Singapore casts tax shadow on India bets, shuns shell companies

Mumbai: Singapore is intensifying scrutiny of companies and investment entities, a move that could ignite new tax disputes. This development particularly impacts many MNCs and international funds that use the Asian financial hub as a base to invest in and acquire companies in India.

The catalyst for these potential disputes is a recent series of advance rulings by the Inland Revenue Authority of Singapore (IRAS), which define and endorse what constitutes 'economic substance'. If a Singaporean entity fails to meet the conditions emphasized by the tax administrator and thus cannot prove it has adequate 'substance,' the Indian Income Tax (I-T) department could levy higher taxes. This could involve claiming tax on certain stock sale transactions or demanding increased tax on earnings from dividends and loan interest paid by an Indian company. Dealmakers and businesses are closely monitoring this situation.

"These advance rulings are the first to evaluate economic substance factors since their inclusion in 2024 as Section 10L of Singapore's Income Tax Act for taxing gains from the sale of foreign assets. These factors could be used by Indian tax authorities to determine whether a Singapore-based entity is merely a conduit, particularly when applying the Principal Purpose Test (PPT)," explained Ashish Karundia of the CA firm Ashish Karundia & Co. (A PPT is a provision that allows denial of treaty benefits).

According to Girish Vanvari, founder of the tax and regulatory advisory firm Transaction Square, the implications are far-reaching due to the change in law prioritizing substance and economic reality over legal form. "For tax professionals and business leaders, this means a necessary recalibration of how Singapore is used in cross-border structuring -especially in relation to Indian operations. So, if you're using Singapore as a holding or IP base for India-related investments, it's time to revisit the structure. The days of relying purely on treaty protection without operational presence are over," said Vanvari.

Many foreign investors betting on India utilize Singapore to leverage the tax treaty between the two countries. A common structure involves one of their arms in a tax-friendly jurisdiction setting up a company in Singapore (say, S1), which in turn owns another company in Singapore (say, S2). In this two-layered structure, S2 serves as a vehicle to invest in India. Typically, when exiting an Indian investment, S1 might sell the shares of S2, which holds shares in an Indian company; alternatively, S2 would directly sell its interest in the Indian company.

THE PARAMETERS
The IRAS underscored that economic substance would require: (a) a company to have adequate human resources with the necessary qualifications and experience; (b) have a premise in Singapore; (c) take key business decisions there; and (d) incurs expenditure.

If S1 or S2 does not fulfil these criteria, they would come under the lens of the tax authorities in either Singapore or India. How? Here are the possible situations:

· Say, S1 sells shares of S2 (both local entities) and if India demands tax on the 'indirect transfer' by invoking India's domestic tax regulations, companies like S1 have till now argued that under the treaty India has no right to tax gains from indirect transfers. However, in future, the I-T department could assert that the treaty holds only if S1 has substance. But if it doesn't (as per Singapore's terms), S1 cannot avail treaty benefits and must pay tax to India. Here, I-T would challenge that S1 was formed primarily to escape tax.

· If S2 directly sells shares of the Indian company, there's no capital gains tax if the shares were bought before 2017 (under a grandfathering provision introduced when the treaty was amended). However, if S2 lacks substance, I-T may demand tax on the grounds that treaty relief can be denied to a shell outfit.

· Suppose, S1 sells stocks it directly holds of another company in a third country. S1 can avoid tax in Singapore if it can demonstrate substance. However, if S1 fails the substance test (and is taxed by Singapore), then India would also have strong grounds to demand tax from S1 when it sells shares of S2.

· Also, there's an increased risk of double taxation - with India taxing based on source and Singapore taxing based on substance.