Is It Royalty Or Non-Royalty For Tax Purposes

In general, “royalty” is not a word to be used for taxpayers dealing with the payment of certain sums from Thailand to offshore suppliers.

In many court cases ruled by the Thai Supreme Court, it was deemed that some ‘general fees’ are regarded as ‘royalties’ and thus subject to Thai withholding tax, and no prevention from the double tax treaties which Thailand entered into with other countries.

For example,

1) Electrolux Case (deemed royalty on marketing fee)

2) Philips Case (deemed royalty on marketing service fee)

3) Esso Case (deemed royalty on cost allocation)

4) Pizza Hut Case (deemed royalty on franchise marketing expense)

5) Hana-Semiconductor Case (deemed royalty on sale proceeds of Customer Data Base)

6) Carnation Case (deemed royalty on engineering service fee)

7) Nestle Case (deemed royalty on engineering service fee)

8) Regent Hotel Case (deemed royalty on hotel management service fee)

It is questionable as to what is the clear definition of ‘royalty’ and ‘non-royalty’ under Thai tax law, for both domestic tax law and international tax law, i.e. double tax agreement.

In the past, the Thai Revenue Department (TRD) viewed in its practice that the ‘leasehold right’ is deemed as a ‘royalty’. However, the Thai Supreme Court usually rules the other way; in favour of the taxpayer. The court in this case interpreted that the meaning of royalty under the Thai Revenue Code (TRC) is required to be strictly considered on its narrow meaning of context and provisions of law. the meaning of royalty under the Thai domestic tax law in view of the court is limited only to the area of intellectual property, e.g. copyright.

Royalty under the Double Tax Agreement

For the wider meaning of royalty under Thai tax law, we can ascertain this from the double tax agreements (DTAs) which Thailand entered into with other countries (now 61 countries in 2018, with the latest one being Cambodia); that the definition of royalty includes the consideration for use of or for the right to use of:

1) Intellectual property

For example, patent, trademark, software, copyright, formula, design, trade secret, e.g. licence, franchise.

2) Equipment

For example, scientific, commercial, industrial equipment, e.g. lease of ship, equipment lease.

3) Experience and information

For example, commercial, scientific, industrial information, e.g. customer database, distribution channel.

In some DTAs, ‘use of equipment’ is not defined under the meaning of royalty, for instance Japan, Mauritius, France, Germany, Italy, Netherlands, U.K., Poland and Singapore.

However, the DTA between Thailand and Singapore was revised in 2017 to include ‘use of equipment’ under the definition of ‘royalties’, and therefore, equipment lease provided by the Singapore company to Thailand is subject to withholding tax at the rate of 8%. Prior to 2017, many Singapore companies leased out industrial and commercial equipment to Thailand, which was not subject to Thai tax on its rental derived from the lease in Thailand, e.g. ship, construction crane, kitchenware, forklift, scaffold. From 2017, such equipment lease contracts as well as budgeting on rental should be reviewed to comply with the amendment of the DTA between Thailand and Singapore, as well as to avoid any mistakes on tax compliance and internal budgeting of the company.

The Court Cases of Non-Royalty Income

In the past, the Supreme Court ruled in other cases on ‘non-royalty’ income against the position of the TRD, based on the relevant evidence and circumstances, in favour of the taxpayers, as follows:

a) Thai Tank Terminal Case (non-royalty on Management Service Fee)

b) Louise T. Leo-Owen Case (non-royalty on Marketing Service Fee)

Until now, the TRD still tends to interpret to impose tax from the ‘general fee’ of cross border transactions and deems it as a nature of ‘royalty’; unless the taxpayer brings the case to the court to consider the final interpretation.

For a good example, the payment of the fee under the ‘Sole & Exclusive Distribution Right Fee Agreement’ between a Thai automotive distributor and a foreign automotive supplier located outside Thailand (“Agreement”) was initially viewed by the Thai distributor as a ‘royalty’ and, thus subject to withholding tax at the rate of 15% when such fee is remitted from Thailand to a foreign supplier. However, the offshore supplier considered otherwise and tried to argue this tax treatment adopted by the Thai distributor.

Under the Agreement, the offshore supplier provided no intellectual property (“IP”) or right to use any IP related asset, nor any information to the Thai distributor. The main purpose of this Agreement is to sell and purchase cars with the protection of the Thai distributor, and not allow the offshore supplier to appoint other distributors in Thailand to compete on the sale of cars in Thailand.

In addition, the Thai tax advisor of the Thai distributor initially provided tax advice to confirm that such fee is regarded as a royalty and also subject to withholding tax at the rate of 15%, based on the simple reason of ‘Sole & Exclusive Right’ without there being any in-depth analysis on the real nature and rationale of the fee payment. Therefore, the offshore supplier considered to seek for a private tax ruling from the TRD, thus to ascertain whether or not the tax status of such fee payment is regarded as a ‘royalty’.

Royalty vs. Non-Royalty

Thai domestic tax law and court interpretations considered that ‘Royalty Right’ is the nature of right in relation to goodwill, copyright and the context of intellectual property.

We found that many rights are not under the context of intellectual property, for example:

1) Protection Right (coverage under insurance policy)

2) Right of way to access the express way

3) Leasehold Right to utilise the property

4) Property Rights and Encumbrances attached to the right of land ownership

5) Sole & Exclusive Right to sell and purchase products

As above, we view that certain rights are ‘Non-Royalty Rights’ and do not relate to the intellectual property, even though they are ‘Intangible Assets’ (Rights) listed in the balance sheet of the company.

In case of ‘Sole & Exclusive Distribution Right’, we consider that it is a nature of “Negative Right” to prevent the offshore supplier to ‘Stay Still’ and not to allow the other distributors in Thailand to compete with the Thai distributor. The negative right is not borne by the owner of the right from the beginning and is different from other IP rights owned by the correct owner from the outset, e.g. software licence, patent, trademark.

Indeed, the negative right in this case is the right of the Thai distributor to limit the offshore supplier not to deal with the other competitors in Thailand for car pricing policy and commercial purposes. Thus, such fee payment is the consideration to pay for the protection; and such protection right under the Agreement should not be treated as a ‘royalty’ for tax purposes.

Tax Ruling on ‘Sole & Exclusive Distribution Right Fee Agreement’

In October 2014, the TRD ruled on a private tax ruling upon the request of the offshore supplier to confirm that the fee payment of B 50,000,000 per year made by the Thai distributor to the offshore supplier is not regarded as ‘royalties’ and not subject to Thai withholding tax.

It is interesting to understand as to what is the basis of this tax treatment adopted by the Thai tax authority against the position previously advised by the Thai tax advisor of the Thai distributor. The TRD in this tax ruling considered that:

1) The fee payment of Baht 50,000,000 per year is calculated on the ‘market price’ for economic purposes, which is a suitable profit wherein the offshore supplier will lose business opportunities by ther appointment of other competitors to sell cars in Thailand;

2) The fee payment is for the remuneration of the Sole and Exclusive Distribution Right of cars in Thailand; NOT for the right to use of trademark or the right to use of trademark of the offshore supplier. In addition, such fee payment does not fall under the definition of royalty under the DTA between Thailand and that Country, and the fee payment is for the encouragement of the Thai distributor to promote sales revenue in Thailand.

Accordingly, the TRD in this tax ruling ruled that this fee payment is a nature of a ‘business profit’ (not royalty) under the double tax agreement and therefore not subject to Thai tax. Please note that the TRD’s position in this case considered in a similar way as the OECD in its commentary on the sole and exclusive distribution right.

Event after Tax Ruling

Prior to 2014, during the period of the Agreement, the Thai distributor paid the fee to the offshore supplier for four years and deducted withholding tax at the rate of 15% from Baht 50,000,000 per year according to the tax position confirmed by its tax advisor.

After the tax ruling issued to the offshore supplier in 2014, the offshore supplier proceeded with the tax refund of Baht 7,500,000 (15% of Baht 50,000,000) per year from the TRD, and the total tax refundable is Baht 30,000,000 (Baht 7,500,000 x four years), which is almost USD 1,000,000.

Unfortunately, under the tax law, the TRD cannot refund the overpaid tax after a three year tax period. It is, therefore, questionable whether the offshore supplier will miss 1 year tax refundable and will be recoupable from the TRD or not. In practice, the taxpayer can bring the case to the Tax Court, via a lawsuit against the TRD, to claim such tax refund under the civil law to follow up the ownership of property. This is an alternative way which was confirmed by precedent court cases to claim the tax refund over three years and no time limit to prevent the taxpayer for the tax recoupable from the Thai tax authority.

SCL’s Recommendation

In the past, tax advisors and accountants in Thailand have had a tendency to suggest to taxpayers not to claim the tax refund, in order to avoid any adverse tax consequences arising from the tax audit conducted by the tax authority. It is true that tax refund triggers the tax audit but it is not suitable to leave the tax refund without any argument on the correct tax position and claim it back.

Tax refundable is the asset of the taxpayer in its balance sheet but subject to a time limit of three years. If the taxpayer gives up by way of writing-off such tax refundable from the balance sheet and deducting from the profit and loss account, such tax refundable will be treated as a non-deductible expense for corporate income tax purposes. In such regard, the taxpayer is required to add it back as taxable income and pay more taxes on non-refundable tax for corporate tax calculation.

Care should be taken when the taxpayer considers proceeding with a tax refund, and SCL would recommend that the taxpayer conduct the ‘Tax Health Check’ prior to the tax refund request, in order to better understand its tax exposures. After that, the taxpayer can reduce such tax risks by voluntary paying off tax exposures to reduce penalties and surcharges if any tax audit is undertaken by the tax authority.