I. Introduction

Determining the true nature of payments in a transaction is crucial in deciding whether a payment is taxable or not, and the case of GFG and another v. Comptroller of Income Tax [2023] SGITBR 1 is one which sheds light on this process. The case deals with the taxability of certain payments in a transaction, specifically whether such payments could be considered payments for services provided. Given how common it is for clients to create different arrangements to provide for compensation for services of a party, this is an important case which highlights to clients how judicial bodies would go about identifying what the true nature of a payment is, in deciding whether said payment is taxable or not.

In this client alert, we will discuss the Income Tax Board of Review’s (the Board) approach in looking at the substance of the transaction to determine the nature of payments and its corresponding tax implications.

II. Brief Facts

The Appellants were shareholders in 5 companies which owned and operated 16 clinic dialysis centres (CDCs). Both Appellants were also practising nephrologists and medical directors of the CDCs.

On 19 September 2012, the Appellants entered into a Memorandum of Understanding (MOU) for the sale of all their shares in the 5 companies to Company A (Share Sale). Purchase consideration was set at S$44 million, with S$6 million in deferred payments explicitly characterised as “nephrologist’s and [medical] director’s fees”.

However, in the eventual Sale and Purchase Agreement dated 31 January 2013 (SPA), the S$6 million in deferred payments was relabelled to form part of the purchase consideration of the Share Sale. S$44 million of the purchase consideration was to be paid first on completion. The remaining S$6 million (comprising yearly payment tranches of S$1.5 million to each Appellant) was to be paid over a period of 2 years from the date the SPA was entered into (Interim Period), provided that the Appellants remained as medical directors of the CDCs during the Interim Period.

The SPA also required the Appellants to enter into Medical Director Agreements (MDAs) with Company A where they would each be paid a nominal consideration of S$100 in exchange for them remaining as medical directors of the CDCs over the Interim Period.

The issue before the Board was whether the S$6 million payments should be characterised as:

• forming part of the purchase consideration for the Share Sale, being capital receipts and not subject to income tax; or
• payments for the Appellant’s services as medical directors and subject to personal income tax in the hands of the Appellants.

III. Outcome

The Board determined that looking at the substance of the transaction, the true nature of the S$6 million was payments for the Appellant’s services as medical directors.

First, pre-negotiation email correspondence adduced as evidence revealed that the Appellants sought to relabel the S$6 million from nephrologist’s and directors’ fees in the MOU to form part of the purchase consideration in the SPA because they did not want to pay tax on the S$6 million. This was an indication to the Board that the true nature of the payments had not changed from that as memorialised in the MOU, that the S$6 million was payments for the Appellants’ services as medical directors.

Second, testimony from the Appellants also revealed that S$6 million was approximately equal to payments received by the Appellants for the same services in their capacity as medical directors in the years preceding the Share Sale. This led to the Board concluding that characterising the S$6 million as forming part of the purchase consideration while the Appellants were only paid a nominal consideration of S$100 for their services as medical directors over the Interim Period, as unrealistic. The Share Sale was clearly a business transaction between arm’s length parties and the Appellants could not have provided their services for gratuitous or charitable reasons.

In the Board’s view, perhaps had the Appellants been separately compensated at arm’s length market value for their services in the MDAs, or compensated based on an alternative arrangement, the conclusion on the substance of the transaction and true nature of the payment might have been different. In the absence of such alternative compensation arrangement and interpreting the SPA purposively in line with surrounding circumstances and adduced evidence, the Board reached the irresistible conclusion that the true nature of the S$6 million was payments for the Appellants’ medical services and subject to personal income tax in the hands of the Appellants.

IV. Conclusion

Transactions like the Share Sale are common, undertaken by businesses and individuals alike across various industries. Take for instance a venture capital fund compensating a founder after buying the founder’s shares while the founder stays on as a key employee, or an intercompany restructuring exercise involving shareholder funding.

Questions relating to the nature of the payments, substance of the transaction and ultimate tax liability are often not straightforward. One may knowingly or unknowingly create an arrangement which could attract tax liability. Advice should therefore be sought on the tax implications of the transaction prior to implementation.

Please feel free to get in touch with any of our key contacts should you have any questions or similar concerns.

Dentons Rodyk Senior Partner Edmund Leow, SC, sat on the Income Tax Board of Review which decided GFG and another v Comptroller of Income Tax.