Transfer Pricing rules have been placed in Malaysia for more than 10 years, but why do organisations still make frequent mistakes when it comes to Transfer Pricing compliance?

Episode 2 of Tax Made Easy features host Amanda Andrea Koh as she dives deeper into key pieces of information on Transfer Pricing and what SMEs or corporates should do when it comes to Transfer Pricing compliance with our panel of experts.

The first speaker to be introduced in the show was Zen Chow, Tax Executive Director of YYC Group. Zen has been involved in tax compliance and tax advisory works for more than 15 years in various industries. YYC is a group of professional chartered accountants, tax specialists, and business consultants dedicated to advise and assist Malaysian businesses grow.

The second speaker introduced was Dr. Esther Koisin, Director of International Tax Department of the Inland Revenue Board of Malaysia (IRBM) or also known widely as Lembaga Hasil Dalam Negeri (LHDN). IRBM was established in accordance with the Inland Revenue Board of Malaysia Act 1995 to give it more autonomy especially in financial and personnel management as well as to improve the quality and effectiveness of tax administration.

The third speaker introduced was Haikal Uzir, Head of Transfer Pricing of FGV Group. FGV is a Malaysia-based agri-business listed on the main market of Bursa Malaysia on 28 June 2012.

What are the wrong perceptions SMEs have towards the Malaysian Transfer Pricing compliance requirements?

Zen mentioned that SMEs often assume that they are well within their rights to determine the prices of transactions with related parties without regard to market prices. In actual fact, transfer pricing principles dictate that related party transactions should be carried out at an arm’s length price, or in other words, the market price.

Haikal said that, “SMEs tend to think that transfer pricing only applies to bigger companies.” He also said that most SMEs operate locally in Malaysia so most of them question the need for transfer pricing since there aren’t any international transactions being made.

However, that is not the case because Transfer Pricing is about pricing transactions based on market prices assuming that two or more companies of the same group are totally independent and separate which is also known as the arm’s length principle.

There have been many occurrences wherein SMEs face headaches that could have been prevented. Some examples include mismatches of income and expenses resulting in losses in one entity and disproportionate profit in other entities, incorrect pricing of services transactions and mark-ups, implementation of incorrect royalty rates, incorrect management of cost centres; the list goes on.

Why are intercompany transactions being scrutinized?

Different companies have different tax rates. Within a group of related companies, some companies could have a tax advantage over the others by way of tax incentives granted. If a company is allowed to price their transactions as freely as they want, they could take advantage of this by shifting profit from one company to the other, thereby exploiting the lower tax rates or tax incentives to pay less tax.

How does transfer pricing affect or protect us? What’s the purpose of transfer pricing (TP) documentation?

“Prices of controlled transactions will affect the profit recorded by a company. In situations where some companies in a group are enjoying tax incentives and others are recording continual losses, it will affect the profit recorded and hence the total amount of tax imposed will be affected,” Dr. Esther said.

She also mentioned that a culture of compliance should be practiced by all companies and the documentation of pricing policies is important since it’s required by law and also used as a means to evaluate the risks involved in intercompany transactions.

This makes it easier for the IRBM when they come for auditing. More importantly, not considering transfer pricing can impact businesses income and expenses and result in incorrect assessment of tax liabilities in different countries or double taxation.

What are some tips and tricks to better manage the intricacies around transfer pricing?

“The whole concept of transfer pricing is to ensure that the transaction price between the related parties is at arm's length. How do we justify that? Through transfer pricing documentation!” Zen exclaimed.

According to Zen, transfer pricing documentation is like a report to explain and analyze what kind of related party transactions that companies have with other related companies and how they justify that those prices are indeed arm’s length prices. “There is no shortcut to this,” Zen opined. “A proper set of transfer pricing documentation that outlines the justifications and rationales of pricing policies has to be prepared if there are related party transactions.”

Does transfer pricing only apply to bigger corporations or SMEs too?

According to Dr. Esther, it should definitely be a concern of SMEs and start-ups today. Although the IRBM places a larger focus on multinational transactions because of the level of tax at stake, they are also interested in all controlled transactions that fall within the scope of transfer pricing regulations.

Common transfer pricing mistakes made by SMEs

A common mistake is when a Malaysian SME group of companies fail to view the companies in the group as separate entities, and therefore they often do not charge the related companies for goods sold or services provided within the group. This is mainly due to the bigger focus on growing profit and sales of the group as a whole. They also tend to give interest-free loans since most SMEs operate among close family members or friends.

The most common thought is that “I own these two companies, so why should I charge interest rates on them?”

What are the procedures of applying Advance Pricing Arrangements (APA)?

According to Dr. Esther, APA is an arrangement which the IRBM offers mostly to multinational companies with cross-border transactions. Among the prerequisites for APA is having a turnover of more than RM100 million and at least 50% of the transactions are related party transactions.

If SMEs with cross-border transactions are unsure whether APA is a suitable avenue for them, they can always request for a pre-filing meeting with the IRBM for further explanation and guidance on applying for APA.

It’s important to have a discussion with the IRBM to evaluate if the cases involved are suitable for APA or not. After the pre-filing process, they may then proceed to apply for a formal application of the APA.

This is to ensure that the arm’s length transactions are acceptable for the purpose of transfer pricing.

What are the benefits of APA in managing transfer pricing?

“The main benefit of APA is the certainty of it,” Haikal commented. Companies usually deal with APA before carrying out transactions. When discussing the transactions with the IRBM, one may outline the expected circumstances for the next 3 to 5 years.

This would then provide certainty to companies on the appropriate transfer pricing methodologies to apply for their businesses in the coming years.

Haikal also mentioned that since 2009, it has been a requirement for all companies to comply with transfer pricing regulations.

“It has been a learning curve not just for taxpayers but also for the tax authorities as well, and not just in Malaysia, but also globally,” he commented.

What if a company is a monopoly company? How do you make sure a company like that goes according to the market price?

“For transfer pricing, there’s a term called benchmarking,” Haikal said.

Benchmarking helps organizations to identify the areas where the gap between their standard and that of the industry is the largest. This helps organizations to prioritize the areas that they need to work on.

One of the common benchmarking processes is to compare one’s own margins to that of different companies in the same industry or carrying out similar business functions within a specific industry.

“The IRBM isn’t looking for a 100% match, just something reasonably similar,” he said, to which Dr. Esther agreed.

If the company indicated that there is no TP documentation available in its Form C 2018 at the time they submitted the form, and they only prepared the TP documentation after the submission, will there be any penalty?

The current requirement is for companies to submit the documentation within 14 days of the IRBM’s request for it, Dr. Esther explained. If the documentation is available for submission by that deadline, there are no penalties to be imposed. Nevertheless, Dr. Esther cautioned that companies shouldn’t take such a risk, as it is hard to predict when the company may be selected for audit by the IRBM.

What if a company already has a chargeable income? If surcharge is imposed, won’t it be a double penalty imposed, which is income tax and surcharge?

“A surcharge is imposed whenever there's a transfer pricing adjustment made by the IRBM, regardless of whether the adjustment causes additional tax payable,” Zen explained. Drawing on his experience in attending various forums with the IRBM, Zen went on to share about what tax practitioners have been made to understand through such forums – in a situation where a transfer pricing adjustment causes additional tax payable and a surcharge is imposed as a result of the transfer pricing audit, the IRBM will impose the surcharge but not the penalty for underpayment of tax.

“The two are mutually exclusive,” Dr. Esther confirmed.

How frequent should TP documentation be updated?

Dr. Esther advised that if there are major changes to a company’s pricing policy, then the TP documentation should be revised, or at the very least reviewed before the tax return for the year is filed. If there are no major changes to the pricing policy, there would be no need to revise the TP documentation as it would still be valid.

Why should people consider YYC for help when managing transfer pricing risk?

YYC has been established for more than 46 years since 1974. Some of their clients are now publicly listed on the stock exchange of Malaysia, some have become globally competitive and have ventured overseas and some foreign investors' businesses are now well established in Malaysia.

If there’s anything YYC is familiar with, it’s SME companies in Malaysia.

The preparation of transfer pricing documentation is rather costly today. It is especially difficult for SMEs to afford the documentation process and requirements. YYC wants to try and make it affordable for them.

“YYC is there to help SMEs prepare a good and high quality transfer pricing documentation at an affordable price,” Zen said.

Have questions about Transfer Pricing? YYC Group is ready to assist you with useful guidelines and knowledge on preparing for your Transfer Pricing documentations. Register your interest now to find out how YYC can help! https://bit.ly/tpmk2

While you’re at it, don’t forget to watch more episodes of Tax Made Easy on how to handle your taxes, sign up for free and join us on Zoom for the third episode titled ‘Tackling Tax: Navigating Through Corporate Tax Audit Issues’ on 16 July at 3pm.