Malaysia: Effective Jan 1, new provisions will target transfer pricing and related party financing
IN less than a month, significant new provisions will be introduced into Malaysia’s tax legislation.
These provisions will specifically target transfer pricing (which applies to related party transactions or RPTs) and thin capitalisation (related party financing).
Given that these changes will be effective from Jan 1, it is crucial that finance directors and finance personnel understand the tax implications of these new provisions so that they can be adequately prepared.
New transfer pricing provision: The new provision provides that RPTs must be carried out on an arm’s length basis.
Simply, this means that taxpayers, who transact with related parties, must be able to prove that the pricing for the RPTs is no different than what it would be if the transaction was with independent parties.
To prove that the RPTs are at arm’s length, taxpayers will be required to prepare transfer pricing documentation on a timely basis based on the Malaysian transfer pricing guidelines. The burden of proof on taxpayers will be much greater.
It would appear that if taxpayers, who are engaged in RPTs, do not have timely and proper documentation, the initial reaction of the Inland Revenue Board (IRB) may be that their RPTs were not carried out on an arm’s length basis.
How should taxpayers prepare? As a start, taxpayers should review all their RPTs and ask themselves if they are able to prove that their RPTs are conducted on an arm’s length basis.
It is uncertain at this moment whether specific thresholds would be applied in determining whether transfer pricing documentation is required so that taxpayers are not over-burdened with additional compliance costs which are disproportionate to their circumstances.
If it is considered that the existing documentation is insufficient to prove arm’s length, preparation of specific transfer pricing documentation should be considered with assistance from professional advisers.
Keeping the required transfer pricing documentation will provide taxpayers with a first line of defence in the event of a tax audit.
Changing transfer pricing environment: Given the significant changes on the transfer pricing scene in Malaysia, it appears that the IRB is placing greater emphasis on transfer pricing compliance and will be more willing to challenge taxpayers during tax audits and, if necessary, in court.
It is also expected that the IRB will redeploy more resources into this area in order to tighten compliance with transfer pricing matters.
It is not all bad news for taxpayers. The Government has recognised the importance of an Advance Pricing Agreement (APA) mechanism and, with effect from Jan 1, taxpayers are allowed to apply for APAs.
An APA is a mechanism to reach agreement with tax authorities on prices of goods and services to be transacted in future between a taxpayer and its related companies for a specified period.
Taxpayers can consider using the APA as a tool to manage their transfer pricing risks as it will allow them to achieve certainty on their pricing for RPTs and also to minimise penalties.
What is thin capitalisation? Thin capitalisation aims to restrict the deduction of interest expenses on loans between associated parties. Broadly, the amount of interest to be restricted is determined by comparing the ratio of associated party debt with the equity of a company.
Where debt is high in relation to equity, the amount of interest attributed to associated party debt over and above the prescribed ratio will not be deductible.
Regionally, debt-to-equity ratios of 3:1 are common with a higher ratio being allowed for financial institutions.
The IRB has on occasion indicated that a 3:1 ratio will also apply in the Malaysian context.
It remains to be seen whether any provisions will be introduced to protect companies whose debt-to-equity ratios exceed the prescribed limit immediately prior to the introduction of the new legislation.
How is thin capitalisation calculated? Although at first glance, thin capitalisation is a relatively straight forward concept, in reality the calculation can be complicated.
A key issue which needs to be addressed is at what point in time equity and debt are measured.
The level of a company’s debt as well as equity may change during the year.
Companies may issue new shares or undergo capital reductions and share options may be exercised during the year thereby varying the debt-to-equity ratio.
Clarification is also required on what is considered as “financial assistance” and, in particular, whether domestic associated party debt is included in the ratio.
Where domestic debt is included, companies may wish to consider obtaining their funding directly from banks instead of through group companies.
With the implementation deadline rapidly approaching, companies will need to critically review their debt-to-equity ratios. Companies which have exceeded the prescribed ratio will not, in the absence of any saving provisions, be able to claim a full tax deduction for interest expenses incurred. This will have an adverse impact on the cash flow of the affected company.
Rules expected: Rules are expected to be issued by the IRB soon in order for the new transfer pricing and thin capitalisation concepts to be operational.
However, pending the issuance of these rules, companies will have to face the additional challenge of uncertainty.
Nicholas Crist and Bob Kee are executive directors of KPMG Tax Services Sdn Bhd.
Source: The Star December 19, 2008
