INTRA-GROUP financing (IGF) has become one of the most scrutinised areas in taxation. The taxman looks at these transactions as a form of financial assistance that should be analysed accurately. The aim of the taxman is to ensure the “real” IGF transaction, i.e. loan, is identified and priced accordingly.
In the area of IGF, loans and advances provided within the group are the most significant financial transactions that occurs in practice. The tax authorities are focusing on this area as they are attempting to ensure that there is no abuse of the use of the loan financing to shift profits to either offshore locations where the taxes are much lower than Malaysia or to tax shelters within Malaysia.
It’s not uncommon to find many tax shelters in Malaysia and they usually arise due to tax holiday (pioneer status, investment tax allowance, loss carried forwards, etc.)
It is the right of the taxpayer to allocate the profits which are commercially justifiable and meet the arm’s length test between the different entities within the group. The tax authorities scrutinise such allocations to ensure that excessive profits are not shifted unreasonably to the tax shelters within Malaysia or outside Malaysia.
The reason loans are given greater emphasis by the tax authorities is that the interest payable on the loans is tax deductible while dividends paid from share capital are not deductible. There is a tendency for the overzealous tax manager in any conglomerate to pump in extra financing so that they can obtain tax deduction on the interest and reduce the overall tax liability.
How should taxpayers avoid “the cat and mouse game”?
Generally, taxpayers and tax authorities are on the same page – to pay the correct amount of tax. The underlying principle that must be met by the taxpayers to satisfy the tax authorities is to organise an IGF loan that will meet the arm’s length test i.e. the IGF loan transaction should be reflective of a similar transaction occurring between two independent parties in the open marketplace.
The first consideration should be whether the amount of debt raised within the group can be substantiated with the characteristics of a debt. Some of the characteristics will be the right to receive regular interest payments, predetermined repayment date, no right to vote, etc.
Even though an IGF has been labelled as loan, if the characteristics do not meet the loan criteria, then the transaction will be regarded as infusion of capital and interest payable will be recharacterised and therefore, not be tax deductible.
A common problem faced by many Malaysian conglomerates is the provision of interest free loans. In such a circumstance, the determination of whether it is a loan or equity is critical in determining the arm’s length nature of the capital structure.
Once you have determined the proportion of the acceptable loan to capital that will meet the arm’s length test, the next steps will be to determine the arm’s length interest rate that should be charged on the IGF loan. In determining the arm’s length rate, you are encouraged to use the accepted transfer pricing methodologies, and the most common one would be a comparable price of a similar transaction available in the marketplace or a cost-plus method. You are entitled to use other methodologies, but you must be able to show that the methodology is acceptable in the marketplace.
To avoid disputes with the authorities, the quantum of the debt versus equity and the pricing of the debt should be reflective of what happens in the open marketplace and it is absolutely key to prepare the necessary documentation to support each step of the analysis so that when the tax authorities come in they are convinced that you will give them the comfort that as a taxpayer you have taken the necessary steps to prove that your transaction meet the arm’s length test.
This article is contributed by Thannees Tax Consulting Services Sdn Bhd managing director SM Thanneermalai (www.thannees.com).
