Example 1: Revenue versus capital
In Hong Kong, Malaysia and Singapore there is much uncertainty regarding the qualification of a divestment gain as ‘capital’ or ‘revenue’ in nature. If it’s the former, the gain is exempt. If it’s the latter, the gain is taxable. When local tax authorities assess the qualification of a divestment gain, they review the totality of facts and circumstances of the case against a set of factors established under case law (‘badges of trade’). Among those factors are the taxpayer's motive or intention when acquiring the asset and the length of ownership.2 Since the factors are not clear cut it is rare that a taxpayer ‘ticks all boxes’ and tax authorities often challenge tax positions.
Having assisted numerous investors on Singapore real estate investments, Wee Hwee Teo, Partner, Head of Real Estate, Tax and Head of Asset Management & Family Office with KPMG, notes that the differing exit tax consequences depend on the mode of divestment and the domicile of the relevant shareholders:
“Where the exit is in the form of an asset sale, the Singapore tax authorities (IRAS) must be convinced that the property has been acquired for long-term investment purposes, therefore subjecting taxpayers to lengthy questioning and protracted correspondences. Often, uncertainty in tax outcomes leads to the provision of contingent tax liabilities, hampering the ability to repatriate cash to investors promptly and most certainly affecting the fund manager’s carried interest. Achieving certainty through an advance ruling is becoming a rarity nowadays as the process is too time-consuming, with some cases dragging up to over a year, rendering this ‘traditional’ option not feasible from a commercial perspective. Needless to say, securing a tax policy becomes the obvious solution.
Where the exit is effected via the sale of shares in the property (intermediate) holding company and where the shareholder(s) are Singapore tax resident persons, there tends to be less scrutiny as long as one can satisfy certain conditions under the Singapore’s version of the participation exemption, also known as the ‘safe harbour rule’. However, there are still cases with grey areas or tax avoidance concerns such as those associated with the sale of an intermediary holding company. In these cases, securing a tax policy would be a prudent solution to remove uncertainties in transactions.”
In case said shares are being sold by an offshore shareholder, Singapore’s semi-territorial basis of taxation normally ensures that the divestment gain does not fall within the Singapore tax web. Practically, challenges from the IRAS are rare. Nonetheless, a tax insurance policy could still be extremely useful where the foreign seller happens to be an offshore fund managed or advised by a Singapore based fund manager, thus potentially bringing the gain to be within the Singapore tax web.”