Category: Case Updates

BFC v Comptroller of Income Tax [2013] SGHC 169

On By taxsgIn Case Updates, Corporate Tax, Deductions, Latest Tax News

26 September 2013

Revenue Law— Income Taxation — Deduction

Facts

The Appellant carries on the business of hospitality, investment holding and property investment. The Appellant also owns and operates a hotel (“the Hotel”). In 1995 and 1996, the Appellant issued bonds (subsequently referred to as “the 1995 Bonds” and “the 1996 Bonds” respectively). Each bond issue was for a five year term with the 1995 Bonds maturing in 2000 and the 1996 Bonds maturing in 2001.

The 1995 Bonds were secured bonds and interest was payable semi-annually in arrears on the principal amount. In addition to interest, discount and redemption premium were also offered to purchasers.  The Appellant presented that the proceeds of the 1995 Bonds were used for (a) the financing of the renovation of the Hotel, (b) the refinancing of the existing borrowings of both the Appellant and its subsidiaries, and (c) as working capital for the day-to-day operations of the Appellant’s business.

The 1996 Bonds were unsecured bonds and interest was payable annually in arrears on the principal. As with the 1995 Bonds, the Appellant offered a discount on the 1996 Bonds. However, no redemption premium was offered for the 1996 Bonds. The proceeds of the 1996 Bonds were used as working capital to finance the day-to-day operations of the Appellant’s business.

The Disputed Tax Treatment 

In assessing the Appellant’s income that was chargeable with tax, the Comptroller of Income Tax (“CIT”) allowed the deduction of interest paid on the 1995 Bonds and the 1996 Bonds. With regard to the 1995 Bonds, the Appellant was able to identify (and the CIT accepted) that part of the net proceeds was used to finance the renovation of the Hotel and the CIT allowed a proportionate deduction for the interest paid on the 1995 Bonds. The Appellant sought a similar deduction relating to the discount and redemption premium incurred in respect of the 1995 Bonds.

As for the balance of the proceeds of the 1995 Bonds and the 1996 Bonds, the CIT regarded this as forming a mixed pool of funds and applied an interest adjustment method known as the Total Assets Method (“the TAM”). In applying the TAM, the CIT only allowed a deduction for interest expenses attributable to income-producing assets. The Appellant thus sought similar deductions based on the TAM for the discounts and redemption premium paid on the 1995 Bonds and the 1996 Bonds.

The Appellant’s claims for the above deductions were disallowed by the CIT on two grounds:

(a)   The discounts and redemption premium did not constitute “interest” and therefore were not deductible under section 14(1)(a) of the Income Tax Act (Cap 134, 2001 Rev Ed)(“the ITA”).

(b)   The discounts and redemption premium were not outgoings and expenses wholly and exclusively incurred in the production of the Appellant’s income chargeable with tax and therefore not deductible under section 14(1) of the ITA.

Dissatisfied with the CIT’s disallowance of its claims, the Appellant appealed to the Income Tax Board of Review (“the ITBR”).

The Decision of the ITBR

The appeal was heard by the ITBR on 25 July 2012 and dismissed in its grounds of decision (“the GD”) dated 14 December 2012. The ITBR held that the discounts and the redemption premium were not deductible for three primary reasons:

(a)   The discounts were not deductible under section 14(1) of the ITA as they only related to the non-receipt of the amount of the discounts. Therefore, they were not “outgoings or expenses” incurred by the Appellant.

(b)   The discounts and redemption premium were not deductible under section 14(1) of the ITA because part of the bond proceeds formed a mixed pool of funds, some of which were not used for income producing purposes. Accordingly, the discount and redemption premium were not wholly and exclusively incurred in the production of the income.

(c)   The discounts and redemption premium were not “interest” within the meaning of the term under section 14(1)(a) of the ITA and therefore did not qualify for deduction under that provision. This was because the discounts and redemption premiums were one-off payments while interest remained payable as long as the bonds remained unredeemed. Furthermore, section 10(1)(d) of the ITA referred distinctly to “interest” and “discount”, thereby importing a difference between the two, even if they were both examples of borrowing costs. In this regard, the 2008 amendments to the ITA which specifically provided for the deduction of discounts and redemption premiums also suggested that such borrowing costs were not interest.

The Appellant appealed to the High Court against the whole of the ITBR’s decision.

Issues

(a)   Whether the discounts and redemption premium constitute “interest” under section 14(1)(a) of the ITA.

(b)   Whether the discounts and redemption premium were outgoings and expenses wholly and exclusively incurred in the production of the Appellant’s income under section 14(1) of the ITA.

(c)   Whether the discounts and redemption premium were capital as opposed to revenue expenses and therefore prohibited from deduction under s 15(1)(c) of the ITA.

Conclusion

The Appellant’s appeal was dismissed.

The key points in arriving at the decision were as follows:

(a)   Were the discounts and redemption premium “interest” under section 14(1)(a) of the ITA?

The Judge noted that section 14(1)(a) of the ITA grants a deduction to sums payable as “interest” upon money borrowed by the taxpayer. However, the term “interest” is not defined by the ITA and its meaning falls to be determined as a matter of statutory interpretation.  There has also been little local authority interpreting the term.

In this regard, case law indicates that interest can be described as the compensation paid to a lender for the use of his money.  Alternatively, from the perspective of the borrower, interest is the consideration paid for the use of the lender’s money. Furthermore, it is said that nomenclature, or the label attached to a payment, does not affect the legal question of whether that payment is or is not interest.  The common law looks at the substance of a transaction and not at its label or form.

While interest, discounts and redemption premiums may be incurred by a borrower as consideration for the use of the lender’s money, the Judge decided that it does not however follow that the discounts and redemption premiums are necessarily interest.

In addition, the Judge held that one must consider the essential characteristics of each of those concepts of “interest”, “discount” and “redemption premium”, in particular, the differences between each concept.  It is only where a payment made by a borrower bears the characteristics of interest, discount or redemption premium that it can be properly called, notwithstanding the label one attaches to that payment. In this regard, the Judge agreed with the CIT’s contention that a fundamental feature of interest is that it accrues with time.

In examining whether true discounts and redemption premiums bear the same features as interest, the Judge relied on the ordinary meaning of these concepts.  He held that a true discount and a true premium, unlike interest, do not bear the feature of accrual with time.

The Judge concluded that the discounts and redemption premium incurred by the Appellant in respect of the 1995 and 1996 Bonds do not constitute “interest” under section 14(1)(a) of the ITA. To count as “interest”, a payment must be consideration paid by the borrower for the use of the lender’s money which bears the fundamental feature of accrual with time. Only then will the payment be interest, notwithstanding the label attached to it. The discounts and redemption premium incurred by the Appellant in respect of the 1995 and 1996 Bonds did not bear this feature. Both the discounts and the redemption premium were one-off obligations, based on a fixed percentage of the principal loan amount. They did not accrue with time, but were ascertainable at the time the bonds were issued.

(b)   Were the discounts and redemption premium outgoings and expenses wholly and exclusively incurred in the production of the Appellant’s income under section 14(1) of the ITA?

The Judge held that the Appellant had, by redeeming the bonds at their full face value, incurred actual outgoings with regard to the discount in Years of Assessment 2001 and 2002.  In addition, the redemption premium paid to the bondholders in Year of Assessment 2001 was an actual outgoing incurred by the Appellant.  As such, it was concluded that the discounts and redemption premium constitute “outgoings and expenses” under section 14(1) of the ITA.

As to whether the expenses were wholly and exclusively incurred in the production of the Appellant’s income, case law indicates that there must be a nexus between the incurring of the discounts and redemption premium and the production of the Appellant’s income.  In addition, section 14(1) of the ITA only grants a deduction to expenditure that is revenue as opposed to capital in nature.  This follows that there is a close nexus between section 14(1) and section 15(1)(c) of ITA. By prohibiting the deduction of capital (as opposed to revenue) expenses, section 15(1)(c) serves to reinforce the requirement under section 14(1) of the ITA that the expenses must be wholly and exclusively incurred in the production of the taxpayer’s income to qualify for deduction under that provision.

(c)   Were the discounts and redemption premium capital expenses and therefore prohibited from deduction under section 15(1)(c) of the ITA?

As regards to the deductibility of interest expenses under section 14(1)(a) of the ITA, case laws indicate that it was necessary to examine the nature of the underlying loan when determining whether interest expenses were in the nature of capital or revenue.

In determining the purpose of the underlying loan, and consequently the nature of the borrowing costs incurred on that loan, the Judge turned to the framework laid down by case law which looked at (i) the purpose of entering into the loan, and (ii) whether there is a sufficient linkage or relationship between the loan and the main transaction or project for which the loan was taken. If, no, or an insufficient, linkage is established, the purpose of the loan must, ex hypothesi, be merely to add to the capital structure of the taxpayer and is therefore capital in nature. If a sufficient linkage is established, one must then ascertain whether the main transaction is of a capital or of a revenue nature. If it is of a capital nature, then (given the linkage to the loan) the loan is also of a capital nature. If, on the other hand, the main transaction is of a revenue nature, then (once again, given the linkage to the loan) the loan is also of a revenue nature.

In this regard, the Judge was satisfied that the Appellant’s submission that 1995 and 1996 Bonds were issued to (i) finance the renovation of the Hotel, (ii) refinance the existing borrowings of the Appellant and its subsidiaries, and (iii) to finance the day-to-day operations of the Appellant’s business. It was also found that a sufficient linkage is established between the 1995 and 1996 Bonds and each of these purposes.

However, on the issue of whether the three uses to which the bond proceeds were intended to be put were themselves capital or revenue in nature:

(i)   The Judge agreed with the CIT’s contention that the expenditure incurred by the Appellant in respect of the hotel refurbishment work was capital in nature.

(ii)   It was held that where a later loan is taken out to refinance an earlier loan, one must first ask whether the earlier loan was capital or revenue in nature. If the earlier loan was revenue in nature, it would follow that the later loan and the borrowing expenses incurred in connection therewith would also be revenue in nature. If on the other hand the earlier loan was capital in nature, one should ask whether the taxpayer was ordinarily engaged in the business of financial operations. If the taxpayer was not, then borrowing expenses incurred on the later loan are likely to be capital expenses and disallowed as a deduction under section 15(1)(c) of the ITA.

In this case, the Appellant failed to adduce evidence revealing the nature of the loans to be refinanced by the 1995 and 1996 Bonds and was not engaged in the business of financial operations. It follows that the refinancing transactions for which the 1995 and 1996 Bonds were issued would have been capital as opposed to revenue in nature. To this extent, it also follows that the 1995 and 1996 Bonds were capital in nature and therefore, disallowed from deduction under section 15(1)(c) of the ITA.

(iii)   It was held that there was no linkage between the 1995 and 1996 Bonds and any specific project or transaction that was clearly revenue in nature. Conversely, it was evident that the bonds were issued for the more general purpose of raising funds for the acquisition of working capital. It follows that insofar as the 1995 and 1996 Bonds were to be put to use as working capital to finance the day-to-day operations of the Appellant’s business. As such, the Judge held that this was a transaction that was capital in nature.

Based on the above, the Judge concluded that the 1995 and 1996 Bonds were capital in nature. Accordingly, the discounts and redemption premium incurred by the Appellant in respect of the 1995 and 1996 Bonds were also capital in nature and therefore, disallowed from deduction under section 15(1)(c) of the ITA.

The above judgement was delivered on 9 September 2013.

High Court – BFH v Comptroller of Income Tax – [2013] SGHC 161

On By taxsgIn Case Updates

28 August 2013

Revenue Law – Income Taxation

BFH (“the Appellant”) operates and provides mobile telecommunications systems and services in Singapore. The telecommunications industry is regulated by the Info-communications Development Authority (“IDA”), which licenses the operation of telecommunications systems and services and oversees the use of electromagnetic spectrum rights.

In 2001, the Appellant paid about $100 million (“Relevant Expenditure”) to IDA for a 20-year grant of both a 3G Facilities-Based Operator (FBO) Licence and a right to use the electromagnetic spectrum at a frequency of 2100 Megahertz (“3G Spectrum Rights”). The issue in this appeal is the deductibility of this Relevant Expenditure for income tax purposes. The Comptroller of Income Tax (“the Comptroller”) did not permit the deduction in the ascertainment of the Appellant’s income on the basis that it constituted capital expenditure, which was disallowed under s 15(1)(c) of the Income Tax Act (Cap 134, 2008 Rev Ed) (“the Act”). The Appellant disagreed and appealed to the Income Tax Board of Review (“ITBR”), which dismissed the Appellant’s appeal in its decision on 3 January 2013 (“the ITBR Decision”). The present appeal is against the ITBR Decision.

The ITBR held that the Relevant Expenditure was a capital expense since it procured for the Appellant 20 years of the 3G Spectrum Rights. This enabled the Appellant to install 3G systems and provide 3G services to existing and new customers. In so doing, the Relevant Expenditure opened up a new field of trade and thus enlarged the core structure of the Appellant’s business. Additionally, the Relevant Expenditure was a one-time payment, suggesting that it was capital in nature.

The respective arguments in the present appeal

The Appellant submits that the ITBR Decision did not give due regard to the purpose of the Relevant Expenditure and instead based its decision on the duration and manner of payment. Essentially, the Appellant argues that the Relevant Expenditure was revenue in nature (and thus deductible) because its purpose was to acquire additional spectrum rights to protect its customer base and maintain its ability to continue providing quality service. Besides, the Relevant Expenditure was merely for regulatory permission and conferred no proprietary rights or structural enhancement. That the Relevant Expenditure was paid as a lump sum does not determine whether it is revenue or capital in nature.

In reply, the Comptroller maintains that the Relevant Payment was capital in nature and therefore not deductible because the consequence of the Relevant Expenditure was a substantive enhancement of the Appellant’s core business structure and enabled the launch of a new line of trade in 3G services, which previously could not be provided by the Appellant. The Appellant’s capitalisation of the Relevant Expenditure as a “non-current asset” in its balance sheet also reflected its assessment that there would be future economic benefits flowing from the asset. The cases cited by the Appellant on payments made to preserve a business or avoid a catastrophic event were different from the present situation as the Appellant was not facing any crisis. The fact that the Relevant Expenditure was a one-time non-refundable lump sum payment of $100m with a 20-year duration suggested it was a capital expenditure. This conclusion is supported by the tax treatment of similar payments for 3G licences in other Commonwealth jurisdictions.

Deductibility under the Act

In ascertaining the net taxable income of a person for any period, the gross income during that period is taken as a baseline. Against this are deductions for outgoings and expenses allowed by the Act, subject to the overriding condition that such outgoings or expenses are not the subject of statutory prohibition.

Notwithstanding this, s 15 of the Act cites certain categories of expenses or payments in respect of which deductions are not allowed, the most pertinent of which, as described in s 15(1)(c), is “any capital withdrawn or any sum employed or intended to be employed as capital except as provided in section 14(1)(h)”. Section 14(1)(h) allows for deduction of capital expenditure as prescribed in subsidiary legislation “where the income is derived from the working of a mine or other source of mineral deposits of a wasting nature”.

The net effect of these provisions is that the Appellant may only deduct the Relevant Expenditure if it is revenue in nature, as neither s 14(1)(h) nor the other exceptions in the Act are applicable. The key question therefore, is whether the Relevant Expenditure should be characterised as capital or revenue in nature.

Case law on the capital-revenue distinction

Both parties accept that the applicable law on the capital-revenue distinction for income tax purposes is as stated in the High Court decision of ABD Pte Ltd v Comptroller of Income Tax [2010] 3 SLR 609 (“ABD v CIT”). In that case, Andrew Phang JA reviewed the various tests to aid the court in ascertaining whether or not a specific expenditure is capital or revenue in nature.

The general principle is that the court must look closely at the purpose of the expenditure and ascertain whether or not such expenditure created a new asset, strengthened an existing asset or opened new fields of trading not hitherto available to the taxpayer, in which case such expenditure would be capital in nature. In particular, the court should consider the following guidelines:

(i) The manner of the expenditure: a one-time expenditure, as opposed to recurrent expenditures, would suggest that the expenditure is capital in nature; and

(ii) The consequence of the expenditure: if the expenditure strengthens or adds to the taxpayer’s existing core business structure, it is more likely to be capital in nature. However, where the expenditure is for “assets” which comprise the cost of earning an income, such expenditure is more likely revenue in nature.

Key issue: whether the Relevant Expenditure was capital or revenue in nature

To recap, the Appellant is a mobile telecommunications provider. What the Appellant was acquiring through the Relevant Expenditure was an intangible right for 20 years to use the 3G Spectrum, as well as a licence to develop and operate a 3G telecommunication network. The question is – whether this expenditure created a new asset, strengthened an existing asset, or opened new fields of trading hitherto not available to the Appellant.

The fact that the Relevant Expenditure constituted a lump sum, one-time payment of $100m instead of recurrent annual payments, is indicative, but not determinative of its capital nature.

In order for an expense to be properly characterised as capital in nature, it should create an asset or advantage of a permanent character. The rights conferred upon the Appellant by the Relevant Expenditure, being valid for 20 years, are of a permanent character. The advantage of being able to use the 3G spectrum to develop and operate a 3G telecommunication network strengthened and enhanced the Appellant’s existing telecommunication systems. From a business perspective therefore, the Relevant Expenditure enlarged the Appellant’s current profit-making operations and provided additional avenues for growth.

It is irrelevant that the other two local telcos acquired the same rights as the Appellant such that the Appellant gained no competitive advantage by virtue of the Relevant Expenditure. The focus of the capital-revenue distinction is the effect of the expenditure on the taxpayer in terms of its assets or business, and not the relative effects of similar expenditure on different taxpayers.

Consistency with tax treatment of cellular licence fees in other jurisdictions

The judge also compared and deliberated on the manner in which the United Kingdom, Australia and Malaysia dealt with similar expenditure. The commonality in these jurisdictions (with tax laws similar to Singapore) is that, but for statutory intervention, such expenditure would not have been deductible as revenue expenditure nor would it have qualified for depreciation allowance. Under the existing statutory scheme in Singapore, no depreciation allowance is permitted for the Relevant Expenditure. Neither has there been any amendment to the Act to sanction the Relevant Expenditure as a revenue expense.

Conclusion

In view of the above considerations, the judge decided that the Relevant Expenditure was capital in nature and thus not deductible under s 14(1) of the Act. The appeal was dismissed.

The above judgement was delivered on 22 August 2013.

High Court – Comptroller of Income Tax v BJX – [2013] SGHC 145

On By taxsgIn Case Updates

2 August 2013

Civil Procedure – Judgment and Orders

On 26 February 2013, the Comptroller of Income Tax (“CIT”) made an application to the High Court pursuant to Section 105J of the Income Tax Act for an order for two banks to release information, documents and bank records pertaining to BJX. Under Section 105J, the CIT can make an application to the High Court for an order to obtain information that is protected from any unauthorised disclosure under Singapore’s domestic law (such as the Banking Act) in response to requests from tax authorities of other jurisdictions that invoke the provisions of the Exchange of Information Article under the tax treaties Singapore has with such jurisdictions. On 5 July 2013, the High Court granted the Order in favour of the Comptroller. Subsequently, on 9 July 2013, BJX applied for a stay of execution of the Order.

Counsel for BJX submitted that disclosure of confidential information pursuant to the Order would cause irreparable loss of confidentiality in the information disclosed.

Replying, Counsel for the CIT contended that since there was no appeal pending, the stay should not be allowed. Moreover, there were no special circumstances justifying the application.

The Judge ruled that there were no convincing reasons to grant the application.

First, BJX had not filed an appeal against the Order.

Second, there were no special circumstances supporting the application. If the information disclosed to the Indian tax authorities proved to be irrelevant, BJX would not be adversely affected as the authorities are bound by secrecy obligations under the Singapore-India DTA.

Third, the information requested was detailed, specific and foreseeably relevant to the administration or enforcement of Indian tax law. The test of foreseeable relevance was not meant to be a high and exacting standard, but rather, to provide for the exchange of information in tax matters to the “widest possible extent”.

For the above reasons, the application was dismissed.

The above judgment was delivered on 30 July 2013.

High Court – AQQ v Comptroller of Income Tax – [2012] SGHC 249

On By taxsgIn Case Updates, Corporate Tax

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

Diagram A

where B and C are Malaysian companies and D, F, G and H are Singapore companies

Diagram B: Post- restructure

Diagram B

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.

Court of Appeal – AQP v Comptroller of Income Tax – [2013] SGCA 3

On By taxsgIn Case Updates

3 February 2013

Income Tax – deduction

The Appellant’s ex-Managing Director (“Ex-MD”) misappropriated company funds and was dismissed in Dec 1999. The Appellant made a provision for doubtful debt for the loss arising from the misappropriation for the year ended 31 December 1999, but did not claim a tax deduction in that Year of Assessment. A judgement was obtained against the Ex-MD in 2003 but the latter was subsequently declared a bankrupt rendering the loss irrecoverable. In December 2005, the Appellant applied to the Comptroller of Income Tax for relief under s 93A of the Income Tax Act on the basis that it had made an “error or mistake” within the meaning of that section by not claiming a deduction for the Loss under s 14(1) of the Act in its Year of Assessment 2000 income tax return. The application was denied.

The Comptroller’s decision that the Loss did not qualify for a deduction under s 14(1) was upheld by the Income Tax Board of Review as well as the High Court. In arriving at this decision, both the Board and the High Court looked at the “overriding power and control” test, which asks whether the defalcator possessed an “overriding power or control” in the company (ie in a position to do exactly what he likes) and whether the defalcation was committed in the exercise of such “power or control”. If so, the losses which result from such defalcations are not deductible for income tax purposes.

The Appellant then appealed to the Court of Appeal with the sole issue being whether the High Court judge had erred in holding that the loss did not qualify for deduction under s 14(1) of the Act.

A plain reading of s14 (1) would suggest that employee defalcations would not usually be considered as an “outgoing” or “expense” which is “wholly and exclusively incurred…in the production of income”.

Case law, however, indicates a different approach when addressing employee defalcations, and courts (across jurisdictions) have, in fact, allowed deductions in so far as defalcations by employees who do not have overriding power or control in their respective organisations are concerned (eg a cashier taking funds from an employer’s till). This is based on the fact that such defalcations are an inevitable fact of commercial life in general and the conducting of the business concerned in particular. Put simply, the granting of such deductions is premised on commercial reality.

The situation is radically different where defalcations are effected by employees who have overriding power or control in their respective organisations. Checks and balances can, and ought to, be in place to prevent such overriding power or control from being abused by the employee concerned, hence resulting in the defalcations perpetrated by that employee.

If a sufficient system of checks and balances has been put in place by the taxpayer and defalcations nevertheless occur as a result of an employee still managing to abuse his or her position of overriding power and control, the court would generally permit a deduction for such defalcations under s 14. Conversely, if the taxpayer does not put in place a sufficient set of checks and balances with the result that overriding power or control is abused by the employee concerned, then it is logical, fair as well as commonsensical, for the taxpayer to be refused a deduction for such defalcations under s 14.

The onus of demonstrating to the relevant tax authorities that the employee concerned was not placed in a position of overriding power or control or that, if he or she had been so placed, that a sufficient system of checks and balances had indeed been instituted, notwithstanding the fact defalcations had still been effected by the employee concerned, lies on the taxpayer concerned.

The High Court had, when disallowing the deduction, relied on the criminal proceedings against the Ex-MD to conclude that the Ex-MD was in a position of overriding power and control. The Appellant, however, was not a party to the criminal proceedings and therefore did not have the opportunity, inter alia, to proffer evidence as to whether or not it had, in fact, instituted a proper system of checks and balances. It had also not been given the opportunity to challenge the findings of the court in the criminal proceedings that the Ex-MD did possess overriding power or control in the first place.

The Court of Appeal therefore held that it would be just and fair for the proceedings to be remitted to the Board in order for the necessary evidence to be adduced with regard to whether the Ex-MD was in a position of overriding power or control for the purposes of the present (civil) proceedings and, if so, whether a sufficient system of checks and balances had been put in place by the Appellant on the facts of this particular case. The Board should then proceed to render a decision in accordance with the “overriding power or control” test.

The above judgement was delivered on 16 January 2013.