Transfer Pricing refers to the intercompany pricing arrangements for the transfer of goods or services between related or commonly controlled legal entities within an organization. Before we explore further, you might wonder how this is related to your business. Here’s why.
Previously, there were no specific penalties imposed on non-compliance of Transfer Pricing documentation. IRBM would only impose penalties if a tax adjustment or Transfer Pricing adjustment was made, whereby taxpayers would be subject to additional tax and penalties for submitting an incorrect tax return under Section 113(2) of the Income Tax Act 1967. Following the announcement of Finance Bill 2020 on Dec 31, 2020, the IRBM imposed some new penalty provisions for non-compliance to Transfer Pricing documentation and audit regime in 2021.
The first recent significant change in Section 113B of the Income Tax Act 1967 (ITA) introduces penalty provisions for taxpayers whom is failure to furnish contemporaneous Transfer Pricing documentation within 14 days upon request. The penalty will be a fine starting from RM20,000 up to RM100,000 per year of assessment, or imprisonment of 6 months or less, or both. A comprehensive TP documentation will easily take more than 30 days to prepare. Hence the 14 days time frame given by IRBM means that IRBM expects all taxpayers who engage with controlled transactions to have up-to-date TP documentation for each year of assessment.
The second significant change in the Section 140A(3C) and (3D) of the ITA is the given discretion of the Director-General of Inland Revenue (DGIR) to impose a surcharge of 5% on any Transfer Pricing adjustment made to a taxpayer’s income tax return, regardless of whether or not the adjustment results in an increase of additional tax payable. Formerly, companies not subject to income tax because of tax incentives may not have adequately reviewed their Transfer Pricing position because there was no tax impact. However, this will not be the case anymore as the surcharge will be applied on the amount of adjustments made, regardless of whether the company’s tax incentives put it in a no additional tax position.
Finally, IRBM introduced an amendment to Section 140A of the ITA that empowers the tax authority to disregard and characterize any structure adopted by a person in a controlled transaction where the economic substance differs from its form, emphasizing the “substance over form” principle. Additionally, the Tax authority will disregard even the form and substance are the same, but the arrangement, when in totality, differs from those that would have been adopted by independent persons behaving in a commercially rational manner.
Accordingly, the DGIR is empowered to make adjustments to the structure of that transaction that would be reflective of the arm’s length principle having regard to the economic and commercial reality. The expansion of power given to the tax authority in this regard will only burden taxpayers with the additional requirement of proving that arrangements such as restructuring exercises or changes in business models with related parties are conducted on an arms-length basis.
Figure 1 – Penalties introduced in the Malaysian Income Tax Act 1967 (ITA 1967)
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So, who is exposed to IRB’s Transfer Pricing scrutiny? If you own a business, the following are considered as your related parties based on Section 139 ITA 1967:
a. Companies in the same group
Example of control and associated persons
In this example, Company A controls Company B and Company C through share ownership. As Company A controls both of Company B and C, Company B & C are associated enterprises. Therefore, Transfer Pricing Laws applied to these transactions.
b. Husband or wife, parent or remoter forebear, child or remoter issue, brother, sister, and partner
The Act provides that transactions between Company A and B are deemed controlled transactions due to the relationship between Mr. and Mrs. Kim.
c. Companies that your company participates directly or indirectly in the management, with control or held share capital of 20% or more
Company A controls Company B, which in turn controls Company C. Company A thus indirectly controls Company C, Transfer Pricing Laws thus applied to these transactions.
d. Companies that you participate directly or indirectly in the management, with control or held share capital of 20% or more.
“Control” has been further defined in Section 140A(5A) ITA 1967 for persons one of whom owns shares of the other person, or a third person who owns shares of both persons, where the percentage of the share capital held in either situation is 20% or more; and
e. The business operations of that person depending on the proprietary rights, such as patents, non-patented technological know-how, trademarks, or copyrights, provided by the other person or a third person;
f. The business activities, such as purchases, sales, receipt of services, provision of services, of that person are specified by the other person, and the prices and other conditions relating to the supply are influenced by such other person or a third person; or
g. where one or more of the directors or members of the board of directors of a person are appointed by the other person or a third person.
Any transactions that occur between your related parties are considered controlled transaction at transfer price, including but not limited to:
- Sales or purchases of raw materials, stock in trade or other tangible assets;
- Royalties/license fees/other types of considerations in connection with use of intangible assets;
- Management fees including charges for financial, administrative, marketing, and training services; Research and development;
- Rents/lease of assets; interests; or guarantee fees.
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