Can A Business Enterprise Ignore Transfer Pricing?
September, 10th 2014
pricing occurs whenever there is a transaction between two business enterprises which are part of the same group of companies or are controlled by a common person. In simple terms we refer to such parties as related parties. The business enterprises can include companies, limited liability partnerships, partnerships, branches, different businesses or a sole proprietorship.
Transfer pricing across the world, when it started out in the early 1990's, focused on multinational enterprises operating across borders. The primary intention of governments were to protect their tax base from being eroded through the use of transfer pricing manipulation or abusive transfer pricing.
With time however, countries such as Malaysia and many others, extended their focus on transfer pricing to domestic transactions between related parties.
IS TRANSFER PRICINIG ILLEGAL? It is not illegal, provided the related parties conduct their transactions in accordance with the arm's length principle. This principle requires related party transactions to be carried out in the same manner as that applied between two independent parties undertaking the transaction under similar terms and conditions.
Politicians and the media worldwide however, have increasingly interchangeably used the phrase "transfer pricing" in the same context when referring to tax evasion and avoidance, tax shelters and profit shifting. Business enterprises who conform to the rules of transfer pricing therefore, are clubbed together with those who abuse it with the intention of avoiding taxes.
If its not illegal, why are tax authorities worldwide, including the ones in Malaysia, allocating greater resources to this area of taxation then? This is because tax authorities in many countries find that taxes paid by multinationals and large companies, do not seem to be commensurate with the revenues they generate in the relevant jurisdictions they operate in. Multinationals have countered these arguments by saying that the taxes were paid based on international rules and the rules of each country and that their transfer pricing practices are legitimate and correct.
This argument is common on most transfer pricing scrutiny by the tax authorities both in Malaysia and overseas. There is never one correct answer, as the determination of the arm's length price that is agreeable to both the tax authorities and the taxpayers, is tremendously difficult to achieve. This is because there is no "one size fits all" formula. Under these circumstances the tax authorities in practice expects the taxpayer to provide adequate evidence to prove their side of the case that the transfer prices adopted between related parties have been conducted at arm's length, otherwise the taxpayer will face a tax adjustment together with penalties. Penalties in Malaysia can vary from 25 % upwards.
WHY IS IT CRITICAL IN MALAYSIA?
Our laws and rules and guidelines on transfer pricing clearly require taxpayers to prepare transfer pricing documentation on a current basis, at the time the transaction is undertaken.
From the year of assessment 2014, the tax returns of companies ( form C ) require taxpayers to mark off a box which states "Yes" or "No" to whether the corporate entity has prepared the transfer pricing documentation. If the answer is negative, the chances of an entity being subjected to a tax audit increases.
During an audit, the absence of such documentation increases the risk of a transfer pricing adjustment as the taxpayer starts from an unprepared, or a weak position, since a comprehensive justification to support the transfer prices or the resultant profits will not be readily available.
In the absence of the documentation required in accordance with the transfer pricing laws, rules and guidelines at the time of a tax audit, there is an assumption the taxpayer's transfer prices may not be at arm's length and therefore any adjustment will be accompanied by a penalty starting at 35 %. Under the transfer pricing guidelines all business enterprises who undertake related party transactions need to prepare transfer documentation. The exception applies only when both the related taxpayers are not assessable or chargeable for tax.
If a taxpayers falls outside the above exception then the taxpayer has to prepare one of the two types of documentation prescribed in the transfer pricing guidelines: full documentation or a limited documentation. Limited documentation applies to all business enterprises whose gross income does not exceed RM25 million annually and the total related party transactions do not exceed RM15 million annually. Similarly in the case of financial assistance rendered between related parties which do not exceed RM50 million, the limited documentation requirement will apply.
Finally with greater emphasis being given to transfer pricing as evidenced by the need to mark off the documentation box in the tax return for 2014 ,taxpayers must allocate resources to ensure their transfer prices meet the all-critical arm's length test and back it up with the relevant transfer pricing policy and documentation as required by our local rules. You do not want to be caught out by the tax authorities.
S.M. Thanneermalai is a Council member and Chairman of the Indirect Tax Committee, transfer pricing sub committee and tax investigations and audit sub committee and a senior executive director in PwC.