IN RECENT years, Malaysia’ Inland Revenue Board (IRB) has stepped up its focus on transfer pricing audits.
Businesses engaging in related party transactions are increasingly in the spotlight. With the growing scrutiny, it’s essential for companies to understand the common pitfalls that can trigger hefty penalties and additional taxes, and how to prepare effectively.
Preparation of Contemporaneous Transfer Pricing Documentation (CTPD) not a choice, but a requirement
The CTPD should not be treated as a mere formality as it is the foundation that supports the pricing of related party transactions and demonstrates that transactions are commercially rational and that it meets the arm’s length principle.
The preparation of CTPD for taxpayers who exceed the prescribed threshold is mandatory. The Transfer Pricing Rules (TP Rules) comprehensively set out the information that must compulsorily be disclosed. If any of the requirements stated in the TP Rules are not applicable, reasons must be provided to support the non-application.
The dating of the CTPD is extremely important as the document must be prepared at the time transaction is being undertaken or before the tax return for a particular year of assessment is filed.
During a transfer pricing audit, IRB typically grants taxpayers 14 days to submit the information requested, which includes the CTPD. Failure to submit the CTPD within this 14-day time frame will automatically be treated as the taxpayer not having CTPD in place, thus triggering penalties and the maximum 5% surcharge on any transfer pricing adjustment arising from the audit.
Taxpayers must ensure that a robust and fully compliant CTPD is prepared within the deadline and updated annually. Having the documentation before an audit begins will protect taxpayers from penalties and surcharges.
Wrong characterisation of transactions
Mischaracterising the nature of a transaction will result in wrong transfer pricing analysis. For example, where the transfer price involves merely an agency arrangement versus a buy-sell arrangement, the arm’s length pricing on the former transaction will be much lower compared to the latter.
Another example will be between a toll manufacturer and contract manufacturer.
If IRB finds that the facts are not aligned with your documentation, they have the right to recharacterise and reprice the transaction resulting in additional taxes and surcharge.
Profit fluctuations without commercial explanation
Profit margins naturally fluctuate in business, but unexplained variations often raise red flags. During audits, IRB expects companies to provide clear commercial reasons for profit swings, such as market changes, new product launches, or operational issues.
Taxpayers must document the commercial reasons behind profit fluctuations thoroughly. Keep internal reports, market analysis, and business decisions that explain changes in profitability to support your position during an audit.
External comparability study is not robust
A key part of transfer pricing is benchmarking against comparable independent parties. If the external comparability study is not robust or reliable, IRB will adjust the company’s profit margin to the median of the independent parties’ margins. This adjustment often results in additional tax payable and a surcharge of up to 5% on the gross adjustments made.
The benchmarking study must be conducted and up to date using reliable databases and appropriate Malaysian comparables. Taxpayers must review and update the comparability analysis regularly to ensure it reflects current market conditions.
Service fees without proper support
Payment of service fees to related parties without adequate documentation to prove the services were actually received and benefited the recipient is a common audit trigger. If companies cannot substantiate these expenses, IRB may disallow them in the tax computation, leading to additional taxes and penalties.
To deal with this, taxpayers must maintain detailed service agreements, timesheets, invoices and evidence of the services and benefits received by the related party.
Ensure that service fees charged reflect actual services rendered and align with the arm’s length principle.
Ignoring these risks can lead to costly penalties, increased tax bills and unnecessary headaches.
This article is contributed by Thannees Tax Consulting Services Sdn Bhd managing director SM Thanneermalai (www.thannees.com).
