AYN Corporation v The Comptroller of Income Tax [2012] SGITBR 1

Article 7 of the OECD Model Tax Convention (treating a branch as a separate and distinct entity) is not concerned with how the second Contracting State deals with the profits so determined, such as by allowing past losses to be used to set off against the profits of the PE. That is the purview of section 37(3)(a) of the ITA. Accordingly, the Board of Review held that the unabsorbed losses of the Appellant (old branch) are available for set-off under section 37(3)(a) of the ITA against its (new branch) profits.

Pasty-gate

I’m following with much interest the furore over the pasty tax in the UK. When the Chancellor imposed 20% VAT on hot baked goods such as the much beloved Cornish pasty, Greggs the high street chain saw red. Through some clever management, they’ve managed to garner what seems to be near universal condemnation of the tax, as well as paint the Chancellor (and the Conservative Party) as people who would rather tax the poor over the rich. The ridiculous nature of this tax has been explored widely in the press e.g. to avoid paying such a tax, it seems that bakers would have to wait for the pasty to cool, thus prompting one baker to say that she would put up a sign in the window: “Hot for the rich, and cold for the poor”! In class-obsessed Britain, such a move by the Chancellor is bound to attract severe criticism. Some might say that this incident makes it even harder for the Conservatives to shake off their image as a party of “toffs” now. Definitely something to think about before you bite into the next hot pasty.

AYH v The Comptroller of Income Tax [2011] SGITBR 4

In this case, a company acquired new plots of land to build an extension to an existing mall. The question was whether the interest expenses on the loans taken out to finance the acquisition could be treated as part of the investment for the existing mall and hence deductible under s10E(1) of the Income Tax Act.

On the facts, the Board was unable to discern any corporate intention at the time of the tender and acquisition to build the existing mall, to also acquire those new plots of land. Ultimately, the appeal by the company was dismissed. It was concluded that the new investment did not produce income prior to the issuance of the TOP, and hence the interest expense deduction claimed was disallowed.

Some points to note from the case:

• Case of JD Ltd advocated an investment-by-investment approach but company sought to distinguish it by classifying the present case as business income while labelling the JD Ltd case as passive investment income. The company argued that CJ Yong said that for s10(1)(a) income, there was no requirement for a source-by-source approach to be applied.
• The Board is of the view that the ordinary meaning of “investments” as understood by businessmen would in essence mean an outlay, usually in money or money’s worth, for the acquisition of an asset with a view to the generation of income and/or the expectation of profit from the asset acquired.
• In T Ltd, it was held that for business to commence in a situation like the present case, the taxpayer must have established an income-generating asset or income-earning structure.
• Other considerations include: four year gap between existing mall and acquisition of new plots, difference in price of the land, need to surrender separate titles to procure a single Certificate of Title.

AQQ v Comptroller of Income Tax

This case involved a complicated financing arrangement in which AQQ unsuccessfully sought to deduct interest expenses incurred on notes against franked dividends received.

There are a number of learning points from this case:

1. Ensure documentary evidence for the commercial reasoning behind the transaction
2. Ensure that there is a reasonable basis for the amount of consideration/valuation of assets etc.
3. Be aware that if you arrange the transaction just to coincide with say the commencement dates of the relevant tax change, there is a greater risk that the transaction will be seen to be a tax avoidance scheme
4. Take note that the Board of Review found that the case law on anti-avoidance in Australia and New Zealand was similar to Singapore’s laws on anti-avoidance. So ultimately it boils down to an interpretation of section 33 Income Tax Act.

Budget Day 2012

Has it been almost a month?

Yesterday was a big day for tax people. Budget Day 2012 was apparently relatively light on tax issues as compared to previous years. The main focus was on increasing productivity and some ways in which that was done was by enhancing the Productivity and Innovation Credit scheme, restricting the dependence on foreign workers and increasing grants for training etc. Viewed from a political angle, it could be also be said that restricting the inflow on foreign workers was actually the end and not the means. The other focus was on senior Singaporean workers. Higher CPF contribution rates should encourage them to continue working, and the Special Employment Credits should ease the higher CPF contribution burden on employers thinking of hiring these older Singaporeans.

I read about some criticism that the labour market was already tight, and restricting the number of foreign workers was thus detrimental to Singapore’s economic growth. While it is true that unemployment rates in Singapore are very low at the moment, Singapore is not projected to have very high levels of economic growth and in fact the economy appears to be slowing down. The government’s argument that these companies should seek to increase the productivity of each worker and not resort to hiring more foreigners is also pertinent in addressing this criticism. The weakness in that argument though is that increasing productivity is a long term solution so in the short term, companies may feel the strain. Then again, there is some time before the changes take effect, so hopefully that reduces the impact of the short term pain.  

One significant development is that greater certainty is now being provided to the tax treatment of the disposal of equity investments. If the divesting company holds at least 20% shareholding and maintains it for a minimum period of 2 years just before disposal, the disposal will not be taxed. This cuts out a lot of the constant exchanges with IRAS on whether the disposal is income or capital in nature.

Lots more analysis coming from all corners especially the Big Four, so I’ll be looking out for that.

Not a day goes by without taxes being mentioned

The first item is the news that Bharti Airtel, a top Indian mobile phone carrier, has been slapped with a 10.67 billion rupee (S$271 million) tax demand from the country’s tax office over payments to international telecom operators. It relates to the applicability of withholding tax on payments made to those international operators. Now obviously Bharti is not sitting back, it’s clearly going to challenge that massive tax bill. I don’t know much else about this, but I’ll be looking forward to finding out more about this case.

The other much bigger headline is Mr Mitt Romney’s tax returns. Because much of his earnings arise from stocks, he gets taxed on the capital gains. The capital gains tax rate is lower than the highest income tax rates, hence he enjoys a lower effective tax rate than people like Warren Buffet’s secretary. It’s the same dilemma everywhere really. Governments want to help the economy grow, so they lower capital gains tax in the hope that people will invest in the various properties and the stock market. However, at the same time, the reduced capital gains tax hugely benefits people such as hedge fund managers, wealthy investors etc whose bulk of their income is in such assets and stocks. These high net worth individuals also argue the old chestnut, that if taxes are raised, they’ll just move somewhere else so a little bit of tax revenue is better than none at all. Then bring in the middle class that feels that they get squeezed dry, an incumbent that is struggling to get re-elected and you’ve got yourself the latest developments in the US 2012 Presidential Elections.

Mr Rubenstein from the Carlyle Group was reported to have said, “If you change the law, we’ll pay the taxes.” This is true to a point really. Perhaps he should have added, “But if you change the law too much for our liking, we’ll be calling our tax advisers and then you wait and see how much taxes you get to collect this time.” The fact of the matter is that the high net worth individuals have so many options at their disposal that they will almost always ensure that they get the best deal no matter the situation.

In other news, just the other day someone who won’t be named spelt Texas as Taxes. Which got me thinking about how taxing Texas’ taxes are. Ok I better stop now.  

Financial Transactions Tax

I’m intrigued by this financial transactions tax that French President Sarkozy and German Chancellor Angela Merkel want to levy. Under this plan, stock and bond trades would be taxed at 0.1% whilst derivatives get taxed at 0.01%. It appears this tax is known as a Tobin tax, named after Prof Tobin who proposed a tax on foreign exchange transactions. Not sure getting a tax named after you is the highest honour in tax.

Anyway, over in UK, David Cameron, the British Prime Minister has stated that he would veto such a tax unless it was imposed globally, fearing the repercussions it would have on the City of London. This seems to be a politically popular decision, and certainly pleases the financial institutions. The argument made surely is that such a tax would increase the costs of carrying out financial transactions in London and drive investors into the open arms of other countries, thereby driving job/consumption etc opportunities overseas. Transaction volumes are likely to fall sharply which also means lower profits and thereby lower taxes payable. This is exacerbated by the fact that the market is very liquid, and investors can transfer their funds to buy shares on another stock exchange literally in a matter of seconds. The net effect would be reduced economic growth.

The counter argument is that it will raise a lot of money even though it may reduce the amount of transactions taking place. It’s also a way for Sarkozy and Merkel to show to the electorate that they are willing to stand up to the financial institutions, and fight for the people. Also, it may be said that if taxes are not raised here, it would have to be raised elsewhere and that elsewhere would be in things like income tax or VAT etc, areas which affect the ordinary citizens a lot more.

At the end of the day, where there is some good and some bad no matter which decision you make, it’s all about what the net effect of the tax will be. We also can’t discount the powerful effect of politics in this. However, with so much gloomy news coming out of Europe these days, I just hope that some certainty is achieved and that the decision, whichever is taken, will allow for a net positive effect.  

AQP v Comptroller of Income Tax [2011] SGHC 229

The following is a summary of the judgment by Tay Yong Kwang J. It deals with conflicting interpretations of Commonwealth cases as well as legal and policy arguments on the scope of deductibility.

The question before the court is whether losses caused to a company by a fraudulent director ("the Ex-MD") are deductible for income tax purposes under s14(1) of the Income Tax Act ("the Act"). The Ex-MD had misappropriated company funds causing the appellant to incur losses ("the Loss"). The appellant is seeking relief for the Loss under s93A of the Act, which concerns relief in respect of error or mistake.

Previously, the Income Tax Board of Review applied Curtis (HM Inspector of Taxes) v J & G Oldfield, Limited (1925) 9 TC 319 (“the Curtis test”) and concluded that the loss sustained by the appellant was not deductible under s14(1). It held that the Ex-MD was 'in the same position as the managing director in the Curtis case".

The Board also considered whether the appellant’s omission to set off the Loss in YA 2000 could qualify as an “error or mistake” under section 93A(1) of the Act, if the Loss were deductible. The Board held that the omission by the appellant was not “due to oversight” as “it was a decision made after due consideration that the Loss was not an allowable deduction under section 14 of the Act” but agreed with the appellant’s argument that “[i]f the decision was a mistake it was one of law and still a mistake falling within section 93A of the Act”.

Hence, two issues arose on appeal:

Issue A: Did the Board err in holding that the Loss incurred by the appellant was not wholly and exclusively incurred by the appellant in its production of income under s14(1)?

The appellant argued that in Curtis, the “real reason” why the loss was not deductible was because the defalcations took place outside the company’s trading or income-earning activities, since the money had already been earned and was simply passed through the company’s books into the pocket of the director. The respondent, however, understood the Curtis test as prohibiting the deduction of losses incurred by a director who was “in a position to do exactly what he likes”.

Tay J agreed with the respondent and held that the correct understanding of the Curtis test, is as follows: Did the defalcator possess an “overriding power or control” in the company (i.e. in a position to do exactly what he likes) and was the defalcation 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. This reasoning was derived from a review of cases from different jurisdictions that considered the Curtis test, with Tay J eventually concluding that the Commonwealth cases are on the whole, in greater support of the "overriding power or control" test.

Tay J also rejected the appellant's argument that such an approach was undesirable both legally and on policy grounds. The Curtis test should be understood as a common law exception developed by the courts to render certain defalcation losses as having sufficient “nexus” with the production of income such that they could be deductible for income tax purposes. The Curtis test seeks to alleviate the hardship of the taxpayer by granting tax-deductibility to certain defalcation losses but it cannot and should not provide a warped incentive for firms to allow certain employees to do as they please and then claim that they had “expected” the losses which result from the employees’ defalcations to be tax deductible.

The distinction between losses resulting from the defalcations of lower echelon employees and those who possess an “overriding power or control” in the firm are justified on two policy grounds. First, the distinction drawn by the Curtis test as understood by the Board is as an extension of sympathy to large firms in view of their inability to keep all their employees, especially those of the lower echelon, in check. Second, and more importantly, it functions as a form of deterrence to firms that do not provide adequate checks on employees who possess such “overriding power or control” that they are able to incur great financial and social damage. As a deterrent tool, the Curtis test only makes sense if it is not only descriptive but also prescriptive of commercial practice.

In addition, it was considered that the appellant’s test may have undesirable consequences. The effect of such a test may be to encourage firms to turn a blind eye towards the power or control wielded by their employees. This is because so long as their employees, especially the high-level ones, “dress up” their defalcations as if they were part of the company’s activities, the losses which they incur would be tax-deductible.

Issue B: Did the Board err in holding that an erroneous opinion or a grossly negligent error, such as a mistake of law, can constitute an "error or mistake" under s93A of the Act?

The Board held that it did not find favour with the respondent’s argument that “error or mistake under section 93A of the Act does not include an erroneous opinion or grossly negligent error, but ‘must be genuinely due to ignorance or inadvertence”.

Tay J held that he agreed with the judge in the Hong Kong case of Extramoney Ltd v Commissioner of Inland Revenue [1997] 2 HKC 38 that errors with regards to the commercial advantage of attributing the said profits to itself are clearly outside the ambit of section 93A(1), which provides only for an “error or mistake in the return or statement made by [the taxpayer]”. It must follow then that genuine mistakes or errors made by the taxpayer in the filling up of the return or statement falls within section 93A(1) and this could have been caused by a genuine mistake of law instead of fact.

On this issue, Tay J agreed with the Board that a genuine mistake of law is still a mistake falling within section 93A of the Act.