Tax issues – Stop using transfer pricing to protect domestic profits

THERE There is a general perception that transfer pricing is largely reserved for multinationals trading across borders; it is therefore a question of international taxation which does not affect domestic companies carrying out purely domestic transactions.

National groups do not pay much attention to transfer pricing, assuming that the group as a whole pays taxes. Therefore, transfer pricing between related parties domestically should not pose a problem.

The above assumptions are incorrect. Transfer pricing covers domestic transactions.

With the introduction of a surcharge of up to 5% on any adjustment made to transfer pricing, it would be foolish for domestic companies to ignore transfer pricing, as the introduction of the surcharge is an exception in the income tax law where penalties are only imposed on any additional taxes. When it comes to transfer pricing, there is no need for additional taxes for the surcharge to come into effect. The difference here is that the surcharge will be imposed on the gross adjustment, not the additional taxes.

The Inland Revenue Board’s (IRB) ultimate requirement for transfer pricing is to meet the arm’s length test. The arm’s length test requires the taxpayer undertaking the transfer pricing transaction to demonstrate that the transaction is comparable to a transaction undertaken between two or more independent third parties in similar circumstances.

Domestic companies treat the area of ​​transfer pricing and the preparation of transfer pricing documentation very lightly. In many cases, transactions do not meet the arm’s length test and the transfer pricing literature remains silent on this point. Silence is not golden here, but it will be costly if not addressed properly.

Where is the abuse?

There are many opportunities to shift profits to tax shelters in Malaysia, such as groups whose companies/operations benefit from tax incentives such as Pioneer Status, Investment Tax Allowance, Digital Incentive in Malaysia, the Bionexus status incentive, incentives for special regions, halal incentives, etc. Similarly, tax shelters can also be found where there are companies/operations in the group with tax losses, excess unused capital allowances, unused investment tax allowances, different tax rates such as tax on oil revenues at 38% compared to corporate tax. at 24% compared to tax rates for SMEs of 15%, 17% and 24%.

Groups tend to use transfer pricing to shift their profits to these tax shelters without meeting the arm’s length test.

How to defend IRB challenges?

There is nothing wrong with shifting part of the profits within the group to companies/operations benefiting from tax shelters, provided that the taxpayer is able to demonstrate that the profits are equivalent to the value created by the companies/operations benefiting from tax incentives. This must be clearly proven by necessary supporting documents such as agreements, underlying documents such as invoices, purchase orders, comparison with similar transactions undertaken by third parties under the same conditions.

In order to support value creation in tax shelters, there must be substance in the form of people, activities and assets, and there must be a clear demarcation of risks and functions undertaken by the parties concerned. The heavy burden of proof falls on the taxpayer. Comparable data and information from the market must be used to defend the independent nature of transactions.

The preparation of transfer pricing documentation in anticipation of any transfer pricing audit by authorities must be taken seriously and must meet the overall requirements of the transfer pricing rules and guidelines.

It is not easy to convince the IRB that the transactions meet the arm’s length test when taxpayers use tax shelters, because the IRB will present counterarguments that excessive profits were attributed to the entity or operations benefiting from tax incentives.

Ultimately, the cost of mispricing, even if a group is already in an overall tax-paying situation, will not save it from the surcharge in the event of a transfer pricing adjustment.

This article is written by SM Thanneermalai, Managing Director of Thannees Tax Consulting Services Sdn Bhd (www.thannees.com).