In 2021, Malaysia expects to collect corporate income tax of RM64.6bn – 8.8% higher than 2020 and approximately the same as in pre-pandemic 2019. While there have been no major tax policy changes, an emphasis is now being placed on enhanced auditing and tax compliance, with the Finance Act 2020 introducing amendments to the Income Tax Act 1967.
Historically, transfer pricing was viewed as an anti-avoidance mechanism to prevent multinationals from shifting profits and taking advantage of the different corporate tax rates in the various jurisdictions that they operate in.
That view has evolved over the years, and many jurisdictions now view transfer pricing as a compliance regime, whereby a penalty is imposed for not complying with requirements, regardless of whether there was any tax benefit.
Until the end of 2020, the Malaysian regime could be argued to take an anti-avoidance position, as only tax underpaid resulting from a transfer pricing adjustment was subject to a penalty under the ‘incorrect tax return’ provision in the Income Tax Act. Such penalties apply only if there are additional taxes to be paid.
Some changes have been made to the nitty-gritty of the existing tax law, including to the transfer pricing regime. Here, we will address two notable changes.
This year, Malaysia has joined the league of countries that view transfer pricing as a strict compliance regime
This year, Malaysia has joined the league of countries that view transfer pricing as a strict compliance regime. It has done so by imposing a surcharge up to 5% on the value of any transfer pricing adjustment (not the value of additional tax).
As such, the surcharge will apply even if the transfer pricing adjustment does not lead to any additional tax, such as in the case of a tax-exempt entity.
The change is effective from 1 January 2021 and is believed to apply even on past years’ transfer pricing adjustments, so long as the tax authority audit takes place after 1 January 2021.
The 5% surcharge is substantial as it is not imposed on the tax amount but on the value of the transfer pricing adjustment, which may be at revenue or net income level. When compared with the 24% corporate tax, the 5% surcharge would amount to 20.8% of tax in ‘plain-vanilla’ cases. But again, the impact will be felt in the cases that involve tax-exempt or loss-making companies.
The impact of RM1m of transfer pricing adjustment will differ according to companies’ different tax profiles. For example:
- Company A is 100% tax exempt. The penalty up to 31 December 2020 (generally at 30% of tax underpaid) is nil. The surcharge from 1 January 2021 is RM50,000.
- Company B is 70% tax exempt. The penalty up to 31 December 2020 is RM 21,600. The surcharge from 1 January 2021 is RM50,000.
- Company C has no tax exemption. The penalty up to 31 December 2020 is RM72,000. The surcharge from 1 January 2021 is RM50,000.
It is obvious that the RM50,000 surcharge (being 5% of the transfer pricing adjustment of RM1m) applies regardless of whether the taxpayer had benefited from the alleged non-compliance to the transfer pricing requirements. This is unlike the previous regime, whereby the penalty was proportionate to the alleged tax saving or avoidance – and may even be zero, such as in the case of Company A above.
At the time of writing, it is not clear whether the penalty (generally 30% of tax) would apply over and above the surcharge, or would simply be abandoned for transfer pricing cases.
Under the new regime, a penalty will be imposed for not preparing transfer pricing documentation
Although there is no express provision to hold the penalty and surcharge mutually exclusive, it is generally acceptable to penalise the taxpayer twice for the same offence. In verbal interactions, the tax authority has indicated that it is likely only surcharges would be imposed on transfer pricing adjustment. This is yet to be confirmed in writing.
In addition, the law allows the tax authority to impose the surcharge up to 5%, and hence it is unclear under which circumstances it would impose the surcharge at a rate lower than 5%.
The transfer pricing audit framework is currently being revised and it is expected that the new guidelines will shed more light on these matters.
The second major change is that, under the new regime, a penalty will also be imposed for the simple act of not preparing transfer pricing documentation, regardless of whether the inter-company transactions were at arm’s length.
The penalty of RM20,000-RM100,000 (in the case of no prosecution) is applicable for each year of assessment and can be hefty, taking into account that transfer pricing audits may cover up to seven years.
The Malaysian transfer pricing provision in Section 140A of the Income Tax Act applies to all transactions with associated persons, not just international transactions. There are some administrative concessions to prepare limited transfer pricing documentation or transfer pricing policy, but there’s no blanket exemption from requirements, even for companies that have domestic transactions only.
Malaysia is not the first country in the region to view transfer pricing from a compliance rather than an anti-avoidance perspective. However, it is noteworthy that both amendments described above are generally believed to apply retrospectively on the previous years for any tax audits conducted since 1 January 2021. Hence, businesses are advised to review the last seven years of documentation and act on any gaps.
In conclusion, the tightening of rules has placed transfer pricing in the limelight and taxpayers should take on a more proactive rather than reactive approach in addressing practices.
Companies that fail to comply and adopt robust documentation and international best practices are invariably exposed to higher risk of transfer pricing adjustment during an audit.