Recently, the High Court dismissed the Director General of Inland Revenue’s (Revenue) appeal against the decision of the Special Commissioners of Income Tax (SCIT) and ruled that there was no basis in law or fact for the Revenue to adjust the taxpayer’s margin to the median when it fell within the arm’s length range of the agreed comparable companies.
Brief Facts
The taxpayer was incorporated in Malaysia where it was a refining company selling cooking oil and related products to parties outside Malaysia (controlled transactions). In 2015, the Revenue conducted a transfer pricing audit on the taxpayer. The taxpayer provided a benchmark analysis for the year of assessment (YA) 2010 by drawing comparison with other refining companies in Malaysia.
The taxpayer suggested 4 companies while the Revenue suggested 9 companies. 3 of the companies proposed by the Revenue were rejected by the taxpayer and the Revenue had agreed to this. In addition, both parties had agreed to use the transactional net margin method (TNMM) to determine the transfer price.
Based on the Revenue’s benchmarking analysis, the taxpayer’s financial results for all YAs, including YA 2010 fell within the interquartile range. Subsequently, the Revenue adjusted the taxpayer’s price margin to 1.23% of median point as an arm’s length transaction by invoking Section 140A(3) of the Income Tax Act 1967 (ITA) and Rule 13(1) of Income Tax (Transfer Pricing) Rules 2012 (2012 Rules). This adjustment by the Revenue resulted in an additional taxes being imposed on the taxpayer. Being aggrieved by the Revenue’s decision, the taxpayer appealed to the SCIT.
The SCIT’s Ruling
The main issue considered by the SCIT was whether the adjustment of the taxpayer’s profit to the median point by the Revenue in determining the arm’s length price is in accordance with Section 140A of the ITA and the 2012 Rules.
The SCIT allowed the taxpayer’s appeal and held the following:
There was no evidence produced by the Revenue to support its decision in using the median point to determine the arm’s length price. The Revenue failed to demonstrate that the adjustment to the median point was in line with or at the arm’s length price or that the decision to adjust the price to the median was supported by any legal provisions or guidelines; and
Thus, there are no facts that show the median price as applied by the Revenue is the arms’ length price and thus, contradicts the power as provided under Section 140A of the ITA and Rule 13(1) of the 2012 Rules.
Being aggrieved by this, the Revenue filed an appeal at the High Court against the SCIT’s decision on 8.2.2021 pursuant to paragraph 34, Schedule 5 of the ITA.
The Taxpayer’s Contention At The High Court
The taxpayer averred that the decision of the SCIT was correct and should be maintained. The submission for the taxpayer can be summarised as follows:
(a) The taxpayer was one of the top 3 most profitable companies amongst its competitors for the YAs 2011, 2012 and 2013 i.e. by achieving its profit margin above the median point.
(b) The profitability of companies fluctuates every year due to various factors such as business decisions and economic factors.
(c) Even amongst the 6 comparables, some companies will have a higher profitability than their competitors in some years and a lesser profitability in other years. The mere fact that the taxpayer’s profitability is below the median in one out of four consecutive years does not mean that the taxpayer had engaged in transfer pricing.
The Revenue’s Contention At The High Court
The Revenue’s argument can be summarised as follows:
a) The SCIT’s decision was inconsistent with the purported finding of facts by the SCIT which had found that there was a comparability defect to the 6 comparable companies under rule 6(3) of the 2012 Rules that were being used to determine the arm’s length price for the transaction between the taxpayer and its related entities.
b) The SCIT has erred in finding that the Revenue had agreed to accept the 6 comparable companies as the SCIT had failed to consider that 6 comparables were accepted upon the agreement of the taxpayer and that there are no other comparable companies that have been selected and provided by the taxpayer to be used as a comparable.
c) The taxpayer had engaged in transfer pricing in the YA 2010 by reducing its profits in Malaysia and inflating the profits of its related parties outside Malaysia. The sole basis for this contention is that in the YA 2010, the taxpayer’s profitability (1.23% margin) was below the median profitability of the 6 comparables.
The High Court’s Ruling
The High Court dismissed the Revenue’s for the following reasons:
a) The Revenue had erred in adopting the median point as the method for determining arm’s length pricing. The median point was an arbitrary measure as the Revenue’s assessing officer had applied the median point solely based on her own interpretation of paragraph 3.57 of the OECD Guidelines.
b) The SCIT correctly rejected the Revenue’s submission that the 6 comparables suffered from comparability defects as it was inconsistent with the Revenue’s assessing officer’s actions in agreeing to the comparables during the audit. Thus, it was not fair for the Revenue to then allege that the taxpayer had failed to provide other comparables and accuse the taxpayer of failing to explain the supposed differences in turnover.
c) Where there was a pattern which showed fluctuating profits between the companies as one would expect in business, a range rather than a single point should be used to determine arm’s length pricing. This is the proper interpretation of the OECD Guidelines. This is the approach taken in Procter & Gamble Procter & Gamble Sdn Bhd v KPHDN (PKCP(R) 189 - 193/2013). The relevant excerpt from the judgment is reproduced below:
“ [57]…. Upon determining the TP method, the Respondent computed the interquartile arm’s length range based on the comparable set of 16 risk distributor companies. It is clear from the summary results for the comparable set of 16 limited risk distribution companies, the Respondent’s margin of 2.25% falls within the interquartile range and therefore no adjustments need to be made.”
d) Thus, there was no basis in law or fact for the Revenue to adjust the taxpayer’s margin to the median of the 6 comparables when it already fell within the arm’s length interquartile range. Therefore, the Revenue had incorrectly raised the assessment for the YA 2010 against the taxpayer.
e) The SCIT’s decision was also consistent with the Revenue’s own evidence that nothing in the guidelines that required an adjustment to be made to the median.
f) As for the issue of penalty, there was no basis in law or in fact for the Revenue to impose a penalty as the taxpayer could not possibly have intentionally fixed its price below the median point as alleged by the Revenue.
11 September 2024