IN Malaysia, transfer pricing (TP) rules have been in place since 2009. TP is essentially a tax concept which requires group companies to transact at market prices with one another, similar to transactions between independent companies.
These TP rules require companies to demonstrate that their inter-company transactions (also referred to as “controlled transactions”) have been carried out on an arm’s length basis by preparing TP documentation (TPD) on a contemporaneous basis.
Examples of controlled transactions are the sale of goods/services, licensing of intellectual property, etc between group companies.
With the introduction of more onerous penalty provisions for non-compliance to TP rules (which came into effect on Jan 1, 2021), it is now even more crucial for Malaysian companies to ensure full compliance to TP rules in relation to their controlled transactions.
As such, this article aims to debunk some common TP myths in order to assist companies to identify and mitigate key TP risks which are relevant to their businesses.
Myth 1: There is sufficient time to prepare TPD when requested by the Inland Revenue Board of Malaysia (IRB)
In accordance with TP rules, contemporaneous TPD must be prepared by companies. This essentially means that it is mandatory to prepare TPD when the company is developing or implementing any controlled transaction, and the TPD must be updated prior to the filing due date of the corporate tax return (seven months after the financial year end) where there are material changes to the controlled transaction.
The TPD does not need to be submitted unless the IRB requests for it in the event of a tax audit.
The preparation of a TPD is often a lengthy, arduous and costly exercise. Many companies do not have the ability to undertake this task in-house and instead outsource the preparation of TPD. Hence, in practice, companies may decide to take a reactive approach by postponing the preparation of TPD until an audit is triggered by the IRB.
The introduction of stricter penalty provisions (which are aimed at increasing the level of TP compliance in Malaysia), companies which take this reactive approach end up facing increased penalties if they fail to comply with the new provisions.
Under the Malaysian TP Guidelines, the time-frame for the submission of the TPD has been reduced to 14 days. Taxpayers who fail to furnish the TPD within that time-frame are subject to a penalty of RM20,000-RM100,000 per year of assessment.
As the IRB is able to audit up to seven years of assessment at any point in time, penalties for failure to produce the TPD could go up to RM140,000 per year at the very least in a tax audit.
Moreover, the new 14-day time-frame may be too short to prepare a robust set of TPD, particularly where the nature of controlled transactions is complex.
In addition, previously, tax audits typically took place several years after the submission of the company’s tax return. This is no longer the case as the IRB has been initiating audits shortly after the submission of the company’s tax return. The incidence of tax audits are now more regular and are triggered within a shorter period of time.
Myth 2: Companies which are not in a tax payable position are not subject to TP penalties
This is only true prior to Jan 1, 2021, where penalty rates were only applicable if TP adjustments resulted in additional tax payable.
Hence, in the past, many companies which are not in a tax payable position (eg loss-making companies, companies which are granted tax incentives and not required to pay income tax) placed less priority on the preparation of TPD given that TP adjustments proposed by the IRB would not give rise to additional tax payable.
However, with the new TP surcharge (of up to 5% of TP adjustments), these companies need to ensure full compliance to TP provisions in Malaysia notwithstanding that there may not be an additional tax assessed. This is because the TP surcharge is computed on the value of the TP adjustment.
Myth 3: Master files/intercompany agreements are sufficient to prove arm’s length
The prevailing TP rules sets out the specific requirements for the TPD to be prepared by companies in Malaysia such as the local company’s details of controlled transactions, functions, assets, risks (FAR) profile, pricing policy as well as industry characteristics and trends which influence the performance of the local company.
In contrast, the master file is prepared from the perspective of the group as a whole within which the local company operates (for example, supply chain within the group and summary of key controlled transactions undertaken by the group).
Hence, the master file does not typically cover the specific details required for the local company’s TPD. In itself, the master file would not be able to prove that all the controlled transactions undertaken by the local company meets the arm’s length requirement from a Malaysian TP perspective.
Similarly, inter-company agreements are supporting documents which set out the formal terms and conditions agreed between related companies and details of the controlled transactions. However, such agreements are not sufficient for the purpose of substantiating the arm’s length nature of the local company’s controlled transactions.
Myth 4: TPD requirements only apply if there are controlled transactions with foreign related parties
As the TP rules do not provide exclusions for domestic controlled transactions, TPD needs to be prepared regardless of whether controlled transactions are entered into by companies with local or foreign related parties.
Similarly, where the company is solely a recipient of services/goods supplied by foreign related parties, TPD is still required to be prepared as the IRB may not accept the submission of the TPD of foreign related parties for the purpose of supporting the arm’s length nature of the local company’s controlled transactions.
Myth 5: TPD requirements do not apply to small and medium-sized enterprises (SMEs)
The TP guidelines in Malaysia provide thresholds to guide companies in determining the level of TPD to be prepared on a contemporaneous basis (ie either a full or limited TPD). However, as there are currently no exemptions or concessions provided for SMEs, SMEs which engage in controlled transactions in the course of their business operations still need to comply with TP provisions in Malaysia.
Myth 6: Companies can provide interest-free loans to related parties
A group company which lends funds to another group company is required to charge market interest rates. As such, interest-free arrangements are typically challenged by the IRB and companies which choose to implement interest-free arrangements will face an uphill battle in terms of justifying such arrangements to the IRB.
If companies are unable to justify interest-free arrangements, the IRB would seek to compute a deemed interest income on the lender in order to comply with the arm’s length requirement.
Companies should not under-estimate the additional costs which may arise if TP issues are not managed effectively given that TP requirements in Malaysia are constantly evolving and TP adjustments can often be significant in terms of value.
A higher level of TP awareness and understanding of the legislative provisions and prevailing IRB practices therefore helps businesses to maintain an appropriate level of TP compliance, develop a more optimised TP strategy and better defend its TP positions during a tax audit. – Sept 13, 2021
Amy Tan and Kelsey Wong are assistant managing consultants of Tricor Taxand Sdn Bhd, an entity within the Tricor Group which is the leading business expansion specialist in Asia.
The views expressed are solely of the authors and do not necessarily reflect those of Focus Malaysia.