4.7 The reduction in corporate income tax will benefit all companies. With the partial exemption of companies' chargeable income since YA 2002, many SMEs already pay less than half the corporate income tax rate. This additional reduction will result in the SMEs paying effective tax rates of between 5.5% and 10%. Besides reducing the rate, we will also restructure the corporate taxation system to introduce two features recommended by the ERC Sub-Committee: group relief and a one-tier tax system.

Group Relief

4.8 Corporations often organise themselves into multiple holding companies, subsidiaries and associates to reflect the structure of their business and to limit liabilities. Sometimes corporations are required by law to set up separate companies for specific purposes. For example, to protect buyers, property developers are required to set up a separate company for each residential development project that they undertake. However, corporations are not allowed to offset the losses of one company against the taxable profits of another within the same group. Each company in a group pays tax as a separate, stand-alone entity. As a result, setting up separate companies effectively raises the tax rate for the whole group.

4.9 The ERC Sub-Committee has recommended allowing group relief to help reduce the cost of doing business in Singapore. Group relief recognises group companies as a single economic entity by allowing the un-utilised losses and capital allowances from one company to offset the profits of a related company in the same group. This is already the case in most developed countries, including the US and the United Kingdom (UK).

4.10 The Government will accept the ERC Sub-Committee's recommen-dation, and introduce a loss-transfer system of group relief with effect from YA 2003. A group consists of a Singapore incorporated parent company and all its Singapore incorporated subsidiaries. Two Singapore incorporated companies could also be members of the same group if one is 75% owned by the other or both are 75% owned by another Singapore incorporated company. Group companies will be allowed to transfer their current year un-utilised capital allowances and losses. However, investment allowances and foreign losses may not be transferred.

4.11 The introduction of group relief will lower the tax burden on companies, and encourage more risk-taking and enterprise. It will also help companies during recessions or the early years of new ventures, when they are likely to make losses. Companies which set up subsidiaries for risky ventures will be able to enjoy the limited liability benefit of separate subsidiaries, and still offset those subsidiaries' losses against their own profits.

4.12 This change will cost the Government $170 million per year. As for the ERC Sub-Committee's recommendation to introduce consortium relief and more complex group relief measures, the Government will study these more carefully before making its decision.

One-tier Corporate Taxation System

4.13 The ERC Sub-Committee recommended replacing the current full imputation corporate taxation system with a one-tier corporate taxation system. It argued that the current system discourages companies with insufficient dividend franking credits from distributing dividends. Furthermore, the full imputation system is not well adapted to sophisticated business transactions, such as share buy-backs and share borrowing and lending. MOF had to craft complicated tax rules for these transactions to meet concerns about tax avoidance. This increased compliance costs for companies.

4.14 The Government has accepted the Sub-Committee's recommendation. We will introduce the one-tier corporate taxation system with effect from 1 Jan 2003. Under this system, the tax collected from corporate profits is final. Singapore dividends are exempt. This will greatly simplify our tax code and reduce the cost of compliance and administration for companies. The one-tier system will work in tandem with group relief and the lower corporate income tax rate to make more profits available for distribution as dividends.

4.15 Many companies will not be able to make full use of the dividend franking credits that they have accumulated by 1 Jan 2003. I will therefore allow a 5-year transition period from 1 Jan 2003 to 31 Dec 2007 for companies to pay franked dividends out of any un-utilised dividend franking credits as of 31 Dec 2002. During this period, shareholders will still be able to receive dividends with credits attached.

4.16 The one-tier system will have the desirable consequence of allowing the unlimited flow-through of exempt dividends to all tiers of shareholders, regardless of shareholding level. However, companies that are still on the imputation system during the 5-year transition period will not be able to do so. I will therefore allow these companies to flow exempt dividends paid out of concessionary income to all tiers of shareholders without restriction on shareholding level.