Transfer Pricing in Malaysia: Explanation, Latest Guidelines, Laws, Compliance Requirements and Penalties

Malaysia has been rapidly growing towards an export-oriented economy, with an export value reaching US$27 billion in February 2024 alone. 

Nevertheless, maintaining fair and transparent business practices is crucial to uphold Malaysia's reputation as a reliable global trading partner and to safeguard government revenues. 

Transfer pricing rules in Malaysia ensure that transactions between associated entities reflect market realities and are conducted at fair consideration. Compliance with these regulations enables accurate tax assessments and prevents penalties.

What is Transfer Pricing?

Transfer pricing refers to setting prices for transactions between two or more entities that are part of the same multinational enterprise group or are otherwise related to each other, such as subsidiaries, affiliates, or branches. These transactions are called “Controlled Transactions” and typically involve transferring goods, services, or intangible assets.

The key principle behind transfer pricing is ensuring that the prices set for these transactions are conducted at arm's length, meaning they reflect the prices that would be charged between unrelated parties in a similar transaction under similar circumstances. This principle is essential for ensuring fairness and accuracy in financial reporting and tax assessments, especially in cross-border transactions.

The core principle for transfer pricing in Malaysia

Three fundamental rules guide the core principle for transfer pricing in Malaysia:

1. Exchange of goods and services: Transfer pricing regulations apply to transactions involving exchanging goods and services.
2. Between related parties: These regulations specifically target transactions between related parties, where one party or company involved in the transaction participates, wholly or substantially, in controlling, managing, or providing capital to the other party.
3. Arm’s Length Pricing: Transactions between related parties must adhere to the arm's length principle, ensuring that prices are set as if the transactions were between unrelated parties under similar circumstances. This principle aims to prevent profit shifting and ensure fair taxation. There are methodologies published by LHDN (IRBM to determine arm’s length price  Income Tax (Transfer Pricing) Rules 2023.

Why is transfer pricing important in Malaysia?

The transfer pricing method establishes prices reflective of prevailing market rates for such transactions, allowing for the allocation of earnings among various entities within the organization. While transfer pricing facilitates financial management within multinational corporations, its significance extends to tax planning and compliance.

One key aspect of transfer pricing is its role in influencing the tax liabilities of multinational corporations. By strategically setting transfer prices, companies can shift profits and costs among internal divisions, potentially reducing their overall tax burden. 

For example, divisions operating in high-tax jurisdictions may charge lower prices to counterparts in low-tax regions, thereby minimizing taxable income in higher-tax areas and maximizing profits in lower-tax regions.

In short, here are three major reasons why transfer pricing is important.

1. Prevent Tax Evasion: Transfer pricing in Malaysia ensures accurate profit allocation among company divisions, preventing manipulation of prices to evade taxes and maintain compliance with LHDN and Malaysian tax laws.
2. Safeguard Stakeholders' Interests: Transparent transfer pricing enhances accountability in financial reporting, fostering trust among shareholders, investors, and regulatory bodies, thus ensuring reliable decision-making information.
3. Promote Fair Market Practices: Transfer pricing prevents market distortions and contributes to a level playing field for all businesses, enhancing Malaysia's business ethics.

Relevant legislation: Income Tax Act 1967 (Section 140A) & Transfer Pricing Rules

• Transfer pricing regulations in Malaysia are primarily governed by Section 140A of the Income Tax Act, 1967 (ITA), which empowers the Director General of the Inland Revenue Board (IRB) to adjust based on the arm's length principle.
• The Transfer Pricing Guidelines (TP Guidelines) introduced in 2003 and updated in 2012, and further updated in 2023 provide detailed guidance on documentation requirements, transfer pricing methods, cost contribution arrangements, and determining arm's length prices for intangible assets and financial arrangements.

Who is subject to transfer pricing regulations in Malaysia?

All entities involved in controlled transactions, whether domestic transactions within Malaysia or cross-border transactions with entities outside Malaysia are subject to transfer pricing regulations.

All the taxpayers under transfer pricing regulation are required to prepare Transfer Pricing Documentation (TPD). The depth, extent and requirements of the TPD depend on the criteria outlined by LHDN.

Full Transfer Pricing Documentation Requirement

Taxpayers and businesses that fall under the following criteria are required to prepare Full Transfer Pricing Documentation:

1. When the company's gross income surpasses RM 25 million, and the combined value of transactions with related parties exceeds RM 15 million. 

OR

2. If the entity has provided or received controlled financial assistance totalling over RM 50 million, excluding transactions involving financial institutions.

Details to be mentioned in Full TPD

• Maintain contemporaneous documents, prepared during the development or implementation of transfer pricing policies, or when reviewing policies while preparing income tax returns.
• Document Material changes to operational and economic conditions affecting controlled transactions.
• Transfer pricing documentation, or local files, should also include:
  1. Organizational structure, including an organizational chart.
  2. Nature of the business or industry and market conditions.
  3. Details of controlled transactions.
  4. Pricing policies.
  5. Assumptions, strategies, and factors influencing pricing policies.
  6. Comparability, functional, and risk analysis.
  7. Selection and application of transfer pricing methods.
  8. Financial information.

Simplified Transfer Pricing Documentation

Those taxpayers and companies that do not fall under the above criteria are still required to prepare Simplified Transfer Pricing Documentation.

However, entities are exempt from preparing the Simplified TPD if.

1. Controlled transactions are solely between accessible and taxable entities within Malaysia.
2. Controlled transactions do not affect the total tax liability of the entities.

Details of Simplified TPD

• Taxpayers provide a general business description of all relevant associated persons.
• No requirement for a complete comparability study.

Other methods besides the five outlined in the Malaysian Transfer Pricing Guidelines (TPGL) may be used if they result in or best approximate arm's length outcomes.

Transfer Pricing Methods in Malaysia

It is important for every organization to determine the Arm’s Length Price for a controlled transaction to comply with transfer pricing regulations.

The Income Tax (Transfer Pricing) Rules of 2023 prescribe five major methods for determining an arm's length price. These methods are majorly divided into two categories: Transactional methods and Profit Method.

Transactional Method

These methods determine arm's length prices by comparing prices or margins in controlled transactions to comparable uncontrolled transactions.

1. Comparable Uncontrolled Price Method (CUP): This method compares prices charged in controlled transactions to those charged in comparable uncontrolled transactions. It's ideal when comparable products are available, or adjustments can be made to eliminate material differences.
2. Resale Price Method (RPM): RPM starts with the price at which a product purchased from an associated enterprise is resold to an independent one. This price is adjusted by an appropriate gross margin to determine an arm's length price for the original transaction.
3. Cost Plus Method (CPM): CPM is useful for transactions involving semi-finished goods, joint facility agreements, contract manufacturing, or service provision. It begins with the supplier's cost, to which an appropriate markup is added, ideally based on comparable uncontrolled sales.

Profit Method

These methodologies assess profits from controlled transactions among associated enterprises to ensure compliance with the arm's length principle. Profit Methods are employed when traditional transactional methods cannot be applied reliably. 

1. Profit Split Method: This method divides the combined profits of associated enterprises based on their contributions.
2. Transactional Net Margin Method (TNMM): TNMM assesses net profit margins relative to an appropriate base (e.g., costs, sales, assets). It's suitable when comparing gross profit margins is challenging due to different accounting treatments.

When selecting the appropriate method, factors like the nature of the transaction, comparability of data, reliability of assumptions, and adjustability of inaccurate data should be considered.

If neither traditional transactional methods nor transactional profit methods are applicable, alternative methods may be permitted by the tax authority if they adhere to the arm's length principle.

Risks and Penalties 

Non-compliance with transfer pricing could result in two major consequences.

1. Adjustment of Transfer Pricing with Surcharge: When the arm’s length principle is not followed, and the controlled transaction impacts the tax liability.
2. Penalty and Prosecution: When transfer pricing documentation is not maintained as per the requirements.

Transfer Pricing Adjustment

Section 140A of the Income Tax Act 1967 grants authority to the Director General of Inland Revenue (DGIR) to adjust controlled transactions of goods, services, or financial assistance based on the arm’s length principle. This includes the power to disregard and adjust a structure, effective from 1 January 2021.

Surcharge on Transfer Pricing Adjustments: A surcharge of up to 5% on the income increase or reduction of tax deduction resulting from Transfer Pricing adjustments may be levied. 

Penalty and Prosecution

Starting from 1 January 2021, Section 113B of the Income Tax Act 1967 introduces penalties for non-compliance with transfer pricing documentation requirements, as detailed below:

If found guilty, individuals or entities failing to submit Transfer Pricing Documentation to the Inland Revenue Board of Malaysia (IRBM) in a timely manner may incur:

• A fine ranging from RM20,000 to RM100,000.
• Imprisonment for up to 6 months.
• Both fines and imprisonment could be enforced.

The burden of proving compliance falls on the taxpayer in case of prosecution. 

Conclusion

It's crucial for every business in Malaysia involved in controlled transactions to adhere to transfer pricing regulations, as these are closely monitored by the Inland Revenue Board of Malaysia (IRBM) and other authorities to prevent tax evasion. All controlled transactions must comply with the arm's length principle, and businesses should maintain transfer pricing documentation in accordance with government guidelines.