Introduction
As businesses operate in an increasingly interconnected global economy, transfer pricing becomes a crucial aspect of international taxation. In Malaysia, several special areas require careful consideration to ensure compliance with the arm’s length principle. This blog post delves into the intricacies of these special areas, including intangible assets, intra-group services, cost contribution arrangements, financial services and transactions, and digital economy transactions.
I. Intangible Assets
Malaysia emphasizes that payments for the transfer and licensing of intangible assets must adhere to the arm’s length principle. Consequently, taxpayers must thoroughly document the selection of transfer pricing methods and the computation of transfer prices. The Inland Revenue Board (IRB) closely scrutinizes payments related to know-how, copyrights, and trademarks, making these transactions more likely to be selected for tax audits.
The Income Tax (Transfer Pricing) Rules 2012 provide guidance on various aspects, such as the existence of intangible property, entitlement to the property, marketing intangibles, and appropriate transfer pricing methods. Documentation should clarify the identity of both the legal and beneficial owners of intangible assets. Reorganizations within groups of companies are closely examined, and royalties paid by Malaysian contract manufacturers to foreign principals may be challenged. The IRB may also challenge arrangements where a Malaysian company claims to be a limited risk company, attributing profits to a foreign entrepreneur with a permanent establishment in Malaysia.
II. Intra-Group Services
The IRB pays close attention to management fees and other parent company service fees paid by Malaysian permanent establishments or subsidiaries. Taxpayers must establish intercompany service agreements, outlining the type of services received and the calculation of service fees. Evidence of services rendered and documented calculations of fees based on cost allocations from the head office are essential. Tax authorities require proof that the PE or subsidiary derived benefits from intercompany services, and the service fees must conform to the arm’s length principle.
Similarly, when Malaysian companies provide management services to overseas PEs or subsidiaries, comparable evidence and documentation are necessary to support the level of intercompany service fees charged. The Transfer Pricing Guidelines 2012 state that intra-group service fees may not be applicable in cases of shareholder services, duplicative services, services with incidental or passive association, or on-call services, depending on the specific circumstances.
III. Cost Contribution Arrangements
Cost contribution arrangements (CCAs) are recognized by the Income Tax (Transfer Pricing) Rules 2012. Tax auditors closely scrutinize CCAs performed within Malaysian groups or internationally. When a Malaysian company provides central support functions to various divisions, transactions involving services rendered to tax-exempt companies or divisions within the group are examined to ensure that profits are not shifted. Malaysian companies contributing to international cost sharing arrangements must adhere to the TP Guidelines 2012 and consult the OECD Guidelines to ensure arm’s length payments and adequate documentation. The allocation of expenses related to research and development is closely examined by the IRB, influencing the selection of audited taxpayers.
IV. Financial Services and Transactions
The IRB pays particular attention to the level of loans and interest payments between related parties, which may influence the selection of taxpayers for audit. Interest paid between related parties is generally tax-deductible, provided that the company is not thinly capitalized. A debt-to-equity ratio of 3:1 is commonly accepted as the limit to avoid thin capitalization rules. Fees for financial services must also conform to the arm’s length principle.
The Income Tax (Transfer Pricing) Rules 2012 provide guidance on the pricing of financial transactions, including the determination, substitution, and imputation of arm’s length interest. Thin capitalization rules have been replaced by earnings stripping rules since 2019, limiting the deduction for net interest to a specified percentage of earnings before tax, interest, depreciation, and amortization (EBITDA). Disallowed deductions can be carried forward, subject to conditions, and a de minimis threshold of MYR 500,000 applies.
V. Digital Economy Transactions
Since January 2020, foreign digital service providers are subject to a 6% digital service tax (DST) if their annual turnover exceeds MYR 500,000. The DST applies to services delivered over the internet or other electronic networks with minimal human intervention. Updated guidelines have been issued, specifying the conditions for foreign service providers (FSPs) and what constitutes a digital service for taxation purposes. Notably, FSPs providing services exclusively to associated companies in Malaysia are exempt from DST.
Conclusion
In conclusion, businesses operating in Malaysia must navigate these special areas to ensure compliance with the transfer pricing regime. Intangible assets, intra-group services, cost contribution arrangements, financial services and transactions, and digital economy transactions require careful consideration, documentation, and adherence to the arm’s length principle. By understanding and addressing these specific considerations, businesses can minimize tax risks and maintain a strong compliance posture in Malaysia’s evolving transfer pricing landscape.