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During August, companies in Taiwan that follow the calendar year accounting cycle have already held their annual shareholder meetings, as mandated by Article 170–2 of the Company Act. When examining the annual reports of these companies, you’ll find a dedicated section titled “Special Disclosures — Affiliated Company,” which contains pertinent information about the company’s affiliated company transactions. Why does this section exist, and what does it entail? This article will provide a brief overview of its contents to assist readers in better understanding and absorbing affiliated company information, dispelling any confusion you may have regarding this topic.
Originally, company law treated each enterprise as independent, with regulations applying solely to individual companies. However, as companies expanded to improve efficiency, diversify, and reduce risks, they began establishing related-party entities. These entities, legally separate from the parent company, don’t easily transfer losses back to the parent when incurred.
Real decision-making often lies with hidden controllers. While these companies appear independent, they often execute the corporate group’s overall business plan. They engage in mutual benefit transactions and, in some cases, manipulate stock prices for profit.
Controllers with significant operational authority can exploit company law’s design, using Taiwan’s unique shareholder system to create layered companies. This grants them control while evading legal responsibilities, potentially harming other stakeholders.
When two or more companies have controlling and subsidiary relationships, they may no longer be considered independent entities but rather a single entity. In June 1997, amendments to the Company Act aimed to regulate related-party operations, introducing a new “Chapter on Affiliated Companies” with twelve articles.
Related-party companies do not have a unified definition; however, the disclosure in annual shareholder reports is based on the “Regulations Governing Information to be Published in Annual Reports of Public Companies.” According to Article 19–6 of these guidelines, it is explained as follows: “Related-party entities mentioned in the previous paragraph refer to those in accordance with Article 369–1 of the Company Act.” Therefore, this article discusses related-party entities based on the definition provided in Article 369 of the Company Act.
Upon examining the legal provisions, related-party companies can be broadly categorized into two types: the first type arises from ownership relationships, and the second type arises from control relationships.
Affiliated companies stemming from ownership relationships can mainly be classified into two categories: direct shareholding and mutual investments.
Direct shareholding is the most straightforward related-party companies type. According to Article 369–2–1 of the Company Act, a company becomes a controlling entity when it holds voting rights exceeding 50% of another company’s issued shares or capital, making the latter a subsidiary. Thus, holding over half of the shares is the primary criterion. Calculating shareholding percentage involves including all shares held by subsidiaries, third parties on behalf of the company, and third parties on behalf of its subsidiaries, encompassing both direct and indirect shareholdings. However, the term “third parties on behalf of the company” lacks a precise definition, allowing interpretation.
Mutual investments stem from direct shareholding but may raise concerns due to capital inflation. Article 167 of the Company Act restricts share repurchases by a company, with exceptions. The Ministry of Economic Affairs interprets that subsidiaries buying back shares from their parent companies is not illegal. Consequently, companies can establish subsidiaries for stock transactions as a financial management tool.
To prevent mutual share buybacks and capital depletion, Article 369–9–1 defines mutual investment companies as those holding over one-third of each other’s voting shares or capital. Such companies are considered related-party companies under Article 369–1–2.
Related-party companies arising from control relationships primarily hinge on the concept of substantial control. However, “substantial control” remains a concept without a precise definition. Article 369–2–2 of the Company Act sheds some light by stating that “a company directly or indirectly controlling another company’s personnel, finances, or business operations is considered a controlling company, and the other company becomes a subsidiary.” While it specifies that substantial control encompasses personnel, finances, and business operations, it doesn’t provide further definitions for “direct” or “indirect control” or the extent of control.
Moreover, in Chinese culture, businesses are often jointly operated by families with familial or related ties, where related individuals serve as shareholders or operators. In these cases, mutual assistance among this closely-knit group may outweigh the aspects of control and subsidiary relationships. Companies formed under such circumstances can be conceptually accepted as related-party companies.
So, Article 369–3 of the Company Act stipulates that under the following circumstances, there is a presumption of control and subsidiary relationships:
It’s essential to note that the term used in the law is “presumption,” and it doesn’t directly establish that compliance with these regulations automatically designates entities as related-party entities. In other words, if the parties involved can provide evidence that companies meeting the aforementioned conditions of shared ownership or director positions do not have a control and subsidiary relationship, they may be exempt from applying the other regulations governing control and subsidiary companies in this chapter.
From the information provided earlier, it is clear that all related-party companies should be considered as a single entity. Therefore, the disclosure guidelines in the “Guidelines for the Preparation of Annual Reports by Public Issuers,” as defined in Article 369 of the Company Act under Article 21, require the special disclosure of related-party companies-related matters. The primary disclosure includes the following 10 items:
TEJ primarily includes data on item 1, “Basic information about each related-party company,” and item 4, “Overview of the business operations of related-party entities.” Additionally, it provides information about the relationships between related-party entities, (often depicted in organizational charts.) TEJ also derives subsidiary company-level data for the TEJ Group based on the collected information.
According to the table above, the number of companies disclosing related-party entities has been increasing annually from 2005 to 2021, with a growth rate of approximately 30%. Similarly, the number of related-party entities established each year has been increasing, with a remarkable growth rate of 70%. This indicates that more and more Taiwanese companies are establishing related-party entities, and the number of such entities is steadily rising. Therefore, to gain a comprehensive understanding of a Taiwanese company, it is essential to include its related-party entities in the observation process to access complete information.
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TEJ, with nearly 20 years of experience in corporate governance recognition, provides a consistent and verifiable basis for identifying the ultimate controllers of groups. By incorporating the TCRI (Taiwan Corporate Credit Rating Index), which has nearly 30 years of company credit rating data, TEJ introduces a quantified model to unveil the credit risk levels of these groups.
Through related-party company information, not only can we understand conflicts of interest in corporate decision-making and governance structures, but it also forms a crucial foundation for group affiliation. It can enable timely awareness of potential credit risks within the group. For more information, please refer to TEJ Credit Risk Solution!
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