Deduction of Interest Expenses s14(1)(a)

BML v Comptroller of Income Tax [2017] SGHC 118 revolves around the interpretation of s 14(1)(a) of the Act on the deduction of interest expenses upon money borrowed for capital employed in acquiring income.

Case Facts to Consider

BML, the appellant, owns and operates a mall. The appellant's transaction in October 2004 came into question when the company assigned its rental income rights to a special purpose vehicle. The goal of creating the special purpose vehicle is to provide security for a loan.

A facility agreement was made with the appellant borrowing $520 million, or the market value of the mall.

The appellant utilized $170 million to refinance previous borrowings, and the remaining balance of $350 million was "lent" to shareholders. The money lent to shareholders was provided as interest-bearing loans.

BML essentially converted their equity-based vehicle into a debt-based vehicle by issuing fixed rate subordinated bonds through a capital reduction exercise.

The appellant then went on to claim deductions for the shareholder bond interest expenses. Deductions were claimed for the years between 2005 and 2009.

The Comptroller of Income Tax disallowed the deductions incurred through Shareholder Bond interest expenses. The Comptroller's decision was upheld, with the appellant appealing the decision to the High Court.

The Board's Stance and the Basis of the Appellant

The Board's decision, in summary, suggests that there was no link between rental income, which is how the appellant makes money from the shopping mall, and the interest that was paid to Shareholder Bonds.

The Board suggests that the interest was not used to provide the mall with further income. Instead, the interest was derived from the intent to provide shareholders with a return for their interest in the company.

As per the board's stance, there was not a substitute in financing which would justify the appellant's deduction of the interest.

The entire basis of the case, from the standpoint of the appellant, was that the Comptroller misinterpreted s 14(1)(a) of the Act. Basis for the argument stems from the following:

  • The Comptroller doesn't have the authority to determine if interest paid is deductible

The governing test under s 14(1)(a) came under question as well the Act's wording of:

  • Any sum payable by way of interest

The question of the case is whether or not the interest paid by the appellant should be deductible. Both parties disagree over whether the Comptroller has the authority to decide on interest being payable under "capital employed in acquiring the income."

The Comptroller asserts that there must be a direct link between money borrowed and income acquired.

Andermatt Investments Pte Ltd v Comptroller of Income Tax [1995] 2 SLR(R) 866

Andermatt Investments is the leading case in the interpretation of s 14(1)(a). The case, used to interpret the Act, involves an investment company that wanted to purchase a property owned by another company.

Shareholders of Andermatt included the Wan family.

Wan Holdings, owner by the Wan family, owned the property in question. Andermatt purchased all shares of Wan Holdings.

The acquisition of the property was problematic because Andermatt purchased all shares in Wan Holdings, effectively making Andermatt vested in the property. Andermatt's purchase of Wan Holdings was then to be satisfied by drawing down on an overdraft facility.

The investment company wanted to deduct the interest payable against the property's rental income.

High Court's Decision on BML v Comptroller of Income Tax [2017] SGHC 118

The case was dismissed by the High Court, meaning the appeal was thrown out. Dismissal was based on the following facts:

  • The Comptroller has the discretion, in accordance with s 14(1)(a), to determine whether the requirements for a deduction are satisfied. The High Court, in effect, also claims that a direct link should be made between income produced and money borrowed under the s 14(1)(a) governing test.
  • The mall's rental income and interest paid on shareholder bonds could not be established, meaning that there was no direct link between the two.
  • The Court decided that it will not intervene unless the appellant can prove that irrelevant considerations were made in the Comptroller's decision to not allow the deduction.

The High Court's decision is that the Comptroller's determination and the decision of the Board were reasonable.

The Court concluded that the mall was already owned and under the control of the appellant and generating rental income prior to the bond issuance. The issuance of the bond was found to neither change the rental income of the mall, nor change the ownership status of the mall. The restructuring, at the admittance of the appellant, was to restructure capital holdings in the firm and not due to financing needs or the desire to generate more rental income.

Direct links for deductions allow for a fair and just way for companies to deduct interest payments. The case points to a direct link requiring more than a balance sheet. Companies, as in the case of the appellant, could make changes to their capital structure whether or not a loan was needed and related to income produced.

The loan and bonds given to shareholders wasn't required to produce income and did nothing to help enhance the appellant's assets.

Rather, there was no link established between the shareholder bonds and the income produced.

A number of factors, following the ruling, will need to be established for companies to make a deduction on interest paid. First and foremost, the link between the interest paid and income produced will need to be tangible and factual.

The Comptroller, under Section 14(1)(a) and the ruling now, without a doubt, has discretion over how much, if any, deduction should be allowed.

Loan capital replaced by equity capital isn't entirely bad, and there are circumstances wherein deductions can be made. The appellant's case is a bad example of loan capital replaced by equity capital, but if the circumstance revolved around an old loan being replaced by a new loan, deductions would be allowed.

Taxpayer intent isn't enough to prove a direct link between income produced and money borrowed.

Intention does remain relevant in the tax code, but it doesn't provide a direct link.


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