Tax Bulletin ACC v Comptroller of Income Tax – Latest updates

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Tax Bulletin
ACC v Comptroller
of Income Tax
– Latest updates
In this issue, we provide an
update on the case of ACC v
Comptroller of Income Tax
[2010] SGHC 316
November 2010
The case of ACC v Comptroller of Income Tax [2010]
SGHC 316
In a landmark decision handed down on 25 October 2010, the Singapore High Court
ruled that interest rate swap (IRS) payments to non-residents are not ordinarily subject
to withholding tax, overturning the practice adopted by the Inland Revenue Authority of
Singapore (IRAS) for many years in relation to payments under financial derivatives
contracts. In handing down this decision, the courts gave clarity to an issue which has
long been the subject of disagreement between the IRAS and taxpayers. While the
outcome of this case would no doubt be well-received by taxpayers, a careful
consideration of the reasoning behind the decision is necessary for a proper
understanding of the scope of its application to financial derivatives.
Overview of the case
The facts of the case are as follows:

A Singapore-incorporated and tax resident company (“SG Co”) and its overseas
subsidiaries were in the business of aircraft leasing. The majority of the
subsidiaries were special purpose companies (SPCs) incorporated in the
Cayman Islands and were not resident in Singapore.

Each SPC owned only one aircraft, and each SPC entered into a loan agreement
with offshore banks to finance the purchase of its aircraft. In the event that the
lease entered into by an SPC was at a fixed-rate rent, the SPC would be exposed
to interest rate fluctuations if its financing were at a floating rate. To hedge the
interest rate risk exposure in this case, the SPC would enter into an IRS
whereby:
- the SPC would pay the counterparty fixed rate payments computed as a
fixed percentage of a notional amount; and
- in exchange, the counterparty would pay to the SPC on the same dates
the floating rate percentages of the same notional amount.

To reduce the administrative burden and to dispense with guarantees that SG
Co would otherwise have to put up if each SPC were to enter into the IRS
separately, SG Co put in place an arrangement whereby it would enter into an
IRS with Singapore banks or Singapore branches of foreign banks. SG Co would
then enter into back-to-back IRS agreements with the SPCs. No tax deduction
was claimed by SG Co on IRS payments to the SPCs, and the receipts from the
banks on the IRS were not brought to tax in SG Co’s hands.

SG Co sought confirmation from the Comptroller that withholding tax was not
applicable to the IRS payments made by it to the SPCs. The Comptroller
disagreed.

SG Co then applied for a court order to quash the Comptroller’s determination.
The High Court found that the IRS payments by SG Co to the SPCs were not
payments in connection with any loan or indebtedness, and as such, there was
no requirement to withhold tax. The application to quash the Comptroller’s
determination was thus granted.
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Diagram 1: Illustration of ACC case facts
Analysis of arguments submitted
In arriving at the conclusion above, Andrew Ang J considered the following arguments
put forth by the taxpayer and the Comptroller.
Meaning of “any other payment”
Withholding tax applies to payments that fall within the scope of section 12(6)(a). The
scope of section 12(6)(a) was widened in 1977 to include “…commission, fees or any
other payments in connection with any loan or indebtedness or with any arrangement,
management, guarantee, or service relating to any loan or indebtedness…”.
As all parties agreed that the IRS payments were not interest, commission or fees, the
main point deliberated was whether the IRS payments may be considered “any other
payments in connection with any loan or indebtedness”.
The judge applied the principle that words of wide import are to be interpreted with
reference to the narrow or specific meaning of associated words in the same text, so that
they refer to matters of the same limited character. The words “any other payment”
were construed as some form of consideration accruing to the payee in return for some
benefit conferred by the payee to the payer, following the narrow meaning of the words
“interest, commission, fees”.
Meaning of “in connection with”
The key requirement to consider in this case was the meaning of the phrase “in
connection with” in section 12(6)(a). The Comptroller contended that the IRS payments
were made in connection with the loans between the SPCs and the offshore banks.
Adopting the purposive approach to statutory interpretation, the judge held that the
widening of section 12(6)(a) was intended to include payments that are of similar nature
to interest, and arose as a result of obtaining financing. The words “in connection with”
should not be interpreted to include a loan or indebtedness not involving the Singapore
payer. The connection between the payment and indebtedness has to be evident in that:

The payment borne is in consideration for the benefit of financing provided.

The obligation to make the payment arises out of the indebtedness.
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Do IRS agreements constitute loans or indebtedness?
The judge emphasised that under the IRS, no funds were passed under a loan or
indebtedness from one IRS counterparty to the other. He further noted that, at the point
of entering into the IRS agreement, it cannot be ascertained which of the counterparties
will be indebted to the other in relation to the net payment that has to be made under
the agreement. Based on the above, he concluded that no loan or indebtedness was
involved in an IRS agreement, and any payment made on such agreement would not be
in connection with any loan or indebtedness. As such, withholding tax does not apply to
the IRS payments by SG Co to the SPCs.
Do IRAS’s practice and subsequent legislation bear any weight on
interpreting tax provisions?
In response to further arguments extended by the Comptroller to support the wider
interpretation of section 12(6)(a), Andrew Ang J made the following points:

The current practice of the tax authority does not explain the meaning or justify
the interpretation of legislative provisions.

Subsidiary legislation made under a different section of the Income Tax Act
which provided for withholding tax exemption for IRS payments, particularly
after a long period of time (13 years in this case), should not be taken as a guide
as to Parliament’s intention for the language used for section 12(6)(a).
Guidance provided by the case
The decision by the High Court in this case should be welcomed by taxpayers, as it has
alleviated, to a certain extent, the uncertainty around the Singapore withholding tax
treatment of IRS and other financial derivatives. The judge has laid out some guidelines
on how to interpret the words “any other payment in connection with any loan or
indebtedness” in section 12(6)(a).
It is also reassuring to note that the judge has confirmed that taxing provisions should
be clear and unambiguous, and that tax should not be levied by inference. Having
withholding tax exemptions in place does not necessarily mean that the payments are
subject to withholding in the first instance. These exemptions may have been introduced
by the Government to facilitate business operations in view of uncertainty (as is the case
of withholding tax on IRS), but they do not necessarily lead to a conclusive
interpretation of the law or an explanation of the intended purpose of the law. As such,
while there is currently also a withholding tax exemption in place for over-the-counter
financial derivatives, this does not necessarily mean that payments on such transactions
are definitely subject to withholding tax in the first place.
3
Question not addressed
In the ACC case, it was clear that the SPCs entered into the IRS to hedge their loans with
offshore banks. However, the question of whether the IRS payments may be considered
“any other payment in connection with… any arrangement… relating to any loan or
indebtedness” was not addressed in this judgment.
Take the scenarios set out in Diagrams 2 and 3 for example. Does the fact that the IRS
was entered into to hedge a loan (or an asset in Diagram 3) result in the IRS payments
being considered payments “in connection with any arrangement relating to any loan or
indebtedness”? It therefore remains an open question as to the extent of connection the
arrangement, management or service has with a loan or indebtedness before they fall
within the ambit of section 12(6)(a).
Diagram 2
Diagram 3
What are the implications?
Request tax repayment for similar cases
For cases in which tax on IRS payments has been withheld and accounted for to the
IRAS, there is an avenue to request tax repayment under section 93 of the Income Tax
Act within the specified time limits.
Apply the guiding principles of the ACC case to other derivatives
transactions
The factors to consider when ascertaining whether IRS payments fall within the scope of
section 12(6) (and hence are subject to withholding tax) set out above should similarly
apply to other derivatives, given the generality of the analysis carried out by the court in
this case. Having said that, taxpayers should not assume that all payments on IRS and
other derivatives will not be subject to withholding tax. One should still consider the
factors discussed above and ascertain on a case-by-case basis, whether the payment on
the financial derivative in question may be subject to withholding tax (e.g. disguised
loans).
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