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Professional Level Options Module, Paper P6 (SGP) Advanced Taxation (Singapore) 1 Tech Singapore Pte Ltd To: Tech Singapore Pte Ltd (TSPL) From: Tax Consultant Date: 1 December 2008 Report on the proposed new venture with the Chinese consortium in either Singapore or Shanghai (a) Location of production facility

December 2008 Answers

A comparison of the tax implications of operating the two locations, Singapore and Shanghai and the resultant profits after tax is set out below. Detailed supporting calculations are provided in the appendix to this report. Comparison of the two locations Singapore $000 0 3,375 Shanghai $000 1,194 N/A

Tax payable over the five-year period (Schedule 3) Deferred tax liability (Schedule 2) Less: Deferred tax asset Investment allowance $45m at 18% Tax loss $2,250,000 at 18% (Schedule 3)

(8,100) (405) (5,130) 16,250 5,130 21,380 2,324

N/A N/A 1,194 20,250 (1,194) 19,056

Accounting profit before tax (Schedule 1) Add: Deferred tax asset Less: Tax payable Profit after tax Incremental benefits after tax

Based on the projected financials, therefore, it is more tax and cost efficient to have the production facility located in Singapore; as shown above, the total incremental benefits amount to $2324 million for the five-year period. (b) Interest incurred on the credit facility from OCBC Limited, Singapore If the production facility is located in Singapore, it will distribute a one-tier tax-exempt dividend. Hence, TSPL will not be subject to Singapore income tax on the dividend income received from the new venture. Consequently, there will be no tax benefit to be derived from the deduction of interest incurred on the OCBC credit facility obtained to fund the investment in the new venture. If the production facility is located in Shanghai, the profits of the production facility will be deemed to have been subject to China tax of 25%, notwithstanding that the profits are either wholly or partially exempt under the tax incentive scheme in China. Thus, the headline tax rate for the purpose of the tax exemption is 25%, which is greater than the minimum tax rate of 15%. Hence, TSPL will be exempt from Singapore income tax when the dividend income is remitted into Singapore. Therefore, there will again be no tax benefit derived from the interest deduction. (c) Use of the fixed deposit funds with HSBC Brunei The taxation of the dividend income from the Singapore and Shanghai production facilities is as stated in (b) above. If the production facility is located in Singapore, TSPL will need to remit the funds withdrawn from HSBC Brunei to Singapore. The remitted funds comprise the proceeds from the disposal of UK equities and interest earned on the fixed deposit. The disposal proceeds are not subject to Singapore income tax as confirmed by the Singapore Inland Revenue. The interest income will, however, be taxed in Singapore at the corporate tax rate of 18% and there will be no credit relief for Brunei tax because the interest is not subject to tax in Brunei. If the production facility is located in Shanghai, the funds injected into China will not be regarded as income deemed to be received in Singapore. Hence, there will be no Singapore income tax implication. (d) Patent contribution to the production facility in Singapore The patent contributed by the Chinese consortium into the new venture will be regarded as an acquisition of the patent by the new venture company. The contributed cost is thus an acquisition cost of a patent, which does not qualify as a tax deduction under s.14 of the Income Tax Act. The expenditure, however, does qualify for writing down allowances. The Singapore Inland Revenue may enquire into the basis of the valuation at $15 million, in particular whether or not it has been independently valued.

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Since it is an acquisition cost and not a lump sum for the right to use the patent, it is not an income deemed to be derived from Singapore under s.12 (7) (a) of the Income Tax Act. Thus, there will be no withholding tax implication. APPENDIX Schedule 1 Accounting profit before tax Singapore $000 2,500 2,750 3,250 3,750 4,000 16,250 Shanghai $000 3,300 3,550 4,050 4,550 4,800 20,250

Year Year Year Year Year

1 2 3 4 5

Schedule 2 Tax depreciation Production equipment Singapore Shanghai $000 $000 15,000 7,500 15,000 7,500 15,000 7,500 7,500 7,500 45,000 37,500 45,000 0 1,350 45,000 7,500 0 Patent Singapore Shanghai $000 $000 3,000 750 3,000 750 3,000 750 3,000 750 3,000 750 15,000 3,750 15,000 0 2,025 15,000 11,250 0 Total Singapore Shanghai $000 $000 18,000 8,250 18,000 8,250 18,000 8,250 3,000 8,250 3,000 8,250 60,000 41,250 60,000 0 3,375 60,000 18,750 0

Year Year Year Year Year

1 2 3 4 5

Qualifying cost Tax written down value at end of 5th year Deferred tax liability (at 18%)

Schedule 3 Tax computations for the five-year period Singapore $000 16,250 37,500 3,750 250 N/A 41,500 57,750 60,000 (2,250) 0 Yr 1 to 3 $000 10,900 22,500 2,250 N/A 300 25,050 35,950 24,750 11,200 0 Shanghai Yr 4 & 5 $000 9,350 15,000 1,500 N/A 200 16,700 26,050 16,500 9,550 1,194

Accounting profit before tax Add: Depreciation on fixed assets Amortisation on patent Expenses on S-plated car Entertainment

Less: Tax depreciation Loss/Exempt profit/Chargeable income Tax payable (at 125%)

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Janet ABC Tax Consultants Firms address Ms Janet Address 1 December 2008 Dear Ms Janet I am pleased to set out below my comments and advice regarding your enquiries. (a) Acquisition of business undertaking If you acquire the business undertaking of Mary Spa Pte Ltd (MSPL) rather than the shares in the company, you can limit the acquisition to those assets and liabilities relating to the business. For example, you will not be obliged to account to the Inland Revenue for the tax assessed in the notice of additional assessment dated 1 October 2008 and the tax not withheld from the franchise fee. Similarly, you will not be responsible for any tax assessed in the year of assessment 2009 (relating to the financial year ended 31 October 2008). Trading stocks you may purchase the trading stocks in accordance with s.32 of the Income Tax Act. Under this section, the Inland Revenue will accept any value agreed between the two parties so long as you continue with the same trade in Singapore and use the agreed value as a deduction for income tax purposes. As the trading stocks include expired products of $50,000, you should advise Mary to write off these items, as MSPL should be able to get a tax deduction for the cost of the obsolete stocks. Trade debts before the transfer, the recoverability of the trade debts needs to be reviewed and an appropriate write off or specific provision made in MSPL. Any loss subsequently suffered by you will not be tax deductible because you did not incur these debts in your normal course of trade. Transfer of spa equipment and other fixed assets a transfer of fixed assets pursuant to a transfer of a business undertaking is regarded as a disposal under s.20 of the Income Tax Act. Thus, there will be a balancing charge or a balancing allowance arising from the disposal in MSPL. The balancing charge or the balancing allowance will be computed based on the difference between the open market value and the tax written down value of the assets at the time of transfer. The election to transfer the qualifying assets in accordance with s.24 is not applicable as the transferor and the transferee in this case are not parties under common control. Hence, it will be necessary for you and Mary to negotiate and agree on the transfer values. (b) Acquisition of shares If you acquire 100% of the shares in MSPL, you will assume all liabilities relating to the pre-acquisition business, which may arise subsequent to the date of acquisition. These will include: (1) The tax assessed in the notice of additional assessment dated 1 October 2008 of $20,000. MSPL did not object to the assessment within 30 days, but if there are reasonable grounds, the Inland Revenue may accept a late objection. Further, MSPL was required to settle the tax assessed within a month from the date of the notice of assessment and since this date has lapsed, the Inland Revenue will levy a 5% penalty. (2) The tax not withheld on the franchise fee and thus, not paid to the Inland Revenue and the penalties for late payment. (3) For the year of assessment 2009, the Inland Revenue may make the following adjustments: disallow the directors allowance of $200,000 payable to Marys daughter; allow the claim for write off of the obsolete stocks of $50,000; and disallow the general provision of $25,000 but allow for any specific provision for doubtful debts that may arise from a review of the outstanding debts.

Consequently, there may be a tax liability for the year of assessment 2009. Similarly, you will benefit from the recovery of any outstanding instalments, which MSPL had previously written off or specifically provided for. Regarding the spa equipment, the tax written down value will be zero if MSPL had previously made a s.19A claim. Hence, there will be a deferred tax liability of $21,600 ($120,000 at 18%). Having regard to the above, I would advise you to do a thorough due diligence and if appropriate, include in the purchase and sale agreement a provision requiring Mary to indemnify you for liabilities in respect of the pre-acquisition business. If, as a result of the adjustments identified above, there is no tax loss in the year of assessment 2009, it will not matter from an income tax point of view whether you acquire 100% or 45% of the shares in MSPL. However, if there is a tax loss, the loss will only be available for carry forward if the continuity of ownership test is satisfied. In this regard, you will need to complete the acquisition of the shares before 31 December 2008. This is because the continuity of ownership test only

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requires a comparison of the shareholders and their shareholding on two relevant dates, namely, the last day of the calendar year in which the loss was incurred and the first day of the year of assessment in which the loss is to be utilised. (c) Benefits of setting up a new company Three possible operating structures are available to you: (1) combine the MSPL business with your existing business and carry on both as a sole proprietor; (2) carry on both businesses under their respective legal entities; or (3) set up a new company to carry on the combined business. If a new company is set up, in the first three years of assessment, its chargeable income will be taxed as follows: the first $100,000 tax exempt; the next $200,000 50% tax exempt; and the balance of chargeable income taxed at 18%.

The profits after tax will be available for dividend distribution, which will be tax free in your hands. If a new company structure is adopted, I would suggest that you draw a reasonable salary, which should be tax deductible in the company, in order to take advantage of the lower rate bands of personal income tax. I can further assist you in this area with the aim of achieving maximum tax efficiency for you and the company. (d) Goods and services tax implications As the annual turnover of the combined business will exceed $1 million, you will be required to register as a goods and services tax (GST) person. As a GST person, you will be required to comply with the provisions in the GST Act, in particular, the following: (1) Collect GST of 7% on all supplies made in Singapore. (2) Issue tax invoices if the customer is a GST-registered person. (3) Show separately the GST charged on the tax invoices or receipts. (4) Print your GST registration number on the tax invoices and receipts. (5) Display all prices inclusive of GST of 7%. (6) Claim the input GST paid to your suppliers against the output GST collected. (7) File quarterly GST returns and pay the GST due to the Comptroller of GST or obtain a refund where the input GST is greater than the output GST. I trust you will find the above of assistance. Please do not hesitate to contact me if you need any clarification or my additional advice. Yours sincerely, ABC Tax Consultants

Mount Elizabeth Pte Ltd (a) There is no provision in the Income Tax Act which distinguishes between a capital receipt and a revenue receipt and in general, the Inland Revenue relies on the badges of trade test for this purpose. The test involves consideration of the following factors: (1) subject matter of realisation; (2) length of period of ownership; (3) frequency or number of similar transactions; (4) supplementary work done on or in connection with the property; (5) circumstances responsible for the realisation; and (6) motive. It should be noted that not all the factors have equal weight and there are instances, where the presence of one factor alone may be adequate for the Inland Revenue to regard the transaction as trading in nature. (b) Mount Elizabeth (Pte) Ltd (MEPL) should have taken the following actions to strengthen its contention: (1) The object clauses of its Memorandum and Articles of Association should have clearly stated the principal and subsidiary activities of MEPL. Instead, the object clauses were widely crafted, suggesting that they professed the activities that MEPL would carry on but not necessarily did carry on.

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(2) The board of directors should have documented the principal and the subsidiary activities by way of resolution. (3) In addition, MEPL should have consistently described both activities in the annual directors report. (4) From the outset, MEPL should have identified the apartments for sale and for retention. (5) MEPL should have classified the eight units identified as for retention appropriately in its balance sheet from the outset. (6) Additionally, MEPL should not have included the eight apartments held for investment in its sale brochures. (7) Alternatively, from the outset, MEPL should have set up two companies, one for carrying on the business of property development and the other for the holding of property for rental. Both companies would have jointly developed and contributed towards the development and construction of the apartments. (c) If MEPL had changed its business activity from property development for sale to property investment for rental income after the sale of the 51 apartments, the actions required and tax implications resulting from the conversion of the remaining eight apartments would be as follows: (1) MEPL would need to value the eight apartments, preferably using an independent valuer to substantiate the valuation. (2) MEPL would be subject to tax on the surplus arising on valuation compared to the cost of the apartments as trading stock, notwithstanding that it is not a realised profit. (3) MEPL would need to reclassify the eight apartments from trading stock to investment assets and state them at their fair market value, as determined by the independent valuer. (4) MEPL should have documented the change of intention by way of a board resolution. (5) MEPL should have objected to any assessment of the rentals as a trade source, instead of as a passive source under s.10(1)(f).

Peter Bush (a) The contract is for a duration of 75 days. Hence, Peter Bush will be a non-resident professional for Singapore income tax purposes. His gross income derived from the services rendered in Singapore will be taxed at 15%. The term, gross income for this purpose will include the cost of the airfare and the hotel accommodation borne by SingCo. The 15% tax on the gross income will be Peters final tax. However, in recognition that each non-resident professional may have a different expense to income ratio, Peter may opt instead to be taxed at 20% of his net income derived from the contract. This is an administrative concession granted to non-resident professionals. Under this administrative concession, the accommodation provided by SingCo for a maximum of 60 days in a calendar year and the airfare borne by SingCo will not be regarded as part of Peters taxable income. In addition, Peter will be allowed to claim for expenses incurred wholly and exclusively in the production of the income from the contract. These will include the hotel accommodation, not borne by SingCo and the fees payable to the engineering undergraduate. (b) Peter will pay less tax if he opts for his income to be taxed at 20% of net income instead of 15% of gross income. The tax savings will be $1,500. (14,850 less 13,350) as follows: Taxed at 15% of gross income $ Gross income 75 days at $1,000 per day Hotel accommodation borne by SingCo 60 days at $300 per day Airfare borne by SingCo $ 75,000 18,000 6,000 24,000 99,000 14,850

Gross income Tax at 15%

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Taxed at 20% of net income $ Gross income as above Less: Amount not taxed by concession Hotel accommodation, limited to 60 days Airfare $ 99,000

18,000 6,000 24,000 75,000

Less: Tax deductible expenses Hotel accommodation for remaining days 15 days at $300 per day Engineering undergraduates fee 75 days at $50 per day

4,500 3,750 8,250 66,750 13,350

Chargeable income Tax at 20% (c)

SingCo is obliged under the Income Tax Act to withhold tax at 15% of gross income and remit the tax to the Inland Revenue by the 15th day of the month following the date of payment of the income. Peter can use the tax withheld to offset against the income tax ultimately payable at 20%. Since the tax payable based on 20% of the net income is less than 15% of the gross income, Peter has to exercise the option within 45 days from the date on which the income accrues to him and inform SingCo accordingly. In this case, SingCo will withhold tax based on 20% of the net income.

(a)

Plan B Ltd For goods and services tax (GST) purposes, goods imported into Singapore are subject to input GST, payable at the Singapore customs. Value Electronics Pte Ltd (VEPL) is an approved person under the major exporter scheme (MES) and hence, it is exempt from GST on goods imported into Singapore. In the proposal, Plan B Ltd (PBL) is required to store the computer chips in a warehouse located in Singapore. This means that PBL will import the goods into Singapore and deliver from Singapore to VEPL. Input GST will be payable on imports into Singapore and if PBL is registered as a GST person, it will be required to collect GST of 7% on the supplies made to VEPL. While PBL will be able to claim the input GST payable on the computer chip imports against the output GST charged on the supplies made to VEPL, this will still result in an unfavourable cash flow effect for PBL. VEPL will be in a similar negative cash flow position; notwithstanding that the GST payable to PBL will be creditable against its output GST. To mitigate the GST impact, PBL should locate the warehouse facility in a free trade zone (FTZ). For GST purposes, the FTZ area is not regarded as Singapore and hence, supplies within the FTZ area do not fall within Singapores GST jurisdiction. Additionally, as a MES person, VEPL is not required to pay input tax on receipt of computer chips drawn from the FTZ warehouse. Tutorial note: Although PBL can appoint its warehouse agent as its GST agent under s.33(2) of the GST Act, thereby making the warehouse agent responsible for filing the GST return instead of PBL, this is only an administrative procedure and will not resolve the cash flow disadvantage identified above.

(b)

Valerie Valerie currently has an annual chargeable income exceeding $320,000. This means that any additional taxable income will be taxed at the highest marginal tax rate of 20%. (1) The income from qualifying debt securities is exempt from tax. Hence, the net return after tax will be 4%. (2) Income from structured products is also exempt from tax with effect from the year of assessment 2008. Thus the net return after tax will be 35%. (3) Similarly, interest income derived from funds placed with Hong Leong Finance Ltd is exempt from tax. Again, the net return will be 35%. (4) Although interest income is generally exempt from tax, interest income derived from a non-financial institution is not taxexempt. In this case, Valerie will be taxed on the interest income at 20%, giving her a net return after tax of 4% (5% less tax of 1%). Additionally, Valerie should be aware that if the loan is not repaid, the amount written off is not tax deductible. (5) Individuals are not taxed on offshore income remitted to Singapore and hence, the net return from the Australian dollar funds placed with the bank in Hong Kong will be 4%. This return does not take account of any exchange gain or loss but Valerie may not be concerned about this, as she wants to buy a property in Australia later.

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Professional Level Options Module, Paper P6 (SGP) Advanced Taxation (Singapore)

December 2008 Marking Scheme Marks

Tech Singapore Pte Ltd (a) Computation of accounting profit Singapore (1/2 for each of the four years, 2 to 5) China Computation of tax depreciation Singapore production equipment patent China production equipment patent TWDVs at end of year 5 (2 x 1/2) Computation of deferred tax liability Singapore (2 x 1/2) China Tax computations for the five-year period Split of Shanghai accounting profit Adjustment of depreciation Adjustment of amortisation Adjustment of car expenses Adjustment of entertainment expenses Claim for tax depreciation Computation of tax payable * Singapore * China first three years * China 4th & 5th years Comparison of 2 locations Deferred tax liability Deferred tax asset * Investment allowance * Tax loss Profit after tax Savings after tax Conclusion (written)

20 05 10 10 05 05 10 10 05 05 05 05 05 05 05 05 10 10 05 10 10 10 10

25

40

15

55

45 10 19

(b)

Singapore One-tier dividend No tax benefit from interest deduction Shanghai Deemed tax at 25% Tax exempt in Singapore No tax benefit from interest deduction

10 10 10 10 10

20

30 5

(c)

Singapore Taxed on remittance Disposal proceeds tax free Interest taxed at 18% No credit relief as interest is not taxed in Brunei Shanghai Not received No Singapore income tax implication

10 05 10 05 10 10

30

20 5

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Marks (d) Regarded as cost of acquisition Not tax deductible under s.14 Qualifies for writing down allowances Valuation basis Not a s.12 (7) payment No withholding tax 05 05 10 10 10 10 5 Appropriate format and presentation of the report, including use of appendix Effectiveness of communication 10 10 2 36

Total

Janet (a) Ability to limit acquisition to business assets/liabilities Notice of additional assessment Franchise fee Tax assessed for the year of assessment 2009 Transfer of trading stocks Transfer of trade debts Transfer of fixed assets Non-applicability of s.24 election 10 05 05 05 20 20 20 05 9 (b) Assume liabilities relating to pre-acquisition business Additional tax of prior years, penalty/objection Withholding tax on franchise fee and penalties Tax adjustments * directors allowance * stock obsolescence * doubtful debts Enjoy benefit of debts written off Spa equipment/deferred tax liability Indemnity clause 100% or 55% does not matter if there is no loss If there is a loss, continuity of ownership test required Recommendation to complete transaction before 31 December 2008, with reasons 05 10 05 05 05 05 05 10 10 05 10 15 9 (c) Three possible structures Beneficial treatment in first three years of assessment Tax exemption on first $100,000 50% tax exemption on next $200,000 Balance taxed at 18% Dividend distribution tax exempt Salary deduction in company Salary taxed in Janets hands/achieving tax efficiency 10 05 05 05 05 10 05 15 6 (d) GST registration required Compliance of key provisions half mark for each, maximum 10 30 4 Appropriate format and presentation of the letter Effectiveness of communication 10 10 2 30

Total

20

Marks 3 Mount Elizabeth Pte Ltd (a) Badges of trade test 05 mark for each factor Not necessarily equal weight/one factor alone may be adequate 30 10 4 (b) Award 15 marks for each valid point maximum Note: marks will also be awarded for any reasonable points, not included in the suggested answers (c) Award 1 mark for each valid point maximum Note: marks will also be awarded for any reasonable suggestion, not included in the suggested answers Total 4 9

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Peter Bush (a) Non-resident professional taxed at 15% on gross income Meaning of gross income hotel accommodation airfare 15% is the final tax Option to tax at 20% of net income Exemption on hotel up to 60 days Exemption on airfare Deduction for expenses incurred hotel engineering student 10 10 10 05 10 10 05 10 10 8 (b) Computation of gross income Tax payable at 15% Computation of net/chargeable income Tax payable at 20% Recommendation Identification of tax saving 10 05 15 05 10 05 5 (c) Requirement to withhold tax at 15%, as payment is to a non-resident Pay by the 15th of the following month Exercise option by informing the Inland Revenue within 45 days Inform SingCo for deduction of tax at 20% of net 10 05 15 10 4 17

Total

21

Marks 5 (a) Plan B Ltd Imports subject to GST Person with MES status exempt from GST on imports Proposal may not result in additional tax but unfavourable from cash flow standpoint, with reasons, for PBL VEPL Use warehouse in FTZ Not regarded as Singapore and supplies within FTZ not subject to GST As MES VEPL enjoys exemption on goods drawn from FTZ warehouse 10 10

20 15 10 20 15 10

(b)

Valerie Highest marginal tax rate of 20% applies Qualifying debt securities Structured products Hong Leong Finance Ltd Loan to a company taxability bad debt Australian funds taxability exchange difference 10 10 15 05 10 05 10 05 7 17

Total

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