Service Companies transiting out of the “Cost Plus Mark-Up” (CM) basis of assessment.

The Inland Revenue Authority of Singapore (IRAS) allows as an administrative concession, service companies providing services to related parties only to compute their chargeable income based on a 5% mark-up on total (direct, indirect, and operating) costs, without any tax adjustments (i.e. applying the CM basis of assessment).

A service company is one that renders service to its related parties – the type of services may include management and administrative support services.

IRAS has updated the conditions for service companies adopting the CM basis of assessment as follows:

Service companies that do not meet both conditions a) and b) below cannot continue to be assessed under the CM basis and are required to transit to the “Normal Trading Company” (“NTC”) basis, latest by the Year of Assessment (YA) 2020 (i.e. financial year ending 2019).

The CM basis of assessment is now strictly meant for service companies that:

  • Provide routine support services to only their related parties (i.e. does NOT offer the same services to an unrelated party) and
  • Adopts a 5% mark-up on costs as the arm’s length charge for their routine support services.

Routine support services include accounting, payroll, human resource and auditing services (the list is not exhaustive – refer to Annex C of IRAS’s E-Tax Guide on “Transfer Pricing Guidelines”). If conditions a) and b) are not met, the service company has to transit to the NTC basis of assessment latest by YA 2020.
This means that service companies currently on the CM basis of taxation and providing:

  1. Routine services and adopting a mark-up other than 5% (supported by a transfer pricing analysis to demonstrate that their charge is on an arm’s length basis)
  2. Non-routine services yet adopting a 5% mark-up on cost
  3. Non-routine services and adopting a mark-up other than 5% on cost

would have to change to the NTC basis in YA 2019 or latest by YA 2020.

Newly incorporated service companies should review the nature/scope of the services they render to ascertain if they qualify for the CM basis of assessment. If yes, is it beneficial to adopt the CM basis of assessment or go ahead with the NTC basis of taxation? The latter may mean preserving start-up losses whilst the CM basis means foregoing these tax losses along with claims for capital allowance on fixed assets, double tax deductions, etc.

Service companies providing routine support services for a fee at a 5% mark-up are not affected. They should, however, continue to monitor their scope of service to ensure that they qualify for the CM basis. In the event that their services change to non-routine (i.e. fall outside the scope of the CM basis of assessment), they would have to change to the NTC basis of assessment.

For service companies that no longer fulfil both conditions a) and b) and are required to transit to the NTC basis, they should apply IRAS’s transition rules in the transition YA. For example, the capital allowances on plant and machinery is computed based on its opening “Net Book Value” (“NBV”) at the start of the transition YA (NBV is deemed as the tax written down value).

Service companies transiting to NTC will now have the option of availing themselves to IRAS’s administrative concession to exempt the following:

  • Group insurance premium benefits (excluding medical) where the employee is
    contractually entitled to a pay-out during trigger events provided the employer
    foregoes a tax deduction on the premium paid
  • Employer contributions to overseas pension funds on their employees, subject
    to conditions.

For service companies on the CM basis of taxation, IRAS’s administrative concession is not applicable. Insurance premiums borne by a service company on group insurance coverage for its employees has to be allocated and reported in the respective employees’ Forms IR8A.

The same applies to a service company on the CM basis that contributes home country
pension/provident funds for its expatriate employees working in Singapore – such
contributions are taxable in the hands of its employees.