Jurisdiction - Singapore
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Singapore – Court Of Appeal Disagrees With IRAS On Tax Treatment Of Investment Gains By Insurance Companies.

6 February, 2014

 

Regulatory Frameworks May Have Little Or Nothing To Do With Tax

 

The Court of Appeal has issued its decision in the landmark case of Comptroller of Income Tax v BBO [2014] SGCA 10, an appeal brought by the Comptroller. As noted by the Court of Appeal in its decision, the significance of this case lies to some degree in the fact that it is the first local case dealing with the income tax treatment of investment gains accruing to insurance companies.

 

The Court of Appeal makes it clear that the holding of assets in statutorily mandated insurance funds and to meet solvency margins prescribed by legislation will not, without more, mean that any gains accruing from the sale of such assets will automatically amount to taxable income. Rather, the relevant tribunal has a proper role in deciding whether in all the circumstances of the case, the gains were properly attributable to the revenue or capital account. The decision then turns on its own facts, in particular, that the assets (in this case, shares in the Respondent’s related companies) sold by the Respondent insurance company were held as part of its corporate preservation strategy rather than for purposes of trade.

 

Facts

 

For reasons of secrecy, the Income Tax Act requires tax cases to on business of be heard in camera and the case report therefore does not general insurer disclose the identity of the taxpayer. The Respondent is a company registered in Singapore and is part of the [C] Group of companies. It carried on the business of a general insurer in Singapore and was registered under the Insurance Act until December 2009.

 

Under section 17(1) of the Insurance Act, an insurer is required to establish separate insurance funds for each class of insurance business and to ensure that all assets, receipts, liabilities, and expenses are properly attributed to the relevant fund. Pursuant to this requirement, the Respondent therefore established the Singapore Insurance Fund and the Offshore Insurance Fund in respect of its Singapore and overseas policies respectively. The Respondent used the funds to invest in [C], [D], and [E] shares (“Shares“).

 

The investment gains that were the subject of this case arose as a insurance funds result of the following transactions: 

 

  • In 2001, a company, [F], launched a successful takeover of [C]. In response to the takeover offer made by [F], the Respondent sold to [F] its entire holding of [C] shares. It made a gain of about S$89 million from this sale.
  • In 2002, the Respondent sold its portfolio of [D] and [E] shares. It made gains of about S$7.9 million from the sale of [D] shares and S$1.4 million from the sale of [E] shares.

 

The Appellant took the view that these gains were taxable and issued revised assessments for YA 2002 and YA 2003 to the Respondent. The Respondent made a request for amendment and, in 2010, the Appellant issued to the Respondent a Notice of Refusal to Amend the Assessments for YA2002 and YA 2003. The Respondent successfully appealed to the Income Tax Board of Review (“Board“), and the Appellant appealed from the Board’s decision to the Singapore High Court and, being unsuccessful, then to the Court of Appeal.

 

Decision

 

Before the Court of Appeal, the Appellant’s argument that the gains from the sales of the Shares were income in nature largely relied on the fact that the Shares had been held pursuant to the requirement under section 17(1) of the Insurance Act. In brief, it asserted that section 17 contained a requirement that the moneys obtained by means of premiums had to be retained in a fund to meet liabilities underwritten by the contracts obtaining those premiums. Where assets had been purchased with those premiums and subsequently sold for a profit, the gain from the sale would be a profit over cost which was part of the taxable insurance business. The only exception would be in respect of assets that were surplus to the section 17 requirements and transferred out of the insurance fund into the shareholders’ fund. Accordingly, so long as the gains had arisen from assets (even fixed assets) held in insurance funds, they would invariably be assessable income.

 

The Court of Appeal rejected this argument, and held that the regulatory requirement for the establishment and maintenance of insurance funds could not, without more, restrict an insurance company from holding capital assets in its insurance funds. It accepted the Respondent’s argument that the purpose of the Insurance Act was for the regulation and not the taxation of the insurance industry. The insurance fund was merely part of the regulatory framework for insurance companies and could not be determinative of their tax treatment: 

 

  • The imposition of tax is solely within the purview of Parliament purview of through the enactment of clear tax legislation which is to be Parliament interpreted by the court or relevant tribunal. The fact that certain gains are attributable to investments held in statutorily mandated insurance funds cannot automatically divest the relevant tribunal of its proper role in deciding whether, in all the circumstances of the case, the gains are properly attributable to the revenue or capital account. Otherwise, any regulatory body would theoretically be able to determine the taxation of companies. This runs counter to the fact that regulatory frameworks are often shaped by intricate policy considerations which may have little or nothing to do with tax.
  • The distinction between the insurance fund and the shareholders’ fund cannot be determinative of the tax treatment of particular assets or investments. Insurance companies (whether holding assets in the insurance fund or shareholders’ fund) should only be taxed according to the ordinary principles of revenue law, albeit the holding of an asset in a particular fund may be a relevant factor in ascertaining whether the investment was intended to be held as a capital asset.
  • Capital assets do not become revenue assets just because they could potentially be applied to meet the company’s liabilities, in a situation of liquidation or otherwise. Merely because assets was held in state-mandated insurance funds and could, in exceptional circumstances, be realised to meet the company’s liabilities, did not mean that the gains attributable to them were invariably revenue as opposed to capital gains. Similarly, assets which are acquired with the receipts of income are not invariably of a revenue nature.

 

The Court of Appeal therefore held that the Insurance Act was not determinative of the central issue in the appeal. Instead, the basic principles of revenue law applied. In this respect, the Court of Appeal noted that whether any gains or profits are subject to income tax would depend on whether the gains or profits were of an income nature. The relevant enquiry to be undertaken in cases involving the taxation of investment gains by insurance (or similar) companies was as follows:

 

  • The crucial question is whether the gain in question is a mere enhancement of value by realising a security or whether it was made in an operation of business in carrying out a scheme for profit-making.
  • This is ultimately a question of fact to be determined according to ordinary concepts having regard particularly to the circumstances under which, and the purposes for which, the investments were acquired and held by the taxpayer.
  • However, as a matter of practicality, the nature of insurance (or similar) businesses would ordinarily give rise to an inference that the gains concerned arose in the course of trade or in the operation of business in carrying out a scheme for profit-making (unless, of course, there is cogent evidence that the investments were acquired and held as capital assets).

 

Taking into account the totality of the evidence before the Board and the High Court, the Court of Appeal held that the Shares were capital assets and the gains attributable to them were therefore not liable to be taxed. The following factors all indicated that the Shares were acquired and held to safeguard the long-term strategic interests of the [C] Group:

 

  • Motive of the taxpayer: The Respondent did not acquire the acquire Shares with an intention to trade in them. Instead, the intention to trade Respondent’s intention in holding the Shares was to promote the long-term strategic interests of itself and the [C] Group. Any decision to sell any shares or rights in the companies within the [C] Group was closely scrutinised and reviewed to ensure that the appropriate level of shareholding and effective control was maintained. The Respondent was not allowed to sell any of its shares and rights in relation to companies within the [C] Group without the requisite approval from [C]. The Shares were also treated differently and segregated from shares that were readily traded by the Respondent.
  • Duration of ownership: The Shares were held for a long period of time. The [C] shares, [D] shares, and [E] shares were accumulated over a period of 30 years, 20 years, and 27 years respectively. This was in line with the Respondent’s stated intention of holding the Shares for an indefinite period pursuant to its corporate preservation strategy.
  • Multiplicity of disposal of the assets: Consistent with the stated corporate preservation strategy, there were few disposals of the [C] shares by the Respondent throughout its relatively long period of holding. There were previously no disposals for the [D] and [E] shares.
  • Finances: The Respondent did not need to and did not in fact liquidate the Shares to meet its liabilities in the insurance business. There was a weak nexus between the sale of the Shares and the carrying on of the Respondent’s insurance business.

 

Our Comments / Analysis

 

As noted by the Court of Appeal, this is the first local decision on the tax treatment of investment gains by insurance companies. Hitherto, taxpayers in the insurance industry had to contend with the Comptroller based on first principles without the guidance of any local decision. The insurance industry now has guidance coming from the highest court in Singapore and is expected to welcome this decision. In particular, it is significant that the Court of Appeal has determined that there is no invariable rule which taxes the gains realised by an insurance company upon the sale of an asset. The inquiry as to whether such gains amount to income or capital ultimately depends on an assessment of the totality of the evidence.

 

As this case confirms that the Comptroller’s reliance on (among other things) section 17 of the Insurance Act is misplaced and erroneous, changes may be expected to section 13Z of the Income Tax Act which currently exempts certain gains derived by a company from the disposal of ordinary shares legally and beneficially owned in another company if the divesting company has owned at least 20% of the ordinary shares in the latter company for at least 24 months. This exemption was announced in Budget Statement 2012 and is effective for five years ending on 31 May 2017. However, the Comptroller’s position has been that section 13Z does not apply to insurance companies. This view is no longer sustainable in light of the Court of Appeal’s decision in Comptroller of Income Tax v BBO.

 

The Court of Appeal also confirms the broader principle that regulatory rules and requirements have minimal or no impact on taxation rules, as regulatory frameworks are often shaped by intricate policy considerations which may have little or nothing to do with tax. This is an important principle of general application to all industries, as regulatory frameworks can often be complex and to superimpose regulatory rules on the taxation framework is not only a flawed approach as held by the Court of Appeal, but also lends unnecessary complexity to the taxation framework.

 

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Tan Kay Kheng, WongPartnership

kaykheng.tan@wongpartnership.com

 

Tan Shao Tong, Partner, Wong Partnership

shaotong.tan@wongpartnership.com

 

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