Meeting of Economic Substance Requirement in Singapore

Foreign-sourced disposal gains resulting from the sale or disposal of a foreign asset in Singapore, excluding intellectual property, become tax-exempt if the entity demonstrates adequate economic substance during the relevant basis period.

Meeting Economic Substance Requirements for Pure Equity-Holding Entities

What is a Pure Equity-Holding Entity?

• A pure equity-holding entity is an organisation whose primary role is to own shares or equity interests in other entities.
• It generates income solely from dividends, gains from selling shares, or income related to shareholding activities.

Conditions to Satisfy Economic Substance

To meet the economic substance requirement, a pure equity-holding entity must fulfil the following conditions in the period when it sells or disposes of foreign assets:

1. Submit necessary documents to a government authority as required by the law under which it is incorporated.
2. Manage and carry out its operations in Singapore, whether by its employees, third parties, or group entities.
3. Possess adequate human resources and physical premises in Singapore for its operations.

Adequate Premises

To meet the “adequate premises” criterion, a pure equity-holding entity can have:

1. An office in Singapore for its employee(s).
2. Shared premises with an associated entity for employee use.
3. An outsourced service provider with an office in Singapore performing core income-generating activities.

A pure equity-holding entity’s registered address, not used by employees or service providers for core activities, does not meet the “adequate premises” requirement.

Tax Treatment Examples for Pure Equity-Holding Entities

• Example 1: Company A holds shares in Company B and manages its investments in Singapore with an employee, meeting filing requirements. Company A complies with economic substance requirements.
• Example 2: Limited Partnership C, managed by General Partner E in Singapore, disposes of shares of Company D. General Partner E overseas investments, complies with filing, and meets economic substance requirements.
• Example 3: Company F, despite being incorporated in Singapore, needs to manage core activities within Singapore. Its economic substance requirement still needs to be because its critical equity investment decisions occur outside Singapore.

Applying the Economic Substance Test for Special Purpose Vehicles (SPVs)

What is an SPV?

An SPV is typically established to isolate investment risks and usually lacks significant headcount or substantial expenditures within the SPV itself.

Circumstances for Economic Substance Assessment

If the immediate holding entity:

• Exercises effective control over the SPV.
• Gains economic benefits from the SPV’s activities.
• Defines the core investment strategies implemented by the SPV.

In this scenario, the immediate holding entity becomes the entity subject to the economic substance requirement rather than being considered a service provider to the SPV.

Additional Consideration:

If the immediate holding entity is itself an SPV and there is another intermediate holding entity or ultimate holding entity:

• That holds effective control over the SPV, including the immediate holding entity of the SPV (if applicable).
• Derives economic benefits from the SPV’s activities.
• Defines the core investment strategies implemented by the SPV.

In this case, the relevant intermediate or ultimate holding entity becomes subject to the economic substance requirement.

Meeting Economic Substance Requirements for Non-Pure Equity-Holding Entity

What is a Non-Pure Equity-Holding Entity?

A non-pure equity-holding entity is any entity that doesn’t fall under pure equity-holding entities.

Economic Substance Determination

The economic substance requirement is assessed by analysing the entity’s primary income-generating activities in Singapore. 

To satisfy the economic substance requirement, the entity must meet the following conditions during the basis period when the sale or disposal takes place:

1. Operations must be managed and performed in Singapore by the entity’s employees, outsourced to third parties, or handled by group entities.
2. The entity must demonstrate adequate economic substance in Singapore, considering factors such as:
   • The number of full-time employees or other individuals managing the entity’s operations in Singapore.
   • Qualifications and experience of these employees or individuals.
   • Business expenditures related to Singapore operations.
   • Whether individuals in Singapore make significant business decisions.

Examples of Non-Pure Equity-Holding Entities

• Example 1: Company G, an investment holding entity in Singapore, invests in equities and provides loans to related parties. It qualifies as a non-pure equity-holding entity. In 2024, Company G disposes of foreign company shares. It employs two qualified full-time employees in Singapore, makes investment and financing decisions, and incurs $100,000 in local business expenses. Company G meets the economic substance requirement in 2024.
• Example 2: Company H, a small entity with an annual turnover below $5 million, is neither a pure equity-holding nor an investment-holding entity. In 2024, it will dispose of foreign assets and employ one full-time worker in Singapore who handles core income-generating activities and critical business decisions. The company also incurs $50,000 in local business expenses. Company H satisfies the economic substance requirement in 2024.

Applying the Economic Substance Test in the case of Outsourcing of Economic Activities

Consideration of Outsourcing

The economic substance requirement considers outsourcing arrangements when entities delegate some or all of their economic activities to third parties or other entities within the group.

Conditions for Satisfying Economic Substance in Outsourcing

To meet the economic substance requirement in outsourcing arrangements, the following conditions must be met:

1. The outsourced entity within Singapore must conduct economic activities.
2. The outsourcing entity must exercise direct and effective control over the activities performed by the outsourced entity on its behalf. This involves thorough monitoring and control of the outsourced economic activities.
3. The outsourced entity providing the services must allocate dedicated resources, such as person-hours, to deliver these outsourced services.

Consideration of Resources

• When evaluating whether the outsourcing entity meets the economic substance requirement for its economic activities, the outsourced entity’s resources within Singapore are considered.
• It is generally expected that the outsourcing entity charges an arm’s-length fee for its activities, adhering to transfer pricing rules where applicable.
• The outsourced entity can support multiple entities as long as its resources align with the complexity and level of services provided to these entities.

Income Tax Advance Ruling on Adequacy of Economic Substance

Starting January 1, 2024, the Income Tax Act 1947 introduces a tax regime for gains derived from foreign asset disposals, as outlined in section 10L. Under this regime, gains from the sale or disposal of foreign assets are taxable in Singapore upon receipt.

However, suppose an entity possesses adequate economic substance in Singapore. In that case, foreign-sourced disposal gains from foreign asset sales or disposals (excluding intellectual property rights) will not be subject to Singaporean taxation.

Suppose you anticipate selling or disposing of a foreign asset within one year from the application date. In that case, you can request an advance ruling to obtain certainty regarding the sufficiency of economic substance in your situation.

An advance ruling is a legal explanation of how the tax rules apply to a specific situation. You can request it when you have a complex tax issue, not when you want to know basic tax facts. It helps people and businesses understand and follow tax laws, reducing confusion and uncertainty in tax matters.

How to Apply for an Advance Ruling?

You can submit your application on an individual entity basis or as a group application. 

However, if you choose to make a group application, all entities within that group must jointly apply to be covered by the advance ruling.

Group applications are allowed under specific circumstances:

1. When the economic activities of the group entities, which seek coverage under the advance ruling, are outsourced to an external entity through a single service agreement.
2. When the economic substance test needs to be applied at the holding company level, representing its special purpose vehicles.

If the advance ruling on the adequacy of economic substance is granted, it can remain valid for up to five (5) Years of Assessment. This period includes the Year of Assessment connected to the basis period in which the intended sale or disposal of foreign assets is anticipated. 

Consequently, the ruling can be applied to any foreign-sourced disposal gains resulting from subsequent sales or disposals of foreign assets within this validity period, provided that the key facts and representations made during the ruling application process remain unchanged. Additionally, this continuity is contingent on no alterations in tax laws or their interpretation from the date the advance ruling was issued.

What Documents Are Required?

Here is a summarised version of the documents required for applications regarding the adequacy of economic substance:

1. Income Tax Advance Ruling Form for Economic Substance (ESR Form) – (DOCX, 128KB)
2. Annex to ESR form, if necessary – (XLSX, 28KB)
3. If applicable, a copy of the outsourcing service agreement
4. Any supplementary information (PDF, 118 KB) that could help speed up the assessment of your ruling application.

Conclusion

In conclusion, we offer expertise in navigating the economic substance requirements. For equity-holding and non-equity-holding entities, we stress the need for robust economic substance in Singapore, encompassing operations, qualified employees, expenditures, and decision-making. We are well-prepared to assist with outsourcing arrangements, ensuring effective control and proper resource allocation. We also provide tailored guidance for Special Purpose Vehicles (SPVs) to meet economic substance criteria while managing overseas investments. 

In addition to our expertise in economic substance requirements, we also specialise in guiding Advance Tax Rulings. We understand the importance of seeking clarity on tax implications for proposed arrangements and transactions. Our services extend to assisting clients in preparing and submitting Advance Tax Ruling requests and ensuring compliance with tax laws and regulations while optimising their tax positions. 

With our comprehensive knowledge and commitment to compliance, we are here to help clients achieve both regulatory compliance and operational excellence in Singapore.

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