Margaret Lim, Director of Tax Services in Singapore, provides an overview of the IRAS related party loans update, set to take effect in January 2025.
The Inland Revenue Authority of Singapore (IRAS) had recently issued an update specifically stating that interest-free related party domestic loans would not be regarded as arm’s length transactions unless companies have reliable evidence that independent parties under comparable circumstances will similarly provide loans without charging any interest.
Related party loans can be a valuable tool for businesses, allowing them to obtain financing from affiliates or associated entities. However, these loans are subject to specific regulatory frameworks to prevent tax avoidance and ensure fair treatment in financial transactions. In Singapore, the IRAS has established clear guidelines for related party loans, emphasizing the importance of the arm’s length principle.
What this means and who does it affect?
For related party domestic loan entered into on or after 1 January 2025, if the lender and borrower (not in the business of borrowing and lending) of a related party loan are both companies in Singapore, companies can apply the IRAS indicative margin to derive the interest rate regardless of the amount of the loan. If the companies choose not to apply the IRAS indicative margin or either of them is in the business of borrowing and lending, they should determine the interest rate based on the arm’s length principle.
Key regulations for domestic related party loans
Loans entered into before 1 January 2025
For related party loans established prior to 1 January 2025, the IRAS has set specific rules:
- Company status: If both the lender and borrower are companies in Singapore and the lender is not in the business of borrowing and lending, IRAS will limit the interest expense that the lender can claim. This limitation serves as a proxy to the arm’s length principle, ensuring that lenders do not gain tax advantages from potentially inflated interest expenses.
- Financial institutions: Conversely, if the lender operates within the financial sector (such as banks or finance companies), the interest rate must be determined based on the arm’s length principle, reflecting market rates.
Loans entered into on or after 1 January 2025
Starting 1 January 2025, new guidelines will come into effect for related party domestic loans:
- Indicative margin application: If both parties are companies in Singapore and neither is engaged in the business of borrowing and lending, they can use the IRAS indicative margin to derive the interest rate for the loan, regardless of the loan amount. This provides a simplified approach to determining fair interest rates without extensive market research.
- Opting out of the indicative margin: Should either party opt not to use the indicative margin, or if either is in the business of borrowing and lending, they must again revert to determining the interest rate based on the arm’s length principles.
Implications for companies
- Simplified interest rate determination
For domestic related party loans between companies who are not in the business of borrowing and lending, the ability to apply the IRAS indicative margin simplifies the process of determining interest rates. Companies will no longer need to conduct extensive market research to establish arm’s length rates, potentially reducing compliance costs and administrative burdens. - Impact on cross-border transactions
Companies engaging in cross-border related party loans will still be required to adhere to the arm’s length principle. This requirement reinforces the need for robust transfer pricing policies and documentation practices. Businesses must ensure they’re aligned with international standards, which may involve additional resources for compliance. - Interest-free loan restrictions
The clarification that interest-free related party loans are not considered arm’s length transactions—unless backed by evidence—means that companies must think carefully about structuring such loans. Businesses offering interest-free loans may need to reconsider their strategies and potentially introduce interest to align with regulatory expectations, impacting cash flow and financial planning. - Risk management and audit preparedness
As the regulatory environment evolves, companies will need to enhance their risk management frameworks. Businesses should prepare for potential audits related to related party transactions, ensuring they have appropriate documentation and justification for the terms of their loans. - Strategic financial planning
The new regulations may prompt companies to reassess their financial strategies regarding inter-company loans. Firms could explore alternative financing structures or reassess the timing and amount of related party loans to optimize their tax positions while remaining compliant.
Navigating the complexities of related party loans requires a firm understanding of the arm’s length principle and compliance with local regulations. As Singapore’s tax framework evolves, especially with the upcoming changes in 2025, businesses must stay informed and adapt their practices accordingly. By adhering to these guidelines, companies can ensure fair dealings in related party transactions and maintain their compliance with tax laws.
The clarification that interest-free related party loans are not considered arm’s length transactions—unless backed by evidence—means that companies must think carefully about structuring such loans. Businesses offering interest-free loans may need to reconsider their strategies and potentially introduce interest to align with regulatory expectations, impacting cash flow and financial planning.
Should you have any comments or questions arising from this tax alert, please contact us.
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