Malaysia: Taxpayer succeeds before the Malaysian High Court in landmark ruling on transfer pricing adjustments

In brief

Wong & Partners successfully represented a Taxpayer before the Malaysian High Court in a landmark transfer pricing ruling against the Malaysian Inland Revenue Board (IRB).

Since 2017, there has been an increased focus on transfer-pricing related issues in Malaysia in view of the nation's commitment to address base erosion and profit shifting as a member of the OECD Inclusive Framework. As transfer pricing is not considered an “exact” science, taxpayers and the IRB often differ in their interpretation of transfer pricing legislation and guidelines. This has led to confusion on how transfer pricing principles are to be applied.

Therefore, the High Court's latest ruling, which provides clarity on the application of key principles under the OECD Transfer Pricing Guidelines ("OECD Guidelines"), is a much welcomed one. The High Court also affirmed and expanded on the Special Commissioners of Income Tax's (SCIT) earlier decision, which was discussed here.


The Taxpayer acted as a limited risk distributor for a related company to oversee the distribution of consumer goods in Malaysia. Under the distribution agreement, the Taxpayer would earn a guaranteed profit margin that adheres to arm's length principles. Following a transfer pricing audit:

  1. The IRB adjusted the Taxpayer's profit margin to the median of the comparable results, despite the Taxpayer's margin falling within the arm's length range.
  2. The IRB found that the Taxpayer had mischaracterized itself as a limited risk distributor and instead claimed that the Taxpayer was a "normal distributor" that was entitled to higher compensation.
  3. The IRB selected its own five comparable companies to justify its adjustments.

The IRB's adjustments resulted in the imposition of additional taxes on the Taxpayer. In making its adjustment, the IRB had disregarded the Taxpayer's detailed transfer pricing report, which proved that the transactions were at arm's length.

High Court's key findings

  1. The IRB’s adjustment of the Taxpayer's profit margin to median is incorrect

The Taxpayer challenged the IRB's long-standing practice of making transfer pricing adjustments to the median of the transactions, even when the pricing falls within the arm's length range. In its decision, the High Court clarified the principles relevant to making transfer pricing adjustments under the OECD Guidelines:

  1. If the pricing falls within the arm's length range, no adjustment is necessary. If the pricing falls outside the arm's length range, the IRB should give the taxpayer the opportunity to provide explanations for why its pricing falls outside such range.
  2. If the taxpayer is unable to give a reasonable explanation to the IRB, the IRB may adjust to any point within the arm's length range and use measures of central tendency to determine this point (e.g., the mean, weighted averages, median).
  3. In the present case, as the Taxpayer's pricing falls within the arm's length range, no adjustment is necessary.

Hence, the High Court found the Taxpayer's profit margin to be at arm's length and dismissed the IRB's transfer pricing adjustments.

  1. In the absence of the IRB's transfer pricing analysis, the Taxpayer's transfer pricing report must prevail

The High Court found that the IRB’s failure to produce a transfer pricing report is fatal to its case. 

The High Court rejected the IRB's classification of the Taxpayer as a “normal distributor” as the IRB did not undertake any functional, comparability and economic tests required for a proper transfer pricing analysis. In its decision, the High Court observed that the IRB "cannot simply pluck characters of a taxpayer and pigeon hole them to one category or another." 

The IRB failed to explicitly state what transfer pricing methodology it was applying, nor provide a detailed comparability analysis to find independent comparable companies. Further, an examination of the OECD Guidelines reveals that the OECD Guidelines only recognize “full-fledged” and “limited risk” distributors. The IRB's classification of the Taxpayer as a “normal distributor” is nowhere to be found in the OECD Guidelines.

Importantly, the extensive transfer pricing analysis performed by the Taxpayer properly supports the characterization of the Taxpayer as a limited risk distributor. In the absence of the IRB's own transfer pricing analysis, the Taxpayer's transfer pricing documentation − being the only evidence capable of being relied upon by the Courts − should prevail.

  1. The IRB's selection of comparable companies is incompatible with the Taxpayer

In the course of the audit, the IRB selected its own five comparable companies to justify its adjustments. However, the High Court found these comparable companies to be dissimilar in functions, assets and risks (FAR) to the Taxpayer. In particular, the IRB's comparable companies had working capital levels, inventories, modes of production and marketing that were vastly different from the Taxpayer's.

Under the OECD Guidelines, comparability adjustments should be made to increase the reliability of the results if there are dissimilarities between the comparable companies and the tested company. However, the IRB failed to make working capital adjustments to address the differences in working capital levels (which reflects the level of risks assumed) between the Taxpayer and the five comparable companies.

The High Court rejected the IRB's inordinate focus on "functions". The High Court held that when assessing the comparability of companies, one must equally assess the functions, assets and risks of the tested company and the comparables. Therefore, the High Court found the IRB's set of comparables to be unreliable. Instead, the High Court adopted the Taxpayer's set of comparables, which were properly selected after undertaking an extensive comparability analysis.

Key takeaways

On 20 April 2022, the High Court affirmed the SCIT's decision and found in favour of the Taxpayer.

This is a decision of much importance as it not only constitutes one of the first few Malaysian Court decisions about the application of the OECD Guidelines, but is also the first decision which provides comprehensive judicial guidance on the steps for determining the transfer price. 

Amongst others, the High Court's ruling sets out in detail the methodology to be adopted when conducting a FAR analysis, and concepts relevant to the identification of potential comparables, the making of comparability adjustments where appropriate, and the interpretation of data collected when determining the arm’s length price. The High Court's decision establishes clearer principles for the interpretation of transfer pricing legislation and guidelines, which must now be adhered by tax authorities and taxpayers alike. 

It is important that taxpayers regularly review their transfer pricing policies and perform benchmarking exercises to ensure that their operating margins are within the arm’s length range established by comparable businesses in similar industries. The availability of contemporaneous and defensible transfer pricing documentation will likely prove to be the key difference in transfer pricing disputes, as seen in the High Court's ruling. Ultimately, the pre-emptive measures adopted by taxpayers today to protect themselves will contribute significantly to building a defensible position against future transfer pricing adjustments. 


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