When senior executives receive severance payments from the termination of their employments, commonly known as ‘golden handshakes’, how will such payments be treated for tax purposes?

The recent decision of the Income Tax Board of Review in GCT v Comptroller of Income Tax [2020] SGITBR 3 (GCT) is the first tribunal ruling in Singapore that expressly addresses this issue. In GCT, the Board held that severance or retrenchment payments for the loss of employment and payments for restrictive covenants are capital receipts which are not subject to tax. However, one must look beyond the mere label of the payment to determine its true character.

Edmund Leow S.C., Deputy Chairman of the Board and Head of our Tax practice, sat amongst the panel of Board members deciding this case.

Brief Facts

GCT concerned a foreign expatriate taxpayer who was employed in Singapore from August 2013 to December 2016 as a Managing Director of a company providing business management and consulting services.

Under the taxpayer’s employment agreement, the taxpayer was entitled to an ex-gratia payment in the event of the termination of his employment, provided that a deed of release would be executed by him following his termination. This ex-gratia payment amounted in principle to S$1,135,000.

In August 2016, the taxpayer was terminated from his employment with the company, due in large part to a strategic decision to wind up the company’s assets and business in Singapore, which rendered the taxpayer’s office redundant.

However, no deed of release was executed. Instead, the taxpayer and the company entered into a ‘Separation Agreement’ wherein the taxpayer was to receive a lump sum “severance payment” or “discretionary ex-gratia payment” of S$2,475,000. The relevant clause stated that this “severance payment” included all entitlements which may have been due to the taxpayer under the original employment contract, including the original ex-gratia payment.

In determining the tax treatment, the Comptroller sought to bifurcate the “severance payment” into two portions: (i) S$1,135,000, being the ex-gratia payment made pursuant to the original employment contract; and (ii) S$1,125,000, being the remainder of the bifurcated amount made pursuant to the Separation Agreement. In relation to the former, the Comptroller declared that any payment stipulated in the employment contract was taxable, and thus assessed this amount to tax. In relation to the latter, the Comptroller deemed this to be a payment for restrictive covenants under the Separation Agreement, which was capital in nature and not subject to tax.

The Issues

The Board had to consider two intertwining issues submitted by the parties:

1. Whether the “severance payment” was compensation for loss of office; and
2. Whether the Comptroller was correct in bifurcating the “severance payment” and assessing the S$1,350,000 as employment income, with the remaining S$1,125,000 as non-income in nature.

The Decision

The Board found that the full amount of the “severance payment” was capital in nature and accordingly allowed the appeal. We set out two notable aspects of the Board’s reasoning.
First, the Board laid down a framework for analysing the tax treatment of severance payments. It emphasized the vital importance of anchoring the analysis on the taxing statute, i.e. the Income Tax Act (Cap. 134) (the Act).

The starting position is that only “gains or profits from an employment” are subject to income tax under section 10(1)(b) of the Act. Specifically, section 10(2)(a) of the Act identifies the following nine categories of payments:

“any wages, salary, leave pay, fee, commission, bonus, gratuity, perquisite or allowance...”

In order for a receipt to qualify as “gains or profits from employment”, the character of the receipt (regardless of its label) must fall strictly within any of these nine categories. This effectively rules out redundancy payments or compensation for loss of office, given that such payments are not mentioned in the provision.

Whether a payment falls under the ambit of section 10(2)(a) is largely a question of fact requiring one to look beyond the label into the true quality or character of the payment. In this regard, each of the nine categories should be understood according to their ordinary meaning and can refer to payments made in recognition of past, present or future services performed. Whether or not a payment is specified in the relevant employment agreement was held to be a factor, but was not conclusive, in determining its true nature.

The Board also found that it was possible to bifurcate a payment to the extent that a payment could comprise different components, which could in turn have a different character (i.e., income or capital).

On the facts, the Board examined both the ex-gratia payment clause in the original employment contract and the “severance payment” clause in the Separation Agreement. Essentially, both payments were payable only on the termination by the employer of the taxpayer’s employment with the company, and would not have been payable in the event of a voluntarily resignation by the taxpayer, even though the services performed would have been the same in both instances. This was a strong factor indicating that the payment was in the nature of compensation for loss of office and that it did not relate to past, present or future services rendered (which had already been compensated elsewhere). The deed of release in the original employment contract and non-competition clauses in the Separation Agreement were also found to be payments for restrictive covenants, which were capital in nature.

Second, the Board commented that the position being taken was aligned with the position articulated by the Comptroller in its own website and practice note. The Comptroller had submitted that it was not bound by the statements on its own website, as practice is not law. Whilst the Board was willing to accept the general proposition that practice is not law, it found that it was not necessary to express a view on whether the Comptroller was always bound to follow the statements in its own website. This is because in GCT, the Comptroller’s website ostensibly stated its interpretation of the law, as opposed to mere practice, and was in any event correct as a matter of law.

Nonetheless, the Board observed that the notion that the Comptroller may at any time choose not to follow the statements on its own website without any explanation nor prior notice was “unsettling”, given that the website is intended to be read by the public and to be relied upon by taxpayers at large.

Conclusion

Senior executives who have negotiated for severance payments in their employment agreements (or by other means) may grapple with similar issues arising from the global economic downturn caused by the COVID-19 pandemic. To this end, the decision in GCT provides welcome authority and guidance on the tax treatment of severance payments and confirms the position currently set out in IRAS’ website.