Transfer Pricing 123. Page 1.

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1 Transfer Pricing 123 Page 1

2 Introduction: Since the issuance of the Transfer Pricing Guidelines in 2003, the Inland Revenue Board has significantly increased its transfer pricing audit on taxpayers both domestic and multinational. With the introduction of Section 140A in the Income Tax Act 1967 in 2009, published of Income Tax (Transfer Pricing) Rules 2012 and follow by issuance of the new Transfer Pricing Guidelines both in 2012, more taxpayers are now under the transfer pricing microscope. We would like to highlight to you the latest developments in Malaysian transfer pricing and compliance requirements in our 3 part Transfer Pricing 123 series on Transfer Pricing. Part 1 : Transfer Pricing Development in Malaysia pg3 Content : Part 2 : Areas which the IRB would focus onpg5 Part 3 : Contemporaneous Transfer Pricing Documentation (TPD)pg8 Page 2

3 Transfer Pricing 123 Part 1: Transfer Pricing Development in Malaysia Legislation Laws and Rules Prior to 1 January 2009, the Inland Revenue Board (IRB) used general anti avoidance provision under Section 140 for transfer pricing adjustments. A specific transfer pricing legislation, Section 140A of the Income Tax Act 1967 was introduced and with effect from 1 January The Income Tax (Transfer Pricing) Rules 2012 were gazetted on 11 May However, have a retrospective effect from 1 January 2009 Guidelines TheIRB issued the first Transfer Pricing Guidelines ( TPG ) on 8 July The Income Tax (Transfer Pricing) Rules 2012 were gazetted on 11 May 2012 and finally a new TPG was issued by IRB on 20 July 2012 to replace the 2003 TPG. Page 3

4 Comparison between TPG 2003 and TPG Scope Cross-border transactions only Cross-border and transactions between domestic entities No threshold Income > RM 25 million + related party transactions > RM 15 million Tested party, multiple year data No Yes Separate / combined, recharacterisation of transactions No Yes Business restructurings No Yes Intra-group charges Yes - minimal Yes detailed Cost contribution arrangement ( CCA ), intra-group financing No Yes Intangibles Yes - minimal Yes detailed Transfer Pricing Documentation Yes Yes detailed Page 4

5 Transfer Pricing 123 Part 2: Areas which the IRB would focus on Controlled transactions and arm s length principle TPG apply to transactions for the acquisition or supply of property or services with associated persons one ofwhich is assessable or chargeableto tax in Malaysia ( controlled transaction ). Controlled transaction means the transaction referred to in Subsection 140A(2) and (5) of Income Tax Act 1967 (ITA) as follows:- 1. Subsection 140A(2) of ITA Where a person in the basis period for a year of assessment enters into a transaction with an associated person for that year for the acquisition or supply of property or services, then, for all purposes of this Act, that person shall determine and apply the arm s length price for such acquisition or supply 2. Subsection 140A(5) of ITA The transactions or the financial assistance referred to in subsection (2) or (4)respectively, shall be construed as a transaction or financial assistance between:- (a) persons one of whom has control over the other; (b) individuals who are relatives of each other; or (c) persons both of whom are controlled by some other person. In view of the above, a taxpayer who enters into a controlled transaction shall determine and apply the arm s length price for the acquisition or supply of property or services in accordance with the method and manner provided in the TPG. Page 5

6 Areas of focus Intercompany sales and purchases intra-group services such as administrative, accounting, human resource, management, secretarial, legal, and etc. Losses over the years Low margins over the years Financial assistance Royalty payments for patent, copyright, research and development and etc. Example: Intra-group services The areasthe taxpayer needs to demonstrate that intra-group services are conducted on an arm s length basis? i. The nature of the service; ii. The value or extent of the benefit of the service to the recipient; iii. The costs incurred by the service provider in providing the service; iv. The functions involved in providing the service; v. The amount an independent recipient would be prepared to pay for similar services in comparable circumstances; vi. Other options realistically available to the recipient Page 6

7 In connection to the above, the taxpayer needs tosubstantiate with supporting documents that: i. Services have been rendered; ii. Service recipient receive benefits that are of economic or commercial value such as enhances the recipient s return or profitability by improving its production efficiency or results in cost savings or a decrease in the recipient s operating expenses; iii. Such services are not a duplication of activities carried out by the service recipients; and iv. Charges for such services must be consistent with the relative benefits intended from the services. Payments made for the following services will be disregarded: 1. Shareholder services; 2. Duplicative services; 3. Services that provide incidental/passive association benefits; and 4. On-call services (except when it can be proved that an independent enterprise would be willing to incur such standby charges). In view of the above, the above activities are regarded as non-chargeable intra-group services and hence not deductible expenses for the recipient. In determining arm s length prices for intragroup services, the service recipient may apply an external CUP together with a benefits test. For the service provider, the CUP or cost plus method may be applied. It is not appropriate to charge a service fee based on mark-up on cost of services procured from independent enterprises (pass through costs). Page 7

8 Transfer Pricing 123 Part 3: Contemporaneous Transfer Pricing Documentation (TPD) Contemporaneous TPD isdefined as:- Documentation prepared when a person is developing or implementing any arrangement or transfer pricing policy with associated person Where there are material changes, the documentation shall be updated prior to the due date for furnishing a return for that basis period for that year of assessment ContemporaneousTPD requirements 1. Organisational structure 2. Group financial statement 3. Nature of the business plus industry and market conditions 4. Analysis of controlled transactions 5. Pricing policies 6. Comparability, functional and risk analysis 7. Selection of the transfer pricing method 8. Documents that support the controlled transactions are at arm s length Contemporaneous TPD is crucial to prove to the IRB that the taxpayer s transfer price is arm s length price. Page 8

9 Transfer Pricing Documentation- Penalty Regime TPG propose the following penalty rates under subsection 113(2) on tax adjustments as a result of a transfer pricing audit :- 1 No contemporaneous transfer pricing documentation 35% 2 Transfer pricing documentation prepared not according to requirements in the TPG 25% Taxpayers who do not fall under the scope of TPG and have notprepared a contemporaneous TPD, may besubjected to 25% penalty on adjustments due to transactions not conducted at arm s length. The TPG also mention that the penalty rate shall be increased by 20% ascompared to the last penalty rate imposed for the previous offence but limited to a sum not exceeding 100% of the amount of tax undercharged, where: a) The taxpayer obstructs or interferes with a transfer pricing audit; or b) The taxpayer fails to comply with the arm s length principle after previous transfer pricing audits. Page 9

10 In view of the above, have you prepared your TPD? Please do not hesitate to contact us should you require further clarifications on the above. AngHeng Ann, Tax - Esther Choy, Business Development - Page 10

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