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Determining the nature of profit Business Times: Wed, Aug 08
WHEN is your profit or gain subject to tax and when is it not? Questions such as these often confront someone who is involved in purchase and resale transactions, which may include real assets such as property. Especially when a sale arises and involves a gain, the impact can be significant.
Put simply, income tax is a tax on income. When an asset is sold, you need to consider whether any gains made on the sale are taxable. Only then should you consider if there are exemptions and deductions you can take advantage of when computing the tax payable.
The concept of "badges of trade" has therefore evolved from the element of doubt which exists as to whether a transaction or series of transactions fall within the definition of "trading income".
The Inland Revenue Authority of Singapore (Iras) relies on the "badges of trade" test to determine whether a tax payer has acquired an asset for trading purposes (revenue gain) or as an investment for generating income (capital gain).
What is the difference between revenue and capital gain? In determining the nature of the profits, the badges of trade test is thus useful. Frequently, the application of one badge may lead to a different conclusion compared to the application of another. Some badges are given more weight than another. The determination is therefore in consideration of all factors.
Let us examine some of the relevant badges of trade, using real estate as an example.
Motive
If a property is acquired for generating profit, the sales proceeds will be of an income nature. The term "profit" in this context means the gain or profit made after the property is sold.
Where the property is bought for investment, the gain after the sale is regarded as a capital gain. Capital gains will not be taxed.
The intention of a company is generally established by documentary evidence. Examples include the Memorandum of Association and the minutes of the Board of Directors, or it can be implied through the activities undertaken by the company.
The importance of documenting the intent similarly applies if the investment property were to be held by an individual. This however may pose a challenge as the intent of an individual is not normally documented for most other purposes, and in that instance the intent may likely be established or even inferred based on the overall relevant facts and circumstances of the case in question.
When evidence does not clearly spell out the individual's intention, the Iras will make an evaluation based on the individual's activities. For example, if an investment property is being used to generate rental income, it is more likely that the property has been used for investment purposes since property is not being traded regularly.
It is important to document the intent - this applies to both individuals and companies alike.
Length of period of ownership
The longer you hold the investment property, the stronger your intent of using it as an investment for capital gain.
Properties which are acquired for a quick sale are more typical of trading activity. The profits from the quick sale will then be treated as revenue and you will be subjected to tax.
This test alone however is not decisive: a quick sale may indicate that the seller changed his mind about holding longer. On the other hand, a long holding period does not shield a clear-cut trader from tax.
Frequency or number of similar transactions by the same person
Profit from a one-off sale is generally considered as capital gain. However, if there is repeated buying and selling of property, this indicates the existence of trade activity dealing in investible property.
Circumstances
The sale event and circumstances leading to the sale of a property, for example, has to be consistent with the owner's intent.
Assets cost money, and any amount of loan used to purchase a property is not one of the "badges of trade". However, it can be used for consideration by Iras to determine the nature of your profit.
Where a large amount in relation to the purchase price has been borrowed to finance the property purchase, or the loan is short-term, Iras may view the intent of purchase as being for short term sale, hence determining it as revenue gain. You will then be taxed on the profit.
Professional expertise
Someone with professional expertise in the property or share markets is more likely to be regarded as a trader in property/shares than an amateur. Examples include real estate agents or remisiers.
In summary, there is no basis to treat you as a trader when you buy an asset consistent for investment through capital gain. However, this does not mean that you will not be taxed as a trader.
If there is sufficient evidence of you being involved in a business organisation, such as having an office or employees, the sale and purchases that take place through that business organisation may be considered business transactions.
The question for individuals as to whether gains or losses are of an income nature will depend on the frequency of the transactions, the length of ownership, and other relevant factors mentioned above. This is similar to the way it is applied for a company.
While these tips may help you to determine the nature of your transaction, they are still general in nature. If in doubt, it would be wise for individuals to seek the opinions of their tax accountants or lawyers.
This article is contributed by BJ Ooi, partner and head of private client services at KPMG, Singapore. The views expressed are his own.
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