The Inland Revenue Authority of Singapore (IRAS) recently released the common reasons for errors in corporate income tax returns as confirmed through audits. The most common misstates are 1.) understatement or omission of income due to incomplete recording of revenue, 2.) Incorrect claims of capital allowances on non-qualifying assets; 3.) failure to apply the arm’s length principle for related party services; and 4.) poor record-keeping and incorrect claims by family-owned/ managed companies.
The examples cited by the IRAS concerning incomplete revenue recording were of a very general nature in areas such as under-reported commissions and scarp sales, and while a genuine issue, are probably not something most multinational companies are failing to record properly. The second issue of incorrect capital allowances would also appear to be an issue with smaller firms with less experienced staff and advisors, and the same would be similar for the fourth point of poor record-keeping and incorrect claims by family-owned/managed companies.
It is the third issue of failing to apply the arm’s length principle for related-party services that are of interest in the context of multinational entities. Services by their nature are always suspect in the eyes of revenue authorities. The notion that services are a disguised means of reallocating income between the parties is inherent in the examiners’ minds, and while there may be some instances where they are indeed vehicles for simply effecting a shift in income and tax consequence, for many companies they are legitimate activities that require adequate compensation.
The IRAS reported undercharging for the services to artificially lower the income within Singapore, and while that may indeed have occurred in certain local enterprises, in the multinational structure the pattern is the inverse of this. Typically, the entity/country getting the bill believes they are being overcharged for the “services,” and which would also reduce the taxable income of the local entity, with the resulting loss of tax revenue.
The moral of the story is simple: Companies need to have the appropriate metrics to support the activity benefitting the related party, and they need to have in place both policies and procedures outlining the activity and accurate agreements in place memorializing same. Of course, this is predicated on having the appropriate arms-length charges and comparables to support the charges. Failures in any of these areas can lead to a less than favorable audit result.
