TP Audit Insights

Learning From Real Cases

Introduction

As part of our ongoing commitment to knowledge sharing, we are pleased to introduce a series of insights drawn from our real-life experiences with the Inland Revenue Board of Malaysia (“IRB”), focusing specifically on tax audit cases involving transfer pricing (“TP”) issues. This initiative is designed to provide practical perspectives to our clients, business associates, and broader network of stakeholders.

These insights are particularly relevant for businesses engaged in controlled transactions with related parties. By distilling key lessons from each case, we aim to support organisations in strengthening their TP framework and ensuring alignment with the IRB’s evolving expectations. Ultimately, this will help mitigate the risk of significant tax exposures, adjustments, and penalties.

Should your organisation require assistance with TP matters, our dedicated TP team would be delighted to engage with you. We offer a complimentary initial consultation to better understand your specific needs, enabling you to make an informed decision before appointing a TP advisor.

Read in PDF

Case #1:

Challenges in a Full-Fledged Risk-Bearing Distributor Model

Quick Facts & Background

The taxpayer, a Malaysian company, is a subsidiary of an overseas holding company. It operates as a distribution arm for its overseas related companies by acting as the exclusive distributor of certain house-branded hardware products in Malaysia. It procures its inventory from related-party manufacturers located overseas.

IRB’s Audit Findings

The IRB conducted a tax audit on the Company covering the preceding six years of assessment (“YAs”) (“audit period”) and raised several key concerns:

Loss-making position
As the Company recorded losses in certain years, the IRB questioned whether these losses were attributable to inappropriate transfer prices for intercompany purchases within the Group.
Challenge on intercompany pricing policies
The IRB challenged the validity of the pricing policies applied to purchases from overseas related parties. The Company was requested to provide detailed documentation at both the Company and Group levels to support the arm’s length nature of the transactions. This included, in particular, costing sheets and profit margin computations of the overseas related-party suppliers for products sold to the Company.
Rejection of TP method (RPM)
The IRB rejected the use of the Resale Price Method (“RPM”) as the most appropriate transfer pricing method, on the basis that gross margin was not a reliable profit level indicator. The IRB argued that gross margin was significantly affected by factors such as differences in product mix, pricing policies, and market conditions, which may not be sufficiently comparable across selected benchmark companies. Consequently, the IRB proposed the application of the Transactional Net Margin Method (“TNMM”).
Rejection of comparables
In the benchmarking analysis, the IRB rejected certain comparable companies on the grounds that they recorded more than two consecutive years of losses. This was despite the fact that the years under review included the COVID-19 period, during which many businesses experienced negative financial performance.
Proposed TP adjustment
Based on the above positions, the IRB proposed a transfer pricing adjustment to bring the Transactional Net Margin to the median of the benchmarking results for the covered period, resulting in an estimated tax exposure of a few million Ringgit for the Company.

Responses and Final Outcome

We assisted the Company in defending its transfer pricing position by working closely with management to address each of the IRB’s concerns.

A key success factor was the ability to substantiate the Company’s position through strong commercial justifications, comprehensive technical analysis, and robust documentary evidence. This enabled us to demonstrate both the soundness of the Company’s transfer pricing policies and the integrity of its compliance framework.

Following extensive discussions, the IRB agreed to compromise, and the proposed transfer pricing adjustment was ultimately set aside. As a result, no adjustment was imposed, and the Company’s transfer pricing position was successfully upheld.

Duration of audit: Approximately 10 months

Key Lessons Learnt

This case highlights several important considerations for taxpayers involved in transfer pricing audits:

Provide clear and structured explanations
Persuasive, technically sound, and commercially grounded arguments are critical in strengthening the transfer pricing position.
Maintain robust supporting documentation
Proper accounting records and legal documentation are essential in substantiating and defending transfer pricing arrangements during an audit.
Ensure cooperation from overseas related parties
Active support from related parties involved in controlled transactions is crucial. Such cooperation enables access to relevant information needed to demonstrate the arm’s length nature and robustness of the pricing.
Prepare contemporaneous TP documentation
Transfer pricing documentation should be prepared on a contemporaneous basis in line with IRB requirements, incorporating both qualitative and quantitative analyses. For companies in a loss-making position, it is particularly important to provide clear evidence demonstrating that losses arise from commercial realities (e.g., market conditions, economic downturns), rather than transfer pricing factors.