Be practical in choosing transfer pricing methodologies
TTCS Virtual Sharing Session on Indirect Tax

26 February 2024

ALL intercompany transactions for tax purposes must be conducted on an arm’s length basis (i.e. conducted on similar terms and conditions comparable to similar transactions undertaken between entirely unconnected third parties).

The Malaysian Inland Revenue Board (IRB) requires such transactions to be transacted at an arm’s length basis because it wants to collect the correct amount of taxes in the appropriate companies or business enterprises. There is a frequent tendency for taxpayers to shift profits within the group to entities with tax incentives, losses, excess capital allowances, or to foreign jurisdictions with lower tax rates.

The underlying theme in transfer pricing is comparing related party transactions versus third party transactions undertaken under similar circumstances, which is referred to under the transfer pricing terminology as “comparability analysis”.

Purpose of transfer pricing methodology

Transfer pricing methodology is used as a tool to either set the transfer prices, or to test whether the transfer prices meet the arm’s length test.

In choosing the correct transfer pricing methodology, it is important to understand the business conditions under which the transactions are being undertaken and the business conditions under which the related parties are operating.

Transfer pricing methodology is not cast in stone

The Malaysian Transfer Pricing Guidelines and the Organisation for Economic Cooperation and Development transfer pricing guidelines recommend five common transfer pricing methodologies – Comparable Uncontrolled Price, Cost-Plus, Resale Minus, Profit Split and Transactional Net Margin (TNMM).

Generally, taxpayers, tax advisers and tax authorities in the majority of instances take it for granted that they must try and use one of these five methods to prove that the transactions between the related parties are being carried out on an arm’s length basis.

This rigid application of the methodologies without taking into account the business conditions and business circumstances in which the related parties operate will give the wrong results. Taxpayers have a choice in our transfer pricing rules and guidelines to choose to use either the five methods, or to use any other methods that reflect their business conditions.

In the real business world, two unrelated parties transacting with one another will look at a whole host of factors before they arrive at the pricing of a transaction. This will basically focus on each party obtaining the best deal (i.e. supplier wants the highest price, and the buyer wants the lowest price). Among the issues that will be under consideration will be demand and supply, return on capital, payback period, competitor pricing, market conditions, barriers to entry, regulatory restrictions, financing options, available capacity, lifecycle of product, etc

There is a danger that the tax preparers and the authorities fall into silos and end up arriving at the wrong arm’s length transfer prices. An example would be where a foreign party sets up a manufacturing entity in Malaysia and supplies goods back to the foreign owner who markets the product in that country.

It is possible that the capacity set up in Malaysia is far in excess of the current demand overseas. However, in the longer run, it is anticipated that the capacity will be used up. In such a situation, it is likely that the Malaysian company which may be a contract manufacturer is experiencing losses due to excess capacity. There is a tendency for the tax authorities to take the position that the Malaysian subsidiary, which is a contract manufacturer, must make profits, and the methodology used here is cost-plus or the TNMM. Is this correct?

Not necessarily. The reason could be the parent company based overseas may not be able to sell the products at a price that will be profitable to the group or the volume of sales is not able to recoup the total costs of the operations in the overseas country and in Malaysia. In that situation, applying a cost-plus methodology or a transactions net margin method from a one-sided perspective (i.e. Malaysia) is incorrect. In such a situation, the business conditions must be taken into account and perhaps a hybrid methodology that combines the cost-plus and the profit split methodology needs to be applied here.

It is extremely important for all parties to be business orientated and flexible in applying the transfer pricing methodology. Trying to fit them into the five boxes will give you wrong results.

This article is contributed by Thannees Tax Consulting Services Sdn Bhd managing director SM Thanneermalai (

This article was originally published on the Sun daily.

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