ACC3024 : Advanced Taxation

Lecture 11 Special Issues in Taxation (Part 1)

For Class Use Only

Topics
Juridical double taxation and how the Malaysian tax authority mitigates this issue. Harmful transfer pricing and Guidelines established to counteract.

For Class Use Only

Juridical Double Taxation

For Class Use Only

Juridical Double Taxation

Definition: imposition of income taxes in two (or more) states on the same taxpayer in respect of the same income. E.g., where a resident of one country derives income from sources in the other country, and both countries domestic tax legislation would tax that income. It can also arise where each country considers the taxpayer to be resident in that country under domestic tax laws.

For Class Use Only

Juridical Double Taxation

Tax conventions reduce juridical double taxation by: allocating taxing rights between residence and source states on various categories of income, by eliminating or limiting source country taxation or by requiring a residence state to grant relief for source state taxation through a credit or exemption mechanism;

For Class Use Only

Juridical Double Taxation

E.g., one country may not tax the business profits earned by a resident of the other country unless that resident has a taxable presence as a permanent establishment (PE) in the first country and the profits are attributable to that PE (see illustration later). Terms & condition clearly spelled out in the Agreement For The Avoidance of Double Taxation And The Prevention of Fiscal Evasion With Respect To Taxes On Income DTA in short. See example of DTA between Malaysia & Hong Kong/ Thailand
For Class Use Only 6

General Objectives of DTA

The objectives of DTA include (non-exhaustive): DTA is an agreement between two countries seeking to avoid double taxation by:
defining the taxing rights of each country with regard to cross border flows of income; and

providing for tax credits or exemptions to eliminate double taxation.

For Class Use Only

General Objectives of DTA

DTA provides for the tax claims of two governments both legitimately interested in taxing a particular source of income either by: assigning to one of the two the whole claim; or else by prescribing the basis on which tax claims is to be shared between them.

For Class Use Only

General Objectives of DTA

DTA helps in avoiding and alleviating the adverse burden of international double taxation, by: laying down rules for division of revenue between two countries; exempting certain incomes from tax in either country; reducing the applicable rates of tax on certain incomes taxable in either countries (see illustration).
For Class Use Only 9

Illustration
Taiko Sdn Bhd would like to pay RM200,000 of fees owed to P&C Ltd (a tax resident company incorporated in Hong Kong) in respect of technical services on the design of Taiko Sdn Bhds CRM system. Services were provided by a panel of consultants of P&C Ltd, who came to Malaysia for 2 weeks, in the management office of Taiko Sdn Bhd at Subang. The service fee is business income to P&C Ltd. Discuss the income tax and withholding tax implications on P&C Ltd.
For Class Use Only 10

Illustration
Income tax implication: Is the service fee subject to income tax liable to P&C Ltd as business income in Malaysia? Article 7 of Malaysia-Hong Kong DTA states that profits of an enterprise of a Contracting Party shall be taxable only in that Party unless the enterprise carries on business in the other Contracting Party through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other Party but only so much of them as is attributable to that permanent establishment. So, what do you think?
For Class Use Only 11

Illustration
Withholding tax implication - recap Where any person is liable to make payments to a non-resident in respect of: s.4A [special classes of income]
under ss (ii) amounts paid in consideration of technical advice, assistance or services rendered in connection with technical management; and

s.15A [deemed derivation]

under ss (ii) if responsibility for the payment . lies with a person who is a resident. provided the amount is attributable to services performed in Malaysia; and

s.109A [collection of tax]

he shall, upon paying or crediting the payments, deduct therefrom tax at the rate applicable to such payments

So, what do you think?

For Class Use Only 12

Illustration
Withholding tax implication - recap:

For Class Use Only

13

Illustration
Withholding tax at 10% ?? Article 13 [Fess for Technical Services] of DTA
Para 1: Fees for technical services arising in a Contracting Party and paid to a resident of the other Contracting Party may be taxed in that other Party. Para 2: However, such fees for technical services may also be taxed in the Contracting Party in which they arise and according to the laws of that Party, but if the beneficial owner of the fees for technical services is a resident of the other Contracting Party, the tax so charged shall not exceed five (5) per cent of the gross amount of the fees for technical services.

Case: SGSS v DGIR Look at the DTA first !!

For Class Use Only 14

Juridical Double Taxation Issues in Malaysia

Foreign income (suffered foreign tax) is assessed to Malaysian tax either on: Remittance basis resident individual is charged to tax in Malaysia on his income received in Malaysia from outside Malaysia [s.3]. World income scope resident companies in the business of banking, insurance, shipping and air transport for income accruing in or derived from Malaysia.
For Class Use Only 15

Juridical Double Taxation Issues in Malaysia Three methods of relieving the burden of double taxation: Para 28, Sch 6 (effective YA 2004); Bilateral relief [s.132]; Unilateral relief [s.133].

For Class Use Only

16

Juridical Double Taxation Issues in Malaysia - Illustration

Alan who is a tax resident in Malaysia, derives dividend income paid by a company in Country X which adopts dividend imputation system, tax would have been deducted from the dividend income in Country X; prior to YA2004, if Alan remit the dividend income back to Malaysia, it would be subjected to tax in Malaysia as well.

For Class Use Only

17

Bilateral Relief [s.132]

Relief (para 5, Sch 7) granted to tax residents who have suffered tax in Malaysia and elsewhere on the same income based on double taxation agreement established. Foreign tax payable under the law of a territory outside Malaysia (having double taxation agreement, DTA with Malaysia) is to be allowed as a credit against Malaysian tax payable [s.132].
For Class Use Only 18

Bilateral Relief [s.132]

This relief will benefit: Company resident taxed on world income scope, i.e. the BIAS companies. Company resident suffered foreign tax payment in overseas despite that income is derived from Malaysia.
E.g. technical fee received in Malaysia from overseas for services performed in Malaysia might be subjected to withholding tax at overseas if required in the DTA.

Individual resident suffered foreign tax payment on employment income.

E.g. salary earned during an overseas assignment incidental to exercising of employment in Malaysia (salary taxed under s.13(2)(c)).
For Class Use Only 19

Bilateral Relief [s.132] - Mechanism

Bilateral credit allowed to a tax resident in respect of any foreign income for a YA is:
i) Malaysian tax payable (before s.132 & s.133 relief) x Statutory income (foreign source) Total income

Or
ii) Foreign tax payable in respect of that foreign income

Whichever is lower (shall not exceed a sum equal to so much of the Malaysian tax payable for that year).

For Class Use Only

20

Bilateral Relief [s.132] - Mechanism

Bilateral credit for a YA has to be claimed within 2 years after the end of that YA the duration may be varied in some of the DTA. If the claim of relief is in dispute, claimant is allowed to file an appeal under s.131 [Para 9, Sch 7] The claim to the DG must be made in writing.
For Class Use Only 21

Unilateral Relief [s.133]

A tax resident who is: charged to tax in Malaysia in respect of foreign income; and has suffered tax in respect of the same income in another tax jurisdiction in which the income is derived, may claim unilateral credit if s. 132 bilateral relief is not available (no DTA or any arrangement between Malaysia and the other tax jurisdiction).
For Class Use Only 22

Unilateral Relief [s.133] - Mechanism

Unilateral credit allowed to a tax resident in respect of any foreign income for a YA is:
i) Malaysian tax payable (before s.132 & s.133 relief) x Statutory income (foreign source) Total income

Or
ii) of the foreign tax payable in respect of that foreign income

Whichever is lower (shall not exceed a sum equal to so much of the Malaysian tax payable for that year).
For Class Use Only 23

Unilateral Relief [s.133] - Mechanism

This relief is also granted to non-resident individual who derived employment income and suffered tax overseas [Para 15, Sch 7].
E.g. director exercising employment outside of Malaysia appointed by a Malaysian resident company [s.13(2)(d)].

Unilateral credit for a YA has to be claimed within 2 years after the end of that YA. The claim to the DG must be made in writing.
For Class Use Only 24

Other Benefits of Having DTA

Fair distribution of revenue by the source and residence tax jurisdictions. DTA helps to combat tax evasion and tax avoidance by making information from one contracting state available to the other contract partner. Sharing of proprietary tax information between signed tax jurisdictions discourages tax treaty shopping. Bilateral relieves will create a favourable climate for both inbound and outbound investments.
For Class Use Only 25

Transfer Pricing

For Class Use Only

26

Transfer Pricing Grey Area

Transfer pricing (TP) is simply the act of pricing of goods and services or intangibles when the same is given for use or consumption to a related party (e.g. Subsidiary). Reasons for setting TP:
Internal reasons - include motivating managers and monitoring performance, e.g. by putting a cost to imported inputs External reasons efficiency in taxes and tariffs.

There can be either market-based or non-market the question of legitimacy again!!

For Class Use Only 27

Transfer Pricing Grey Area

TP used in the act of pricing of goods transferable between business units for accountability purposes (and with commercial sense) is generally acceptable no tax implication. However, transfer pricing manipulation (TPM) is an act of tax avoidance. Reason - TPM is fixing transfer price on non-market basis which generally results in saving of organisations tax by shifting taxable profits from:
high tax to low tax jurisdictions (cross-border); profit making to loss incurring associated companies/ business entities.

For Class Use Only

28

Transfer Pricing Implication on Supply Chain- Illustration

What should be done if the tax rate of the country where the Sales Centre resides is 15%? Tax haven? Next lecture!
Source of the diagram: http://www.scdigest.com/images/AFTERTAX.jpg For Class Use Only
29

Latest Development in TPM Monitoring & Control

Income Tax (Transfer Pricing) Rules 2012 TP Guidelines 2012 for business entities with cross border transactions:
E.g., business with gross income > RM25 mil, and total amount of related party transactions > RM15 mil. Keep contemporaneous TP documentation right from development, implementation & further review of TP policy established based upon most current reliable data.

Advanced Pricing Arrangement (APA) Guidelines 2012 [s.138C]

Advanced agreement between taxpayers & DGIR/ other authorities on TP policy on cross-border related party transactions over a specified period of time, terms and conditions. Entities with turnover > RM100 mil, > 50% sales or purchases based on TP policy, or total value > RM25 mil of other transactions.
For Class Use Only 30

10

General Objectives of Transfer Pricing Guidelines

To ensure TP methods used by MNEs are reasonable on intragroup transactions [next slide] between their entity (PE or associated company) in Malaysia and entity located overseas [scope of the guidelines, entities related via control and capital, s.2(4) & s.139]. To ensure MNEs Malaysian entities are paying their fair share of tax. To provide MNEs with information on existing domestic legislation for determination of arms length price and administrative regulation and conformance to internation practices (e.g. OECD model). To provide general guidance on an anti-avoidance provision (s.140 & s.140A) on TPM.
For Class Use Only 31

Transactions covered in TP Guidelines

Sales or purchases of raw materials, stock in trade or other tangible assets; Royalties / license fees / other types of considerations in connection with use of intangible assets; Management fees including charges for financial, administrative, marketing and training services; Research and development; Any other services not previously mentioned; Rents / lease of assets; Interests; or Guarantee fees.
For Class Use Only 32

General Objectives of Transfer Pricing Guidelines

The Guidelines are largely based on the arms length principle as set out according to the OECD standards. Key term: Arms Length Arms length price is the price, which would have been determined if such transactions were made between independent entities under the same or similar circumstances.

For Class Use Only

33

11

Transfer Pricing Guidelines - IRBM

TP methodologies can be used in determining arms length price: i) Comparable uncontrolled price method ii) Resale price method iii) Cost plus method iv) Profit split method v) Transactional net margin method
For Class Use Only

Other Method
34

Comparable Uncontrolled Price Method

Ascertaining an arms length price by direct price comparison of a similar product between independent parties. Ideal only if comparable products are available, or if reasonably accurate adjustments can be made to eliminate material product differences. Other methods will be used if material product differences cannot be adjusted to give a reliable measure of arms length price.
For Class Use Only 35

Comparable Uncontrolled Price Method Illustration

Taxpayer A, an MNE sells 70% of its product to an overseas associated company B, at a price of RM100 per unit. At the same time, the remaining 30% of that product are sold to a local independent enterprise C at RM150 per unit. Transfer price

A
Selling price
For Class Use Only

C
36

12

Comparable Uncontrolled Price Method Illustration

The transaction between A and C (same product) may be considered as a comparable uncontrolled transaction. However, a functional analysis of B and C must first be carried out to determine any differences (i.e. the business function) If there are differences, adjustments must be made to account for these differences.

For Class Use Only

37

Comparable Uncontrolled Price Method Illustration

Adjustments must also be made to account for different market conditions (B and C located in different countries) and for product quantity discounts (volume of sales to B and C are not the same). Assuming that reasonably accurate adjustments can be made to eliminate the material effects of these differences, then the CUP method may be applied using the unit price of RM150 as a comparable arm's length price.

For Class Use Only

38

Resale Price Method

Most appropriate where transaction is with an independent party (uncontrolled) which carries same function as the related party (controlled) - functional test. Depends on how much added value or alteration reseller has done on product before it is resold, or time lapse between purchase and onward sale (price fluctuation). More difficult to apply if reseller contributes substantially to the creation or maintenance of an intangible property that is attached to the product. If there are product differences (e.g. warranty extension, insurance, maintenance, etc), when comparing the controlled and uncontrolled transactions, the premium/ discount due to the differences should first be removed to facilitate the establishment of arms length price.
For Class Use Only 39

13

Resale Price Method - Illustration

B Associated Reseller Retailer/ Market price End market

Transfer price* A Manufacturer Wholesale price

C Market price Retailer/ Independent End market Reseller

*Product difference to be adjustment when establish arms length price.

For Class Use Only 40

Resale Price Method

Arms length price = Resale price1 (Resale price1 x Resale price margin) Where: Resale price margin = (Resale price2 - Purchase price)/ Resale price2 Resale price margin must be comparable to margins earned by other independent enterprises performing similar functions, bearing similar risks and employing similar assets. This method resembles the GP margin in accounting & auditing (see tutorial question later). 1 Resale price of the related party (controlled). 2 Resale price of the non-related party (uncontrolled).
For Class Use Only 41

Transfer Pricing Anti Avoidance Provisions

s.140A of ITA67 Taxpayers must determine and apply the arms length price on controlled transactions. DG may make adjustments to reflect the arms length price, or interest rate, for that transaction by substituting or imputing the price or interest, as the case may be. s.140 of ITA67 DG may disregard certain transactions which he believes has the direct or indirect effect of altering the incidence of tax (e.g. non arms length transactions); and make adjustments accordingly (e.g. reassessment). Non arms length dealings include transactions within a group structure (e.g. related companies, common control holding structure) [s.140(6)].

For Class Use Only

42

14