The new international tax environment has opened up many interesting questions about the future use of holding companies for investors, write Chiu Wu Hong, head of tax, and Simon Clark, regional tax partner and ASPAC leader, alternative investments, at KPMG in Singapore.
In this article, we briefly explore how the principal purpose test (PPT) and other tax changes are impacting the decision to use and construct holding companies. In the interest of brevity, we will restrict ourselves to consider these questions in the context of transactional cross-border investment.
The new tax landscape is not limited to a consideration of the PPT. Investors are also facing a refocus on beneficial ownership issues by some countries and the continued emergence of general anti-avoidance rules (GAAR) which is impacting the preferred holding company jurisdiction.
We are already seeing a range of responses from investors. Some are determined to do away with the use of holding companies in the context of transactional activity and invest directly. Others have decided to focus on building substance in a particular jurisdiction (for example, Luxembourg) for the purposes of their transactional activity and to set up in that jurisdiction even if it is not the optimal solution for all investments. A few have gone even further and started to develop solutions to the beneficial ownership issue to negate the need for holding companies to immediately repatriate monies received from investments to their parent entities.
These choices can be made by large standalone investors. It may be more challenging for small investors who invest in funds and the funds industry that serves them. None of this is helped by the fact that:
Overall, there is uncertainty as to how much of the test resolves itself to a substance issue (it is clear that some countries will continue to rely on receiving a certificate of residence (COR)) and, if so, what is an acceptable level of substance.
There are some countries, like the Netherlands, which have already proposed changes to the way they qualify foreign investment holding companies, which rely on mixture of purpose and increased substance requirements. We need to see the detail of these proposals in the third quarter of this year but on first read, they appear to be both a unilateral application of a PPT and the creation of a safe harbour.
While the substance requirements appear to be tougher than we have seen in the past, it is a positive move for the Dutch to set out the requirements. We would expect that a range of other 'holding jurisdictions' might follow suit and seek to clarify how these rules operate.
Europe remains the key centre of developments in this area. There are ongoing issues arising out of the European processes including the recent tax advice transparency proposals and the EC blacklist proposal with some 92 countries still being considered for inclusion on the blacklist which will impact on the ability to create holding structures.
On the tax advice front, we could ultimately end up with effective pre-approval of structures such as occurs under the Australian Foreign Investment Review Board rules. How inclusion on the blacklist will impact the willingness and ability of taxpayers to use listed countries for holding company purposes is still unclear.
The US stands in splendid isolation from most of these changes. Given that all of its significant tax treaties contain limitation on benefits provisions, and that there are a range of domestic protections like Foreign Investment in Real Property Tax Act (FIRPTA), investors do not get a lot of tax relief on investment. The combination of these outcomes make it difficult to effectively use holding companies for US investments.
The Asia Pacific region has a diversity of outcomes. China, India and Australia have all developed a range of measures which affect investors. At the other end of the scale, there are some significant countries which have yet to sign on to the MLI and continue to rely on COR-type measure as a basis for treaty reliance.
Hong Kong has committed to the core MLI outcomes and is aiming to build an onshore fund regime similar to that in Singapore. Singapore has also committed to the core MLI outcomes and continues to manage its global reputation by adopting a full set of TP outcomes, and other transparency measures such as the recently introduced requirement to identify nominee directors and a more rigorous approach to COR and other administrative processes.
In addition, the peer review exercise conducted under the BEPS Inclusive Framework concluded that most of Singapore's tax incentives to attract headquarter, finance and treasury activities were not harmful, likely due to the fact that these involve commitment by companies to anchor substantive activities, expenditure and significant headcount in Singapore.
In relation to the above, we see more focus on creating substantial holding companies rather than cherry-picking based on the best outcome for an individual case. We also see less tiers of holding companies being adopted in the future.
Beyond that, meaningful levels of substance, quality directors and front-office employees are likely to be required rather than a brass plate office space. We are less certain how funds will deal with the emergence of beneficial ownership as a meaningful requirement where investors still want returns passed-through immediately and the fund's return depends on investors not holding cash for any period of time.
The next few years will present an opportunity for innovation in the design of holding structures and require us to look back at many of the holding structures implemented in the past.
The government has been proactive in making it easier for taxpayers to pay their taxes, and this has borne fruits as tax compliance among Singapore's residents is high. More than 80% of individual and corporate taxpayers paid their taxes on time in the fiscal year of 2016/2017. This, combined with Singapore's growing economy and low unemployment levels, has contributed to the Singapore government collecting $35 billion in taxes this year – 5% more than in the previous year.
The Inland Revenue Authority of Singapore (IRAS) is harsh on non-compliant taxpayers, and through audits and investigations it identified non-compliant cases and collected $244 million in unpaid taxes this year.
The country has made the expansion of its tax base an important priority for government expenditure to be sustained. In his budget speech in February 2017, Minister for Finance Heng Swee Keat said Singapore needs to strengthen its revenue base in a pro-growth and progressive manner.
The budget has enhanced and extended the country's corporate income tax rebate to help businesses. For the assessment year 2017, the corporate income tax rebate cap was raised from SG$20,000 ($14,700) to SG$25,000. The rebate rate remains unchanged from last year at 50% of corporate tax payable. The corporate income tax rebate will be extended for another year, to assessment year 2018, but at a reduced rate of 20% for tax payable and capped at SG$10,000.
Other announcements in the budget included the introduction of a new intellectual property (IP) regime called the IP Development Incentive (IDI). The IDI aims to encourage businesses to capitalise on use of IPs which flow from the research and development activities of taxpayers, and has adopted a BEPS-compliant approach. This was to take effect on July 1 2017, however, the Economic Development Board has delayed the introduction of the IDI and will announce a new introduction date by the end of 2017. The decision to delay the regime's introduction was based on the feedback of companies which stated that they needed more time to review their positions on this matter.
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