Transfer pricing, which refers to the manner in which multinational corporations transfer goods and services between and within each other, continues to be an important issue for the Inland Revenue Board (IRB) in Malaysia. This article discusses recent developments in transfer pricing in Malaysia and advises taxpayers operating in Malaysia on how to prepare for scrutiny by the IRB.
Transfer pricing as a concept is not new in Malaysia but has been a part of the corporate tax environment since 2003, when the first set of transfer pricing guidelines was issued. However, the scrutiny of transfer pricing in the country remained quite limited in the initial years.
Transfer pricing issues came to the fore in 2009 with the introduction of Section 140A,which provided the Director General with the power to substitute the price and disallow interest on certain transactions. In public comments made by the Malaysian Government in relation to the introduction of transfer pricing provisions in the Income Tax Act, it was noted that business transactions between related companies tend to be conducted at non-arm’s length prices as a means to reduce incomes (and thereby taxes owing). But does this mean that any reduction in income will necessarily be the result of non-arm’s length pricing? Couldn’t the Malaysian taxpayer suffer a reduced income as the result of commercial pricing, for example, reduced demand for the product / service?
The introduction of Section 140A also specified “disallowance of interest,” which brought the issue of thin capitalization into the Malaysian Income Tax Act. To date, there are no specific rules on thin capitalization and the implementation of any such provision has been deferred to 31 December, 2015.
In addition, 2009 also saw the introduction of Section 138(c), which introduced provisions associated with negotiating and concluding advance pricing arrangements (“APAs”) by the Malaysian taxpayer with the IRB. As noted in Budget 2009, the primary motive of introducing the APA regime in Malaysia is to provide certainty on pricing issues for inter-company trades within a group and to ensure that the tax framework is transparent and business-friendly so as to keep Malaysia an attractive destination for investment in the region, particularly among multinational companies.
Although these measures were introduced in 2009, there was little guidance from the IRB on how it would approach transfer pricing issues. Clarity in this regard was provided in 2012, when the Income Tax (Transfer Pricing) Rules 2012 and Income Tax (Advance Pricing Arrangement) Rules 2012 were implemented in May 2012.
The most interesting point raised by these Rules was that they were deemed to have retrospective effect from 1 January 2009. What this essentially means is that the IRB expects taxpayers to have adhered to the principles introduced in 2012 through the Rules. This has been a bone of contention between Malaysian taxpayers and the IRB, as most taxpayers did not prepare the necessary transfer pricing analyses in prior years. However, the IRB’s position has been that given that Section 140(a) was introduced in 2009, Malaysian taxpayers were expected to prepare for transfer pricing scrutiny and that the retrospective application of the Rules should have not have taken them by surprise.
Both Rules provided much needed guidance to taxpayers. With respect to the Transfer Pricing Rules, the IRB specified the following:
- The necessity for contemporaneous annual documentation;
- The ability of the IRB to re-characterize transactions, particularly where it is believed that a third party would not have engaged in transactions in a similar manner;
- The application of transfer pricing methods on a transactional basis, explicitly requiring taxpayers to test transactions on separate basis, rather than on a combined basis; and
- Considerations for intra-group services / intangible property and intercompany financing;
- A penalty regime for the lack of transfer pricing documentation.
The Advance Pricing Arrangement Rules provided procedural guidance (e.g., required forms and procedures) to taxpayers on how to negotiate and conclude APAs. In addition, it provided conditions under which the IRB may reject / decline an application.
With the implementation of these Rules, the IRB also released updated transfer pricing guidelines. These guidelines provide additional guidance, with detailed examples, on how the IRB will review related party transactions. In addition, the guidelines provide considerations for when Malaysian taxpayers enter into specific transactions e.g., intercompany services, intangible property and intercompany financing.
Transfer pricing audit guidelines were released in April 2013. Although the guidelines are targeted towards tax auditors and intended to provide tax auditors with the necessary support on how to conduct transfer pricing audits, they also serve as an important source of information to taxpayers in Malaysia on what to anticipate during the course of a transfer pricing audit. The audit guidelines outline how tax auditors should select companies for audit and what they should look out for during the desk audit phase and subsequently in the field audit phase. Such guidelines will also help taxpayers prepare themselves for tax audits.
Transfer pricing audits are intensifying year-by-year, bolstered by news that the first transfer pricing audit was concluded in favor of the taxpayer in 2013 by the Special Commissioners of Income Tax. This audit focused on service fees paid by the Malaysian taxpayer to an overseas company, as well as reduced commissions received by the Malaysian taxpayer for logistics services provided. The taxpayer was able to substantiate its position with comprehensive transfer pricing documentation which included detailed benchmarking.
In assisting our clients in transfer pricing audits in Malaysia, we have noticed the following:
- Transfer pricing documentation is requested and has to be provided to the tax auditor prior to the commencement of the audit. We noticed that the tax auditor was well-prepared and familiar with the relevant policies for transfer pricing documentation and price setting and / or checking.
- Intercompany agreements were requested and where they were not provided, the tax authority re-requested them, suggesting that tax auditors wanted to ensure a sufficient legal structure was in place to support the intercompany transactions. The existence of intercompany transactions is also evidence of arm’s length pricing.
- In addition to transfer pricing documentation, other documentation was requested from the taxpayers—e.g., invoices, purchase orders, delivery information—to render support to the pricing policy.The tax-auditor also requested that they be allowed to withhold some of these documents for further analysis.
- Specific focus was placed on services fees paid to overseas affiliates. The tax auditors were particularly focused on whether the taxpayer benefitted from the support provided, and whether they necessarily needed such support to operate their business.
- During the audit visit, detailed discussions were conducted with key business personnel to understand transfer pricing policies in the organization. In addition, detailed factory visits were also conducted for companies that had manufacturing operations in Malaysia.
- Emphasis was given to local Malaysian comparable companies to the extent that the IRB preferred taxpayers to rely on financial data obtained from the Companies Commission of Malaysia (“CCM”).
With effect from the Year of Assessment 2014, taxpayers operating in Malaysia will be required to disclose whether they have transfer pricing documentation for the financial year.Taxpayers that do not have transfer pricing documentation will be penalized.
It is expected that intercompany financing, services and intangible property will remain contentious areas of transfer pricing audits.Furthermore, it is expected that companies will appeal through the judicial system to settle transfer pricing disputes with the Malaysian tax authority, and may even rely on APAs to achieve certainty on transfer prices rather than wait for an audit.
Business & Investment Opportunities
Saigon Business Corporation Pte Ltd (SBC) is incorporated in Singapore since 1994.