Summary
In May 2023, the Income Tax (Transfer Pricing) Rules 2023 (“TP Rules 2023”) was published in the federal gazette, marking a significant leap forward in the enhancement of the transfer pricing legislative framework in Malaysia. The TP Rules 2023 has effectively made the preparation of a transfer pricing documentation in Malaysia a compulsory requirement on a yearly basis, with many Chief Financial Officers and Heads of Tax taking notice of the wider implications to the ordinary course of business. Amidst the backdrop of a slew of tax related changes announced by the Malaysian government, some opted to postpone the preparation of the transfer pricing documentation to a later date. However, the timely preparation of a transfer pricing documentation is essential to ensure transfer pricing risks (and penalties) are mitigated to acceptable levels.
A pertinent question that ought to be raised is this – given that the preparation of a transfer pricing documentation is mandatory, how are companies managing the transfer pricing process to ensure compliance without sacrificing their focus on other business objectives? The following represents some observations regarding the practical realities of managing these transfer pricing complexities in an era post-TP Rules 2023.
Table of contents
- Practical difficulties arising from the TP Rules 2023
- The requirements under the TP Rules 2023 differ from the past compliance expectations
- Introduction of the TP Rules 2023 has redefined the tax calendar for many companies
- Information requirements of the TP Rules 2023 are voluminous and diverse
- Greater emphasis on a transactional approach
- Domestic transfer pricing is not excluded from focus
- Potential benefits – better managed audits
- Shift in mindset needed to successfully mitigate transfer pricing risks moving forward
Practical difficulties arising from the TP Rules 2023
1. The requirements under the TP Rules 2023 differ from the past compliance expectations
In the past, companies may have taken the stance that a transfer pricing documentation was to be prepared periodically without a fixed timeframe. Certain companies have also taken the view that the transfer pricing documentation was not an annual requirement, and as such opted to rely on globally prepared transfer pricing documentations to fulfil local requirements.
In order to appreciate the changes within the TP Rules 2023, it is worth reviewing the previous version of the rules in brief to better reflect understanding. The Income Tax (Transfer Pricing) Rules 2012 (“TP Rules 2012”), which was the precursor to the TP Rules 2023, provides that a transfer pricing documentation was considered contemporaneous if it was brought into existence:
- When a person is developing or implementing any controlled transaction; and
- Where in a basis period for a year of assessment the controlled transaction is reviewed and there are material changes, the documentation shall be updated prior to the due date for furnishing a return for that basis period for that year of assessment.
The TP Rules 2012 stopped short of providing a definitive timeline for the preparation and completion of the documentation. Instead, the requirements to perform annual updates to relevant sections of the transfer pricing documentation were outlined in the Malaysian Transfer Pricing Guidelines. Specifically, Paragraph 11.2.2. of the Malaysian Transfer Pricing Guidelines provides that so long as operational conditions remained unchanged, only the comparable searches supporting the transfer pricing documentation as well as the financial information of comparable data required updates. The transfer pricing documentation as a whole need only be updated in its entirety where material changes take place. Such material changes refer to significant changes that would give impact to, amongst others, the functional analysis or transfer pricing analysis of the tested party.
2. Introduction of the TP Rules 2023 has redefined the tax calendar for many companies
The current position under Rule 4 of the TP Rules 2023 is that a person who enters into a controlled transaction shall prepare a contemporaneous transfer pricing documentation which is brought into existence prior to the due date for furnishing a return. Effectively, the TP Rules 2023 requires an annual preparation of the transfer pricing documentation and specifies detailed content requirements under Rule 4 (2) of the TP Rules 2023 in order for the transfer pricing documentation to meet the contemporaneous definition. The preparation of the transfer pricing documentation is no longer contingent on material changes taking place. Rather, regardless of whether there is a significant change or otherwise, a transfer pricing documentation must be brought into existence yearly prior to the due date of furnishing the return. Such preparation must also be evidenced in the event that companies are required to prove to the tax authority that the documentation was prepared on a contemporaneous basis.
The effect of this change is that companies must now go beyond thinking of the transfer pricing documentation as a document that is updated periodically. Instead it is a mandatory document that goes hand in hand within a company’s annual tax compliance program. Shifting the mindset in this manner is crucial to ensure that all companies that have controlled transaction prepare their transfer pricing documentation in line with the rules and guidance in force in any particular year.
3. Information requirements of the TP Rules 2023 are voluminous and diverse
In contrast to years of assessment prior to 2023, the transfer pricing documentation was aimed at detailing the controlled transactions of companies and included information that was listed in Chapter XI of the MTPG. Whilst the TP Rules 2012 outlined the basic information that shall form part of the transfer pricing documentation, the detailed contents were only explained within the MTPG. As the MTPG did not have force of law and was considered to be an interpretation of legislation, much of the contents of the transfer pricing documentation, in practice, was curated to achieve the objective of justifying the arm’s length nature of controlled transactions.
However, with the introduction of the TP Rules 2023, the information required to be included in the transfer pricing documentation has been clearly prescribed under Rule 4(2). A transfer pricing documentation shall be considered to be contemporaneous only if the documentation sufficiently addresses the information requirements under Schedules 1, 2 and 3 of the TP Rules 2023. For companies which have not perused the contents of these schedules, the nature of information can be voluminous and diverse. Some information disclosure requirements would necessitate companies spending additional time to collate information internally. Examples of these types of information are the requirement to disclose management reporting lines, business strategies, corporate business plans, commercial agreements, source documents, forecasts and budgets, and assumptions regarding the setting of pricing policies. Whilst some of these documents are typically requested during a tax audit, taxpayers are now expected to compile such documents at the time of preparing the transfer pricing documentation.
Further, information regarding certain controlled transactions may be difficult to collate as they may be retained at the headquarters of Multinational Enterprise (“MNE”) Groups. This may include documentation relating to certain class of controlled transactions (such as intragroup services), which would outline the specific economic benefits that would accrue to the recipient of such services. The absence of this documentation at the local level creates practical difficulties for local tax and finance teams when addressing queries from the IRB.
Given the above, it is safe to summarize that not all of the information that is contained within the respective schedules of the TP Rules 2023 would be readily available at present. As such, companies should factor in additional time to facilitate the smooth collection and incorporation of such information into the annual transfer pricing documentation. Going forward, companies may have to coordinate better internally to ensure such information is available on a yearly basis to minimize the time required to collate information given the short timeframe to prepare the documentation.
4. Greater emphasis on a transactional approach
As alluded to earlier, in documenting the controlled transactions, the TP Rules 2023 now calls for companies to consider adopting a transactional approach to addressing the arm’s length nature of the controlled transactions. Schedule 2 of the TP Rules 2023 outlines specifically that companies must take into consideration the nature of the controlled transactions but also provide a functional analysis of all the associated persons with whom the taxpayer has transacted with. Item (d) of Schedule 2 of the TP Rules 2023 also states that a comparability study should be prepared to justify that the price is at arm’s length.
As these new requirements have force of law, companies now must re-evaluate their existing transfer pricing approach to ensure that the requirements of the TP Rules 2023 are addressed on a transactional level on a yearly basis. This includes evaluating existing transfer pricing analyses to determine if such an approach continues to produce outcomes that are consistent with the intent of the TP Rules 2023.
For example, previous transfer pricing analyses in an existing transfer pricing documentation may involve the application of the Transactional net Margin Method on an entity wide basis. Companies need to reassess the application of this aggregate approach and determine its compatibility with the requirements of the TP Rules 2023. For regional tax personnel, the approach of adopting a single transfer pricing analyses to cover transfer pricing requirements across multiple tax jurisdictions may also become less practical due to the differences in requirements between the TP Rules 2023 in Malaysia and those in other tax jurisdictions.
5. Domestic transfer pricing is not excluded from focus
Another practical reality that companies have to deal with is the emphasis on domestic transfer pricing. This is especially the case when dealing with MNEs who may have the misconception that controlled transactions between related parties within Malaysia (i.e., domestic transactions) are exempt from the transfer pricing requirements or are less critical from the IRB’s perspective. This is not the case as domestic transfer pricing matters remains to be a key area of focus during transfer pricing audits.
In fact, upon reviewing Rule 4 of the TP Rule 2023, it is noted that no exemption is provided on the basis of the location of the taxpayer or the nature of the transaction (e.g. cross border transactions vs. domestic transactions). So long as a person enters into a controlled transaction, the requirement to prepare a contemporaneous transfer pricing documentation remains. However, to ease the compliance burden of taxpayers, companies are allowed to prepare a minimum transfer pricing documentation based on a template provided by the IRB where the gross income, total controlled transactions and quantum of financial assistance fall below prescribed thresholds.
It is worth noting that the IRB pays particular attention to domestic transfer pricing cases as audits are focused towards ensuring that transactions entered into between members of a domestic group of companies are transacted at arm’s length. This is largely due to the fact that certain companies may benefit from tax incentives or tax holiday that could result in profit shifting practices. As such, companies should be aware that the transfer pricing requirements in Malaysia have embedded within them a domestic focus, where the IRB has the authority under Rule 13 of the TP Rules 2023 to make adjustments on both cross border and domestic controlled transactions where such transactions are not conducted on an arm’s length basis.
Given the above, companies should ensure that domestic transactions between related parties are also reviewed yearly to align the conduct of such transactions to the transfer pricing requirements in Malaysia. The failure to do so may result in adjustments being made by the IRB, where an imposition of a surcharge under Section 140A(3C) of the Income Tax Act 1967 would still apply.
Potential benefits – better managed audits
The ability of a company to overcome the practical difficulties in managing the transfer pricing compliance process would be a decisive factor in managing the complexities surrounding transfer pricing compliance. Whilst the TP Rules 2023 has placed the burden of maintaining more extensive documentation requirements, there are some long-term benefits to the additional requirements that may arise from the perspective of the taxpayer. In particular, common transfer pricing audit issues may be better mitigated in the event that companies are able to maintain their transfer pricing documentations in line with the TP Rules 2023.
This may be the case when dealing with the transfer pricing audit process involving loss making companies and cross-border transactions. The IRB often raises concerns during the transfer pricing audit process regarding companies that are in a loss making position with high levels of controlled transactions. Such companies may be requested to provide evidences to justify that the losses incurred were due to commercial factors during the audit period. By ensuring compliance with the detailed disclosure requirements in the TP Rules 2023, companies would have sufficiently considered the various factors effecting the pricing polies and outcomes on a yearly basis. In addition, detailed information regarding the controlled transaction, including comparability studies on each controlled transaction, would have been compiled annually. This would enable companies to defend their existing practices and draw attention to more relevant factors that may have affected their profitability during the audit period.
With respect to cross-border transactions, disputes with the IRB may also be mitigated as a result of the increased level of documentation requirements that is required within the TP Rules 2023. With transfer pricing analysis being carried out on a transactional basis, information regarding cross-border transactions would be more readily available to the local tax teams. This would allow information relating to cross-border transactions to be communicated and provided to tax authorities in a more effective manner, thus increasing the level of transparency between the taxpayer and the tax authority. The requirement of local tax teams to keep a detailed record regarding pricing policies adopted along with a two-sided functional analysis would also enhance their ability to respond to the IRB’s on-going queries during the transfer pricing audit process. Overall, this may result in more positive audit outcomes as the element of uncertainty that often exists surrounding cross-border transactions may be removed.
Shift in mindset needed to successfully mitigate transfer pricing risks moving forward
The above provides an overview of some of the practical realities facing companies in managing transfer pricing complexities in Malaysia after the introduction of the TP Rules 2023. The enhancement of the rules serves to increase the level of compliance among taxpayers with transfer pricing requirements and ensure that controlled transactions are carried out in a manner that is consistent with the arm’s length standard. While the implementation of the TP Rules 2023 creates practical difficulties due to its additional requirements, it also creates an opportunity for companies to face future transfer pricing audits with greater confidence as controlled transactions would be analyzed more frequently on an annual basis. This effectively creates lesser shocks to the business in the long term both in terms of responding to queries and dealing with negative audit outcomes.
On an overall basis, the landscape has shifted significantly, with these new requirements necessitating those charged with tax matters to rethink their annual tax compliance process. The requirement to embed the planning, documentation and analysis of controlled transactions in the yearly tax calendar is now more pertinent than ever before. Even though taxpayers have taken their responsibilities to prepare a transfer pricing documentation by the time the tax return is due seriously, it is hoped that the IRB will provide some concession in this first year of implementation to provide some much needed relief to companies that may have struggled to comply. It is also hoped that the IRB will continue its on-going engagement and outreach with the wider community to increase awareness among taxpayers of the importance of maintaining good quality transfer pricing documentation on a yearly basis.
On the part of taxpayers, companies should move quickly to ensure that controlled transactions are effectively managed on a proactive basis to avoid the risk of disputes with the tax authorities regardless of whether such transactions are cross border or domestic in nature. It is only with a proactive and measured approach that taxpayers can hope to effectively navigate the complexities and manage their transfer pricing risk in the years to come.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
Chang Mei Seen is the Executive Director at KPMG Tax Services Sdn Bhd. She advises local and multinational companies on transfer pricing issues, including preparation of transfer pricing documentation, transfer pricing advisory and planning as well as involvement in dispute resolution process.
Kishenjeet Dhillon is the Associate Director at KPMG Tax Services Sdn Bhd. His main area of focus includes advising on transfer pricing documentation compliance and carrying out transfer pricing studies for clients across a wide range of industries. He also has experience in transfer pricing dispute resolution with the Malaysian tax authorities as well as handling transfer pricing planning projects for groups of companies.
