The 2012-established Malaysia Transfer Pricing Guidelines define "transfer pricing" as "intercompany pricing arrangements for the transfer of products, services, and intangibles between related individuals." The transfer price should, in a perfect world, be the same as the market value that would be represented in a deal between two independent parties.
On the other hand, business dealings involving connected parties may not always represent market dynamics. The Organization for Economic Co-operation and Development's (OECD) Transfer Pricing Guidelines' definition of the arm's length concept is the foundation of the Guidelines.
So, what is Transfer Pricing?
The term refers to the science and art of establishing transfer prices. When two or more linked parties exchange goods or services with one another, transfer pricing is involved. The tax authorities would anticipate that taxpayers in these circumstances would adhere to the arm’s length principle and set an arm’s length price.
What is an arm’s length price and why do we use it?
The price that independent parties will agree to for comparable transactions with comparable terms, conditions, and circumstances is referred to as an arm’s length pricing. In reality, it is difficult to determine arm’s length prices since few transactions are exactly the same, for instance, the terms and circumstances of export sales are frequently different from those of domestic sales. Even if the transactions are equal, prices can change throughout the day as well as from day to day, for example, the price of commodities.
When two parties are related, the tax authorities are free to let them conduct business at whatever price (i.e. market price) that was mutually agreed upon. These exchanges are referred to as unregulated trades. This term is called related parties. This is done to prevent linked parties from shifting profits (inadvertently or on purpose) to other countries, intentionally to loss-making businesses that receive tax breaks, which would cause the government to lose tax income.
What is Related Parties?
These parties are directly or indirectly in control of one another or are under the common control of another party. They include local and international holding firms, subsidiaries, branches, and corporate headquarters.
But under Section 140A(5) of the Income Tax Act 1967 has defined related to mean the following:
The person who has control over the other.
People who are related to one another. According to Section 140(8) of the ITA 1967, the term “relative” refers to a parent, a child (including a stepchild and a child adopted in accordance with any legislation, a brother, sister, uncle, aunt, nephew, cousin, ancestor or a lineal descendant.
Person both of whom are controlled by some other person (Third person).
Section 140A (5) of the ITA state “control” to exist in the situation below where person, one of whom owns shares of the other person or a third person owns shares of both persons, where the percentage of the share capital held in either situation is 20% or more:
The person’s economic operations are dependent on the intellectual rights, such as patents, non-patent technological know-how, trademarks, or copyrights, granted by the other person or a third party.
The other person specifies the commercial activities of that person, including purchases, sales, receiving services, and providing services, and they or a third party influences the prices and other terms connected to supply.
Where one or more of the directors or members of the board of directors of a person are appointed by the other person or third person.
Is Transfer Pricing a bad thing?
The government is worried about transfer pricing arrangements that are not at arm’s length even though it is usual and important for related parties to transfer goods and services to one another. Certain associated parties may set pricing for their goods and services that are not accurate representations of the dynamics driving the market in order to avoid paying taxes. Prices are purposefully or misrepresented to obtain a tax benefit. And the nation would frequently lose tax money because of this approach.
What is the Guidelines for Transfer Pricing?
To help those participating in transfer pricing agreements operate in compliance with the regulations and administrative requirements of the Inland Revenue Board Malaysia (IRBM), including record keeping and documentations, LHDN has released transfer pricing guidelines (transfer pricing documentation).
It is untrue to believe that regulations for transfer pricing solely apply to foreign trade. These rules apply to both domestic and foreign transactions. These regulations also apply to frequent transactions like property rentals and intra-group loans between affiliated businesses.
What are the documents you need to prepare for transfer pricing?
When determining prices for related party transactions, all business entities are obligated to adhere to the arm’s length standards. They must also create contemporaneous transfer pricing documents and data that taxpayers can use to calculate the transfer price before or at the time the transaction are carried out.
These may consist of the following information:
Organizational Structure
Nature of business/ industry and market conditions
Description of the concerned transactions and parties involved
Pricing policies and pricing formula
Assumptions, strategies, and information that are relevant to the pricing policies
Comparability, functional and risk analysis
Selection and application of pricing method
Financial Information
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