Malaysia: The latest development of transfer pricing in Malaysia

Transfer pricing (TP) is the intercompany pricing arrangements for the transfer of goods, services and intangibles between associated companies or companies in the same group. A high TP shifts profits to the seller and vice versa. Ideally, TP should be based on arm’s length principle, i.e. the prevailing market price which would be reflected in a transaction between independent persons, so as to avoid the manipulative allocation of profits. 

Prior to 1 Jan 2009, there were no specific TP legislations, the Director General of Inland Revenue (DGIR) relied on the general anti avoidance tax provisions and a 2003 issued TP Guidelines to make TP adjustments. Effective 1 Jan 2009, TP is specifically dealt with the enactment of a new Section 140A of the Income Tax Act, 1967 (“the Act”). However, there were no issuances of accompanied new TP Rules nor updated TP Guidelines. 

The much anticipated Income Tax (TP) Rules 2012 and TP Guidelines 2012 were issued on 11 May 2012 and 20 July 2012 respectively but are deemed to be effective retrospectively from 1 Jan 2009. The TP Rules cover the application of Section 140A whereas the Guidelines help to explain the administrative aspects of it. 

The TP Guidelines exclude transactions of financial institutions, individuals who are not carrying on business, and parties who are both assessable and chargeable to tax in Malaysia where both can prove that any adjustments made will not alter their total tax payables. 

On the other hand, the TP Guidelines are applicable on business with gross income exceeding RM25 million and the total amount of related party transactions exceeding RM15 million. As for persons providing financial assistance exceeding RM50 million, they would be required to comply with it too. Nevertheless, the TP Rules have not provided further guidance on thin capitalisation. The above said thresholds would not apply to transactions between permanent establishment (“PE”) and its head office or other related branches as PE for this purpose shall be treated as a distinct and separate entity. 

There is also an emphasis on the requirement of “contemporaneous” TP documentation, which must be prepared when a person is developing or implementing any controlled transaction; and also where the controlled transaction is being reviewed and there are material changes, the documentation shall be updated prior to the date for furnishing a return for that relevant basis period. The contents of a TP documentation and the documentation requirements of specific transactions such when a tax payer engaged in the provision or acquisition of intra group services, transfer of intangible property or participate in cost sharing arrangement, were clearly stated in the TP Guidelines. 

A penalty of 35% of the tax understated will be imposed if there is no contemporaneous TP documentation. Where TP documentation is prepared but not in accordance with the guidelines, a 25% penalty of the tax understated will be imposed.

The following methodologies can be used in determining arm’s length price: 

i. Comparable uncontrolled price (CUP) method 

ii. Resale price method 

iii. Cost plus method 

iv. Profit split method

v. Transactional net margin method 

Although tax payers are given the rights to choose any method, the first three “traditional transactional methods” are indicated as the preferred ones. Whereas the last two methods can be used only when traditional transactional methods cannot be reliably applied or cannot be applied at all. 

In respect of intra-group services, tax payers need to demonstrate that services have been rendered and the services have conferred an economic benefit or commercial value to the business; and charges for the services are at arm’s length. Any charge made by a person in a controlled transaction in respect of the intra-group services shall be disregarded if it involves shareholder or custodial activities, duplicative services, services that provide incidental or passive benefits, or on-call services.

In addition to the above, there is also the Advance Pricing Agreements (APA) Rules and Guidelines which explain the manner in which a taxpayer may apply for an APA from the DGIR/Competent Authority. 

Over these years, in line with many competent tax authorities, the Inland Revenue Board of Malaysia (IRBM) has been devoting their time and scrutiny to TP, especially on cross borders transactions involving intra-group services. Hence, the development of these TP Rules and Guidelines, including those on APA, are utmost imperative to enhance taxpayers’ compliance.