07 December 2018 - Article
On February 17, 2006, Prime Minister and Minister for Finance Lee Hsien Loong presented Singapore’s 2006 Budget in Parliament. Noting that Singapore’s economic growth in 2005 had exceeded expectations, he set out a blueprint for developing key sectors of the economy in 2006 and beyond.
Many of the tax changes announced in the Budget aim to enhance Singapore’s already solid position as an international financial centre. These include favourable changes in the taxation of trusts and trust companies. While many well-designed offshore structures involving the use of Singapore already eliminate Singapore tax exposure under current rules, the latest changes enhance the range of planning options available to foreign families seeking a favourable trust jurisdiction. Moreover, the collective impact of the Budget proposals on the broader financial sector will likely give offshore trust business an indirect boost.
Changes to the Taxation of Trusts and Trustees
1. Foreign Trusts vs. Domestic Trusts
The tax treatment of trusts in Singapore depends to a large extent on whether the trust is a foreign trust or a domestic trust. A foreign trust is one that is created by written instrument, and whose settlors and beneficiaries include only: (i) individuals who are neither residents nor citizens of Singapore; and (ii) foreign companies. A foreign trust may retain its status as such even if a settlor or beneficiary of the trust subsequently becomes a citizen or resident of Singapore, but only if restrictive conditions relating to additional trust contributions, beneficial entitlements and the exercise of powers under the trust are met. Trusts that do not qualify as foreign trusts are taxed as domestic trusts.
2. Changes to the Tax Treatment of Foreign Trusts
Under current law, foreign trusts (and foreign underlying companies) administered by licensed trust companies in Singapore are exempt from tax on most types of investment income. The licensed trust companies themselves also enjoy a concessionary 10% corporate tax rate on fees derived from the administration of foreign trusts, instead of the standard 20% corporate tax rate.
Under the Budget proposals:
- The definition of ‘foreign trust’ will be expanded to include trusts whose settlors or beneficiaries include foreign non-corporate entities.
- The tax exemption in respect of investment income earned by foreign trusts will be extended to foreign trusts administered by private trust companies (PTCs) in Singapore. PTCs do not require a license to carry on trust business in Singapore, but foreign trusts administered by PTCs do not presently qualify for the tax exemption on their investment income.
- The concessionary 10% corporate tax rate currently enjoyed by licensed trust companies on trustee fees derived from the administration of foreign trusts will be extended to similar fee income derived by PTCs.
3. Changes to the Tax Treatment of Domestic Trusts
Domestic trusts are taxed on their Singapore-source income, as well as foreign-source income that they receive in Singapore. To the extent that trust income is distributed currently to a Singapore resident beneficiary, it will be taxed only in the hands of the beneficiary, at individual marginal tax rates. All other income (i.e. income that is accumulated in the trust or distributed to non-resident beneficiaries) is taxed at a flat 20% rate in the hands of the trustee. When such income is distributed to a beneficiary, the beneficiary is taxed on the trust distribution, but allowed a credit in respect taxes paid by the trustee on the distributed income.
The credit mechanism is designed to prevent economic double taxation of trust income. However, due to a quirk in the credit mechanism, income that would otherwise be exempt if received directly by an individual – such as bank interest, dividends from Singapore companies and foreign-source income – would be exempt in the hands of the trustee, but taxable when received by the individual as a trust distribution (with no corresponding credit since the trustees paid no taxes).
The Budget proposals seek to eliminate this anomaly, i.e. preserve the tax-exempt character of domestic source investment income and foreign source income in the hands of a Singapore resident individual, whether the individual derives such income directly or through a ‘qualifying domestic trust’. A qualifying domestic trust is a domestic trust whose settlors are individuals and whose beneficiaries are individuals or charities.
Changes Relevant to the Broader Banking & Finance Industry
1. Special Tax Regime for Unit Trusts Restricted to Sophisticated Investors The Designated Unit Trust tax incentive scheme exempts certain types of investment income, both at the level of the unit trust and that of the individual investor. This scheme currently applies only to domestic unit trusts aimed at the retail market. The Budget proposals will extend the scheme to restricted funds targeted at sophisticated investors and institutional investors.
2. Tax Exemption for Singapore-Resident Investment Funds Under current law, certain types of investment income derived by investment funds structured in corporate form are exempt from Singapore income tax if: (i) the fund investors are foreigners; and (ii) the company is not tax resident in Singapore. To encourage the domiciliation of investment funds in Singapore, the Budget proposals will extend this favourable treatment to funds structured as Singapore resident companies, as long as foreign ownership requirements are met.
3. Enhanced Tax Treatment of Singapore-listed REITs Under current law, Singapore-listed Real Estate Investment Trusts may be granted a tax exemption on certain types of income derived from foreign real estate. The Budget proposal broadens the categories of income that may be exempted from tax, and allows the recovery of Goods and Services Tax (value added tax) paid in certain circumstances.
*4. Qualifying Debt Securities Scheme Broadened * Income from qualifying debt securities is currently taxed at concessionary tax rates in the hands of corporate investors and non-resident investors. This preferential treatment does not apply, however, to debt securities with a tenure of more than one year. The Budget proposals extend this preferential tax treatment to resident individual investors and to debt securities that have a tenure of more than one year.
5. Finance & Treasury Centre Tax Incentive Broadened The FTC incentive was introduced some years ago to encourage multinational companies to locate their treasury functions in Singapore. Qualified income derived by approved FTCs is taxed at a concessionary rate of 10%. The Budget proposals expand the categories of ‘qualified income’ to include gains from derivatives trading with specified counterparties.
6. Tax Incentive for OTC Derivatives Clearing Facilities A new tax incentive scheme will be introduced to encourage the establishment of over-the-counter derivatives clearing facilities in Singapore. Income derived from the provision of such services will be taxed at a concessionary rate of 5% for 5 years, rather than at the standard 20% corporate tax rate.
7. Measures to Promote Islamic Finance The Budget announced that the Government will align the tax treatment of Islamic financial products and their conventional economic equivalents. For example, gains accrued and expenses incurred by various Islamic investment vehicles will be treated for tax purposes as equivalent to interest income or expense where appropriate. The stamp duty and Goods and Services Tax rules will also be rationalized to ensure comparable treatment of Islamic and conventional financial products.
Comment: Another Step in the Right Direction
Trust Structuring and Tax Residence Planning It is already possible to design foreign trust structures to achieve a tax-free result under current law, relying on general features of the Singapore tax system rather than on special exemptions. However, the Budget proposals expand range of planning options available to foreign settlors and beneficiaries, making Singapore even more attractive as an offshore trust jurisdiction.
The changes to the domestic trust taxation rules also create new opportunities for tax residence planning. Under current law, foreign families that use Singapore as an offshore trust jurisdiction their risk losing tax-free treatment of their family trusts if they take up residence in Singapore and thereby convert the trusts into domestic trusts. The proposed changes to the taxation of domestic trusts will allow well-advised settlors and beneficiaries to transition between resident and non-resident status as part of their long-term international tax planning, without negative Singapore tax consequences. This favourable tax situation would complement the Financial Investor Scheme, an immigration programme that allows foreigners with net personal assets of at least SGD 20 million to obtain permanent residence permits if they place SGD 5 million with Singapore financial institutions for 5 years.
*Building Critical Mass in the Local Trust Industry * Trust companies doing business in Singapore will be making significant investments in manpower, infrastructure, know-how and capital in the coming months in order to meet licensing requirements under the new Trust Companies Act. To the extent that the favourable changes to the trust taxation regime encourage greater use of trusts – both onshore and offshore – the increased business should go some way toward justifying these investments. In the longer term, the increased use of trusts in Singapore will result in more experienced trust personnel, advisors and courts.
Sophisticated Financial Structuring The measures aimed at the financial sector as a whole will hopefully produce a broader universe of investment products and structuring options for clients with sophisticated planning needs, such as private family investment vehicles or tailor-made financial products.
*Singapore’s Unique Onshore-Offshore Offering * Singapore’s ascendance as an offshore trust jurisdiction is relatively recent, but its onshore financial industry has a solid reputation and proven track record. This unique combination of offshore and onshore offerings gives Singapore a unique edge over many of the ‘traditional’ offshore centres. For example, a foreign family establishing its offshore trust in Singapore has the option of using Singapore’s financial infrastructure for banking, asset management and custody as well – thus extending the benefits and protections of Singapore’s laws (e.g. against forced heirship claims) to the entire structure. In contrast, many offshore centres provide excellent protection at the trust level, but do not offer onshore banking, asset management and custody, thereby exposing trust assets to potential attacks in a third jurisdiction where protections may be weaker. Thus, the further development of the financial industry as a whole will provide a solid foundation for the growth of Singapore’s trust industry as well.