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Basis of Assessment for Service Companies

Basis of Assessment for Service Companies

08/10/2018
Basis of Assessment for Service Companies

Introduction

The income of a company that is set up for the sole purpose of rendering services to its holding company and/or other related companies is taxed like any other company that is carrying on a trade or business in Singapore.

However, as an administrative practice, the Inland Revenue Authority of Singapore (IRAS) allows companies that only render services to its related companies and are remunerated on a cost-plus mark-up basis to compute their chargeable income based on the mark-up without any tax adjustments. This basis of assessment is commonly referred as the “cost plus mark-up” basis of assessment.

In this article, we explain the two methods of taxing the income derived by a service company.

Cost Plus Mark-Up Basis of Assessment (CM Basis)

Under the CM basis, the chargeable income is equivalent to the mark up imputed on the total expenditure incurred in providing the services. Companies adopting this basis of assessment are not allowed to claim double tax deductions, capital allowances, tax losses, donations and foreign tax credits against the income.

With effect from the year of assessment (YA) 2020, the CM basis will continue to be available to service companies as an administrative practice only if they meet the following conditions:

  • Provide routine support services that fall within Annex C of the IRAS e-tax guide titled “Transfer Pricing Guidelines” to only related parties;
  • A 5% mark-up is adopted as the arm’s length charge for the routine support services; and
  • The total cost base (before offsetting revenue grants received, if any) as shown in the profit and loss account and as determined under the Singapore Financial Reporting Standards is used to compute the 5% mark-up, without further adjustments.

Companies which do not meet the above conditions to apply the CM basis are required to prepare their tax computations on a “normal trading company” basis of assessment. Companies that meet the above conditions can choose to prepare their tax computations on a “normal trading company” basis of assessment.

For investment holding companies, they do not qualify for the CM basis even if they meet all the above conditions.

Under IRAS’ transfer pricing guidelines, as an administrative practice, taxpayers can apply a safe-harbour cost mark-up of 5% for specified routine support services as a reasonable arm’s length charge if certain conditions are satisfied. Companies that are able to satisfy the conditions to use the safe-harbour mark-up in charging their related parties can choose to apply the CM basis to prepare their tax computation as they would have met the conditions to apply the CM basis.

Normal Trading Company Basis of Assessment (NTC Basis)

The NTC basis requires detailed examination of a company’s accounts in accordance with provisions of the Income Tax Act to arrive at the chargeable income. Typically, the service company would need to make, inter-alia, the following tax adjustments to compute its chargeable income:

  • Deduct non-taxable income
  • Add back non-deductible expenses
  • Claim for capital allowances on qualifying plant and machinery

Companies Transiting from the CM Basis to NTC Basis

Service companies which are not eligible for the CM basis have to transit to the NTC basis, latest by YA2020. The IRAS has set out certain transition rules and in the YA of transition, those rules should be applied.

Some of the transition rules include:

  • A company transiting to the NTC basis will be allowed to claim capital allowances based on the net book value of qualifying plant and machinery acquired prior to the YA of transition.
  • Any write-back of general provisions after transiting to the NTC basis in respect of general provisions made prior to the YA of transition shall not be taxable.

Service companies which are currently adopting the CM basis should review if they still fall within the scope of the CM basis. If they do not qualify for the CM basis, they could consider an early transition to NTC basis as, in some situations, there may be certain advantages to transit to the NTC basis before YA2020.