A tax optimum supply chain structure such as the one illustrated in Figure 1 relies on the internationally accepted standards (based on the arm’s length principle) where profits are attributed to group entities based on assets used, functions performed and risks assumed. As such, if key assets, functions and risks are centralized in a low tax environment, then profits related to the value chain would also follow, thereby reducing the overall effective tax rate of the business.
Such a centralization strategy has many commercial benefits, such as synergies, efficiency, better risk management, as well as the associated tax benefits. Although tax saving is one of the reasons for centralization, entrepreneurs that choose to do so often would also improve their pre-tax earnings as this approach allows them to lower costs through synergies and improved efficiency. Risks can be better managed through a central location by people who specialized in such functions. For these reasons, a tax effective supply chain structure has been popular and will remain so in the foreseeable future globally.
Singapore and Supply / Value Chain Structures
For entrepreneurs worldwide, Singapore is an interesting location for principal company in their global business. It offers not only a strategic location for access to the world market, modern and latest technology as well as the related IT infrastructure, it also offers skilled workforce who are able to manage the business for the entrepreneurs and provide related services that the entrepreneurs may need.
Figure 2 provides an example of how IT entrepreneurs based in the US or Australia make use of a supply chain structure with Singapore as the central principal company location.
How does this structure operate?
To implement this structure, a holding company has to be incorporated in Singapore with its management and control in Singapore. i.e. the legal and substantive elements have to indicate that it is a proper Singaporean company. The holding company is owned by the entrepreneur(s) who continue to be based in their home countries – in these cases the US/Australia.
The holding company, in turn, will hold shares in the principal company, another Singaporean company. The principal company owns key assets in the supply chain, performs the important functions and assumes the economically significant risks. To the extent that existing assets, functions and risks are currently owned, performed or assumed by the entrepreneurs in their home countries, these elements have to be transferred to the principal company.
The principal company has to have staff to control and/or perform all the important elements in the business. This includes contracting directly with the clients, either physically or via an online system. Invoices are issued by the principal company and all related acquisitions (including services from the entrepreneurs and other service provides) are made by the principal company.
What are the tax and associated benefits?
The entrepreneurs will carry out their business under this centralized structure using a principal company and a holding company, which are separate legal entities, based in Singapore. Carrying out businesses through such a structure instead of running the business and taking on the full risks personally has the effect of separating, and limiting, the legal liabilities of the entrepreneurs from those of the business (which will now be borne by the companies).
Further, the holding company is an investment vehicle that is separate from the principal company. This separation provides a range of legal, regulatory and commercial benefits for the entrepreneurs, particularly in anticipation of future expansion, sales or re-organization.
The structure also offers a range of tax benefits. Profits of the principal company would be taxed favourably in Singapore. These profits will also not be taxed in the home countries unless the entrepreneurs receive dividends from the Singaporean holding company. Furthermore, the principal company would not be taxable in the countries where the customers are located. For example, a principal company that operates websites through which its customers can transact online does not have a taxable presence in the countries of the customers.
In terms of accessing the benefits of their success, this structure also offers IT entrepreneurs a range of flexible options. The entrepreneurs will be paid for the services they provide to the principal company and dividends may be distributed to them in their capacity as shareholders with minimal tax liability in Singapore (although such income would be taxable in their home countries). In addition, the holding company is able to sell shares in the principal company (and the IT business it operates) without any capital gains tax in Singapore.
Technical tax considerations
The effectiveness of this structure from a tax perspective depends to an extent on the taxation rules in the home countries. A properly structured company in Singapore with its own management and control would ensure that the company could not be treated as a resident of the home country. This is an important consideration particularly for entrepreneurs based in Australia, where a company that is incorporated in Singapore can still be considered an Australian company if the management and control of that company remains with the entrepreneurs in Australia. This issue is less relevant for entrepreneurs in the US, since a Singaporean incorporated company will not be considered a US resident under US tax rules.
In addition, an anti-avoidance rule, known as the controlled foreign company (CFC) rules in the countries of the entrepreneurs may seek to tax the profits in the Singaporean holding company and principal company before these Singaporean companies distribute their dividends to the entrepreneurs. This aspect has to be managed by relying on the exceptions that are provided for in CFC rules in the entrepreneurs’ home countries. For entrepreneurs in the US and Australia, income of the principal company would qualify for an exemption under the CFC rules in those countries as it earns income from active business.
Where existing assets, functions and risks were transferred from other locations (for example, from the entrepreneurs) to the Singaporean company, such transfers may be subject to tax. This usually dictates that the transferor would have to be compensated for the transfers in the same way that a third party would be compensated. The compensation would likely be taxable in the countries where the transferor is located. As a result of this consideration, it is often useful to anticipate the true value of the assets being transferred, and executing the transfer well before the anticipated growth.
All the support and other services that are performed by the service providers (including the entrepreneurs in their capacity as service providers, if any) for the principal company would have to be paid for based on the market price for such services. These fees are taxable to the service providers and are deductible against the profits of the principal company.
Withholding tax liability may arise from the service fees paid by the principal company to any non-Singaporean service providers. This withholding tax liability would need to be managed by relying on the tax treaties entered into by Singapore and the countries in which the service providers are located. When service fees are paid to the entrepreneurs in Australia, these fees would not be subject to withholding taxes in Singapore under the tax treaties. However, there is currently no tax treaty between the US and Singapore – to the extent that service fees are paid to US service providers, Singapore may impose a withholding tax on such service fees. Notably, however, no withholding tax is applicable if the service is performed wholly outside Singapore.
There is a risk that the principal company may become taxable in the countries in which the customers are located if it is found to have a taxable presence, known technically as a permanent establishment (PE), in those countries. When that is the case, profits that are attributable to the PE would become taxable in those countries. The PE risk of the principal company would have to be managed using the large network of Singaporean tax treaties, in order to secure the tax benefits of this centralized supply chain structure.
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