Under the old property tax regime, land and buildings are taxed separately, where sales of land is exempt from value-added tax (“VAT”) and corporate income tax (“CIT”), but subject to land value incremental tax based on the increase in government announced value. On the other hand, sale of building is both subject to VAT and CIT assessment. This results in an incentive for business entities subject to the old property tax regime to allocate a higher sales price to land (capital gain is tax exempt) and a lower sales price to building (resulting in minimal taxable capital gain or even a loss), where the building sales price is usually lower than fair market value.
According to Article 17 of the Value-Added and Non-Value-Added Business Tax Act and Article 25 of the Enforcement Rules of the Value-Added and Non-Value-Added Business Tax Act, in the event a business entity sells goods or services at a price unreasonably lower than the market price, the competent tax authority may determine the sales price based on the market price and adjust VAT accordingly.
If after investigation, the tax authority finds out that the building sales price is lower than the market price, or the allocation between the land sales price and building sales price is abnormal, and the business entity is unable to provide sufficient reason and supporting documentation for such pricing strategy, the competent tax authority will adjust the building sales price to reflect the higher market price, and additional VAT and CIT will be due as a result of the adjustment.
Although the new property tax regime has been implemented effective 1 January 2016, the VAT treatment for land and building is still different. Additionally, since taxpayers may still adopt the old property tax regime when specified criteria are met, there may still be a need to split the sales price between land and building components. The below example illustrates the tax liability due on different allocation between sales price of land and building where it is sold for a lump sum price of TWD 20,000,000, which is inclusive of VAT:
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Note: The tax authority may reference building valuation performed by banks when extending a loan to the taxpayer, net book value of underlying building on the fixed asset register disclosed in the taxpayer’s corporate income tax return, or market value of building obtained from newspapers and magazines, etc., when determining the market price of building.
In the illustration above, even if the underlying contract separately indicates the sales price of land and building, where the building is sold at a loss, the tax authority may still adjust the building sales price to the market price, and request the taxpayer to pay an additional TWD 95,000 and TWD 170,000 in VAT and CIT respectively. Therefore, business entities should maintain sufficient supporting document when differentiating between the sales price of land and building.