How will the latest enforcement trends affect taxpayers?
Recent legislation changes increase the onus on taxpayers to prove their tax positions to the satisfaction of the tax authorities.
Taxpayers, particularly multinational enterprises with cross-jurisdictional operations, have faced increased tax enforcement activities by tax authorities in recent years. Many are also involved in tax controversies and disputes with tax authorities that may have significant operational and financial impact on their businesses.
Governments around the world are also rolling out legislative changes to tax laws and regulations. This may include enhancement to the enforcement powers of tax regulators and their ability to apply penalties on taxpayers. While such actions may be justified to ensure taxpayers pay their fair share of tax, these actions have also raised concerns among taxpayers that tax regulators may not always use their enhanced powers in a fair manner.
Closer to home, the Inland Revenue Authority of Singapore (IRAS) will see its ability to exact a surcharge on taxpayers strengthened if a proposed legislation is enacted. These legislative changes have the effect of shifting the onus to taxpayers to prove their positions on tax matters to the satisfaction of the IRAS.
Surcharge to apply on tax avoidance arrangements as determined by the IRAS, if new section 33A is enacted
In the draft Income Tax (Amendment) Bill 2020 released by Ministry of Finance (Singapore) on 20 July 2020 for consultation, a new section 33A has been proposed. This will enable the IRAS to impose a 50% surcharge on a taxpayer of the tax assessed on any adjustments that the IRAS has made pursuant to the existing section 33 anti-avoidance statute. And unless agreed by the IRAS, such surcharge imposed is payable within a month of its imposition. The proposed amendment, if enacted, will be effective from the Year of Assessment 2023.
The introduction of section 33A will certainly send a strong signal that Singapore frowns upon aggressive tax behaviours and artificial tax avoidance arrangements. In its current and proposed form, section 33 allows the IRAS to disregard or vary an arrangement and make an appropriate adjustment on a taxpayer if the Comptroller is satisfied that the purpose of the arrangement is to directly or indirectly:
- Alter the incidence of any tax that is payable by or that would otherwise have been payable by the taxpayer
- Relieve the taxpayer from any liability to pay tax or to make a tax return
- Reduce or avoid any liability imposed or which would otherwise have been imposed on the taxpayer under the Income Tax Act
Section 33 does not apply if the arrangement is carried out for bona fide commercial reasons and had not as one of its main purposes the avoidance or reduction of tax. Therefore, the taxpayer will need to prove to the satisfaction of the Comptroller, that the arrangement had been carried out for bona fide commercial reasons and not, as one of its main purposes, for the avoidance or reduction of tax.
The determination if an arrangement is one that comes under section 33 will invariably involve an element of subjective assessment and is largely a question for the IRAS to be satisfied with. With the proposed 50% surcharge, it is a timely reminder for all taxpayers to instil the necessary corporate discipline for proper file review to ensure there is sufficient and appropriate documentation and evidence of commercial rationale for change in arrangements.
Surcharge applicable on transfer pricing (TP) adjustments as determined by the IRAS
The introduction of section 33A in the Income Tax (Amendment) Bill 2020 to apply a 50% surcharge follows closely the enactment of section 34E in the Income Tax Act that applies a surcharge on TP adjustments made. The provisions of new section 33A are largely similar to the provisions of section 34E except for the difference in the circumstances for applying the surcharge and the difference in the basis for computing the surcharge.
Section 34E, which has taken effect from the Year of Assessment 2019, allows the IRAS to apply a surcharge on the amount of TP adjustments made by the IRAS. Under section 34E, the IRAS can apply a surcharge equal to 5% of the TP adjustments made on a taxpayer that result in one of the following outcomes:
- An increase in the amount of income of the taxpayer
- A reduction in the amount of any deduction allowed to the taxpayer
- A reduction in the amount of any loss of the taxpayer
Based on the above, taxpayers will have to pay the surcharge applied regardless of whether they are in a taxpaying position. In other words, even if a taxpayer is in a non-taxpaying position due to losses or its income being exempt from tax, the taxpayer will have to pay the surcharge applied on the TP adjustments made. Unless agreed by the IRAS, any surcharge imposed under section 34E is also payable within a month of its imposition regardless of whether the taxpayer agrees with the appropriateness of the TP adjustments determined by the IRAS.
As is the case for the new section 33A, section 34E also provides that the Comptroller may, for good cause, remit wholly or in part any surcharge or interest payable under the section. However, to date, the IRAS has yet to make known the grounds that it will consider to constitute a good cause for the full or partial remission of any surcharge or interest payable under the section.
Taxpayers who engage in transactions with related parties are expected to ensure that the pricing of such transactions keeps to the arm’s length principle. However, the IRAS recognises that the application of the arm’s length principle is not without difficulties. The IRAS has in fact explicitly stated in its TP Guidelines that TP is not an exact science and establishing and demonstrating compliance with the arm’s length principle requires the exercise of judgement. For this reason, the IRAS advocates adoption of a pragmatic approach in ascertaining the arm’s length pricing for related party transactions.
It therefore seems counter-intuitive that section 34E was set in place to allow the IRAS to apply a surcharge on the TP adjustments even if the taxpayers may not agree with them. So far, we have not yet seen the IRAS apply the 5% surcharge in any of our client situation. It is our hope that the IRAS will be reasonable in the exercise of this power to impose financial penalties, taking into account the available documentation and circumstances of each case.
Implications for Singapore taxpayers
The application of a financial surcharge with the view to influence a taxpayer’s behaviour, is a recent development in Singapore tax laws. This is seen by the introduction of the new section 33A shortly following section 34E coming into effect.
Unlike the case of a fine or financial penalty, which comes about only after a taxpayer has committed an offence under the Income Tax Act, the surcharge can apply if the IRAS is satisfied that a tax arrangement comes under section 33 or makes the TP adjustments it determines to be appropriate.
Any surcharge suffered by a taxpayer under section 34E or the new section 33A, if enacted, is unlikely to be tax deductible for Singapore tax purpose as the IRAS is unlikely to consider the surcharge to have met the “wholly and exclusively incurred in the production of income” test in section 14 of the Income Tax Act. As the surcharge is not specifically a charge of income tax under section 10(1) of the Income Tax Act, it also will likely not qualify as Singapore tax paid for the purpose of foreign tax credit claim by a foreign taxpayer.
What should Singapore taxpayers do?
Going forward, Singapore taxpayers should expect even greater scrutiny from the IRAS on all their tax matters, particularly in areas where a surcharge can apply. In line with global tax authorities’ focus on inter-company transactions, Singapore taxpayers can expect TP to remain a top priority of the IRAS’ tax enforcement activities as the IRAS steps up efforts to vigorously protect Singapore’s tax base while preserving Singapore’s reputation as a responsible international tax player. Singapore taxpayers should also expect that the IRAS will be stringent in these tax enforcement activities and apply the surcharge as provided in section 34E and the new section 33A, if enacted, as it deems appropriate where there is a case for it.
In summary, in view of the international tax developments and local domestic legislative changes, taxpayers must therefore make even more conscientious efforts on the following:
- Anticipate areas of potential tax controversy with tax authorities and consider taking steps to further strengthen the defence of their tax positions to mitigate potential tax, penalties and reputation risk.
- Adopt a “whole of company” approach in doing so and educate all stakeholders of the potential tax risk areas. This includes:
- Involving the tax function when assessing any business decision to make sure the company does not unknowingly fall afoul of rules.
- Reviewing internal processes to see if there are controls to catch and address potential red flags before the risks manifest.
- Maintain robust documentation and analysis to explain and support commercial rationale of transactions or arrangements.
- For related party transactions, ensure robust TP documentation is in place and prepared on a timely basis. Consider engaging in more active dialogue with tax authorities, including the IRAS, to address and mitigate potential areas of tax controversy.
- Consider pursuing Advance Pricing Arrangements to prevent tax disputes or Mutual Agreement Procedure to resolve tax disputes.
- Be prepared to adopt a more litigious approach to defend tax positions with the tax authorities.
These recent legislative changes to give the IRAS the ability to apply a surcharge on taxpayers seems to encourage “self-censorship” and “self-examination” by taxpayers. However, it is also possible that many legitimate business arrangements may be “caught”. The execution and implementation of this new power by the IRAS is key in influencing how the business world and the international tax community perceives the Singapore Government in its combat against aggressive tax behaviours while not impeding business changes, expansion and restructuring.
The co-authors of this article are Chai Sui Fun, EY Asean International Tax Policy and Controversy Leader and Partner, Transfer Pricing and Wong Hsin Yee, Partner, International Tax and Transaction Services from Ernst & Young Solutions LLP.