TAX – An essential consideration for startups

Lim Maan Huey Tax Partner PwC Singapore

Trevina Talina Tax Director PwC Singapore

This article provides a general introduction to various concepts under the Singapore taxation regime for startups or business owners to consider, from financing / funding to operational and human resource perspectives. 

Whilst commercial considerations are important in operating a company, start-ups should not omit tax considerations as it could otherwise increase the costs of doing business and erode returns to founders and/or investors. As Singapore is a leading start-up hub in Asia, the Government implements tax policies and incentives that support start-up businesses. This section provides a general introduction to various concepts under the Singapore taxation regime for start-up founders or business owners to consider from financing/funding, operational and human resource perspectives.

A. OVERVIEW OF TAXATION REGIME IN SINGAPORE

Singapore operates on a quasi-territorial basis of taxation. What this means is that tax is imposed on income which has its source in Singapore as it arises, but only imposes tax on income sourced elsewhere (foreign-sourced income) when it is received in Singapore. The prevailing corporate income tax rate is currently 17% and the prevailing personal income tax rate is progressive up to 22%.

As noted above, Singapore tax is imposed on income. Singapore does not impose tax on capital gains. There is no definition of what constitutes income and capital in the Income Tax Act.[1] The determination of whether a receipt is income or capital in nature is generally done with reference to case law and based on the facts and circumstances of each case. Generally, gains on disposal of assets are considered income in nature if they arise from or are otherwise connected with the activities of a trade or business carried on in Singapore.

The above also makes reference to Singapore and foreign sourced income. There is no definition in the Income Tax Act of what constitutes Singapore source or foreign source, aside from specified income items such as interest and royalty income. References are made to case law in determining the source location of income/gains and the tests which are applicable may differ depending on the types of income/gains. For instance, dividend income is sourced where the dividend paying company is tax resident in. Gains on assets is generally sourced where the income producing activities took place. Operating revenue is generally sourced where the operations took place from which the profits in substance arose.

Singapore also implements a Goods and Services Tax (GST) system. GST is charged at 7% on the supply of goods and services made in Singapore by a taxable person in the course or furtherance of one’s business unless the supply qualifies for zero-rating or exemption. It was announced in the 2018 Budget that this rate would be increased to 9% sometime between 2021 and 2025. It was subsequently announced in the 2020 Budget that this GST hike will not take place in 2021 (i.e. it would be increased between 2022 and 2025).

B. TAX CONSIDERATIONS ON FINANCING/FUNDING MATTERS

One of the most important factors in the survival and growth of start-ups is the availability of funding from angels or venture capital (“VC”) investors. There are several ways in which a start-up can be funded. The common ways of capitalising a start-up company are through the issuance of ordinary shares, preference shares (“PS”), convertible notes or loans. Generally, founders will own ordinary shares in the company while the investors will own PS, convertible notes or loans in the company.

It is important to understand the tax implications for both the start-ups and the investors when proposing a funding request. Adverse tax implications to the investors could impact investors’ internal rate of return (“IRR”), thereby making the investment in the start-ups less attractive.

The table below summarises the Singapore tax implications for a Singapore start-up company and its investors, depending on the choice of funding.

Capital structure	Singapore tax implications for start-ups	Singapore tax implications for investors
Ordinary shares/ RPS (equity)[2] issued by Singapore company	Dividends No corporate income tax deduction on the dividends paid. No withholding tax on dividends payment. Gains No withholding tax on redemption of the RPS.	Dividends Singapore/foreign investors: not subject to further tax   Gains Singapore investors: No tax on capital gains.[3] However, if the gains are considered as income in nature and is sourced in Singapore,[4]income tax applies on such gains. There is also a domestic exemption scheme which provides for non-taxability of gains derived from the disposal of ordinary shares (ie, not applicable to RPS or other instruments) where the divesting company has held at least 20% of the ordinary shares in the investee company for a continuous period of at least 24 months immediately prior to the disposal. Other conditions may apply. This is currently applicable to disposals during the period 1 June 2012 to 31 May 2022 (both dates inclusive). It was announced in the Budget 2020 that this exemption will be extended to cover disposals of ordinary shares by companies from 1 June 2022 to 31 December 2027. Foreign investors: Generally sourced outside Singapore[5]and not subject to tax in Singapore provided they do not carry on a business in Singapore by themselves or through an agent.

 

Convertible notes	Please refer to “ordinary shares/RPS” section above for periods after conversion to equity and refer to “loans” section below for the period before the notes are converted.
Loans/notes	Interest payments May be tax deductible provided the funding from the loans/notes are used in the production of income (e.g, to acquire income producing assets). Where the loans/ notes are used for multiple purposes, the deduction is restricted to the interest relating to income producing assets. Withholding tax may apply if the interest payment is made to non-residents. The domestic withholding tax rate on interest is 15%, which may be reduced under an applicable tax treaty depending on the profile of the investors.	Interest payments Singapore investors: Generally subject to tax at the prevailing income tax rate as considered sourced in Singapore. However, note that many VC funds managed by fund management companies in Singapore may be approved under certain tax incentives (such as 13R/13X Scheme), which provides Singapore income tax exemption on interest from loans/notes issued by certain start-up companies. Foreign investors: generally would receive the interest after deduction of applicable withholding tax.

1. Other incentives to investors

Further, to encourage investments in start-ups and/or other Singapore companies, Enterprise Singapore introduced the Angel Investors Tax Deduction (“AITD”) for individuals (commonly known as “angel investors”), subject to certain conditions and approval.

To enjoy the tax deduction, an approved angel investor must commit a minimum of S$100,000 in a qualifying start-up company within 12 months from the date of his first investment in that company. An approved angel investor can enjoy a tax deduction of 50% of its investment at the end of a two-year holding period. The amount of tax deduction for each Year of Assessment (“YA”) is based on 50% of the cost of qualifying investment, subject to a cap of S$500,000 of investment costs (that is, deduction cap of S$250,000). The qualifying deduction will be offset against the individual's total taxable income. Any unutilised deduction in any YA will be disregarded.

It has been announced in Budget 2020 that the above scheme will lapse with effect from 31 March 2020. Angel investors, whose approved angel investor status commences on or before 31 March 2020, can continue to be granted the tax deduction under the AITD scheme in respect of qualifying investments made during the period of his approved angel investor status, subject to existing conditions of the AITD scheme. Enterprise Singapore will provide further details of the transitional arrangement for approved angel investors by end-March 2020.

C. TAX CONSIDERATIONS ON OPERATIONAL MATTERS

1. Corporate income tax

(a) Tax exemption scheme for new start-up companies

To support entrepreneurship and help local enterprises, new start-up companies may enjoy tax exemption on their chargeable income under the normal tax category (17%) for the first three consecutive years of assessment, subject to the following conditions being met:

(a) The company’s principal activity must not be that of investment holding or undertaking property development for sale, for investment, or for both investment and sale.
(b) The company must be incorporated in Singapore;
(c) The company must be a tax resident in Singapore for that YA; and
(d) The company’s total share capital is beneficially held directly by no more than 20 shareholders throughout the basis period for that YA where:

1. all of the shareholders are individuals; or
2. at least one shareholder is an individual holding at least 10% of the issued ordinary shares of the company.

For the YA 2020 onwards, the exemption is calculated based on 75% on the first S$100,000 of chargeable income and a further 50% exemption on the next S$100,000 of chargeable income.

(b) Partial tax exemption

Companies that do not meet the qualifying conditions for Tax Exemption Scheme for New Start-Up Companies can enjoy partial tax exemption on their chargeable income under the normal tax category (17%). This is also applicable to the periods subsequent to the first consecutive three YAs under the Tax Exemption Scheme for New Start-Up Companies.

From the YA 2020 onwards, partial tax exemption is given to all companies on chargeable income of up to S$200,000 to be computed as follows: 75% tax exemption on the first S$10,000 of chargeable income and a further 50% exemption on the next S$190,000 of the chargeable income.

(c) Taxability of income

Income derived by start-ups from carrying on trade or business activities in Singapore would be considered Singapore-sourced and be subject to income tax as it arises. Foreign-sourced income derived by the startups (for example, interest on deposits with banks outside Singapore) are subject to Singapore income tax when received in Singapore. The current corporate tax rate is 17%.

Additionally, Singapore offers a range of tax incentives and grants for undertaking qualifying activities. Information can be found on Enterprise Singapore website.

(d)Deductibility of expenses

Expenses wholly and exclusively incurred in the production of income of start-ups are generally tax deductible, unless otherwise prohibited by the tax rules. Among others, capital expenses (for example, expenses incurred to get ready for business, applying for licence, new leases, legal and professional fees or setup costs), private expenses (for example, personal entertainment costs), depreciation expense and private car expenses are not deductible for tax purposes.

Employee remuneration expenses (for example, salaries, bonuses, Central Provident Fund (CPF) contributions within statutory limit) are generally deductible. However, note that tax deduction for medical expenses is subject to 1% (or 2% if the business implements certain scheme) of the total remuneration. Also, there are special rules for deduction of share-based expenses (refer to the discussion on “Tax considerations on Human Resource matters” below).

(e) Interest expenses and other borrowing costs

Please refer to the discussion on “Tax considerations on financing/funding matters” above. Start-ups may have incurred other types of borrowing costs (such as upfront fees, guarantee fees). Certain prescribed borrowing costs that are incurred as a substitute for interest or to reduce interest costs may be tax deductible.

(f) Start-up expense

Generally, expenses incurred prior to the commencement of business are not tax deductible. To facilitate business start-ups, the Singapore Government has introduced a concession to allow businesses to claim tax deduction on revenue expenses incurred in the accounting year immediately preceding the accounting year in which the business earned its first dollar of trading income.

(g) Capital allowances (also known as tax depreciation)

Capital allowances are available on costs incurred in the acquisition of “plant and machinery” for use in the start-up’s trade or business. Certain types of machinery (for example, computers, servers or automated equipment) qualify for accelerated capital allowance claim over one year. Other types of qualifying “plant and machinery” (for example, workstations, tables, chairs) may be claimed over a straight-line basis over their specified working life based on the tax rules or on accelerated basis over three years.

Note that costs to acquire private car or on certain structural renovation or refurbishment work do not qualify for capital allowance claims. That said, certain qualifying renovation and refurbishment works may qualify for special tax deduction under section 14Q of the Income Tax Act. The deduction is capped at S$300,000 for every relevant three consecutive YAs starting from the year in which the renovation and refurbishment costs are incurred.

(h) Research and development (“R&D”) expenses and intellectual property (“IP”) acquisition expenses

For the YAs 2019 to 2025 (that is, financial years ended/ending 2018 to 2024), enhanced tax deduction of 250% of qualifying expenditure is available for R&D carried out in Singapore, subject to conditions. Where the R&D is carried out overseas, a deduction of 100% of qualifying expenditure is allowed.

In addition for YAs 2019 to 2025, enhanced tax deduction of 200% is available for each of the following:

1. the first S$100,000 of qualifying expenditure incurred to register qualifying IP; and
2. the first S$100,000 of expenditure incurred to license qualifying IP.

(i) Tax incentives for start-ups

To encourage Singapore businesses to expand overseas, the Singapore Government has introduced a Double Tax Deduction for Internationalisation scheme which provides double tax deduction on qualifying expenses incurred from 1 April 2012 to 31 March 2020. An approval by Enterprise Singapore or the Singapore Tourism Board is required (with some exceptions).

No approval from the relevant authorities is required on expenses incurred on the certain activities (such as overseas business development trips/missions, overseas investment study trips/missions, overseas trade fairs and certain approved local trade fairs). However, this is subject to a cap of S$150,000 per YA for YA 2019 to 31 March 2020.

It has been proposed in Budget 2020 that the above scheme will be extended to 31 March 2025 and the scope of qualifying expenses will be enhanced to cover, among others, certain third party consultancy costs relating to new overseas business development or overseas business missions.

(j) Carry-forward/carry-back of losses

Trade losses and unutilised capital allowances may be carried forward to set-off against future taxable income, subject to continuity of shareholding test. Additionally, for capital allowances to be carried forward, the same trade needs to be continued. The continuity of shareholding test is considered met where not less than 50% of the total number of issued shares of the ultimate holding company were held by or on behalf of the same shareholders on the relevant comparison dates. The Inland Revenue Authority of Singapore (“IRAS”) may exercise discretion to allow utilisation of brought forward tax losses and unutilised capital allowances, even when there has been a change in shareholding beyond 50%, absent any tax avoidance motives.

Losses and capital allowances of up to S$100,000 incurred by the company in the current year can be carried back for one year (excluding for YA 2020 where the qualifying deductions can be carried back up to 3 years). The carry-back of losses and tax depreciation is subject to the continuity of shareholding test and the same trade test (for carry-back of capital allowances).

(k) Transfer pricing rules

All transactions with related parties must be carried out on an arm’s length basis, and contemporaneous transfer pricing documentation must be maintained to demonstrate this except in limited circumstances. If the arm’s length principle is not complied with or if the compliance with the arm’s length principle is not supported by adequate documentation and profits have been understated, IRAS is empowered to make transfer pricing adjustments. Penalties and surcharges may also apply.

(l) Withholding tax

Start-ups should be mindful of the withholding tax requirements when making payments to non-residents or foreign companies/establishments. A person in Singapore is obliged to withhold tax on certain kind of payments to non-residents, including

(a) interest and related payments,
((b) technical service fee for services rendered in Singapore, and
(c) management fees.

2. Goods and Services Tax (“GST”)

(a) Overview

As a basic rule, a supply of goods or services made in Singapore is subject to GST at the standard rate of 7%, unless the supply qualifies for zero-rating or exemption under the GST legislation. Both standard-rated supplies (i.e. subject to GST at 7%) and zero-rated supplies (i.e. subject to GST at 0%) are considered as taxable supplies and contribute to the calculation of GST registration threshold.

Most supplies in Singapore are taxable supplies. Exempt supplies are limited to the following:

1. provision of certain financial services
2. sale and lease of residential properties
3. import and local supply of prescribed investment precious metals
4. supply of digital payment token (with effect from 1 January 2020)

Exempt supplies do not contribute to the calculation of GST registration threshold.

(b) Registration requirement

A business has a liability to register for GST if:

1. it has made taxable supplies (standard-rated and zero-rated supplies) that exceeded S$1 million at the end of a calendar year (that is, 31 December); or
2. there are reasonable grounds to believe that the total value of its taxable supplies in Singapore will exceed S$1 million in the next 12-month period.

Subject to conditions, a business may also apply for GST registration on a voluntary basis subject to the approval of the IRAS.

With effect from 1 January 2020, a non-GST registered business is also liable for GST registration  if the value of imported services (i.e. services procured from overseas persons) exceeds S$1 million a year and the business is not entitled to full input tax claims (due to making certain exempt supplies or carrying on non-business activities)

Once GST registered, a start-up is required to comply with the GST rules (e.g. charge and account for GST on its supplies, issue tax invoice, file GST returns). On the other hand, it is entitled to claim GST incurred on its business expenses and importation of goods, subject to satisfying the conditions governing input tax claims.

D. TAX CONSIDERATIONS ON HUMAN RESOURCE MATTERS

1. Share-based remuneration scheme

To entice talented individuals to work with start-ups, it is common to implement employee incentive schemes such as share-based remuneration scheme. A tax deduction for employee share-based remuneration (stock awards or stock option schemes) is allowed only if treasury shares in the company or its holding company are purchased to fulfil such obligations. In other words, no deduction is allowed if the scheme is fulfilled by way of issuance of new shares (that is, no costs incurred). The deduction is restricted generally to the lowest of the actual outlay incurred by the company, its holding company or the special purpose vehicle used to administer such scheme.

2. Employer tax and other filing obligations

Do note that as an employer, you are required to prepare a year-end return of remuneration (Form IR8A) to be electronically filed directly to IRAS by 1 March, if you are under the Auto Inclusion Program. If you are not, you are required to prepare a paper form IR8A and provide the same to the employee by 1 March. You are also required to make CPF contributions for your employees who are Singapore citizens or Singapore permanent residents. The CPF contributions are subject to capping limits and are due at end of the month and are payable to the CPF Board no later than 14 days from the end of the month.

You are also required to contribute the Skills Development Levy (SDL) for all employees, both local and foreign (limited exemptions apply only), at the prevailing rate based on each employee's total monthly wages. SDL payments are also payable no later than 14 days from the end of the month, and may be made in conjunction with CPF payments, or directly to the Skills Future Singapore Agency (SSG) in the case where your organisation employs only foreign employees.

In addition, if your non-Singapore Citizen employee (i.e. foreign, work pass holders or Singapore Permanent Resident employee) ceases employment with you in Singapore, goes on an overseas posting or plans to leave Singapore for more than three months, you may be required to seek tax clearance for him. If so, as an employer, you are responsible for filing Tax Clearance for Foreign & SPR Employees (Form IR21) and withholding all monies due to the employee for tax clearance purposes. This Form needs to be filed no later than one month prior to the cessation or departure date. The monies withheld can only be released after the tax clearance is issued by the tax authorities or after 30 days of filing the Form IR21, whichever is earlier.

3. Travelling employees

As businesses are becoming international, start-ups should note activities carried out by employees or personnel representing the start-ups in overseas jurisdictions may create permanent establishment (taxable presence) for the start-ups in those jurisdictions. As a result, profits attributable to the permanent establishment in those jurisdictions may be subject to tax in those jurisdictions. Careful planning of where activities are performed should be done to mitigate such risks.

E. GENERAL TAX COMPLIANCE REQUIREMENTS

Singapore companies are required to comply with the annual corporate tax filing requirements to IRAS. Below is a general summary of the requirements.

Corporate income tax – Estimated chargeable income (“ECI”)	Within 3 months of the financial year end of the company
Corporate income tax – Annual tax returns	By 30 November of the year following the financial year
GST (if GST-registered)	One month after the end of the GST (quarterly) accounting period
Return of employee remuneration	1 March of the year following the financial year
CPF contribution	End of each month

You should also consider the applicability of the Foreign Account Tax Compliance Act (FATCA) and the Common Reporting Standard (CRS), and comply with the compliance requirements, where applicable.