A service company under this section generally refers to a company which renders services to its related companies and is reimbursed for the operating expenses incurred in connection with the services rendered. It may or may not receive a fee from the related companies.
Generally, the service arrangement between a service company and the related company falls under one of the following categories:
- Free or at cost to related companies;
- At cost plus mark up;
- At arm’s length prices.
When services are provided free or at cost to related companies, the chargeable income of the service company is to be assessed at 5% of the total expenditure and assessed to tax without adjustments. This reason is that since the company is rendering commercial services, the amount charged for the services should be on an arm’s length basis.
For guidance on the application of the arm's length principle and the recommended preparation and maintenance of documentation to demonstrate compliance with the arm's length principle, please refer to the following e-Tax Guides:
For example:
Total cost reimbursed from holding company $100,000
Total expenditure incurred $100,000
Net profit Nil
Chargeable income (deemed 5% of total expenditure) $ 5,000 (5% x 100,000)
Based on the above example, if the company received interest income or other separate sources of income, the separate source of income must be added to the deemed trade income to arrive at the total chargeable income.
Assuming the interest income is $500, the chargeable income will be:
Trade income (as above - deemed 5% of total expenditure) $5,000
Interest income $ 500
Chargeable income $5,500
Where services are provided at cost with a mark-up, the mark-up margin may be accepted as the chargeable income of the company and assessed to tax. This is provided that the mark-up is charged on an arm’s length basis.
Where services are provided at arm’s length prices, the service company will be assessed on the same basis as a normal trading company.