By Edmund Leow SC, Senior Partner (Tax) at Dentons Rodyk & Davidson LLP, Singapore
Singapore has implemented regulations on its new concessionary income tax rate for intellectual property, which came into effect on January 22. The regulations govern the application of concessionary tax rates to businesses deriving qualifying intellectual property income under the Singapore Income Tax Act, bringing into legal effect the IP Development Incentive introduced in the government’s 2017 Budget Speech.
Singapore’s IP Development Incentive is administered by the Singapore Economic Development Board and is designed to encourage the use and commercialisation of research and development activities by offering concessionary tax rates of either 5% or 10% on qualifying IP income. To determine the applicable rate of tax, Singapore adopts the “modified nexus approach,” an international standard set by the OECD in alignment with the base erosion and profit shifting (BEPS) project.
Singapore’s IP Development Incentive is one of many developments reflecting Singapore’s position in the shifting global tax landscape towards greater substance, in particular, impressing upon businesses that change is inevitable. In light of this, multinationals may take an active interest in the context and features of this incentive to structure their dealings in Singapore moving forward.
Understanding the IP Development Incentive
IP is frequently used in the tax planning of multinational corporations primarily because IP is a mobile and valuable asset. With its competitive tax environment and robust business infrastructure, Singapore has been traditionally viewed as an attractive destination to hold IP and other key assets.
In this regard, the Singapore Economic Development Board offers two key tax incentives to multinationals undertaking substantive operations in Singapore, such as global or regional headquarter activities: the Pioneer Certificate Incentive and the Development and Expansion Incentive.
Under these incentives, an approved applicant may enjoy a concessionary tax rate of 5% or 10% on income derived from qualifying activities, ranging widely from engineering or technical services to industrial or other activities approved by the Economic Development Board. Therefore, historically, the Pioneer Certificate Incentive and Development and Expansion Incentive would apply to IP income derived from qualifying activities.
In recent years, the BEPS project led by the OECD and G20 has placed greater scrutiny on global IP holding practices. Put simply, the BEPS project aims to address mismatches between the location where profits are booked and where profits are generated, leading to an erosion of taxable base and distortion of competition for certain high-tax countries. BEPS Action Plan 5 was developed to deal specifically with harmful tax practices involving transparency and substance, looking first at IP regimes.
In particular, a consensus “modified nexus approach” allows a taxpayer to benefit from IP only to the extent that the taxpayer itself incurred qualifying R&D expenditures that gave rise to the IP income. R&D expenditure acts as a proxy for substantial activities because IP regimes are typically designed to encourage R&D activities and foster growth and employment. Therefore, taxpayers who wish to benefit from IP regimes should in fact, engage in and incur actual expenditures on such activities.
As a participant of the BEPS project, reform to Singapore’s IP tax regime was introduced in the Budget 2017 for consistency with international tax standards. The Singapore government announced the introduction of an IP Development Incentive and, accordingly, that IP income would be removed from the scope of the existing Pioneer Certificate Incentive and Development and Expansion Incentive with effect from July 1, 2018.
The exclusion of IP income from the Pioneer Certificate Incentive and Development and Expansion Incentive would also follow the grandfathering timelines based on international tax standards during the interim period from July 1, 2018, to June 30, 2021.
This generally depends on whether the income is derived from “new IP rights” or “existing IP rights” as defined in the relevant legislation, where IP income derived by approved companies from existing IP rights will be grandfathered and subject to the concessionary tax rate under the existing Pioneer Certificate Incentive and Development and Expansion Incentive until June 30, 2021, while IP income derived from “New IP Rights” will be excluded from the scope of the two incentives.
The BEPS-compliant IP Development Incentive
To qualify for Singapore’s new IP development incentive, prior application and approval from the Economic Development Board is required.
With effect from July 1, 2018, an approved company is eligible for a base concessionary tax rate of either 5% or 10% on a percentage of qualifying IP income derived by it during the incentive period. The incentive period is limited to an initial period not exceeding ten years and may be further extended for a period or periods not exceeding ten years each. In addition, the concessionary tax rate will also increase by 0.5% at regular intervals as prescribed in Singapore’s Income Tax Act.
At a glance, the key differences in the tax treatment of IP income under the IP Development Incentive (as opposed to previously under the existing Pioneer Certificate Incentive and Development and Expansion Incentive) are summarised below.
Scope of qualifying IP income
Under the IP Development Incentive, qualifying IP income is limited to royalties or other income received as consideration for the commercial exploitation of elected qualifying IP rights (i.e., patents and copyrights subsisting in software) as prescribed in the regulations. Previously, under the Pioneer Certificate Incentive and Development and Expansion Incentive, there was no strict requirement to this effect.
This restriction aligns with the “modified nexus approach,” which provides that only patents and other IP assets that are functionally equivalent to patents can qualify for benefits under an IP regime. IP assets that are functionally equivalent to patents can include copyrighted software or other IP assets that are non-obvious, useful, and novel. This arises from the type of innovation and R&D that IP regimes are typically designed to encourage. On the other hand, other IP assets, such as marketing-related trademarks, will not qualify for tax benefits.
Percentage of qualifying IP income
Under the IP Development Incentive, the percentage of qualifying IP income derived by an approved company from elected qualifying IP rights is determined in accordance with a “modified nexus” formula set out in the regulations. In general, IP income will qualify for tax benefits if there is a direct nexus between the income receiving tax benefits and the expenditures contributing to that income. This ensures that tax benefits are granted only to IP income where the actual R&D activity was undertaken by the taxpayer itself. Stemming from this, this means that the R&D activities should be conducted by the approved company in Singapore, to qualify for benefits under the IP Development Incentive. Previously, under the Pioneer Certificate Incentive and Development and Expansion Incentive, there was no requirement to this effect.
Under the regulations, an approved company is required to maintain records of information in relation to qualifying IP income, expenditure incurred in producing the qualifying IP income, and qualifying IP rights. In particular, they must record details of how each specified right is obtained and the basis for determining that any expenditure incurred is for the purpose of obtaining the specific right.
IP structuring options in a post-BEPS world
In this globalised era, IP continues to be a critical income-generating asset for multinationals, and thus the impact of global tax developments on IP regimes is equally critical.
In Singapore, businesses that wish to apply for the Pioneer Certificate Incentive and Development and Expansion Incentive must note that IP income has been excluded from the scope of these incentives.
The introduction of the IP Development Incentive appears promising at first blush; however, given the restrictions on the scope and percentage of qualifying IP income, in keeping with the “modified nexus approach,” careful structuring may be required to achieve businesses’ intended objectives.
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