Income Tax – E-Tax Guide on Income Tax Treatment of Hybrid Instruments

On 19 May 2014, the IRAS issued the E-Tax Guide on “Income Tax Treatment of Hybrid Instruments”.

The IRAS” approach in determining whether a hybrid instrument is to be treated as equity or debt for Singapore income tax purposes is important to  the issuers and investors alike as it determines the deductibility and taxability of payments and receipts arising from such instruments.

Characterisation of hybrid instruments 

Currently, there are no specific provisions in the Income Tax Act (“ITA“) that stipulate the conditions or factors in determining the nature of an hybrid instrument, i.e. whether it is a debt or equity instrument.

Under the IRAS’ approach,  the first step in determining the
characterisation of a hybrid instrument such as redeemable preference share as either debt or equity is to determine its legal form; where the legal terms of the instrument indicate ownership interest in the issuer, the instrument is generally regarded as equity.

Singapore-based issuers of hybrid instruments

Where the legal form of the hybrid instrument issued by a Singapore-based issuer is not indicative of the legal rights and obligations, IRAS would examine the facts and circumstances surrounding the instrument and a combination of the following non-exhaustive factors in order to determine the characterisation of the hybrid instrument:

More likely towards Equity

  • Investor acquires shareholding and residual interest in the issuer 
  • Investor acquires right to participate in issuer’s business 
  • Instrument confers investor with voting rights 
  • Where right of investor to repayment of principal is subordinated to that of general creditors or to holder of subordinated debt of the issuer
  • Where investor is required to bear current or future losses of the
    issuer by way of either a write-down of the principal amount of such instrument or conversion to ordinary shares of the issuer

More likely towards Debt

  • Principal sum: there is a fixed repayment date in a reasonably foreseeable future and repayment is not conditional on business performance of the issuer
  • Principal sum: where there is no fixed repayment date, there is incentive for the issuer to redeem the instrument (such as a step-up feature which provides for an increase in the distribution rate at a specific point in time)
  • Distributions: cumulative and payment is not conditional on business performance 
  • Investor has unconditional right to enforce payment of distribution and repayment of principal amount 
  • Regulatory authorities (other than IRAS) in Singapore regard hybrid instrument as debt, e.g. the issuance of the instrument would affect the borrowing limit imposed on the issuer.

Foreign-based issuers of hybrid instruments

IRAS would examine the factors listed in the above in relation to determination of the characterisation of hybrid instruments issued by a foreign-based issuer of hybrid instruments

IRAS has stated that it will also consider the characterisation of the instrument in the country of the issuer and that “the use of this guide may be limited by new forms of hybrid instruments as well as changes in tax treatments adopted by foreign tax jurisdictions which
may have an impact on the Singapore income tax consequences”. In doing so, IRAS appears to have taken a leaf out of OECD’s recommendations to address mismatches in the tax treatment of hybrid instruments across jurisdictions under its action plan to address Base Erosion and Profit Shifting (“BEPS“).

Nevertheless, the IRAS acknowledges that the characterisation of a hybrid instrument should be based on the full facts and circumstances and a combination of relevant factors including
those mentioned in the e-Tax Guide. There is no simple or single factor that can be employed in all cases.  The Guide seems to deviate from the recommended primary response under BEPS Action Point 2. It remains to be seen whether the IRAS will ultimately accept the BEPS recommendations relating to hybrid instruments once those recommendations are finalised.

Availability of seeking advance ruling from IRAS

Advance ruling from the IRAS on the characterisation of the hybrid instrument is available for Singapore-based issuers. The issuer is required to communicate the ruling obtained from IRAS to investors or prospective investors through appropriate channels such as the offering circular, information memorandum, website etc.

It is unclear whether the issuer is required to communicate adverse rulings by the IRAS, given that rulings are binding only upon the authorities. Also, although the Guide is silent, it should be possible for a Singapore-based investor to seek advance ruling on characterisation of an instrument issued by a foreign issuer for Singapore income tax purposes.

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