Is the fine line between tax planning and avoidance always clear?
The recent case of GCL v Comptroller of Income Tax provides clarity on the subtle differences between tax planning and avoidance.
It is often said that planning for taxes is legitimate, but avoidance of taxes is not. Attempts to distinguish the two tend to be difficult, simply because the surrounding circumstances for each case is different. Depending on specific facts, certain transactions or arrangements can easily fall foul of Singapore’s anti-avoidance rule.
From an enforcement standpoint, a clear trend is emerging. Tax avoidance has unanimously been rejected by governments around the world and resources are extensively being utilised to combat tax avoidance, including in Singapore. We expect this to continue to be a major theme in the future.
With these in mind, determining where business arrangements fall in relation to the “planning versus avoidance” divide can be fraught with uncertainty. Disputes are therefore expected to increase as governments step up both enforcement actions and sanctions on avoidance.
With more controversy expected, we share the key takeaways for taxpayers and possible implications in future transactions by looking at how Singapore’s anti-avoidance rule was applied by the courts in the recent case of GCL v Comptroller of Income Tax (GCL), together with the proposed changes to Singapore tax legislation to introduce a surcharge relating to tax avoidance arrangements.
GCL: A clear example of avoidance?
In GCL, the taxpayer in question was a dentist that was employed in an orthodontic clinic that he also owned. In 2012, the taxpayer ceased his employment relationship with the clinic, and incorporated a company, with the taxpayer as the sole shareholder and director. The new company then entered into a service agreement with the orthodontic clinic to provide dental services, which were discharged by the taxpayer during the relevant years.
In return for services provided to the clinic, the new company received service fees that were subject to corporate income tax. The taxpayer also received (a) certain remuneration from the company that which was subject to personal income tax, and (b) dividends from the company that was tax exempt under the law.
Comparing the overall taxes paid prior to and after the foregoing arrangement, there was a reduction in tax liability for the following reasons:
- The net profits of the company, after deducting the remuneration paid to the taxpayer, was largely at a level that maximised certain benefits from tax exemptions available under tax law.
- The remuneration paid to the taxpayer was maintained at levels below the market salary ranges paid to dentists of comparable experience and expertise.
- The excess profits in the company were distributed to the taxpayer as tax exempt dividends.
Pursuant to a tax audit, the Comptroller of Income Tax subsequently invoked his discretion under Section 33 and raised additional assessments on the grounds that the foregoing arrangement constituted tax avoidance. At the Income Tax Board of Review (the Board), the taxpayer lost the appeal.
In its decision, the Board applied the three-step framework set out in landmark Court of Appeal decision of Comptroller of Income Tax v AQQ (AQQ) in finding that the arrangement constituted tax avoidance. Interestingly, the Board considered the application of the anti-avoidance rule to the arrangement in two parts – firstly, the incorporation of a company to receive the income and secondly, the setting of the level of remuneration paid to the taxpayer by the new company. In summary, while the Board found that the former did not constitute tax avoidance, it took issue with the latter. In our view, the decision by the Board is relatively uncontroversial and the appropriate conclusion was reached. However, certain observations raised by the Board in GCL are valuable takeaways.
Key takeaways for taxpayers
By way of background, the threshold for anti-avoidance in Singapore is crossed if the Comptroller is satisfied that the purpose or effect of any arrangement is directly or indirectly:
- To alter the incidence of any tax which is payable by or which would otherwise have been payable by any person
- To relieve any person from any liability to pay tax or to make a return under this Act
- To reduce or avoid any liability imposed or which would otherwise have been imposed on any person by this Act
Where this threshold is crossed, there is then a statutory exception where 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”.
The first key takeaway from GCL to note is that the Board rejected the notion that “an arrangement falls within the ambit of Section 33(1) merely because its tax outcome was more favourable than a prior arrangement, without considering the reasonableness of the overt acts undertaken. If this were the case, any restructuring that results in a more favourable tax outcome would, prima facie, fall within Section 33(1)”.
This is a crucial principle because it reaffirms the distinction between tax planning and tax avoidance. Tax authorities are becoming more aggressive in asserting tax avoidance, and there is a growing political discourse on paying one’s fair share of taxes. As such, this principle is a useful reminder that it would not be appropriate for authorities to adopt the position that any arrangement that leads to a more beneficial outcome automatically raises the suspicion of tax avoidance. Put another way, it is important to realise that not every transaction that results in tax benefits will amount to tax avoidance. If the transaction can be explained by reference to business reasons, then the transaction may constitute legitimate planning.
The second takeaway is an interesting observation made by the Board in obiter. The Board noted that as the taxpayer was the sole shareholder and director of the company, both the taxpayer and the company were related parties and transactions between the two had to be at arm’s length. The low levels of remuneration paid by the company to the taxpayer could be challenged under the transfer pricing arm’s length requirement. This specifically endorses the arm’s length requirement even in pure domestic transactions.
Ramifications for future transactions
The Singapore Government is proposing to introduce a 50% surcharge on tax liability imposed if the Comptroller takes the view that an arrangement constitutes tax avoidance. It should be noted that once the Comptroller asserts tax avoidance, the burden of proof to demonstrate otherwise generally falls on the taxpayer in adducing evidence and raising arguments in appealing the assessment.
In addition, Singapore has a “pay first” tax dispute process, where taxpayers generally must settle tax assessments, including the new tax avoidance surcharge in full before the appeal is heard. This could have a significant financial impact on taxpayers defending against tax avoidance assertions by the Comptroller, which, in turn, increases business risk.
While this proposed change has yet to be passed as law, the stakes will become higher for taxpayers to fall on the right side of the “planning versus avoidance” divide if it gets legislated.
In our view, the decision in GCL and the proposed impending introduction of the 50% surcharge reinforces the trend of enforcement against tax avoidance. The anti-avoidance rule, coupled with the proposed changes, enhance the arsenal of measures that the Comptroller has at his disposal to combat tax avoidance.
In response to this trend and evolving tax legislation and practices, taxpayers need to be aware of and understand the scope of the anti-avoidance rule in Singapore and risks of challenge by the Comptroller. It is important to understand that complex arrangements are never typically clear-cut, and the risks tend to be ambulatory depending on the facts, circumstances and evidence available. In fast-paced transactions, it will be important to identify and address these risks at the outset and take steps to protect the tax positions taken. Maintaining contemporaneous defence documentation to evidence that an arrangement does not fall within the ambit of the anti-avoidance rule also becomes increasingly important.
The co-authors of this article are James Choo, Partner, International Tax and Transaction Services from Ernst & Young Solutions LLP and Agnew Su Ling, Associate Director, International Tax and Transaction Services from Ernst & Young Corporate Advisors Pte Ltd.