*Please note that the tax advice herein does not constitute legal advice and should not be taken as such.
An Example of our International Tax Advice :
Our client (“A”), a Singapore / overseas citizen currently residing in overseas, is in the business of providing online / E commerce services.
A currently have clients worldwide and A is able and willing to live and work in either Singapore or overseas, with a preference for the former.
For the purposes of this tax advice, it is assumed that A will be performing services in Singapore only (as Singapore tax rates is lower than most jurisdation).
A wishes to legitimately reduce his overall tax and compliance cost, and has proposed the following structure (the “Proposed Structure”):
(a) A will incorporate and own a Hong Kong private limited company (“HK Co”), which will enter into services agreements with online client.
(b) A’s business partner (“B”) will incorporate and own a Singapore private limited company (“SG Co”).
(c) HK Co will subcontract the services required under the marketing services agreements to SG Co. SG Co will be remunerated at a “subsidized rate”. It is assumed that the services will be rendered by SG Co’s employees in Singapore.
Advice in relation to Proposed Structure
Under the Proposed Structure, SG Co will be subject to tax at the prevailing corporate tax rate (i.e. 17%, subject to any partial tax exemption for companies or full tax exemption for qualifying start-up companies, if applicable) in respect of the service income paid to it by HK Co. As SG Co and HK Co are strictly speaking not related parties, it should not be a problem to remunerate SG Co at a “subsidized rate” as transfer pricing requirements would not prima facie be applicable. Any dividends distributed by HK Co to A as shareholder in Singapore will be exempt from tax in Hong Kong, as well as in Singapore under the Foreign Source Income Exemption.
However, any profits attributed to HK Co (i.e. the difference between the service fee payable to HK Co under the marketing services agreements and the subsidized service fee payable by HK Co to SG Co may or may not be considered to be sourced in Hong Kong. This is important as Hong Kong adopts a pure territorial basis of taxation, which means that this profit will only be taxable in Hong Kong if it is considered to be sourced in Hong Kong.
While there are a number of case law principles that have been formulated over the years for the purposes of determining the source of an income, the issue of source of income is nevertheless still a “hard, practical matter of fact” which depends on the facts of the case. As a matter of revenue practice, it is noted that the Hong Kong Inland Revenue Department (“IRD”) has in Advance Ruling Case No. 46 ruled that the applicant, a Hong Kong company which has derived service income for services rendered wholly by its employees and the employees of another related company with which the Hong Kong company has a service agreement outside of Hong Kong, did not derive any Hong Kong sourced service income.
This appears to be consistent with the IRD’s position in its publication entitled A Simple Guide on the Territorial Source Principle of Taxation that service fee income is taxable “if the services which give rise to the payment of the fees are performed in Hong Kong”. However, it should be noted that in Advance Ruling Case No. 46 (as well as other favorable advance ruling cases in relation to source of service fees, e.g. No. 23 and 36), there appears to be a commercial reason for outsourcing the work (e.g. it is either necessary or expedient for the employee providing the services to be physically in the jurisdiction in which the services are actually required). This should be contrasted with the present facts where the clients are in Canada and China, and therefore, there is no readily apparent commercial reason why the services must be provided remotely out of Singapore (as opposed to Hong Kong which is geographically even nearer to China).
As there appears to be some differences in the facts of the present case and those of the favorable advance rulings, there is a chance that the profits attributed to HK Co may nevertheless still be considered to be Hong Kong sourced by the IRD, and therefore may be subject to profits tax in Hong Kong, even if the contracts are negotiated and concluded outside of Hong Kong. If so, what little tax benefit that may be derived from the small differential in corporate tax rates in Singapore and Hong Kong may well be offset by the additional compliance cost in setting up and maintaining HK Co, as well as the partial tax exemption for companies in Singapore.
Another risk in relation to the Proposed Structure is that A will not be in control of SG Co. Therefore, care should be taken in relation to the legal arrangement and documentation to ensure that A’s interest under the Proposed Structure will not be compromised in future, should relations with B take a turn for the worse.
As for potential tax consequences arising from exiting the investment, the main question is whether the gains derived from subsequent disposal of shares in HK Co and/or SG Co will be treated as taxable revenue gains or non-taxable capital gains.
This is a question of mixed law and fact. Generally, the courts will consider a number of factors in determining whether the gains are taxable or not, including: (a) subject matter of realization, (b) frequency of similar transactions, (c) supplemental work on the property realized, (d) motive, (e) circumstances responsible for the realization; (f) length of period of ownership; (g) financing method; and (h) classification of asset in accounting records. Unless the shares in HK Co and/or SG Co are disposed of within a short period of time, it would generally be unlikely that the gains derived therefrom will be treated as taxable gains.
It should also be borne in mind that the transfer of shares will generally attract stamp duty in both Singapore (0.2% of the consideration or net asset value, whichever is higher) and Hong Kong, which can be substantial if the consideration for the shares is significant.
Single HK Co with employees in Singapore
This is a slight variation of the Proposed Structure. Advance Ruling Case No. 36 suggests that where a service provider provides services through its employees completely outside Hong Kong, the service income derived therefrom will be treated as foreign sourced income that is not subject to profits tax in Hong Kong. However, the same caveat applies, i.e. given that there is no commercial reason to outsource the work to Singapore, there is no guarantee that the IRD will follow these precedent rulings. However, this alternative has the benefit of incurring only one set of compliance cost (i.e. that of setting up and maintaining a Hong Kong company), and unlike the Proposed Structure, it will only attract one set of stamp duty upon disposal of the shares (although in reality that should not make a difference if the aggregate net asset value of the shares of HK Co and SG Co is the same as that of HK Co in this alternative). It also avoids the risk associated with ceding control of the company to another person. Of course, repatriation of profits in the form of dividends to A will not attract any tax in Singapore and Hong Kong.
However, this alternative raises an additional challenge in terms of A’s personal income tax liabilities (as well as that of other employees of HK Co). Since A will be performing the services in Singapore, the Inland Revenue Authority of Singapore (“IRAS”) will generally treat A’s employment income as Singapore sourced, and therefore subject to Singapore income tax. At the same time, there is a risk that it may be classified as Hong Kong employment income, which may attract Hong Kong salaries tax. This is important as Singapore does not have a comprehensive avoidance of double taxation agreement with Hong Kong, and therefore, if both jurisdictions are to tax on A’s employment income, he will be subject to double taxation on the same.
As a matter of administrative practice, the IRD has indicated in its Departmental Interpretation and Practice Note No. 10 (Revised) that it will take into account all relevant facts in determining the source of employment income, with particular emphasis on:
(a) where the contract of employment was negotiated and entered into, and is enforceable, whether in Hong Kong or outside Hong Kong;
(b) where the employer is resident, whether in Hong Kong or outside Hong Kong; and
(c) where the employee’s remuneration is paid to him,whether in Hong Kong or outside Hong Kong.
(a) and (c) can be easily arranged to be done or performed outside Hong Kong. As for (b), the IRD has indicated that it will look at where the company’s central management and control is located, and in this regard, importance is generally attached to the place where the board meetings of the company are held. As such, provided that the board meetings of HK Co are held in a country other than Singapore and Hong Kong, the IRD is unlikely to be regard A’s employment income as Hong Kong sourced.
Another alternative is to set up a company in the Cayman Islands or another jurisdiction which does not impose a tax on profits, and another company in Singapore to provide the services. This ensures that the share of profit allocated to the Cayman company will not be subject to any income tax. There is also no issue of stamp duty or capital gains upon disposal of the shares in a Cayman company. However, the reality is that the Cayman Islands (as well as other traditional tax haven jurisdictions) are now under a lot of scrutiny, which means that this may attract the risk of a tax audit and investigation, and consequentially a higher chance of being struck down as impermissible tax avoidance. Also, A’s clients may not be comfortable entering into agreements with a company located in a tax haven jurisdiction.
It should also be borne in mind that if the services to be provided from Singapore will or will be expected to exceed S$1 million, there will be a need to register for GST in Singapore (although the provision of services to overseas clients will probably qualify for zero-rating as provision of international services – but note that zero-rated supplied are still to be taken into consideration in determining liability to register).