Tax reflections for the keenly awaited Budget 2017

SINGAPORE is, at least from a tax perspective, living in interesting times. With the Budget 2017 announcement just around the corner, it is opportune to reflect on the confluence of externalities and domestic forces that have led to this point; their impact on Singapore and some thoughts on measures that can be taken to cushion some of these forces.

We start with the observation that recent developments, notably with Brexit in the United Kingdom and the presidential election in the United States, have created uncertainties for the global economy. This poses risks for Singapore, which has a highly trade-oriented and small economy. In spite of the possible road-blocks that may be put up against free trade as a result of these developments, businesses in Singapore have little choice but to press on with their internationalisation plans, as growth in the Singapore economy is expected to remain low in the coming years.

The government is well aware of this constraint and has done much in recent Budgets to encourage businesses to go overseas. For example, expenses incurred to identify overseas investment opportunities and to send staff overseas, amongst others and subject to conditions, qualify for double tax deductions. High-potential Singapore companies that continue to anchor their key functions in Singapore, whilst expanding abroad, may also enjoy concessionary tax treatment on income derived from overseas.

There is more that the government can do in the area of financing such overseas investments. Some effort has already been made to address the access to funding. For example, the government, recognising that it is generally difficult for Singapore businesses to source for funding in the investment jurisdiction or even in Singapore, especially if the Singapore group does not have a track record or sizeable operations in that country, has stepped in to offer risk-sharing of loans for overseas investments under the Internationalisation Finance Scheme.

Perhaps more can be done from a tax perspective. For instance, to defray part of funding costs, the government can consider granting a special tax deduction on interest or related borrowing costs incurred to acquire or set up overseas equity investments. These costs are generally not tax deductible currently. The special deduction could also be targeted at small and medium enterprises to encourage them to expand, and this may also benefit Singapore financial institutions.

2017 marks the last financial year for businesses to enjoy the Productivity and Innovation Credit (PIC) Scheme, a broad-based government initiative to support investments in a range of activities along the innovation value chain. Since 2010, businesses have gradually grown accustomed to the generous tax deductions and, to a lesser extent, cash payouts offered for a gamut of activities - ranging from buying a laptop to undertaking research and development (R&D) - and may wonder if the government would continue supporting such expenditure post-PIC.

Perhaps with a view to combating this perception, in Budget 2016, the government introduced the Automation Support Package, which comprises grants, additional tax allowances and enhanced financing support for approved projects undertaken by businesses to automate and scale up. With the "P" in PIC addressed, we feel that the 'soft-landing' from PIC should also be extended to the "I".

Innovation is an all-encompassing term. It does not necessarily entail the creation of something 'new' from scratch. An archetypal case would be Uber, which by combining existing technologies (global positioning system, online payment systems, etc) is able to offer new value for customers. This is precisely the 'value' that Singapore is trying to emulate in a 'value-creating' economy.

INNOVATION VS R&D

Whilst there are well-defined rules to grant enhanced deductions for undertaking research and development (R&D) activities, taxpayers who undertake innovative activities or projects by combining existing technologies to create new products or services may not be viewed as engaging in R&D; and as a consequence are also ineligible for PIC claims, unless some automated equipment or computer software is created.

With the PIC scheme expiring, the taxpayers may find no additional broad based support for such projects in future, unless these projects qualify as R&D activities, for which an additional 50 per cent tax deduction is available, where the R&D is conducted in Singapore. However, the issue is that what a businessman views as innovative may not constitute R&D for tax purposes.

As such, the government could consider granting enhanced tax deductions for spending incurred on "innovative activities" that lead to the creation of new products or services. We acknowledge that such innovation projects may be of a much broader scope, and hence the tax incentives of encouraging such activities could be set at a lower tier vis-à-vis existing R&D incentives.

No article on topical tax issues would be complete without mentioning the Base Erosion and Profit Shifting (BEPS) Project - an ambitious revamp of international tax rules by the world's major economies to ensure multinational corporations pay their 'fair share' of taxes. With the recent completion of a multilateral instrument that allows countries which sign up to swiftly implement tax treaty measures aimed at preventing cross-border tax avoidance, there is no doubt that we are now firmly in the implementation phase of BEPS.

Singapore has taken a principled stance with regard to the BEPS Project. It has consistently voiced support for the fundamental BEPS principle that profits should be taxed where substantive economic activities generating the profits are performed and where value is created, whilst also stressing that it is every country's sovereign right to determine its tax policies to attract investments. That said, collateral damage is perhaps unavoidable as countries big and small vie for their share of the tax pie.

One of the practical considerations of the BEPS Project on Singapore, amongst others, is that some of its tax incentives may need to be tweaked or dropped in order to stay kosher in a post-BEPS world. Previous Budgets have seen selected tax incentives lapsing upon expiry or being removed, especially those that may not require substantive business activities to be carried out in Singapore.

Tax incentives are a key plank of Singapore's tax policy and we do not expect the authorities to give them up in the foreseeable future. Nevertheless in the long run, with developed countries such as the UK and neighbouring countries such as Indonesia lowering their headline corporate tax rate to stay attractive to investments and thus closing the gap to Singapore's 17 per cent corporate tax rate, could we one day see Singapore adopting a lower flat tax rate sans incentives? Only time will tell.

What we can tell with reasonable certainty is that, as budgets go, Budget 2017 will certainly be a keenly awaited one as it comes on the back of soon-to-be-released recommendations by the Committee on the Future Economy. This Committee was tasked with charting the course of Singapore's economic future and we, along with other stakeholders in Singapore, are eagerly awaiting the outcome of its discussions.