Transfer Pricing 2022 Comparisons

The Malaysian transfer pricing policies are modelled after the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations issued in 2010 (the “OECD Guidelines”) by the Organisation for Economic Co-operation and Development (OECD), with some variations to ensure compliance with local laws.

For entities governed by the Income Tax Act 1967 (ITA), the arm’s-length doctrine in transfer pricing is mandated under Section 140A of the ITA. Similar provisions are also found at Section 72A(3) of the Petroleum (Income Tax) Act 1967 and Section 17D of the Labuan Business Activity Tax Act 1990 (LBATA) for entities falling within the purview of the respective acts.

Taxpayers would also need to comply with other subordinate rules, such as the Income Tax (Transfer Pricing) Rules 2012 (the “Rules”), which supplement the ITA. The Rules prescribe:

• the preparation of contemporaneous transfer pricing documentation;
• methods to determine arm’s-length price;
• conditions on comparability of transactions;
• rules on separate and combined transactions; and
• rules applicable to intra-group services and cost contribution arrangements.

Taxpayers are also guided by various guidelines issued by the Malaysian Inland Revenue Board (MIRB) detailing the MIRB’s approach to transfer pricing regulations and compliance with the requirements of Section 140A of the ITA and other transfer pricing obligations. However, these guidelines do not bear the force of law.

The advance pricing agreement (APA) regime is regulated under Section 138C of the ITA. An application for an APA is a determination by the Director General of Inland Revenue (DGIR) or the competent authority (CA) with the taxpayer of the transfer pricing methodology to ensure the arm’s-length transfer prices in relation to a transaction.

As part of Malaysia’s efforts for effective implementation of the transfer pricing documentation standards, the Income Tax (Country-by-Country Reporting) Rules 2016 (the “CbCR Rules”) introduced the country-by-country reporting requirements (CbCR). Multinational enterprises meeting a list of criteria would need to prepare and file a country-by-country report in Malaysia.

The Labuan Business Activity Tax (Country-by-Country Reporting) Regulations 2017 (the “Labuan CbCR Regulations”) are largely similar to the CbCR Rules except that they apply where the ultimate holding entity or any of the constituent entities is a Labuan entity carrying on a Labuan business activity.

Failure to furnish a CbCR return is an offence and punishable with a fine or imprisonment or both under Section 112A of the ITA or Regulation 9 of the Labuan CbCR Regulations.

Following the publication of the first draft of the OECD Guidelines, Malaysia jumped on the bandwagon with the release of the Transfer Pricing Guidelines in 2003. These guidelines were replaced by the Transfer Pricing Guidelines 2012 (the “Guidelines”) and last updated in July 2017. The Guidelines do not have the force of law and only touch the surface. The Guidelines do not explain the national transfer pricing regime in detail other than stating that a transfer price is acceptable if all transactions between associated parties are conducted at arm’s length and that the transfer price should not differ from the prevailing market price reflected in a transaction between independent persons.

The governing standard for transfer pricing is the arm's-length principle as set out in the OECD Guidelines, recently updated on 20 January 2022.

Before 1 January 2009, there was no specific statutory provision in the ITA governing transfer pricing matters. Consequently, the MIRB regularly invoked Section 140 of the ITA, a general anti-avoidance provision, to undertake transfer pricing adjustments on transactions deemed not to be at arm’s length. Unfortunately, this abuse of power by the MIRB was not challenged until the Maersk Malaysia case.

In 2009, formal legislation was enacted via the insertion of Section 140A, which, inter alia, provided the DGIR with the power to substitute prices and disallow interest deductions on certain transactions if the DGIR is of the view that the transactions were not conducted at arm’s length. In 2012, the Rules were introduced, which detailed specific obligations for taxpayers to comply with the arm’s-length principle. The Rules had retrospective application from 1 January 2009.

In 2013, the MIRB released a Transfer Pricing Audit Framework outlining the MIRB’s approach and requirements in the event of a transfer pricing audit. This Transfer Pricing Audit Framework 2013 was replaced by the Transfer Pricing Audit Framework 2019.

Malaysia adopted and implemented BEPS Action 13 for transfer pricing documentation from 1 January 2017 onwards. Malaysia also enacted mandatory rules on CbCR around this time.

Recently, the Malaysian Parliament amended various relevant pieces of legislation to ensure further adherence with transfer pricing regulations. The amendments accorded the MIRB with wider powers under the legislation.

Under the ITA, persons entering into transactions with associated persons for the acquisition or supply of property or services must determine and apply the arm’s-length price for the acquisition or supply. Where a company has direct or indirect control over another company’s affairs, they are presumed to be related and transfer pricing rules would apply.

Section 139 of the ITA presumes control where a person:

(a) exercises or is able to exercise, or is entitled to acquire, direct or indirect control over the company’s affairs;

(b) possesses or is entitled to acquire the greater part of the share capital or voting power in the company; or

(c) is entitled to the greater part of the assets available for distribution among members in the event of a winding-up.

Similarly, Section 2(4) of the ITA defines companies belonging to the same group of companies where:

(a) two or more companies are related within the meaning of Section 6 of the Companies Act 1965;

(b) a company is so related to another company that is itself so related to a third company;

(c) the same persons hold more than 50% of the shares in each of two or more companies; or

(d) each of two or more companies is so related to at least one of two or more companies to which paragraph (c) applies.

Malaysia applies transfer pricing methodologies following the OECD Guidelines. The Rules categorise the transfer pricing approaches into two broad categories: the traditional transactional method and transactional profit method.

There are three methodologies under the traditional transactional method:

• the comparable uncontrolled price method;
• the resale price method; and
• the cost plus method.

Separately, the two methodologies under the transactional profit method are:

• the profit split method; and
• the transactional net margin method.

Although the adoption of an unspecified method is not specifically allowed, there is no strict prohibition of the same. Rule 5 of the Rules provides that where the approaches under the Rules do not apply or are unsuitable for a particular arrangement/transaction, the DGIR has discretion to allow the application of another transfer pricing methodology that provides the highest comparability between the transactions by the taxpayer.

Paragraph 3.2 of the Guidelines states that taxpayers who do not fall within the purview of the Guidelines may apply any method other than the five methods described that results in, or best approximates, arm’s-length outcomes.

Malaysia adopts a hierarchical approach in carrying out transfer pricing analysis. Rule 5 of the Rules establishes that the taxpayer must first use the traditional transactional method to ascertain the arm’s-length price of a controlled transaction; ie, the comparable uncontrolled price method, resale price method, or the cost plus method.

If the aforementioned approaches are unsuitable, the taxpayer may then use the transactional profit method; ie, the profit split method or the transactional net margin method.

Where the aforementioned five methodologies are unsuitable, the taxpayer may utilise any other methods that provide the highest degree of comparability between the transactions.

The MIRB gives priority to the availability of sufficient and verifiable information on both tested parties and comparables in carrying out transfer pricing analysis. Thus, the MIRB is reluctant to accept foreign tested parties where information is neither sufficient nor verifiable. However, there is no statutory prohibition of the same.

The Guidelines state that an arm’s-length range is a range of figures that are accepted to establish the arm’s-length nature of a controlled transaction. The median of the range is often the starting point to evaluate arm’s-length pricing.

Additionally, the MIRB uses statistical multiple-year data to identify comparability and any abnormal factors influencing the outcome of a particular year. Data from the years before and after the year under examination will commonly be examined to give a clearer indication of where a taxpayer’s reported loss was contributed to.

However, the lack of appreciation of the OECD transfer pricing policies and the universal rule that transfer pricing is not an exact science by the MIRB causes difficulty for law-abiding taxpayers. In most circumstances, the MIRB ignores loss-making comparables and chooses profit-making comparables for its benchmarking analysis. Furthermore, there has been a persistent reluctance by the MIRB to adopt the weighted average method in examining benchmarking analysis. This produces skewed results, which are inaccurate representations of the economic reality.

Comparability adjustments are not mandatory and are allowed where they enhance the accuracy and reliability of comparisons. However, the MIRB takes the view that comparability adjustments are only allowed on a case-by-case basis. The differences between the transaction of the comparables and the tested party must be identified and adjusted for in order for the comparables to be useful as a basis for determining the arm's-length price.

Rule 11 of the Rules requires that the sale or license of an intangible property must be at arm’s-length price and the value shall be the benefit that the intangible property is expected to generate. Intangible property includes patent, invention, formula, process, design, model, plan, trade secret, know-how or marketing intangible.

Rule 11(6) states that a person will be deemed an owner of intangible property and is entitled to any income attributable from it if the expenses and risks with the development of the intangible property are borne by that same person.

Under the Guidelines, where the legal ownership of an intangible property does not vest with the developer, the developer of the intangible property would be expected to receive an arm’s-length consideration for its development services. The reimbursement to the contract developer must contain a profit element.

Similarly, where a distributor undertakes marketing activities and bears the costs and risks that exceed an independent distributor but is not the owner of a trade mark or trade name, the MIRB expects that the distributor is entitled to obtain a share of the intangible-related returns from the owner of the trade mark or related intangibles.

In determining the arm’s-length price for controlled transactions involving intangibles, the profit split method or ex ante valuation techniques is/are preferred if it is difficult to find comparable uncontrolled transactions.

There are no rules regarding hard-to-value intangibles. The Guidelines indicate that when it is difficult to find comparable transactions involving intangibles such as hard-to-value intangibles, it may be necessary to utilise transfer pricing methods not directly based on comparables, such as the profit split method and ex ante valuation techniques, to appropriately reward the performance of those important functions.

Malaysia recognises cost sharing/cost contribution agreements (CCAs). Under Rule 10 of the Rules, when a taxpayer enters into a CCA with associated persons, the arrangement should reflect that of an arm’s-length transaction.

However, a recent trend by the MIRB is the arbitrary treatment of CCAs as intra-group services. Rule 9 of the Rules, which applies to intra-group services, is more restrictive in nature than a CCA; for example:

• an intra-group services charge comprising of shareholder activities, duplicative services, services that provide incidental benefits and passive association benefits will be disregarded; and
• the taxpayer is required to justify that intra-group services have been rendered and the taxpayer has received and benefitted from the services.

Taxpayers are advised to proceed with caution and ensure that the CCA is crafted properly to defend any recharacterisation of the agreement by the MIRB.

The Guidelines recognise two types of CCA: an arrangement for the joint development of intangible property and a service agreement. However, if a service arrangement does not result in any property being produced, developed or acquired, the principles applicable to intra-group services will apply to that arrangement, whether it is described as a CCA or otherwise.

To determine whether a CCA complies with the arm’s-length principle, the MIRB may take the following matters into consideration.

• The CCA should be entered into with a prudent and practical business judgment, with a reasonable expectation of its benefits. This estimation of expected benefit is to be based upon the anticipated additional income that will be generated or the expected cost savings or an appropriate allocation key.
• The terms of the arrangement should be agreed beforehand and be in accordance with the economic substance that is judged by reference to the circumstances known or reasonably foreseen at the time of entry into the arrangement.

When a participant wishes to withdraw from the CCA, the MIRB expects the exiting participant to be compensated upon an arm’s-length value of their transferred interest. This buy-in payment is determined by the price an independent party would have paid for the rights obtained by the new participant, taking into account the expected benefit from the CCA in accordance with the shares.

The ITA does not expressly allow a taxpayer to make affirmative transfer pricing adjustments after filing their tax returns. Taxpayers wishing to make a transfer pricing amendment must rely on the general application of Section 77B of the ITA relating to the amendment of an income tax return.

This is subject to a few conditions, including that the amendment must be made no later than six months from the due date of furnishing the return and there may be additional penalties imposed.

Alternatively, the taxpayer may make an application for relief within five years after the end of the year of assessment for an error or mistake made on the tax returns filed under Section 131 of the ITA. The burden of proof is on the taxpayer to prove an error or mistake and the DGIR has discretion to determine if the error or mistake is just and reasonable. If the taxpayer is dissatisfied with the decision of the DGIR, the taxpayer may file an appeal to the Special Commissioners of Income Tax (SCIT) for further determination.

Malaysia is a participating country of the automatic exchange of information (AEOI) system initiated by the OECD and has publicly declared its commitment to the Common Reporting Standard (CRS).

Tax information exchange agreements with treaty countries and non-treaty countries are provided for under Section 132 and Section 132A of the ITA respectively. Section 132B of the ITA serves to facilitate mutual administrative assistance in tax matters with government authorities outside Malaysia involving simultaneous tax examinations, AEOI or tax administrations abroad.

Under the CRS, Malaysian financial institutions are required to identify customers who appear to be tax resident outside of the jurisdiction where they hold their accounts and products, and report relevant information to the MIRB, which may share this information with the participating foreign tax authorities of where the customers are tax residents.

Malaysia would also receive financial account information on Malaysian residents from other countries' tax authorities. This will help ensure that residents with financial accounts in other countries are complying with their domestic tax laws and acts as a deterrent to tax evasion.

Section 138C of the ITA allows taxpayers to apply to the MIRB for an APA from 1 January 2009 onwards. This is an arrangement between a taxpayer and the DGIR or between competent authorities to predetermine the price of goods and services that are to be transacted in the future between the taxpayer and its related companies outside of Malaysia over a specified period to ensure compliance with the arm’s-length principle. The DGIR is tasked to ensure that the transfer pricing methodologies adopted by the foreign affiliates are fair and reasonable to the resident taxpayer in Malaysia.

Under the Malaysian APA programme, there are three types of APA available: bilateral, multilateral and unilateral. The scope of the APA may cover:

• the taxpayer and the foreign related parties;
• cross-border transactions;
• the agreed transfer pricing methodology to be employed;
• the duration of the APA;
• critical assumptions; and
• other agreed terms and conditions.

A bilateral APA concerns transactions between a resident company with its related companies abroad and the tax authority of the foreign country. A multilateral APA is where there is more than one related company and the tax authority of the foreign country. A unilateral APA only deals with a resident company and its transactions with its related companies abroad.

Section 138C states that the DGIR and the CA (on double taxation arrangements) are capable of entering into the APA with the taxpayer or counterparty CA, respectively, to determine the transfer pricing methodology to be used in a related-party cross-border transaction. A related-party transaction for the purposes of an APA is where:

• one has control over the other;
• they are relatives of each other; or
• both are controlled by some other person.

Additionally, the mutual agreement procedure (MAP) article in Malaysia’s tax treaties allows the Malaysian CA to interact with the CAs of a treaty partner to resolve international tax disputes involving double taxation and inconsistencies in the interpretation and application of a tax treaty. The Malaysian CA can assist in resolving issues such as residence status, withholding tax, permanent establishment and characterisation of income.

The MIRB administers the APA programme. An application for an APA should be made to the MIRB and the Malaysian CA would be involved in bilateral and multilateral APAs. The authorised CAs include:

• the Head of Tax Analysis Division, Ministry of Finance;
• the DGIR;
• the Deputy DGIR of Compliance;
• the Deputy DGIR of Police; and
• the Director of the Department of International Taxation, MIRB.

Separately, the Malaysian CA directly administers MAP matters other than bilateral and multilateral APAs.

Where the issue concerns a bilateral or multilateral APA, the procedure as set out in the Advance Pricing Arrangement Guidelines 2012 (the “APA Guidelines”) would apply. For all other matters under a MAP, the procedure under the MAPs would be applicable. These guidelines are directive and do not have the force of law.

The process applicable for a bilateral and multilateral APA is set out in the APA Guidelines, which provide as follows:

• a request for a pre-filing meeting must be made at least 12 months prior to the first day of the covered period;
• the taxpayer will be notified of the outcome of the pre-filing meeting within 30 days for a bilateral and multilateral APA;
• where it is decided that there are merits, the taxpayer may submit a formal application for an APA;
• the Malaysian CA will negotiate with the CA of the treaty partners;
• when the APA is finalised, the APA is then signed by the relevant parties; and
• the taxpayer would need to submit an annual compliance report within seven months from the close of the accounting period throughout the covered period.

For a case for CA assistance under a MAP, the process is as follows:

• the time limit for presenting a case to invoke a MAP is dependent on the relevant tax treaty; if this is not specified, the time limit will be three years from the notification of the action resulting in taxation following Article 25 (MAP) of the OECD Model Tax Convention on Income and on Capital;
• the taxpayer should make a request for a pre-filing meeting;
• where there are merits considerations for a MAP, the Office of MAP will inform the taxpayer to submit a formal request;
• the Tax Division and Office of MAP will evaluate the request;
• if a MAP is to be initiated, a proposal will be conveyed by the Tax Division to the CA of the treaty partner;
• where an agreement will be reached with the CA of the treaty partner, the Office of MAP will inform the taxpayer and confirm their acceptance; and

• the Malaysian CA will reach an agreement with the CA of the treaty partner after confirmation.

According to the MIRB APA Guidelines, a taxpayer must satisfy several conditions to qualify to make an APA application:

• the taxpayer is a company having chargeable income under the ITA;
• the taxpayer has a turnover value exceeding MYR100 million;
• the value of the proposed covered transaction exceeds 50% of the turnover or purchases from total purchases or the total value exceeds MYR25 million; and
• the transaction relates to income that is chargeable; or
• where the taxpayer receives financial assistance that exceeds MYR50 million.

A permanent establishment/branch in Malaysia may only apply for a bilateral or multilateral APA through an application by its principal to the CA of the treaty partner country where the principal resides.

Additionally, the DGIR may decline an APA application where:

• the taxpayer fails to comply with the requirements under the Rules and the Guidelines;
• the covered transaction is based on a hypothetical situation or is not seriously contemplated;
• the pursuance of the APA appears to be an inefficient use of resources;
• the matter sought by the APA is subject to an appeal before the SCIT; or

• the proposed transaction involves a tax avoidance scheme.

Under Rule 4 of the Income Tax (Advance Pricing Arrangement) Rules 2012 (the “APA Rules”), a taxpayer must first write to the DGIR for a pre-filing meeting for an APA at least 12 months prior to the first day of the proposed covered period.

Thereafter, an application for an APA must be submitted within two months after the receipt of notification from the MIRB pursuant to the pre-filing meeting.

An application fee of MYR5,000 is payable upon application for, or renewal of, an APA.

An APA covers between three and five years of assessment. Renewal of an APA requires the consent of both parties and is subject to the requirements under Rule 20 of the APA Rules.

A request for renewal must be made no later than six months before the existing APA expires. The taxpayer must submit the updated information and supporting documents. The APA may be renewed under similar terms and conditions where:

• there had been no material changes to the facts and circumstances of the APA;
• the critical assumptions identified by the taxpayer remain valid and relevant; and

• the taxpayer complied with the terms and conditions of the previous APA.

Rule 11 of the APA Rules states that when the DGIR and/or the CA enters into any type of APA with the taxpayer or counterpart CA, the transfer price will be binding for the stated duration.

However, taxpayers may apply for a rollback application on years prior to the covered period if the taxpayer can demonstrate that the transfer pricing methodology applied is appropriate and the facts and circumstances are substantially the same as those of the covered period.

The new Section 113B of the ITA penalises taxpayers in the event of defaulting to furnish contemporaneous documentation for transfer pricing. If found guilty, the taxpayer may be sanctioned with a fine and/or imprisonment for a term not exceeding six months.

Section 140A(3C) of the ITA imposes a surcharge on any adjustments made by the DGIR in ascertaining the arm’s-length price of a transaction. This surcharge of not more than 5% on the adjustment may be imposed regardless of whether the adjustment results in additional tax payable, and will be collected and treated as if it was tax payable by the taxpayer.

Additionally, penalties can be imposed under Section 113(2) of the ITA where the taxpayer submits an incorrect income tax return. The understatement of tax payable may result in a maximum penalty of 100% on the tax due but the DGIR has discretion to reduce the penalty.

A taxpayer aggrieved by a decision for the imposition of penalties may appeal to the SCIT or apply for judicial review to the High Court.

In line with the OECD’s recommendation in BEPS Action 13, Malaysia has implemented the CbCR Rules and Labuan CbCR Regulations, which prescribe compliance with CbCR rules in Malaysia.

The rules apply to multinational enterprise (MNE) groups governed by the ITA where:

• the total consolidated group revenue in the financial year preceding the reporting financial year is at least MYR3 billion; and
• any of its constituent entities:
1. is an ultimate holding entity, entity or surrogate holding entity incorporated, registered or established or deemed as such under the Companies Act 2016 or under any written law and resident in Malaysia; or
2. is a permanent establishment in Malaysia.

Similarly, the Labuan CbCR Regulations are applicable to an MNE group that has a total consolidated group revenue in the financial year preceding the first reporting financial year of at least MYR3 billion, and its ultimate holding entity or any of its constituent entities is a Labuan entity carrying on a Labuan business activity.

Taxpayers in Malaysia entering into a controlled transaction must prepare contemporaneous transfer pricing documents, including:

• organisation structure;
• group financial report;
• nature of the business/industry and market conditions;
• details of the controlled transactions (eg, parties involved, nature, terms and pricing);
• pricing policies;
• assumptions, strategies and information regarding factors that influenced the setting of pricing policies;
• comparability, functional and risk analysis;
• selection of the transfer pricing method;
• application of the transfer pricing method;
• a list of APAs entered into by members of the group with respect to transactions to which the taxpayer is a party;
• documents that provide support for the taxpayer’s transfer pricing analysis; and

• other relevant documents/information, such as official publications, studies, market research, technical publications, agreements and correspondence.

Although Malaysia is not a member of the OECD, the domestic law and policy relating to transfer pricing mirrors the OECD Guidelines. Several features that mirror the OECD Guidelines include:

• the arm’s-length principle;
• the preparation of contemporaneous transfer pricing documentation;
• methodology;
• the rules on comparability;
• intra-group services; and
• cost contribution arrangements.

Notably, in Damco Logistic Malaysia Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri (2011) MSTC 30-033, the Malaysian courts held the OECD's commentaries on the Model Tax Convention on Income and on Capital 2014 as persuasive authority when interpreting double taxation agreements.

However, the Guidelines differ from the OECD Guidelines in certain aspects.

Firstly, the MIRB’s approach has a hierarchal preference of transactional methods before the transactional profit method and median value over the interquartile range approach. However, the MIRB has stated that this was primarily due to the fact that the Rules were drafted before issuance of the revised OECD Guidelines. In practice, the best method approach outlined in the revised OECD Guidelines will be followed.

Secondly, the MIRB has a tendency to cherry-pick comparables that are favourable to its transfer pricing approach even where the taxpayer is acting in accordance with the OECD transfer pricing principles. The MIRB displays reluctance in applying comparability adjustments that result in an incorrect determination of arm’s-length price. This approach is not consistent with the principle that a reasonable and robust economic comparability analysis must be carried out to determine the arm's-length nature of the comparables and the transfer prices to be considered as arm’s-length.

The principle of arm’s length in Malaysia closely resembles the OECD Guidelines. Section 140A(2) of the ITA mandates that persons entering into transactions with associated persons for the acquisition or supply of property or services must determine and apply the arm's-length price for the acquisition or supply.

In 2017, Malaysia joined the OECD's Inclusive Framework on BEPS. Malaysia’s participation in the project has led to several notable developments on the domestic transfer pricing landscape in line with the OECD, which could be summarised based on the BEPS Action Plan as follows.

Action 1: Addressing the Tax Challenges of the Digital Economy

This action was released in 2015 to counter risks arising from the digital economy and provides a recommendation for the taxation of digital businesses. This led to the implementation of a digital tax effective from 1 January 2020 at a rate of 6% on digital services provided to consumers in Malaysia.

Action 5: Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance

Malaysia endeavours to ensure that the tax incentives available in Malaysia comply with certain safeguards in accordance with the Forum on Harmful Tax Practices (FHTP). In order to fulfil the FHTP criteria, several legislative changes were gazetted to amend existing tax incentives.

The amendments affect two broad groups of incentives: IP incentives and non-IP incentives. For IP incentives, a nexus approach is adopted where only research and development expenditures incurred in Malaysia are eligible for income tax exemption. For non-IP incentives, there is the introduction of substance requirements by requiring an adequate investment amount or annual business operating expenses to be incurred in Malaysia and an adequate number of full-time employees in Malaysia to be eligible for the incentive.

Action 6: Prevent Treaty Abuse

Malaysia signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (the “MLI Convention”) in January 2018. BEPS Action 6 provides that tax treaties under the MLI must include anti-abuse rules to prevent abuse of treaty benefits. This may be done by implementing one of the following approaches:

• a principal purpose test (PPT);
• a PPT and simplified or detailed limitation on benefits (LOB) provisions; or
• a detailed LOB provision supplemented by an anti-conduit rule.

Malaysia had adopted the PPT approach, under which treaty benefits are to be denied “if it is reasonable to conclude... that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit”. The exception is where it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of this Convention. This led to the ratification of the MLI Convention in local legislation and with amendments to Section 132(1A), Section 132B(1A) and Section 132 of the ITA as well as Section 21(1)(b) of the LBATA.

Action 7: Preventing Artificial Avoidance of Permanent Establishment (PE)

Malaysia chose to apply the proposed wordings in Action 7; ie, PE exemption should only be available if the specific activity listed is of a preparatory or auxiliary character. Through the introductions of subsections 12(3) and 12(4) of the ITA, the existing PE threshold is lowered to provide clarity where a non-double taxation agreement person who carries on business in Malaysia is taxable on their profits.

Action 13: Re-examine Transfer Pricing Documentation

Malaysia introduced the CbCR Rules, which mandate certain MNEs to prepare and file a country-by-country report in Malaysia effective from 1 January 2017. The MIRB published CbCR Reporting Guidelines in January 2019 outlining preparation of the CbCR that are adopted from the Action 13 Final Report.

In October 2021, the OECD updated BEPS 2.0, known as its Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy, namely Pillar One and Pillar Two. BEPS 2.0 is expected to bring a significant deviation from the present tax rules by offering market jurisdictions new taxing rights over MNEs. Pillar One is expected to reallocate more than USD125 billion of profits from around 100 of the world’s largest and most profitable MNEs to market jurisdictions. Pillar Two, on the other hand, introduces a first-of-its-kind global minimum tax (GMT) that would establish multilaterally agreed-upon limits on tax competitiveness across nations.

Pillar One

Under Pillar One, only in-scope MNEs with a global turnover exceeding EUR20 billion and profitability above 10% will be impacted. Furthermore, the turnover threshold is expected to be lowered to EUR10 billion in 2031. At this juncture, it is expected that Malaysia has the potential to increase its tax revenue following the implementation of this proposal.

Pillar One aims to eliminate the possibility of double taxation. For instance, if an in-scope MNE has already been taxed on its residual profits, then the residual profit allocated to the market jurisdiction will be capped through Amount A. In addition, in-scope MNEs can avoid issues related to Amount A such as disputes on business profits and transfer pricing. However, in the absence of a co-ordinated global agreement, it is of no surprise that double taxation issues will arise in countries that have introduced digital services taxes and applied Pillar One elements through their own local domestic legislation. Another eminent issue that may arise is the difficulty in forming a global agreement on the implementation of the proposal.

Pillar One also introduces, under Amount B, a simplified and streamlined approach to the application of the arm’s-length principle, focusing mainly on low-capacity countries.

Nevertheless, due to the high turnover threshold and with Amount B focusing on the needs of low-capacity countries, MNEs in Malaysia are less likely to be impacted by Pillar One, which is targeted to be implemented in 2023.

Pillar Two

On the other hand, Pillar Two should be the focus of Malaysian taxpayers as it introduces a GMT of 15% for MNEs with a global annual revenue above EUR750 million. Therefore, it is possible that a top-up tax will be imposed on a parent entity in respect of the low-taxed income of its subsidiaries when its subsidiaries do not meet the minimum tax of at least 15%.

Malaysian subsidiaries of large MNEs that are currently enjoying the tax benefits of paying concessionary tax rates that are far below 15% are expected to be impacted by Pillar Two. Similarly, Malaysian-based MNEs with overseas subsidiaries that are enjoying low tax rates overseas could be subjected to a top-up tax in Malaysia following the implementation of Pillar Two.

The Malaysian transfer pricing regime recognises limit risk and the provision of intercompany financial assistance. For example, Rule 10 of the Rules allows for the sharing of costs and risks for the acquisition or supply of property or services under a CCA. However, the cardinal principle applicable to these arrangements is the arm’s-length principle.

The Guidelines denote that risk-bearing transactions by virtue of guarantee must comply with the arm’s-length principle. This means that interest-free arrangements are not accepted by the MIRB as the transfer pricing regime in Malaysia requires these arrangements to be charged at market interest rates (or arm’s-length rates).

The Guidelines consider the comparable uncontrolled price method to be the most reliable in determining the arm’s-length interest rate. Appropriate indices such as the Kuala Lumpur Inter Bank Offered Rate (KLIBOR), prime rates offered by banks and/or specific rates quoted by banks for comparable loans can be used as a reference point. The Guidelines, although not having the force of law, are indicative of what the MIRB considers to be arm’s length.

The Guidelines recognise that characterisation of a business, whether it is fully fledged or limited risk, is important to determine the arm’s-length price of a controlled transaction. Many MNEs adopt the limited risk model in Malaysia, particularly in the manufacturing, distribution and service sectors. Companies engaged in these arrangements would generally prepare transfer pricing documentation with the functional analysis by highlighting the functions undertaken and contrast the risks assumed by the company.

Malaysia does not apply the UN Practical Manual on Transfer Pricing.

Malaysia does not have a safe harbour in the transfer pricing regime and policies.

However, the Guidelines prescribe certain thresholds allowing taxpayers to prepare limited transfer pricing documents to ease the compliance burden. The Guidelines need not be strictly adhered to by:

• a person carrying on a business with gross income not exceeding MYR25 million and the total value of the related-party transaction does not exceed MYR15 million; or
• a person providing financial assistance that does not exceed MYR50 million.

The Guidelines acknowledge that it is commercially rational for a multinational group to restructure its business to procure tax savings.

The MIRB would take cost advantage, net savings and location savings into consideration when making transfer pricing adjustments. For example, expected cost savings will be taken into consideration in determining whether a CCA is conducted at arm’s length. Any business arrangement or restructuring must also comply with the governing independent arm’s-length standard.

The transfer pricing regime in Malaysia has stricter regulations applicable to intra-group services compared to a CCA. Rule 9 of the Rules states that:

• an intra-group services charge comprising of shareholder activities, duplicative services, services that provide incidental benefits and passive association benefits will be disregarded; and
• the taxpayer is required to justify that intra-group services have been rendered and the taxpayer has received and benefitted from the services.

Furthermore, interest expenses in a controlled transaction are restricted under Section 140C of the ITA supplemented by the Income Tax (Restriction on Deductibility of Interest) Rules 2019. In summary:

• the restriction applies where a person receives financial assistance in a controlled transaction whereby the total amount of interest expense is more than MYR500,000 in a year of assessment;
• the maximum amount of interest expense allowed is an amount equal to 20% of the tax-EBITDA of the person from a source of business; and

• excess interest expense in a particular year of assessment can be carried forward provided that the shareholder composition remains substantially the same.

In Malaysia, there is no legislation pertaining to the co-ordination of transfer pricing and customs valuation. Co-ordination between the MIRB and the Royal Malaysian Customs Department (RMCD) on the relationship between transfer pricing and customs valuation has been low.

Customs valuation routinely uses the transactional value of the goods imported. In the case of a related-party transaction, Regulation 3(2) of the Malaysian Customs (Rules of Valuation) Regulations 1999 states that the Malaysian importers have the burden of proof to prove that the relationship with the seller did not impact the price paid for the imports. This burden can be discharged if the Malaysian importers can prove that the transaction value of the imports mirrors the transaction value, deductive value or computed value of identical goods or similar goods.

On the other hand, transfer prices are determined through the five methodologies as stated within the Rules to achieve an arm’s-length price.

However, due to different goals between the MIRB and the RMCD, this may lead to different prices on the same product. For a particular import, the MIRB may insist that the price is lower, leading to higher taxable profits, whereas the RMCD takes the view that the value of imports ought to be higher, which results in higher import duties. It remains unclear how the different stances can be reconciled due to lack of integration and co-ordination of valuation methods between the MIRB and the RMCD.

A taxpayer aggrieved by a transfer pricing assessment made by the DGIR may appeal against the DGIR’s decision by filing a notice of appeal to the SCIT pursuant to Section 99 of the ITA. The appeal must be filed within 30 days from the date of issuance of the notice of assessment(s) pursuant to the transfer pricing audit.

Notwithstanding the filing of an appeal before the SCIT, the taxpayer must make full payment of the tax payable under the notice of assessment as required under Section 103(1) of the ITA.

An appeal before the SCIT may take approximately two years to be heard, subject to the complexity of the matter and whether there are extraordinary circumstances warranting deferment. If a taxpayer is dissatisfied with the decision of the SCIT, the taxpayer may appeal the matter to the High Court, with the highest appealable court being the Court of Appeal.

Alternatively, a taxpayer may also file an appeal directly to the High Court via a judicial review application within 90 days of the impugned assessment. The main difference between an appeal before the SCIT and the High Court is that unlike the SCIT, the High Court is empowered to grant a stay. The highest appealable court in a judicial review is the Federal Court.

It is held that a case under judicial review must only be where there are exceptional circumstances in the form of:

• a clear lack of jurisdiction;
• a blatant failure to perform some statutory duty; or
• a serious breach of the principles of natural justice.

Taxpayers taking this route should note that the dispute is restricted to questions of law and not factual dispute.

Since the transfer pricing regime was newly enforced in Malaysia in 2009, there are not many precedents on transfer pricing matters. Thus, Malaysian courts have made reference to cases from other Commonwealth jurisdictions and the OECD Guidelines for guidance and support.

Figures within The Interquartile Range Are Reflective of An Arm’s-Length Transaction

In MM Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri (2013) MSTC 10-046, the taxpayer was the shipping agent for another company and was contracted to manage the customers of the said company with agreed commission payments in return. The MIRB argued that the only true arm’s-length commission rate is 3.25% and thereby disapproved the taxpayer’s rate of 3%, despite being within the interquartile range of 1.02% and 5.12%. The SCIT held that the MIRB erred when deciding that there was only one true arm’s-length rate without any supporting evidence to justify that position.

This is a notable conclusion reached by the SCIT that suggests not only that the MIRB’s long-standing practice of only accepting certain methodology or formulae in identifying arm’s-length transactions is overly rigid but, in practice, the law recognises that “(t)ransfer pricing is not an exact science but it does require the exercise of good commercial judgment on both the tax administration and the taxpayer”.

The DGIR Has No Power to Recharacterise an Agreement under Section 140A

In SPSASB v Director General of Inland Revenue (unreported), the Court of Appeal granted leave to the taxpayer to commence judicial review against the DGIR for raising notices of assessment made pursuant to Section 140A of the ITA.

The taxpayer is part of a contractual arrangement for the sharing of services and resources within a CCA with the related companies in the Shell group. The DGIR invoked Section 140A of the ITA in alleging that the transaction between the taxpayer and the related companies is more akin to the provision of intra-group services than a CCA and imposed a mark-up on costs recovered from the related companies.

The taxpayer contended that if the DGIR wanted to recharactise the nature of the agreement, namely the CCA, the DGIR should have invoked Section 140 of the ITA and specify the subsection relied upon as held by precedents in Malaysia. Furthermore, Section 140A of the ITA does not give power to the DGIR to recharacterise the CCA but merely to substitute the price to reflect the arm’s-length price.

Upon hearing the parties’ submission, the Court of Appeal granted the taxpayer leave to commence judicial review and the matter was remitted to the High Court for a determination on the substance of the judicial review application.

The Burden of Proof Is on The DGIR to Prove that a Transaction Was Not at Arm’s Length

In OMSB v Director General of Inland Revenue (unreported), the DGIR alleged that certain transactions entered into by the taxpayer were not at arm’s length and insisted that the comparable uncontrolled price method ought to be given priority over the transactional net margin method.

The SCIT found in favour of the taxpayer. Section 140(6) of the ITA places the burden of proof on the DGIR to prove that the transaction was not conducted at arm’s length. The SCIT was not satisfied that the DGIR had successfully discharged its burden of proof.

Furthermore, the DGIR failed to provide sufficient explanation as to why the comparable uncontrolled price method ought to be given priority over the transactional net margin method. This landmark case establishes the fact that the burden of proof is on the DGIR to satisfy the court that the transaction was not at arm’s-length.

Pass-Through Cost Should Not Receive a Mark-Up

Recently, in CC(M) Ltd v Director General of Inland Revenue (unreported), the DGIR alleged that the taxpayer’s direct marketing expenses (DME) incurred were not in accordance with the arm’s-length principle pursuant to Section 140A of the ITA and should receive a mark-up.

The taxpayer facilitates only the provision of marketing services and products by external third-party service providers in Malaysia and all the expenses incurred in relation to the DME are fully reimbursed by the principal company.

The SCIT held in favour of the taxpayer and agreed that the DME are in accordance with paragraph 7.34 of the OECD Guidelines and Rule 20.7.3 of the Rules. Thus, no mark-up should be imposed on the DME.

This is the first time a court in Malaysia has decided on a pass-through cost issue.

There is currently no restriction on outbound payments in uncontrolled transactions other than capital limits imposed by the Central Bank of Malaysia.

In addition to the trite principle that payments must be reflective of the arm’s-length price, there are restrictions imposed on the deductibility of interest expenses incurred by an individual in the course of business where the interest is payable to an associated person outside of Malaysia.

Under Section 140C of the ITA, interest expenses in a controlled transaction are restricted where the interest expenses pertain to financial assistance granted directly or indirectly to the taxpayer and exceed the maximum amount of interest allowed by the rules under the ITA. The salient points under the Income Tax (Restriction on Deductibility of Interest) Rules 2019 pertaining to deductibility of interest payments are as follows:

• it applies to any person who has received financial assistance in a controlled transaction whereby the total amount of interest expense exceeds MYR500,000 in a year of assessment;
• the maximum amount of interest expense allowed is an amount equal to 20% of the tax-EBITDA of the person from a source of business; and
• excess interest expense in a particular year of assessment can be carried forward provided that the shareholder composition remains substantially the same.

Although it is not explicitly stated in the Income Tax (Restriction on Deductibility of Interest) Rules 2019, the Restriction on Deductibility of Interest Guidelines narrowed the scope of the application of the above rule to apply only to interest expenses that are payable to:

• an associated person outside of Malaysia;
• an associated person outside of Malaysia but operating through a permanent establishment in Malaysia; and
• a third party outside of Malaysia where the financial assistance is guaranteed by its holding company or any other enterprises under the same MNE group.

However, unlike the Income Tax (Restriction on Deductibility of Interest) Rules 2019, the Restriction on Deductibility of Interest Guidelines do not have the force of law.

Malaysia does not have rules regarding the effects of other countries' legal restrictions.

Malaysia does not publicly disclose information on APA or transfer pricing audit outcomes, citing privacy and confidentiality.

In relation to APAs, Rule 21 of the APA Rules states that all information is confidential. The MIRB does not share any information relating to the types and number of advance pricing agreements that it issues each year.

However, such documents may be disclosed to the public in the form of court documents for the purposes of civil litigation against the MIRB or where the taxpayer has a duty to report any findings by the MIRB to Bursa Malaysia.

The MIRB does not allow the utilisation of “secret comparables”.

The COVID-19 pandemic has impacted the Malaysian economy and the three main areas affected from a transfer pricing viewpoint are:

• effect on limited risk entities;
• selection of comparables; and
• meeting the substance test.

Effect on Limited Risk Entities

With a decline in global demand for goods and services, MNEs may be considering ways to redistribute profit allocation, risk distribution and costs assignment with their operating limited risk operators to minimise costs around the globe. In light of the economic downturn, it is unlikely that these limited risk operators will be as profitable as previous years due to reductions in sales and additional government regulations to comply with, which increase the costs of production and logistic disruption in transporting goods.

For entities more adversely impacted by the pandemic, it may even result in a loss-making situation. The question is then whether the MIRB will expect these limited risk entities to earn their routine profit and for the principal to absorb these losses. There may be concerns for MNEs and limited risk operators in Malaysia on how much risk an entity can bear on behalf of others and whether it would be a problem if they record results that differ significantly from normal business conditions from the MIRB’s point of view.

Selection of Comparables

The time lag in obtaining comparables for comparable analysis may cause difficulty for MNEs to determine the level of profit to be generated by the Malaysian entity. Selection of third-party companies should be made in compliance with the comparability requirements and independence criteria. Given the overall unfavourable economic environment, there is a risk that the MIRB may reject loss-making comparables.

In this vein, taxpayers may encounter difficulties in determining arm’s-length conditions due to the lag in time between the occurrence of controlled transactions and the availability of information due to fluctuation in the economy. The lack of accurate and real-time comparable analysis may hinder the substantiation required for comparability adjustment and selection of comparables to be made.

Meeting the Substance Test

The implementation of travel restrictions may result in an increase in the use of digital and virtual platforms to conduct meetings, provide services and carry out daily work routines. This raises questions of whether there is sufficient provision of value-added service, particularly in intra-group services.

Similarly, there were concerns that a person’s continued existence in Malaysia due to travel restrictions may result in the creation of a PE. However, the MIRB has clarified that where a non-tax resident is isolated in Malaysia due to travel restrictions, the period in which the person has stayed in Malaysia will not be contributory to the calculation of the period to be considered as a Malaysian tax resident.

Be that as it may, this approach is inconsistent with the statutory mandate that if a person remains in Malaysia for 182 days or more, they shall be considered as a tax resident in Malaysia under Section 7(1) of the ITA. It is trite that statutory laws override any guidelines that are only persuasive in nature and the interpretation of Section 7(1) of the ITA amidst the COVID-19 pandemic has yet to be tested.

In response to the disruption caused by COVID-19 to the Malaysian economy, the Malaysian government has provided interim relief to Malaysian taxpayers to alleviate cash flow problems but has also introduced measures to tighten transfer pricing regulations.

During the initial phase of lockdown in Malaysia, the MIRB extended the deadline for filing of documents required under the ITA, such as income tax returns, and introduced deferment of tax instalment payments for certain industries. The government also allowed a special revision of estimated tax payable to cushion the impact of COVID-19.

In light of Budget 2021, new laws were introduced that made it a criminal offence where a taxpayer fails to comply with transfer pricing documentation. Previously, there were no specific penalties for the late or non-submission of transfer pricing documentation. This change would see any person who defaults in furnishing contemporaneous transfer pricing documentation to be liable to a fine between MYR20,000 and MYR100,000 or to imprisonment for a term not exceeding six months or to both. Recently, the MIRB provided further guidance on the compliance requirements specifically on transfer pricing documentation of the Guidelines to help taxpayers understand the transfer pricing documentation required under the Guidelines and avoid any penalty for non-compliance.

Additionally, Section 140A of the ITA grants the DGIR wider powers in relation to controlled transactions. The DGIR may disregard and recharacterise any structure in a controlled transaction if the economic substance of the transaction differs from its form, or the arrangement when viewed in totality differs from that which would have been adopted by independent persons behaving in a commercially rational manner.

Amendments to the law also allow the DGIR to sanction up to a 5% surcharge on transfer pricing adjustments made by the DGIR, regardless of whether the adjustments result in additional tax payable or otherwise under Section 140A(3C) of the ITA.

The MIRB has halted applications for APAs where the taxpayer is significantly impacted by the pandemic but still allows for them where the taxpayer is not affected. For ongoing applications, the proposed arm’s-length range will be based on the benchmarking analysis of pre-COVID-19 conditions. For taxpayers who are unable to comply with the critical assumptions in APAs due to COVID-19, the MIRB allows the taxpayers to apply for a revision or setting aside of the APA. Taxpayers are still allowed to renew APAs but the terms should be similar to the expiring APA.

Audits by the MIRB have been gaining momentum since the relaxation of lockdown laws in Malaysia. During the Movement Control Order in March 2020, the MIRB gave extensions of time to taxpayers to provide documents and information for tax audits, which led to slower tax audits progress.

When the lockdown was gradually lifted, there was an increase in the number of tax audit cases. The MIRB has been actively pursuing transfer pricing audits remotely through electronic modes of communication.