Write a letter of representations to the IRAS on tax deductibility of expenses under Singapore law

Essay Instructions:

Facts Gamma Investments Pte Ltd (“Gamma”), a Singapore-based asset management firm, holds a $1 million debenture issued by Innovatech Ltd, an Australian company. In the last fiscal year, Gamma faced several financial challenges and incurred various expenditures related to its investment activities, the details of which are as follows: (1) Legal Costs: Gamma incurred $80,000 in legal fees to negotiate a settlement with Innovatech Ltd after it had failed to pay the contracted interest since 2022. This amount was incurred for procuring advisory as well as drafting services for a settlement agreement. (2) Late Payment Penalty: Due to cash flow difficulties, Gamma failed to file its corporate income tax return on time and paid a penalty of $6,000. (3) Lobbying Fees: To advocate for more favorable tax and regulatory policies for asset management firms, Gamma entered into a 5-year agreement with a public relations agency. The last financial year was the second year of the contract, and Gamma paid the agency $35,000 for services rendered. New Facts Another year has passed, and you now have a better understanding of the firm. Gamma is a boutique investment firm specializing in fixed-income strategies, with a particular focus on corporate debentures, such as those issued by Innovatech. Established in 2003, the firm has built a solid reputation for delivering robust, risk-adjusted returns through its diversified portfolio of debt securities. With over S$20 million in assets under management, Gamma leverages its deep market insights and rigorous credit analysis to identify investment opportunities in high-quality debentures issued in Singapore and elsewhere in the region. Unfortunately, the negotiations with Innovatech have failed. As a result, Gamma has been forced to initiate arbitration proceedings against Innovatech and has incurred—and continues to incur—significant legal expenses in the process. The unpaid interest on the debenture and the mounting legal fees have placed considerable strain on Gamma’s cash flow, forcing the firm to liquidate some of its other investments in order to meet its financial obligations and continue funding the arbitration. Meanwhile, the operating environment has become increasingly challenging for asset management firms. It has become more difficult to recruit talent, particularly from overseas, due to Singapore’s increasingly restrictive foreign talent policies. Additionally, the Monetary Authority of Singapore ("MAS") introduced a series of new regulatory requirements, which have significantly increased the compliance costs for Gamma’s business. As a result, you understand that Gamma has had to decline at least two attractive investment opportunities—each exceeding S$5 million—that it would otherwise have pursued. In an attempt to mitigate the difficult financial situation, Gamma stepped up its lobbying efforts through the public relations agency. The scope of the agency’s work was to highlight the onerous regulatory burdens imposed by MAS on asset management firms, particularly over the past year, and to advocate for more favorable tax relief measures for the industry. As part of this effort, total payments in the third year to the agency have surged to over S$300,000, nearly ten times of the amount paid in the previous year. The CEO is deeply concerned about the rising costs. To alleviate some of this burden, Gamma adopted a more aggressive approach towards to tax burdens. It claimed full deductions under the Income Tax Act for all the legal expenses incurred (whether related to negotiations or the ongoing arbitration) associated with the dispute with Innovatech. The firm also deducted the lobbying fees paid to the public relations agency. However, the IRAS has recently written to Gamma to question the basis on which Gamma has claimed these deductions. Scope of work (Final Draft): Your General Counsel has requested you to prepare a letter to IRAS to justify the tax deductions by Gamma, and also to secure a more favorable outcome from this query that may potentially lead to a full-scale tax audit on Gamma’s tax positions taken on other issues and filings. This persuasive letter is known as “representations”. Please see the picture file for comments on writing, this piece should consider additional legal cases beyond the draft outline, to support the arguments. To consider the deductibility of expenses and also any issues of double taxation

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Inland Revenue Authority of Singapore (IRAS) Taxpayer Services Division 55 Newton Road, #07-01 Revenue House Singapore 307987 Re: Representations for Tax Deductibility of Expenses Incurred by Gamma Investments Pte Ltd for AY 2024/25 November 15, 2024 Letter of Representation to the Inland Revenue Authority of Singapore (IRAS) Dear Sir/Madam, We submit this letter of representation on behalf of Gamma Investments Pte Ltd ("Gamma"), a Singapore-based asset management firm specializing in fixed-income strategies. We aim to establish the tax deductibility of various expenses associated with Gamma and specifically to consider the legal fees, penalties charged, and lobbying expenses. The tax positions assumed by Gamma are legally tenable under the Income Tax Act of Singapore and have cited Singapore principles and precedents, as well as other comparable jurisdictions under the common law. Issue 1: Deductibility of Legal Fees Incurred by Gamma Gamma has heard legal fees of $80000 in adviser and settlement services connected with a debenture granted by Innovatech Ltd, an Australian organization. These legal fees were spent to recover unpaid interest, which is an essential source of income for Gamma, especially in fixed-income investments, most of which are held for revenue collection. Under "Section 14(1) of the Income Tax Act (ITA)", expenses are deductible if they are "wholly and exclusively" incurred in income production. However, "Section 15(1)(c) ITA" excludes capital expenditures from deductibility, necessitating a close examination of the nature of these legal expenses—whether they fall under capital or revenue expenditure—and of Gamma's business activity about the debenture. Capital vs. Revenue Nature In determining the permissibility of deducting legal costs, it is essential to very carefully look at the type of payment for which legal services were provided and the service /subject /consideration in which legal services were provided. The purpose is to argue whether the legal action is to recover income or protect a capital asset. Therefore, the subject or consideration is the settlement's concrete financial or legal aspect, such as the amount of other unpaid interest or the capital controversy. For instance, if the settlement entitles Gamma to sue for unpaid interest—this is part of Gamma's income stream—the fees are revenue-based. However, if it relates to the price of the acquisition of a debenture or related issues of maintaining or improving the value of the debenture, the fees would be capital. This nuanced analysis ensures that the legal fees are classified correctly under "Section 14(1) or Section 15(1)(c) of the ITA". For legal fees to be classified as revenue or capital, more than an assumption is needed; one has to examine the nature of the debenture in issue and the purpose of the expenses incurred. The legal fees were used here exclusively to retrieve unpaid interest, an ongoing and direct revenue stream for Gamma. This points significantly to the view that the expenses are revenue expenses since they were incurred on income-generating activities in their entirety. Moreover, legal fees to maintain an operational income source align with the principles outlined in "John Fairfax and Sons Pty Ltd v FCIT [1959]," reinforcing the revenue characterization of such expenses. On the other hand, if the debenture is recognized as a fixed intangible asset, then the legal fees may be capitalized. The Atherton case defines those expenses placed to increase or improve the capital assets or obtain a long-term advantage as capital. This interpretation finds further support in "American Leaf Blending Co Sdn Bhd v DGIR [1979] 1 MLJ 1 (Malaysia)", where expenses related to the preservation of capital assets were deemed capital expenditures, not deductible for tax purposes. Under "Section 15(1)(c) ITA", Gamma's legal fees would, therefore, be non-deductible if the debenture is held for capital appreciation rather than regular income production. To decide whether we have rightly accounted for the legal fees as capital or revenue expenditure, we need to find out what kind of business Gamma is, as determined by its articles of incorporation. If Gamma's strategy centers on trading in debentures as part of its stock in trade, then these expenses would easily qualify as revenue expenses. Determining the Source of Interest Income One crucial aspect is whether the interest income is from a foreign source or sourced locally since, as established, Innovatech Ltd is an Australian-based company. This determination is critical under "Section 10(25)(a) ITA", which exempts foreign-sourced income from taxation unless remitted to Singapore. In "Commissioner for Inland Revenue v Lever Brothers & Unilever [1946] 14 SATC 1 (UK)", the court emphasized the importance of identifying the source of income for tax purposes, especially where foreign entities are involved. Where interest received from Innovatech is regarded as interest derived from an overseas source and has not been remitted, the legal fees may not be deductible because the income associated with those fees is not taxable in Singapore. Alternatively, if the income is classified as Singapore-sourced, it would fall under "Section 10(1)(d) ITA", which subjects interest income derived locally to taxation. In this scenario, the legal fees directly support Gamma's income production, thus satisfying the "wholly and exclusively incurred" criterion under "Section 14(1) ITA. In the Australian case of FCT v Munro [1926] HCA 23, it was held that expenses relatable to income could be appropriately claimed no matter where regarded as coming from, provided they are not inconsistent with the local tax laws. Conclusion for Legal Fees We humbly urge the Commissioner to accept legal fees and expenses as allowable if the debenture forms part of Gamma's trading stock or the income is sourced in Singapore. Conversely, if the debenture is held for long-term investment purposes, the expenses may be non-deductible as capital expenses under "Section 15(1)(c) ITA". Issue 2: Deductibility of Penalty for Late Filing of Corporate Income Tax Gamma had to pay a $6,000 fine because of the late filing of corporate income tax returns. This penalty does not qualify for a tax deduction under "Section 15(1)(b) of the Income Tax Act (ITA)", which explicitly excludes expenses that are not "wholly and exclusively incurred in the production of income." This provision forms part of the rationale of the legislation, which designs penalties to serve as punitive and a form of regulation that does not form part of business expenses. If penalties can be deducted, they would immediately lose their deterrent value and weaken compliance mechanisms. In contrast, the principle that ...

Updated on February 12, 2025

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