Merely describing an arrangement as a loan is not enough. The terms, risks and actual behaviour of the parties must reflect the commercial reality that would exist between independent parties operating under similar circumstances.

A legal entity must have the capacity to manage and control the financial risks it assumes. If it lacks the ability to control those risks, it may not be entitled to receive the associated returns.

The return earned by each party should align with the functions performed, assets used and risks assumed. This helps ensure that all participants are appropriately rewarded for their economic contribution to the transaction.

The guidelines also make clear that where a transaction is considered commercially irrational compared to arrangements that would be undertaken by independent parties, the DGIR may disregard or recharacterise the arrangement to reflect its true nature.

The IRBM places significant emphasis on assessing whether a purported loan is genuinely debt.

Within multinational groups, financing arrangements may be labelled as loans even though their commercial characteristics more closely resemble equity. As a result, the IRBM requires taxpayers to determine whether a financial arrangement is truly debt before analysing whether its interest rate is arm’s length.

A purported loan may ultimately be treated as equity if the economic reality indicates that the arrangement lacks the characteristics expected between independent lenders and borrowers. This distinction is critical because it affects both the pricing and tax treatment of the transaction.

The guidelines provide a detailed framework for distinguishing debt from equity.

Characteristics of Debt

Debt instruments typically exhibit:

• A legal obligation to repay principal and interest
• A fixed maturity date
• Predetermined returns
• Creditor status upon liquidation
• Enforceable repayment rights
• Classification as a liability in financial statements
• An intention to create a debtor-creditor relationship

Characteristics of Equity

Equity instruments typically exhibit:

• No obligation to repay capital
• No fixed maturity date
• Returns dependent on profitability
• Residual rights on liquidation
• Voting rights or management influence
• Limited repayment rights
• Classification as equity in financial statements
• An intention to create ownership interests

The IRBM further identifies several specific criteria that should be considered when determining whether an arrangement is debt or equity, including repayment obligations, maturity dates, expected returns, liquidation priorities, management participation, enforceability, accounting treatment, tax treatment and the intent of the parties.

Importantly, no single criterion determines the outcome. The substance of the arrangement must be assessed holistically based on all relevant facts and circumstances.

The guidelines reinforce the DGIR’s ability to recharacterise a purported loan as equity where the arrangement does not reflect commercial reality.

In such circumstances, interest deductions may be denied, transfer pricing adjustments may arise and taxpayers may be exposed to surcharges and additional tax liabilities.

The IRBM provides an example involving a Malaysian company receiving unsecured funding from an associated foreign lender at a high interest rate despite having a risk profile that would not attract financing from independent lenders. In this situation, the DGIR may disregard the structure under subsection 140A(3A) of the Income Tax Act and treat the arrangement as an equity contribution rather than debt.

An independent lender would evaluate:

• The borrower’s financial position
• The purpose of the financing
• Sources of repayment
• Cash flow capacity
• Balance sheet strength
• Alternative uses of capital
• Economic conditions affecting repayment risk

The lender must also consider factors such as rising interest rates, foreign exchange risks and broader market conditions that may affect the borrower’s ability to repay the loan.

The guidelines acknowledge that in an intra-group context, the importance of security may differ from third-party lending because parent companies already control the borrowing subsidiary. Nevertheless, security and collateral remain economically relevant when pricing financing arrangements.

Borrowers generally seek to minimise financing costs while ensuring that funding meets operational and strategic objectives.

Independent borrowers would consider:

• The cost of available financing options
• Security requirements
• The impact of interest rate fluctuations
• Currency risks
• Long-term funding requirements
• Future capital raising needs

The guidelines also recognise that borrowers and lenders may reasonably renegotiate terms in response to changing market conditions in the same way that independent parties would.

The borrower’s creditworthiness is identified as one of the most important factors affecting arm’s length pricing.

Credit ratings provide a useful indication of the likelihood that a borrower will meet its debt obligations. Accordingly, they are often used in transfer pricing analyses when benchmarking interest rates or assessing comparability.

The IRBM notes that credit assessments typically consider:

• Financial strength
• Profitability
• Repayment history
• Cash flow stability
• Existing debt levels
• Industry conditions
• Jurisdictional factors

For Malaysian businesses, recognised rating agencies and information sources may include RAM Ratings, Moody’s, Standard & Poor’s, CTOS and CCRIS.

When using credit ratings in transfer pricing analyses, taxpayers must ensure comparability between both the borrower and the financial instrument being assessed.

Factors influencing credit ratings include:

• Financial strength
• Profitability
• Existing leverage
• Repayment history
• Market exposure
• Currency risk
• Security arrangements
• Maturity periods
• Covenants and guarantees

Even loans with identical contractual terms may receive different ratings if the borrowers have different risk profiles or operate in industries with different risk characteristics.

The guidelines also stress the need to use reliable market data and make appropriate adjustments where differences exist in size, currency, geography or economic conditions.

The IRBM distinguishes between an issuer rating and an issue rating.

While an issuer rating reflects the creditworthiness of the borrower generally, an issue rating considers characteristics specific to a particular debt instrument, including guarantees, security arrangements and debt seniority.

Where both ratings are available and sufficiently comparable, the issue rating may provide a more reliable basis for pricing a controlled financial transaction.

Where no standalone rating is available for a specific group entity, taxpayers may need to replicate the methodologies used by independent rating agencies.

Relevant assessment factors include:

• Ownership structure
• Management quality
• Strategic importance
• Asset quality
• Liquidity
• Financial performance
• Capital adequacy

The IRBM expects taxpayers to document the rationale behind any credit rating analysis within their contemporaneous transfer pricing documentation.

One of the most significant concepts addressed by the guidelines is implicit group support.

An entity may benefit from being part of a multinational group because independent lenders may assume that the group would support the entity during periods of financial stress. This expectation can improve credit ratings and reduce borrowing costs.

The extent of this support depends on factors such as:

• Strategic importance to the group
• Operational integration
• Legal and regulatory considerations
• Reputational implications
• Historical support practices

Importantly, the guidelines state that no separate transfer pricing charge should arise for the benefit of implicit support because it naturally results from group membership rather than a specific service or contractual arrangement.

Loan agreements must accurately reflect the actual arrangement and behaviour of the parties. Documentation should clearly articulate the commercial terms of the financing.

Taxpayers must analyse the functions performed, assets used and risks assumed by each party involved in the financing arrangement.

Relevant considerations include:

• Nature and purpose of the loan
• Principal amount
• Duration
• Currency denomination
• Exchange rate risks
• Borrower creditworthiness
• Security arrangements
• Guarantees
• Covenants
• Seniority
• Fixed or floating interest rates

Pricing may vary depending on:

• Geographic location
• Currency markets
• Industry sector
• Local regulations
• Central bank rates
• Broader economic conditions

Business strategies may affect financing terms. For example, lenders may accept different risk profiles when funding mergers, acquisitions or strategic growth initiatives.

The IRBM views the CUP method as the preferred pricing approach where reliable comparable data is available.

The method leverages the extensive information available in financial markets regarding loans, borrowers and interest rates. Comparable transactions may include:

• Third-party loans
• Bond issuances
• Deposit instruments
• Commercial paper
• Internal CUPs where comparable third-party data exists within the group

The guidelines emphasise that average group borrowing rates generally do not satisfy comparability requirements and should not ordinarily be used as internal CUPs.

The arm’s length analysis extends beyond interest rates.

Independent lenders frequently impose fees such as:

• Arrangement fees
• Commitment fees
• Facility fees
• Other loan-related charges

Where similar fees exist within intra-group arrangements, they must be analysed and supported in the same manner as any other controlled transaction.

Where comparable third-party data is unavailable, taxpayers may apply a cost of funds approach.

This method considers:

• External borrowing costs
• Funding costs
• Loan servicing expenses
• Risk premiums
• Appropriate profit margins
• Opportunity costs associated with internal funds

The IRBM stresses that pricing outcomes must remain consistent with market conditions and realistic alternatives available to the borrower. In addition, taxpayers must validate outcomes against observable market rates where possible.

The method may be particularly relevant in intermediary financing structures where capital passes through one or more group entities before reaching the ultimate borrower.

To reduce compliance costs, the IRBM has introduced a simplified method for selecting arm’s length interest rates for eligible taxpayers.

Deposit Rate Method

Taxpayers may use the Bank Negara Malaysia deposit rate where:

• The taxpayer is not in the lending business
• Interest income is assessed under paragraph 4(c)
• Funds originate from internal resources
• Loans are denominated in Malaysian Ringgit
• Aggregate loans do not exceed RM50 million
• The borrower is a Malaysian resident associated entity

Average Lending Rate (ALR) Method

Taxpayers may use the Bank Negara Malaysia average lending rate where:

• The taxpayer is not in the lending business
• Interest income is assessed under paragraph 4(c)
• The loan is denominated in Malaysian Ringgit
• Aggregate cross-border loans do not exceed RM50 million

The simplified method is not available for back-to-back funding arrangements where borrowed funds are transferred through group entities to an ultimate borrower.

Where eligibility criteria cease to be satisfied, taxpayers must revert to a full transfer pricing analysis using an appropriate methodology.

The guidelines also allow taxpayers to review arm’s length interest rates every three years where facts and circumstances remain unchanged, helping reduce administrative burdens.

• Loan agreements
• Credit assessments
• Comparability analyses
• Pricing methodologies
• Evidence supporting interest rates
• Reviews demonstrating ongoing arm’s length compliance

• The lender and borrower
• Financing dates
• Loan amounts
• Interest rates
• Interest charging policies

The IRBM also expects taxpayers to document all economically relevant characteristics forming part of the transfer pricing analysis.

Taxpayers relying on the simplified method must retain evidence demonstrating eligibility, including:

• Loan agreements
• Confirmation of internal funding sources
• Proof of currency and loan amounts
• Evidence that the taxpayer is not carrying on a lending business
• Evidence that applicable thresholds have been met
• Documentation supporting the applicable Bank Negara Malaysia reference rates

CTPD is not required to be submitted with a taxpayer’s annual tax return. However, taxpayers must be able to submit the documentation within 14 days if requested by the DGIR. Failure to do so may result in penalties under section 113B of the Income Tax Act.

Documentation may be prepared in either Bahasa Malaysia or English. Supporting documents prepared in other languages must be translated upon request.

Taxpayers must retain records for a minimum of seven years, including:

• Books of account
• Invoices and vouchers
• Receipts
• Transfer pricing documentation
• Supporting analyses and records relevant to controlled transactions

Failure to maintain adequate records may constitute a criminal offence and can result in fines or imprisonment.

The guidelines also remind taxpayers of other tax provisions that may apply.

While most intra-group loans are governed by section 140A, loans made by a company to its directors are governed by section 140B, which contains specific rules for determining deemed interest income.

Interest deductions remain subject to general deductibility provisions under section 33 and interest restriction rules under section 140C, regardless of whether the interest rate itself is arm’s length.

The guidelines further clarify that lenders may be deemed to receive interest income when it becomes due, even where payment has not yet been received from the borrower.