AQP v Comptroller of Income Tax

• Jurisdiction: Singapore
• Judge: Tay Yong Kwang J
• Judgment Date: 17 October 2011
• Neutral Citation: [2011] SGHC 229
• Court: High Court (Singapore)
• Docket Number: Income Tax Appeal No 1 of 2010/Y
• Published date: 09 April 2013
• Year: 2011
• Hearing Date: 06 July 2011
• Plaintiff Counsel: Nand Singh Gandhi (Allen & Gledhill LLP)
• Defendant Counsel: Julia Mohammed (Inland Revenue Authority of Singapore)
• Subject Matter: Revenue Law,Income Taxation
• Citation: [2011] SGHC 229

Tay Yong Kwang J: Introduction

This is an appeal concerning the question whether losses caused to a company by a fraudulent director (“the Ex-MD”) are deductible for income tax purposes under section 14(1) of the Income Tax Act (Cap 134, 2008 Rev Ed) (“the Act”). The Ex-MD had misappropriated company funds and caused the appellant to incur a loss of $12,272,917 (“the Loss”). A few years after the Loss, the appellant lodged a claim with the respondent seeking relief for the Loss under section 93A of the Act. The respondent rejected the appellant’s claim.

After hearing the parties and considering the evidence and the submissions, I now dismiss the appeal. I will set out the reasons for my decision after the outline of the relevant facts and the decision from which this appeal arises.

Facts Background

The appellant is a company incorporated in Singapore. It began as a sole proprietorship established by the founder, Mr B (“the Founder”) in 1956. It was initially involved in the trading of re-conditioned bearing products before becoming distributors of bearings and seals. In 1973, the sole proprietorship was incorporated as a company. On 10 November 1995, it was listed on SESDAQ. On 2 February 1998, it was upgraded to the SGX Main Board.

Among the children of the Founder who took over the management of the appellant was the youngest son Mr C (“the Ex-MD”). The Ex-MD entered into a service agreement with the appellant to hold office as Managing Director for three years commencing on 20 October 1995. The service agreement was renewed for a further term of three years from 20 October 1998. At all material times, he also served as a member of the Board of Directors.

On 1 December 1999, the Ex-MD was dismissed as both Director and Managing Director for misappropriation of the company’s funds as revealed by the investigations of the Commercial Affairs Department (“CAD”). The Ex-MD was charged and tried in the District Court.

The conviction of the Ex-MD

In Public Prosecutor v Kwek Chee Tong in DAC 48461/99 (“PP v KCT”), the District Judge (“the DJ”) convicted the Ex-MD of 24 charges of criminal breach of trust under section 409 of the Penal Code (Cap 224, 1985 Rev Ed) and sentenced him to a term of nine years in prison.

During the trial, it was revealed that the Ex-MD’s modus operandi was to make out false purchase orders to the appellant’s suppliers for the purchase of bearings, the appellant’s stock in trade. Based on these false purchase orders, several cheques were issued to him or his nominees on his claim that he had advanced money from his personal account to the appellant to make the purchases. He also falsely claimed that he had made loans to the appellant’s customers for their purchases against which he reimbursed himself from the appellant’s funds.

In reality, the Ex-MD used the misappropriated company funds to pay for his gambling debts and for personal use (at [151]). The DJ found at [284] that:

The evidence revealed that no one questioned [the Ex-MD’s] instructions. There was total trust reposed in the accused by virtue of his senior management position. In evidence he said that he need not have to tell anyone about, and (as a fact) he had complete control over, the usage of [the appellant’s] funds. He had access to millions of dollars as [the appellant] was a public listed company at the material time.

The DJ also considered the following aggravating factor at [288]:

There was another aggravating factor: the blatant way in which the monies were siphoned from the company, some in the form of cash cheques, others as company cheques, made out directly in the names of or given to, junket operators, or individuals with no trade dealings with [the appellant]. In most instances the company’s funds were used to repay the accused’s gambling debts and feed his gambling habit. The effect on the victim company (as well as the financial market) would be an erosion of confidence.

The actions leading to the current proceedings

After the Ex-MD’s misappropriation came to light, the appellant made provisions for doubtful debts of $12,410,141 inclusive of the Loss in its statutory accounts under Extraordinary items for the year ended 31 December 1999. However, no claim for deduction for the Loss was made for the Year of Assessment 2000 (“YA 2000”).

In 2003, the appellant instituted legal proceedings against the Ex-MD for the amount misappropriated and obtained judgment against him. However, recovery proved fruitless and the Ex-MD was subsequently adjudged bankrupt.

On 15 December 2005, the appellant lodged an “error or mistake” claim for the Loss under section 93A of the Act with the respondent. By a letter dated 1 December 2008, the respondent made a determination that relief could not be granted “as there is no error or mistake within the meaning of Section 93A of [the Act]”.

The appellant then filed a Notice of Appeal to the Income Tax Board of Review (“the Board”) on 5 December 2008. This was followed on 30 December 2008 by the Petition of Appeal seeking an order (among other things) to direct the respondent to grant relief to the appellant under section 93A of the Act and to allow the Loss as a deduction for YA 2000 under section 14(1) of the Act.

The decision of the Income Tax Board of Review

The Board referred to the English approach in Curtis (HM Inspector of Taxes) v J & G Oldfield, Limited (1925) 9 TC 319 (“the Curtis test”) and came to the conclusion that the Loss sustained by the appellant was not deductible under section 14(1) of the Act. The appellant’s appeal was therefore dismissed.

In applying the Curtis test to the facts of the present case, the Board took particular notice of the power or control the Ex-MD had wielded in the appellant at [17]:

Besides being the Managing Director the Ex-MD was a substantial shareholder. Both directly and through his family company D Pte Ltd his interest or deemed interest ranged between 12.8% to 14.9%. This is a substantial shareholding. As a substantial shareholder and Managing Director, and based on the evidence, the Ex-MD was in the language of Rowlatt J supra “in a position to do exactly what he likes”.

The Board reasoned that the Loss was not deductible since the Ex-MD was “in the same position as the managing director in the Curtis case”. The Board further held that the Curtis test (as understood and applied by the Board) is consistent with subsequent cases such as The Roebank Printing Company Limited v The Commissioners of Inland Revenue (1928) SC 701, 13 TC 864 (“The Roebank case”) and Bamford (HM Inspector of Taxes) v ATA Advertising Ltd (1972) 48 TC 359 (“Bamford”).

The Board then went on to opine on the issue of whether the appellant’s omission to set off the Loss in YA 2000 could qualify as an “error or mistake” under section 93A(1) of the Act, if the Loss were deductible. The Board held that the omission by the appellant was not “due to oversight” as “it was a decision made after due consideration that the Loss was not an allowable deduction under section 14 of the Act” (at [28]). However, the Board agreed with the appellant’s argument that “[i]f the decision was a mistake it was one of law and still a mistake falling within section 93A of the Act”. Nonetheless, the Board held that this was an academic point as it had already decided that the Loss was not deductible.

The issues on appeal

Two issues arise on appeal: Did the Board err in holding that the Loss incurred by the appellant was not wholly and exclusively incurred by the appellant in its production of income under section 14(1) of the Act? Did the Board err in holding that an erroneous opinion or a grossly negligent error, such as a mistake of law, can constitute an “error or mistake” under section 93A of the Act?

Deducibility of losses incurred as a result of defalcation The Curtis test

Section 14(1) of the Act stipulates the deductions a taxpayer is allowed to make against taxable income:

For the purpose of ascertaining the income of any person for any period from any source chargeable with tax under this Act (referred to in this Part as the income), there shall be deducted all outgoings and expenses wholly and exclusively incurred during that period by that person in the production of the income...

Section 15(1)(b) reinforces section 14(1) by emphasizing that any other types of disbursements or expenses “not being money wholly and exclusively laid out or expended for the purpose of acquiring the income” are not allowed as deductions.

The statutory framework thus emphasizes that the touchstone for deductibility of expenses is that they must necessarily be incurred for the specific purpose of the production of income. The Court of Appeal in Pinetree Resort Pte Ltd v Comptroller of Income Tax [2000] 3 SLR(R) 136 stressed (at [47]) that section 14(1) “requires a nexus between the incurrence of the expense and the production of income.” [emphasis added]

The general requirement of a “nexus” in the relevant statutory provisions, however, does not in itself shed light on how losses sustained by a company due to the defalcation of an employee is to be treated. When would losses resulting from defalcation have sufficient nexus to be considered “wholly and exclusively incurred ... in the production of the income”?

In the seminal case of Curtis (HM Inspector of Taxes) v J & G Oldfield, Limited (1925) 9 TC 319 (“Curtis”), the managing director of the company was, up to the time of his death, in control of its business in wines and spirits. An investigation after his death revealed that many payments and receipts not relating to the company’s business but to his private affairs had passed through the company’s books. The amount was accordingly written off as a bad debt. A dispute then arose between the company and the Revenue as to whether the said loss had “arisen in the course of a company’s trading”...