Founders or Employees: Income Tax Implications for Quasi-owners of a Company in Share Sale Transactions

Introduction

There is a peculiar blend of excitement and exhilaration when starting a company. The rush of setting up a company and in seeing a vision materialise often causes founders to overlook the need to formalise and/or to document their legal rights and obligations. Some may even not register themselves as shareholders of the company. Such informal arrangements not only set the stage for potential disputes, they also create challenges when the founder seeks to eventually exit the company by way of a sale. If a buyer were to make a payment to the founder (who was not formally registered as a shareholder of the company) in connection with the purchase of the company, would such payments be taxable as employment income, or are they capital payments forming part of the purchase price and therefore not subject to tax?

In UZF and another v The Comptroller of Income Tax [2025] SGITBR 4 (“UZF“), the Income Tax Board of Review (“Board“) considered this issue in the context of two taxpayers who were quasi-owners of the company, and who had received payments from the buyer of the company in connection with the sale and purchase agreement.

The Board found that (i) the taxpayer employees were indeed quasi-owners; (ii) they had received the payments in their capacity as quasi-owners; and (iii) the payments were not related to their employment with the company. In this Update, we look into the factors that the Board took into account in concluding that the payments were capital payments.

The appellants were successfully represented by Adrian Wong (Head, Dispute Resolution Group) and Ang Leong Hao (Partner, Commercial Litigation) of Rajah & Tann Singapore LLP.

Background

The appellants were husband and wife, and worked as financial advisors. They approached a third party (“NIR“) to propose the joint setting up of a life insurance brokerage business. NIR wholly owned ZDR Ltd, which in turn wholly owned ZDRA Pte Ltd (“ZDRA“) and two other subsidiaries. The four companies were referred to as the ZDR Group.

Subsequently, the appellants joined ZDRA under their respective letters of appointment (“2005 EAs“). The first appellant was appointed as ZDRA’s managing director and Chief Executive Officer, while the second appellant was appointed as its director. In addition to their basic salaries, the appellants received a share of ZDRA’s annual profits from 2005 to 2013. These were declared as director’s fees to the Inland Revenue Authority of Singapore (IRAS) and taxed accordingly.

In 2014, NIR, the appellants, and a third party (“Buyer“) entered into an agreement for the sale and purchase of all the issued shares of ZDR Ltd (“SPA“). Key clauses in the SPA included:

1. The provision of warranties and undertakings by NIR and the appellants.
2. The formula for the various components of the purchase price. This included payments to be made directly to the appellants in consideration for the warranties and undertakings they had provided.

The Buyer paid the relevant sums under the SPA to the appellants (“Disputed Payments“) in three tranches from May 2014 to May 2016. NIR and the appellants also entered into new contracts of employment with ZDRA (“2014 EAs“).

The appellants duly declared the Disputed Payments to the Comptroller of Income Tax (“Comptroller“) and sought its determination that the Disputed Payments were not in the nature of employment income. The Comptroller disagreed with the appellants’ arguments and assessed the Disputed Payments to be taxable employment income under section 10(1)(b) of the Income Tax Act (“Act“), rather than capital payments forming part of the purchase prices of the shares in ZDR Ltd. After the appellants’ objections to this assessment were unsuccessful, they filed Notices of Appeal to the Board.

Arising from the appeal, the following key issues presented itself for the Board’s determination:

1. Whether the appellants were quasi-owners of ZDRA Pte Ltd;
2. Whether the appellants entered into the SPA and gave the warranties and undertakings in their capacity as quasi-owners or as employees;
3. The purpose for the payment of the Disputed Payments in the SPA; and
4. Whether, taken as a whole, the Disputed Payments were of the nature of an employment gain or benefit having regard to the other relevant factors from the leading authority of ABB v Comptroller of Income Tax [2010] 2 SLR 837 (“ABB“).

For context, in ABB, the High Court laid down guidelines to aid in determining if a particular gain or benefit obtained by the taxpayer was indeed a gain or benefit from employment and hence taxable as income under section 10(1)(b) of the Act. It noted that in assessing if a “gain or profit” was taxable as employment income, the “capacity as employee” test did not require it to be tied to the taxpayer’s services in the sense that it was a reward for those services — a particular gain can be treated as having arisen from employment even if it is not referable to services rendered by the employee. What was important was whether the gain or profit was paid to the taxpayer in return for him acting as or being an employee.

Board Decision

The Board heard evidence from the appellants at trial and eventually found in favour of the appellants at first instance. 

The appellants were quasi-owners of ZDRA 

1. Although the appellants did not own any legal shareholdings in ZDRA, the Board accepted various pieces of evidence that indicated that they were quasi-owners of ZDRA. This included two diagrams and a draft shareholders’ agreement that evidenced an agreement for them to receive 49% of the shares in ZDRA.

2. The appellants’ receipt of a share of ZDRA’s annual profits were by virtue of their ownership in the company, rather than bonus payments. The Board noted that the 2005 EAs did not make provision for any bonus payments or sales incentives.

3. Although the appellants had declared their share of profits as director’s fees instead of dividends, they had done so only because they were not formally legal shareholders and “had to declare it as something”.

4. The fact that the appellants’ monthly salaries were extremely low in comparison with their share of profits further buttressed their argument that they were regarded as quasi-owners and not mere employees. The Board accepted that the appellants had to enter an employment agreement with ZDRA to obtain the necessary licence to act as financial advisors.

5. While the SPA provided for “Staff Retention Bonuses” to be paid to employees who remained in employment with the ZDR Group, the appellants did not receive such bonuses, again indicating that they were not regarded as staff. 

The appellants entered into the SPA and gave the warranties and undertakings in their capacity as quasi-owners

In coming to its decision, the Board also took into account the following:

1. Only the appellants and NIR received a share of the purchase price. There was no cogent reason why the Buyer would pay a substantial part of the purchase price to an employee who had no equity or share in the business. No other employee was a party to the SPA or provided warranties and undertakings to the buyer.

2. A key warranty was related to the ownership or shareholding of ZDR Ltd. Ordinarily, only the business owners or shareholders would be privy to, and be willing and able to, provide such a warranty as to shareholding, not an employee. NIR – who was not an employee of ZDRA – had given the same warranties, strongly suggesting that the knowledge required to give such warranties was obtained in an ownership capacity.

3. The warranties and undertakings were given to, and were enforceable only by, the Buyer and not ZDRA as the appellants’ employer.

4. The applicable time periods in relation to the giving of the warranties and claims for breaches of the warranties were tied to the completion date of the SPA itself, without reference to the appellants’ employment with ZDRA.

5. The evidence indicated that the appellants’ 49% quasi-ownership of ZDRA was equivalent to 30% of the value of the ZDR Group. As the amount of consideration received by the appellants was pegged at about 30% of the purchase price, this strongly indicated that they had given the warranties and undertakings as quasi-owners of 49% of ZDRA, not as employees.

The Board dismissed the argument that the appellants had provided the warranties and undertakings due to their position as “Key Employees” of the ZDR Group, as set out in the SPA. In this regard, the Board took into account the fact that NIR had also been referred to as a “Key Employee” despite not being an employee. This indicated that the term was merely a convenient way to define NIR and the appellants in the SPA, and that it was not intended to define the capacity of NIR and the appellants.

The Disputed Payments were in consideration for the warranties and undertakings provided

The Board took into account the express terms of the SPA which provided that the Disputed Payments were given in consideration for their provision of the warranties and undertakings.

In coming to its decision, the Board also dismissed the Comptroller’s submissions that the payments were an incentive bonus for the appellants to continue employment, and as compensation to supplement the appellants’ salaries. In this regard, the Board reasoned as follows: 

1. The Disputed Payments were not conditional upon the 2014 EAs being entered into.

2. Although there was a contractual clawback mechanism and a contractual provision which rendered the consideration not payable to the Appellants in circumstances where they were no longer in the employ of ZDRA Pte Ltd, this alone did not indicate that the Disputed Payments were made in return for the appellants’ continued employment. This was so as the clawback would only take effect if the appellants fell within a “Bad Leaver” clause, rather than taking effect if they left the company under any circumstances.

3. The Disputed Payments were not intended to provide the appellants with remuneration that was on par with their remuneration pre-SPA. Among other matters, the Board reasoned as follows:

• • As the appellants received a share of profits as quasi-owners, it would not be accurate to measure the post-SPA pay package against the pre-SPA pay package by including their share of profits.
  • The Disputed Payments terminated in 2020, and not whenever the appellants ceased to be employed.

Other ABB factors

The Board considered four other ABB factors that were relevant, namely:

1. The class of persons to whom the Disputed Payments were granted: The Disputed Payments were also made to NIR, who was not an employee in ZDRA. This indicated that the Disputed Payments were not made to the appellants in their capacity as employees of ZDRA.

2. Whether the Disputed Payments were granted by ZDRA or a third party: The Disputed Payments were made by the Buyer, whereas the appellants’ remuneration was paid by ZDRA. 

3. Whether the Disputed Payments had a foreseeable element of recurrence: They were not recurring in nature, even though they were to be paid over six tranches in five years. The total amount was set and finite with an end date. 

4. Whether the Disputed Payments were granted pursuant to the 2005 EAs or the 2014 EAs: There was no term in the 2005 EAs or the 2014 EAs providing for such payments. This again indicated that the Disputed Payments did not constitute a benefit obtained by reason of the appellants’ employment.

Disputed Payments were not taxable employment income

Accordingly, the Board found that:

1. The appellants were quasi-owners of ZDRA.
2. They had entered into the SPA and gave the warranties and undertakings therein in their capacity as quasi-owners.
3. The Disputed Payments were paid in consideration for the warranties and undertakings given by the appellants, as expressly stated in the SPA.
4. The Disputed Payments did not arise out of the appellants’ employment relationship with ZDRA, and were not paid in return for them acting as or being employees of ZDRA.

Concluding Remarks

The decision in UZF underlines the Board’s emphasis on the substance of any payment as opposed to any given labels. Although the appellants were employees on paper and declared their shares of profits as “director’s fees”, the Board conducted a robust review of the nature of the payment to recognise and find that the appellants were in truth quasi-owners of ZDRA. 

UZF also demonstrates the importance for founders to contemporaneously document their ownership arrangements and/or to ensure that their ownership is clearly reflected, so as to establish a solid foundation for the assertion that they are indeed owners and that they had received the relevant payments in such capacity. Parties may also wish to avoid any ambiguity in sale and purchase agreements that might suggest that the payments in question could be tied to their prior or continuing employment with the company.

Should you have any questions about this development, please feel free to approach our team set out on this page for further information.