5-35%, and many entrepreneurs may fall into the higher brackets.

By Rachanee Prasongprasit and Professor Piphob Veraphong. They can be reached at admin@lawalliance.co.th