New IRAS Transfer Pricing Guidelines on related party domestic loans

On 14 June 2024, the Inland Revenue Authority of Singapore (IRAS) published the 7^th edition of its Transfer Pricing (TP) Guidelines,¹ replacing the previous edition published in 2021. Amongst the changes introduced, a significant change is the discontinuation of the interest restriction approach as a proxy for the arm's length principle for related party domestic loans. For related party domestic loans entered into on or after 1 January 2025, an arm's length interest rate must be charged based on the indicative margin rate provided by IRAS or otherwise determined according to the arm's length methodology. This change will have direct implications on both corporate and private wealth clients, such as single family offices (SFOs) that currently have interest-free loans within their existing structures, as we will elaborate on below.

A. Updated TP Guidelines on related party domestic loans

Background

For compliance with transfer pricing rules, IRAS requires taxpayers to comply with the arm's length principle for related party loans. The arm's length interest rate is defined as the interest rate which would have been charged between independent parties under similar circumstances at the time the indebtedness arose.²

A "related party domestic loan" refers to a loan in which a taxpayer in Singapore lends to or borrows from a related party in Singapore. Two persons are considered "related parties" if:

1. either person, directly or indirectly, controls the other person; or
2. both persons are, directly or indirectly, controlled by a common person.³

Current approach: Interest restriction approach

Currently, IRAS generally applies the interest restriction approach in the case of a related party domestic loan where the lender is not in the business of borrowing and lending. Under the interest restriction approach, the taxpayer (lender)'s claim for any interest expense incurred in providing the loan is limited to the interest charged on such loan.⁴ While IRAS acknowledges that the interest restriction approach does not exactly conform to the arm's length principle, the approach is accepted by IRAS as a close proxy to facilitate taxpayers' compliance with the arm's length principle.⁵

However, as announced in the latest TP Guidelines, IRAS will discontinue the use of the interest restriction approach for related party domestic loans entered into on or after 1 January 2025.⁶

New approach: Indicative margin approach

For any related party domestic loan entered into on or after 1 January 2025 where neither party is in the business of borrowing and lending, IRAS will regard the parties as having complied with the arm's length principle only if:

1. the parties apply the IRAS indicative margin to determine the interest rate; or,
2. where the parties choose not to apply the indicative margin, the arm's length methodology is applied to determine the interest rate.⁷

The IRAS indicative margins are published by IRAS to facilitate compliance with the arm's length principle. It is a rate which taxpayers can apply as an alternative to conducting a detailed transfer pricing analysis, and is not mandatory.

B. Implications on existing related party domestic loans

Under the interest restriction approach (which will soon be discontinued), we observe that interest-free loans between Singapore entities could still be acceptable to clients for various reasons such as the following:

1. If the lender (taxpayer)'s source of funds was not obtained through borrowing, there would be no interest expense incurred. Thus, a restriction on the amount of interest expense that can be claimed as deduction would not be a relevant consideration for such a lender. For example, in SFO fund structures involving a Singapore trust, holding company and incentivised fund company, it is common to inject funds into the fund company by way of interest-free shareholder loans among these Singapore entities, and the interest restriction is typically not a concern given that the originating funds are usually not obtained through borrowings.
2. At the fund company level, there would be little taxable income given the tax exemptions on relevant income, thus reducing the need to claim deductions.

Going forward, under the latest TP Guidelines, interest-free related party domestic loans will generally no longer be acceptable (unless the taxpayer can demonstrate that independent parties under comparable circumstances would similarly provide such interest-free loans). To comply with the arm's length principle, taxpayers will be required to charge interest on related party domestic loans at the indicative margin rate or otherwise at a rate determined according to the arm's length methodology. If taxpayers fail to comply with the arm's length principle, IRAS states that it will disregard any interest expense in excess of the arm's length amount determined by IRAS for tax deduction purposes even if tax may have been withheld on the full interest payment, and IRAS may not support the taxpayers in mutual agreement procedure (MAP) discussions either.⁸

With the requirement to charge interest on related party domestic loans, there may also be tax leakage if the Singapore lender would be subject to tax on interest income received. This depends on whether there is any tax exemption available to the Singapore lender. Thus, taxpayers may consider whether the injection of funds on or after 1 January 2025 should be done through capitalisation rather than loans.

In view of the updated TP Guidelines, clients should review their existing related party financing arrangements especially those involving interest-free loans. This is even more pertinent considering the more stringent TP audit process announced, under which IRAS may make a TP adjustment and impose a surcharge if it considers that the arm's length principle has not been adhered to and the taxpayer has to file a formal objection if they disagree with the assessment⁹ - in contrast to the previous practice where there would be consultation with the taxpayer before IRAS makes the adjustment.

Please feel free to reach out to any of our key contacts should you have any questions or concerns on navigating these changes.

Dentons Rodyk thanks and acknowledges Associate Joy Chen for her contributions to this article.

1. https://www.iras.gov.sg/media/docs/default-source/e-tax/etaxguide_cit_transfer-pricing-guidelines_7th.pdf?sfvrsn=26bfb1a6_15↩
2. [15.14]↩
3. [3.24]↩
4. [15.16]↩
5. [15.17]↩
6. [15.18]↩
7. [15.18]↩
8. [15.19]↩
9. [7.7] - [7.12]↩

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