On 01 November 2018, the Inland Revenue Board of Malaysia (“IRBM”) had a dialogue session with the Chartered Tax Institute of Malaysia (“CTIM”)’s Technical Committee on the updated version (mainly from Chapters II to XI) of the Malaysian Transfer Pricing Guidelines (“TP Guidelines”). The dialogue session was held to provide clarity on the updates and other issues encountered by taxpayers in preparing their transfer pricing documentation whilst referring to the requirements of the TP Guidelines.
The TP Guidelines explain the provision of Section 140A in the Income Tax Act 1967 and the Transfer Pricing Rules 2012 (“TP Rules”). It governs the standard and rules based on the arm's length principle to be applied on transactions between associated persons.
Currently, the TP Guidelines is being updated to reinforce the existing standard and reformatted on its presentation in the IRBM’s website. The TP Guidelines is updated gradually based on Chapters. The new or updated chapter is indicated and can be found under 'Updated version of Transfer Pricing 2012' while the remaining chapters can be referred in the TP Guidelines 2012. Some of the key issues discussed during the dialogue session are provided below:
1. To what extent is the supply chain information of a Multi-National Enterprise (“MNE”) Group is deemed adequate for the purpose of preparing a comprehensive local file?
The CTIM’s Technical Committee raised concerns over the fact that local taxpayers do not have full transparency of the entire supply chain of an MNE Group given that the Malaysian entity may be small and less significant within the entire supply chain. As such, local taxpayers may face difficulties in identifying the commercial and financial relations in transactions between the members of the MNE Group.
The IRBM officers are in the view that it is the responsibility of the local taxpayer to provide information with regards to the supply chain of the MNE Group in its local file and further adds that the MNE Group should make such information available to the local taxpayers regardless of the size and role of the local taxpayer. The IRBM officers further communicated that the supply chain structure based on Function, Asses and Risk (“FAR”) is also acceptable as the attribution of income among entities in the MNE Group ideally should reflect their respective FAR and which significantly overlaps with the supply chain structure of the MNE Group.
In line with the global implementation of Base Erosion and Profit Shifting (“BEPS”) Action 8 to 10, MNE Groups should be aware of the importance of the process of identifying the commercial and financial relations between associated persons. Thus, documentation such as supply chain information is crucial in ascertaining the contribution and position of local taxpayer within the global MNE Group.
2. What is the IRBM’s position when it comes to accepting foreign comparable companies for benchmarking purposes and how are the information of the foreign comparable companies regarded to be sufficient and verifiable?
As the local benchmarking analysis is time consuming and significant costs are incurred by taxpayers, the CTIM’s Technical Committee seeks clarification on circumstances where foreign related parties can be considered as tested parties given that sufficient and verifiable information are available.
Generally, IRBM applies by the principles prescribed by the Organisation for Economic Co-operation and Development (“OECD”) Transfer Pricing Guidelines whereby the tested party is selected based on the least complicated entity and where the transfer pricing method can be most reliably applied should be adopted. The local comparables subsidiaries of foreign MNE are predominantly contract manufacturers or routine distributors, hence in most cases the tested parties selected are the local entities.
The IRBM may accept the use of foreign comparables in circumstances where local comparables cannot be found. Foreign comparables can be accepted if the audited financial statements of the foreign tested party can be provided and other documentation or analysis to support the use of foreign tested party or comparables is available and verifiable.
If a foreign tested party is used, it must be of simpler functions compared to the local entity and verifiable documents provided to IRBM to include:
Foreign comparables can be similarly considered if annual reports, financial statements and background information of the comparables can be provided for verification by the IRBM.
3. How often should the contemporaneous transfer pricing documentation be updated?
The CTIM’s Technical Committee’s stance on this is that since the contemporaneous transfer pricing documentation has already been prepared, there is no necessity to update it at the year end.
According to IRBM, taxpayers should update the transfer pricing documentation accordingly (i.e. at the year end) where there are material changes. As for the comparables information for benchmarking analysis, they should be updated if the data is available at the end of the relevant year of assessment.
4. How will the IRBM request taxpayers to submit their transfer pricing documentation?
The request letter sent by IRBM to taxpayers is often received by taxpayers two (2) weeks from the date of the letter. If the IRBM gives a period of thirty (30) days for taxpayers to submit the transfer pricing documentation, the Technical Committee of CTIM believes that it should be from the date of receipt instead of date of the letter. In such cases where the date of receipt is two (2) weeks after the date of the letter, the IRBM shouldn’t regard the additional two (2) weeks given for response as an extension and to consider it as part of the thirty (30) days.
The IRBM officers clarified that the respective officers will give a call and confirm with taxpayers or their tax agents to inform them about the request of the transfer pricing documentation. The call will be followed by official email and a formal request letter (softcopy) will be attached. Meanwhile, the formal letter (hardcopy) will be posted to the taxpayers.
5. Can the information for the organisational and ownership structure be limited to certain related persons for the purpose of preparing the local documentation?
The CTIM’s Technical Committee is in the view that the information required for the organisational and ownership structure listed in Appendix A of the TP Guidelines should be limited to the relevant related persons transacting with the taxpayers as covering all other other associated persons may not be as relevant due to differences in geographical locations and business activities.
The response provided by the IRBM is that the global organisational chart or structure is important to ascertain how the MNE Group operates globally and how it will affect the local taxpayer. Certain related persons might carry out on other business activities which are not connected to local taxpayer but as a Group, the business activities will be reflected in the financial position of the Group.
The IRBM, however, has agreed to give the flexibility to taxpayer on providing the structure of the global organisational chart in the form of a list or chart. The IRBM accepts the submission of list of subsidiaries (with an adequate reason) for instances where the taxpayers are unable to furnish the comprehensive organisational and ownership structure.
6. Will the IRBM give due consideration for the assumption, strategies and information regarding factors that influence the setting of taxpayer’s pricing policies during the conduct of an audit?
The assumption, strategies and information are in relation to the following:
(i) business strategies and special circumstances at issue, for example, intentional set-off transactions, market share strategies, distribution channel selection and management strategies that influenced the determination of transfer prices;
(ii) assumptions and information regarding factors that influenced the setting of prices or the establishment of any pricing policies for the taxpayer and the related party group as a whole; and
(iii) documentation to support material factors that could affect prices or profits in arm’s length dealings.
The IRBM (especially the auditors) generally rely on information on how taxpayers set their transfer price whereby such information such as (1) details of controlled purchase transactions embedded with other related party cost and (2) market penetration strategy that might affect taxpayers’ sales prices to third party customers are often not disclosed in the transfer pricing documentation.
The IRBM urge that the transfer pricing documentation should outline the supply chain and indicate the assumptions to support the basis of the price setting. Taxpayers who make those price setting assumptions have to review their assumptions based on the market conditions.
7. Will the IRBM allow for weighted average data for comparable companies to be used as comparable data may not be available to carry out a year on year analysis?
Based on CTIM’s Technical Committee’s observation, it is not practical to have a year on year requirement when the data is not available at the time the documentation is prepared (on a contemporaneous basis).
When selecting comparables companies and compilation of its financial data, the IRBM clarified that the previous year or average year data of comparables can be used for the purpose of contemporaneous documentation. However, comparison will be made on year on year basis when an audit takes place.
The latest available comparable data is acceptable and date of comparable search must be stated in the transfer pricing documentation. Adjustments will be made on comparables based on year to year comparison of financial information i.e. data available at the time of the transfer pricing audit. No penalty will be imposed if the transfer pricing documentation is prepared according to the TP Guidelines. Additional tax payable may be imposed if there is an adjustment..
8. How is the arm’s length determined?
The CTIM’s Technical Committee is in the opinion that the TP Guidelines refers to arm’s length range but it is not very clear whether the inter-quartile range (“IQR”) will satisfy the requirement. In practice, the IRBM uses the median as a point of comparison, however, the TP Guidelines does not make reference to median.
In all transfer pricing audit cases conducted by the IRBM, adjustments to the median of the IQR are always applied when applying the transactional net margin method on the basis that the median is the sole arm’s length reference point in the IQR. This is not withstanding that the results of the taxpayer may be within the range for that year. While the median is used as the sole arm’s length reference point, no downward adjustments are given when the results are above the median of the IQR in any given year.
As such, the Technical Committee of CTIM suggests that no adjustment should be made in instances where the results of the taxpayer are within the IQR (computed using the comparable companies accepted by the IRBM). If for any given year, the results are below the IQR, then an adjustment to the median can be proposed. This should be formalised in the Malaysian TP Rules and/or TP Guidelines to provide certainty to taxpayers.
9. To what extent would the IRBM expect the conditions for comparability to be analysed and whether any analyses on comparability must be based on objective and publicly available information?
The CTIM’s Technical Committee highlights that publicly available information is very limited, and that the quality of such publicly available information is usually not good enough to perform an in-depth comparability analysis. Given the limitations, a more flexible approach should be allowed when determining comparability.
The IRBM has confirmed that comparability analyses are not based on information or data which are privy to the IRBM and no secret comparables are used.
10. To what extent does the IRBM expect information on other party of the controlled transactions and other entities within the MNE Group (based on the updated chapter of the TP Guidelines) to be incorporated into the transfer pricing documentation?
The CTIM’s Technical Committee’s point of view on this matter is that such information is often not available locally and time consuming to obtain. Besides, the information should be available where the MNE Group has prepared the Master File.
IRBM expects taxpayers to provide a broad based understanding of the industry sector and identification of how each entity operates within the group. Such information should be incorporated in the transfer pricing documentation.
Failure to comply with the requirement will result in the transfer pricing documentation provided being considered as incomplete and one-sided adjustments being made subject to penalty.
Contact Transfer Pricing Solutions. We can assist with the preparation of transfer pricing documentation locally and regionally, Master File and Local File to comply with the OECD and also local legislation.
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Contributed by our Consultant Kaval Aulakh
Kaval works as a consultant for Transfer Pricing Solutions Australia, Transfer Pricing Solutions Asia and Transfer Pricing Solutions Malaysia. Kaval has more than five years of experience in various areas of transfer pricing assignments such as transfer pricing documentation, comparability studies, shared costs allocation and Mutual Agreement Procedure (MAP).
In her spare time, Kaval enjoys socialising, reading and playing badminton.
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