WHENEVER there are transactions between different persons, whether they are related or not, it will inevitably have to be recorded or understood by the parties. This can be stated in written documents, oral agreements, or implied from the behaviour of the parties.
All transactions, unless it is specifically excluded or exempted within the tax legislation, will be brought to tax through the income tax provisions, capital gains tax provisions, stamp duty provisions, real property gains tax provisions, etc. Whenever there is income that is excluded or deductions being claimed, documentation in the form of invoices or purchase orders, are required to support the transaction that gives rise to the income or deduction. The invoices and purchase orders are for the respective transactions, but if the transaction is of a continuing nature, or the transaction is of a one-off nature, or transactions involving significant amounts, will usually be supported with an agreement. The reason being the agreements will comprehensively set out the terms and conditions of the transactions which cannot be stated in the individual documents such as the invoices.
The tax authorities are always asking for documents to support the transactions. The key document the authorities usually ask for are agreements that support the transaction. As stated above, the agreement will tell you what is the intention of the parties and the detailed terms and conditions which will include the pricing of the transaction. The authorities will then go on to look at the individual documents such as invoices to check whether the transactions have been carried out in accordance with the agreement. The purpose here is to ensure that the terms and conditions of the contract is being reflected in the conduct of the parties through the subsidiary documents. In the event the actual conduct differs from the agreements, the authorities will scrutinise the transactions undertaken by the taxpayer more thoroughly.
Having proper legal documentation is crucial for transactions between third parties to support the bona fide nature of the transaction. Without the proper written documentation, the credibility of the representations made by the taxpayer may be in doubt. This is even more important when transactions are between related parties where the starting position taken by the authorities will be that related party transactions do not reflect the market forces experienced by independent parties. Having documentation similar to what third parties would have entered into would certainly help the taxpayer in any claim made for tax purposes.
In transfer pricing cases, the availability of agreements for transactions between related parties is “mandatory” although it is not stated in the law. This is usually the first question the authorities will ask in most countries because it will provide them a lot of answers to the basic questions such as the terms and conditions of the transaction, the pricing arrangement, the roles played by the respective parties, and in some cases, the risks borne by the parties, and the assets used to provide the goods or services. This will be a useful starting point for the authorities to begin their transfer pricing scrutiny.
Whenever there are transactions involving capital gains, real property gains, or stamp duty, the presence of agreements are more or less mandatory. Absence of the legal documents will only leave the taxpayer in a weak situation and give an upper hand to the tax authorities to make assumptions and impose the relevant taxes. Stamp duty only kicks in when there is a written instrument, which is an agreement.
It is easier in most audits or investigations to defend a taxpayer’s actions whenever there are agreements to support the transactions which were carried out in accordance with the terms and conditions of the agreement.
This article is contributed by Thannees Tax Consulting Services Sdn Bhd managing director SM Thanneermalai (www.thannees.com).