Section 10L: Singapore tax treatment of foreign-sourced capital gains as from 1 Jan 2024: mind the foreign IPRs

Singapore’s Ministry of Finance (MOF) recently proposed amendments to the Income Tax Act 1947 (SITA). This included the introduction of a new Section 10L. Under Section 10L, gains from the sale or disposal of foreign assets will be subject to tax, if such gains are received in Singapore by businesses without economic substance. Section 10L will enter into force as from 1 January 2024. As the non-taxation of capital gains is one of the cornerstones of the Singapore tax regime, the introduction of Section 10L is a fundamental change. The reason for the amendment is to align Singapore’s tax regime with international anti-tax avoidance norms and to anchor substantive economic activities in Singapore.

On 8 December 2023, the Inland Revenue Authority of Singapore (IRAS) released the eagerly awaited guidance on the application of Section 10L in its e-Tax Guide on the Tax Treatment of Gains or Losses from the Sale of Foreign Assets (hereafter the e-Tax Guide). In this article, we cover the most relevant clarifications and updates on Section 10L set out in the e-Tax Guide.

Key features of Section 10L

Currently, gains from the sale of foreign assets that are capital in nature are not subject to Singapore tax. From 1 January 2024, gains from the sale or disposal of foreign assets by a relevant entity that are received in Singapore will be treated as income chargeable to tax if the entity does not have adequate economic substance in Singapore or the gains are from the disposal of a foreign intellectual property right (IPR).

Key features are:

• The scope is limited to gains derived by an entity¹ of a “relevant group”. A group is a “relevant group” if one of the entities of the group is incorporated, registered or established in another jurisdiction or where at least one entity of the group has a place of business outside Singapore. As such, domestic groups and standalone entities are excluded.
• Only gains that are received in Singapore from outside Singapore are caught. Gains are typically considered to be received in Singapore if (deemed) remitted into Singapore. As such, foreign entities that are not operating in or from Singapore are not in scope of Section 10L.
• Entities that have adequate economic substance and whose operations are managed and performed in Singapore are excluded (also known as excluded entities). However, this exclusion does not apply to foreign-sourced disposal gains, received in Singapore, from the sale or disposal of foreign IPRs.
• Section 10L does not apply to foreign-sourced disposal gains (except for the ones related to foreign IPRs) when the disposal is carried out by prescribed financial institutions, as well as entities that benefit from specific tax incentives, where the disposal is carried out as part of, or incidental to, their business activities.

Adequate economic substance

New guidance

As Section 10L does not apply to entities that have adequate economic substance in Singapore, a key concern was that there was no clearly defined threshold. Section 10L only provides general economic substance indicators, which also vary depending on whether the entity is regarded as either a pure equity-holding entity or a non-pure-equity holding entity. Therefore, the most anticipated clarifications in the e-Tax Guide relate to the economic substance requirements.

Logically, adequate economic substance depends on the income generating activities of the entity and varies from sector to sector. Therefore, the e-Tax Guide provides industry-specific guidance, for example for holding, headquarters and fund management companies. However, there are still no prescribed minimum thresholds to determine the adequacy of the economic substance, and what is considered adequate depends on an objective evaluation of the entity's business model and scale of operations. While this lack of specific thresholds offers flexibility, it also creates uncertainty.

Non-pure equity-holding entities

Along with the requirement that the operations of non-pure equity-holding entities are managed in Singapore, the following indicators should be assessed:

• The number of full-time employees.
• The qualifications and experience of such employees.
• The amount of business expenditure incurred by the entity in respect of its operations in Singapore, such as rental, salaries and statutory expenses.
• Whether the key business decisions of the entity are made in Singapore.

A couple of examples for non-pure equity-holding entities are provided in the e-Tax Guide which specifically emphasise the required amount of full-time employees and local business expenses, which varies depending on the entity’s core income generating activities (including the business model and scale of operations). The reference to the required local business expenses is relevant for Singapore entities benefiting from Singapore fund tax incentives, such as Section 13U or 13O, as they are expected to have a certain minimum number of business expenses (including the management fees paid to the Singapore fund manager) to qualify for and meet the requirements of those tax incentives.

Pure equity-holding entities

The economic substance requirements for pure equity-holding entities are more limited as their core generating activities are limited. The requirements are:

• The entity submits all applicable filings, such as returns, statements and accounts.
• The operations of the entity are managed and performed in Singapore (whether by its employees or outsourced to third parties or group entities).
• The entity has adequate human resources and premises in Singapore.

Adequate premises are for example an office in Singapore for the use of entity’s employees. This includes owned, rented or shared premises, co-working office spaces, and even the office of the outsourced service provider when it performs the entity’s core income generating activities. Adequate human resources include the Singapore non-nominee directors of the entity. Typically, a pure registered address (eg address of the corporate secretary) will not qualify as adequate premises.

The e-Tax Guide provides several examples which put importance on the role performed by the Singapore directors (excluding nominee directors) which either manage the operations of the Singapore entity and ensure that the entity complies with its filing requirements or monitor said activities if they are performed by a third-party service provider.

IRAS has clarified that a Singapore holding entity that also provides loans to its related parties should be considered as a non-pure equity-holding entity and, hence, is subject to the higher economic substance test explained in the previous section, which is more burdensome for this kind of entities.

Outsourcing

A welcome clarification is that to meet the substance requirements, some or all economic activities can be outsourced to a third-party service provider or a group entity. The conditions are:

• The activities are carried out by the outsourced entity in Singapore;
• The outsourcing entity has direct and effective control over the outsourced activities and has formally documented the arrangement in for example an outsourcing agreement or internal policy;
• The outsourced entity must set aside dedicated resources (eg manhours) to provide the outsourced services.

The e-Tax Guide provides examples on Singapore Real Estate Investment Trusts (REITs) and Singapore Trusts confirming that these vehicles can rely on the substance provided by their REIT Manager and the Trustee (respectively). The outsourcing provisions put emphasis on the legal documentation, especially regarding the documentation of the monitoring mechanism. Therefore, it is important for Singapore REITs and Trust structures to properly draft and review their trusts deeds, investment management agreements, internal policies, etc. to meet Section 10L’s outsourcing requirements.

Economic substance within the group – special purpose vehicles (SPVs)

It is common for multinational groups or funds to use multiple special purpose vehicles (SPVs) to ring-fence the risks of investments. That raises the question whether the adequate economic substance requirements must be applied on a per-entity basis, as SPVs typically do not meet such requirements.

The e-Tax Guide clarifies that if a Singapore SPV is held by an immediate holding entity, or – if this immediate holding entity is also an SPV – by another (intermediate or ultimate) holding entity (hereafter the holding entity), the economic substance requirements can be tested at the level of the holding entity, and not at the level of the SPV. The holding entity must (i) have effective control over the SPV, (ii) derive economic benefits from the activities carried out by the SPV, and (iii) define the core investment strategies that the SPV implements.

This look-through approach up to the holding entity is a welcome clarification for the asset management industry following concerns that were raised in the consultation phase.

Advance ruling

Certainty on the adequacy of economic substance can be sought via an advance ruling when a proposed sale or disposal of foreign assets is envisaged to take place within one year from the date of the application.

Gains from the sale of foreign IPRs

A novelty in the e-Tax Guide is that it explicitly mentions that the tax treatment of gains from the sale or disposal of foreign IPRs is different from that of foreign assets. The non-taxation of foreign-sourced disposal gains for prescribed financial institutions, entities benefiting from specific tax incentives or entities that meet the above-mentioned economic substance test, is not applicable to gains from the disposal of foreign IPRs.

Instead, a specified approach is applied which makes a distinction between qualifying and non-qualifying IPRs. For qualifying IPRs (patents, applications for patents and copyrights), a modified nexus approach is used to determine the extent of gains that will not be taxable when received in Singapore. For non-qualifying foreign IPRs, the full amount of the gains from the sale or disposal of the IPRs will be subject to tax when such gains are received in Singapore, regardless of whether the entity has adequate economic substance in Singapore. This puts importance on the qualification of IPRs.

This is a significant update given that this is not specifically mentioned in the current wording of Section 10L.

Foreign-sourced dividends originating from the sale of foreign assets

The e-Tax Guide clarifies that the remittance of foreign-sourced dividends originating from gains from disposal of foreign assets is not in scope of Section 10L. This is a welcome clarification as several U.S. stakeholders raised concerns on whether the IRAS would tax, under Section 10L, foreign-sourced dividends received in Singapore that are originating from disposal gains of foreign assets sold or disposed by underlying U.S. entities that are considered partnerships from a U.S. tax perspective.

Losses and tax credits

The e-Tax Guide clarifies that any loss incurred by an entity from the sale or disposal of any other foreign asset could be used to offset the amount of gains from the sale or disposal of foreign assets chargeable to tax. In addition, the e-Tax Guide confirms that the existing Singapore foreign tax credit regime is also applicable to foreign-sourced disposal gains received in Singapore and chargeable to tax under Section 10L.

Administrative requirements

The e-Tax Guide sets out administrative requirements to ensure that entities keep track of the gains/losses from the disposal of foreign assets and accurately report their taxes when such gains are received or losses are utilised in Singapore.

Taxpayers should provide tracking information listed in the e-Tax Guide in their tax computations when submitting their annual tax returns, as well as retain relevant supporting records, such as payroll documents reflecting the number of Singapore employees and sales proceeds documents (among others).

This is an additional administrative burden that taxpayers should be prepared to handle or outsource.

Recommendations

Section 10L is a fundamental change to Singapore’s existing tax regime. Low or no substance investment holding entities with a blend of investments and foreign IPR transfers could be affected.

Should you or your entities be in scope, please reach out to your trusted tax advisor to address this timely and where necessary to (re-)structure your (investment) holdings, and transactions before the entry in force of Section 10L, especially if you deal with foreign IPRs. When properly and timely addressed the impact should be manageable.

Based on industry discussions, further clarifications and amendments to the e-Tax Guide are expected to be released next year.

To learn more, please contact us.

¹An entity is a member of a group if its assets, liabilities, income, expenses and cash flows (i) are included in the consolidated financial statements of the parent entity of the group or (ii) are excluded from the consolidated financial statements of the parent entity of the group solely on size or materiality grounds or on the grounds that the entity is held for sale.