IN Malaysia, each separate entity is taxed on a standalone basis. There is no group or consolidated taxation in Malaysia where companies within the group can transfer losses or capital allowance to one another. This provides an incentive to stretch the use of transfer pricing to move losses, profits, capital allowances, expenses and receipts around the group of companies to minimise taxes.
The issue is whether the transfer is undertaken within the legitimate realm of the acceptable transfer pricing laws, regulations, and guidelines? Where is the tipping point before legitimate transfer pricing becoming abusive transfer pricing?
Is transfer pricing legal?
Every intercompany transaction involving sale or purchase of goods, services, provision of finance, and use of intangibles between related companies where one has significant economic influence over the other involves a transfer price. If the transfer price is equivalent to the price that would have been charged between two unconnected independent parties, then it is perfectly legal and would meet the “arm’s length” test.
The tipping point for abusive transfer pricing
Fictitious transactions do not fall within the ambit of transfer pricing and are considered as tax evasion. Similarly, if transactions give rise to a tax benefit without incurring a loss or a cost, this enters the realm of abusive tax avoidance.
The tipping point where transfer pricing moves into abusive transfer pricing is where transactions are put in place between related parties to move profits and losses through the use of tax shelters to lower the overall taxation of the group without commercial substance.
Where are the tax shelters?
The tax shelters in a group can be found in companies with unused losses or capital allowances, and another category that is far more attractive for abusive transfer pricing is the availability of all types of tax incentives such as MSC Malaysia incentive, Principal Hub, Pioneer Status, Investment Tax Allowance and Reinvestment Allowance.
Availability of tax shelters provides an incentive to groups to shift profits to the companies or operations enjoying tax incentives. In simple terms, the company with the incentive enjoys either a zero rate of tax or a lower rate of tax and the opposite company within the group will normally be paying tax at 24%. It is common sense that when you move the profits from a 24% regime to a 0% regime, the tax savings can be significant. The tax shelters can also extend to cross-border transactions and a common example is to move profits from Malaysia which has a 24% tax regime to Singapore or Hong Kong where the tax rates are 17% or 16.5%.
Legitimate transfers of profits are acceptable
Moving profits to enjoy tax incentives or to offshore entities is perfectly acceptable provided the transaction is actually conducted, commercially explainable, and it is part and parcel of the group’s normal business activities. Equally important is the pricing of the transaction must be on an arm’s length basis which will be equivalent to the pricing undertaken between independent third parties. The documentation of related party transactions must be comprehensive, and the standard adopted should be no less than if the transaction had taken place between third parties. Documentation alone is not sufficient. There must be evidence that the subsequent implementation of the transaction follows the documentation.
General observation
Generally Malaysian domestic groups do not allocate sufficient resources to manage their transfer prices. It is time to pay more attention to this area, otherwise the cost of any mispricing or lack of evidence could result in substantial additional tax, surcharge, and penalties. Malaysian groups mistakenly focus most of their efforts on transfer pricing documentation rather than on setting and implementing the transfer pricing transactions.
This article is contributed by Thannees Tax Consulting Services Sdn Bhd managing director SM Thanneermalai (www.thannees.com).
Source: The Sun Daily
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