3 February 2013
Income Tax – Anti-avoidance provisions in s 33
The Appellant, a Singapore company, was incorporated as part of B group’s restructuring exercise in 2003, where the Appellant is wholly owned by B, a Malaysian public company. The group’s structure before and after the restructuring exercise are illustrated in Diagrams A and B respectively.
Diagram A: Pre- restructure
where B and C are Malaysian companies and D, F, G and H are Singapore companies
Diagram B: Post- restructure
The Appellant acquired the Singapore subsidiaries (D, F, G and H) after obtaining the funds by issuing convertible notes (“Notes”) to N Bank Singapore, which then sold it on to N Bank Mauritius. N Bank Mauritius in turn sold it on to C. All of the parties involved paid the same principal amount for the Notes (ie $225m), which flowed in a circle from the Appellant through N Bank Singapore and N Bank Mauritius to C. All these happened on the same day. C obtained the $225m required to buy the Notes by getting loans amounting to $150m from B and D, the very companies from which the Appellant bought its shares in the Subsidiaries and combining these loans with the $75m it received from the Appellant for its original interest in the Subsidiaries. The $225m essentially flowed in a circle from N Bank Singapore to the Appellant to the related parties (ie D, B and C) to N Bank Mauritius and then back to N Bank Singapore.
During the relevant years of assessment, the Appellant received dividends, being income chargeable to tax, from the acquired subsidiaries,. These dividends carried tax credits arising from tax deemed deducted at source which could be set off against tax payable on the Appellant’s chargeable income. At the same time, the Appellant duly paid the interest due under the Notes to the bank. These interest payments constituted interest expenses which were deductible from the dividend income.
The Appellant, in its tax returns for the relevant years of assessment, claimed the deduction of the interest expenses from the dividend income as well as the benefit of the tax credits under the full imputation system for the taxation of dividends through the s44 account mechanism. This resulted in substantial tax refunds to the Appellant.
The Comptroller of Income Tax (“the Comptroller”), initially accepted the Appellant’s tax computation, but subsequently formed the view that the Appellant had engaged in a tax avoidance arrangement and purported to exercise his powers under s 33(1) of the Income Tax Act to disregard both the dividend income and the interest expenses by issuing notices of additional assessments to recoup the earlier tax refunds. The Comptroller was not satisfied that there was commercial justification for the Financing Arrangement and stated that the arrangement was for the main purpose of deriving a tax advantage.
The appeal to the Income Tax Board of Review against the Comptroller’s decision was dismissed on the grounds that the link between the loan and the dividend income was artificial and the Appellant was incorporated pursuant to an artificial and contrived financing arrangement in order to obtain the benefit of the s 44 credits; and that that the interest payments were artificial because the interest paid by the Appellant to N Bank Singapore was in substance returned to the B group in the form of conditional payments. As such, the Comptroller had the power and authority under s 74 of the Act to assess the Appellant to additional tax.
The Appellant appealed to the High Court.
The central questions in the appeal were whether the arrangement by which the Appellant incurred interest expenses which it set off against dividends from its subsidiaries constituted tax avoidance within the ambit of s 33; and whether the Comptroller was entitled to exercise his powers under s 33(1) in the manner that he did.
The following issues were considered:
i. Whether the Board adopted the right approach towards s 33;
ii. Whether the Financing Arrangement fell within any of the three limbs of s 33(1);
iii. Whether the Appellant could avail itself of the statutory exception under s 33(3)(b);
iv. Whether the Appellant could avail itself of the relevant specific provisions of the Act (ie ss 14(1)(a), 44, 44A and 46) and override the operation of s 33;
v. Whether the Comptroller was right to disregard both the dividend income and interest expenses under s 33;
vi. Whether the Comptroller had the power to issue the Additional Assessments.
The appeal was allowed. In summary, the High Court held that the Comptroller was right in applying the anti-avoidance provisions in s 33 only in so far as the Financing Arrangement was concerned, but not when it came to the restructuring arrangement. The Comptroller was therefore right to disregard the interest expenses, but he should not have disregarded the dividend income.
The key points in arriving at the decision were as follows:
i. Whether the Board adopted the right approach towards s 33
The Income Tax Board of Review had focused on the point that the Financing Arrangement was artificial and contrived and lacked commercial justification and therefore s 33(3)(b) applied.
Judge, however, agreed with the Appellant that the correct approach was to first determine whether the arrangement fell within one or more of the three limbs of s 33(1) as only if so would the statutory exception in s 33(3)(b) be triggered. The Board hence adopted the wrong approach by erroneously conflating s 33(1) and 33(3)(b).
It must be noted that even if the Board’s approach was incorrect, it may be that the Board’s ultimate conclusion that s 33 was properly invoked is correct. Thus, to succeed in its appeal, the Appellant must also show that even if the right approach was adopted, s 33 would not apply.
ii. Whether the Financing Arrangement fell within any of the three limbs of s 33(1)
The Financing Arrangement fell within s 33(1)(c), where the purpose or effect of the arrangement in question was “to reduce or avoid any liability imposed or which would otherwise have been imposed on any person by this Act”. The following supports this conclusion:
• Without the interest expenses, the whole dividend income would be subject to tax. By generating interest expenses which are claimed as deductions against dividend income, the Financing Arrangement had the purpose or effect of reducing the total tax chargeable on the dividend income.
• In addition, the Financing Arrangement also had the effect of avoiding the liability of C to bear withholding tax under s 45 for the interest payments that it received. By interposing N Bank Singapore and N Bank Mauritius, the Financing Arrangement had the effect of enabling C to receive the full interest payments without being liable to pay withholding tax at all.
iii. Whether the Appellant could avail itself of the statutory exception under s 33(3)(b)
To avail itself of the statutory exception under s 33(3)(b), the Appellant must show that the Financing Arrangement was “carried out for bona fide commercial reasons and had not as one of its main purposes the avoidance or reduction of tax”. This it failed to prove.
In fact, the chief financial officer/director of B admitted that the main objective of the Financing Arrangement was indeed to extract the tax credits in the Subsidiaries’ s 44 accounts.
In addition, the Appellant acquired the Subsidiaries at a cost greatly exceeding the approximate value of the Subsidiaries. The larger the amount paid for the Subsidiaries, the more the borrowing, and the more the interest to be paid, resulting in more allowable deductions thereby reducing the tax on the dividend income. Ultimately, that would lead to more tax refunds from the Comptroller. There was also no satisfactory evidence that the interest rate was commercially arrived at.
The loan and corresponding interest flowed in a circle such that, in substance, there was no real loan made by N Bank to the Appellant. N Bank Singapore and N Bank Mauritius were interposed in the Financing Arrangement so that the Appellant would be able to obtain the tax refunds without the interest it bore being taxed in the hands of C.
The Financing Arrangement was, therefore, not carried out for bona fide commercial reasons and had, as one of its main purposes, the avoidance or reduction of tax.
iv. Whether the Appellant could avail itself of the relevant specific provisions of the Act and override the operation of s 33
This point is unnecessary as Singapore already has a statutory exception under s 33(3)(b) to protect taxpayers from the over-extensive application of anti-avoidance provisions. Ultimately, the question is whether a proper balance is struck between the rights and interests of taxpayers and the Comptroller in interpreting and applying s 33. A proper balance is struck by interpreting s 33(1) as importing an objective test, while allowing taxpayers to avail themselves of the statutory exception under s 33(3)(b) which should be interpreted as importing a purely subjective test
v. Whether the Comptroller was right to disregard both the dividend income and interest expenses under s 33
As it was the Financing Arrangement alone that offended s 33, the Comptroller should not have disregarded the dividend income. His power under s 33(1) is to disregard or vary only the impugned arrangement.
In addition, the Comptroller should not have disregarded all the interest expenses. Instead, he should have disregarded only the interest expenses borne by the Appellant attributable to the $150m lent by D and B to C (ie, two-thirds of the total interest expenses incurred by the Appellant). The Comptroller should have allowed the interest expenses arising from the $75m loan made by C to be deductible expenses in assessing the Appellant to tax (ie, one-third of the total interest expenses incurred by the Appellant). At the same time, the Comptroller should have required the Appellant to account to it for the withholding tax that ought to have been paid by C on interest payments borne by the Appellant arising from the $75m loan.
Based on the above, the Comptroller did not exercise his powers under s 33(1) fairly and reasonably when he disregarded both the dividend income and the interest expenses. For this reason, the tax assessed ought to be discharged.
vi. Whether the Comptroller had the power to issue the Additional Assessments
The Appellant’s submission that the Comptroller acted ultra vires when he issued the Additional Assessments under s 74(1) was accepted. This is because in each of the assessments, the Comptroller assessed the Appellant to less tax than that under the Original Assessments.
The above judgement was delivered on 18 December 2012.