There Transfer pricing is primarily limited to multinational companies that trade across borders and, therefore, there is a general perception that it is an international tax issue that does not affect domestic companies that trade purely domestically.
In domestic groups, transfer pricing is not given much importance, on the assumption that taxes are paid across the group, so transfer pricing between domestic related parties should not be an issue.
The above assumption is incorrect. Transfer pricing applies to domestic transactions.
With the introduction of a surcharge of up to 5% of the transfer pricing adjustment, it would be foolish for domestic companies to ignore transfer pricing, as the introduction of the surcharge is an exception to the Income Tax Act, where the penalty is levied only on the surcharge. With regard to transfer pricing, there is no need for a surcharge for the surcharge to apply. The difference here is that the surcharge is levied on the total adjustment, not on the surcharge.
The Internal Revenue Board’s (IRB) final requirement in transfer pricing is to satisfy the arm’s length test, which requires a taxpayer entering into a transfer pricing transaction to demonstrate that the transaction is comparable to transactions conducted under similar circumstances between two or more independent third parties.
Domestic companies pay very little attention to the area of transfer pricing and the preparation of transfer pricing documentation. In many cases, transactions do not meet the arm’s length standard and the transfer pricing documentation says nothing about this. Silence is not golden here and not doing it properly can be costly.
Where is the abuse?
There are many opportunities in Malaysia to transfer profits to tax benefits such as groups with companies/businesses enjoying tax incentives such as Pioneer Status, Investment Tax Allowance, Malaysia Digital Incentive, Bio Nexus Status Incentive, Special Territory Incentive etc. Halal Incentives etc. Similarly, tax avoidance strategies can also be found when there are companies/businesses within a group with different tax rates such as tax credits, excess unused capital allowances, unused investment tax credits, SME tax rates of 15%, 17%, 24% etc against petroleum income tax of 38% and corporate income tax of 24%.
Groups tend to shift profits to these tax havens using transfer pricing without meeting the arm’s length threshold.
How can you defend against an IRB challenge?
There is nothing wrong with transferring part of the profits within a group to a tax-advantaged company/business, provided the taxpayer can prove that the profits are equivalent to the value created by the tax-advantaged company/business. This must be clearly evidenced by necessary supporting documentation such as supporting documents like contracts, invoices, purchase orders etc. and benchmarking against similar transactions undertaken by third parties on the same terms.
To support value creation in a tax haven, substance must exist in the form of people, activities and assets, and there must be a clear division of the risks and functions assumed by the parties involved. A heavy burden of proof lies on the taxpayer. Comparable data and information from the market must be used to defend the arm’s length nature of the transaction.
Preparing transfer pricing documentation for transfer pricing audits by authorities needs to be taken seriously and should meet the comprehensive requirements of transfer pricing rules and guidelines.
When taxpayers engage in tax avoidance schemes, it is not easy to convince the IRB that the transactions meet the arm’s length standard, as the IRB will raise the counterargument that excessive profits are being allocated to the entities or operations receiving tax benefits.
After all, even if the group is already liable to tax as a whole, mispricing costs will not allow it to escape additional tax if there are any adjustments in transfer prices.
This article was contributed by SM Thanneermalai, managing director of Thannees Tax Consulting Services Sdn Bhd (www.thannees.com).