Understanding Controlled Transactions – Insights from Malaysia’s Transfer Pricing Regulations
Are all business transactions created equal?
It is questionable, as the transfer pricing environment, where transactions between two related entities within a same group are often conducted differently as compared with those between independent parties. The element of “control” plays a dominant role in every transfer pricing arrangement. Whenever transactions occur between related parties, the general rule is they are usually considered controlled transactions. Hence, this is precisely why the arm’s length principle often becomes the key point of contention between taxpayers and the Inland Revenue Board of Malaysia (IRBM) when determining the pricing of transactions.
In the glossary of the Malaysian Transfer Pricing Guidelines 2024 (MTPG 2024), controlled transactions are defined as transactions involving the acquisition or supply of property or services between associated persons. For such transactions, the Inland Revenue Board of Malaysia (IRBM) requires taxpayers to demonstrate that the prices charged between the transacted entities fall within the arm’s length range. Whether the control arises from a parent company, between sister subsidiaries or through common shareholder or common decision maker, it influences how the pricing process is determined. In the absence of “control”, the arm’s length principle would not be applicable as independent parties naturally negotiate terms based on market forces.
Control as provisioned in Malaysian Transfer Pricing Framework and OECD Guidelines
The provisions and scope of control are defined in Malaysia’s primary legislation, the Income Tax Act 1967 and further elaborated in the Malaysian Transfer Pricing Guidelines 2024 (MTPG 2024). The transfer pricing framework is aligned with Article 9 of the OECD Tax Convention on Income and on Capital (2017).
Article 9 provides:
[Where] conditions are made or imposed between the two [associated] enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which would, but for those conditions, have accrued to one of the enterprises, but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly.
Article 9(1) defines and established the scope of “associated persons”:
(a) an enterprise of a Contracting State participates directly or indirectly in the management, control or capital of an enterprise of the other Contracting State, or
(b) the same persons participate directly or indirectly in the management, control or capital of an enterprise of a Contracting State and an enterprise of the other Contracting State
Article 9 emphasizes two forms of participation to capture the reality of most commercial structures where the participation in the management, control or capital can be in the form of direct participation or indirect participation. In Malaysia, this principle is codified in section 139 of Income Tax 1967 (ITA 1967) which provides for both the direct and indirect control. Direct control arises through direct ownership of majority shares and voting right, while indirect control is through a third person (intermediaries or nominees).
It is crucial to note that paragraph 1.12 of MTPG 2024 refers taxpayers to section2(4) of ITA, which defines the concept of “companies in the same group” and further explains that companies can be controlled directly or indirectly under section 139 ITA. In addition, paragraph 1.13 of the MTPG 2024 reinforces the definition of “associated persons” stating that two companies are associated with each other if one o of the companies participates directly or indirectly in the management, control or capital of the other company; or if the same person participates directly or indirectly in the management, control or capital of both companies. This principle applies equally to both cross-border transactions and domestic transactions. Unlike the threshold set for determining the type of transfer pricing documentation, whether full or limited transfer pricing documentation; there is no specific threshold in defining control in transactions between associated persons.
Illustrated Examples of Transfer Pricing
Examples of control are illustrated in Example 1.1 -1.3 below[1]
It cannot be said that Malaysian tax regulators are lacking in providing a clear definition of what constitutes control among parties within the same group. To further demonstrate this, Section 140A(5) ITA specifies that “controlled transactions” refer to transactions that occurred between:
(a) persons one of whom has control over the other;
(b) individuals who are relatives of each other; or
(c) persons both of whom are controlled by some other person.
Section 139(7) ITA has broadened the scope of associated persons to include:
(a) A person of the following relationship: husband or wife, parent or remote forebear, child or remoter issued, brother, sister and partner;
(b) The trustee or trustees of a settlement where the person or their relatives ( as listed above) are settlors; or
(c) Where a person is interested in shares or obligations of a company subject to a trust or part of a deceased person’s estate, any other person interested therein.
A new subsection 140A(5A) begins by emphasizing that it operates without prejudice to the general provisions of S139 and section 140A(5). This new subsection expands the meaning of “control” to persons who directly own shares or a third person who owns both entities where the percentage of share capital held is at least 20% and meets one or more of the following conditions:
(a) The business operations of a person depend on the proprietary rights, such as patents, non-patented technological know-how, trademarks, or copyrights, provided by the other person or third person; or
(b) The business activities, such as purchases, sales, receipt of services, provision of services, of a person are specified by the other person, and the prices and other conditions relating to the supply are influenced by such other person or third person; or
(c) One or more of the directors or members of the board of directors of a person are appointed by the other person or third person.
Section S140A(5A) applies in circumstances where Company B relies on Company A for its proprietary rights to conduct its business activities or where Company A exercises influence over Company B’s pricing policy or where Company A has the authority to dictate the appointment or removal of director(s) of Company B.
Transactions 3 and 4 in Example 1.7 as illustrated in MTPG 2024 are particularly noteworthy. The guidance concludes that the purchases between XYZ Co and MyABC Sdn Bhd in Transaction 3 do not constitute controlled transactions as XYZ Co does not hold any direct shareholding in MyABC Sdn Bhd. The similar conclusion is reached in Transaction 4 where the transacting parties are not regarded as associated persons due to the absence of direct shareholding by ABC Co in My ABC Sdn Bhd. Consequently, the sale transaction between the parties is also deemed not to be a controlled transaction.
Interestingly, these two transactions suggest that no element of control exist in the absence of direct shareholding between the transacting entities.
This raised an important question – do the conclusions in these Transactions 3 and 4 align with the arm’s length principle and the requirements of transfer pricing regulations in Malaysia? A misinterpretation of Example 1.7 could potentially expose taxpayers to significant transfer pricing adjustments and penalties. Avoid ambiguity, learn more, and stay updated through our ongoing workshops. Check the schedule here.
Follow us in our future blog, “Is Example 1.7 Misunderstood? Why Section 140A(5A) Deserves a Closer Look”
[1]Extracted from Transfer Pricing Guidelines 2024
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About The Author
Alycia Lee Mie Sin, a transfer pricing professional based in Kuala Lumpur, is the principal consultant of Treasure Advisory, a boutique firm specialising in transfer pricing. She holds a Bachelor of Law degree from the University of London and Advanced Professional Certificate in Transfer Pricing I & II from IBFD Amsterdam. She weaves regulatory issues with a pragmatic perspective. Her articles are designed to simplify complex transfer pricing concepts into practical insights tailored for directors, business owners and heads of departments. Through her writing, she seeks to educate and raise awareness about transfer pricing compliance and its impact on business operations. She may be reachable at alycia@treasureadvisory.com
Disclaimer: This article is written for general informational purposes only. The content should not be construed as professional tax, legal, or transfer pricing advice. Readers are encouraged to seek tailored guidance from qualified professionals before making any business or compliance decisions