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Cross-Border Franchise: Tax Court Objects against Tax Planning Scheme

Thailand
7 Dec 2010

Thailand has no specific anti-avoidance rule enacted into its revenue tax laws. They do not have legal provisions in place to manage tax avoidance schemes such as sham transactions, thin capitalisation, transfer pricing etc. In addition, Thailand has no clear definitions of tax evasion, tax avoidance and tax planning and it is up to the discretion of the revenue officer to identify a potential bad tax practice. The Thai Revenue Code ("TRC") provides the Revenue Department ("RD") with general power to assess any transaction that they believe to be avoiding tax. On the other hand, any application of anti-abuse rules must take into consideration the principle of Autonomy of Will of contractual parties. Taxand Thailand discussed this in detail.

In practice, there are some provisions provided to control tax avoidance such as the RD guidelines that the Revenue Officer can use to advise a taxpayer in respect of transfer pricing. The RD, under the authority of the TRC, also has the power to disallow a transaction they believe to be evading tax in some way. However, while the RD has the power to attack transactions they believe have an element of tax avoidance, the court doesn't always agree with their guidelines and tax rulings and is not committed to do so.

In the past, the court accepted an 'Autonomy of Will' of the contractual parties when entering to express their intention to enter into a contract even though the alternative structure chosen or the type of contract may have a slight element of tax avoidance. The court in many cases of cross-border transactions accepted the structuring of a construction contract by way of splitting contracts between supply of goods and the provision of services to reduce the risks of permanent establishment (PE) of a foreign contractor. In a court case of infrastructure construction contracts, the court accepted the split of the overall agreement into an offshore sale contract and an onshore sale contract with a local subcontractor to reduce the amount of local withholding tax.

In other cases, the 'Autonomy of Will' was challenged by the court in the recent years. In the latest tax dispute on franchise fee, the Supreme Court ruled in favour of the RD forcing the Thai franchisee (The Minor Food Group Plc) to deduct tax and self-assessed value added tax (VAT) from the marketing expense, paid by the franchisee under the franchise agreement. Remarkably, the marketing expense (eg Marketing expenses include advertising cost, marketing collateral, PR channel and promotion activities) was not paid to the US franchisor (Pizza Hut Inc. now known as Yum Restaurant International). Instead the Thailand franchisee was obliged to spend at the certain percentage of gross sale of pizza for certain goods pursuant to certain guidelines of the franchisor.

The franchise agreement in this case was a typical franchise contract in which the franchisor will control and supervise the marketing activities including advertising and promotion schemes of products. The marketing costs shall be borne by the franchisee, depending on the gross sale. Apart from that, the franchisor did not derive any remuneration directly or indirectly, except for brand awareness.

At the level of court of first instance, the Central Tax Court in this case ruled in late 2003 in favour of the franchisee not to deduct withholding tax and self-assessed VAT on a marketing expense. However, in 2010 the Supreme Court overruled the lower court's decision and deemed the marketing expense as a part of franchise fee payable for the US franchisor, thus resulting in a withholding tax and VAT charge.

The Supreme Court ruled on the circumstances that the franchisor has its sole discretion to control and approve all details and form of marketing activities with the franchisee's expenses. In addition, the franchisee has no control over the management of the marketing and advertising over the business and that the marketing expense was required to be linked with the gross sale of pizza in Thailand. The leading basis of the decision was to deem 'assessable income' on marketing expense derived by the franchisor. The reason is that 'assessable income' is defined under the TRC to include "assets or other benefits derived which can be computed in terms of monies". As a result, the Supreme Court ruled that the Thai franchisee is required to follow to the relevant tax duties when paying the marketing expenses.

The Supreme Court also ruled in its decision that marketing expense shall be deemed as an assessable income derived by the US franchisor. The court thereby distinguished impermissible tax avoidance from lawful tax planning, preventing other tax payers from implementing the idea.


Taxand's Take


The court decision should be noted by multinationals investing in Thailand using franchise schemes, a structure that is commonly used by investors in industries like hotel and spa, coffee, ice-cream, restaurant, education, retails, and health & beauty. Some franchises, the offshore franchisors have set up their subsidiary in Thailand to distribute its franchise under sub-franchise contract to supervise the market activities in Thailand. In such cases the marketing expense under the franchise contract in the similar nature of this case should be a time bomb for such subsidiaries in Thailand.

In the case where the sub-franchisor in Thailand enters into the franchise contract with the Thai franchisee, the sub-franchisor shall be deemed to include marketing expense as its taxable income and also is required to charge VAT from the amount of marketing expense.

Please note that the RD has 10 years of time to collect unpaid tax from the taxpayers. If this interpretation is still adopted without the subsequent court decision to supersede this case, the franchising parties should consider tax risks from official tax audit on withholding tax and VAT. In addition, the revision of the franchise agreement should be done at the earliest as the agreement cannot be amended to have retroactive effect when all activities have been transacted and all marketing expense has been paid.

Your Taxand contact for further queries is:
Chinapat Visuttipat
T. +66 26 32 18 00
E. chinapat.vs@hnpcounsel.com

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