Widespread tax audits conducted by the Inland Revenue Board (“IRB”) on companies lately are causing jitters among CFOs and tax managers. The ongoing “Operasi Mega Corp” has set off alarm bells on thorny issues such as transfer pricing, withholding tax, retrospective clawback of tax incentives, and the deductibility of expenses.

In terms of transfer pricing, glaring intercompany loans and amounts owing from related companies that are sitting in financial statements are being looked at, with the threat of IRB slapping taxpayers with imputed interest income and penalties looming large. The IRB’s approach often disregards the fact that such transactions are genuinely intended by companies as equity contributions rather than loans.

Urgent Action

Companies must immediately:

  • Dig up all historical intercompany balances, loans, and advances
  • Characterise these transactions by obtaining legal and tax advice
  • Use legal documents, such as Agreements and internal corporate documents, to justify the non-charging of interest
  • Prepare transfer pricing Documentation

Legal Position – Interest or No Interest

A plethora of Commonwealth and foreign case laws have ruled that equity-like advances or loans are not considered debt in nature and, therefore, the charging of interest is unnecessary. The courts have also ruled that the features[1] of an intercompany transaction should be examined holistically before determining and characterising whether it is equity-like or even quasi-equity.

In fact, the Commentary to the OECD Model Tax Convention also sets out the possibility that a prima facie loan may have characteristics of a contribution to equity. Therefore, it is premature to assume that all your intercompany financing or loans must be interest-bearing.

Legal agreements and transfer pricing documentation are therefore vital to support and evidence such characterisation. All these documents and arguments are required to be submitted to the IRB during the audit.

Jason Tan and Chris Toh are Tax Partners of LHAG with heavy specialisation in transfer pricing. They have been advising companies on complex intragroup financing structures, structuring intragroup legal agreements, and formulating effective strategies.

If you have any queries, please contact Partners, Jason Tan Jia Xin ([email protected]) and Chris Toh Pei Roo ([email protected]).