Singapore High Court, SGHC 118, decided on 5 June 2017.
Introduction: This is an appeal under section 81(2) of the Income Tax Act against the Income Tax Board of Review’s decision regarding the interpretation of section 14(1)(a) of the Income Tax Act on the deductibility of interest expenses upon money borrowed for capital employed in acquiring income.
The question thus is whether the interest paid by the Appellant on the shareholder bonds is a “sum payable by way of interest… upon any money borrowed by that person where the Comptroller is satisfied that such sum is payable on capital employed in acquiring the income”. If so, that interest would be deductible as against that particular income for tax purposes.
The Court of Appeal held in BFC v Comptroller of Income Tax [2014] 4 SLR 33 that for interest expenses to be deductible under s 14(1)(a) of the Income Tax Act, the general deductibility test in s 14(1) that the expense be “wholly and exclusively incurred… in the production of the income”) does not need to be fulfilled (at [10]).
Section 14(1)(a) of the Income Tax Act is also an exception to the prohibition against deductions of capital expenditure in s 15(1)(c) of the Act (at [39]). This means that although interest expenses payable on capital employed in acquiring the income are nonetheless considered capital expenditure, they are deductible pursuant to s 14(1)(a) of the Act.
Relevant Legislation; Section 14(1)(a) of the Singapore Income tax Act (Chapter 13).
Case Facts:
The appellant owns and operates a mall (“the Mall”). Company A and Company B each hold 50% of the issued share capital of the Appellant (“the shareholders”).
On 20 October 2004, the Appellant borrowed $520m from a special purpose company secured by a charge over certain accounts and an assignment of the rights to the tenancy agreements and rental income of the Appellant. Of the loan amount of $520m, $170m was used by the Appellant to re-finance its borrowings and the balance of $350m was lent to the shareholders in interest-bearing loans.
The shareholders decided to convert their equity holding in the Appellant into a debt-based investment to allow them to earn a return in the form of interest. On 26 November 2004, at an extraordinary general meeting, the shareholders resolved to reduce the share capital of the company by capitalising $325,300,000 from the Appellant, paying it up in full ordinary shares and issuing it to the shareholders in equal proportions, and reducing the Appellant’s capital from $335,500,000 to $2,500,000. This capital reduction was approved by Justice V K Rajah on 2 December 2004. Upon the capital reduction, a debt of $333m became due and payable to the shareholders. Instead of returning cash to the shareholders, the appellant issued fixed rate subordinated bonds for an aggregate amount of $333m, and the shareholders each subscribed for 50% of the issue (“the shareholder bonds”).
The Appellant sought to claim deductions in respect of the interest payable on the bonds, relying on section 14(1)(a) of the Income Tax Act. The Respondent disallowed the deduction claims in the Years of Assessment 2005 to 2009. The Appellant appealed to the Income Tax Board of Appeal (“the Board”).
On 8 November 2016, the Board dismissed the appeal finding that there was no direct link between the bonds and the Mall’s rental income. The appellant appealed to the High Court.
Conclusion: The appeal was dismissed.
- For a deduction to be allowable under s 14(1)(a), there must be a direct link between the money borrowed and income produced, this was established by the Court of Appeal in Andermatt Investments Pte Ltd v Comptroller of Income Tax (1995) 2 MSTC 7287.
- The test in s 14(1)(a) whether there is a direct link between the money borrowed and the income produced has to be real, tangible, precise and factual. This requires the consideration includes but is not limited to whether the original source of income can be said to be the same source as the income against which a deduction is now sought.
- Section 14(1)(a) allows deductions where capital is employed in income-generating activities. It even requires that income be produced before deductions are allowed. The onus is on the taxpayer to show the direct link in any case.
- On the facts the directors’ resolutions showed that the Appellant had intended to carry out the shareholders’ intentions of capital restructuring by issuing the bonds. It was therefore reasonable for the Board to hold that the bonds were “issued for reasons completely distinct from the continued earning of the rental income from the Mall”.
- The Appellant had to replace the missing capital following the capital reduction. However, this did not mean that the Appellant was entitled to a deduction on the interest expenses of the loan. There needed to something more beyond the loan simply being necessary for a taxpayer to avoid selling his assets.
- As s 14(1) conferred discretion on the Comptroller to determine if its requirements are satisfied, and as the Appellant was not able to show that the Comptroller had taken into account irrelevant considerations or had arrived at an unreasonable or wrong result. In this case, the Appellant faced a few problems in establishing a direct link between the shareholder bonds and the Mall’s rental income, all of which were correctly considered by the Comptroller. First, the Mall was already under the Appellant’s ownership and was generating rental income prior to the bond issue. The bond issue neither changed the ownership status nor the rental income. Second, the appellant’s shareholders admitted that the bond issue was part of their plan to restructure their capital holding in the firm. It was not due to any financing needs or the desire to generate more rental income. The Comptroller had exercised his discretion correctly by taking these factors into account and denying the deduction of interest expenses on the shareholder bonds as against the Mall’s rental income.