TAX667

ADVANCED TAXATION

TRANSFER PRICING AND

ADVANCE PRICING ARRANGEMENT
(APA)
 Learning Outcomes
• At the end of this chapter, students should be able to:
– Explain the objectives of transfer pricing guidelines
– Explain the tax authorities practice and the methods
acceptable by the IRBM
– Explain the meaning of arm’s length principle and
contemporaneous documentation
– Explain the importance of the advance pricing arrangement
(APA)
 Chapter’s Outline

TP Guidelines issued Tax authorities’

by IRBM practices

Methods of Arm’s length

computation principle
acceptable by IRBM

Contemporaneous The importance

documentation of APA
 Introduction to Transfer Price

• Ideally, the transfer price should not differ from the prevailing
market price.
– However, when business dealings are made between such
connected persons, they may not always reflect the dynamics of
market forces as would be expected if such transactions were
carried out by independent enterprises.
– As with any tax administration, it is the duty of the IRBM to ensure
that the transfer pricing methodologies adopted by MNEs are
reasonable, and that their Malaysian subsidiaries are paying their
fair share of tax.
– In order to do so, MNEs involved must be able to provide adequate
documented proof to support their transfer pricing policies.
 TRANSFER PRICING
Pricing system on transfer of goods, services and
intangibles between entities in a group of companies

This pricing system usually applies for MNEs with

holding companies in overseas and branches in Malaysia ,
and for controlled transactions

The pricing adopted between related companies must

be at MARKET VALUE, reflecting the actual work done.
CONTROLLED TRANSACTIONS =
Transactions that took places between associated persons

Individuals who are relatives

Associated 1 of each other
Persons
Person of whom has
2 control over the other

Person controlled by some

3 other person
 TP as Audit Area
• TP is strictly monitored by IRBM because:
– A country with a higher rates of tax would sell goods at a
low profit margin to a low tax country so that a large
portion of profit will eventually tax at a lower tax.
– Since Malaysia income tax rate is relatively higher, IRBM
wants to ensure that TP is not arbitrary and no loss of
revenues for the government.
– IRBM has formulated TRANSFER PRICING GUIDELINES in
July 2003 to ensure that all companies pay their fair share
of tax, based on prevailing market value of goods.
 TP Guidelines 2003
The TP Guidelines existing domestic legislation
seek to provide all
MNEs concerned
with information on methodologies acceptable to IRB
that can be used in determining
ARM’S LENGTH PRICE
administrative regulations
including the types of records
and documentation expected
from taxpayers involved in
transfer pricing arrangements
 ARMS LENGTH PRICE

The price, which would have been determined if such

transactions were made between independent entities
under the same or similar circumstances.

• The arm’s length approach, which is internationally accepted as

the preferred basis for determining the transfer price of a
transaction between associated parties will be the basis
adopted by IRBM.
• This is consistent with the objective of minimizing the
possibility for double taxation.
 Comparability Analysis
• A COMPARABILITY ANALYSIS is a pre-requisite in the
application of all transfer pricing methodologies that conform
to the arm’s length principle.
– This involves comparing conditions in a controlled
transaction with those in transactions between
independent parties.
• Transactions are deemed comparable if there are no material
differences between the transactions being compared or,
reasonably accurate adjustments can be made to eliminate any
material differences in the transactions.
 Comparability Analysis
– In a comparability analysis, focus is usually directed at
circumstances surrounding the commercial and financial
relations between associated enterprises, the processes
involved, the economic performance such as profits and
margins, and factors that influence the economic
performance.
– Comparability must also be considered when dealing with
products that are sophisticated or high-tech such as
computer software, or involve services such as consultancy
or engineering.
 Factors Determining Comparability
Characteristics of
property or services
• The physical features, quality
and the volume of supply of
property;
• In the provision of services,
the nature and extent of
services; and
• In the case of intangible
property, the form of
transaction and type of
property.
Functions performed
• The functions that need to be
compared include product
design, manufacturing,
marketing, advertising, and
research and development
(R&D).
• In comparing such functions,
assets employed (e.g. plant
and machinery) as well as the
nature of such assets (e.g. age
and market value), and the
use of intangibles must also
be considered.
• The type of risks to consider
include market risks, financial
risks including exchange rate
risks and the risks associated
with the success or failure of
R&D that the MNE
undertakes.
Other factors –
economic and business
• Economic circumstances that
may affect prices charged or
profits earned in controlled
and uncontrolled transactions
include the geographic
location of the market; the
size of the market; the
availability of substitute goods
and services; the extent of
government intervention
• Business strategies that are
relevant in determining
comparability include
innovation and new product
development, degree of
diversification, market
penetration schemes,
distribution channel selection
and market level and location
TP Conventional Methods

Cost
Comparable Plus Price (CUP)
Uncontrolled
Resale Price
 1. CUP Method
• This method focuses directly on the price of the goods or
services transferred in a controlled transaction to the price
charged for the goods or services in a comparable independent
transaction.

ARM’S LENGTH PRICE =

The selling price of similar products
between independent parties

• Some pricing adjustments would be made for product

differences, brand name, sales volume, market risk etc.
• The CUP method is ideal only if comparable products are
available, or if reasonably accurate adjustments can be made to
eliminate material product differences.
 2. Resale Price Method
• This method is employed to adjust on purchase price.
• Malaysian entity may purchase products from its related party
and sell to the third party.

ARM’S LENGTH PRICE =

Resale Price – (Resale Price X Resale Price Margin)

• The usefulness of the method largely depends on how much

added value or alteration the reseller has done on the product
before it is resold, or the time lapse between purchase and
onward sale.
 2. Resale Price Method

Resale Price Margin = Sales Price – Purchase Price

Sales Price

• Resale price margin must be comparable to margins earned

by other independent enterprises performing similar
functions, bearing similar risks and employing similar assets.
• This method focuses on the gross margin obtained by the
distributor.
• This method is suitable where a product is purchased from
an associated person and then resold to an independent
distributor.
 3. Cost-Plus Method
• The cost plus method is often useful in the case of
• 1) semi-finished goods which are sold between associated
parties (related party distributor)
2) when different companies in an MNE have concluded
joint facility arrangements
3) when the manufacturer is a contract manufacturer, or
where the controlled transaction is the provision of services.

ARM’S LENGTH PRICE =

Costs + (Costs X Cost plus mark up)
 3. Cost-Plus Method

Cost plus mark up = Sales price – Cost

Cost

• Cost plus mark up must be comparable to mark-ups earned by

independent parties performing comparable functions,
bearing similar risks and using similar assets.
Transactional Net Margin Method (TNMM)
• Transactional profit method should only be considered when
conventional methods discussed before are not applicable.
• Its methodology is based on profit derived from related party
transaction as compared to an equivalent comparable
transaction between independent enterprises.
• Transactional net margin method is more accurate where:
– Profit is derived from comparable uncontrolled
transactions between same taxpayer and independent
parties
– Net profit that would have been earned in comparable
transactions by an independent enterprise is available
 Documentation
• Taxpayers are required to keep sufficient records for a period of seven
years from the end of the year to which income from the business relates,
as provided for under paragraph 82(1)(a) of the ITA, to enable the DG to
ascertain income or loss from the business.
• Subsection 82(7) further provides that all records relating to any business
in Malaysia must be kept and retained in Malaysia. 'Records' under
subsection 82(9) include books of accounts, invoices, vouchers, receipts and
other documents necessary to verify entries in any books of accounts.
• For transfer pricing purposes, adherence to the following documentation
and record keeping requirements will be advantageous to the taxpayer as it
reduces the risk of a tax audit and subsequent adjustments under section
140, which will be made according to what the DG thinks are reasonable
transfer prices.
 Documentation
• Documents pertaining to transfer pricing are not to be submitted
with Return Forms but should be made available to the IRBM upon
request.
• All relevant documentation must be in/translated into the Malay or
English language, prepared at the time the transfer price is
established, and contain particulars (where applicable, depending
on the type of transaction) as stated under paragraph 10.3.

1 Company’s details

2 Transaction’s details

3 Method used to compute arm’s length price

 Advance Pricing Arrangement (APA)
• With effect from 1.1.2009, any person who carries out a cross
border transaction with an associated person can apply to the DG:
– To enter into an advance pricing arrangement (APA) with the DG
in Malaysia, or
– Competent authorities (relevant overseas tax authorities) in
overseas
To determine the basis of transfer pricing methodology of future
apportionment of income or deduction to ensure arm’s length
transfer prices are applied.

• This APA assists to resolve any future dispute among the two
countries’ tax authorities on the appropriate profit attributable to
the two countries.
 Importance of APA
Because APA Provides certainty on the appropriate TPM to apply in pricing a covered
transaction thus enhancing the predictability of tax treatment on
addresses international transactions
future
transactions, Avoids and eliminates potential double taxation through bilateral or
multilateral APA, ensuring that all profits are correctly allocated and taxed. A
a taxpayer taxpayer is, thus, always encouraged to apply for a bilateral/multilateral APA
stands to
benefit from Alleviates costly and time-consuming examination of transfer pricing issues
in the event of an audit, and lessens the possibility of protracted and
an APA as expensive litigation
follows:
Places the taxpayer in a better position to predict costs and expenses,
including tax liabilities

Reduces record keeping burden as the taxpayer will know in advance the
required documentation to be kept to substantiate the agreed TPM.
 Tutorial Questions
1. Jun 2019, Q4
2. Dec 2018, 4(d).
3. Jan 18, Q4 (a).
4. Jul 2017, Q4 (A).
5. Dec 2016, Q3 (D)
6. Jun 2016, Q4 (iv)