Contributed By Rosli Dahlan Saravana Partnership
The Malaysian transfer pricing policies are modelled after the Transfer Pricing Guidelines issued in 2010 (the “OECD Guidelines”) by the Organisation for Economic Co-operation and Development (OECD), with some variations to ensure compliance with local laws.
For entities governed by the Income Tax Act 1967 (ITA), the arm’s-length doctrine in transfer pricing is mandated under Section 140A of the ITA. Similar provisions are also found at Section 72A(3) of the Petroleum (Income Tax) Act 1967 and Section 17D of the Labuan Business Activity Tax Act 1990 (LBATA) for entities falling within the purview of the respective acts.
There are other subordinate rules that taxpayers would need to comply with, such as the Income Tax (Transfer Pricing) Rules 2012 (the “Rules”), which supplement the ITA. The Rules prescribe:
Taxpayers are also guided by various guidelines issued by the Malaysian Inland Revenue Board (MIRB). These guidelines detail the MIRB’s approach on transfer pricing regulations and compliance with the requirements of Section 140A of the ITA and other transfer pricing obligations. It is pertinent to note that these guidelines do not bear the force of law.
The advance pricing agreement (APA) regime is regulated under Section 138C of the ITA. An application for an APA is a determination by the Director General of Inland Revenue (DGIR) or the competent authority (CA) with the taxpayer of the transfer pricing methodology to ensure the arm’s-length transfer prices in relation to a transaction.
As part of Malaysia’s efforts for effective implementation of the transfer pricing documentation standards, the Income Tax (Country-by-Country Reporting) Rules 2016 (the “CbCR Rules”) introduced the country-by-country reporting requirements (CbCR). Multinational enterprises meeting a list of criteria would need to prepare and file a country-by-country report in Malaysia.
The Labuan Business Activity Tax (Country-by-Country Reporting) Regulations 2017 are largely similar to the CbCR Rules except that they apply where the ultimate holding entity or the constituent entities is a Labuan entity carrying on a Labuan business activity.
Failure to furnish a CbCR return is an offence and punishable with a fine of between RM20,000 and RM100,000 or imprisonment for a term not exceeding six months or to both under Section 112A of the ITA or Regulation 9 of the Labuan Business Activity Tax (Country-by-Country Reporting) Regulations 2017.
Following the publication of the first draft of the OECD Guidelines, Malaysia jumped on the bandwagon with the release of the Transfer Pricing Guidelines in 2003. These guidelines were replaced by the Transfer Pricing Guidelines 2012 (the “Guidelines”) and last updated in July 2017. The Guidelines are merely instructive and do not have the force of law. Unfortunately, the Guidelines only touch the surface and do not explain the national transfer pricing regime in detail other than stating that a transfer price is acceptable if all transactions between associated parties are conducted at arm’s length and that the transfer price should not differ from the prevailing market price that would be reflected in a transaction between independent persons.
The governing standard for transfer pricing is the arm's-length principle as set out in the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2010 (the "OECD Transfer Pricing Guidelines").
Before 1 January 2009, there was no specific statutory provision in the ITA governing transfer pricing matters. Consequently, the MIRB had been regularly invoking Section 140 of the ITA, which is a general anti-avoidance provision, to undertake transfer pricing adjustments on transactions deemed to be not at arm’s length. Unfortunately, many taxpayers comprising large multinationals did not challenge this abuse of power by the MIRB until the Maersk Malaysia case.
In 2009, formal legislation was enacted vide the insertion of Section 140A, which, inter alia, provided the DGIR with the power to substitute prices and disallow interest deductions on certain transactions if the DGIR is of the view that the transactions were not conducted at arm’s length. In 2012, the Rules were introduced, which detailed specific obligations for taxpayers to comply with the arm’s-length principle. The Rules had retrospective application from 1 January 2009.
In 2013, the MIRB released a Transfer Pricing Audit Framework outlining the MIRB’s approach and requirements in the event of a transfer pricing audit. This Transfer Pricing Audit Framework 2013 was later replaced by the Transfer Pricing Audit Framework 2019.
Malaysia adopted and implemented Base Erosion and Profit Shifting (BEPS) Action 13 for transfer pricing documentation from 1 January 2017 onwards. Malaysia also enacted mandatory rules on CbCR around this time.
Recently, the Malaysian Parliament amended various relevant pieces of legislation to ensure further adherence with transfer pricing regulations. The amendments accorded the MIRB with wider powers under the relevant pieces of legislation.
Under the ITA, transactions between associated persons for the acquisition or supply of property or services must determine and apply the arm’s-length price for the acquisition or supply. Where a company has direct or indirect control over another company’s affairs, they are presumed to be related and transfer pricing rules would apply.
Section 139 of the ITA presumes control where a person:
(a) exercises or is able to exercise, or is entitled to acquire, direct or indirect control over the company’s affairs;
(b) possesses or is entitled to acquire the greater part of the share capital or voting power in the company; or
(c) is entitled to the greater part of the assets available for distribution among members in the event of a winding-up.
Similarly, Section 2(4) of ITA defines companies belonging to the same group of companies where:
(a) two or more companies are related within the meaning of Section 6 of the Companies Act 1965;
(b) a company is so related to another company that is itself so related to a third company;
(c) the same persons hold more than 50% of the shares in each of two or more companies; or
(d) each of two or more companies is so related to at least one of two or more companies to which paragraph (c) applies.
Malaysia applies transfer pricing methodologies following the OECD Guidelines. The Rules categorise the transfer pricing approaches in two broad categories: the traditional transactional method and transactional profit method.
There are three methodologies under the traditional transactional method, namely:
Separately, the two methodologies under the transactional profit method are:
Although the adoption of an unspecified method is not specifically allowed, there is no strict prohibition of the same. Rule 5 of the Rules provides that where the approaches under the Rules do not apply or are unsuitable for a particular arrangement/transaction, the DGIR has discretion to allow the application of another transfer pricing methodology that provides the highest comparability between the transactions by the taxpayer.
Paragraph 3.2 of the Guidelines also states that taxpayers who do not fall within the purview of the Guidelines may apply any method other than the five methods described that results in, or best approximates, arm’s-length outcomes.
Malaysia adopts a hierarchical approach in carrying out transfer pricing analysis. Rule 4 of the Rules establishes that the taxpayer must first use the traditional transactional profit method to ascertain the arm’s-length price of a controlled transaction. This refers to the use of the comparable uncontrolled price method, resale price method, or the cost plus method.
If the aforementioned approaches are unsuitable, the taxpayer may then use the transactional profit method; ie, the profit split method or the transactional net margin method.
Where the aforementioned five methodologies are unsuitable, the taxpayer may utilise any other methods that provide the highest degree of comparability between the transactions.
The MIRB gives priority to the availability of sufficient and verifiable information on both tested parties and comparables in carrying out transfer pricing analysis. For this reason, the MIRB is reluctant to accept foreign tested parties where information is neither sufficient nor verifiable. However, there is no statutory prohibition of the same.
The Guidelines state that an arm’s-length range is a range of figures that are accepted to establish the arm’s-length nature of a controlled transaction. The median of the range is often the starting point to evaluate arm’s-length pricing.
Additionally, the MIRB uses statistical multiple-year data to identify for comparability and any abnormal factors influencing the outcome of a particular year. Data from both the years before and after the year under examination will commonly be examined. This comparison can give a clearer indication of where a taxpayer’s reported loss was contributed to.
However, the lack of appreciation of the OECD transfer pricing policies and the universal rule that transfer pricing is not an exact science by the MIRB cause difficulty for law-abiding taxpayers. In most circumstances, the MIRB ignores loss-making comparables and chooses profit-making comparables for its benchmarking analysis. Furthermore, there has been a persistent reluctance by the MIRB to adopt the weighted average method in examining benchmarking analysis. This produces skewed results, which are not accurate representations of the economic reality.
Comparability adjustments are not mandatory and are allowed where they enhance the accuracy and reliability of comparisons. However, the MIRB takes the view that comparability adjustments are only allowed on a case-by-case basis. The differences between the transaction of the comparables and the tested party must be identified and adjusted for in order for the comparables to be useful as a basis for determining the arm's-length price.
Rule 11 of the Rules requires that the sale or license of an intangible property must be an arm’s-length price and the value shall be the benefit that the intangible property is expected to generate. Intangible property includes patent, invention, formula, process, design, model, plan, trade secret, know-how or marketing intangible.
Rule 11 (6) states that a person will be deemed an owner of intangible property and is entitled to any income attributable from it if the expenses and risks with the development of the intangible property are borne by that same person.
Under the Guidelines, where the legal ownership of an intangible property does not vest with the developer, the developer of the intangible property would be expected to receive an arm’s-length consideration for its development services. The reimbursement to the contract developer must contain a profit element.
In the same manner, where a distributor undertakes marketing activities and bears the costs and risks that exceed an independent distributor but is not the owner of a trade mark or trade name, the MIRB expects that the distributor is entitled to obtain a share of the intangible-related returns from the owner of the trade mark or related intangibles.
In determining the arm’s-length price for controlled transactions involving intangibles, the profit split method or ex-ante valuation techniques is/are preferred if it is difficult to find comparable uncontrolled transactions.
Presently, there are no rules regarding hard-to-value intangibles. The Guidelines indicate that when it is difficult to find comparable transactions involving intangibles such as hard-to-value intangibles, it may be necessary to utilise transfer pricing methods not directly based on comparables, such as the profit split method and ex-ante valuation techniques, to appropriately reward the performance of those important functions.
As a key trading hub in the South-East Asian region and a growing knowledge economy, Malaysia recognises cost sharing/cost contribution agreements (CCAs). Under Rule 10 of the Rules, when a taxpayer enters into a CCA with associated persons, the arrangement should reflect that of an arm’s-length transaction.
However, a recent trend by the MIRB is the arbitrary treatment of CCAs as intra-group services. Rule 9 of the Rules, which applies to intra-group services, is more restrictive in nature than a CCA, such as:
Taxpayers are advised to proceed with caution and ensure that the CCA is crafted properly to defend any recharacterisation of the agreement by the MIRB.
The Guidelines recognise two types of CCA: an arrangement for the joint development of intangible property and a service agreement. However, if a service arrangement does not result in any property being produced, developed or acquired, the principles applicable to intra-group services will apply to that arrangement, whether it is described as a CCA or otherwise.
To determine whether a CCA complies with the arm’s-length principle, the MIRB may take the following matters under consideration.
When a participant wishes to withdraw from the CCA, the MIRB expects the exiting participant to be compensated upon an arm’s-length value of their transferred interest. This buy-in payment is determined by the price an independent party would have paid for the rights obtained by the new participant, taking into account the expected benefit from the CCA in accordance with the shares.
The ITA does not expressly allow a taxpayer to make affirmative transfer pricing adjustments after filing their tax returns. Taxpayers wishing to make a transfer pricing amendment would need to rely on the general application of Section 77B of ITA relating to the amendment of an income tax return.
An amendment under Section 77B of the ITA is subject to a few conditions, including that the amendment must be made no later than six months from the due date of furnishing the return and there may be additional penalties imposed.
Alternatively, the taxpayer may make an application for relief within five years after the end of the year of assessment in respect of an error or mistake made when the tax returns are filed under Section 131 of the ITA. The burden of proof is on the taxpayer to prove an error or mistake and the DGIR has discretion to determine if the error or mistake is just and reasonable. If the taxpayer is dissatisfied with the decision of the DGIR, the taxpayer may file an appeal to the Special Commissioners of Income Tax (SCIT) for further determination.
Malaysia is a participating country of the automatic exchange of information (AEOI) system initiated by the OECD and has publicly declared its commitment to the Common Reporting Standard (CRS).
Tax information exchange agreements with treaty countries and non-treaty countries are provided for under Section 132 and Section 132A of the ITA respectively. Section 132B of the ITA serves to facilitate mutual administrative assistance in tax matters with government authorities outside Malaysia involving simultaneous tax examinations, automatic exchange of information or tax administrations abroad.
Under the CRS, Malaysian financial institutions are required to identify customers who appear to be tax residents outside of the jurisdiction where they hold their accounts and products, and report relevant information to the MIRB, which may share this information with the participating foreign tax authorities of where the customers are tax residents.
Malaysia would also receive financial account information on Malaysian residents from other countries' tax authorities. This will help ensure that residents with financial accounts in other countries are complying with their domestic tax laws and act as a deterrent to tax evasion.
Section 138C of the ITA allows taxpayers to apply to the MIRB for an APA from 1 January 2009 onwards. This is an arrangement between a taxpayer and the DGIR or between competent authorities to predetermine the price of goods and services that are to be transacted in the future between the taxpayer and its related companies outside of Malaysia over a specified period of time to ensure compliance with the arm’s-length principle. The DGIR is tasked to ensure that the transfer pricing methodologies adopted by the foreign affiliates are fair and reasonable to the resident taxpayer in Malaysia.
Under the Malaysian APA programme, there are three types of APA available: bilateral, multilateral and unilateral. The scope of the APA may cover:
A bilateral APA concerns transactions between a resident company with its related companies abroad and the tax authority of the foreign country. A multilateral APA is where there is more than one related company and the tax authority of the foreign country. A unilateral APA only deals with a resident company and its transactions with its related companies abroad.
Section 138C states the DGIR and the CA (on double taxation arrangements) are capable of entering into the APA with the taxpayer or counterparty CA, respectively, in order to determine the transfer pricing methodology to be used in a related-party cross-border transaction. A related-party transaction for the purposes of an APA is where:
Additionally, the mutual agreement procedure (MAP) article in Malaysia’s tax treaties allows the Malaysian CA to interact with the CAs of a treaty partner with the intent to resolve international tax disputes involving double taxation and inconsistencies in the interpretation and application of a tax treaty. The Malaysian CA can assist in resolving issues such as residence status, withholding tax, permanent establishment and characterisation of income.
The MIRB administers the APA programme. An application for an APA should be made to the MIRB and the Malaysian CA would be involved in bilateral and multilateral APAs. The authorised CAs include:
Separately, the Malaysian CA directly administers MAP matters other than bilateral and multilateral APAs.
Where the issue concerns a bilateral or multilateral APA, the procedure as set out in the Advance Pricing Arrangement Guidelines 2012 (the “APA Guidelines”) would apply. For all other matters under a MAP, the procedure under the mutual agreement procedures would be applicable. These guidelines are directive and do not have the force of law.
The process applicable for a bilateral and multilateral APA is set out in the APA Guidelines, which provide as follows:
For a case for CA assistance under a MAP, the process is as follows:
According to the MIRB APA Guidelines, there are several conditions that a taxpayer must satisfy to qualify to make an APA application:
A permanent establishment/branch in Malaysia may only apply for a bilateral or multilateral APA through an application by its principal to the CA of the treaty partner country where the principal resides.
Additionally, the DGIR may decline an APA application where:
Under Rule 4 of the Income Tax (Advance Pricing Arrangement) Rules 2012, a taxpayer must first write to the DGIR for a pre-filing meeting for an APA at least 12 months prior to the first day of the proposed covered period.
Thereafter, an application for an APA must be submitted within two months after the receipt of notification from the MIRB pursuant to the pre-filing meeting.
An application fee of MYR5,000 is payable upon application for or renewal of an APA.
An APA covers between three and five years of assessment. Renewal of an APA requires the consent of both parties and is subject to the requirements under Rule 20 of the Income Tax (Advance Pricing Arrangement) Rules 2012.
Rule 20 states that the request for renewal must be made no later than six months before the existing APA expires. The taxpayer must also submit the updated information and supporting documents. The APA may be renewed under similar terms and conditions where:
Rule 11 of the Income Tax (Advance Pricing Arrangement) Rules 2012 states that when the DGIR and/or the CA enters into any type of APA with the taxpayer or counterpart CA, the transfer price will be binding for the stated duration.
However, taxpayers may apply for a rollback application on years prior to the covered period. Under the APA Guidelines, a rollback application will only be considered if the taxpayer can demonstrate that the transfer pricing methodology applied is appropriate and the facts and circumstances are substantially the same as those of the covered period.
The new Section 113B of the ITA penalises taxpayers in the event of defaulting to furnish contemporaneous documentation for transfer pricing. If found guilty, the taxpayer may be sanctioned with a fine of between MYR20,000 and MYR100,000 and/or to imprisonment for a term not exceeding six months.
Section 140A(3C) of the ITA imposes a surcharge on any adjustments made by the DGIR in ascertaining the arm’s-length price of a transaction. This surcharge of 5% on the adjustment is imposed regardless of whether the adjustment results in additional tax payable or not. This surcharge will be collected and treated as if it was tax payable by the taxpayer.
Additionally, penalties can be imposed under Section 113(2) of the ITA where the taxpayer submits an incorrect income tax return. The understatement of tax payable may result in a maximum penalty of 100% on the tax due but the DGIR has discretion to reduce the penalty.
A taxpayer aggrieved by a decision for the imposition of penalties may appeal to the SCIT or via judicial review to the High Court.
In line with the OECD’s recommendation in BEPS Action 13, Malaysia has implemented the Income Tax (Country-by-Country Reporting) Rules 2016 and Labuan CbCR Regulations 2017, which prescribe compliance with CbCR rules in Malaysia.
The rules apply to multinational enterprise (MNE) groups governed by the ITA where:
Similarly, the Labuan Regulations are applicable to an MNE group that has a total consolidated group revenue in the financial year preceding the first reporting financial year of at least MYR3 billion, and its ultimate holding entity or any of its constituent entities is a Labuan entity carrying on a Labuan business activity.
Taxpayers in Malaysia who enter into a controlled transaction must prepare contemporaneous transfer pricing documents. The Rules describe records and documents forming part of the documentation include:
Although Malaysia is not a member of the OECD, the domestic law and policy relating to transfer pricing mirrors the OECD Guidelines. Several features that mirror the OECD Guidelines include the following:
Notably, in the case of Damco Logistic Malaysia Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri (2011) MSTC 30-033, the Malaysian courts held the OECD's commentaries on the Model Tax Convention on Income and on Capital 2014 as persuasive authority when interpreting double taxation agreements.
However, it is also noted that the Guidelines differ from the OECD Guidelines in certain aspects.
Firstly, the MIRB’s approach has a hierarchal preference of transactional methods before the transactional profit method and median value over the interquartile range approach. However, the MIRB has stated that this was primarily due to the fact that the Rules were drafted before issuance of the revised OECD Guidelines. In practice, the best method approach outlined in the revised OECD Guidelines will be followed.
Secondly, the MIRB has a tendency to cherry-pick comparables that are favourable to its transfer pricing approach even where the taxpayer is acting in accordance with the OECD transfer pricing principles. The MIRB displays reluctance in applying comparability adjustments that result in an incorrect determination of arm’s-length price. This approach is not consistent with the principle that a reasonable and robust economic comparability analysis must be carried out to determine the arm's-length nature of the comparables and the transfer prices to be considered as arm’s length.
The principle of arm’s length in Malaysia closely resembles the OECD Transfer Pricing Guidelines. Section 140A(2) of the ITA mandates that transactions between associated persons for the acquisition or supply of property or services must determine and apply the arm's-length price for the acquisition or supply.
In 2017, Malaysia joined the OECD's “Inclusive Framework on BEPS”. Malaysia’s participation in the project has led to several notable developments on the domestic transfer pricing landscape in line with the OECD, which could be summarised based on the BEPS Action Plan as follows.
Action 1: Address the Tax Challenges of the Digital Economy
This action was released in 2015 to counter risks arising from the digital economy and provides a recommendation for the taxation of digital businesses. This led to the implementation of a digital tax effective from 1 January 2020 at a rate of 6% on digital services provided to consumers in Malaysia.
Action 5: Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance
Malaysia endeavours to ensure that the tax incentives available in Malaysia comply with certain safeguards in accordance with the Forum on Harmful Tax Practices (FHTP). In order to fulfil the FHTP criteria, several legislative changes were gazetted to amend existing tax incentives.
The amendments made affect two broad groups of incentives: IP incentives and non-IP incentives. For IP incentives, a nexus approach is adopted where only research and development expenditures incurred in Malaysia are eligible for income tax exemption. For non-IP incentives, there is the introduction of substance requirements by requiring an adequate investment amount or annual business operating expenses to be incurred in Malaysia and an adequate number of full-time employees in Malaysia to be eligible for the incentive.
Action 6: Prevent Treaty Abuse
Malaysia signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (the “MLI Convention”) in January 2018. BEPS Action 6 provides that tax treaties under the MLI must include anti-abuse rules to prevent abuse of treaty benefits. This may be done by implementing one of the following approaches:
Malaysia had adopted the first approach, the principal purpose test. Under the PPT approach, treaty benefits are to be denied “if it is reasonable to conclude... that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit”. The exception is where it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of this Convention. This led to the ratification of the MLI Convention in local legislation and with amendments to Section 132(1A), Section 132B(1A), Section 132 of the ITA and Section 21(1)(b) of the LBATA.
Action 7: Preventing Artificial Avoidance of Permanent Establishment (PE)
Malaysia chose to apply the proposed wordings in Action 7; ie, PE exemption should only be available if the specific activity listed is of a preparatory or auxiliary character. Through the introductions of subsections 12(3) and 12(4) to the ITA, the existing PE threshold is lowered to provide clarity where a non-DTA person who carries on business in Malaysia is taxable on his or her profits.
Action 13: Re-examine Transfer Pricing Documentation
Malaysia introduced the Income Tax (Country-by-Country Reporting) Rules 2016, which mandate certain MNEs to prepare and file a country-by-country report in Malaysia effective from 1 January 2017. The MIRB published CbCR Reporting Guidelines in January 2019 outlining preparation of the CbCR that are adopted from the Action 13 Final Report.
The Malaysian transfer pricing regime recognises limit risk and the provision of intercompany financial assistance. For example, Rule 10 of the Rules allows for the sharing of costs and risks for the acquisition or supply of property or services under a cost contribution agreement. However, the cardinal principle applicable to these arrangements is the arm’s-length principle.
The Guidelines denote that risk-bearing transactions by virtue of guarantee must comply with the arm’s-length principle. This means that interest-free arrangements are not accepted by the MIRB as the transfer pricing regime in Malaysia requires these arrangements to be charged at market interest rates (or arm’s-length rates).
The Guidelines consider the comparable uncontrolled price method to be the most reliable in determining the arm’s-length interest rate. Appropriate indices such as the Kuala Lumpur Inter Bank Offered Rate (KLIBOR), prime rates offered by banks and/or specific rates quoted by banks for comparable loans can be used as a reference point. The Guidelines, although not having the force of law, are indicative of what the MIRB considers to be arm’s length.
The Guidelines recognise that characterisation of a business, whether it is fully fledged or limited risk, is important to determine the arm’s-length price of a controlled transaction. There are many MNEs that adopt the limited risk model in Malaysia, particularly in the manufacturing, distribution and service sectors. These companies earn a stable and consistent remuneration within the ordinary course of business. Companies engaged in these arrangements would generally prepare transfer pricing documentation with the functional analysis by highlighting the functions undertaken and contrast the risks assumed by the company. The general rule remains that these arrangements must comply with the arm’s-length standard as stipulated in the Guidelines and/or the OECD Guidelines. However, it is noted that the MIRB may expect these limited risk entities to earn routine profits despite market conditions.
Malaysia does not apply the UN Practical Manual on Transfer Pricing.
Malaysia does not have a safe harbour in the transfer pricing regime and policies.
However, the Guidelines prescribe certain thresholds that allow taxpayers to prepare limited transfer pricing documents to ease the compliance burden. The Guidelines need not be strictly adhered to by:
The Guidelines acknowledge that it is commercially rational for a multinational group to restructure its business to procure tax savings.
The MIRB would take cost advantage, net savings and location savings into consideration when making transfer pricing adjustments. For example, expected cost savings will be taken into consideration in determining whether a CCA is conducted at arm’s length. Any business arrangement or restructure must also comply with the governing independent arm’s-length standard.
The transfer pricing regime in Malaysia has stricter regulations applicable to intra-group services compared to a CCA. Rule 9 of the Rules states that:
Furthermore, interest expenses in a controlled transaction are restricted under Section 140C of the ITA supplemented by the Income Tax (Restriction on Deductibility of Interest) Rules 2019. In summary:
In Malaysia, there is no legislation pertaining to the co-ordination of transfer pricing and customs valuation. Co-ordination between the MIRB and Royal Malaysian Customs Department (RMCD) on the relationship between transfer pricing and customs valuation has been low.
Customs valuation routinely uses the transactional value of the goods imported. In the case of a related-party transaction, Regulation 3(2) of the Malaysian Customs (Rules of Valuation) Regulations 1999 states that the Malaysian importers have the burden of proof to prove that the relationship with the seller did not impact the price paid for the imports. This burden can be discharged if the Malaysian importers can prove that the transaction value of the imports mirrors the transaction value, deductive value or computed value of identical goods or similar goods.
On the other hand, transfer pricing prices are determined through the five methodologies as stated within the Rules to achieve an arm’s-length price.
However, due to different goals between the MIRB and the RMCD, this may lead to different prices on the same product. For a particular import, the MIRB may insist that the price is lower, leading to higher taxable profits, whereas the RMCD takes the view that the value of imports ought to be higher, which results in higher import duties. It is still unclear how the different stances can be reconciled due to lack of integration and co-ordination of valuation methods between the MIRB and the RMCD.
A taxpayer aggrieved by a transfer pricing assessment made by the DGIR may appeal against the DGIR’s decision by filing a notice of appeal to the SCIT pursuant to Section 99 of the ITA. The notice of appeal must be filed within 30 days from the date of issuance of the notice of assessment(s) pursuant to the transfer pricing audit.
Notwithstanding the filing of an appeal before the SCIT, the taxpayer must make full payment of the tax payable under the notice of assessment as required under Section 103(1) of the ITA.
An appeal before the SCIT may take approximately two to two and a half years to be heard, subject to the complexity of the matter and whether there are extraordinary circumstances warranting deferment; ie, COVID-19. If a taxpayer is dissatisfied with the decision of the SCIT, the taxpayer may appeal the matter to the High Court, with the highest appealable court being the Court of Appeal.
Alternatively, a taxpayer may also file an appeal directly to the High Court vide a judicial review application. The main difference between an appeal before the SCIT and the High Court is that unlike the SCIT, the High Court is empowered to grant a stay. If obtained, the taxpayer does not need to pay the tax payable until such time as ordered by the High Court. The highest appealable court in a judicial review is the Federal Court.
It is held that a case under judicial review must only be where there are exceptional circumstances in the form of:
Taxpayers taking this route should note that the dispute is restricted to questions of law and not factual dispute. A judicial review application must be made within 90 days of the impugned assessment and requires leave by the High Court.
In view of the fact that the transfer pricing regime was newly enforced in Malaysia in 2009, there are not many precedents on transfer pricing matters. As such, Malaysian courts have made reference to cases from other Commonwealth jurisdictions and the OECD Guidelines for guidance and support.
Figures within The Interquartile Range Are Reflective of An Arm’s-Length Transaction
In the case of MM Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri (2013) MSTC 10-046, the taxpayer was the shipping agent for another company and was contracted to manage the customers of the said company with agreed commission payments in return. The MIRB argued that the only true arm’s-length commission rate is 3.25% and thereby disapproved the taxpayer’s rate of 3%, despite being within the interquartile range of 1.02% and 5.12%. The SCIT held that the MIRB erred when deciding that there was only one true arm’s-length rate without any supporting evidence to justify that position.
This is a notable conclusion made by the SCIT that suggests not only that the MIRB’s long-standing practice of only accepting certain methodology or formulae in identifying arm’s-length transactions is overly rigid but, in practice, the law recognises that “(t)ransfer pricing is not an exact science but it does require the exercise of good commercial judgment on both the tax administration and the taxpayer”.
The DGIR Has No Power to Recharacterise an Agreement under Section 140A
In the case of SPSASB v Director General of Inland Revenue (unreported), the Court of Appeal granted leave to the taxpayer to commence judicial review against the DGIR for raising notices of assessment made pursuant to Section 140A of the ITA.
In this instant case, the applicant is part of a contractual arrangement for the sharing of services and resources within a CCA with the related companies in the Shell Group. The DGIR invoked Section 140A of the ITA in alleging that the transaction between the taxpayer and the related companies is more akin to the provision of intra-group services than a CCA and imposed a mark-up on costs recovered from the related companies.
The taxpayer contended that if the DGIR wanted to recharactise the nature of the agreement, namely the CCA, the DGIR should have invoked Section 140 of the ITA and specify the subsection relied upon as held by precedents in Malaysia. Furthermore, Section 140A of the ITA does not give power to the DGIR to recharacterise the CCA but merely to substitute the price to reflect arm’s-length price.
Upon hearing the parties’ submission, the Court of Appeal granted the taxpayer leave to commence judicial review and the matter was remitted to the High Court for a determination on the substance of the judicial review application.
The Burden of Proof Is on The DGIR to Prove That a Transaction Was Not Arm’s Length
In the case of OMSB v Director General of Inland Revenue (unreported), the DGIR alleged that certain transactions entered into by the taxpayer were not at arm’s length and insisted that the comparable uncontrolled price method ought to be given priority over the transactional net margin method.
The SCIT found in favour of the taxpayer. It is clear that Section 140(6) of the ITA places the burden of proof on the DGIR to prove that the transaction was not conducted at arm’s length. The SCIT was not satisfied that the DGIR had successfully discharged its burden of proof.
Furthermore, the DGIR also failed to provide sufficient explanation as to why the comparable uncontrolled price method ought to be given priority over the transactional net margin method. This landmark case establishes the fact that the burden of proof is on the DGIR to satisfy a court of law that the transaction was not at arm’s length and substantiate the same with good and cogent evidence.
There is currently no restriction on outbound payments in uncontrolled transactions other than capital limits imposed by the Central Bank of Malaysia.
In addition to the trite principle that payments must be reflective of the arm’s-length price, there are restrictions imposed on the deductibility of interest expenses incurred by an individual in the course of business where the interest is payable to an associated person outside of Malaysia.
Pursuant to Section 140C of the ITA, interest expenses in a controlled transaction are restricted where the interest expenses pertain to financial assistance granted directly or indirectly provided to the taxpayer and exceed the maximum amount of interest allowed by the rules under the ITA. The salient points under the Income Tax (Restriction on Deductibility of Interest) Rules 2019 pertaining to deductibility of interest payments are as follows:
Although it is not explicitly stated in the Income Tax (Restriction on Deductibility of Interest) Rules 2019, the Restriction on Deductibility of Interest Guidelines narrowed the scope of the application of the above rule to apply only to interest expenses that are payable to:
However, taxpayers should take note that unlike the Income Tax (Restriction on Deductibility of Interest) Rules 2019, the Restriction on Deductibility of Interest Guidelines do not have the force of law.
Malaysia does not have rules regarding the effects of other countries' legal restrictions.
Malaysia does not publicly disclose information on APA or transfer pricing audit outcomes citing privacy and confidentiality.
In relation to APAs, paragraph 21 of the Income Tax (Advance Pricing Arrangement) Rules 2012 states that all information is confidential. As such, it is unlikely that any information pursuant to the conclusion of the APA will be publicly available. The MIRB also does not share any information relating to the types and number of advance pricing agreements that it issues each year.
However, such documents may be disclosed to the public in the form of court documents for the purposes of civil litigation against the MIRB or where the taxpayer has a duty to report any findings by the MIRB to Bursa Malaysia.
The MIRB does not allow the utilisation of “secret comparables”.
As a country strategically located as a key trading economy, the COVID-19 pandemic has impacted the Malaysian economy and the three main areas affected from a transfer pricing viewpoint are:
Effect on Limited Risk Entities
With a decline in global demand for goods and services amidst the lockdown, MNEs may be considering ways to redistribute profit allocation, risk distribution and costs assignment with their operating limited risk operators to minimise costs around the globe. In light of the economic downturn, it is unlikely that these limited risk operators will be as profitable as previous years, for reasons such as reductions in sales, additional government regulations to comply with that increase the costs of production and logistic disruption in transporting goods.
For entities more adversely impacted by the pandemic, it may even result in a loss-making situation. The question is then whether the MIRB will expect these limited risk entities to earn their routine profit and for the principal to absorb these losses. There may be concerns for MNEs and limited risk operators in Malaysia on how much risk an entity can bear on behalf of others and would it be a problem if they record results that differ significantly from normal business conditions from the MIRB’s point of view.
Selection of Comparables
The time lag in obtaining comparables for comparable analysis may cause difficulty for MNEs to determine the level of profit to be generated by the Malaysian entity. Selection of third-party companies should be made with compliance with the comparability requirements and independence criteria. Given the overall unfavourable economic environment, there is a risk that the MIRB may reject loss-making comparables.
In this vein, taxpayers may encounter difficulties in determining arm’s-length conditions due to the lag in time between the occurrence of controlled transactions and the availability of information due to fluctuation in the economy. The lack of accurate and real-time comparable analysis may hinder the substantiation required for comparability adjustment and selection of comparables to be made.
Meeting the Substance Test
Additionally, the implementation of travel restrictions all around the world may result in an increase in the use of digital and virtual platforms to conduct meetings, provide services and carry out daily work routines. However, this raises questions of whether there is sufficient provision of value-added service, particularly in intra-group services.
Similarly, there were concerns that a person’s continued existence in Malaysia due to travel restrictions may result in the creation of a permanent establishment. However, the MIRB has clarified and stated that where a non-tax resident is isolated in Malaysia due to travel restrictions, the period in which the person has stayed in Malaysia will not be contributory to the calculation of the period to be considered as a Malaysian tax resident.
Be that as it may, this approach is inconsistent with the statutory mandate that if a person remains in Malaysia for 182 days or more, he or she shall be considered as a tax resident in Malaysia under Section 7(1) of the ITA. It is trite that statutory laws override any guidelines that are only persuasive in nature and the interpretation of Section 7(1) of the ITA amidst the COVID-19 pandemic has yet to be tested.
In response to the disruption caused by COVID-19 to the Malaysian economy, the Malaysian government has provided interim relief to Malaysian taxpayers to alleviate cash flow but has also introduced measures to tighten transfer pricing regulations.
During the initial phase of COVID-19 lockdown in Malaysia, the MIRB extended the deadline for filing of documents required under the ITA. For example, the MIRB had extended the filing deadline for income tax returns by approximately three months and introduced deferment of tax instalment payments for certain industries. The government also allowed a special revision of estimated tax payable to cushion the impact of COVID-19. Throughout 2020, the government also announced various economic incentive plans to stimulate the economy.
Upon tabling Budget 2021, new laws were introduced that tightened the transfer pricing rules and, more pertinently, made it a criminal offence where a taxpayer fails to comply with transfer pricing documentation. Previously, there were no specific penalties for the late or non-submission of transfer pricing documentation. This change would see any person who defaults in furnishing contemporaneous transfer pricing documentation to be liable to a fine of not less than MYR20,000 and not more than MYR100,000 or to imprisonment for a term not exceeding six months or to both.
Additionally, Section 140A of the ITA empowers the DGIR with wider powers in relation to controlled transactions. The DGIR may disregard and recharacterise any structure in a controlled transaction if the economic substance of the transaction differs from its form, or the arrangement when viewed in totality differs from that which would have been adopted by independent persons behaving in a commercially rational manner.
Amendments to the law also allow the DGIR to sanction a 5% surcharge on transfer pricing adjustments made by the DGIR, regardless of whether the adjustments result in additional tax payable or otherwise under Section 140A(3C) of the ITA.
The MIRB has halted applications for APAs where the taxpayer is significantly impacted by the pandemic but still allows for them where the taxpayer is not affected. For ongoing applications, the proposed arm’s-length range will be based on the benchmarking analysis of pre-COVID-19 conditions. For taxpayers who are unable to comply with the critical assumptions in APAs due to COVID-19, the MIRB allows the taxpayers to apply for a revision or setting aside the APA. As regards the renewal of an APA, taxpayers are still allowed to renew APAs but the terms should be similar to the expiring APA.
Audits by the MIRB have been gaining momentum since the relaxation of lockdown laws in Malaysia. During the period when Malaysia was under the Movement Control Order in March 2020, the MIRB gave extensions of time to taxpayers to provide documents and information for tax audits that led to slower tax audits progress.
When the lockdown was gradually lifted, there was an increase in the number of tax audit cases. The MIRB has now been actively pursuing transfer pricing audits remotely through Zoom calls and electronic modes of communication.