By ANG LEA LEA AND POK SOY YOONG

THE world economy is under siege. No economy seems able to escape the wrath of the global economic storms. What started off as a localised sub-prime crisis snowballed into a financial crisis, then a credit crisis, a consumer spending crisis, and now a global economic crisis.

Just a few months ago, Germany was certain it was not affected by the chain of events enveloping the US and the rest of Europe. However, it was the first developed country in Europe to go into recession. It cited faltering orders and declining export of its capital goods as the main reasons.

Being far away from the epicentre of the financial and economic crises offers no assurance of safety. If anything, our economy is far more open and export dependent than Germany's. Clearly, we are entering into a period of financial and economic consequence.

Fear has taken its grip across continents. It is the cornerstone of the fight or flight syndrome. Except that this time round, it is more of the en masse flight globally. This is where it unleashes its raw power, adding on to the woes of unintended consequences.

Lenders do not lend as freely as they used to. Investors prefer to put their money in 'safe' assets. With declining orders for goods and services, businesses are rapidly reducing their cash burn rate. So, they save costs. They cut costs. They hunker down, waiting for the storm to blow over.

Businesses and individuals are responding to the developing crisis in different ways. For some, their responses aim at survival. For others their responses are to hunker down, or differentially invest while waiting for the storm to blow over.

Whatever their response, the common denominator is the mantra that cash is king. The Government has already stepped in to reduce the risk aversion of financial institutions. With only 20 per cent risk exposure, the hope is that this will drive the lending institutions to more readily start lending again. Time will tell if this carrot does its job.

Looking at happenings elsewhere, the question is what role can tax cut and fiscal measures help to boost demand, avert more business failures and reduce unemployment?

We do not pretend to have the answers. Quite clearly, no one seems to have any clear or workable solutions. The web of interacting complexities that shroud the developing recession in an economically integrated world defies even a reasonable comprehension. We therefore offer our limited views, and from our perspective as tax professionals, on what might be worth exploring.

It seems to us that the distinction this time round is between a fiscal package that stimulates consumption and one that aims at sustainability and survival over the next 18 to 24 months. Most things we consume come from a point of origin outside of Singapore. Tax cut and fiscal measures aimed at stimulating consumption are unlikely to give the desired economic impact.

Because of the credit squeeze and the precipitous fall in demand, the key words that surface again and again in our conversations with our clients are 'survival' and 'cash flows'.

We therefore make our suggestions in the context of averting more business failures and reducing unemployment. In the very short term, two things will likely count. One is cash flow. The other is hope and confidence. Cash flow creates hope. Hope sustains confidence. These three are intertwined to improve, we believe, sustainability and survivability.

Lower direct taxes

For many individuals and households, there is little available by way of bank credit. For them, their cash stream comes from employment income and savings. If recession deepens, subsistence may become an issue with any widespread job cut. Social spending will clearly be one of the biggest challenges to the Government. Since this group of people pay very little or no tax, tax relief and tax cuts do nothing to help them.

However, a cut in personal and corporate income tax rates will clearly reduce the cash burden of those who are paying taxes. In a recession, especially in a recession that some say will rival even the Great Depression, the behavioural inclination is to hoard the cash from tax savings rather than to spend these. There is of course this other issue even if these tax savings are spent - some 60 per cent of this spending will likely leak to other economies. So we get into this paradox - one country spends the money but helps jobs creation or spurs demand in another country!

With the stimulus packages already announced by many countries, including China's US$586 billions, arguably some of the benefits will trickle into the Singapore economy as well. Although not a zero sum game, our sense is that if more and more governments act in unison on stimulus packages, the leakage from our own economy is arguably lower than the current estimate of 60 per cent. But if tax savings fuel cash hoarding, then it calls to question the economic stimulant effect of any sizeable tax cuts.

So the question is whether the tax savings will be hoarded rather than spent. Again, our sense is that there will be some degree of hoarding. But this is unlikely to be hoarding for hoarding's sake. More likely than not, it is to stretch the dollar for as long as possible. We therefore see this hoarding akin to slowing down the cash burn rate, increasing sustainability and therefore survival, both for individuals and businesses. If our sensing is right, then cutting taxes could be an option on the table.

Since the aim is to put cash in the hands of individuals and businesses, cutting taxes is only one of a number of available options. Another obvious tool is to give a one-off tax rebate for both corporate and individual taxes. Yet another is to offer a programme to allow a far larger number of instalments for tax payments. Between cutting taxes through rates cut and rebate, we vote for rebates.

Any corporate and income tax rates cut from their present level will signify a change in the longer term tax rates structure. Once changed, it is difficult to reverse course even if economic conditions later support this. A tax rebate offers the advantage of releasing cash into the economy but leaving the present tax rate structure unchanged. To create hope and instill confidence, this rebate needs to be large, and should cast over a longer horizon of two years, rather than for only one year to allow for greater cash predictability.

The present crisis is fear-induced and the main fear is cash availability. This rebate ought to help both individuals and businesses stretch their dollar for as long as possible. The intent is to soften the fall and help buy time to get into a period of better stability and normalcy. No matter how difficult the recession might be, the storm will one day blow over. When that happens, the lesser the casualties the better the economic combativeness of our business communities and our people, and the faster it is to gear up for the up-swing.

Clearly tax rebates alone will not be enough to ensure survivability with no casualties. And the intent is clearly not to advocate a bailout, but to give businesses the maximum support possible to weather out the storm.

There is in fact a far more radical option. This is the switch to a current year tax system and coupled with a one-off 'tax holiday' for everyone. Currently, tax is paid only on the income earned in the year before. Changing this to a current year system means tax is paid as the income is earned. And in the present economic condition, a current year system takes away the cash flow pressure of having to pay tax in a bad year on the income earned in a good year.

Notional Goods and Services Tax (GST) refund relief

There are already indications that lowering the GST rate is not on the cards. At any rate, not any time soon. If the developing economic environment warrants another look at a short term tinkering with the GST rate, we have this suggestion.

Cutting the GST rate from the current 7 per cent will entail significant costs as businesses will have to reconfigure their accounting and point-of-sales systems. Also, this takes time to implement and therefore even longer to see the effect filtering through to the economy. Conceptually, we believe there is an 'easier' short term mechanism.

If the input GST claim is notionally 'inflated' by a multiplier (for example 1.2 times or 1.5 times, as the case may be) GST-registered businesses will either receive a larger refund or pay less output tax. Indirectly cash is returned to the GST-registered businesses. This is akin to a 'GST rebate', similar in effect to a corporate tax rebate, but with far greater reach and impact.

This mechanism does not deal with the GST burden at the ultimate consumer level, which remains at 7 per cent. It may, however, significantly ease the cash availability to the businesses and shave off some business costs. And hopefully aid our businesses to cushion off the level of work force downsizing.

This mechanism is conceptually easy to understand. It is not necessarily as easy to implement. Obviously, other policy and implementation considerations will come into play to assess if this is indeed a viable short term economic tool.

Among the difficult issues to consider include questions such as whether there should be a limit or cap on the additional GST refund or reduction in the net GST payable, whether the GST reduction or refund created by the multiplier should be considered as loans to the GST registered businesses, whether it is equitable to lessen only the cost burden and cash flow pressures of GST registered business but not directly addressing the GST burden of the ultimate consumers and the like.

These and other issues are difficult issues to tackle. Nonetheless, this could be yet another item in the Government's arsenal of options for the near future.

Exempt foreign income

Over the last few years, the remittance regime has been significantly relaxed. Individuals are no longer paying tax on the remittance of their foreign-sourced income. Companies, however, still pay tax on certain types of foreign-sourced income remittances. The inclination is therefore to keep any foreign-sourced income that does not qualify for exemption offshore for as long as is possible.

If a company with offshore income is running short of cash locally, reality will dictate that it remits the offshore income irrespective of the tax consequence. Survival carries a far distinctive priority than having to pay the tax later. Be that as it may, an exemption will have a strong signalling effect to those companies with offshore income accumulation overseas.

This option has a number of sub-options. One is a permanent exemption and therefore a total relaxation of our tax regime into a full territorial basis of taxation. This sub-option may have longer term consequences. Another sub-option is to grant the equivalent of an Amnesty; effectively remittance within a certain time period is exempt from tax altogether. The question is who might be the beneficiaries of this exemption. Clearly all Singapore-based companies with unremitted foreign sourced income will benefit.

Although we do not have the statistical data to validate this, our sensing is that the beneficiaries will be largely those companies with ultimate parentage in Singapore. As these companies built their external wings and trade linkages overseas, they are the most likely candidates to accumulate foreign-sourced income offshore to defer the liability to Singapore tax. They are therefore likely to be the prime beneficiaries of any such exemption. Again, we ask the Government to add this as another item in its arsenal of options.

Donations

In an economic downturn, social plights heighten. More so than ever, charitable organisations will need more funding at a time when funding is hard to come by.

Tripling the deduction relief for approved donations for a defined period of time, that is for a year or two only, ought to help. For every $1,000 of approved donation by a company, the Government forgoes a tax revenue of $540 ($1,000 x 3 x 18 per cent). The flip side of this is that it costs the Government $540 to 'stretch' a charitable effort into $1,000. It looks like our charitable organisations will need all the help they can get. So, this is something to think about.

Conclusion

This recession is quite unlike any other recession. With a world so integrated, the effort of one economy is potentially affected by the action of another economy. The tendency is to proceed as cautiously as possible.

In an article entitled When the rules don't apply published in the International Herald Tribune on 14 November 2008, economist Paul Krugman said: ' . . . When depression economics prevail, the usual rules of economic policy no longer apply: Virtue becomes vice, caution is risky and prudence is folly . . . '

And he said: 'Under current conditions however, it's much better to err on the side of doing too much than on the side of doing too little.' We concur fully.

The writers are Ang Lea Lea, tax partner and Pok Soy Yoong, former head of tax, Ernst & Young Solutions LLP.

This article was first published in The Business Times on January 05, 2009.