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Singapore – Gains from Disposal of Shares: Taxable?

3 May, 2014

 

Legal News & Analysis – Asia Pacific – Singapore – Tax

 

Comptroller of Income Tax v BBO [2014] SGCA 10 (“BBO Case”) is the first Singapore Court of Appeal case dealing with the income tax treatment of investment gains derived by insurance companies. The crux of the issue was whether the gains arising from the Taxpayer’s disposal of certain shares were revenue (hence, liable to income tax) or capital (hence, not subject to income tax) in nature.

 

Background: The Taxpayer, which is part of the [C] Group of companies, carried on the business of a general insurer in Singapore and was registered under the Singapore Insurance Act, which requires an insurer 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.

 

The Taxpayer established the relevant insurance funds pursuant to the Singapore Insurance Act and used such funds to invest in [C] shares (listed shares), [D] shares (listed shares) and [E] non-listed shares (collectively, “Relevant Shares”). Earlier on in the 1970s and 1980s, the Taxpayer sold some of the Relevant Shares and reported the gains as taxable income.

 

In 2001, the shareholders of [C] were subject to a takeover offer. In response to the takeover offer, the Taxpayer sold its entire holding of [C] shares and subsequently sold its portfolio of [D] and [E] shares in 2002. The Singapore tax authorities took the view that the gains from the sale of the Relevant Shares made by the Taxpayer were taxable.

 

The Law: The Court of Appeal held that in cases involving the taxation of investment gains by insurance (or similar) companies, the relevant enquiry may be summarised as follows:

 

  1. The key question is whether the gain in question:
    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.

    1. is a mere enhancement of value by realising a security; or
    2. was made in an operation of business in carrying out a scheme for profit-making.
  2. 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.
  3. 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. However, where there is convincing evidence that the predominant motivation of acquiring the investment is different, this would be relevant in assessing whether the investments were in fact acquired and held as capital assets.

 

The question of whether investment gains are properly attributable to the revenue or capital account is ultimately a question of fact. It cannot be said that merely because the Relevant Shares were held in statutorily-mandated insurance funds and could, in exceptional circumstances, be realised to meet the Taxpayer’s liabilities, the gains attributable to them are invariably revenue (as opposed to capital gains).
The Court of Appeal considered the “badges of trade,” and concluded the Relevant Shares were capital assets. More specifically:

 

  1. Motive: The motive of the Taxpayer in acquiring and holding the Relevant Shares is highly relevant to the enquiry. The factual finding that the Relevant Shares were acquired and held as part of a group corporate preservation strategy (i.e., to afford a defence mechanism against any potential hostile takeover of any company in the [C] Group) gave rise to a strong inference that the Relevant Shares were capital assets. In particular:
    • the Taxpayer did not acquire the Relevant Shares with an intention to trade in them. Instead, the Taxpayer’s intention in holding the Relevant Shares was to promote the long-term strategic interests of itself and the [C] Group;
    • there were numerous cross-holdings of shares and cross-directorships between companies within the [C] Group;
    • regular updates on the status of cross-holdings of companies in the [C] Group were generated to the senior management of [C];
    • any decision to sell any shares or rights in the companies within the [C] Group was closely scrutinised and reviewed by the senior management of the [C] Group to ensure that the appropriate level of shareholding and effective control was maintained; and
    • the Relevant Shares were treated differently and segregated from shares that were readily traded by the Taxpayer.
      1. Duration Of Ownership The [C] shares, [D] shares and [E] shares were accumulated over a period of 30 years, 20 years and 27 years respectively – undoubtedly long periods of time – which was consistent with the Taxpayer’s stated intention of holding the Relevant Shares for an indefinite period1pursuant to its corporate preservation strategy.
      2. Multiplicity Of Similar Transactions: There were few disposals of the Relevant Shares by the Taxpayer throughout its relatively long period of holding:

        • No [D] shares and [E] shares were disposed before the takeover offer in 2002.
        • There were only nine disposals of [C] shares over a period of 30 years, and they were mostly to other companies within the [C] Group.
        • During the period from 1983 to 1991, the percentage of [C] shares held by the [C] Group remained relatively constant and ranged between 21.28 percent and 22.78 percent.
      3. Finance: The Taxpayer had no need to sell the [C] shares to meet its liabilities and it did not in fact do so.

        • Its net cash flow was positive from a year-to-year basis from 1973 to 2003.
        • Where offshore claims were higher than premiums collected, the Taxpayer, to meet the offshore claims:
          1. drew upon cash reserves in its offshore fund, as well as dividend and interest income; or
          2. transferred moneys from accumulated profits of its onshore fund to its shareholders’ fund and then transferred moneys from the shareholders’ fund to the offshore fund.

 

The Court found that there was a weak nexus2 between the sale of the Relevant Shares and the carrying on of the Taxpayer’s insurance business. The Relevant Shares were therefore “structural” or capital assets, and they were not revenue assets incidental to the carrying on of the Taxpayer’s insurance business.

 

  1. Previous Tax Statement: It was interesting to note that the Court of Appeal agreed that the earlier tax treatment of shares sold by Taxpayer of the same counters were unpersuasive, or at most, neutral.

 

Final Takeaway: Although the BBO case was decided specifically in the context of the Taxpayer’s insurance business, inference of facts drawn from the analysis of the badges of trade considered can similarly be applicable to investment holding companies and other financial institutions. It is also interesting to note that the Singapore Court of Appeal affirmed the prior decisions of the Singapore High Court and Income Tax Board of Review in deciding in favour of the Taxpayer. With the guidance from the Court of Appeal, there is now greater clarity as to when investment gains may be treated as capital in nature.

 

End Notes:

 

1 As noted in the Privy Council case of Waylee Investment Ltd v The Commissioner of Inland Revenue [1991] 1 HKLR 237 (“Waylee Investment”) in the context of banks and financial institutions, “the clearest indication that an investment was acquired as a capital asset would be an indication that the [company] intended to hold the investment as such for an indefinite period.” Waylee Investment took pains to emphasize that a bank, like any other trader, could in certain circumstances hold investments as capital assets.
2 Following the New Zealand decisions in Commissioner of Inland Revenue v National Insurance Company of New Zealand Ltd (1999) 19 NZTC 15, 135; andState Insurance Office v Commissioner of Inland Revenue [1990] 2 NZLR 444.

Duane Morris Selvam LLP

 

For further information, please contact:

 

David Teo Shih Yee, Director, Duane Morris & Selvam

dteo@duanemorrisselvam.com

 

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