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  • Interpretation
  • No.650
  • Date
  • 2008/10/31
  • Issue
    • Is Article 36-1 of the Guidelines for the Audit of Income Taxes on Profit-Seeking Enterprises that levies tax on interests actually not earned unconstitutional?
  • Holding
    •     Article 36-1, Paragraph 2 of the Guidelines for the Audit of Income Taxes on Profit-Seeking Enterprises, as amended and promulgated on January 13, 1992, stipulates that, by lending its capital to shareholders or other persons, a company which does not otherwise charge interest or undercharge interest in the [loan] agreement shall nevertheless report interest income and subject to tax levy based upon the prime lending rate applicable by the Bank of Taiwan as of January 1 of that year.  The tax collection authority summarily levies taxes over interest income based on this rule on company loans to its shareholders or other persons. Since such regulation lacks clear and specific authorization from the Income Tax Act, increases the tax obligation which does not legally exist for tax payers, and contradicts the meaning and purpose of Article 19 of the Constitution, it shall be invalid as of the date this Interpretation is issued.
  • Reasoning
    •     Article 19 of the Constitution states, the people shall have the duty to pay taxes in accordance with the law.  It means that the State must impose tax duty or provide preferential tax deduction or exemption treatment to its people based on laws or regulations having clear authorization of a given law, taken into consideration such conditions as the subject, subject matter, tax base or tax rates.  In the event the law authorizes the tax collection authority to promulgate supplemental regulations, such authorization must be clear and specific; the tax collection authority may promulgate other necessary regulations only for matters that concern technical details or secondary issues in the enforcement of the law (see J. Y. Interpretation Nos. 443, 620, 622, and 640). 
      
    •     Article 24, Paragraph 1 of the Income Tax Act (Internal Revenue Code), as amended on January 30, 1977, states: “The amount of income of a profit-seeking enterprise shall be the net income, i.e., the gross annual income after deduction of all costs, expenses, losses and taxes.”  While “gross income” naturally includes interests earned, in the situation where a company loans its capital to its shareholder or other individuals without agreeing on the interests, the fact that the tax collection authority nevertheless presumes and calculates interests not actually earned involves the subject matter of the tax being assessed and must be regulated by law or regulation having clear and specific authorization of the law in order to comply with the principle of nullum capitagium sine lege (no taxation without legal authority).
      
    •     Article 36-1, Paragraph 2 of the Guidelines for the Audit of Income Taxes on Profit-Seeking Enterprises, as amended and promulgated on January 13, 1992, stipulates: “Shareholders, members of the board, supervisors of a company who receive funds on behalf of the company and do not pay back in kind or appropriate such company funds are subject to tax levy on the interests earned in accordance with the prime lending rate applicable by the Bank of Taiwan as of January 1 of that year.  A company which does not otherwise charge interest or undercharge interest in the [loan] agreement shall nevertheless report interest income and shall apply mutatis mutantis the regulation stipulated in the previous paragraph.”  The tax collection authority summarily levies taxes over interest income based on this rule on company loans to its shareholders or other persons.  Yet such regulation lacks clear and specific authorization from the Income Tax Act (Internal Revenue Code); its presumptive calculation as provided in Article 36-1, Paragraph 2 also lacks legal basis.  Although this rule has been in practice for some time and may be beneficial to the enrichment of national treasury, the reduction of levying costs, or even the prevention of tax evasion, it nevertheless expands or presumes interests not actually earned, which involves taxable subject matter, and does not concern technical details or secondary issues by the levying authority in its enforcement of the Income Tax Act, thus the regulation clearly exceeds the scope of the Income Tax Act, increases the tax obligation which does not legally exist for tax payers, contradicts the meaning and purpose of Article 19 of the Constitution, and shall be invalid as of the date this Interpretation is issued.
      
    •     A new Paragraph 5 was added to Article 80 of the Income Tax Act when it was amended on January 15, 2003: “The measure governing how the tax collection authority conducts an assessment of an income tax return by paper reviewing, auditing or any other method of investigation, as well as the criteria tax collection how the aforesaid authority audits the items affecting the amounts of income, tax payable and tax credits of an income tax return, shall be prescribed by the Ministry of Finance.” This expressly authorizes the Ministry of Finance the power to promulgate [tax returm] review and audit measures.  However, in accordance with the illustrations contained in the Executive Yuan’s memorandum to the Legislative Yuan requesting for review and approval of the amendments to the Income Tax Act, the addition of Article 80, Paragraph 5 is “to ensure that the tax collection authority should have a set of unified regulations in conducting its investigations and reviews.  Although the Ministry of Finance has currently promulgated Directions for the Review of Profit-Seeking Enterprises Income Tax Returns, Regulations Governing the Random Auditing of Paper-Review Cases over Profit-Seeking Enterprises Income Tax Returns, and Guidelines for the Audit of Income Taxes on Profit-Seeking Enterprises, among other rules, they nevertheless lack legal authorization.  In order to achieve the objective of tax fairness, and to cope with the rapidly changing industrial society, such Directions, Regulations and Guidelines must inevitably subject to constant amendments and, therefore, should be better suited in the form of legally authorized administrative regulations to maintain their flexibility. It is also necessary to promulgate related regulations on omnibus income tax cases.  As a result, based on the present and future need to conduct audits and reviews over income tax cases, and in accordance with Article 150, Paragraph 2 of the Administrative Procedure Act,  Paragraph 5 is added to authorize the Ministry of Finance to promulgate related regulations and guidelines for tax collection authority to follow in conducting its investigations and in auditing items affecting the amounts of income, tax payable and tax credits of an income tax return.”  It is clear that while Article 80, Paragraph 5 now provides the legal authority to promulgate Guidelines for the Audit of Income Taxes on Profit-Seeking Enterprises, its scope entails the audit of “items affecting the amounts of income, tax payable and tax credits.”  Yet the purpose of this provision is to only authorize the tax collection authority to audit and review the accuracy of income tax returns, so as to promote honest filing among tax payers.  It has not expressly and specifically authorized the Ministry of Finance to promulgate regulations that summarily presume and calculate interest income.  Therefore, it needs to be pointed out that Article 36-1, Paragraph 2 of the Guidelines for the Audit of Income Taxes on Profit-Seeking Enterprises concerning the presumption and calculation of interest income has not gained a clear and specific legal authorization [even] in light of the addition of Article 80, Paragraph 5, and is still not in conformity with the requirement of nullum capitagium sine lege.
      
    • Translated and edited by Professor Andy Y. Sun
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