A common question for most SME that has and receives overseas income is whether such income is taxable. As simple a question as it seems to be, it is however, not so straight forward. Underlying the question, are two key conditions, the concept of where is the source of income and is it ‘received or deemed received’ under s10(25) of the Income Tax Act (ITA). Between the two conditions, the locality of the source of income is usually the more complex and contentious. Although there are no standard rules that we can apply on every scenarios, there are some fundamental principles that we could follow.
- Whether you have a principal place of business in Singapore
The broad rule is the source of income usually follows where the operations which produced the relevant income is located. The simplest scenario is where you have no overseas business presence and the only principal place of business is located in Singapore, the overseas income is likely to be treated as sourced in Singapore.
- Where is the place where the deal or contract is concluded
The broad rule is to identify the place where the major work relating to the conclusion of the deal is substantially performed. Although the place where the contract is legally signed and executed is important, it is not conclusive. The fundamental principle of major work relating to supply chain leading to the conclusion which includes the structuring, negotiation, post execution of the contractual terms bears equal importance. End of the day, one must be able to conclusively demonstrate the major commercial performance is done at the country of source.
- Nature and quality of activities
Key determining factors will depend on the nature and the importance of each activity leading up as well as recurring post-sales to the deal conclusion. These will include an assessment of how substantial is the following activities being performed in the locality:
- Initial raining-making activities performed by the sales or commission agents.
- Extent and nature of negotiation activities.
- Main performance of legal and compliance work.
- Management and control of the entity.
In the recent IRAS Advance Ruling Summary No. 3/2021 published on 1 Apr 2021, some of the key takeaway points are worth noting. This advance ruling concluded that overseas franchise income derived by a company is sourced in Singapore and it is taxable on an accrual basis.
Facts of the case:
Group X is a MNC operating internationally and has no business presence in Singapore relating to its international franchise activities. As part of its internal business restructuring, it intends to incorporate a new company (Co A) in Singapore to:
- Takeover all the legal and economic rights to all intangible assets which include IP (on which the franchise income is accruing) from its overseas subsidiary company B.
- All existing contracts that Co B has will be transferred to Co A and that include major franchise agreement that Co B has with Co C (an overseas related company under Group X). Therefore, Co A will receive all overseas franchise income from Co C that Co B is receiving.
- All existing operational activities relating to global relations and transactions will remain unchanged. These are majority performed outside of Singapore by non-resident employees outside of Singapore.
- All conclusion of contracts relating to IP rights will continue to be negotiated and executed outside of Singapore.
- The tax residency of Co A will be established in Singapore. The management and control of Co A will be exercised in Singapore by ensuring a Board with a majority of Singaporean that will hold and execute all key decisions in Singapore.
- A management establishment will be created with the managing director and its office in Singapore to perform the following:
- Key franchisee management including monitoring of franchisees’ terms of compliance and franchisee business performance and reporting any non-compliance or non-performance to the Board
- Regular reporting to the Board on the daily operations (relations/transactions, deal negotiation/execution etc) performed outside Singapore
- Statutory compliance relating to maintenance of accounts and records
- Financial management including annual budgeting and business plans
- Development of long-term staffing plans
Key takeaway points:
- Incorporation of a new entity to takeover an existing entity is not deemed to be “tax driven” (and not likely to be challenged IRAS) as long as it is done with bona fide commercial reason (ie internal business restructuring).
- It is not necessary for the new entity to assume all the major key activities as long as it can be demonstrated that a management and control structure resides in Singapore and there are legitimate commercial reasons for such activities to remain overseas (to minimise disruptions to it global relations). Specifically, majority of the deal conclusion (execution, relationship management, negotiation) remains overseas and are done outside of Singapore by non-resident employees outside of Singapore.
- The management of the franchise business and the establishment of the independent operation of its management office (MD and supporting team) must reside in Singapore.
- The Control of the franchise business and its Board must be established in Singapore.
There is no conclusive answer to the taxability of overseas income as it depends on the specific facts in each scenario. However, it is accords a bit more clarity in the murky water of taxability of overseas income with the latest IRAS advancing ruling.