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Demystifying the Arm’s Length Principle in Malaysian Transfer Pricing


The arm’s length principle is a fundamental concept in transfer pricing that ensures fairness and accuracy in transactions between associated persons. In Malaysia, the application of the arm’s length principle is explicitly required for related party transactions involving the acquisition or supply of property or services. This blog post aims to provide an in-depth understanding of the arm’s length principle and its practical application in Malaysian transfer pricing regulations.

Defining the Arm’s Length Principle

While the Income Tax Act, 1967 (ITA) in Malaysia does not provide a specific definition for the term “arm’s length,” the Transfer Pricing Guidelines 2012 (TP Guidelines 2012) offer clarity on the principle and its application. According to the TP Guidelines 2012, the arm’s length principle necessitates that all transactions between associated parties are conducted at a price that would be determined if the transactions were carried out between independent entities under similar circumstances.

Key Elements of the Arm’s Length Principle

The application of the arm’s length principle in Malaysian transfer pricing regulations involves several key elements, including the definition of transactions and related parties.

1. Transactions: The term “transaction” encompasses various legal arrangements, such as trusts, grants, covenants, agreements, and other dispositions. It includes both written and oral transactions entered into by individuals or entities. Additionally, it applies to transactions between two or more persons with another person or persons.

2. Related Parties: Related parties are defined based on specific relationships:

– Persons with control: One person having control over another establishes a related party relationship. Control can be exercised directly or indirectly, and it includes scenarios where a person possesses the majority of share capital or voting power in a company.

– Individuals who are relatives: Relatives of each other are also considered related parties.

– Persons controlled by another person: When two or more persons are controlled by the same entity, they are deemed related parties.

Determining Control

The ITA provides a detailed definition of “control” to ascertain the existence of related party relationships. Control is established if:

1. A person exercises, is able to exercise, or is entitled to acquire control over the affairs of a company. This includes possessing the majority of share capital or voting power in the company.

2. A person possesses or is entitled to acquire a significant portion of the issued share capital, which would entitle them to receive the majority of the distributed income in the event of a winding-up.

3. In the event of a winding-up, a person would be entitled to the majority of the available assets for distribution among members.

Furthermore, control can be established through nominees exercising rights or powers on behalf of a person or by being a loan creditor of a company. Additionally, persons who, collectively, control a company based on the sum of their holdings are also considered to have control.

Recent Amendments and Enhanced Disregard of Structures

The Finance Act 2020 introduced new subsections (3A & 3B) to Section 140A of the ITA, empowering the Director General of the Inland Revenue Board (IRB) to disregard and recharacterize structures adopted in controlled transactions. These subsections come into play when either the economic substance of the transaction differs from its form or the arrangements made deviate from those that independent persons would adopt in a commercially rational manner, and the actual structure hinders the determination of an appropriate transfer price.

In cases where the Director General disregards a structure adopted by a person under subsection (3A), adjustments may be made to reflect the structure that an independent person would have adopted, considering the economic and commercial reality.


The arm’s length principle forms the foundation of transfer pricing regulations in Malaysia, ensuring that related party transactions are conducted at prices equivalent to those in transactions between independent entities. Understanding the key elements of the arm’s length principle, including transactions and related parties, is vital for businesses to comply with Malaysian transfer pricing regulations. It is also crucial to stay informed about recent amendments, such as the enhanced disregard of structures, to ensure alignment with the evolving regulatory landscape. By adhering to the arm’s length principle, businesses can mitigate the risk of transfer pricing disputes and maintain transparency in their cross-border transactions.

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