A BIG, FRUSTRATING CONUNDRUM: REFLECTIONS ON SINGAPORE'S DEDUCTION REGIME FOR INTEREST AND OTHER BORROWING COSTS FOLLOWING BFC V CIT

Published date01 December 2015
AuthorJustin Jerzy TAN LLB (National University of Singapore); Advocate and Solicitor (Singapore); Sheridan Fellow, National University of Singapore.
Date01 December 2015
Citation(2015) 27 SAcLJ 506

In BFC v Comptroller of Income Tax[2014] 4 SLR 33, the Court of Appeal provided a clear and practical solution to a conundrum: how to prevent s 14(1)(a) of the Income Tax Act (Cap 134, 2014 Rev Ed) from being otiose? However, the solution has no basis, and leads to uncertainty regarding other deduction provisions. Further, one of the principles underlying the conundrum causes confusion regarding the distinction between the deduction and capital allowance regimes and should be discarded. Ultimately, this article argues that comprehensive legislative reform is the best solution to these issues, and makes some suggestions on the shape of the new rules. Lastly, the judgment raises a second, lesser conundrum: whether borrowing costs on working capital loans can ever be deducted.

I. Introduction

1 In the 2014 decision of BFC v Comptroller of Income Tax1 (“BFC CA”), the Court of Appeal appeared to have settled the law on the deductibility of borrowing costs, by explaining the relationship between s 14(1)(a) and s 15(1)(c) of the Income Tax Act2 (“ITA”). However, a closer examination reveals that the court's explanation was essentially an attempt to resolve a big, frustrating conundrum: how to prevent s 14(1)(a) from being otiose? In this article, the author argues that the court's solution, although clear and practical, should be discarded. The search for an alternative solution reveals that one of the principles underlying the conundrum should also be discarded. Ultimately, it will be submitted that comprehensive legislative reform is the best solution to these issues. Lastly, a second, lesser conundrum raised by the judgment in BFC CA will be highlighted.

2 This article is divided into six parts. Part I contains the introduction3 and Part VI the conclusion.4 Part II summarises BFC CA, and this includes a summary of the principles underlying our deductibility regime for borrowing costs.5 Part III discusses the big, frustrating conundrum: what it is, how the court solved it and why the court's solution is unsatisfactory.6 In Part IV, the author searches for an alternative solution to the conundrum, argues that one of the principles underlying the conundrum should be discarded, and ultimately concludes that the best solution is comprehensive legislative reform.7 Part V discusses the second, lesser conundrum: can borrowing costs on working capital loans ever be deducted?8

II. Summary of BFC CA

3 The taxpayer company owned and operated a hotel in Singapore. It wanted to raise money to (a) renovate its hotel; (b) refinance existing borrowings of itself and its subsidiaries; and (c) finance its day-to-day operations.9 To that end, the company issued bonds in 1995 and 1996.

4 Certain borrowing costs were incurred by the company from the bond issuance. These took the form of interest, discount and redemption premium components.10

5 About $36m of the bond proceeds was used to renovate the hotel. The remaining proceeds went into a mixed pool of funds, part of which was income producing and part of which was not. The Comptroller of Income Tax (“Comptroller”) allowed deductions on the interest paid on the $36m, and the proceeds that formed the income producing part of the mixed pool of funds.

6 However, the Comptroller disallowed deductions claimed by the company on the discount and redemption premium that were attributable to (a) the $36m spent on renovating the hotel; and (b) the income producing part of the remainder of the bond proceeds that went into the mixed pool of funds (collectively, the “Deduction Claims”). The company's appeal failed at the Income Tax Board of Review, the High Court and the Court of Appeal; ie, the Deduction Claims were ultimately rejected.

7 The Deduction Claims failed on two grounds. Firstly, the discount and redemption premium were not “interest”, and so could not be deducted under the relevant version of s 14(1)(a) of the Income Tax Act11 which applied only to interest and not other types of borrowing costs.12 Secondly, on the facts, the discount and redemption premium were capital expenditure and could not be deducted under the general deduction formula in s 14(1) of the ITA.13

8 The first ground, that the discount and redemption premium were not “interest” under s 14(1)(a), is uncontroversial. The court noted that while commercial men may consider that interest, the discount and redemption premium were all in substance compensation for the use of money, the legislative scheme has greater weight than the views of commercial men. In this regard, the court was of the view that the legislative scheme supported a narrower reading of “interest” for two reasons.14

9 Firstly, there is no justification to interpret “interest” broadly, because the general deduction formula in s 14(1) is already phrased broadly. Secondly, “interest” should be interpreted the same way throughout the ITA, unless the context clearly suggests otherwise. In this regard, the ITA as a whole treats “interest” and “discounts” as distinct things. Thus, s 10(1)(d) charges to tax certain income in respect of

“dividends, interest or discounts”, implying that “interest” and “discounts” are different things.15

10 What then did “interest” under s 14(1)(a) mean? The court stated that the essence of interest is compensation for the deprivation of the use or delayed payment of money by another.16 Not only that. Interest must also accrue with time. In other words, the total amount of interest payable depends on the duration of the loan.17 The discount and redemption premium did not have this feature, as they were fixed once and for all. Hence, they were not “interest” under s 14(1)(a).

11 As mentioned, the court's holding on the definition of interest is unsurprising. The court is bound by s 9A of the Interpretation Act18 to interpret “interest” purposively.19 Significantly, the court's holding on the definition of “interest” shows how two payments arising from the same arrangement and which differ more as to form than substance (ie, interest on the one hand, and the discount and redemption premium on the other), may have very different tax outcomes. In any event, the current version of s 14(1)(a) allows discounts and redemption premiums to be deducted,20 thus closing any gap between the result in BFC CA and the presumed views of commercial men (ie, that discounts and redemption premiums should be deductible as they are akin to interest).

12 The second ground for the failure of the Deduction Claims involved merely an application of existing law to the facts of the case. Nevertheless, it is useful to discuss the second ground as it provides a summary of the principles and approaches underlying our deductibility regime for borrowing costs, and these principles will be analysed in detail later in this article. The second ground is that on the facts of BFC CA, the discount and redemption premium were capital expenditure, and so were not deductible under the general deduction formula in s 14(1). This is because s 15(1)(c), which applies notwithstanding the provisions of the ITA, prohibits the deduction of capital expenditure.21 At the outset, the classification of the discount and redemption premium as capital or revenue expenditure was the same as the classification of the underlying loan's purpose; ie, the capital or revenue purpose for which the bonds were issued, objectively determined at the time of issue, unless there was a change in purpose. If the purpose was revenue in nature, the discount and redemption premium would be revenue in nature. Conversely, if the purpose was capital in nature, the discount and redemption premium would be capital in nature.22

13 In order to ascertain the purpose of the bond issuance, the court applied the approach set out by the Court of Appeal in Comptroller of Income Tax v IA23 (“IA”). This approach is as follows24 (“IA Approach”):

(a) Ascertain if there is a sufficient linkage or relationship between the loan and the main transaction or project for which the loan was undertaken.

(b) If, in (a) above, no, or an insufficient, linkage is established, the purpose of the loan must be merely to add to the capital structure of the taxpayer and is thus capital in nature.

(c) If there is a sufficient linkage between the loan and the main transaction for which the loan was undertaken, ascertain whether the main transaction is itself capital or revenue in nature; and the purpose of the loan will follow the nature of this main transaction.

14 Applying the IA Approach, the court in BFC CA made the following holdings.25 The first purpose of renovating the hotel was capital in nature since the hotel was a capital asset; ie, it was part of the company's permanent business structure. The second purpose was to refinance the existing loans of the company and its subsidiaries. This purpose was also capital in nature because there was no indication that the loans that were refinanced were linked to a main transaction that was revenue in nature. Lastly, the third purpose of financing the day-to-day operations of the company was capital in nature as well. This was because the company did not show any sufficient linkage or relationship between that part of the bond proceeds applied towards the third purpose, and a main transaction of a revenue nature.

15 Since all the purposes of the bond issuance were capital in nature, the bonds were capital in nature. Following from that, as the discount and redemption premium were derivative of the bonds, they shared the same classification as the bonds. In other words, they were capital in nature, and prohibited by s 15(1)(c) from deduction under s 14(1).

III. A big, frustrating conundrum: How to prevent s 14(1)(a)
from being otiose?

16 The most important parts of the judgment in BFC CA did not actually affect the outcome of the case. They relate to the court's ruling on the proper relationship between s 14(1)(a) and s 15(1)(c). In effect, the...

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