The Tax Treatment of Haircuts in Financial Reorganizations in Singapore

By Hui Min Chiow (Student, Singapore Management University)

A debt restructuring generally involves an agreement between a debtor and its creditors with the purpose of helping viable companies facing or anticipating financial trouble. These agreements, which allow debtors to adapt their capital structure to their actual generation of cash-flows, usually include a debt forgiveness (“haircut”) and/or a deferral of payments. Under Singapore law, the sum of the debts forgiven may be treated as a taxable income for companies. Given that this income does not involve any cash-flows for the debtor, financially distressed companies engaging in a debt restructuring involving haircuts may be required to pay taxes for the haircuts potentially included in a financial reorganization. This situation may then end up harming the effective reorganization of viable companies facing liquidity problems. 

In an article published in the Revenue Law Journal, two scholars from Singapore Management University suggested several ways to improve the tax treatment of haircuts under Singapore law. Namely, they argued that the tax treatment of haircuts under Singapore law can be improved by enacting safe-harbour or deeming provisions which may (1) uniformly treat all income from forgiven debts as tax-exempt or (2) deem all income from forgiven debts as capital in nature and thus not subject to tax (Gurrea-Martinez & Ooi, 2020). 

As a response to the COVID-19 pandemic’s impact on the economy, the Ministry of Law established a temporary Simplified Insolvency Programme (SIP) comprising a Simplified Debt Restructuring Programme (SDRP) and a Simplified Winding Up Programme (SWUP). In the absence of any change to the tax regime, the haircuts potentially achieved as part of the SDRP might be taxable as any other income potentially generated by a company. However, as previously mentioned, since this income does not generate any actual cash flows for the insolvent firm, requiring companies to pay taxes for these haircuts may hamper the successful reorganization of viable companies facing liquidity problems. For this reason, adopting one of the policy recommendations suggested by Gurrea-Martinez and Ooi, the Inland Revenue Authority of Singapore (IRAS) recently announced that all debt forgiveness achieved as part of the SDRP will be treated as capital in nature, and therefore exempt from taxes.

This tax reform recently adopted by the IRAS is expected to contribute to the successful reorganization of many viable but financially distressed micro and small firms affected by COVID-19. It is a very desirable and timely measure to promote economic recovery in the current situation. Moreover, even though the current classification of forgiven debts as capital only applies to micro and small companies subject to the SDRP, this reform may be a useful pilot test and provide insights on whether and how such tax treatment can be expanded and applied to the broader insolvency and restructuring framework available in Singapore.