IRAS e-Tax Guide

1 INCOME TAX IMPLICATIONS ARISING FROM THE ADOPTION OF FRS 39 FINANCIAL INSTRUMENTS: RECOGNITION & MEASUREMENT IRAS e-Tax Guide Published by Inland Revenue Authority of Singapore Revised on 16 Mar 2015 First edition on 30 Dec 2005 Disclaimers: IRAS shall not be responsible or held accountable in any way for any damage, loss or expense whatsoever, arising directly or indirectly from any inaccuracy or incompleteness in the Contents of this e-Tax Guide , or errors or omissions in the transmission of the Contents. IRAS shall not be responsible or held accountable in any way for any decision made or action taken by you or any third party in reliance upon the Contents in this e-Tax Guide . The information provided in the Guide aims to provide a better understanding of taxpayers tax obligations and is not intended to comprehensively address all possible tax issues that may arise.

2 While every effort has been made to ensure that this information is consistent with existing law and practice, should there be any changes, IRAS reserves the right to vary our position accordingly. Inland Revenue Authority of Singapore All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means, including photocopying and recording without the written permission of the copyright holder, application for which should be addressed to the publisher. Such written permission must also be obtained before any part of this publication is stored in a retrieval system of any nature. TABLE OF CONTENTS PAGE INTRODUCTION .. 2 CURRENT TAX TREATMENT OF FINANCIAL ASSETS AND LIABILITIES .. 2 CHANGES IN INCOME TAX TREATMENT .. 3 OPTION TO REMAIN IN PRE-FRS 39 TAX TREATMENT.

3 8 TAXPAYERS NOT REQUIRED TO COMPLY WITH FRS 39 .. 9 ENQUIRIES .. 9 UPDATES AND 10 ANNEX 1 .. 11 ANNEX 2 .. 13 2 IRAS e-Tax Guide INTRODUCTION 1. With effect from 1st January 2005, companies with annual periods beginning on or after 1st January 2005 have to comply with Financial Reporting Standard 39 Financial Instruments: Recognition and Measurement (hereinafter referred to as FRS 39 ) for accounting purposes. This e-Tax Guide explains the changes to the treatment of financial assets and liabilities for income tax purposes arising from the adoption of FRS 391 for accounting purposes. CURRENT TAX TREATMENT OF FINANCIAL ASSETS AND LIABILITIES 2. Presently, for income tax purposes, only realised gains or losses arising from the disposal of financial assets are subject to tax or allowed as a deduction if the taxpayer derives such gains or incurs such losses on revenue account.

4 As an exception, where the financial assets on revenue account are carried at the lower of cost and market value, and a provision for diminution in value has been made in the accounts, the provision may be allowed as a deduction for income tax purposes while any write-back up to the cost brought to tax. 3. For a taxpayer whose gains or losses are derived on capital account, the gains or losses are not taxable or allowed as a deduction. The provision for diminution in value is also not allowed as a deduction. 4. For banks and certain other entities that engage frequently in financial derivatives for both hedging and trading purposes, we have, since 1996, granted an administrative concession to accept the accounting treatment for financial derivatives on the condition that they follow certain accounting treatment2.

5 5. For taxpayers with financial liabilities, such as loans taken or bonds issued, the interest expense3 incurred on such liabilities is allowed as a deduction by virtue of section 14(1)(a) of the Income Tax Act (hereinafter referred to as ITA ) when the conditions in that section are met. In the case of financial liabilities that do not constitute accretion to capital, any premium or discount incurred is taxed or allowed as a deduction. 1 The version of FRS 39 referred to in this e-Tax Guide is the fourth version issued in August 2005. It can be downloaded from the website of the Accounting Standards Council (which has taken over from the Council on Corporate Disclosure and Governance ( CCDG ) the task of prescribing accounting standards from 1st November 2007) - 2 (a) For financial derivatives for trading, they are accounted on a marked-to-market basis and the resultant profit/losses are recognised immediately and taken to the profit and loss account.

6 (b) For financial derivatives used for hedging purposes, they must be clearly identified at the outset and the gains or losses realised must be amortised over the life of the underlying hedged transactions and matched with the gains/losses or income/expenditure of the latter transactions, in all cases where there is a mismatch in the timing of the closing out of the two types of transactions. The bank will maintain clear rules on how this matching is done. 3 This is based on the rate of interest in the contract. 3 CHANGES IN INCOME TAX TREATMENT 6. With the adoption of the FRS 39 for accounting purposes, companies will now have to reflect their financial assets and liabilities at market values in their financial statements. A brief overview of the FRS 39 accounting treatment is provided in Annex 1.

7 To minimise tax adjustments, the income tax treatment of financial assets and liabilities has been changed so as to be closer generally to the accounting treatment (this new tax treatment is hereinafter referred to as the FRS 39 tax treatment ). (A) FINANCIAL ASSETS Financial assets on revenue account 7. For the financial assets on revenue account, the income tax treatment will be aligned with that of the accounting treatment under FRS 39. This would mean that - (a) for the assets classified as fair value through profit or loss, all gains or losses recognised in profit or loss (hereinafter referred to as the profit and loss account ) will be taxed or allowed as a deduction even though they are unrealised; (b) for the assets classified as available-for-sale, all gains or losses which are recognised in balance sheet (as a separate item in the equity) will not be taxed or allowed as a deduction.

8 At the time of derecognition4, the cumulative gains or losses recognised in equity that are transferred to the profit and loss account will be taxed or allowed as a deduction. For these assets, impairment losses (please also refer to paragraph 11), reversal amount of impairment losses5 and foreign exchange gains or losses that are recognised in the profit and loss account will be taxed or allowed as a deduction; (c) for the assets classified as held-to-maturity and loans, the interest income based on the amount shown in the accounts, which is calculated using the effective interest method6 under FRS 39, will be taxed. Arising from this alignment with the accounting treatment, taxpayers need not make any adjustment for income tax purposes. Financial assets on capital account 8.

9 In the event that the taxpayer claims that the financial assets are on capital account, it should submit a list of these assets to the Comptroller of Income Tax (hereinafter referred to as the CIT ) for his determination whether they are indeed assets on capital account. Where the CIT has agreed that they are assets on capital account, the gains or losses will not be taxed or allowed as a deduction. This 4 Generally, this refers to the time when the assets are disposed of. 5 There is an exception for equity securities. The reversal amount of impairment losses for equity securities are recognised in the balance sheet and only transferred to the profit or loss account when they are derecognised. 6 Please refer to footnote 16 for an explanation of the effective interest method.

10 4 treatment will continue until such time that circumstances have changed and the taxpayer requests for a review to treat the assets as being on revenue account, in which case, the change of tax treatment will be prospective. However, the CIT reserves the right to tax the gains that have been agreed to be on capital account if at the time of realisation, there is evidence to show that the gains are revenue gains. 9. For assets on capital accounts (except for debt securities and negotiable certificates of deposit where the tax treatment is provided in paragraph 10 below), gains or losses reflected in the profit and loss account, such as those arising from fair valuing of the items or impairment losses, are to be adjusted since they are neither taxable nor deductible for income tax purposes.