What You Need to Know about the Malaysian Updates to Transfer Pricing Guidelines incorporating the BEPS Action Plans 8 to 10.
By Abdul Razak Rahman
On 15 July 2017 the Inland Revenue Board Malaysia (IRBM) announced new updates to the Transfer Pricing Guidelines 2012. The updates, which are an expansion of the existing guidelines, are effective immediately and introduce changes to the following chapters:
- Chapter II: The arm’s length principles
- Chapter VIII: Intangibles
- Chapter X: Commodity transactions
- Chapter XI: Documentation
The updated guidelines essentially realign the existing transfer pricing (TP) standards to that of the Base Erosion and Profit Shifting (BEPS) Actions 8 to 10 (Aligning transfer pricing outcomes with value creation) and BEPS Action 13 (Transfer pricing documentation and country-by-country reporting).
The following are the key points from the session by SM Thanneermalai, Managing Director of Thannees Tax Consulting Services at the MIA Transfer Pricing Conference 2017.
Chapter II: Arm’s Length Principles
- Transfer price is acceptable if all transactions between associated entities are conducted at arm’s length price which would have been determined if such transactions were made between independent parties under similar circumstances.
- Ensuring that returns are aligned to value creation and not to an entity solely because it has contractually assumed risks or provided capital, and identify circumstances in which transactions can be re-characterised
- Accurately delineate or draw the responsibility lines of the controlled transactions, to ensure that the actual conduct substantially conforms to the terms of the written contract.
- Focused and robust analysis on functions, assets and risks (FAR) with emphasis on value creation between affiliate entities to ascertain the transfer pricing outcomes.
- Functions involve allocation of the functions, identification of the party undertaking and the capability to undertake.
- Assets involve identification of the party contributing and the type of assets.
- Risks deal with the allocation of risks supported by the actual decision making.
- Introduction of the Risk Analysis Framework (a six-step approach) for the purpose of accurately delineating actual transactions in relation to risks. The 6-step approach encompasses:
- Step 1: Identify economically significant risks with specificity.
- Step 2: Contractual assumption of risks
- Step 3: Functional analysis in relation to risks
- Step 4: Interpreting Steps 1 to 3
- Step 5: If differences exist, reallocating the risks accordingly
- Step 6: Pricing the transaction
- Introduces measures that taxpayers can consider such as working capital adjustments and recognition of Berry Ratio as a profit level indicator.
Chapter VII: Intangibles
- Detailed guidance on identification and categorisation of intangibles. In addition to trade and marketing intangibles, the definition of intangibles has been broadened to cover government licenses and exclusive rights, production sharing contracts, licenses that grant trade restrictions, power purchase agreement, and contracts to supply pharmaceutical products to government hospitals.
- Introduction of the Development, Enhancement, Maintenance, Protection and Exploitation (DEMPE) concept to analyse transactions involving intangibles, and to identify legal owner and economic owners for allocation of the arm’s length remuneration with regards to their contribution towards the development of intangibles.
- Guidance on determination of arm’s length compensation for specific transactions and owners, which include R&D service providers, limited risk distributors performing AMP activities and local contract manufacturers.
- Guidance on transfer pricing analysis involving the use and transfer of intangibles, which include transfer of rights in intangibles, transfer of combination of intangibles and transactions involving the use of intangibles in connection with the sale of goods or performance of services.
- Introduction of valuation techniques in addition to Comparable Uncontrolled Price (CUP) and Profit Split Method to estimate the arm’s length price for intercompany transfer of intangibles.
Chapter X: Commodity Transactions
- This is a new chapter and provides taxpayers with guidance on the application of CUP method on commodity transactions.
- Reasonably accurate adjustments should be made to the quoted price for the commodity to ensure the economically relevant characteristics.
- Evidence of Price-Setting Policy to be provided by the taxpayer to the IRBM as part of the transfer pricing documentation
- In case of mismatch of pricing dates between the contract and actual conduct, the IRBM has the discretion to determine the pricing date based on evidence available to the IRBM. The pricing date refers to the specific time and date selected by the parties to determine the price for commodity transactions.
Chapter XI: Documentation
- Introduces the Master File as part of the transfer pricing documentation for taxpayers who are required to comply with the Country-by-Country Reporting requirements
- Taxpayers are no longer encouraged but required to maintain contemporaneous documents. Documentation should include a description of the management structure of the local entity and local organisation chart, as well as a detailed description of the business and business strategy pursued by the local entity.
- The comparable searches in the database supporting part of the Transfer Pricing should be updated every three years rather than annually. However, financial data and suitability of the existing comparable should be reviewed and updated every year.
- Guidance provided on disclosure of material changes impacting transfer pricing analysis such as changes in shareholding, changes in business model and structure, changes in business activities, changes in financial/financing structure, changes in TP policy or merger and acquisition.
- Additional information on pricing analyses is spelt out to improve clarity. Pricing policy should include information such as details on the formula adopted, how the formula is applied, who determines the pricing policy, how often the policy is revised, the sample of documents to support the pricing policy, and results of a comparability study to ensure the arm’s length price.
- Taxpayers are required to evaluate the management, allocation and assumptions of risks by making reference to the Risk Analysis Framework.
- The chapter also re-emphasises the power of the IRBM to impose penalty and the penalty is expected to increase up to 100% in 2018.