September 2002

Tax & Revenue

WHEN INTEREST-FREE LOANS BECOME

TAXABLE

What Are Interest-Free Loans
............................................ 1
Implications Of Interest -Free
Loans .................................. 1
Interest Free Loans To
Directors And Executive
Employees........................... 2
Every working adult is fully aware of his obligations to pay taxes on the income
he earns. But the exact scope of what constitutes income can be somewhat
difficult to ascertain to the undiscerning. Put very simply, any moneys or
benefits in kind which an individual receives as a consequence of his
employment may be considered income and made subject to tax. Section
10(1)(b) of the Singapore Income Tax Act allows the Comptroller of Income
Tax at the Inland Revenue Authority of Singapore (IRAS) to charge to tax
‘gains and profits from any employment’. This could include the free holiday
one receives as part of an incentive scheme, the incentive payments for good
attitude at work, and yes, the interest-free loan that one gets from being
employed at the particular organisation.
This Update discusses when an income or deemed income will be taxable.
Special focus is given to the discussion on interest-free loans received by
executive employees and directors.

Concessionary Penalties..... 2

Action Required .................. 3

What Are Interest-Free
Loans
Interest-free loans are simply loans
granted by an employer (company)
to an employee for which the
employee need not pay any
interest. In other words, only the
capital sum taken need be repaid
by the borrowing employee to the
employer (company).
Such interest-free loans are most
frequently taken by directors and
executive employees at small and
medium sized businesses for varied
reasons. Such a loan could be
taken to buy a property or to buy
stocks and shares in another
company. (To take an interest-free
loan to buy stock and shares in the
same company itself raises issues
of potential financial assistance
under the Singapore Companies
Act.)
Implications Of
Interest-Free Loans
In line with the old adage that
nothing comes for free, there is a
tax cost to an employee who takes
an interest-free loan from his
employer. This arises from the
amount of interest that an employee
would have had to pay if the loan
were taken from a third party, eg a
bank. That interest is considered by
IRAS as a gain or profit to the
employee from his employment and
therefore subject to income tax.
Interest-free loans or even
subsidised loans to all employees
are deemed taxable by IRAS
because they falls under the term
‘perquisite’, ie benefit-in-kind, within
the extended meaning of ‘gains or
profits from any employment’ under
Section 10(2)(a) of the Singapore
Income Tax Act. The value of the
benefit is deemed by IRAS as the
amount of interest payable on the
loan taken as calculated at bank
prime lending rate.
Another implication is that an
employer is required to report the
taxable benefits in the employee’s
annual Return of Employee’s
Remuneration (Form IR8A). IRAS

© Rajah & Tann, Knowledge & Risk Management September 2002

Page 1

Corporate & Capital Market
may impose penalties on employers
for non-reporting or for under-
declaring their employees’ taxable
benefits when reporting the income
of the employees for each year of
assessment in these forms,
whether manually or electronically.
Interest Free Loans To
Directors And
Executive Employees
The decision by IRAS to embark on
the taxation of directors and other
employees in respect of interest-
free loans is believed to have
originated from the decision of the
Income Tax Board of Review last
year in Ng Yew Keng & Ng Yew
Hwee v CIT. In that case, it was
held that directors of a company
were to be regarded as employees
for the purpose of determining
benefits-in-kind which were subject
to income tax. In response to
representation on this issue, IRAS
issued a ruling dated 2 July 2002
providing an administrative
concession from such taxation
where loans are made to
employees who do not have control
or influence over the company. But
IRAS regards directors and
executive employees as having
control or influence over the
company. As such, they do not fall
within the scope of the
administrative concession provided.
The interest-free loan, in such
cases, will therefore be taxable.
In the case where the director or
executive employee is also a
shareholder, it is possible that the
loan could have been extended to
the individual in his capacity as a
shareholder. If so, the benefit
derived from the non-payment of
interest is not taxable as part of his
employment income. As such, the
interest element saved will not
amount to a perquisite or be a
taxable benefit to the individual.
Where, however, the interest-free
loan is made to the executive
employee or director-cum-
shareholder of a company in his
capacity as an employee (someone
© Rajah & Tann, Knowledge & Risk Management
Page 2
having management control) or to a
person in his capacity as a director,
the interest-free element will be
deemed by IRAS an employment
gain in his hands. As such, the
interest element is a taxable
benefit. The taxable value of this
benefit is calculated based on the
prime interest rate of banks.
In its ruling, the IRAS makes clear
that whether the loans to the
executive employee or director-
cum-shareholder is provided to him
in his capacity as a shareholder or
as an executive employee or
director is a question of fact to be
ascertained on a case-by-case
basis. The following facts are
examples which suggest that the
loan provided is not a taxable
perquisite:
• There are bona-fide reasons for
the loan arrangement, without
tax being the primary reason.
• The loans do not represent
remuneration or benefits
relating to employment but are
disguised in the form of loans.
In other words, there must be
genuine intent for a creditor-
debtor relationship to exist, with
a reasonable expectation of the
loans being repaid.
• The loans are extended to all
shareholders rather than only to
executive employees and
directors who are also
shareholders, under similar
loan terms and the loan
quantum determined on similar
basis.
• Documentary evidence that the
loans are made in the
employee’s capacity as
shareholders.
The IRAS may initiate inquiries or
make visits to companies’ premises
to request for details of interest-free
loans provided to its directors or
executive employees. Where
companies and their directors or
other executive employees face
these tax issues, it is important to
take a pro-active approach and
initiate contact with IRAS, through
September 2002
September 2002
professional tax advisors if need be,
early and before IRAS commences
a tax audit or tax investigation into
the affairs of the company and its
directors or executive employees.
This is because through voluntary
disclosure, it is possible to resolve a
tax case with IRAS on the basis of
minimal penalties, or even no
penalties at all if there should be
any tax chargeable in the first
place. Once such an enquiry has
been instituted by the IRAS, the
company and its personnel may
face enhanced penalties which are
a multiple of the tax involved rather
than a fraction of it.
Concessionary
Penalties
In cases where the tax liability for
interest-free loans is clear,
voluntary disclosure would be the
best policy. In its ruling, IRAS has
indicated that it will consider
imposing concessionary (minimal)
penalties rather than full penalties,
but only if the taxpayers or
employers voluntarily come forward
to disclose any past omissions or
under-declaration of income. These
penalties are calculated based on
10% of the tax undercharged per
annum for each back year of
assessment. In this regard, the
IRAS is encouraging taxpayers to
come forward early and inform the
IRAS before 30 October 2002 of
such benefits they have derived for
all past years.
Action Required
In assessing the right option to
take, a first step would be to review
whether the present fact situation of
interest-free or subsidised loans
taken by company employees
(including directors), falls within the
tax net as cast by IRAS. Where the
tax liability is not clear, an
assessment to tax may be resisted
on valid grounds, and the
imposition of unlawful penalties
likewise. For companies and their
employees who do fall within the
net, the next step is to seek a
 September 2002

Corporate & Capital Market

settlement with IRAS as early as tax prosecution in the Raffles Town
possible on the quantum of the Club case last year is another
taxes involves and the applicable reminder for timely action. Further,
concessionary penalties. based on prosecutions for tax
offences earlier this year, the
Penalties for undeclared income
current judicial attitude appears to
may be for notional income as in
be that tax offences warrant
the case of a deemed benefit from
imprisonment. This potential loss of
a deemed employment like an
liberty should also be taken into
interest-free loan, or for an actual
account.
item of income like bank interest
earned and received but As the deadline of 30 October 2002
undisclosed. draws near, critical decisions would
need to be made on how the
In either case, the imposition of
company and its affected personnel Soon Choo Hock
penalties is the legal recourse
wish to address these tax issues, Executive Partner
available to IRAS in lieu of
which may extend for several back
prosecution. The implication is that
years of assessment, and the Contact Details
after 30 October 2002, cases under
implications of any course of action, Direct: (65) 62320656
audit or investigation by IRAS may
or even non-action, should be Facsimile: (65) 64380248
be slated for court prosecutions, if
carefully considered. E-mail: choo.hock.soon
the higher penalties (eg at 20% of
@rajahtann.com
the tax involved) are not agreed to
by the taxpayers concerned. The

Sundareswara Sharma
Partner
Rajah & Tann is one of the largest law firms in Singapore. It is a full service
firm and given its alliances, including US premier firm Weil, Gotshal & Manges, Contact Details
is able to tap into resources in a number of countries. Direct: (65) 62320453
Rajah & Tann is firmly committed to the provision of high quality legal services. Facsimile: (65) 64380248
It places strong emphasis on promptness, accessibility and reliability in
dealings with clients. At the same time, the firm strives towards a practical yet E-mail: sundareswara.sharma@
creative approach in dealing with business and commercial problems. rajahtann.com

The information contained in this Update is correct to the best of our knowledge and
belief at the time of writing. The contents of the above are intended to provide a
general guide to the subject matter and should not be treated as a substitute for
specific professional advice for any particular course of action as the information
above may not necessarily suit your specific business and operational
requirements. It is to your advantage to seek specific legal advice for your specific
situation. In this regard, you may call the lawyer you normally deal with in Rajah &
Tann or e-mail the Knowledge & Risk Management Group at
eOASIS@rajahtann.com.

© Rajah & Tann, Knowledge & Risk Management September 2002

Page 3