Tax Planning

Section 14(1) of the Income Tax Act states the general deduction formula: "...there shall be deducted all outgoings and expenses wholly and exclusively incurred during that period...in the production of the income". We shall now discuss the general deduction formula, determine deductibility of expenses, and examine non-deductible expenses that are given special concessions.

"Wholly and exclusively"

The judgment in Bentleys, Stokes and Lowless v Beeson (1952) 2 All ER 82 at 85 clearly highlights that expenditure incurred must be for the sole objective of income production. If the intention behind an expenditure is a purely business benefit but an incidental personal benefit arises, a deduction is allowed. Thus, the taxpayer's intention and motive for incurring the expenditure must be considered.

Often, most expenditure are dual purposes. Although in principle, dual-purpose expenditure would fail the "wholly and exclusively" test, the Comptroller may apply rules of apportionment.

"Incurred"

Using the cases of New Zealand Flax Investments Ltd v FCT (1938) 61 CLR 179 and CIR (Hong Kong) v Lo & Lo (1984) WLR 986, an expense is "incurred" as long as there is a liability to pay and such expense is deductible, taking into account that this does not necessarily mean that the expense has been paid.

"During that period"

Expenses incurred before the commencement of business, or after the termination of the business are not deductible, because they are incurred before or after the production of the income respectively, and not in the production of the income. In other words, one can deduct expenses where the liability to pay arises during the same tax year of the income.

With effect from YA 2004, as a concession, all expenses of a revenue nature and not prohibited under s15 that are incurred from the first day of the accounting year in which a business derives its first dollar of trading receipt will be deductible. However, this does not extend to investment holding companies.

"In the production of the income"

A nexus between the expense incurred and the income produced must be established, thus we would need to evaluate the closeness or remoteness of an expense to the income-earning operations.

In Vallambrosa Rubber Co. Ltd v Farmer (5 TC 529), it is held that an expense may relate to future income, i.e. expenses are deductible if the source of income to which it relates has already commenced.

Also, the judgment in Elizabeth Electric Tramway Company Ltd v CIR 8 SATC 13 has clearly stated that expenses closely linked to income earning operations are deductible.

Following the general deduction formula, s14(1)(a)-(h) lists the expenditures that are specifically deductible. It also provides for expenses that are deductible subjected to restrictions such as payments to related employees, motor car expenses and medical expenses.

However, according to s15 of the ITA: "Notwithstanding the provision of this Act, for the purpose of ascertaining the income of any person, no deduction shall be allowed in respect of--"

Based on the wording, it is clear that s15 prevails over s14 i.e. if an expense is deductible under s14 but is prohibited under s15, this expense is not deductible. S15(1)(a)-(p) is the list of expenditures that are specifically prohibited. Therefore, for an expense to be deductible it has to satisfy s14 and not be prohibited under s15.

We shall now discuss certain expenses that violate s14 and s15, but is deductible due to provisions in the Act and concessions given by the Comptroller.

Foreign Exchange Losses

Foreign exchange losses are only deductible if they are realized and on revenue account. A concession to allow unrealised foreign exchange losses of revenue nature to be deducted was granted in recognition of the administrative problems faced by banks in having to comply with the requirement to distinguish between realised and unrealised foreign exchange gains or losses for their huge volume of transactions.

With effect from YA 2004, this concession was extended to all businesses because IRAS had received feedback from companies that adhering to the strict legal position, additional efforts would be involved to trace each transaction to establish if conversion of the foreign currencies into the functional currencies had taken place.

Head Office and Management Expenses

When the "head office" of a group of companies provides services such as investment management and financial management, partial recouping of expenses from the group members are justifiable and acceptable. This is due to the fact that a centralized "expertise" results in greater business efficacy and that allocation of expenses must be consistent and conducted at arm's length. Allocation should adhere to the following rules: (i) all direct expenses applicable to each territory must be charged to that territory; and (ii) all indirect common expenses