Tax issues – Avoid abusing transfer pricing to shelter profits

IN Malaysia, each separate entity is taxed on a stand-alone basis. There is no group or consolidated taxation in Malaysia where group companies can transfer losses or depreciation to each other. This provides an incentive to extend the use of transfer pricing to move losses, profits, depreciation, expenses, and revenues within the enterprise group to minimize taxes.

The question is, is the transfer being made within the legitimate domain of acceptable transfer pricing laws, regulations and guidelines? Where is the tipping point before legitimate transfer pricing becomes abusive transfer pricing?

Are transfer prices legal?

Each business-to-business transaction involving the sale or purchase of goods, services, the provision of financing and the use of intangible assets between related companies where one has significant economic influence over the other involves a transfer price. . If the transfer price is equivalent to the price that would have been charged between two unrelated independent parties, then it is perfectly legal and would meet the “arm’s length” test.

The tipping point of abusive transfer pricing

Fictitious transactions do not fall within the scope of transfer pricing and are considered tax evasion. Similarly, if the transactions give rise to a tax benefit without incurring any loss or cost, this falls within the scope of abusive tax avoidance.

The tipping point where transfer pricing turns into abusive transfer pricing is when transactions are put in place between related parties to shift profits and losses through the use of tax shelters to reduce the global taxation of the group without commercial substance.

Where are the tax havens?

Group tax havens can be found in businesses with unused losses or depreciation, and another category that is far more attractive to abusive transfer pricing is the availability of all types of tax incentives such as l MSC Malaysia Incentive, Principal Hub, Pioneer Status, Investment Tax Allowance and Reinvestment Allowance.

The availability of tax shelters incentivizes groups to transfer their profits to companies or operations benefiting from tax incentives. In simple terms, the company benefiting from the incentive benefits either from a zero tax rate or a lower tax rate and the opposite company within the group will normally pay a tax of 24%. It is common sense that when you move profits from a 24% plan to a 0% plan, the tax savings can be significant. Tax shelters can also extend to cross-border transactions and a common example is shifting profits from Malaysia, which has a 24% tax regime, to Singapore or Hong Kong, where tax rates are 17% or 16.5%.

Legitimate benefit transfers are acceptable

The transfer of profits to benefit from tax incentives or to offshore entities is perfectly acceptable provided that the transaction is actually carried out, commercially explainable and that it forms an integral part of the normal commercial activities of the group. It is equally important that the price of the transaction is established on an arm’s length basis, which will be equivalent to the price agreed between independent third parties. Documentation of related party transactions should be complete and the standard adopted should be no less than if the transaction had taken place between third parties. Documentation alone is not enough. There must be evidence that the subsequent implementation of the transaction follows the documentation.

General observation

In general, Malaysian domestic groups do not allocate enough resources to manage their transfer pricing. It’s time to pay more attention to this area, otherwise the cost of incorrect pricing or lack of evidence could result in substantial additional taxes, surcharges and penalties. Malaysian groups mistakenly focus most of their efforts on documenting transfer pricing rather than defining and implementing transfer pricing transactions.

This article was written by Managing Director of Thannees Tax Consulting Services Sdn Bhd, SM Thanneermalai (www.thannees.com).

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