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Issue No. 2 October 2016 A Tax Publication by OSH Not for Sale

BEPS Redefinition of Permanent Establishment

IT’S Issue No. 2

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Contents Issue No. 2 | October 2016

FOCUS 3

IT’S

BEPS Redefinition of Permanent Establishment

15 A “reasonable excuse” for failing to file a tax return on time

In June this year, Singapore announced that it is joining the inclusive framework for the global implementation of base erosion and profit shifting (BEPS) project proposed by the Organization for Economic Co-operation and Development (OECD) as a BEPS Associate.

ThThe UK First-Tier Tribunal (FTT)

in the case of Paramount Electrical Contractors LLP v HMRC [2016] UKFTT 0519 considered what would be considered a reasonable excuse when a taxpayer fails to make a return on time.

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Editor Seah Ching Ling ONG SIM HO Advocates & Solicitors 1 Coleman Street #05-15 The Adelphi, Singapore 179803 All rights reserved. No part of this publication may be reproduced in any form or by any means without the written permission of the publisher. The views and opinions expressed or implied in IT’S are those of the authors and contributors and do not necessarily reflect those of the publisher.

GET BRIEFED 10 The importance of economic substance in tax planning An elaborate tax structure was held by the UK Upper Tribunal (Tax and Chancery Chamber) (UT) to have failed in the long-running case of Acornwood LLP and others v HMRC [2016] UKUT 0361, which had been widely reported in the UK press for its high-profile investors.

This publication is intended for your general information only. It is not designed to provide legal or other advice.

For enquiries, please email its@ongsimho.com

12 ‘Vineyard and farming’ The New Zealand Taxation Review Authority (TRA) recently confirmed in Smith v Commissioner of Inland Revenue [2016] NZTRA 9 that a taxpayer who has not engaged in taxable activities may not claim input tax incurred.

13 Recovering input tax from paying legal fees Can a company recover input tax incurred from paying legal fees in defending civil proceedings brought against its director? The UK First-Tier Tribunal (FTT) was of the opinion that the taxpayer company could in the case of Praesto Consulting v HMRC [2016] UKFTT 495.

14 Understanding the Double Tax Treaty In Tech Mahindra Limited v Commissioner of Taxation [2016] FCAFC 130, the Australian Federal Court examined the interaction between Article 7 (business profits) and Article 12 (royalties) of the Australia-India Double Tax Treaty (DTA).

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BEPS REDEFINITION OF PERMANENT E S TA B L I S H M E N T By Seah Ching Ling

In June this year, Singapore announced that it is joining the inclusive framework for the global implementation of base erosion and profit shifting (BEPS) project proposed by the Organization for Economic Co-operation and Development (OECD) as a BEPS Associate.

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BACKGROUND OF BEPS PROJECT AND SINGAPORE’S ROLE The key principle underlying the BEPS project is that profits should be taxed where the real economic activities generating the profits are performed and where value is created. To counter the existence of loopholes, gaps, frictions or mismatches in the interaction of countries’ domestic tax laws as a result of which BEPS may occur, the OECD has come up with 15 Action Plans.

As a BEPS Associate, Singapore will work with other participating jurisdictions to ensure consistent implementation of measures under the BEPS project, and a level playing field across jurisdictions. Singapore has also committed to implementing the 4 minimum standards under the BEPS project, namely the standards on countering harmful tax practices (Action Plan 5), preventing treaty abuse (Action Plan 6), transfer pricing documentation (Action Plan 13), and enhancing dispute resolution (Action Plan 14).

PERMANENT ESTABLISHMENT (PE) REDEFINED -

This article focuses on Action Plan 7 of the BEPS project, which identifies 2 main problems with the current definition of PE under Article 5 of the OECD Model Tax Convention (MTC). Article 7 of the MTC provides for the taxation of profits of an enterprise in a country in which it has a PE and where the said profits are attributable to 04

the PE. The definition of “Permanent Establishment” is in turn defined under Article 5 of the MTC. The definition currently focuses on 2 aspects – (i) a fixed place of business in the country and (ii) a dependent agent in the country with contracting authority. The definition also provides for certain situations under which a company will not be deemed a PE (Exceptions). The definition of PE thus has important consequences for enterprises that carry out activities in more than one country. Action Plan 7 of the BEPS project identifies 2 main problems with the current definition of PE under Article 5. The first is the use of tax avoidance strategies such as the use of commissionaire arrangements to avoid having a PE status. The second is the exploitation of the Exceptions under Article 5. Amendments were thus proposed to enable taxing rights to be properly shifted towards countries where profits are properly sourced. We will examine in this article the amendments proposed to counter the 2 problems identified above. (The proposed amendments to Article 5 may be found at the end of this article.)

TAX AVOIDANCE STRATEGIES (SUCH AS COMMISSIONAIRE ARRANGEMENTS) The OECD, in the public discussion draft released on BEPS Action Plan 7, gave an illustration of a commissionaire arrangement entered into by a medical products company under which the company was found not to have a PE to which profits from the sale of its products could be attributed and taxed, under the current wording of Article 5. The company XCo was a resident of State X. XCo sold its products to clinics and hospitals in State Y through YCo, a resident of State Y. XCo and YCo were members of the same multinational group.

In 2000, XCo and YCo entered into a commissionaire arrangement. Under the arrangement, YCo transferred its fixed assets, stock and customer base to XCo. XCo would then be the owner of the medical products but October 2016


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YCo would sell the products in State Y in its own name. The effect of such a commissionaire arrangement under the current wording of Article 5 is that the foreign owner of the goods will not have a PE in the country of sale to which the sale profits can be attributed and taxed. The local seller of the goods also cannot be taxed on the profits of the sales as it does not own the products that it sells and will at most, be taxed on the commission it receives. To address such arrangements, the OECD proposed amendments to Article 5(5) and 5(6) of the MTC such that where an intermediary’s activities in a country are intended to result in the regular conclusion of contracts to be performed by a foreign enterprise, the foreign enterprise should be considered to have a sufficient taxable nexus in that country unless the intermediary performs the activities in the course of an independent business. The key proposed amendments to Article 5(5) were as follows: - The focus is on the actual activities of the intermediary, as opposed to its authority to conclude contracts; - The intermediary does not need to actually conclude contracts to be a PE; - The contract need not be in the name of the foreign enterprise; - New concepts such as “principal role leading to the conclusion of contracts” and routine non-modification of the contracts by the foreign enterprise were introduced.

under which a company will not be deemed a PE where a place of business is used only for the activities listed. Apart from Article 5(4)(e) and (f), the Exceptions are not restricted to preparatory or auxiliary activities. The OECD envisaged that an enterprise should not be able to avoid having a PE in a country by using the Exceptions under Article 5(4) where it carries out activities which are not preparatory or auxiliary, or by fragmenting a cohesive operating business into several small operations, each of which by itself appears to merely be engaged in preparatory or auxiliary activities. As a result, the “preparatory or auxiliary” restriction has now been extended to all situations under Article 5(4). Relevant factors to consider as to whether an activity is preparatory or auxiliary in nature may include the presence of the intended substantive business, the period of time the activity has been taking place and the nature of the activity (e.g. whether it is a supporting or non-essential activity). In addition, a new anti-fragmentation rule has been introduced under Article 5(4.1) as an exception to Article 5(4). This targets enterprises which have a place of business in a country not deemed to be a PE under Article 5(4) (Para (4) Place). Where this enterprise (or its closely related enterprise) has another place of business in the country in addition to the Para (4) Place and (i) such other place of business is a PE or (ii) the overall combination of activities is not preparatory or auxiliary in nature, but constitutes complementary functions that are part of a cohesive business operation, then the Article 5(4) Exception will not apply.

The requirements of the intermediary habitually carrying out the activities and being an agent (i.e. “acting on behalf of”) remains. As for Article 5(6), the Article was given a complete overhaul whereby specific classes of independent agents such as brokers, general commission agents were removed as exceptions to being regarded a PE and the general concept of “person carrying on business as an independent agent” was introduced. It is further specified that in order for an agent to be independent and avoid being regarded as a PE, the agent cannot act exclusively or almost exclusively for an enterprise it is “closely related” to.

EXPLOITATION OF EXCEPTIONS UNDER ARTICLE 5 Currently, Article 5(4) provides for certain situations

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The anti-fragmentation rule is wide-reaching as can be seen from the following scenario provided in the OECD’s public discussion draft. RCo is a resident of State R and manufactures and sells appliances. It has a wholly-owned subsidiary SCo in State S which owns a store selling appliances purchased from RCo. RCo maintains a warehouse in State S where it houses large appliances. When SCo makes a sale of a large appliance, SCo employees will go to RCo’s warehouse and take possession of the appliance for delivery to the customer. The ownership of the appliance passes from RCo to SCo only when the item leaves the warehouse. 05


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In such a case, RCo’s warehouse in State S will not fall within the Exceptions under Article 5(4) as the provisions of the anti-fragmentation rule are met. Specifically, RCo and SCo are closely related enterprises, SCo’s shop is its PE and the business activities carried on by RCo at the warehouse and SCo at its shop constitute complementary functions that are part of a cohesive business operation. Hence, regardless of whether RCo’s warehouse carried out only auxiliary storage purposes, it will be considered RCo’s PE in State S as a result of SCo’s activities.

OTHER AMENDMENTS The OECD is also concerned about the abuse of the exception given under Article 5(3) where a building site, construction project or installation project constitutes a PE only if it lasts more than 12 months. Instead of an amendment to the Article, OECD proposed that a principal purposes test rule be added to the MTC to deal with any abuse of Article 5(3).

ENTERPRISE RESPONSE -

that PE planning be undertaken systematically in the manner shown in the diagram below. Businesses which have not carried out any PE planning previously should conduct a PE survey, which involves a consideration of (i) the trade and business processes of the enterprise (e.g. the location and extent to which each of these processes take place), (ii) the trading rules and mandates and (iii) the forms and interfaces of the enterprise (e.g. if these impose any perimeters on PE planning). With the information gathered from the PE survey, the enterprise can determine the baseline for PE exposures in different jurisdictions for forward planning. Companies which have previously carried out PE planning should also carry out a resurvey as to the enterprise’s current position is the light of the new rules so that the current baseline in PE planning can be determined. With the baseline ascertained, arrangements to avoid or mitigate the PE exposure can be considered holistically by relocation, and process or contractual modifications.

The proposed redefinition of PE will affect all enterprises that carry out activities in more than one country. It will be advisable for companies to begin reviewing their business structures and consider the possible tax implications that may arise once the amendments to Article 5 take effect. To mitigate these tax implications, PE planning will have to be done. We recommend

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OECD MODEL TAX CONVENTION (2014) ARTICLE 5 PERMANENT ESTABLISHMENT 1. For the purposes of this Convention, the term “permanent establishment” means a fixed place of business through which the business of an enterprise is wholly or partly carried on. 2. The term “permanent establishment” includes especially: a) a place of management: b) a branch: c) an office: d) a factory: e) a workshop, and f) a mine, an oil or gas well, a quarry or any other place of extraction of natural resources. 3. A building site or construction or installation project constitutes a permanent establishment only if it lasts more than twelve months. 4. Notwithstanding the preceding provisions of this Article, the term “permanent establishment” shall be deemed not to include: a) the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise: b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery; c) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise: d) the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise or of collecting information, for the enterprise: e) the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity of a preparatory or auxiliary character: f) the maintenance of a fixed place of business solely for any combination of activities mentioned in subparagraphs a) to e), provided that the overall activity of the fixed place of business resulting from this combination is of a preparatory or auxiliary character. 5. Notwithstanding the provisions of paragraphs 1

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and 2, where a person — other than an agent of an independent status to whom paragraph 6 applies — is acting on behalf of an enterprise and has, and habitually exercises, in a Contracting State an authority to conclude contracts in the name of the enterprise, that enterprise shall be deemed to have a permanent establishment in that State in respect of any activities which that person undertakes for the enterprise, unless the activities of such person are limited to those mentioned in paragraph 4 which, if exercised through a fixed place of business, would not make this fixed place of business a permanent establishment under the provisions of that paragraph. 6. An enterprise shall not be deemed to have a permanent establishment in a Contracting State merely because it carries on business in that State through a broker, general commission agent or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business. 7. The fact that a company which is a resident of a Contracting State controls or is controlled by a company which is a resident of the other Contracting State, or which carries on business in that other State (whether through a permanent establishment or otherwise), shall not of itself constitute either company a permanent establishment of the other.

OECD BEPS ACTION 7 CHANGES TO PARAGRAPHS 4, 5 AND 6 OF ARTICLE 5 PERMANENT ESTABLISHMENT Changes to the existing text of Article 5 appear in bold for additions and strike through for deletions 4. Notwithstanding the preceding provisions of this Article, the term “permanent establishment” shall be deemed not to include: a) the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise; b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery; c) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise; d) the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise 07


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or of collecting information, for the enterprise;

c) for the provision of services by that enterprise,

e) the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity of a preparatory or auxiliary character;

that enterprise shall be deemed to have a permanent establishment in that State in respect of any activities which that person undertakes for the enterprise, unless the activities of such person are limited to those mentioned in paragraph 4 which, if exercised through a fixed place of business, would not make this fixed place of business a permanent establishment under the provisions of that paragraph.

f) the maintenance of a fixed place of business solely for any combination of activities mentioned in subparagraphs a) to e), provided that the overall activity of the fixed place of business resulting from this combination is of a preparatory or auxiliary character provided that such activity or, in the case of subparagraph f), the overall activity of the fixed place of business, is of a preparatory or auxiliary character.

NEW ANTI-FRAGMENTATION RULE 4.1 Paragraph 4 shall not apply to a fixed place of business that is used or maintained by an enterprise if the same enterprise or a closely related enterprise carries on business activities at the same place or at another place in the same Contracting State and a) that place or other place constitutes a permanent establishment for the enterprise or the closely related enterprise under the provisions of this Article, or b) the overall activity resulting from the combination of the activities carried on by the two enterprises at the same place, or by the same enterprise or closely related enterprises at the two places, is not of a preparatory or auxiliary character, provided that the business activities carried on by the two enterprises at the same place, or by the same enterprise or closely related enterprises at the two places, constitute complementary functions that are part of a cohesive business operation. 5. Notwithstanding the provisions of paragraphs 1 and 2 but subject to the provisions of paragraph 6, where a person other than an agent of an independent status to whom paragraph 6 applies is acting in a Contracting State on behalf of an enterprise and has, and habitually exercises, in a Contracting State, an authority to conclude contracts, in doing so, habitually concludes contracts, or habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise, and these contracts are

6. An enterprise shall not be deemed to have a permanent establishment in a Contracting State merely because it carries on business in that State through a broker, general commission agent or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business. a) Paragraph 5 shall not apply where the person acting in a Contracting State on behalf of an enterprise of the other Contracting State carries on business in the first-mentioned State as an independent agent and acts for the enterprise in the ordinary course of that business. Where, however, a person acts exclusively or almost exclusively on behalf of one or more enterprises to which it is closely related, that person shall not be considered to be an independent agent within the meaning of this paragraph with respect to any such enterprise. b) For the purposes of this Article, a person is closely related to an enterprise if, based on all the relevant facts and circumstances, one has control of the other or both are under the control of the same persons or enterprises. In any case, a person shall be considered to be closely related to an enterprise if one possesses directly or indirectly more than 50 per cent of the beneficial interest in the other (or, in the case of a company, more than 50 per cent of the aggregate vote and value of the company’s shares or of the beneficial equity interest in the company) or if another person possesses directly or indirectly more than 50 per cent of the beneficial interest (or, in the case of a company, more than 50 per cent of the aggregate vote and value of the company’s shares or of the beneficial equity interest in the company) in the person and the enterprise.

a) in the name of the enterprise, or b) for the transfer of the ownership of, or for the granting of the right to use, property owned by that enterprise or that the enterprise has the right to use, or 08

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- CASE UPDATES -

GET BRIEFED A selection of case law updates spanning various jurisdictions and areas of tax

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The importance of economic substance in tax planning An elaborate tax structure was held by the UK Upper Tribunal (Tax and Chancery Chamber) (UT) to have failed in the long-running case of Acornwood LLP and others v HMRC [2016] UKUT 0361, which had been widely reported in the UK press for its high-profile investors. The taxpayers in the Acornwood case were members of LLPs, which had entered into arrangements giving rise to a significant accounting loss in each LLP’s first accounting period. The individual members then sought to claim the loss against their own income tax liability. The issue was whether the losses claimed to have been made by the LLPs were allowable trading losses i.e. whether they arise from expenses incurred wholly and exclusively for the purposes of trade. The principal players in this case were: (i) the individual taxpayers, (ii) the LLP of which the individual taxpayers are members of, and whose purpose is to acquire rights and exploit intellectual property (Rights); (iii) a principal exploitation company (known as Shamrock) which helped the LLP arrange for the exploitation of the Rights; (iv) a commercial producer (Producer) which actually exploited the Rights. The facts of the case are briefly as follows. (For ease of explanation and understanding, the figures

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used in this update are examples and not the actual sums involved.) Individual taxpayers-LLP - The individual taxpayers contributed a sum of $100 to the LLP. $20 was from the taxpayers’ own resources and $80 was borrowed from a bank with quarterly interest payable. - In accordance with its purpose, the LLP acquired Rights for a modest sum. (For example, the LLP acquired from Sinead O’Connor a licence in respect of some 20 songs she had written to enable the LLP to exploit master recordings of these songs.) LLP-Shamrock - As the LLP did not have expertise to exploit the Rights, it licensed the Rights to Shamrock and entered into agreement for Shamrock to exploit the said Rights to turn it into an end product (for example, by arranging for the production of an album of Sinead O’Connor’s songs). - Under the agreement, the LLP paid Shamrock a fee of $95 for its services. - The revenue from the end product was to be shared by the LLP and Shamrock, with Shamrock also being allowed to assign a part of the revenue to third parties. - Shamrock also agreed to pay the LLP quarterly amounts (which matched the taxpayer’s quarterly interest payments to the bank) and a final minimum sum of $80 (which matched the amount the taxpayer had to repay the bank), secured by a letter of credit. Shamrock-Producer - Shamrock in turn entered into a production agreement with a Producer to develop the end products from the Rights (for example, by producing the Sinead O’Connor album). - Shamrock paid the Producer $90 under the production agreement for its services. - At the same time, the Producer and Shamrock entered into a separate agreement called IT’S Issue No. 2

Assignment of Revenues Agreement whereby the Producer paid Shamrock $80 in return for a grant by Shamrock to the Producer of a percentage of the revenues it would receive from the exploitation of the Rights. (For example, Shamrock granted the Producer 50% of the revenues it would receive from its exploitation of the Sinead O’Connor album.) - The net result was that Shamrock parted with and the Producer received only $10.

needed in order to enter into the production agreements and the Assignment of Revenues Agreement was $10 (which is the difference between the $90 payable to the Producer under the production agreement and the $80 it received back from the Producer under the Assignment of Revenues Agreement). As such, the LLP did not need to pay Shamrock $95 at all. Shamrock could have carried out all its activities having received only $15 from the LLP.

Shamrock-LLP - Shamrock, which now held $85, paid $80 into an interest-bearing blocked account with a bank to obtain the letter of credit it required to secure the payment of the quarterly sums and final minimum sum to the LLP. - The interest earned by Shamrock from the blocked account was paid to the LLP quarterly, to match the interest which the taxpayer had to pay the bank on the $80 loan taken out by the taxpayer.

The $80 was not, and could not be, used in the exploitation of the Rights (which was the LLP’s trade) and the borrowing was an arrangement with no commercial but only a tax purpose to artificially multiply the LLP’s losses.

LLP-Individual taxpayer - The LLP then claimed a deduction of the $100 it had paid out as an expense, such that it ended up with a substantial loss in its first accounting year. - The individual taxpayer used the loss to claim against his personal income tax liability. The HMRC disputed that the sum of $80 (part of the $95) paid by the LLP to Shamrock (which matched the final minimum sum payable by Shamrock back to the LLP) was deductible as an expense incurred wholly and exclusively for the purposes of the trade. The UT agreed with the First-Tier Tribunal (FTT), who had earlier found against the taxpayers, that the taxpayers’ borrowing of $80 had no commercial reason behind it at all and was not paid by the LLP to Shamrock for the purposes of its trade (i.e. to exploit Rights).

The UT also agreed with the FT that purpose of the LLP in paying the $80 of the $95 to Shamrock was to secure the guaranteed income stream to pay the quarterly interest due from the taxpayers to the bank. This however was not a trading purpose as the LLP’s business was the exploitation of Rights and not the acquisition of a guaranteed income stream.

EDITORIAL NOTE This case which is touted as a great success for the HMRC is a reminder that in taxplanning, economic substance is paramount. It was precisely the lack of substance in the $80 borrowing that resulted in the defeat of the entire structure. An interesting exercise for the Singapore practitioner is to consider these transactions in the light of our Section 33 of the Income Tax Act. We will share our analysis of this case in the context of Section 33 in a lead article in our next issue.

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‘Vineyard and farming’ The New Zealand Taxation Review Authority (TRA) recently confirmed in Smith v Commissioner of Inland Revenue [2016] NZTRA 9 that a taxpayer who has not engaged in taxable activities may not claim input tax incurred. The taxpayers in this case were Mr Smith (Smith) and a company of which he was the sole shareholder and director (Company). Smith registered for GST in 2011 for an activity described on the registration form as “vineyard and farming”. Subsequently, he submitted GST returns seeking GST refunds for payments made “Purchasing grapes vineyard and winery” and “Start up of vineyard”. In 2012, he incorporated a company of which he was the sole shareholder and director (Company). The Company was registered for GST and its business activity was stated to be “grow grapes/wine marketing”. The Company filed a GST return claiming input tax credit for the purchase of 2 motorbikes and a tractor, as well as some private items. Payment was never made on the 2 motorbikes and the tractor and the transactions were subsequently reversed. The Commissioner of Inland Revenue (Commissioner) took the view that neither Smith nor the Company were engaged in any taxable activity in the relevant GST periods and disallowed the claims made. The TRA found that the taxable

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activities of Smith and the Company were vague. Smith had described his business activity as “vineyard and farming”. However, although he entered into around 40 agreements for the sale and purchase of wineries, vineyards and farms, the agreements were all conditional on successful financing and no deposit was paid on the agreements, none of which settled. After Smith incorporated the Company, it was even unclear what his own taxable activity would be. As for the Company, it was described as engaging in the business activity of grow grapes/ wine marketing” but Smith had furnished a business proposal for the Company to borrow money to invest in vineyards which were to be operated by separate subsidiary companies. There was no evidence that either Smith or the Company had the financial resources available to be able to commence the stated business activities. Little weight was put on Smith’s oral evidence of his negotiations with potential investors. In addition, the TRA found that neither Smith nor the Company had the financial resources to even complete the purchase of the motorbikes and tractor.

Smith had also told the TRA that he intended that the motorbikes and tractor would be leased out while the vineyard project was being developed. However, there was no evidence of any contracts having been entered into or any business proposal relating to this alleged activity. The TRA held that the steps taken by Smith and the Company could be described at best as preparatory steps towards the commencement of a taxable activity. However, such commencement work is not sufficient and does not create or amount to a taxable activity. There still must be an activity to which those steps attach. In this case, there was no activity which Smith or the Company was carrying on continuously or regularly and which involved or was intended to involve the making of supplies to other persons for a consideration. Instead, Smith and the Company merely had a rudimentary proposal for an ambitious development which they did not advance to any extent. The TRA thus concluded that it was not satisfied that the disputants were engaged in any taxable activity during the time that they were registered for GST and that the input tax credits claimed were disallowed.

EDITORIAL NOTE The Smith case affirms that in order for a taxpayer to make input tax claims, the taxpayer must at least be carrying out activities to make taxable supplies. Merely carrying out commencement work is not sufficient.

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Recovering input tax from paying legal fees Can a company recover input tax incurred from paying legal fees in defending civil proceedings brought against its director? The UK First-Tier Tribunal (FTT) was of the opinion that the taxpayer company could in the case of Praesto Consulting v HMRC [2016] UKFTT 495. The director of the taxpayer, Mr Ranson (Ranson) was formerly an employee of another company (CSP). Subsequently, he resigned and set up the taxpayer company (Praesto) to compete with CSP. CSP then brought an action against Ranson for breach of his contract of employment. In addition, CSP also wrote to Praesto as a proposed defendant, alleging that Praesto had defamed CSP and induced employees of CSP to join Praesto in breach of restrictive covenants in their employment contracts. Ranson and Praesto instructed solicitors (Sintons) who wrote to CSP identifying their clients as both Ranson and Praesto. After an unsuccessful mediation between Ranson and Praesto on the one side and CSP on the other, CSP commenced proceedings but only against Ranson. After the end of the proceedings, Sintons issued separate invoices to Praesto for work done until the commencement of proceedings and to Ranson for other work done. Praesto paid for all the invoiced. The HMRC did not dispute Praesto’s claim for input tax on the invoices addressed to Praesto but refused

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the claims in respect of all the other invoices issued to Ranson.

sufficient that the supplied had benefitted Praesto.

The HMRC contended that in order for Praesto to claim input tax, Sinton’s services must have been supplied to Praesto and have a direct and immediate link to its taxable activities.

In this instance, the FTT found that the direct and immediate link between the legal services supplied and Praesto’s taxable activities did exist. Praesto had made the profits from any breach of duty by Ranson. Hence, if the legal services had not been supplied to Praesto such that CSP’s claim was successful, Praesto would have to account for the profits of its past and future taxable activities. The supplies were thus found to have been made for the purpose of Praesto’s business.

The FTT found that both Ranson and Praesto had been clients of Sintons and all the work done by Sintons was on behalf of both Ranson and Praesto. It was irrelevant that Praesto was not a party in the proceedings as it was directly affected by the result. The FTT reiterated the principle that in order for input tax to be recovered, “there must be a direct and immediate link between the transaction in which the input tax is incurred and the taxable person’s output transactions or the taxable activity as a whole” and that “the existence of a direct and immediate link depends on objective factors and the objective character of the transaction in issue”. The FTT noted that for the purpose of finding the direct and immediate link, it is not

EDITORIAL NOTE It is noteworthy that the FTT did not regard the issue of the invoices to Ranson as a deterrent to Praesto’s claim but instead looked at the transaction as a whole to determine if supplies were made to Praesto. The substance of the transaction over its form was clearly emphasized (and rightly so) in the FTT’s decision.

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Understanding the Double Tax Treaty In Tech Mahindra Limited v Commissioner of Taxation [2016] FCAFC 130, the Australian Federal Court examined the interaction between Article 7 (business profits) and Article 12 (royalties) of the Australia-India Double Tax Treaty (DTA).

expression “effectively connected with” connotes in ordinary language a connection which serves to effect the purposes of the PE. As the Indian Services contributed to the discharge of contractual obligations undertaken by the taxpayer in relation to the business carried on through the Australian PE, they served to effect the purposes of the PE and were accordingly “effectively connected with” the PE.

The Indian-resident taxpayer carried on business in Australia through a permanent establishment (PE). It performed services for its Australian customers both in Australia and in India. The issue was whether Australia had any taxing rights in respect of the income from the services performed by the taxpayer in Indian (Indian Services).

The Commissioner of Taxation (Commissioner) took the view that the Indian Services would be “effectively connected” to the Australian PE where the profits arising thereunder are “attributable to [the Australian] PE” (which the parties had agreed was not the case). The purpose of Article 12(4) was to give the source state where the royalties had arisen (i.e. Australia) the right to tax the royalties under Article 7 in lieu of Article 12 where the Indian Services were effectively connected with the Australian PE.

Articles 12(1) and (2) of the DTA gave taxing rights of royalties earned to both Australia and India. The taxpayer argued that the payments for the Indian Services were royalties which fell under Article 12(4) of the DTA which provided that Articles 12(1) and (2) “shall not apply” if the taxpayer carries on business in Australia through an Australian PE and “the property, right or services in respect of which the royalties are paid or credited are effectively connected with such PE”. If this was the case, Article 7 would apply such that India would have taxing rights unless the royalties paid in respect of the Indian Services were “attributable to [the Australian] PE”. It was accepted by the parties that the Indian Services were not attributable to the Australian PE. The taxpayer argued that the 14

Article 7 which allocates the taxing rights to Australia in respect of the profits of the taxpayer that are attributable to the Australian PE. In addition, the Federal Court also took the view that “effectively connected with” should be taken to mean having a real or actual connection with the activities carried on through the PE. It is insufficient that the Indian Services “served to effect the purposes of the PE”.

EDITORIAL NOTE The double tax treaties Singapore has entered into generally contain the equivalent of Article 12(4) relating to royalties. This decision would serve as helpful guidance on how to interpret the requirement of “effectively connected with”.

The Federal Court held that the evident purpose of Article 12(4) was to relieve the source state (i.e. Australia) from the limitation on taxing rights imposed under Article 12 (which caps the amount of tax that may be charged at a specified percentage of the royalties) by taxing the royalties under Article 7. It is not the intention of Article 12(4) to disentitle Australia from any taxing rights where otherwise Article 7 would not give such taxing rights. The Federal Court also agreed with the Commissioner’s interpretation of the Articles and agreed that the phrase “effectively connected with” is intended to encapsulate the test of connection under October 2016


| C A S E U P DAT E S |

A “reasonable excuse” for failing to file a tax return on time

The UK First-Tier Tribunal (FTT) in the case of Paramount Electrical Contractors LLP v HMRC [2016] UKFTT 0519 considered what would be considered a reasonable excuse when a taxpayer fails to make a return on time. The taxpayer in this case was required to file a tax return for the period ended 5 April 2015. The filing date was 19 April 2015. However, his tax return was only filed on 22 April 2015. The HMRC imposed a late filing penalty. The taxpayer accepted that the tax return was filed late but claimed that he had a “reasonable excuse” which would absolve him from the

IT’S Issue No. 2

late filing penalty. In particular, he claimed that he had not received the tax return form from the HMRC through the post on time. He also pleaded an insufficiency of funds. The FTT found that the taxpayer did not have a reasonable excuse. First, the FTT held that the taxpayer should have put in place procedures to ensure that the tax return form was received on time. When he had not received the form by 5 April 2015, he should have contacted the HMRC but there was no evidence that he had done so till 19 April 2015. This alleged late receipt of the tax return form was not a matter beyond the control of the taxpayer. Second, the FTT held that an insufficiency of funds cannot amount to a reasonable excuse unless the lack of funds was caused by an event outside the taxpayer’s control. The FTT did not accept that the effect of the

economic circumstances was an event outside the taxpayer’s control. It was incumbent on the taxpayer to have in place contingency arrangements to pay his taxes.

EDITORIAL NOTE The term “reasonable excuse” is similarly found in section 94A(2) of the Singapore Income Tax Act in relation to the obligation to file tax returns on time. This case is helpful to remind us that any late receipt of a tax return form from the IRAS is not considered a “reasonable excuse” to absolve one from the penalties arising from a failure or delay in filing tax returns.

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IT’S is a tax publication and resource which aims to keep our clients up to date on tax law developments. In addition to providing a review of select recent judicial developments from the UK and in the region, and notable tax legislative changes in Singapore, each issue of IT’S will bring you a discussion and the OSH insight on a tax issue relevant to local tax professionals. its.ongsimho.com 00

October 2016

IT'S - October 2016  

A Tax Publication by OSH its.ongsimho.com

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