theoretical pricing

Malaysia adopted the OECD transfer pricing rules in the year 2003 by issuing formal guidelines. For those who are not required to be familiar with the intricacies of tax laws, these guidelines require taxpayers who have inter-company transactions to prepare transfer pricing documentation.

With the insurgence of global trade, a lot of multi-nationals are subjected to these rules. And also local homegrown companies.

The transfer pricing rules require companies to adopt an arms-length price. This is based purely on economic theory that when parties transact, the real price is the market price or the arms-length price. This theory is as difficult to implement as that of the efficient market hypothesis in the securities industry.

As much as it is nice to make assumptions, so that a nice formula can be developed, it is quite a different thing, to subject businesses to spending loads of money to conform to that mathematical formula. The business world is dynamic and moves in real time. It does not always work in a formulaic manner.

Much as the tax authorities globally would like to have a certain and nicely justified arms-length price in order to compute the tax, the tax authorities ought to recognise that ultimately the price is computed based on assumptions. And in many instances, that price eventually arrived at, if at all possible, is not reflective of the company's transacted price nor does it resemble any other price in the real market place. Why expend so much resources to arrive at a fictional figure?

When rules such as this is implemented, the tax authorities ought to invest resources by using the field audits not as audits, but as a field visit to understand how businesses in each of the industries are common in its basic features.

With that understanding, the functions, assets and risks analysis can be better developed. And the tax authorities ought to be sharing its database with the companies to see how best the functions, assets and risk analysis apply to each of these companies. The businesses can explain their best case and what is most workable.

Whilst there is no understanding between the businesses and the tax authorities, it cannot be possible to place an obligation on the taxpayer to comply with an abstract set of rules such as the transfer pricing rules.

Hence it is wrong for the tax authorities to ask taxpayers during its first field audit if they have any transfer pricing documentation and to threaten a big penalty on taxpayers if they do not have the transfer pricing documentation, or to reject such documentation because the comparables are not acceptable by the tax authorities. Such penalties could run as high as 60%.