The Malaysian “Budget 2021”, which was announced by the finance minister on November 6, 2020, strives to raise MYR 322.5 billion and is the largest budget in Malaysian history. Themed as “Stand United, We Shall Prevail”, - Budget 2021 focuses on the Raykat’s well-being (i.e. - welfare of the people), business continuity and economic resilience amid the COVID-19 pandemic. The expansionary Budget 2021 aims to spur the nation’s economic growth as the country grapples with the pandemic’s effects via a boost in allocation to operating expenditure (73.3%), development expenditure (21.4%), and a reserve for the COVID-19 fund (5.3%). It is notable that the federal government's revenue in 2021 will be mainly driven by direct tax revenue of RM131.9 billion (representing 40.9% of the total), in contrast to MYR127 billion targeted for the year 2020. On the other hand, indirect tax revenue is projected to contribute 13.2%, while non-tax revenue and borrowings and use of government’s assets are anticipated to constitute 19.4% and 26.5%, respectively.
To enable economic recovery and growth, the government has proposed various new and enhanced incentives designed to make the nation more attractive for multinationals to do business in Malaysia. From a tax standpoint, the government continues to provide industry-centric support and tax measures targeted towards enhancing Malaysia’s position as a destination for foreign direct investment, especially with the review of current tax incentives, and an increased focus on transfer pricing compliance with the aim of strengthening transfer pricing rules.
The tax measures introduced in Budget 2021 should be viewed in the context of recent developments in international taxation and transfer pricing. The OECD has lately initiated the Base Erosion and Profit Shifting (BEPS) 2.0 project that seeks to address the tax challenges of the digitalization of the economy and intends to provide a coordinated approach to the re-allocation of taxing rights (under Pillar One) and the introduction of global minimum tax rules (under Pillar Two). At this juncture, as a member of the BEPS Inclusive Framework countries, Malaysia is committed to proceed toward agreement on the BEPS 2.0 project. Therefore, ongoing review and re-alignment of unilateral measures (including various incentives) towards international developments are vital and remain to be seen.
This article highlights the salient transfer pricing and tax measures announced in Budget 2021, and their implications for multinationals operating in Malaysia.
New Penalty for Failure to Furnish Contemporaneous Transfer Pricing Documentation
Currently, taxpayers who enter into controlled transactions are required to prepare contemporaneous transfer pricing (TP) documentation under the Income Tax (Transfer Pricing) Rules 2012. The TP documentation is required to be furnished to the Inland Revenue Board (IRB) within 30 days upon request. In case of an audit event commencing on or after January 1, 2021, the TP documentation should be submitted within a shorter timeline, i.e. 14 days as recently stipulated by the IRB. Taxpayers that fail to furnish the TP documentation are currently not subject to any specific penalty.
It is proposed that a new Section 113B of the Income Tax Act (ITA) be introduced, with an effective date of January 1, 2021, under which any person who defaults in furnishing contemporaneous TP documentation shall be liable for the following:
- A fine of not less than MYR20,000 and not more than MYR100,0001; or
- Imprisonment of the company’s director for a term not exceeding six (6) months; or
In addition, taxpayers can appeal against such a decision by filing an appeal with the Special Commissioners of Income Tax but the burden of proof of furnishing of contemporaneous documentation rests with taxpayers.
Under the Malaysian Transfer Pricing Guidelines 2012 as revised in 2017, documentation is deemed “contemporaneous” if it is prepared:
- At the point when the taxpayer is developing or implementing any arrangement or transfer pricing policy with its associated person; or
- If there are material changes when reviewing these arrangements, prior to preparing the income tax return for the relevant year of assessment.
Material changes are significant changes that would impact the functional analysis or transfer pricing analysis of the tested party. Material changes include changes to the operational conditions (for example: changes in shareholding, changes in business model and structure, changes in business activities, or changes the TP policy), and economic conditions (such as foreign exchange; economic downturn; or natural disaster) that will significantly affect the controlled transactions under consideration.
In preparing the documentation, the arm’s length transfer price must be determined before pricing is established based upon the most current reliable data that is reasonably available at the time of determination. However, taxpayers should review the price based on data available at the end of the relevant year of assessment and update the documentation accordingly.
Even though at the time of submission of tax returns taxpayers are not required to submit the contemporaneous TP documentation, they are required to tick a box on the tax filing indicating whether they have prepared the TP documentation. Taxpayers who opt to tick “Yes” should ensure that the TP documentation is in place and be ready to furnish it to the IRB within 30 days upon request. Since such documentation cannot be prepared from scratch in 30 days, the introduction of a specific provision to empower the IRB to impose a penalty for failure to furnish contemporaneous TP documentation represents a bold move towards mandatory preparation of TP documentation. Failure to ensure that contemporaneous TP documentation is readily available to be furnished to the IRB may result in penalties being imposed, regardless of whether a TP adjustment is made or not. When read together with the prevailing Rule 3 of the Income Tax (Transfer Pricing) Rules 2012, the new proposed Section 113B of the ITA provides further enhancement of the current transfer pricing legislation and is a clear indication of the IRB’s expectation for taxpayers engaging in controlled transactions to prepare up-to-date TP documentation for each year of assessment.
Power to Disregard and Adjust Structures
Currently, there is a specific provision empowering the Director General of Inland Revenue (DG) to disregard and make adjustment to any structure adopted by a taxpayer for TP purposes, under the Income Tax (Transfer Pricing) Rules 2012.
A new Section 140A(3A) is proposed to be introduced, with effect from January 1, 2021, to empower the DG to disregard any structure adopted by a person if:
- The economic substance of that transaction differs from its form; or
- The form and substance of that transaction are the same, but the arrangement made in relation to the transaction, viewed in totality, differs from those which would have been adopted in an arm’s length situation.
In addition, the DG will be allowed to make adjustments to the structure of that transaction as DG thinks fit to reflect the structure that would have been adopted by the independent party dealing at arm’s length having regard to the economic and commercial reality.
The current proposal increasingly emphasizes the substance over form requirement and stresses the need for taxpayers to actively review their controlled transactions. This would ensure that such transactions have an economic substance that aligns to the form of the transaction and are supported by transfer pricing analyses demonstrating adherence to the arm’s length principle.
In addition, if the DG exercises the power and makes any adjustment under this provision, the burden of proof would shift to the taxpayer. There is no specific guidance on steps that taxpayers would need to take in order to discharge this burden of proof, e.g., whether they need to demonstrate that the DG has exceeded its powers or has not acted in good faith. Potentially, depending on how this new power is exercised by the DG in practice, this increases risks for multinational companies in Malaysia significantly. Hence, a proactive and strategic risk assessment to identify mitigation measures to be taken becomes imperative for Malaysian entities of a multinational group.
New Surcharge on Transfer Pricing Adjustments, And Power to Remit Surcharge Imposed
Currently, where TP adjustments are made by the DG, the taxpayer is only subject to a penalty if the TP adjustments result in additional tax payable. Where the TP adjustments do not result in additional tax payable, no penalty is imposed.
It is proposed that, with effect from January 1, 2021, a “surcharge” of up to 5% of the total TP adjustments will be imposed whether or not the adjustment results in additional tax payable. The surcharge shall be treated as tax payable for the purposes of tax payment and recovery of the tax payment by civil suit under Sections 103 to 106 of the ITA, and it would not be treated as a tax payable under any other provision within the ITA. In other words, no double tax relief would be available for this surcharge under any of Malaysia’s tax treaties, and thus the surcharge would cause an actual incremental cash outflow to taxpayers.
The proposed surcharge is also applicable to adjustments made in relation to structures disregarded by the DG under the proposed new Section 140A(3A) as discussed above. However, the DG is proposed to be given the discretion to remit the surcharge.
The imposition of a surcharge will affect many companies, especially non-taxable entities that are enjoying tax incentives, suffering losses, etc., as the surcharge is imposed on the total TP adjustment instead of the tax undercharged. Consequently, even non-taxable companies are now under pressure to take TP seriously and undertake an active approach in managing their TP risks.
Relaxation of Substance Requirements for Various Incentives
Currently, Principal Hub (PH) is a broad incentive to position Malaysia as a regional or global hub to conduct strategic management, control and support functions. It is proposed under Budget 2021 that the application period for this incentive be extended for two years until December 31, 2022. It has also been proposed that the current qualifying conditions relating to the required economic substance such as number of value-added jobs, annual operating expenditure and number of key posts be relaxed for the second five-year period of the incentive.
As a measure to enhance and simplify tax incentives for trading activities, a new tax incentive has been proposed for the establishment of Global Trading Center (GTC) at a concessionary tax rate of 10% for a period up to 10 years (5+5). This incentivizes multinational companies to use Malaysia as a procurement or distribution hub. Simultaneously, it allows investors to perform more complex and greater value-add functions to continue using the PH model, which has lower concessionary tax rates. Further clarifications and guidelines are needed on how the GTC incentive is distinguishable from the existing PH incentive in terms of qualifying activities and conditions. This would be especially relevant to companies that carry out both PH services and trading activities but are unable to meet the minimum annual sales value of MYR 500 million for the purposes of the PH incentive. The GTC appears comparable to Singapore’s Global Trader Programme (GTP), which provides for a concessionary tax rate of 5% or 10% on income derived by approved global trading companies from qualifying transactions in qualifying commodities. Although Singapore’s GTP incentive may allow a 5% tax rate, Malaysia’s GTC could still be competitive, for example, due to Malaysia’s cost-competitiveness or the conditions and scope of the GTC.
The government also recognizes the need for increasingly targeted incentives to encourage investments in key sectors in Malaysia. Targeted incentives for manufacturers of pharmaceutical products, including vaccines, have been proposed in the form of a preferential income tax rate of 0% to 10% for the first 10 years and 10% for the next 10 years. In addition, companies that relocate their business or manufacturing activities from overseas to Malaysia are proposed to be eligible for a concessionary tax rate of 0% to 10% for a new company, and 10% for an existing company for a period up to 10 years. Applications for those incentives are required to be submitted to the Malaysia Investment Development Authority (MIDA) no later than December 31, 2022. The tax incentive can be expanded to companies operating in selected services sectors. These include companies adapting digitalization technology with investment that contributes to significant multiplier effects in the following services: (i) provision of technology solution, or more typically technology company which develops technology and provides technology solutions based on substantial scientific or engineering challenges; (ii) provision of infrastructure and technology for cloud computing; (iii) research and development/design and development activities; (iv) medical devices testing laboratory and clinical trials; and (v) any services or manufacturing related services as determined by the Minister of Finance.
Having said that, moving away from a 0% tax rate for incentivized companies is a strategic initiative by the overnment as it encourages foreign direct investment and stimulates the economy while still maintaining a stream of tax revenue for the country. A 10% tax rate may also be in line with international trends, with the OECD proposing a minimum (yet to be determined) global tax rate as part of its BEPS 2.0 Project.
Taxpayers should watch closely for any further developments with regard to the proposals announced in this budget. At this juncture, companies should be aware of the new penalty imposed for failure to furnish contemporaneous TP documentation, the new surcharge levied on TP adjustments instead of on the tax undercharged amount, and the new broad powers given to the DG to disregard and adjust structures adopted by taxpayers. Immediate actions and measures should be considered by multinational groups, including the following:
- Urgently review their compliance status in Malaysia with effect from January 1, 2021 and carry out a strategic risk assessment in respect of their Malaysian presence due to the new powers afforded to the DG.
- Revisit and, if necessary, redesign the current TPpolicies to ensure the form of the transaction aligns with the economic substance and is commercially realistic.
- Prepare contemporaneous TPdocumentation, for both profit and loss-making companies, as per the Malaysian TPrules.
1.Approximately equivalent to USD 5,000 to USD 20,000, respectively