TRANSFER PRICING UPDATE: Malaysia Tightens Transfer Pricing Compliance Requirements
25 May 2021
The Income Tax (Transfer Pricing) Rules 2012 (“Malaysian TP Rules”) require taxpayers in Malaysia to prepare Contemporaneous Transfer Pricing Documentation (“TPD”). This legislation has been effective in Malaysia since 1 January 2009. Previously, taxpayers were given 30 days to submit TPD upon request by the Inland Revenue Board of Malaysia (“MIRB”).
Under Section 113(2) of the Income Tax Act 1967, penalties would be imposed on TP adjustments arising from preparing an incorrect return and the TP Audit Framework 2019 (“TP Audit Framework”) provides that a penalty of 50% of the tax undercharged is applicable if no Contemporaneous TPD is prepared. If TPD is prepared but is not submitted by the due date upon request by the MIRB or in instances when the TPD has been prepared but the TPD is not in accordance with the requirements in the TP Guidelines 2012, the penalty would be 30% of the tax undercharged.
The MIRB has however noted that the level of non-compliance amongst taxpayers is still very high. With a view to increasing the rate of compliance, the Finance Act 2020 introduces the following key transfer pricing amendments which are effective in Malaysia from 1 January 2021:
Failure to Furnish Contemporaneous TPD
A new Section 113B(1) of the Income Tax Act 1967 provides that where a company fails to furnish Contemporaneous TPD upon request by the IRB, the taxpayer may be prosecuted and, upon conviction be subject to a fine of between RM20,000 and RM100,000 and/or imprisonment of up to 6 months. This applies regardless of whether the company is taxable or not and the Court may still order the taxpayer to furnish the TPD within 14 days or such other period as the Court deems fit. Where prosecution is not instituted, the taxpayer may nevertheless be subject to a penalty of between RM20,000 and RM100,000 for failure to submit the TPD. Note that this penalty applies in respect of each year of assessment (with the time bar period in Malaysia being seven years).
Submission of Transfer Pricing Documentation within 14 Days of a Request by the MIRB
On 29 January 2021, MIRB has updated the Malaysian Transfer Pricing Guidelines 2012 to provide that TPD should be made available within 14 days (as opposed to the previous 30 days) of a request by the MIRB.
This requirement will apply to transfer pricing audit cases which have commenced on or after 1 January 2021.
Surcharge on the Transfer Pricing Adjustment
Previously, taxpayers would not be subject to penalties if the TP adjustment does not result in additional tax liability. The new Section 140A(3C) provides that a surcharge of up to 5% will be imposed on all TP adjustments and this will apply irrespective of whether there is tax payable on the adjustment.
This new provision essentially closes the net on taxpayers who previously were not subject to TP penalties notwithstanding a TP adjustment as a result of unabsorbed tax losses, unabsorbed capital allowances, tax incentives, etc.
Power to Disregard Structure in a Controlled Transaction
Pursuant to Rule 8 of the Malaysian TP Rules, the Director General (“DG”) has the power to disregard and re-characterise the structure in a controlled transaction to reflect arm’s length economic and commercial reality. The DG’s power has now been inserted into the principal legislation via Section 140A(3A) and 140A(3B) of the Income Tax Act, 1967.
Section 140A(3A) further fortifies the DG’s power to disregard a related party transaction if the DG is of the opinion that:
i) The economic substance of the transaction defers from its form; or
ii) The form and substance are the same but the transaction, viewed in totality, differs from those which would have been adopted by independent parties behaving in a commercially rational manner and the structure impedes the DG from determining the appropriate transfer price.
Under Section 140A(3B) the DG has the power to re-characterise the transaction to reflect the structure that would have been adopted by an independent person dealing at arm’s length having regard to the economic and commercial reality.
With increased enforcement expected on MNCs worldwide through the BEPS initiative, these changes reflect the MIRB’s expectation that Malaysian taxpayers comply with the requirement to prepare Contemporaneous TPD.
Given that the statute of limitations for the raising of assessments or additional assessments for transfer pricing adjustments is seven years (in the absence of fraud, wilful default or negligence), it now becomes increasingly crucial for companies that are required to prepare Contemporaneous TPD to ensure that their TPD is up-to-date and that they are able to meet the 14-day deadline imposed by the MIRB or face penalties of up to RM100,000 per year of assessment.
Companies that have previously not prepared TPD due to the availability of unabsorbed losses or tax incentives can no longer avail themselves to this stand given that they will now be subjected to a surcharge of up to 5% on all TP adjustments and penalties will be imposed for failure to submit TPD on time.
The DG’s power to disregard and re-characterise an intercompany transaction to reflect arm’s length behaviour shows the importance that the MIRB is placing on enforcing the arm’s length principle in Malaysia. Taxpayers should therefore look closely at their existing supply chain, TP pricing and policies and ensure that this is supported by robust TPD and corroborative analysis accordingly.