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November 2009 - Projects, Energy & Natural Resources . Legal Developments by Drew & Napier LLC .

More articles by this firm.

The charging section in the Income Tax Act brings within Singapore’s taxing jurisdiction not only income that is sourced in Singapore, but also income which is received in Singapore from outside of Singapore. In the light of criticism against remittance of income as a basis for taxation and the persistent lobbying of businesses in Singapore, recent amendments to the Income Tax Act have been steadily chipping away at the remittance basis of taxation in Singapore.

The erosion of the remittance basis started with the groundbreaking amendment in 2003 to exempt foreign-sourced dividends, foreign branch profits and foreign-sourced service income received in Singapore by resident non-individuals. This exemption is subject to certain anti-abuse conditions being met, including the requirements that (a) the relevant income is subject to a similar tax in the foreign jurisdiction from which it is received; and (b) at the time the income is received in Singapore, the headline tax rate of the said foreign jurisdiction is at least 15 per cent.

In the following year, a blanket exemption was granted for all foreign-sourced income received in Singapore by resident individuals.

In the latest development, the Minister of Finance has announced in his Budget Statement 2009 a one-year tax amnesty for all foreign-sourced income received in Singapore by resident non-individuals between 22 January 2009 to 21 January 2010 (both dates inclusive), provided the income had accrued to the resident non-individual on or before 21 January 2009.

With the above amendments exempting foreign-sourced income from income tax in Singapore, the determination of the jurisdictional source of income received in Singapore has become more important than before.

Whilst the geographical source of limited forms of income, including interest and royalties, is addressed through the use of deeming provisions in the Income Tax Act, for most forms of income (in particular, business or trade profits), the issue of source remains to be determined on the basis of common law principles. This article revisits the relevant common law authorities in an attempt to decipher a coherent approach to the issue.

Broad guiding principle.

The classic statement of the test to be applied (if it can be called a "test") in the determination of the geographical source of income is that "one looks to see what the taxpayer has done to earn the profit in question and where he has done it" (Commissioner of Inland Revenue v. HK-TVB International Ltd [1992] 2 AC 397; Commissioner of Inland Revenue v. Hang Seng Bank [1990] STC 733, 739 which were applied in Singapore in TTT Pte Ltd v. Comptroller of Income Tax [1995] 2 MSTC 5189). This broad guiding principle, which has been clutched at as the legal test for determining the question of source, has left many questions unanswered.


The main difficulty is best described as one of perspective, which arises as there are at least several levels at which one can "look to see what the taxpayer has done to earn the profit in question". For starters, does one take a wide-angled, birds' eye view of what the taxpayer's business entails or does one zoom in on a single aspect of the taxpayer's business? If one is to zoom in on a single aspect, which aspect should this be? Does one look at substance or form?

The authorities do offer a clear answer to at least the first question. The courts have consistently rejected suggestions by the Revenue authorities the world over that all profits of a taxpayer with a business presence in their respective jurisdiction are "sourced" in that jurisdiction. The Revenue authorities' other oft-cite argument, that the profits of a taxpayer arise where its "brain" (i.e. the management of the company) is, has likewise not found favour with the courts. It is clear, therefore, that the test envisages focusing on a particular aspect of the taxpayer's business.

The Hang Seng Bank and HK-TVB cases did not, however, define the scope of the relevant activities that are to be taken into account beyond setting out the following examples of relevant activities and their geographical source - (i) if the taxpayer has rendered a service or engaged in an activity such as the manufacture of goods, the profit will have arisen or derived from the place where the service was rendered or the profit making activity carried on; (ii) if the profit was earned by the exploitation of property assets as by letting property, lending money or dealing in commodities or securities by buying and reselling at a profit, the profit will have arisen in or derived from the place where the property was let, the money was lent or the contracts of purchase and sale were effected.

The examples were never intended to be any more than mere examples and were certainly never intended to lay down legal rules as to the source of income. Perhaps because of this, whilst the examples suffice to address the issue of source in simple and straightforward transactions falling squarely within all fours of the examples, they are of no assistance when it comes to addressing the issue of source in more complex transactions. This was aptly illustrated in the case of Commissioner of Inland Revenue v. Orion Carribean Ltd (in voluntary liquidation) [1997] STC 923. The taxpayer (OCL) was a company incorporated in the Cayman Islands which derived income in the form of interest differential in its business of borrowing and on-lending money. Counsel for the taxpayer in that case sought to rely on one of the examples in Hang Seng Bank - that where income is derived from the exploitation of property assets as by lending money, the profit will have arisen in or derived from the place where the money was lent - to make out a case that the interest differential was derived by the taxpayer in the Cayman Islands where, amongst other things, the loans to the ultimate borrower were approved in form. In coming to its decision, the Privy Council stated in no uncertain terms that the instant case was far removed from a simple loan transaction and the source of the interest differential could not be determined applying the examples given in Hang Seng Bank.

In a recent development, the Hong Kong Court of Final Appeal in Kwong Mile Services Limited (in Members' Voluntary Winding-up) v. Commissioner of Inland Revenue FACV No. 20 of 2003 proffers a legal proposition for defining the scope of the relevant activities that matter in deciding the source of profits. The court in Kwong Mile Services held that one need only focus on "effective causes without being distracted by antecedent or incidental matters" or transactions which "proximately produce the profits". This has subsequently been expanded upon by the same court in ING Baring Securities (Hong Kong) Limited v. Commissioner of Inland Revenue FACV No. 11 of 2006 to mean that the focus is on the taxpayer's "profit-producing transactions" themselves as distinct from activities antecedent or incidental to those transactions, even where such antecedent activities may be commercially essential to the operations and profitability of the taxpayer's business.

The application of this approach is well illustrated in ING Baring Securities. The taxpayer in that case carried on the business of undertaking, on behalf of its own clients and those of its group companies, the trading of securities listed in global stock markets. The issue in ING Baring Securities concerned the source of commission income, placement income and marketing income arising from the buying and selling of securities in various stock exchanges outside Hong Kong. It was through these transactions that the taxpayer earned its commissions and charges which were payable only after the completion of the transactions. These transactions were not completed until after they had been executed; and execution took place at the stock exchange where the securities were traded. The court determined that the commission income, placement income and marketing income derived by the taxpayer on trades executed on foreign stock exchanges were derived outside of Hong Kong. In relation to the commission income and placement income, the profit-generating transactions were the successful trades or purchase orders in question, effected abroad, so that the profits produced did not derive from Hong Kong.

What was more informative from the decision was the nature of the activities that were written off as irrelevant - these included the taxpayer's research and sales activities, the negotiation and signing of contracts with customers and the giving of instructions to overseas stock brokers. Although these elements of the chain of supply were recognized as commercially essentially, they were ultimately found to be irrelevant for the purposes of determining the source of the commission and income as they were not the "profit-producing transactions".

This development to focus only on the "profit-producing transactions" appears to open up possibilities for source planning. What, then, are the limits?

Planning considerations.

The fundamental cause for uncertainty in source planning is the constant struggle between giving due regard to the legal form of a transaction while at the same time recognizing that "source means not a legal concept, but something which a practical man would regard as a real source of income" (Liquidator, Rhodesia Metals Ltd v. Commissioner of Taxes [1940] AC 774). Hence, in practical terms, it is of paramount importance to determine the point along the spectrum where the substance of a transaction starts to take precedence over its legal form in the characterization of the transaction for the purpose of determining its geographical source.

On one extreme would be cases where the legal form of the transaction amounts to the use of "screens, pretexts, devices and other unrealities" (Tariff Reinsurances Ltd v. Commissioner of Taxes (Victoria) [1938] 59 CLR 194, per Rich J). In such cases, the legal form of the transaction would generally be cast aside. An example may be found in Chandos Pte Ltd v. Comptroller of Income Tax [1987] 2 MLJ 670, where the taxpayer's primitive attempt to shift the source of interest on a loan by executing the loan documents outside of Singapore (when all other relevant steps in the transaction were effected in Singapore) was held by the Singapore High Court to be ineffective as "[g]iven all these facts, it just cannot possibly be argued that a practical man would regard the source of income in respect of the interest as not being in Singapore. Such a practical man would also regard as highly artificial the selection of Johore Bahru as a place for execution of the loan agreement and handing over of the cheque, and would find it difficult to accept that the source can be affected by the ceremonial acts performed there". In any case, such arrangements would likely be caught under the general anti-avoidance provision in Singapore, under which the Comptroller of Income Tax is empowered to exercise very broad powers to reconstitute an arrangement where he is satisfied that the purpose or effect of the arrangement is to alter the incidence of tax, relieve any liability to pay tax or to reduce or avoid any liability under the Act.

Beyond the clear cut cases involving "screens, pretexts, devices and other unrealities", the authorities tend to indicate that the significance of the legal form of a transaction declines exponentially once there is a divergence between the commercial substance and the legal form of the transaction. For example, income routed through foreign subsidiaries may not be regarded as foreign-sourced where the foreign subsidiary does not have economic substance. In the Privy Council decision of Orion Carribean, for instance, the court found that the taxpayer's business of borrowing and on-lending money were carried on for the taxpayer by its parent company, acting for the taxpayer on each side of the transaction. This was despite express wording in the management agreement between the taxpayer and its parent company that prevents the latter from acting as the taxpayer's agent in law. Addressing the question of what OCL did to earn the profits in question, the Privy Coucil found that "the answer is that OCL allowed itself to be interposed between ORPL [OCL's parent company] and the ultimate borrowers" and that OCL had "allow[ed] itself to be used as a channel for loans of funds raised or provided by ORPL in Hong Kong and passed through OCL to the ultimate borrowers under loans agreements negotiated, approved and serviced by ORPL". On this basis, the court went on to find that the taxpayer's business of borrowing and on-lending money were carried on for the taxpayer by its parent company, acting for the taxpayer on each side of the transaction. The court thus concluded that the profits of the taxpayer arose from business transacted in Hong Kong on the taxpayer's behalf.

More recent decisions of the Hong Kong Court of Final Appeal seem to suggest a further swing towards the determination of the question of geographical source as a hard, practical matter of fact in preference to relying on the legal form of a transaction in the context of the question of source. In ING Baring Securities, the geographical source of the income derived by the taxpayer was attributed to profit-producing activities carried out by a third party (i.e. the overseas stock brokers) on the basis that they were carried out on behalf of the taxpayer, even though there was no formal agency relationship between the third party and the taxpayer. This development in ING Baring Securities arose in the context of the court's attempt to give effect to the commercial reality of transactions effected through stock brokers. It remains to be seen whether the case marks the beginning of a trend towards commercial substance taking precedence over legal form in the question of source or whether it is a mere blip to be confined to transactions involving stock brokers.