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Malaysia’s new Income Tax (Transfer Pricing) Rules 2023 were gazetted on May 29, revoking the Income Tax (Transfer Pricing) Rules 2012. Transactions entered into during the taxpayer’s financial year ended 2023 and subsequent periods will be subject to the 2023 rules. How have the new rules changed the transfer pricing landscape in Malaysia?
Documentation Requirements and Timelines
With effect from year of assessment 2023, taxpayers with controlled transactions are required to prepare contemporaneous transfer pricing documentation and complete this prior to the taxpayer’s tax filing due date. The transfer pricing documentation must state the date of its completion. Prior to the 2023 rules, taxpayers were only required to make the documentation available on request by the Inland Revenue Board of Malaysia.
While contemporaneous transfer pricing documentation requirements are arguably intended to prevent retrospective justifications for taking certain transfer pricing positions, the sudden deadline change presents practical problems, as it takes effect almost immediately from the gazetting of the 2023 rules at the end of May.
This would mean that businesses with a financial year ending in for instance February would only have a couple of months to engage advisers to prepare the required benchmarking analysis and other transfer pricing documentation, which would have to be completed within seven months of the close of their accounting period and filed within 14 days upon request.
A grace period ought to have been given to enable taxpayers to comply with the new deadline, particularly as the 2023 rules also require far more detail and mandatory information to be disclosed than the 2012 rules.
The new deadline will also mean that taxpayers have to start preparing their transfer pricing documentation much earlier. Some financial and other relevant data may not yet be available, with a possible impact on the quality of the benchmarking and other analyses.
The recent imposition of penalties for failure to submit contemporaneous transfer pricing documentation will mean that the preparation of documentation is no longer optional, as failure to prove its submission may give rise to prosecution, with fines of between 20,000 Malaysian ringgit ($4,300) and 100,000 Malaysian ringgit, or six months’ imprisonment, or both.
However, adjustments or penalties imposed on a retrospective basis may be legally challenged by taxpayers.
Arm’s Length Price and ‘Arm’s Length Range’
Under Section 140A of the Income Tax Act 1967, the arm’s length price shall be determined and applied by taxpayers who transact with “associated persons” for the acquisition or supply of property or services, as defined under the act.
Although not previously defined prior to year of assessment 2023, the Revenue had in practice construed arm’s length price to mean the median and above and didn’t adopt the interquartile range although that was the universally accepted meaning of the arm’s length principle.
The Revenue’s practice has now been incorporated into the 2023 rules, with Rule 13(2) stating that only prices that fall within the “arm’s length range” are acceptable as the arm’s length price. Accordingly, pricing that falls outside the arm’s length range will be substituted with the median.
Defined as “a range of figures or a single figure falling between the value of 37.5 percentile to 62.5 percentile of the data set,” this significantly whittles down the arm’s length range, and taxpayers could potentially be left with a much smaller selection of comparables, which in turn affects the determination of the arm’s length price.
Further, even controlled transactions that fall within the whittled-down “arm’s length range” may be adjusted to the median and above if, under Rule 13(3), the Director General of Inland Revenue takes the view that the uncontrolled transaction that had been used as the taxpayer’s comparable had a lesser degree of comparability, or if the comparability defects can’t be quantified, identified, or adjusted.
It is not clear how Inland Revenue would evaluate the level of comparability. Absent any objective criteria clearly defined, the exercise of such unfettered discretion could leave taxpayers at risk of being subject to arbitrary adjustments on tenuous or vague grounds of incomparability or defective comparables, thereby increasing the likelihood of transfer pricing litigation.
Selection of Comparables
In practice, the taxpayer’s comparables are closely scrutinized by the Revenue, who may supplant their own set of comparables for the taxpayer’s. Loss-making companies and foreign comparables are also rarely accepted. The narrowing of the arm’s length range would affect the selection and availability of appropriate comparables, as mentioned above.
Under Rule 7(5) of the 2023 rules, the selection process has been rendered even more challenging, as any data relating to the periods subsequent to the year under examination is excluded. Further, although prior years’ data may be referred to, it can’t be used to obtain multiple-year averages to support the taxpayer’s arm’s length price, and its use is confined to enhancing the reliability of the taxpayer’s comparability analysis.
As single-year data may not fully reflect the actual business cycle or commercial realities, due to extraordinary or one-off events for example, excluding data relating to the subsequent periods could result in more extreme or skewed results. The 2023 rules are also inconsistent in permitting the use of prior years’ data (albeit under limited circumstances) while excluding subsequent years’ data.
Outlook
The 2023 rules clearly foreshadow stricter transfer pricing compliance. Many of the changes introduced will only make it more onerous for taxpayers to comply and the new rules portend increased scrutiny and audits by the Revenue of a taxpayer’s transfer pricing strategies. All these changes only serve to confirm the underlying intent of the new rules.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Author Information
Irene Yong is a partner with Shearn Delamore & Co.
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