Following from IRAS guidance in Nov 2019 on advisory to all medical professionals that conduct their medical practice through companies, it seems that it is no longer as critical as a perquisite onus on the taxpayer at the onset of the corporatisation to substantiate that the sole motivation is not driven by tax benefit and that there exists a commercial basis.
The key facts of the case:
A dentist GCL was employed and paid a market salary by YCO (an orthodontic clinic). He subsequently incorporated a company, XCO with himself as sole director and shareholder. He then resigned his employment with YCO. XCO entered into a dental service agreement with YCO, to provide dental service. The tax payer in fact provided the same services to YCO as an employee before XCO incorporation, and through XCO under contract for service after incorporation. YCO paid a service fee to XCO. XCO would then pay dividends and a salary (a significantly lower amount based on the taxpayer personal upkeep and maintenance) to the taxpayer.
2 key relevant points and conclusion are made by the Board
- Whether Incorporating a company to receive income for the provision of dental services (previously received directly by the taxpayer) constitute a tax avoidance arrangement under s33.
This was ruled as NOT a tax avoidance arrangement but an acceptable commonly and widely adopted bona fide commercial set-up. The “predication principle” is applied as when an arrangement is objectively capable of explanation by reference to ordinary business or family dealing, then the arrangement is not an act of tax avoidance.
It would suffice that at the time of incorporation, that the taxpayer chose a form of business structure that would give him the intended commercial advantages. It is irrelevant whether the taxpayer actually followed his original intention at the point of incorporation to realise or avail himself of such stated benefits (business expansion, financing) subsequently. However, contemporaneous documentation of the reasons and commercial decisions of the execution or non-execution of the original intended basis of incorporation would help to provide clarity to the arrangement before and after incorporation.
2. Whether the arrangement before and after the incorporation specificially relating to the level of taxpayer remuneration constitutes a tax avoidance arrangement under s33.
The significantly lower salary paid to the taxpayer after incorporation through XCO (in the form of salary) vs the salary paid directly to the taxpayer before incorporation was ruled to be NOTa bona fide transaction and therefore constitute a tax avoidance structure.
Given that the taxpayer role is essentially the same before and after incorporation and the arrangement relating to the significantly lower salary cannot be explained by reference to ordinary business or commercial basis, or otherwise substantiated by the taxpayer, the arrangement failed the bona fide commercial reasons. Nevertheless, it may still fail the bona fide test if the arms-length rule under s34D is invoked and this significantly lower salary would have not passed the “arms-length” basis.
From the above Board decision, it would appears that if the taxpayer remuneration before (as salary directly paid by YCO) and after (as salary paid by XCO as sole director/employee) incorporation remains the same, the arrangement would have been likely to be ruled as bona fide. Unless s34D is applied on the basis that the salary is significantly lower than the market and therefore not on ”arms-length”.
This latest decision by the Board provides some extent of relief to the professionals that incorporation itself does not constitute tax avoidance but rather the arrangement after incorporation eg the level of remuneration would be more critical.