Applying the arm’s length principle to related party loans
Applying the arm’s length principle, related party loans should be charged interest rates that reflect the rates charged between unrelated parties under similar circumstances.
If the related party loan is between 2 domestic entities, IRAS will continue the practice of restricting the interest expense claimed on loans made to related entities that are interest-free or at interest rates not supported by transfer pricing analysis. This practice will not apply if the lender is in the business of borrowing and lending funds, for example banks or other financial institutions, finance and treasury centres.
If the related party loan is a cross-border loan, taxpayers should ensure compliance with the arm’s length principle. For loans that are interest-free or the interest rate is not supported by transfer pricing analysis, and entered into prior to the issue of the IRAS Supplementary e-Tax Guide on Transfer Pricing Guidelines for Related Party Loans and Related Party Services (108KB) on 23 February 2009, IRAS is prepared to continue applying the interest restriction until 31 December 2010. From 1 January 2011 onwards, these loans must reflect arm’s length conditions.
To determine the arm’s length interest rate, some factors to consider include
- the nature and purpose of the loan,
- market conditions at the time the loan was granted,
- the principal amount,
- tenure and terms of the loan, etc.
Applying the arm’s length principle to related party services
There should be an arm’s length charge for services provided between related parties, comparable to the charge for such services provided between unrelated parties under similar circumstances.
If the services provided between related parties are in the list of routine support services in Annex A of the IRAS Supplementary e-Tax Guide on Transfer Pricing Guidelines for Related Party Loans and Related Party Services (108KB), IRAS is prepared to accept the charging of these routine support services at cost plus 5% mark-up. This is provided the routine support services are only provided to related parties. Examples of the routine support services in Annex A are accounting and auditing services, general administrative services and staffing and recruiting services.
If the routine support services are provided to related parties and there is a cost-pooling arrangement amongst them, IRAS is prepared to accept that services are charged at no mark-up provided the following conditions are met:
(a) The services are not provided to any unrelated party;
(b) The provision of the services is not the principal activity of the service provider. If the cost of providing the services does not exceed 15% of the total expenses of the service provider for that financial year, the services will not be treated as the principal activity;
(c) The services are listed in Annex A of the IRAS Supplementary e-Tax Guide on Transfer Pricing Guidelines for Related Party Loans and Related Party Services (108KB); and
(d) There is documentation showing that the parties intended to enter into the cost pooling arrangement before the provision of the service.
A Singapore taxpayer may merely act as the paying agent for services provided by a third-party service provider (whether independent or related) to the Singapore taxpayer’s related parties. When the Singapore taxpayer pays the third-party service provider and onward charges these costs to its related parties, IRAS is prepared to consider these costs as strict pass-through costs and accept no mark-up on the onward charges when the following conditions are fulfilled:
(i) The services provided by the third-party service provider for which the Singapore taxpayer passes on the related costs are for the benefit of the Singapore taxpayer’s related parties;
(ii) The third-party service provider charges an arm’s length fee for the services provided;
(iii) The Singapore taxpayer is merely the paying agent and does not enhance the value of the services provided by the third-party service provider; and
(iv) The Singapore taxpayer’s related parties are legally or contractually liable for the payment of the costs. However, where the Singapore taxpayer has contracted with, and is therefore considered by, the third-party service provider as legally or contractually liable to pay for services provided but there is a written agreement between the Singapore taxpayer and its related parties that requires the related parties to assume all contractual obligations or liabilities arising from the contract between the Singapore taxpayer and the third-party service provider, IRAS may regard this condition to be met in this situation.
The treatment of related party services for transfer pricing purposes is summarized in the flowchart below.
Q1. My company provides routine support services to related parties and charges for these services at cost. However, for tax purposes, there will be a deemed 5% mark-up on the costs. May we continue with such a practice? Will IRAS now mandate that the company must charge for the services at a mark-up instead of deeming a mark-up for tax purposes?
A: The company may still continue with its current practice, as long as the company’s tax return includes the appropriate mark-up in accordance with the guidance in the IRAS Supplementary e-Tax Guide on Transfer Pricing Guidelines for Related Party Loans and Related Party Services (108KB). A 5% mark-up on costs is only applicable for routine services provided only to related parties. For non-routine services, the company has to determine the arm’s length price for tax purposes.
Q2. A third-party service provider is providing information services to my company as well as my other corporate group members. However, the third-party service provider is unwilling to enter into separate service contracts with the different members of the corporate group as it is administratively too cumbersome. Thus, my company signs the agreement with the third-party services provider to provide the information services to all the members of the corporate group. My company arranges and pays for the entire bill. My company does not enhance the value of the services provided by the third-party service provider. May my company charge out such costs to its related parties without a further mark-up?
A: IRAS is prepared to accept 0% mark-up on costs for services provided to related parties under either a cost-pooling arrangement or if these costs are strict pass-through costs.
To qualify as a cost-pooling arrangement, the conditions stated at paragraph 3.3.16(a) to (d) of the IRAS Supplementary e-Tax Guide (108KB) should be fulfilled.
As for strict pass-through costs where no mark-up needs to be charged, they are intended to apply only in situations where the contractual liability to pay for the services falls on the related party benefiting or expected to benefit from the services, and the group service provider is merely a paying agent and does not enhance the value of the services provided by the third-party service provider. In this scenario stated, the legal or contractual liability falls on your company, and not on the related parties benefiting from the services. Therefore, it cannot be considered as strict pass-through costs unless your company can demonstrate with relevant documentation that the obligations and liabilities under the contract with the third-party service provider are ultimately assumed by your company’s related parties. For example, if your company has contracted with, and is therefore considered by, the third-party service provider as the party contractually liable to pay for the services provided but your company has entered into a written agreement with your related parties that requires them to assume all such contractual obligations and liabilities arising from the contract between your company and the third-party service provider, the costs may be regarded as strict pass-through costs.
Q3. My company performs services in Singapore for an overseas related company and charges the overseas company an arm’s length fee. Will the overseas company have any tax obligations in Singapore resulting from this inter-company service arrangement?
A: The activities performed by a company in Singapore for its overseas related company may create for the overseas company a permanent establishment (“PE”) in Singapore. As such, profits that are attributable to the PE would be liable to tax in Singapore. However, if the following conditions are met, there will be no attribution of profits to the PE and thus, there will be no Singapore tax liability for the overseas company arising from the inter-company service arrangement:
i) The Singapore company receives an arm’s length fee from the overseas company that is commensurate with the functions performed, assets used and risks assumed by the Singapore company;
ii) The fee paid by the overseas company to the Singapore company is supported by adequate transfer pricing documentation to demonstrate compliance with the arm’s length principle; and
iii) The overseas company has not performed any functions, used any assets or assumed any risks in Singapore, other than those arising from the activities carried out by the Singapore company under the inter-company service arrangement.