On 14 August 2020, the Bank Negara Malaysia released a report on the dismaying contraction of GDP of -17.1% for the Second Quarter of 2020 (“2Q20”). In the previous quarter (1Q20), the GDP growth was 0.7%. For the whole year of 2020, the GDP growth is forecasted at between -3.5% and -5.5%. Certainly, the on-going COVID-19 pandemic and the resultant Government’s Movement Control Order (“MCO”) have made a big dent in Malaysia’s economy.
Against this backdrop, the Malaysian Inland Revenue Board (“IRB”), which had suspended its audit activities during the MCO period, have wasted no time in resuming its tax audit activities soon after the lifting of the MCO in early May 2020. Given that the IRB has a tax collection target of RM155 billion for year 2020, it is not surprising to see more intensified audit activities in the coming months. The biggest challenge to the IRB is to race against time to find tax revenue through uncovering errors in the tax returns during these tax audit exercises.
Increased focus on transfer pricing audits
For groups of companies, transfer pricing is a key area of focus for the IRB’s audit as there is a high tendency in “mis-pricing” related party transactions due to complication of the subject matter. In this regard, companies involving in related party transactions (or technically known as “controlled transactions”) are obligated to observe the transfer pricing provisions under Section 140A of the Income Tax Act 1967. Section 140A places the onus on the taxpayers to prove to the IRB that their controlled transactions have been conducted in accordance with the arm’s length principle. Failure of which, the IRB is empowered to make transfer pricing adjustments it deems fit on the controlled transactions in the spirit of arm’s length principle. Under the arm’s length principle, the transactions between companies within a group are expected to be transacted as if they are dealing with independent parties.
Defending Transfer Pricing Position
In many instances, taxpayers were not able to defend their transfer pricing positions when subjected to close scrutiny by the IRB as they have under-estimated the amount of documents required to be supplied to the IRB during a transfer pricing audit.
As in other tax audits, prior preparation is key in avoiding any unforeseen issues during an official tax audit. An early preparation in anticipation of a transfer pricing audit will help taxpayers to alleviate the stress level of all concerned when the company is selected for a tax audit.
To take precautions one step further, one should adopt a positive mindset with the objective of managing a transfer pricing audit successfully and with the desired favourable outcomes. Whilst taxpayers may have already gained a sense of familiarity with the compliance requirements under the Malaysian Transfer Pricing Guidelines (“MTPG”), many may not be aware of the transfer pricing audit process, let alone how to effectively manage the audit exercise.