Burden Of Proof In Transfer Pricing Disputes
The burden of proof in a civil litigation refers to the duty of the party to prove a fact or allegation in a dispute. This alert examines the burden of proof in transfer pricing disputes in Malaysia – essentially examining whether the legal requirement that the burden of proof is on the taxpayer achieves a consistent and fair balance between the rights of the taxpayer and tax authority.
It is trite that for tax disputes in Malaysia, the burden of proof is on the taxpayer to establish, on the balance of probabilities, that the assessment raised by the tax authority is erroneous. This simply means that the onus is on the taxpayer to prove that the assessment raised by the tax authority was raised arbitrarily and/or are not in accordance with the law. The exception to this general rule is when there is a time barred assessment, where burden of proof is on the tax authority that the taxpayer has either committed negligence, fraud or wilful default in managing their tax matters.
Burden Of Proof: The OECD Transfer Pricing Guidelines
The rule saying that he who asserts must prove, is not always the case in relation to tax matters. The underlying principle at the heart of most tax regime is that the burden of proof should rest on the party with the easiest access to information pertaining to the tax matter. Nevertheless, Malaysia upholds a different principle that the party wishing to assert must prove the allegations.
Given that the tax regime from each jurisprudence allocates the burden of proof in a different manner and based on different policies and principles, the Organisation for Economic Co-operation and Development Guidelines for Multinational Enterprises and Tax Administrations 2022 (the OECD Guidelines) has provided some guidance to ensure that there is a fair balance between the burden placed on taxpayers and tax administrators.
First and foremost, the OECD Guidelines acknowledge that transfer pricing is not an exact science and urge tax administrators not to impose an unduly harsh burden on the taxpayer in the provision of transfer pricing documentation. The OECD Guidelines consistently provide that there is a need for tax administrators to be forgiving and accepting of limitations on taxpayer’s ability to provide transfer pricing documentation and supporting evidence.
Notably, paragraph 4.13 of the OECD Guidelines states that the burden of proof may shift from the taxpayer to the tax administrator in circumstances where the taxpayer has already provided a reasonable amount of evidence to show that the transfer pricing was at arm’s length. It is crucial to be mindful that whilst the OECD Guidelines are not binding in Malaysia, they are very persuasive and courts including the Special Commissioners of Income Tax (SCIT) have in many occasions applied the OECD Guidelines in determining transfer pricing disputes in Malaysia.
Standard Of Burden Of Proof In Malaysia
The case of MM Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri (2013) MSTC 10-046 is instructive that when the tax authority alleges that there are shortcomings in the taxpayer’s transfer pricing documentation, then the tax authority must produce its own report to support its allegation. The SCIT in the MM case was aware of the shortcomings of the taxpayer’s transfer pricing report but decided in favour of the taxpayer as the tax revenue was not able to show countervailing evidence of the proposed ideal version of the transfer pricing report. At this juncture, it is clear that the courts find it unacceptable to impose an unduly harsh burden on the taxpayer and to require taxpayers to produce the proposed ideal transfer pricing documentations where the tax authority, themselves, could not produce a said version of the report.
Even though the Inland Revenue Board’s Transfer Pricing Guidelines 2012, the Income Tax (Transfer Pricing) Rules 2012 and the ITA do not expressly require the tax administrator to undertake the preparation and provision of the transfer pricing documentation, it is clear that based on the MM case, the tax authority would need to be able to produce countervailing transfer pricing documentations to contend that the taxpayer’s version of the transfer pricing report is inadequate.
Section 140(6) of the ITA places the burden of proof on the tax authority to establish that the transaction in question was not conducted at arm’s length between the associated parties. In OMSB v DGIR, the SCIT ruled in favour of the taxpayer and agreed that the burden of proof was on the tax authority to establish its allegation. In this case, the tax authority alleged that certain transactions entered into by the taxpayer were not at arm’s length and insisted that the comparable uncontrolled price method ought to be given priority over the transactional net margin method. However, the tax authority failed to adduce a sufficient explanation as to why the comparable uncontrolled price method ought to be given priority over the transactional net margin method.
Similarly, in CC (M) Ltd v DGIR, the tax authority alleged that the taxpayer’s direct marketing expenses (DME) incurred were not in accordance with the arm’s length principle pursuant to Section 140A of the ITA and hence, a mark-up should have been added. The SCIT ruled in favour of the taxpayer and agreed that the DME were in accordance with paragraph 7.34 of the OECD Guidelines and paragraph 20.7.3 of the Malaysian Income Tax (Transfer Pricing) Rules 2012. The SCIT was of the view that the tax authority merely relying on an agreement entered by the taxpayer with a third-party service provider and an invoice issued in the taxpayer’s name, had failed to discharge its burden of proof in proving that the taxpayer bears the risk associated with the DME.
The cases of OMSB and CC(M) Ltd established the position that the burden of proof is on the tax administrator to satisfy the court that the taxpayer’s transaction was not at arm’s length and substantiate the same with good and cogent evidence.
Transfer pricing matters are notoriously complex as it often pertains to corporate entities that have operations across various jurisdictions. Investors may show reluctance to consider Malaysia for their business investment and growth if the law does not strike a fair balance between the burden of proof of taxpayers and tax authority. In this regard, the SCIT and our courts have been consistent in requiring tax authority to produce rebuttal evidence when claiming that the taxpayer’s transfer pricing documentation is inadequate.
Be that as it may, it is important for the taxpayers to maintain contemporaneous transfer pricing documentations to support their related party transactions - this certainly comes handy when the tax authority conducts a transfer pricing audit on them.
Authored by Edyn Gan, a pupil with the firm’s Tax, SST and Custom practice.
18 JULY 2022