THE noose is tightening on companies that use price or cost manipulations in transactions with related parties to adjust their tax bills following the introduction by the Inland Revenue Board (IRB) of sweeping new guidelines that could paralyse this practice.
The practice, generally known as transfer pricing, is being aggressively targeted by the IRB in the new guidelines it rolled out on Tuesday which introduced five testing methods that would determine if an inter-company transaction was priced at arm's length. (An arm's length transaction would be one involving two unconnected, independent parties.)
Tax experts warned that failure to demonstrate an arm's length consideration using one of these prescribed methods could subject a firm to hefty additional taxes and penalties. They said section 140 (1) of the Income Tax Act 1967, which allows the IRB to disregard transactions not believed to be made at arm's length, would be applied in the adjustment of transfer pricing.
Although primarily targeted at multinational corporations with cross-border operations where the differing tax rates and regimes of different jurisdictions make transfer pricing an attractive tax efficiency proposition, the new rules apply equally to local corporations which transact business among group companies operating wholly within Malaysia.
In an interview with StarBiz in Kuala Lumpur yesterday, Ernst & Young Tax Consultants Sdn Bhd executive director Kenneth Lim said he was concerned the detailed requirements of the new guidelines could affect many Malaysian companies that would be caught without documentation and justification when faced with an IRB tax audit.
He said very few local companies and even subsidiaries of multinationals had established any clearly- defined methodologies for determining if the prices they charged their parent, subsidiary or related companies were at arm's length, and urged them to prepare the necessary documentation now.
Do not wait for a tax audit it would be too late, he warned.
Lim, nevertheless, said the setting of rules by the IRB was beneficial as it would add transparency to the determination of what constituted transfer pricing. It's actually a good thing because it adds certainty to the tax payer, he said.
The head of Ernst & Young's transfer pricing practice, Yvonne Chan, expects transfer pricing to start featuring even more prominently now in the IRB's audit objectives.
The IRB had, for some time already, been conducting transfer pricing audits and had made assessments of additional tax payable, she said.
The IRB has said that following implementation of the self-assessment tax system, field audits would be conducted on every company at least once every five years.
Chan said the amount of tax recovered from the exercise of these transfer pricing guidelines during such audits would likely rise in the future as had been the case in every other country that started introducing such rules. It's a revenue churner, she said.
A global Ernst & Young survey last year found inter-group management and technical services, sale of goods and royalties to be areas most commonly targeted by tax authorities.
Malaysia is the latest among 21 countries, which include the United States, Britain, Australia and Japan, to have adopted some form of transfer pricing legislation.
According to Chan, the IRB guidelines are similar to those in an Organisation for Economic Cooperation & Development (OECD) model that was used in many tax jurisdictions around the world.
This is commendable and makes it much easier for multinationals to comply as they are already familiar with the OECD model and are expected to apply it when trading with their group companies in most countries, she said.
On the risk of foreign investors seeing the guidelines, which appear to target multinationals, as a deterrent to investing in Malaysia, Lim said that, on the contrary, foreign companies would likely see the greater clarity in the rules as a positive factor.
It will add greater certainty in their investment decisions, he said.