Advance Pricing Arrangements (APA): Everything You Need to Know

The Malaysian government mandates that transactions between associated entities must reflect market realities and be conducted at fair consideration, as per the Income Tax Act 1967 (Section 140A) and Transfer Pricing Rules. The Inland Revenue Board of Malaysia (IRBM) provides several methodologies for determining such prices to ensure these transactions are at arm's length.

While these methodologies offer a framework for establishing arm's length prices, their application can be complex and contentious, often leading to disputes between taxpayers and tax authorities. This is where Advance Pricing Arrangements (APAs) come into play. APAs establish an agreed-upon transfer pricing methodology between taxpayers and tax authorities, thus providing greater certainty and reducing the risk of disputes.

Before we get into details of APA, let's discuss Transfer Pricing and Arm’s length price.

Transfer Pricing, Arm’s Length Price, and Methodologies

Transfer pricing involves setting prices for goods, services, and intangible assets exchanged within a multinational company or between related entities in different tax jurisdictions. 

In Malaysia, transfer pricing regulations ensure that these transactions occur at arm's length prices. The arm's length principle mandates that prices in transactions between related parties should resemble those in transactions between unrelated parties under similar circumstances. 

The Inland Revenue Board of Malaysia (IRBM) has identified five transfer pricing methodologies for determining arm's length prices. Taxpayers can choose any of these five methodologies based on the nature of the transaction, data comparability, and assumptions' reliability. An alternative method may be used if permitted by tax authorities.

What is an Advance Pricing Arrangement (APA)?

An Advance Pricing Arrangement (APA) is a formal agreement between a taxpayer and a tax authority, such as the Director General of Inland Revenue (DGIR) in Malaysia or between Competent Authorities in other countries. 

The APA determines transfer pricing methodology (TPM) that will be used to establish the arm’s length prices of specified related party transactions in the future. This agreement aims to provide certainty and prevent disputes over transfer pricing issues by setting acceptable pricing methods and conditions for cross-border transactions over a defined period.

Why are APAs used?

Advance Pricing Arrangements (APAs) are used for two major reasons:

1. Certainty in Tax Treatment: APAs provide certainty on the appropriate transfer pricing methodology (TPM) to be applied in pricing specific transactions. This helps taxpayers ensure that their cross-border transactions are treated consistently and correctly for tax purposes.
2. Avoidance of Double Taxation: In the case of bilateral or multilateral APAs, they help avoid and eliminate potential double taxation. This is achieved by ensuring that all profits are correctly allocated and taxed in the respective jurisdictions involved.

Types of Advance Pricing Arrangement (APA)

There are three major types of Advance Pricing Agreements (APA):

1. Unilateral APA (UAPA): An agreement between a taxpayer and the tax authority of the country where the taxpayer is located. This would be an agreement between the taxpayer and the Director General of Inland Revenue (DGIR) in Malaysia.
2. Bilateral APA (BAPA): An agreement between the taxpayer and the tax authorities of two countries. In Malaysia, this involves the Malaysian Competent Authority (CA) and the CA of another country with which Malaysia has signed a double taxation agreement (DTA).
3. Multilateral APA (MAPA): An agreement involving the taxpayer and the tax authorities of multiple countries. This includes the Malaysian CA and the CAs of two or more other countries in Malaysia.

Who Can Apply for an APA?

Not every company can apply for an Advance Pricing Arrangement (APA) because the process is complex and requires significant time and resources. Here are the criteria for businesses or companies that can apply for an APA:

Eligible Taxpayers:

• Companies that are assessable and chargeable under the Income Tax Act carry out cross-border transactions with associated persons.
• Permanent establishments (PE) under Section 132 of the Act, subject to applicable tax treaties.

Conditions Based on Jurisdictions:

• Taxpayers with cross-border transactions involving associated persons from non-treaty countries can apply for a unilateral APA.
• Transactions involving treaty countries require a bilateral (BAPA) or multilateral APA (MAPA).

The APA application will only be considered if the following criteria are met

• Business operations of covered transactions must exceed RM100 million in taxable business income.
• The proposed transaction values must meet specific thresholds:
  • Sales exceeding 50% of revenue.
  • Purchases exceeding 50% of total purchases.
  • Other transactions exceeding RM25 million.
• For financial assistance, thresholds follow the IRBM Transfer Pricing Guidelines.
• Covered transactions must relate to chargeable income, excluding exempt income under certain Acts and treaties.
• Taxpayers under audit or investigation cannot apply until resolution.
• New businesses must be operational for at least 36 months, with covered transactions in operation for at least 12 months if the business is older.
• The proposed benchmarking analysis should not significantly reduce operating margins unless justified by changes in functions, assets, and risks (FAR), including the transfer of significant people functions.

APA Application Process

The Advance Pricing Arrangement Guidelines 2024 outline the application process for APA in detail. There are three main steps.

1. Pre-filing Meeting

• Request a pre-filing meeting in writing to the Department of International Taxation (DIT) at least 12 months before the proposed APA period.
• Have a preliminary discussion with the Inland Revenue Board Malaysia (IRBM) to provide an overview and determine eligibility.
• Discuss details such as controlled transactions, covered transactions, proposed TPM, expected returns, and potential costs.

2. Submission of Formal Application

• Submit the formal application using Form APA 1 for Unilateral APA or Form APA 2 for BAPA/MAPA within six months after the pre-filing meeting notification.
• Include the applicable APA fee.
• Ensure the applicant signs the application and includes all necessary documents in English or Bahasa Malaysia, or with translations if needed.

3. Reviewing and Negotiating the Application

• The DGIR will review the application and may propose alternative methodologies, adjust the scope, or decline the application.

Benefits of Advance Pricing Arrangements

Transfer pricing and determining the arm's length price for controlled transactions is complex, often leading to disputes between the Inland Revenue Board of Malaysia (IRBM) and taxpayers, especially when foreign companies are involved.

APAs offer several benefits over simply choosing a Transfer Pricing Methodology (TPM) and waiting for the IRBM to assess and accept it. Here are some of the key benefits:

1. Certainty in Tax Treatment: An APA provides clarity on the appropriate Transfer Pricing Methodology (TPM) for covered transactions, ensuring consistent and predictable tax treatment for cross-border transactions. 
2. Avoidance of Double Taxation: For bilateral or multilateral APAs, the agreement between tax authorities of the involved countries ensures that profits are correctly allocated and taxed in each jurisdiction. 
3. Reduced Audit Risk: By agreeing on the transfer pricing methods and conditions upfront, businesses can significantly reduce the likelihood of tax audits and adjustments. 
4. Enhanced Compliance: An APA encourages rigorous documentation and adherence to agreed transfer pricing policies. 
5. Global Consistency: APAs help ensure consistency in transfer pricing practices across different jurisdictions. 

Conclusion

Transfer pricing (TP) is essential for ensuring related party transactions are conducted at arm's length. However, the complexity of transfer pricing methodologies (TPM) often leads to disputes, especially when foreign companies are involved. These disagreements can be time-consuming and resource-intensive, amplifying challenges in cross-border transactions.

Advance Pricing Arrangements (APAs) effectively reduce these disputes and audits by pre-establishing a mutually agreed-upon TPM. This certainty streamlines compliance, minimises contentious examinations, and provides a more predictable tax environment, benefiting companies engaged in international trade.