THIS is the final month for many Malaysian companies since the December financial year-end is in alignment with the tax year. Adjustments are needed to correctly reflect the financial position of the company.
The common ones include adjustments to accrued income and expenses, recognising deferred revenues, inventory adjustments, transfer pricing adjustments, depreciation and amortisation, etc.
The majority of these adjustments have implications from both income tax and indirect tax perspectives. All such adjustments made should be justifiable commercially, supportable legally, and meet the necessary provisions of the tax laws.
The types of adjustments are:
► Transfer pricing
In the majority of transfer pricing methods except the Comparable Uncontrolled Price method, there is always a need to adjust the transfer prices from the budgeted results (costs and billings) to the actual results, or to adjust the margins where the actual margin earned is not at arm’s length compared to the comparable companies in the marketplace. These adjustments are usually reflected at the final month of the financial year end, or the first month of the new financial year.
These transfer pricing adjustments will also have an impact on the customs duties and sales tax paid on the imported goods, and there are also service tax implications on imported services. If there are additional taxes to be paid due to the increase of the profits or prices of the goods or services, there will be no issues with the tax authorities. However, if the adjustments are on the reverse side, the question the taxpayer needs to examine is whether he will be able to get back the refund, or will it be a sunk cost.
If there is a refund situation, the tax authorities will certainly examine whether you have the necessary legal agreements to support such adjustments, whether such adjustments for income tax purposes are wholly and exclusively incurred in the production of income, and whether the transaction meets the arm’s length test.
From a customs perspective, such adjustments could be challenged on the grounds that the price declared at the point of importation is the true transaction value, and the subsequent adjustments may not be acceptable.
► Other adjustments
Other common adjustments would be adjustments for accruals, stock adjustments, making provisions for deferred expenses and revenues, bad debt adjustments, non-cash adjustments such as amortisation and depreciation, etc.
The accounting and tax treatment of income and expenses have diverged. The deductibility of expenses and the taxability of income is very strictly based on the tax legislation. This is similar for customs purposes.
Accounting standards and practices are only used as a reference, and it is not the determining factor for tax purposes. For example, bad debt provisions must follow the strict requirements of the law and the public ruling which requires either legal action and follow up reminders to be sent to the debtor, and actions taken to recover the debt will suffice for a tax deduction, whilst the accounting standards may apply different criteria for accepting such a provision. Similarly, accrual of expenses for tax purposes must be supported with the legal obligation to incur the expense, and the amount is determinable with certainty.
Why extra scrutiny?
The tax authorities will pay greater attention to year-end adjustments because there is a tendency for taxpayers to make such adjustments to reduce their taxes without the necessary legal and commercial basis. Please avoid abusing the year-end adjustments by introducing fees, charges, or fictitious sales to shift profits from profitable companies to loss-making companies within the group, or attempting to defer income to the following year, etc.
You must exercise vigilance in making one-off year-end adjustments compared to adjustments which are done regularly throughout the year. Evidence to support the tax position taken should be documented and kept in case there is a challenge by the tax authorities.
This article is contributed by Thannees Tax Consulting Services Sdn Bhd managing director SM Thanneermalai (www.thannees.com).
