In this Part 2 of the article, we continue the discussion from Part 1, which covers the scope of foreign-sourced disposal gains tax regime, covered entities, and economic substance requirement (ESR).
The ESR takes into account outsourcing arrangements where an entity outsources some or all of its economic activities to third parties or group entities.
For an outsourcing arrangement to satisfy the ESR, the following conditions must all be satisfied:
When determining whether the outsourcing entity is able to satisfy the ESR in respect of its economic activities, the resources of the outsourced entity in Singapore will be considered. It is generally expected to charge the outsourcing entity an arm’s length fee for the activities performed, subject to transfer pricing rules where applicable. The outsourced entity can provide support to more than one entity, provided that its resources are commensurate with the complexity and level of services it provides to other entities.
The tax treatment of gains from the sale or disposal of foreign IPRs is different from that of other foreign assets.
Qualifying foreign IPRs, like patents or software copyrights, as defined in section 43X of the ITA, follow a modified nexus approach to determine the extent of such gains that will not be taxable when received in Singapore. A transitional period of three years allows entities to adapt, applying a transitional nexus ratio before shifting to the modified ratio.
Non-qualifying IPRs gains, however, are fully taxed upon receipt in Singapore, irrespective of the entity’s economic substance in Singapore.
When determining the taxable gains on the sale of foreign assets, certain deductions are allowed. Only the net gains received or deemed received in Singapore are subject to tax. Allowable deductions include expenditure incurred to acquire, create or improve; protect or preserve; or sell or dispose of the foreign assets, as well as losses from other foreign asset sales. However, certain expenses are not deductible, such as those previously allowed against other incomes or specific capital expenses. Losses from foreign asset sales can offset taxable gains under specific conditions, with any remaining loss carried forward for future tax offsets against chargeable gains in Singapore.
If the sale price of a foreign asset is lower than its open market price, the Comptroller may adjust the amount of gains received in Singapore to take into account the open market price.
When the foreign-sourced disposal gains received in Singapore are also taxed in the foreign jurisdiction before the gains are received in Singapore, a Singapore tax resident entity may, subject to meeting certain conditions, claim foreign tax credits.
Tax exemption under section 13(1)(zu) of the ITA will be given on the capital gains derived from the sale or disposal of a foreign asset where the gains are assessable as the income of an individual. The tax exemption will not be granted if the gains are business revenue gains.
There are no significant updates and amendments in this Second Edition issued on 9 December 2024.
Apart from editorial changes made to various paragraphs and the re-numbering of certain paragraphs, there is an updated footnote on the definition of “full-time employees” and the addition of some frequently asked questions (FAQs).
In the Second Edition, the number of full-time employees to satisfy the ESR now includes:
Previously, in the First Edition, a) and b) were not included.
Notable FAQs include clarifications on these special scenarios:
FAQ on Liquidation
Where a Singapore entity undergoes liquidation and distributes its foreign assets to its shareholders (as part of liquidation proceeds) without receiving any consideration, the transaction does not fall within the ambit of Section 10L, given that there are no gains to be received in Singapore in the absence of receipt of any consideration.
FAQ on Dividends
Where a Singapore entity distributes its foreign assets to its shareholders as payment of dividends (that is, dividends in kind), such distribution also does not fall within the scope of Section 10L. This is because there is no consideration received for the disposal and, consequently, there are no gains to be received in Singapore.
The change in the foreign-sourced income regime aligns with the government’s commitment to play its part to counter international tax avoidance. It is also consistent with its longstanding policy on attracting foreign entities that intend to anchor genuine substantive business operations in Singapore.
As the ESR has to be met in the year the foreign assets are disposed of, an entity falling within the scope of section 10L of the ITA should take proactive measures to meet the ESR in order to mitigate any unintended adverse tax consequences.
If there are doubts about the adequacy of economic substance, the entity can opt to apply for an advance ruling, either on an entity or group basis, if the planned sale or disposal of foreign assets is expected to take place within one year from the date of the application. This ruling, once issued, will be valid for up to five years of assessment, and will provide certainty on the sufficiency of economic substance and is, therefore, worth considering.
Simon Poh, FCA (Singapore), is Associate Professor (Practice), Department of Accounting, NUS Business School. The opinions expressed are those of the writer and do not represent the views and opinions of NUS.
© 2024 Institute of Singapore Chartered Accountants
