Malaysia: Negotiating and Amending Advance Pricing Agreements in View of Covid-19 Disruptions

The Covid-19 pandemic and its accompanying economic recession and rise in unemployment rates have led to reduced tax revenues for the Malaysian Government. In November 2020, the Ministry of Finance (MOF) reported that government revenue is projected to decline by 14% to 227.3 billion Malaysian ringgits ($55.35 billion) for 2020 as a result of lower tax collections. Much has also been made of the decline in oil prices affecting Malaysia, an oil-producing country. Against this backdrop, the Malaysian Government has had to roll out special concessions, monetary aids, and measures to revive and rebuild the national economy. This has put increased pressure on the Malaysian Inland Revenue Board (IRB) to collect more taxes.

It is therefore unsurprising that the IRB has been conducting more aggressive tax audits in an effort to add to and broaden tax collections. In 2021, government revenue is projected to increase by 4.2% to 236.9 billion ringgits ($57.69). According to the MOF, the higher projected revenue is the result of better tax collection, which is expected to increase by 13.8% to 174.4 billion ringgits ($42.47) (direct tax collection in 2021 is estimated to constitute 55.7% to total revenue).

From a transfer pricing perspective, we can expect the IRB to examine in greater detail transfer pricing policies and pricing arrangements between related parties. There is an imminent need for taxpayers to review and reconsider transfer pricing models that were adopted in the past, and analyze the impact of Covid-19 on their pricing arrangements. This would also require an examination of taxpayers’ APAs.

Malaysia’s APA regime

Malaysia’s APA regime has been in place since 2012. Under the Malaysian Income Tax Act 1967 and the Advance Pricing Arrangement Guidelines 2012 (APA Guidelines), a taxpayer that carries out a cross border transaction with an associated person can apply for a unilateral APA, bilateral APA, or multilateral APA.

An APA may cover a minimum period of three to a maximum period of five years, and may be renewed depending on the facts and circumstances. Taxpayers may apply for a rollback, so that the transfer pricing methodology used in the APA may be applied to the years prior to the covered period, if the facts and circumstances surrounding those years are substantially similar to that of the covered period.

The objective of the APA regime is to provide certainty about the appropriate transfer pricing method to be applied in pricing a covered transaction. A well-negotiated APA will reduce the risk of potential double taxation, place the taxpayer in a better position to predict tax liabilities, and minimize audit-related costs and burdens.

Covid-19-related concerns

Taxpayers may have opted to enter into an APA prior to the occurrence of Covid-19, or are considering entering into an APA notwithstanding the current environment. In October 2020, the IRB issued a set of guidance in the form of frequently asked questions (FAQ) about Covid-19 related issues that are pertinent to APAs. The FAQ provides an indication of the IRB’s response to issues that may arise in relation to taxpayers’ existing APAs, as well as new and ongoing applications, if their businesses are potentially impacted by the pandemic.

The key takeaways of the FAQ are as follows:

• New Applications

The IRB has maintained that it will not be accepting new APA applications from businesses that are “significantly affected” by the Covid-19 pandemic. Businesses that are not significantly affected by the Covid-19 may submit APA applications in accordance with the procedures outlined in the Income Tax (Advance Pricing Arrangements) Rules 2012 and the APA Guidelines.

The IRB’s refusal to accept new APA applications from businesses that are significantly affected by Covid-19 may be due to some extent to difficulties in sourcing for reliable comparable data, as well as fluctuating economic conditions. Given that supply chain disruptions and other Covid-19-related challenges have affected MNEs differently and their responses may be different, the IRB may be hesitant to rely on any data for the purpose of benchmarking until conditions have stabilized.

• Existing or Ongoing Applications

Taxpayers that are significantly impacted by Covid-19 can choose to either continue with or withdraw applications that have been submitted to the IRB. An existing APA application will be reviewed based on information previously submitted, and the proposed arm’s-length range will be determined using a benchmarking analysis of comparable data in pre-pandemic economic and market conditions. The IRB has maintained that it will not allow any amendments, substantial updates, or material changes to be made to applications that have been submitted or are under review. Revised profit and loss margins or projections are unlikely to be accepted. The IRB has taken this position as it is of the view that the full impact of Covid-19 is still highly uncertain.

This may have the effect of discouraging some taxpayers from proceeding with an APA application. For example, in the case of an MNE group that has experienced Covid-19 disruptions, there may be changes to the functions of entities involved in an APA application or the value they create, which significantly affect their projected allocated profits. Potentially, such an MNE group may need to withdraw its application if the IRB remains disinclined to amending the application to reflect the MNE group’s changed circumstances and the MNE group is unable to attain greater transfer pricing security through the APA.

Nonetheless, it is encouraging that the IRB has stated in its FAQ that it may, in certain circumstances, take into account the impact of the Covid -19 pandemic on proposed covered transactions by considering the application of a term test with any compensating adjustment to be made at the end of the APA covered period. The IRB will review data submitted and form an opinion on a case by case basis. If the APA is bilateral or multilateral, the application of a term test would be subject to negotiations with the competent authorities of corresponding jurisdictions.

• Expiring APAs

An expiring APA can be renewed with similar terms and conditions unless the critical assumptions of the APA are no longer valid or relevant due to material changes to the taxpayer’s business.

• Concluded APAs

Taxpayers must continue to comply with all of the critical assumptions of their concluded APAs. If there is a potential breach of any of the critical assumptions of a concluded APA, taxpayers should consider notifying the IRB and requesting for a revision or cancellation of the APA. The IRB may cancel and revoke the APA if there has been a breach of the critical assumptions and parties fail to conclude a revised APA.

The APA Guidelines and the FAQ state that taxpayers are required to notify the IRB and provide supporting documentation within 30 days of becoming aware of the need to revise the APA due to a failure to meet any of the critical assumptions of the APA. As such, taxpayers should notify the IRB in a timely manner about any material change that leads to a breach of a critical assumption, notwithstanding that the IRB may defer its response until there is more information about the full impact of Covid-19.

It would be to the MNE’s advantage to consider its negotiation strategy ahead of engaging in discussions with the IRB, and the data and analysis that should be offered to achieve a favorable outcome. In December 2020, the OECD issued guidance on the transfer pricing implications of the Covid-19 pandemic, which sets out a list of documents that taxpayers can provide to tax administrations in order to document a breach of critical assumptions, including the projected and actual business segment profits for Covid-19-affected years, copies of proposed or implemented modifications to pre-existing contracts, an explanation of the anticipated effects of Covid-19 economic conditions, detailed profit and loss statements for Covid-19 affected years, and information about third-party behavior. Such documents may be potentially useful in the context of engagements with the IRB.

Conclusion

The IRB has indicated that it will review and update its FAQ from time to time as the Covid-19 pandemic unfolds, and more data and information about the impact of Covid-19 become available. Taxpayers should review their signed APAs in view of the potential impact of Covid-19, and if necessary, formulate a negotiation strategy and raise Covid-19-related issues with the IRB in a timely manner. Similarly, if taxpayers are negotiating new APAs, they should consider how the current economic conditions may affect, among other things, their projected allocated profits, and consider how they should raise these issues with the IRB in order to achieve greater transfer pricing certainty based on a principled approach.

In the current environment, negotiating new APAs or the revision of existing APAs can be difficult; taxpayers will need to, among other things, collate data and information about the actual and potential impacts of Covid-19 on their businesses and industries, explain how they have taken measures to minimise these impacts, undertake additional analyses, and prepare financial models. However, a well-negotiated revised or new APA will provide the taxpayer with greater transfer pricing certainty, and the benefits of arriving at a mutually agreeable position can outweigh the potential costs of being audited and suffering a full-blown dispute later.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Adeline Wong and Krystal Ng are partners at Wong & Partners, member firm of Baker McKenzie in Malaysia.

Bloomberg Tax Insights articles are written by experienced practitioners, academics, and policy experts discussing developments and current issues in taxation. To contribute, please contact us at TaxInsights@bloombergindustry.com.