KHOO, Teng Aun

TAN, Clement Kai Guan

Institutional Knowledge at Singapore Management University

Singapore Management UniversityInstitutional Knowledge at Singapore Management UniversityResearch Collection School Of Accountancy School of Accountancy3-2015Splitting Specified Foreign Sourced Incomebetween Tax Exempt and Taxable Portions: AnOptimal Solution (Part 3 of 3)Teng Aun KHOOSingapore Management University, takhoo@smu.edu.sgClement Kai Guan TANNanyang Technological UniversityFollow this and additional works at: https://ink.library.smu.edu.sg/soa_researchPart of the Accounting Commons, Corporate Finance Commons, International BusinessCommons, and the Taxation CommonsThis Journal Article is brought to you for free and open access by the School of Accountancy at Institutional Knowledge at Singapore ManagementUniversity. It has been accepted for inclusion in Research Collection School Of Accountancy by an authorized administrator of InstitutionalKnowledge at Singapore Management University. For more information, please email libIR@smu.edu.sg.CitationKHOO, Teng Aun and TAN, Clement Kai Guan. Splitting Specified Foreign Sourced Income between Tax Exempt and TaxablePortions: An Optimal Solution (Part 3 of 3). (2015). IS Chartered Accountant. 56-59. Research Collection School Of Accountancy.Available at: https://ink.library.smu.edu.sg/soa_research/1437IS Chartered Accountant 56TECHNICAL EXCELLENCE FOREIGN TAX CREDIT  POOLING BY KHOO TENG AUN ANDCLEMENT TAN KAI GUANPHOTO SHUTTERSTOCKDON’S COLUMNSPLITTING SPECIFIED FOREIGN-SOURCED INCOME BETWEEN TAX EXEMPT AND TAXABLE PORTIONSAn Optimal Solution (Part 3 of 3)1 Specified foreign income refers to foreign dividend income, foreign branch profit and foreign service income.2 Elected income means any item of foreign income for which a resident person qualifies to claim the foreign tax credit under the PS. Under the PS, the excess referred to in (2) can be offset against the excess in (1) above.  This would mean a higher amount of pooled foreign tax credit granted eventually. However, with the inclusion of the specified foreign income, the “overall tax payable before foreign tax credit” will also increase. Therefore, one needs to test the “beneficial tax exemption” condition under the FSIE regime by determining the extent of the increase in the “overall tax payable before foreign tax credit” versus the extent of the increase in the pooled foreign tax credit granted. If the former exceeds the latter, then tax exemption is more beneficial. If the latter exceeds the former, the overall tax payable can be further reduced by not claiming the tax exemption under the FSIE regime. In Article 2, the amount of foreign dividend income was treated as either fully tax exempt or fully taxable. In this article, we consider the various possible scenarios between these two extremes by determining whether the overall taxable position can be further improved if we were to treat only a portion of the foreign dividend income as being tax exempt and the remaining portion as being taxable.    T his is the final piece of a three-part series. In Article 2, published in IS Chartered Accountant, February 2015, we had concluded that if a specified foreign income1 qualifies for tax exemption under the foreign-sourced income tax exemption (FSIE) regime, and also for the foreign tax credit under the pooling system (PS), generally, tax exemption under the FSIE regime is more tax beneficial unless:1) Prior to the inclusion of the specified foreign income, there is already an excess of pooled Singapore tax payable (STP) over the pooled foreign tax paid (FTP) in respect of the other foreign income, and2) There will be an excess of the FTP over the STP in respect of the specified foreign income if it is not tax exempted.illusTRATionCompany A, a Singapore tax resident company, derives a local trade income of $3 million and receives in Singapore the following elected gross incomes2 under the PS:  Foreign interest income of $10,000 (FTP @ 8%);   Foreign royalty income of $2 million (FTP @ 5%);   It also derives and receives in Singapore a gross foreign dividend income of $5 million which qualifies for tax exemption under the FSIE regime and also for the foreign tax credit under the PS. The foreign dividend income suffered a foreign tax rate of 30%. Table 1 shows the tax computation under two scenarios where the entire amount of the foreign dividend income is:Scenario 1: Tax exempt under the FSIE regime; Scenario 2: Taxable.  Foreign tax credit is claimed in respect of the interest income and royalty income under the PS. 57March 2015IS Chartered Accountant 58Technical excellence Foreign Tax CrediT  Pooling utilisation is restricted to the amount of the excess in (a). Nevertheless, it would effectively mean a higher amount of overall pooled foreign tax credit granted. However, with the inclusion of the foreign dividend income, the overall tax payable before the foreign tax credit also increases.  The extent of the increase in both the “overall tax payable before the foreign tax credit” and the amount of the “overall pooled foreign tax credit granted” will depend on the amount of the foreign dividend income that is treated as being taxable. In this case,  it is not beneficial for Company A  to claim tax exemption on the entire amount of the foreign dividend income under the FSIE regime as opposed to AnAlysis of TAble 1Electing for tax exemption under the FSIE regime for the foreign dividend income may not be beneficial for Company A as Table 1 indicates that: a) There is an excess of pooled STP over the pooled FTP of $230,4995 prior to the inclusion of the foreign dividend income, andb) The FTP, at 30%, is greater than the STP6 on the foreign dividend income if the foreign dividend income were to be subject to tax.Under the PS, the excess of the FTP over the STP on the foreign dividend income in (b) could be used to offset against the excess7 of the pooled STP over the pooled FTP in (a), but its FI: Foreign incomeFTC: Foreign tax credit3 ($10,000 + $2,000,000) x SETR of 16.48253% 4 ($10,000 + $2,000,000 + 5,000,000) x SETR 16.74101% 5 $331,299 (pooled STP) less $100,800 (pooled FTP) 6 Maximum rate is at the prevailing corporate tax rate of 17%7 This excess is expected to increase as the Singapore effective tax rate (used to compute the pooled STP) increases with the inclusion of the foreign dividend income.having the entire amount of the foreign dividend income subject to tax and then claiming the foreign tax credit under the PS. The latter tax treatment can bring down its tax by $222,745. Although tax exemption on the foreign dividend income under the FSIE regime is not beneficial to Company A, the question is whether having the entire amount of the foreign dividend income being taxable is optimal for Company A.   Table 2 shows the tax savings arising from the difference between the taxes payable for each of the Combinations B to K  (reflecting different amounts of tax exempt and taxable portions of the foreign dividend income), and Combination A (when the entire amount of the foreign dividend income is tax exempt).   AnAlysis of TAble 2By first treating the $1 million portion of the foreign dividend income as being taxable under the PS and the remaining $4 million as being tax exempt (Combination B), the amount of tax savings is approximately $130,000. As this taxable portion increases (from Combinations B to D), the corresponding tax savings also increase. As the taxable portion increases beyond that in Combination D,  tax savings start to taper off to $222,745, which is the point when the entire amount of the foreign dividend income is treated as being taxable (Combination K). Hence, it is not optimal for Company A to have the entire amount of the foreign dividend income subject to tax (Combination K). This is because there is still an excess of the FTP over the STP (that is, $427,255) in respect of the foreign dividend income that is disregarded (Table 2, column v). The implication is that an excessive amount of foreign dividend income has been Table 1 Tax computation for Company A receiving foreign income Amount of FDI subject to tax Tax exempt $5 million$ $Local trade income 3,000,000 3,000,000foreign income:Interest income (FTP @ 8%, that is, $800) 10,000 10,000Royalty income (FTP @ 5%, that is, $100,000) 2,000,000 2,000,000FDI ($5 million exempt under the FSIE with foreign tax rate of 30%)0 5,000,000Normal chargeable income before Partial  tax exemptionX 5,010,000 10,010,000Less: Partial tax exemption 152,500 152,500Normal chargeable income after Partial  tax exemption4,857,500 9,857,500Tax payable before FTC (@ 17%) Y 825,775 1,675,775 Less: FTC - lower of pooled FTP ($100,800, that is, $800 + $100,000) and pooled STP ($331,2993) 100,800 -Less: FTC - lower of pooled FTP ($1,600,800, that is, $800 + $100,000 + $1,500,000) and pooled STP ($1,173,5454) 1,173,545Net tax payable after FTC 724,975 502,230(724,975)Tax savings 222,745Excess of STP over FTP 230,499Excess of FTP over STP disregarded NA 427,255# Singapore effective tax rate (SETR)  Y/X 16.48253% 16.74101%	   5	  disregarded (Table 2, column v). The implication is that an excessive amount of foreign dividend income has been subject to Singapore tax for which the foreign tax credit is not granted for the FTP paid on such an amount.    An optimal amount of foreign dividend income that should be subject to Singapore tax is the combination in Table 2 that reduces both “the excess of the pooled FTP over the pooled STP” (column v) and “the excess of the pooled STP over the pooled FTP” (column vi) to zero, which is Combination D.  Figure 1 shows that Combination D has the maximum tax savings when the $1,742,257 portion of the foreign dividend income is treated as being taxable, and the remaining $3,257,743 portion is treated as being tax exempt under the FSIE regime.   Figure 1 Tax savings arising from differences between taxes payable for Combinations B to J, and Combination A      Conclusion Tax exemption under the FSIE regime is granted where it is beneficial to the resident person. Where a specified foreign income qualifies for tax exemption under the FSIE regime and also for the foreign tax credit under the PS, tax exemption on the entire amount of specified foreign income under the FSIE regime may not always be necessarily beneficial. In most situations, it may be more tax beneficial to treat a certain portion of the specified foreign-sourced income as tax exempt under the FSIE regime, and the remaining portion as taxable under PS. The optimal combination will be the one where both “the excess of the pooled FTP over the pooled STP” and “the excess of the pooled STP over the pooled FTP” are reduced to zero.   ---- Khoo Teng Aun is Associate Professor of Accounting, Singapore Management University, and Clement Tan Kai Guan is Associate Professor of Accounting, Nanyang Business School, Nanyang Technological University.    A	  B	  C	  D	   E	   F	   G	   H	   I	   J	   K	  0	  50	  100	  150	  200	  250	  0.00	   0.50	   1.00	   1.50	   2.00	   2.50	   3.00	   3.50	   4.00	   4.50	   5.00	  Tax	  Savings	  in	  $'000	  Amount	  of	  foreign	  dividend	  income	  treated	  as	  taxable	  (in	  $	  millions	  )	  59March 2015Khoo Teng Aun is Associate Professor of Accounting, Singapore Management University, and Clement Tan Kai Guan is Associate Professor of Accounting, Nanyang Business School, Nanyang Technological University.   taxable, and the remaining $3,257,743 portion is treated as being tax exempt under the FSIE regime. ConClusionTax exemption under the FSIE regime is granted where it is beneficial to the resident person. Where a specified foreign income qualifies for tax exemption under the FSIE regime and also for the foreign tax credit under the PS, tax exemption on the entire amount of specified foreign income under the FSIE regime may not always be necessarily beneficial. In most situations, it may be more tax beneficial to treat a certain portion of the specified foreign-sourced income as tax exempt under the FSIE regime, and the remaining portion as taxable under PS. The optimal combination will be the one where both “the excess of the pooled FTP over the pooled STP” and “the excess of the pooled STP over the pooled FTP” are reduced to zero.  ISCA  ove  t e pooled STP” (column v) and “the excess of the pooled STP over the pooled FTP” (column vi) to zero, which is Combination D. Figure 1 shows that Combination D has the maximum tax savings when the $1,742,257 portion of the foreign dividend income is treated as being subj ct to Singapor  tax for which the foreign tax credit is not granted for the FTP paid on such an amount.  An optimal amount of for ign dividend income that should be subject to Singapore tax is the combi ation in Table 2 that reduces both “the excess of the pooled FTP Table 2 Tax savings from tax treatment in Combinations B to K over Combination A    (i) (ii) (iii) (iv) (v) (vi)Combination # Amount of FDI exempt under the FSIE ($)Amount of FDI subject to tax ($)Tax savings ($) Excess of  pooled FTP over pooled STP disregarded ($) Excess of  pooled  STP over pooled  FTP ($)A 5,000,000 0    NA NA NAB 4,000,000 1,000,000 130,000 0 97,916C 3,500,000 1,500,000 195,000 0 31,922D 3,257,743 1,742,257 226,493 0 0E 3,000,000 2,000,000 226,070 33,930 0F 2,500,000 2,500,000 225,331 99,669 0G 2,000,000 3,000,000 224,685 165,315 0H 1,500,000 3,500,000 224,114 230,886 0I 1,000,000 4,000,000 223,607 296,393 0J 500,000 4,500,000 223,153 361,847 0K 0 5,000,000 222,745 427,255 0figure 1 Tax savings arising from differences between taxes payable for Combinations B to J, and Combination A

Splitting Specified Foreign Sourced Income between Tax Exempt and Taxable Portions: An Optimal Solution (Part 3 of 3)

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Splitting Specified Foreign Sourced Income between Tax Exempt and Taxable Portions: An Optimal Solution (Part 3 of 3)

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