BSL Bulletin

In recent years, many multinational corporations (“MNC”) have come under scrutiny by the tax authorities with regard to the amount of taxes they have paid as compared to their actual profits generated. Many MNC’s have been subject to much public outcry on how they have mitigated or managed to reduce their taxes. This is possible given the loopholes that are present in a globalized network of different tax jurisdictions offering many tax breaks.

Hence, governments are clamping down on such “tax planning” practices to increase their collection of tax revenue which have been lost through tax evasion and avoidance.

Tax avoidance vis-à-vis Tax evasion

What is tax avoidance? Is tax avoidance legally permitted? The simple answer is tax avoidance is the legitimate use of a tax jurisdiction’s policies to the taxpayer’s own advantage to reduce the amount of tax that is payable within the confines of the legal framework. In other words, it is permissible for a company to plan its tax affairs to mitigate and reduce the amount of the taxes it has to pay within the law. In many instances, tax avoidance involves the legal exploitation of loopholes and ambiguities in the tax regime to cut the tax costs.

On the other hand, tax evasion is when the company evades tax by illegal means. This happens when a series of transactions is artificially arranged with the main motive to eliminate or reduce the tax costs substantially without proper business or economic substance to the arrangement. Tax evasion is an action or omission usually deliberate, to wriggle out of tax obligation by breaking the law.

Hence tax avoidance is legal, whereas tax evasion is illegal. Tax planning encompasses all legitimate means of reducing tax liabilities, and includes activities such as making full use of group relief claims or the application of tax incentives as granted by the relevant tax authorities.

Tax case laws have established rules to distinguish a tax avoidance arrangement as opposed to a tax evasion scenario. In the well-established Ramsay principle from UK, tax authorities challenged the tax planning arrangement as being one without proper business or economic substance.

Ramsay principle

The Ramsay principle required a commercial reading to be applied for the interpretation of the particular statue to view a series of transactions as a whole. Hence, if certain steps have been inserted without any commercial reality or serve any economic purpose, such transactions would be disregarded.

Hence, putting in place very aggressive tax planning strategies may give rise to enquiries and challenges by the tax authorities. Many tax authorities have in place general anti-avoidance legislations which restrict such practices. For example in the United States “the business purpose” and “economic substance” is critical to underpin any tax planning or avoidance strategies undertaken by taxpayers or MNCs, to avoid and mitigate later challenges from the tax authorities.

Section 33 of the Singapore Income Tax Act

The main anti-avoidance provision is section 33 of the Singapore Income Tax Act. Basically section 33 targets transactions that are conducted with a primary aim to achieve a tax benefit without any justifiable commercial reasons. It provides a strong deterrent effect, and one must steer clear of a successful challenge by the tax authorities. In other words, the transactions must be carried out in the ordinary course of business and not for the sole purpose of achieving a tax advantage. In the end, commercial reasons must override fiscal considerations to avoid scrutiny or challenge from the tax authorities.

Use of tax haven

A tax haven is a country or jurisdiction that impose very minimum or no taxes. Many individuals or corporates establish their foreign bank accounts or businesses there to take advantage of the relatively low or no tax.

However, the use of tax haven should be considered only when it is used for purposes other than taxation. For example, where a business transaction requires a special purpose vehicle in a certain country, but because that country has certain regulatory restrictions or makes it difficult to do so, a tax haven with a neutral regulatory framework may be chosen to house such a vehicle so that the overall business transaction or arrangement can be conducted effectively and efficiently.

It is perfectly legal to try and minimise your tax costs. Company directors have a duty to shareholders to protect the assets of the company and enhance shareholder value.

But overly aggressive tax avoidance or even worse tax evasion may invite trouble. Problems arise when directors unwittingly allow their companies into the arena of tax evasion. There is a very real challenge especially for the non-tax professional in knowing where to toe the line.

It should be noted that where the directors of an offshore company located in a tax haven are residents of say Singapore, or if the shares of the offshore company are held by Singapore shareholders, who then exercise control over the offshore company in Singapore, the offshore company can potentially be deemed as tax resident of Singapore for income tax purposes. If the offshore company is considered to be tax resident in Singapore, where the board of directors meet to exercise the management and control of the offshore company, it may be exposed to Singapore income tax in respect of the business activities carried on by it.

Even if the offshore company is treated as a non-resident of Singapore, the gains or profits of its operations, if partly carried on in Singapore, can be deemed to be Singapore sourced to the extent that it is not directly attributable to the operations which are carried on outside of Singapore.

Hence, one should consider the following important criteria for the need to set up a company in a tax haven:

1. What is the objective that prompts the use of a tax haven structure?
2. Whether the success of the structure depends on the tax authorities not being aware of the details of the transactions?
3. What are the risks associated with such a structure and the potential of challenge by the relevant tax authorities?

In recent years there are increasing pressures from global governmental organisations, such as OECD for tax havens to provide more transparency and effective exchange of information. If MNCs or taxpayers must use a tax haven, it is critical to ensure that there are proper governance and due consideration given to all the factors highlighted above. Political activists, whether rightly or wrongly, are questioning the legitimacy of tax avoidance structuring under moral grounds.

Therefore, it is important to review existing tax structures or when putting in place new tax structures to ensure that the commercial reality and economic substance tests are fulfilled so that they can withstand scrutiny from tax authorities.

DID YOU KNOW?

Directors’ duties in relation to financial reporting and review and sanction process of the Financial Reporting Surveillance Programme administered by the Accounting and Corporate Regulatory Authority (“ACRA”)

The ACRA has issued the Practice Direction No. 2 (the “Practice Direction”) on 23 April 2014 which sets out the following:

• The duties of a director in relation to financial reporting; and
• The review and sanction process of ACRA’s Financial Reporting Surveillance Programme (FRSP), which involves the review of financial statements to detect and enforce against financial reporting breaches.

The Practice Direction took effect from 1 April 2014.

Under the FRSP which was established by ACRA’s in 2011, ACRA reviews selected financial statements to determine whether they comply with the financial reporting requirements under the Companies Act, Chapter 50 (the “Act”).

The salient points of the Practice Direction are as follows:

DIRECTORS’ DUTIES IN RELATION TO FINANCIAL REPORTING

-Sections 201(1A), 201(3) and 201(3A) of the Act require directors of a company incorporated in Singapore to present and lay before the company, at its annual general meeting, financial statements that:

• comply with Accounting Standards issued by the Accounting Standards Council; and
• give true and fair view of the profit and loss, as well as the state of affairs of the company.

-In addition, Sections 199(2A) and 199(1) of the Act require directors to maintain a system of internal accounting controls and keep proper accounting and other records respectively that will enable the preparation of true and fair profit and loss accounts and balance-sheets.

-A financial reporting breach occurs when a director has failed to comply with Sections 201(1A), 201(3) and 201(3A) and/or sections 199(1) and/or 199(2A) of the Act.

THE REVIEW AND SANCTION PROCESS

Formal Enquiry Letters to Directors and Auditors

1. Where there are matters requiring additional information upon review of the financial statements, ACRA will raise formal enquiry letters to each individual director who authorised the financial statements to request for explanation, supporting documents and other records as necessary. In certain cases, ACRA may also direct the enquiries to the auditors of the financial statements.
2. To provide directors with opportunities to make voluntary corrective changes (if any) to the next set of annual financial statements, ACRA needs to conclude the review promptly. ACRA will therefore request directors and/ or auditors to respond to the enquiry letters within two (2) to three (3) weeks from the date of the enquiry letters.
3. ACRA will receive all explanations in writing and will consider requests for physical meetings to provide verbal clarifications on a case-by-case basis. However, such verbal clarifications must be followed by the same explanations in writing and within the same timeline of two (2) to three (3) weeks from the date of the enquiry letters.
4. All information provided to ACRA will be kept strictly confidential.

Types of Financial Statements which will be Prioritised for Review

ACRA will adopt a risk-based approach in prioritising the financial statements for review. Emphasis will be placed on financial statements of public and large private companies with:

1. modified audit opinions as well as audit opinions with emphasis of matter paragraph, indicating potential non-compliance with Accounting Standards and other requirements of the Act;
2. significant public interest risks based on several criteria such as market capitalisation size, revenue size, asset size, and multiple employees, creditors, customers and other stakeholders;
3. operations that require subjective judgement in accounting for its transactions, hence increasing the risk of significant misstatement;
4. change in listing or trading status (e.g. newly listed, suspended or delisted); and
5. significant change in key stakeholders including controlling shareholders, directors, management and auditors.

The above factors are provided as a general guideline, and ACRA reserves the right to conduct any review of financial statements as deemed necessary.

Range of Sanctions which may be imposed on Directors

1. ACRA may call upon directors for interviews before imposing sanctions depending on the severity of the financial reporting breach(es). Whilst the Act provides for sanctions such as fines and imprisonment, ACRA may employ other sanctions for first time offenders and less severe technical breaches.
2. The range of enforcement actions that will be decided by the Registrar of Companies will include: advisory letter; warning letter; fine by offer of composition; and prosecution leading to fines and/or imprisonment.
3. When directors of a listed company have been the subject of regulatory sanctions under paragraph (ii), the directors should consider whether the regulatory sanction on the directors constitute “material information” in relation to the Company, where an SGX-net announcement is necessary under Rule 703 of the Singapore Exchange’s Listing Manual.

Requirement to Rectify the Deficient Financial Statements

1. Where significant prior period corrections are made in the next set of annual financial statements as a result of ACRA’s FRSP, the company may be required to disclose the fact that the correction arises from ACRA’s FRSP in the notes to the financial statements explaining the correction.
2. As a result of severe financial reporting breach(es), the company may also be required to rectify the deficient financial statements, have the restated financial statements re-audited and re-file the restated financial statements with ACRA.

Reporting to the Public

1. For more transparency, ACRA will publish annual reports summarising the activity and findings of FRSP for the past year. The report aims to help companies improve their financial reporting by enhancing their understanding of the application and interpretation of accounting standards and requirements. The report will include the findings of the financial reporting breaches but will not identify the name of the companies.
2. To guide directors and other financial statements preparers, ACRA has published the areas of the FRSP’s review focus for selected FY2013 Financial Statements. This will remind directors of the risks of misstatements and/or non-disclosures in the financial statements as well as the information needs of shareholders and other stakeholders.

ACRA strongly encourages Directors to attend the Director Financial Reporting Essentials Course organised by the Singapore Institute of Director (SID) in collaboration with the Institute of Singapore Chartered Accountants (ISCA), so as to keep abreast with the financial reporting developments. The first 3,000 directors who voluntarily attend this course before 31 March 2016 will be entitled to subsidies of $300 per individual (about 50% of the course fees) funded by ACRA.

The Practice Direction No. 2 of 2014 and the Annex A to the Practice Direction which provides further guidance to directors on carrying out their duties in relation to financial reporting are available from the ACRA website at www.acra.gov.sg.