SINGAPORE – A doctor declared monthly salaries of around $5,000 and $6,000 from his companies, but did not pay any personal tax on additional payouts averaging over $2 million a year.
He claimed there was no need to declare the additional income because the sum was received as tax-exempt dividends and “shareholders’ loans” after his companies paid the standard corporate tax of 17 per cent on their profits.
This doctor, a private specialist, thought he had a foolproof arrangement that would shield him from higher personal income taxes. Income beyond the $1 million mark would have hit the highest personal tax bracket of 24 per cent.
But it was the taxman who got the last laugh.
After scrutinising past assessments between 2013 and 2018, the Inland Revenue Authority of Singapore (IRAS) deployed its most powerful weapon – Section 33 of the Income Tax Act – which can shoot down any arrangements that are created mainly to avoid tax.
It imposed additional taxes on the doctor’s overall income, which the High Court upheld despite the doctor’s challenge.
Under the personal income tax regime, someone earning $6,000 monthly would have been taxed less than $3,000 a year, but taking home $2 million could entail over $400,000 in taxes annually.
The decision has likely sent shockwaves through the league of high-income earners who have been using company structures to avoid paying more personal taxes.
The doctor was among 279 high-income earners IRAS has caught to date for using sham arrangements to avoid paying more taxes.
An example of such an arrangement involves setting up companies to receive income but paying owners salaries below market rate so that they can pay lower taxes.
As companies enjoy various concessions to encourage entrepreneurship, the owners will end up paying less tax on their profits than individuals earning the same amount.
The companies then channel the after-tax profits to the owners in the form of dividends, which will not be taxed again. In some cases, the payments are given out as “interest-free loans”, which are not taxable, provided these are debts that have to be repaid.
In the current case, the doctor received over $9 million in dividends and another $3 million in interest-free loans during those six tax assessments.
But IRAS invoked Section 33 to disregard his arrangements and assess the payments as the doctor’s own income.
The doctor appealed against this decision, but the court dismissed his case and upheld the use of Section 33, noting that no taxpayer can escape assessment of tax on income resulting from his effort by assigning his income to another party, such as his company,
As the income was deemed earned by the doctor, IRAS could claw back the appropriate tax amounts that should have been payable over the years, while providing some adjustments for the companies which had paid taxes for its “profits” before the avoidance scheme was discovered.
Here are three important lessons that all taxpayers should know so that they do not run afoul of the law.
Hard to avoid detection
The tax regime in Singapore is largely self-reporting, and all income earners are responsible for accurately complying with their tax obligations.
For many employees here, the tax season is a non-event because their employers report their income directly to IRAS, which calculates the taxes due and informs the taxpayer.
The self-employed file their own returns. For this group, it does not pay to under-report your income because you can end up losing more, or worse, be prosecuted for tax evasion for hiding income.
As all income data through the years is stored digitally, it is very easy for IRAS to detect any anomaly in your returns.
For instance, the doctor in the current case used to draw a monthly salary of over $45,000 when he was working at a government hospital.
When he left to set up his own clinic, he paid himself a monthly salary of only $5,000, claiming that the business had yet to take off. A few years later, he paid himself a monthly salary of $6,000 through another company, but received large dividend payments and loans on the side.
When IRAS flagged his case, he did not explain why his salary remained way below his government pay cheque even after the practice had become more profitable, or why he paid himself huge dividends and shareholder loans.
This led the court to find that he did not increase his salary because he had used his corporate arrangement to pay himself huge sums of additional income through his companies to avoid more taxes.
Setting up companies with no commercial purpose
Besides a relatively low corporate tax rate of 17 per cent, companies here enjoy various tax concessions so that they can reinvest profits into their businesses to pursue growth opportunities and business ideas.
These concessions aimed at encouraging entrepreneurship are not meant to enrich those whose sole purpose in setting up companies is to avoid personal taxes.
The court found no evidence that profits from the doctor’s companies had been used to pursue new ideas or expand the business, and that the companies had instead been used just to receive income and shield against liabilities.
Another doctor probed by IRAS in the same audit had even used her company to invest in a commercial property.
As a result of the court’s ruling, IRAS might take a closer look at the doctors’ corporate expenses, because it found that the fees for providing administrative and support services for one of the companies appeared disproportionately high when compared with the amount paid for the medical services provided by the doctors.
Hiding behind professionals
When things go wrong, people may push the blame to others, saying they acted on the advice of their lawyers or accountants.
In this case, the doctor claimed that he had followed his accountant’s advice on the set-up of his companies and that he was unaware of the specifics of the tax advantages he gained.
The court noted that if the arrangement had a genuine commercial purpose and was not aimed solely at avoiding taxes, the doctor could have asked his accountant to testify, as showing that his arrangement was done in good faith would have exonerated him.
But the doctor did not ask the accountant to give his side of the story.
High Court Judge Alex Wong noted that he found it concerning that the doctor had been in contact with his accountant but did not clarify how the arrangement could impact his liability.
“At best, (the doctor’s) evidence shows that he turned a blind eye to what his tax obligations could be in the hope that legal consequences would not follow. I fail to see how this approach can be used to justify the position that the arrangement falls outside the ambit of Section 33,” the judge added.
Clearly, the lesson here is that it does not pay to create an artificial scheme just to avoid taxes, because the taxman will pick up on your paper trail sooner or later.
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