17 March, 2014
Legal News & Analysis – Asia Pacific – Singapore – Tax
Introduction
Section 33 of the Income tax Act (Cap. 134 of Singapore, 2008 Rev Ed) (the “Act”) contains a general anti-avoidance rule (the “GAAR”) which enables the Comptroller of Income Tax (the “Comptroller”) to disregard the legal form of transactions in certain circumstances to counteract any impermissible tax advantage obtained by a taxpayer. The construction and application of the GAAR, as well as the ambit of the Comptroller’s power to counteract the tax advantage gained through an avoidance arrangement, was considered in the recent Court of Appeal decision of Comptroller of Income Tax v AQQ and another appeal [2014] SGCA 15. This is a landmark decision as it marks the first time that the GAAR is considered by the highest court since its enactment in its current form 26 years ago.
Brief Facts
The case involved the 2003 restructuring and financing (the “Restructuring and Financing Arrangement”) of a group of companies (“B Group”), in which the equity interests of a number of subsidiary companies (the “Subsidiaries”) were sold to a newly incorporated company (“AQQ”). One of the main purposes of the Restructuring was to utilize the tax credits that the B Group companies had accumulated before restructuring under the then-existing imputation system for corporate income tax.
To finance this transfer, AQQ had, inter alia, issued SGD 225m in fixed rate notes (the “Notes”) to a bank operating through its Singapore Branch (“N Bank Singapore”) at an interest rate of 8.850%. The principal component of the Notes was subsequently sold by N Bank Singapore to the bank’s Mauritius branch (“N Bank Mauritius”) with a promise by N Bank Singapore to pay N Bank Mauritius a sum equivalent to interest of 8.845%, or 0.005% less than what it was to receive from AQQ. N Bank Mauritius in turn sold the principal component of the Notes to another member of B Group (“Company C”) with a promise by N Bank Mauritius to pay Company C a sum equivalent to interest of 8.840%, or 0.005% less than what it was to receive from N Bank Singapore.
Through this circuitous series of conditional payment arrangements, the principal component of the notes was repaid to N Bank within the same day, and each of N Bank Singapore and N Bank Mauritius effectively received an interest payment of 0.005%. Arising from these transactions, AQQ was able to claim a deduction for the interest expenses incurred on the Notes against the dividends paid by the Subsidiaries. This led to a tax refund claim of around SGD 13.6m under the then-applicable imputation system.
In 2007, the Comptroller conducted an audit of AQQ, and decided to invoke the GAAR to disregard the tax effects of all the transactions undertaken. The Comptroller issued a Notice of Assessment for the year of assessment (“YA”) 2007 in which all dividend income and the relevant interest expenses of AQQ were disregarded, and used his power under section 74(1) of the Act to issue Notices of Additional Assessments for YAs 2004 to 2006 to recover around $9.6 million of tax refunds paid out during that period.
Sitting in the High Court below, Andrew Ang J. had held that the transactions constituted tax avoidance under the GAAR, but that the Comptroller had not exercised his power under the GAAR fairly and reasonably by choosing to disregard both the dividend income and interest expenses under the Additional Assessments for YAs 2004 to 2006 and the Notice of Assessment for YA 2007. The learned judge held that the Comptroller should have disregarded only the interest payments attributable to the part of the loan that was in substance not a real loan to AQQ and should not have disregarded such part of the interest payments attributable to the loan that Company C had in substance extended to AQQ by buying the Notes from AQQ and receiving the corresponding interest payments from AQQ through the series of conditional payment arrangements. It further held that the Comptroller did not have to power to issue Additional Assessments under section 74(1) of the Act for YAs 2004 to 2006 as Additional Assessments may only raised if the taxpayer had originally been assessed to tax at an amount lower than that which ought to have been charged.
Decision
On appeal, the Court of Appeal considered five issues, namely:
(a) whether any of the threshold limbs in section 33(1) of the Act was satisfied on the facts;
(b) whether AQQ could rely on the exception in section 33(3)(b) of the Act;
(c) whether any specific provisions of the Act could preclude the operation of the GAAR;
(d) whether the Comptroller had exercised his powers under the GAAR fairly and
reasonably to counteract the tax advantage obtained; and
(e) whether the Comptroller had acted ultra vires section 74(1) of the Act by issuing
the Additional Assessments.
Application Of The GAAR
The Court of Appeal held that the GAAR should be applied as follows:
(a) the Court will first consider whether an arrangement prima facie falls within the threshold limbs of section 33(1) of the Act such that the taxpayer has derived a tax advantage, i.e. whether the purpose or effect of the arrangement is to alter the incidence of tax, relieve a liability to pay tax, or reduce or avoid any liability imposed or would have otherwise been imposed;
(b) if any of the threshold limbs of section 33(1) of the Act is satisfied, the Court will then consider whether the statutory exception in s33(3)(b) applies; and
(c) if the statutory exception in section 33(3)(b) of the Act does not apply, the Court would ascertain whether the tax advantage was legitimate, in that it arose from a specific provision in the Act, the use of that specific provision was within Parliament’s intended scope and the legal form and resulting tax effect of such use was within the contemplation and purpose of Parliament.
In considering whether any of the threshold limbs in section 33(1) of the Act is satisfied, the Court of Appeal upheld the predication test enunciated by Lord Denning in Lauri Joseph Newton and others v Commissioner of Taxation of the Commonwealth of Australia [1958] 1 AC 450, i.e. whether it may be predicated from the observable acts by which an arrangement is implemented that it was implemented in that manner in order to achieve the ends stated in any of the limbs in section 33(1) of the Act. Applying the predication test, the Court of Appeal undertook an objective evaluation of the totality of the Restructuring and Financing Arrangement and held that it is possible to predicate that the objective purpose or effect of the deduction of interest expenses by AQQ was to reduce a tax liability which would otherwise have been imposed by the Act, namely the tax chargeable on the full sum of dividend income.
The Court of Appeal then proceeded to consider the second issue of whether the statutory exception in section 33(3)(b) applies, i.e. whether the arrangement was carried out for bona fide commercial reasons, and whether the arrangement does not have had as one of its main purposes the avoidance or reduction of tax. The Court of Appeal held that both are necessarily subjective inquiries concerning the taxpayer’s subjective commercial motives for entering into a transaction, and the subjective consequences that the taxpayer wishes to obtain. On the issue of subjective commercial motives, the Court of Appeal considered it necessary that the commercial reasons for a particular step in an arrangement “should ordinarily be construed within the context of the entire economic and commercial reality of the arrangement, but based on the evidence on record, it might not have been possible for the Court to come to a conclusion as to whether there were bona fide commercial reasons for the entire arrangement. However, this was not material as the Court considered that one of the main subjective purposes of the Restructuring and Financing Arrangement was to generate interest expenses on the Notes so as to reduce AQQ’s tax liability on the dividend income from the Subsidiaries. In coming to this finding, the Court drew a distinction between choosing a tax efficient method of corporate restructuring and tax avoidance. In particular, the Court was influenced by the fact that the fixed rate notes were bought back by B Group on the same day, and that there was thus no real injection of funds from N Bank. Further, N Bank bore only a negligible commercial risk for their purchases of the notes. The round tripping of the purchase price of the Subsidiaries and the artificial interposition of the external entities thus crossed the line between tax efficiency and tax avoidance in the absence of any cogent explanation for the complicated arrangement.
Given that the statutory exception does not apply, the Court of Appeal then considered the third issue of whether any specific provisions of the Act could preclude the operation of the GAAR, which entailed an examination of the interaction between the GAAR and other specific provisions of the Act. In this regard, the Court adopted the New Zealand scheme and purpose approach as taken by the majority in the Supreme Court of New Zealand case of Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2009] 2 NZLR 289. i.e. where a taxpayer relies on specific provisions of the Act, the taxpayer must satisfy the court that the use of the specific provision: (a) was within its intended scope; and (b) viewed in the light of the arrangement as a whole, has altered the incidence of tax in a manner within the contemplation and purpose of Parliament. Taking into consideration the Restructuring and Financing Arrangement as a whole, the Court concluded that it was not within Parliament’s contemplation and purpose that deductions could properly be made in respect of the interest expenses in order to reduce the quantum of assessable dividend income, where the payment of interest expenses did not incur any real economic costs to the B Group as a whole, and therefore, the GAAR remains applicable to the Restructuring and Financing Arrangement.
‘Fairly And Reasonably’
The Court of Appeal disagreed with the High Court’s view that the Comptroller had acted incorrectly in choosing to “counteract the tax advantage” by disregarding all dividend income and interest expenses of AQQ’s for the relevant years of assessment, and held that the appropriate standard of review by the courts on the exercise of discretion by the Comptroller under the GAAR is one of fairness and reasonableness. Where there are two or more methods to counteract an impermissible tax advantage, the court will not insist that one particular method is to be preferred over the others. The Court would only step in where the Comptroller’s adjustments were arbitrary or unreasonable or where the exercise of discretion is excessive or abusive. On the facts, the Court of Appeal held that the Comptroller’s approach in choosing to disregard both the Restructuring and the Financing Arrangements as a single arrangement was fair and reasonable, and that the High Court should not have substituted its own view for that of the Comptroller as to how the impermissible tax advantage ought to have been counteracted.
Additional Assessments
The Court of Appeal held that Additional Assessments may not be raised where the amount of tax assessed under the Additional Assessments is less than the amount of tax assessed under the original assessments for YA 2004 to 2006. In this case, to arrive at the additional tax payable, the Comptroller simply added the tax refunds previously paid to AQQ to the reduced tax assessed. The tax refunds, in the absence of specific provision to that effect, should not be regarded as existing chargeable income liable to be assessed to tax. There being no shortfall of tax assessed, the Comptroller should not have issued the Additional Assessments. The Court of Appeal therefore allowed the Comptroller to maintain his assessment for YA 2007, but ruled against his issue of Additional Assessments under section 74 of the Act to recover the tax refunds paid out for YA 2004 to 2006.
The Court recognized that this left the Comptroller with no apparent statutory mechanism to claw back tax refunds wrongly given to taxpayers. However, the Court suggested that section 33(1) of the Act may be wide enough for the Comptroller to impose a tax liability equivalent to the tax refunds and then raise additional assessments on AQQ for these additional sums. Since the point was not argued, the Court refrained from making a decision on this point.
Comments
From the Court of Appeal’s decision in this case, it is clear that the GAAR grants broad reconstruction powers to the Comptroller. In the event that the Comptroller finds that an arrangement constitutes impermissible tax avoidance falling within the scope of the GAAR, he has wide discretion to impose whatever measures as may be appropriate to negate the tax advantage obtained. The courts will not interfere with such measures unless they are clearly unreasonable or unfair.
Given the court’s reluctance to interfere with the anti-avoidance measures adopted by the Comptroller, it becomes even more important to determine when an arrangement will be treated as falling within the scope of the GAAR. As set out by the Court of Appeal in this case, if it can be predicated based on an objective assessment of the acts by which an arrangement is implemented that it was implemented in that way to achieve any of the ends stated in the threshold limbs under section 33(1) of the Act, the Comptroller would be entitled to invoke the GAAR to reconstruct the arrangement unless it either falls within the statutory exception in section 33(3)(b) of the Act or it satisfies the scheme and purpose test. However, it is unclear what constitutes a bona fide commercial purpose, and even if the court is satisfied that such a commercial purpose exists, the Comptroller may nevertheless strike down the arrangement if tax avoidance is one of the main purposes. In this regard, the courts tend to regard transactions which appear artificial or needlessly complex with suspicion, unless a cogent and sensible explanation for such a choice can be provided.
The scheme and purpose test under case law provides a fallback on which the taxpayer may rely should the statutory exception fail to apply. However, it may not be easy for taxpayers to demonstrate that the steps taken are or would have been within the intention of Parliament when it enacted the specific provision of the Act on which the taxpayer relies. Therefore, while the scheme and purpose approach provides a theoretical exception to the application of the GAAR, it may not be easy for taxpayers to avail themselves to such exception in practice.
For further information, please contact:
Irving Aw, Partner, Rajah & Tann