IN RECENT YEARS, Malay­sia’s Inland Rev­enue Board (IRB) has stepped up its focus on trans­fer pri­cing audits.

Busi­nesses enga­ging in related party trans­ac­tions are increas­ingly in the spot­light. With the grow­ing scru­tiny, it’s essen­tial for com­pan­ies to under­stand the com­mon pit­falls that can trig­ger hefty pen­al­ties and addi­tional taxes, and how to pre­pare effect­ively.

The CTPD should not be treated as a mere form­al­ity as it is the found­a­tion that sup­ports the pri­cing of related party trans­ac­tions and demon­strates that trans­ac­tions are com­mer­cially rational and that it meets the arm’s length prin­ciple.

The pre­par­a­tion of CTPD for tax­pay­ers who exceed the pre­scribed threshold is man­dat­ory. The Trans­fer Pri­cing Rules (TP Rules) com­pre­hens­ively set out the inform­a­tion that must com­pulsor­ily be dis­closed. If any of the require­ments stated in the TP Rules are not applic­able, reas­ons must be provided to sup­port the non-applic­a­tion.

The dat­ing of the CTPD is extremely import­ant as the doc­u­ment must be pre­pared at the time trans­ac­tion is being under­taken or before the tax return for a par­tic­u­lar year of assess­ment is filed.

Dur­ing a trans­fer pri­cing audit, the IRB typ­ic­ally grants tax­pay­ers 14 days to sub­mit the inform­a­tion reques­ted, which includes the CTPD. Fail­ure to sub­mit the CTPD within this 14-day time frame will auto­mat­ic­ally be treated as the tax­payer not hav­ing CTPD in place, thus trig­ger­ing pen­al­ties and the max­imum 5% sur­charge on any trans­fer pri­cing adjust­ment arising from the audit.

Tax­pay­ers must ensure that a robust and fully com­pli­ant CTPD is pre­pared within the dead­line and updated annu­ally. Hav­ing the doc­u­ment­a­tion before an audit begins will pro­tect tax­pay­ers from pen­al­ties and sur­charges.

Wrong characterisation of transactions
Mis­char­ac­ter­ising the nature of a trans­ac­tion will res­ult in wrong trans­fer pri­cing ana­lysis. For example, where the trans­fer price involves merely an agency arrange­ment versus a buy-sell arrange­ment, the arm’s length pri­cing on the former trans­ac­tion will be much lower com­pared to the lat­ter.

Another example will be between a toll man­u­fac­turer and con­tract man­u­fac­turer.

If IRB finds that the facts are not aligned with your doc­u­ment­a­tion, they have the right to rechar­ac­ter­ise and reprice the trans­ac­tion res­ult­ing in addi­tional taxes and sur­charge.

Profit fluctuations without commercial explanation
Profit mar­gins nat­ur­ally fluc­tu­ate in busi­ness, but unex­plained vari­ations often raise red flags. Dur­ing audits, IRB expects com­pan­ies to provide clear com­mer­cial reas­ons for profit swings, such as mar­ket changes, new product launches or oper­a­tional issues.

Tax­pay­ers must doc­u­ment the com­mer­cial reas­ons behind profit fluc­tu­ations thor­oughly. Keep internal reports, mar­ket ana­lysis, and busi­ness decisions that explain changes in prof­it­ab­il­ity to sup­port your pos­i­tion dur­ing an audit.

External comparability study is not robust
A key part of trans­fer pri­cing is bench­mark­ing against com­par­able inde­pend­ent parties. If the external com­par­ab­il­ity study is not robust or reli­able, IRB will adjust the com­pany’s profit mar­gin to the median of the inde­pend­ent parties’ mar­gins. This adjust­ment often res­ults in addi­tional tax pay­able and a sur­charge of up to 5% on the gross adjust­ments made.

The bench­mark­ing study must be con­duc­ted and up to date using reli­able data­bases and appro­pri­ate Malay­sian com­par­ables. Tax­pay­ers must review and update the com­par­ab­il­ity ana­lysis reg­u­larly to ensure it reflects cur­rent mar­ket con­di­tions.

Service fees without proper support
Pay­ment of ser­vice fees to related parties without adequate doc­u­ment­a­tion to prove the ser­vices were actu­ally received and benefited the recip­i­ent is a com­mon audit trig­ger. If com­pan­ies can­not sub­stan­ti­ate these expenses, IRB may dis­al­low them in the tax com­pu­ta­tion, lead­ing to addi­tional taxes and pen­al­ties.

To deal with this, tax­pay­ers must main­tain detailed ser­vice agree­ments, timesheets, invoices and evid­ence of the ser­vices and bene­fits received by the related party.

Ensure that ser­vice fees charged reflect actual ser­vices rendered and align with the arm’s length prin­ciple.

Ignor­ing these risks can lead to costly pen­al­ties, increased tax bills and unne­ces­sary head­aches.

This article is contributed by Thannees Tax Consulting Services Sdn Bhd managing director SM Thanneermalai (www.thannees.com).

This article was originally published on TheSun.