Dear Valued Clients and Readers
In the case AQP v. Comptroller of Income Tax, the Singapore High Court held that defalcation losses incurred by an employee exercising overriding power or control in the taxpayer firm were not deductible under s 14(1) of the Income Tax Act. The High Court also clarified that a genuine mistake of law could fall within the meaning of the phrase “error or mistake” under s 93A(1).
The following is the Supreme Court Note to assist readers to understand the Court’s judgment. It is not intended to be a substitute for the reasons of the Court.
In this case, the managing director (“the Ex-MD”) of the appellant taxpayer had defalcated the appellant’s funds and caused the appellant to incur a loss of $12,272,917. The Ex-MD had made out false purchase orders to the appellant’s suppliers, and falsely claimed to have made loans to the appellant’s customers, before drawing from the appellant’s funds under the pretext of reimbursement. The appellant omitted to include a deduction for the loss incurred and only lodged a claim for relief under s 93A(1) five years later. The Comptroller of Income Tax and the Income Tax Board of Review rejected the appellant’s claim for relief.
In the judgment, the High Court recognised that the crux of the dispute with regard to the tax-deductibility of defalcation losses centred around the correct understanding of the seminal English case of Curtis (HM Inspector of Taxes) v J & G Oldfield, Limited (1925) 9 TC 319 (“the Curtis test”). Having surveyed the relevant cases of various Commonwealth jurisdictions, the High Court came to the conclusion that the correct understanding of the Curtis test was as follows: Did the defalcator possess an overriding power or control in the taxpayer firm (i.e. in a position to do exactly what he liked), and was the defalcation committed in the exercise of such power or control? If so, the losses which resulted from such defalcations were not deductible for income tax purposes.
Having formulated the test, the High Court defended its viability on the policy ground of deterring firms from not providing adequate checks on employees who had possessed overriding power or control (i.e. directors). The fact that the appellant’s business was successful when the Ex-MD had overriding power or control was held to be irrelevant. The High Court also clarified that what mattered was whether the taxpayer factually did give the defalcator unjustified overriding power or control.
In the present case, the Ex-MD was held to have possessed an overriding power or control in the appellant as there was total trust reposed in him and he did not have to tell anyone about his usage of the appellant’s funds. His defalcations were also committed in the exercise of such overriding power or control, as evident in the blatant way in which he had siphoned funds from the appellant without restraint. The loss incurred by the appellant from the Ex-MD’s defalcation therefore did not qualify for deduction under s 14(1).
Having dismissed the appellant’s appeal on the point of deductibility, the High Court then proceeded to hold in obiter that the phrase “error or mistake” under s 93A(1) was wide enough to cover a genuine mistake of law (i.e. a mistake as to what was thought to be established law) made by the taxpayer whilst computing its taxable income. However, the High Court also observed that s 93A(3) appears to have the effect of qualifying the granting of relief to a taxpayer who was operating under a mistake of law, assuming that the Comptroller had also been mistaken as to “the basis on which the liability of the [taxpayer] ought to have been computed” at the material time.
As always, we are pleased to assist you or your company in resolving any potential tax issues. Please contact us at firstname.lastname@example.org if you would like to discuss any of your/ your company’s concern on tax issues.
Jack HM Wong
Founder and Lead Business & Tax Advisor
WHM Consulting Pte Ltd