Contributed By Baker McKenzie Wong & Leow
Capital versus Revenue
Under the Singapore Income Tax Act (Cap. 134) ("ITA"), any gains or profits of an income nature are chargeable to tax under section 10(1)(a) to (g). Singapore imposes tax on income that is revenue in nature, but not on capital gains. There is no capital gains tax regime in Singapore.
Similarly, on the deductibility front, expenditures that are "wholly and exclusively incurred … in the production of the income" are deductible under the general deduction formula in section 14(1) of the ITA, while capital expenditure is generally prohibited from deduction under section 15(1) of the ITA.
There is no bright-line test to distinguish gains/expenditures of a revenue or capital nature. As such, this is an area that often gives rise to controversy between taxpayers and the tax authority. In ABD Pte Ltd v Comptroller of Income Tax  3 SLR 609, the High Court laid out the following guidance:
Singapore taxes income on a territorial and remittance basis. This means that gains or profits of a revenue nature is subject to tax in Singapore only if it is sourced in Singapore, or if it is foreign-sourced but received or deemed to be received in Singapore. Whether the particular gain or profit is sourced in Singapore is therefore a common source of contention.
In the context of interest income, the Singapore court in Chandos v Comptroller of Income Tax  SLR(R) 246 held that the source of interest depends on the precise factual matrix on a case-by-case basis. To determine whether the interest income is sourced in Singapore or elsewhere, the court would consider factors such as the place of execution of the agreement providing for the credit, the place of disbursement of the financing, the place where the loaned funds are credited as well as the currency denomination of the financing.
Under the ITA, certain categories of payments made to a non-resident tax resident are subject to withholding tax. An issue that may give rise to controversy is whether the payment in question is one that falls within the withholding tax net. Below are just a few examples of how disputes may arise.
(i) any payment for the rendering of assistance or service in connection with the application or use of such knowledge or information; or
(ii) any payment for the management or assistance in the management of any trade, business or profession.
Section 33 of the ITA is the general anti-tax avoidance provision that provides the IRAS with the power to disregard or vary arrangements that are implemented for the purpose or effect of reducing or avoiding tax liability.
The authoritative case on section 33 of the ITA is the Singapore Court of Appeal case of Comptroller of Income Tax v AQQ and another appeal  2 SLR 847 ("AQQ"). In AQQ, the Court of Appeal set out the following three-step framework for analysing whether section 33 of the ITA may be triggered:
Following the decision in AQQ, IRAS has published guidance on scenarios that IRAS would regard as falling within the scope of section 33 of the ITA.
Other common issues
There are no thin-capitalisation rules in Singapore. However, Singapore courts have held that in order for a particular interest expense to be deductible against taxable income under section 14(1)(a) of the ITA, the taxpayer must show that there is a direct link between the money borrowed and the income produced. This requirement, known as the "direct link test" was first established by the Court of Appeal in Andermatt Investments Pte Ltd v Comptroller of Income Tax  2 SLR(R) 866. Over the years, the Singapore courts have upheld the validity of the direct link test under section 14(1)(a) in a number of cases concerning the deductibility of interest expenses.
In the recent case of BML v Comptroller of Income Tax  2 SLR 1009 ("BML"), a taxpayer undertook a series of steps that converted its issued equity into debt to the shareholders and sought to claim deduction on the interest on that debt. The Court of Appeal upheld the lower court's decision that the interest was not deductible because of the taxpayer's failure to show that there is a direct link between the debt and the income. The taxpayer's attempt to argue that the direct link test was not the exclusive test for determining interest deductibility was rejected.
The application of the direct link test is an area that often gives rise to tax controversy. Also, as an administrative concession, the Comptroller may allow interest deductions based on the "Total Asset Method" where the certain requisite conditions are met, although the application of such an administrative concession may give rise to disputes at times.
Payments for Research and Development
Expenditures on qualifying research and development ("R&D") activities that are not deductible under the general deduction formula of section 14(1) of the ITA may be deductible under section 14D of the ITA. Enhanced deductions on such expenditures may also be available under the Productivity and Innovation Credit (PIC) Scheme (before its expiry after YA 2018) or section 14DA(1) of the ITA.
One key condition that is subject to tax controversy is whether the R&D activities undertaken constitute a qualifying R&D project. A qualifying R&D is defined under the ITA as "any systematic, investigative and experimental study that involves novelty or technical risk carried out in the field of science or technology with the object of acquiring new knowledge or using the results of the study for the production or improvement of materials, devices, products, produce, or processes, but does not include —
a. quality control or routine testing of materials, devices or products;
b. research in the social sciences or the humanities;
c. routine data collection;
d. efficiency surveys or management studies;
e. market research or sales promotion;
f. routine modifications or changes to materials, devices, products, processes or production methods; or
g. cosmetic modifications or stylistic changes to materials, devices, products, processes or production methods."
IRAS has also published detailed administrative guidance on its views as regards the definition of "research and development" under the ITA.
Payments relating to Intellectual Property Rights
Section 19B allows taxpayers to claim writing-down allowances on capital expenditure for the acquisition of intellectual property rights for use in the taxpayers' trade or business, provided certain qualifying conditions are met.
Disputes can arise between the corporate taxpayers and the IRAS over the scope of IP rights that qualifies for writing-down allowances, as well as the amount of writing-down allowance which may be claimed in respect of a particular acquisition.
Under section 19B of the ITA, only the acquisition of certain qualifying IP rights is eligible for writing-down allowances. Qualifying IP rights are defined in section 19B(11) as "the right to do or authorise the doing of anything which would, but for that right, be an infringement of any patent, copyright, trade mark, registered design, geographical indication, layout-design of integrated circuit, trade secret or information that has commercial value, or the grant of protection of a plant variety". However, section 19B(11A) of the ITA goes on to exclude certain items from the expressions "trade secret" and "information that has commercial value" and any work or subject-matter to which the expression "copyright" is applied. Disputes can arise over whether the IP rights acquired fall within the scope of qualifying IP rights.
Taxpayers are required to submit an independent valuation to support their claim for writing-down allowances under section 19B where the capital expenditure incurred is above SGD500,000 (for acquisitions from unrelated parties) or SGD2,000,000 (for acquisitions from related parties). Disputes can arise over the supporting valuation.
Although Singapore has yet to see a decision on a transfer-pricing dispute, transfer-pricing audits and disputes have been on the rise in recent years.
On 23 February 2018, IRAS published the fifth edition of its Transfer Pricing Guidelines (the "2018 TP Guidelines"). The Income Tax (Transfer Pricing Documentation) Rules 2018 (the "TPD Rules") which were made on 21 February 2018 came into effect on the same day as the 2018 TP Guidelines were published.
Together with the updated transfer-pricing provisions introduced in the Income Tax Act (the "ITA") in October 2017, the 2018 TP Guidelines and TPD Rules aim to maintain the broad alignment of Singapore's transfer-pricing regime with the principles outlined in the 2017 OECD Transfer Pricing Guidelines. The new rules also significantly develop the circumstances, process and guidance by which documentation should be prepared and maintained in order to demonstrate that a transfer-pricing analysis had been prepared. New powers are also granted to IRAS to define and enforce the arm's-length principle, and penalise taxpayers who are not deemed to be in compliance.
The combined changes are likely to entail an increased compliance burden for many taxpayers and signal the intent of IRAS to continue and make more robust its focus on transfer-pricing enforcement.