BML v Comptroller of Income Tax

• Jurisdiction: Singapore
• Judge: Choo Han Teck J
• Judgment Date: 05 June 2017
• Neutral Citation: [2017] SGHC 118
• Date: 05 June 2017
• Docket Number: HC/Tax Appeal No 29 of 2016
• Published date: 31 August 2018
• Plaintiff Counsel: Ong Sim Ho, Joanne Khoo, and Keith Lam (Ong Sim Ho)
• Defendant Counsel: Foo Hui Min, David Lim, and Christopher Lim (Inland Revenue Authority of Singapore)
• Court: High Court (Singapore)
• Hearing Date: 31 March 2017
• Subject Matter: Revenue statutes,Income taxation,Statutory Interpretation,Deduction,Appeals,Revenue Law

Choo Han Teck J:

This is an appeal under s 81(2) of the Income Tax Act (Cap 134, 2014 Rev Ed) (“the Act”) against the Income Tax Board of Review’s decision (“the Board”) in Income Tax Appeal Nos 19-23 of 2013, regarding the interpretation of s 14(1)(a) of the Act on the deductibility of interest expenses upon money borrowed for capital employed in acquiring income.

The appellant owns and operates a mall (“the Mall”). Company A and Company B each hold 50% of the issued share capital of the appellant (“the shareholders”). On 20 October 2004, the appellant entered into a facility agreement with a special purpose company for the appellant to borrow a sum of $520m (“the Loan”). The Loan was made in consideration of periodic interest payments. It was secured by a fixed charge over a set of accounts to be opened and maintained by the appellant and an assignment of the rights to the tenancy agreements and rental income of the appellant. This $520m was based on the full market value of the Mall. $170m of the $520m was used by the appellant to refinance its borrowings and the balance of $350m was lent to the shareholders as interest-bearing loans.

This meant that the appellant was unable to declare dividends that it might have done but for its having to repay the Loan. The shareholders then decided to convert their equity holding in the appellant into a debt-based investment. This would allow them to earn a return in the form of interest since they would not be getting dividends. To achieve this, the shareholders resolved to reduce the share capital of the company at an extraordinary general meeting on 26 November 2004. This was done by capitalising $325,300,000 from the appellant, paying it up in full ordinary shares and issuing it to the shareholders in equal proportions, and reducing the appellant’s capital by a sum of $333,000,000 from $335,500,000 to $2,500,000. This capital reduction was approved by Justice V K Rajah on 2 December 2004. Upon the capital reduction, a debt of $333m became due and payable to the shareholders. Instead of returning cash to the shareholders, the appellant issued fixed rate subordinated bonds for an aggregate amount of $333m, and the shareholders each subscribed for 50% of the issue (“the shareholder bonds”).

The interest paid by the appellant on the shareholder bonds is the subject of the present appeal. The question is whether the appellant is entitled to claim these interest payments as deductions in ascertaining its taxable income under s 14(1)(a) of the Act. The Comptroller of Income Tax (“the Comptroller”) disallowed such deductions in the Years of Assessment 2005 to 2009.

The Board’s decision

The appellant appealed against the Comptroller’s decision to the Board under s 79(1) of the Act. On 8 November 2016, the Board dismissed the appeal and upheld the Comptroller’s decision to refuse deductions of the interest expenses on the shareholder bonds against the rental income of the Mall. It found that the test in s 14(1)(a) of the Act was whether there was a “direct link” between the money borrowed and the income produced. This link had to be “real, tangible, precise and factual”. On the facts, the Board found no direct link between the shareholder bonds (the money borrowed) and the Mall’s rental income (the income produced) as the Mall’s rental income was derived independently from the issuance of the shareholder bonds. This was because: The Mall was owned by the appellant and generating rental income before the shareholder bonds were issued. There was no cash flow impact generated by the shareholder bonds. No moneys were generated by the shareholder bonds – the change of the capital structure of the appellant from an equity-based to debt-based structure was reflected only by accounting entries; The shareholder bonds were issued for the purpose of allowing the shareholders to obtain a return in the form of interest rather than helping them to preserve the Mall or generate more rental income. There was in fact no need to issue the shareholder bonds to preserve the Mall. The appellant had sufficient working capital to hold the Mall and it would have been inconceivable for the shareholders to sue the appellant to satisfy the debt arising from the capital reduction. There was thus no real threat to the continued operation of the Mall; It was clear from the entire series of transactions from the Loan to the issuance of the shareholder bonds that the moneys obtained from the shareholder bonds had no connection with, and was superfluous to, the equity capital of the appellant; and The appellant’s capital restructuring was not a case of “substituted financing” and it could not therefore rely on the Australian case of Yeung v Federal Commission of Taxation (1988) 88 ATC 4193 (“Yeung”). Even if it was a case of substituted financing, the test of “direct link” would still not have been satisfied.

The present appeal

The appellant appeals to this court on the basis that the Comptroller and the Board had interpreted s 14(1)(a) of the Act wrongly. The provision reads:

Deductions allowed

14.---(1) For the purpose of ascertaining the income of any person 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, including – (a) except as provided in this section – (i) any sum payable by way of interest; … (ii) …

upon any money borrowed by that person where the Comptroller is satisfied that such sum is payable on capital employed in acquiring the income

The question thus is whether the interest paid by the appellant on the shareholder bonds is a “sum payable by way of interest… upon any money borrowed by that person where the Comptroller is satisfied that such sum is payable on capital employed in acquiring the income”. If so, that interest would be deductible as against that particular income for tax purposes. It is not disputed by the parties that this is all that the statute requires. The Court of Appeal held in BFC v Comptroller of Income Tax [2014] 4 SLR 33 that for interest expenses to be deductible under s 14(1)(a) of the Act, the general deductibility test in s 14(1) of the Act (that the expense be “wholly and exclusively incurred… in the production of the income”) does not need to be fulfilled (at [10]). Section 14(1)(a) of the Act is also an exception to the prohibition against deductions of capital expenditure in s 15(1)(c) of the Act (at [39]). This means that although interest expenses payable on capital employed in acquiring the income are nonetheless considered capital expenditure, they are deductible pursuant to s 14(1)(a) of the Act.

The parties disagree over the factors that the Comptroller can take into account when deciding whether the interest is payable on “capital employed in acquiring the income”. In particular, the appellant argues that the Comptroller is not empowered by s 14(1)(a) of the Act to look behind the transaction into the subjective purpose or necessity of the money borrowed when he determines whether the interest is indeed payable on capital employed in acquiring the income. The Comptroller’s case is that the test of whether there is a “direct link” between the money borrowed and the income acquired is a question of fact, including the purpose for which the money is borrowed and whether the money borrowed was necessary for the acquisition of income.

The test under s 14(1)(a) of the Act

The leading case on the interpretation of s 14(1)(a) of the Act is Andermatt Investments Pte Ltd v Comptroller of Income Tax [1995] 2 SLR(R) 866 at [26]-[27] (“Andermatt Investments”). Andermatt was an investment holding company. Its shareholders were members of the Wan family. It wanted to acquire a Hillview property owned by another company, Wan Holdings, whose shareholder was also a Wan family member. To do so, Andermatt first purchased all the shares in Wan Holdings. The requisite resolutions were then passed to initiate the winding up of Wan Holdings. The Hillview property (as a return of capital in specie) was vested in Andermatt as a result. To pay the balance purchase price for Wan Holdings, Andermatt drew down an overdraft facility and sought to deduct the interest payable on the facility against the Hillview property’s rental income.

The Court of Appeal disallowed the deduction. It endorsed the view that under s 14(1)(a) of the Act, there must be a “direct link between the money borrowed and income produced” (at [27]). In that case, the money from the overdraft facility was used to pay a debt due to the vendor of the shares, for the purchase of shares in Wan Holdings. The Hillview property was obtained by liquidation of Wan Holdings and the consequent distribution of its assets. They were “extraneous matters brought about by acts of the shareholders of Wan Holdings” and had no direct link with the overdraft facility.

The requirement of a direct link between the money borrowed and income acquired has been followed in cases such as JD v Comptroller of Income Tax [2006] 1 SLR(R) 484 (at [29] and [47]). The appellant accepts this, but Mr Ong, counsel for the appellant, submits that the test does not allow an unrestrained fact-finding exercise beyond the statutory requirement that the capital be employed in acquiring the income. Mr Ong argues that the statute only requires that income-producing assets represent the specific capital on which interest is payable. This is because the only way that a company acquires income is through use or employment of its assets. The capital of the company is therefore said to be represented by its assets. Such capital may be said to be employed in acquiring income when it is represented by assets that are income-producing. Thus, so long as the money borrowed is to obtain capital that...