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GAAR case throws up fascinating questions
This decision of the lower court has been appealed and the Court of Appeal is yet to provide a decision. But such commentary has overlooked its most interesting aspect, which happens to have little or nothing at all to do with anti-avoidance.
What were the facts of the case?
The ultimate litigant, Lafarge Malaysia Berhad (or Lafarge Malayan Cement Berhad as it was previously called) is a major public company listed on the Bursa Malaysia.
Lafarge Malaysia had a number of operating companies in Singapore. For historical reasons, the corporate structure of its Singapore operations was unusual. Half of each operating company in Singapore was owned by a Malaysian holding company. And the other half of each operating company in Singapore was owned by a Singapore holding company.
Lafarge Malaysia decided to put all its companies in Singapore under a single new Singapore holding company, LMCB Holding Pte Ltd.
How was it done?
Lafarge Malaysia lent SGD225 million to Standard Chartered Bank. Standard Chartered Bank lent $225m to LMCB Holding in Singapore. LMCB Holding in Singapore then paid Lafarge Malaysia $225m to acquire the Singapore operating companies.
The transaction is reported in Notes 11 and 22 (‘Subsidiaries’ and ‘Borrowings’, respectively) of Lafarge Malaysia’s 2003 annual report and in the company’s announcement of 30 July 2003 to the Kuala Lumpur Stock Exchange (as Bursa Malaysia was then called).
The interest of the Inland Revenue Authority of Singapore (IRAS) was especially piqued by the following statement in the announcement to the KLSE:
“The issue [by LMCB Holding] of the Notes [representing LMCB Holding’s SGD 225 million borrowing] will not have any impact on the consolidated net borrowings of the LMCB Group.”
Since StanChart collected 8.85% interest from LMCB Holding, and paid Lafarge Malaysia 8.84% interest, the net interest cost to Lafarge Malaysia as a whole was just 0.01%.
What did the court say about this?
The Singapore High Court decided that:
- There was nothing wrong with reorganising the corporate structure
- The financing arrangement was, however, unacceptable
- Lafarge Malaysia was capable of financing the restructuring without the involvement of the bank
- In substance there was no real loan made by StanChart to LMCB Holding
- Lafarge Malaysia could have loaned the money interest-free directly to LMCB Holding without involving the bank; and
- The bank was involved mainly to achieve the objective of using up tax credits in Singapore
Which tax credits were these?
The credits in question were for the tax deducted at source from the dividends distributed by Lafarge Malaysia’s operating companies in Singapore to their new parent, LMCB Holding Pte Ltd.
At the time of the events, tax was payable on dividend income in Singapore. (Now, dividends paid by companies resident in Singapore are exempt from income tax.) That did not mean, however, that the same profits were taxed twice, with companies paying tax once on their profits, and then their shareholders paying tax again when those profits were distributed.
Instead, the tax already paid by a company on its profits was credited to its shareholders as and when the company distributed dividends. In other words, dividends were treated as having had tax deducted at source, and shareholders were credited with the tax paid by the company on its profits. If a shareholder was on a lower rate of tax than the company, the excess tax originally collected by the IRAS from the company was refunded to the shareholder. In other words, most individual investors actually paid no tax; on the contrary, they received tax refunds. Corporate shareholders would be on the same tax rate as the companies in which they invested, but they received tax refunds corresponding to the financing cost of their investments.
In 2003, the Singapore government announced that it was ending the taxation of dividends. Companies would have five more years — that is, until the end of 2007 — within which they could pay dividends to their shareholders with credit for tax at source. After 2007, shareholders would no longer receive tax credits with their dividends.
Lafarge Malaysia’s Singapore companies had a large amount of retained earnings and the corresponding tax credits to match. It therefore had a pressing need to pay out those retained earnings before the companies’ credits for all the taxes paid over the years expired and became worthless.
How were the tax credits used?
LMCB Holding, in borrowing at interest to acquire the Singapore operating companies, incurred a financing cost equivalent to the greater part of the dividends that the operating companies distributed. When most of the dividend income is offset by the interest expense on the acquisition of the shares paying the dividend, then the net income and, correspondingly, the tax payable are substantially reduced. Accordingly, the IRAS must refund the excess tax deducted at source from the dividends.
In essence, the Singapore High Court decided that it was abusive and unacceptable to use tax credits when the net financing cost to the group of companies as a whole was as close to nothing as to make no difference.
In that case, how did Lafarge Malaysia win the case?
The IRAS, as he was obliged to do under the Income Tax Act, duly assessed the income of LMCB Holding on which tax was payable. This, of course, included the income LMCB Holding received as dividends from the Singapore operating companies that it had acquired.
The size of the refund of tax deducted at source caused the IRAS to inquire into the circumstances and reconsider his assessment.
He concluded that LMCB Holding was not entitled to the refunds, and proceeded to recover them by means of “additional assessments” derecognising the company’s dividend income. In other words, the IRAS refused the company any credit for the tax it had paid at source for its dividend income simply by excluding all the dividend income from assessment.]
The Income Tax Act allowed the IRAS to make additional assessments where a taxpayer has either not been assessed at all or “has been assessed at a less amount than that which ought to have been charged.”
In striking contrast, the IRAS’ “additional assessments” in AQQ v IRAS of Income Tax were — as a result of his wholesale disregard of the dividend income —actually for less tax than his original assessments. And for that, the High Court decided, the additional assessments were ultra vires and void. As the High Court pointed out, the IRAS might have questioned the deductibility of the interest expenses but he should not have ignored the fact of the dividends.
Quality tax advice, globally
The IRAS in this case succeeded in the High Court on the substantive anti-avoidance issue, but lost on a technicality.
The decision of the High Court implies that, in theory, the IRAS might rectify the position by amending his assessments. However, most of the tax years in issue are past the limitation period allowed under the Income Tax Act. The appeal from the decision of the High Court was heard in the Court of Appeal (the final court in Singapore) in August 2013 and judgment has been reserved.
Companies in a similar situation may expect the IRAS to seek disclosure of all proposals, concept papers, notes of meetings and discussions, board papers, and professional advice concerning a transaction. They can expect the IRAS to try and develop three primary lines of inquiry or attack from this evidence (although it should be noted: when the High Court judge gave his decision against the IRAS, he suggested that the IRAS ought to have followed the line of argument regarding deductibility of interest expenses).
Firstly, to what degree was the transaction tax-motivated? Secondly, is the beneficial ownership of interest payments open to question and, if so, might interest withholding tax — otherwise exempt under treaty — apply? Thirdly, can deduction of the interest expense be disallowed?
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