Section 44 tax credits 0 comments

(P.S: Sorry for any disturbances the advertisements above may have caused you)
On the first day of this year I had penned down some fundamental themes to watch out for in 2007 and promised I would elaborate on some of them. Well, I haven't kept to that promise so far as I drifted into a long series on Malaysia, so thought I'd start here with a writeup on the Section 44 tax credits theme, one of the domestic themes that I'd thought would be an interesting play.

Prior to the start of 2003, Singapore's corporate tax system was known as a "full imputation system"; however from 2003 onwards it adopted a "one-tier corporate tax system" which would apply to all companies starting January 2008. The mechanics of these tax systems are not necessary to understand; suffice to say that the difference is mainly in the maintenance of a "Section 44 account" which was necessary under the old system but would not be needed under the new system. However, companies which had accumulated large balances in their Section 44 account up till end-2002 obviously had to be given a chance to clear these accounts, and hence a transition period was declared from 2003 to December 2007 for these companies to fully utilise their Section 44 tax credits via issuing franked dividends. Technically, these Section 44 credits belong to the shareholders and in my opinion, it is the duty of the companies to fully utilise them. Any Section 44 balances that remain unutilized as at 31 December 2007 would be forfeited and no longer available to pay future franked dividends.

The utilisation of the tax credit is as follows. If the company has $1M Section 44 tax credit, it would need to pay out $5M in dividends to fully utilise the tax credits. This is obtained by dividing the $1M by the corporate tax rate of ~20%. The amortisation of this balance can be distributed over an extended duration up till end-2007, but of course, now we only have another 6 months left.

Many companies are reluctant to reveal their Section 44 balances. Understandably so, because the next demand made by shareholders would be for them to fully utilise the balance via issuing dividends, which they may feel hard-put to do (eg. because free cash balance is low, or because controlling shareholder unwilling to do so for various reasons). Just look at the case of Isetan and the shareholder lobbying.

This might be an interesting theme coming up for the August interim results announcement period, given that time is running out. Although many companies are tight-lipped, it may be reasonable to expect substantial Section 44 balances primarily in older companies. Note that the bulk of Section 44 balances for companies were accumulated before the transition period commenced in 2003. Except for certain technical adjustments post-2003, the abovestated observation suggests that it makes sense to target older Singapore-resident companies lasting far back into the early 1990s or earlier, which would have allowed them to build substantial Section 44 balances. For those newer companies established in 2000 or later, they are likely to possess insignificant balances, however fast growers they are. For companies with substantial foreign operations, it is a bit unclear about their tax situation but it is possible that they might not even have Section 44 balances at all (this point should be independently verified). For a cross-section of those which have already utilised their balances: Allgreen, Hupsteel, Rotary, Hiap Seng, Low Keng Huat, Tai Sin, Federal, Sing Investments, Amtek: all companies with long histories with the tax board. It will be useful to ferret around for others that exhibit similar characteristics which still haven't played their card. Perhaps the best plays would be those stalwarts that have faded into the background in recent years, which had their best years in the 1990s. Of course, the company must be shareholder-friendly in the first place, else it is possible that they might just let the balance dissipate quietly over 2007-08.

References:
(1) Deloitte Singapore Tax Briefing
(2) Ernst & Young One-Tier Corporate Tax System writeup