What is comparability analysis for transfer pricing in Malaysia?

This refers to the similarity in product characteristics between controlled and uncontrolled transaction:

This refers to the functional similarity between controlled and uncontrolled transaction in relation to the:

     a. Functions Performed

• Functions are activities performed by each person in a business transaction such as distribution, procurement, sales and marketing. It is important to identify economically significant functions as it should be compensated for the functions performed e.g higher expected returns.

    b. Assets Employed

• Tangible assets such as property, plant and equipment are usually expected to earn long-term returns that commensurate with the business risks assumed.
• Intangible assets are also expected to generate returns for the owners by way of sales or licensing. Therefore, it is important to identify the parties to whom the returns generated are attributable.

     c. Risks Assumed

• Evaluation of risks is important in determining the arm’s length price with the economic assumption that higher risks generate higher expected return. The type of risks includes operational risk, market risk, product risk, business risk, financial risks and credit risk.
•  The allocation of risks should be based on the functions performed and must be consistent with the economic substance of the transaction.

The analysis of contractual terms between controlled and uncontrolled transaction is important as it sets out the nature of assignment, responsibilities, risks, and returns shared between parties in a transaction.      

 Different markets affect the arm’s length price even for transactions of the same property and services. Factors that may affect the pricing of a transaction include:

• Geographic location
• Market size
• Extent of competition in the markets
• Consumer purchasing power
• Government policy and regulations

• Business strategies such as innovation and new product development, degree of diversification, market penetration schemes, distribution channel selection, market level and location may influence the price charged for a product.
• Therefore, it is important to evaluate whether independent entities in the same circumstances would have adopted similar strategies and if so, what rewards would have been expected.

The IRBM generally prefers local comparables i.e Malaysian companies for benchmarking purposes. However, the IRBM may accept the use of foreign comparables in circumstances where local comparables cannot be found.
 
Foreign comparables can be considered if annual reports, financial statements, and background information of the comparables can be provided for verification by the IRBM.
 
It is also important for Malaysian taxpayers to exercise care in verifying the comparables with similar restrictions or conditions in order to provide a reliable and relevant comparability analysis.
 
The use of loss-making comparables should be permissible if they meet the comparability criteria. 

In general, the Transactional Net Margin Method (“TNMM”) is the most preferred transfer pricing method in Malaysia due to the non-availability of sufficient and reliable comparable data. The current Covid-19 pandemic has raised certain challenges in the application of TNMM to justify the arm’s length principle.
 
One of the challenges faced by the Malaysian taxpayers when performing a benchmarking study is the historical data for the current year may not be readily available by the time of preparation of Transfer Pricing Documentation.
 
The transfer pricing documentation should be ready when the company files its tax return for the year of assessment i.e. usually seven months after the financial year end. In addition, the historical data may not reflect the current economic conditions and therefore would not provide a reliable basis to establish the arm’s length principle.
 
For TNMM, Malaysian taxpayers can consider documenting the following key information in the TP Documentation for comparability analysis purposes:

1.  To perform an analysis on the budgeted vs actual sales
2. To justify on the exceptional expenses such as bad debts written offs, increase of marketing expenses, retrenchment fees
3. Impact of government assistance (if any)