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What is the Arm’s Length Principle in Transfer Pricing?

Malaysia is an attractive business destination to global corporations due to its stable tax framework, ease of doing business, and a large pool of multilingual talent. The country’s tax structure has been instrumental in luring enterprises from all over the globe. 


Malaysia is home to a number of tax countries, resulting in both international and domestic transfer pricing regulations. The Malaysian Inland Revenue Board (IRB) has no specific priority areas regarding transferring pricing. 


Instead, authorities normally concentrate on a specific sector for a certain length of time since it is easier to focus on firms with similar challenges.


Nonetheless, due to the expanding number of companies, particularly large-scale organizations, tax audit activity in Malaysia has increased dramatically. It is necessary to be acquainted with the procedure of producing transfer price paperwork to deal with transfer pricing in Malaysia.


The Arm’s Length Principle is the foundation of transfer pricing. This article discusses the role of Arm’s Length Principle in transfer pricing and how accounting firms in Malaysia use it in transfer pricing documentation. 


Why is the Arm's Length Principle Necessary?

When your business is made up of many legal companies, those entities often exchange commodities, services, and intellectual property. 


If this is the situation with your company, you must ensure that all transactions are conducted at a distance. This is necessary to ensure that your company is tax compliant.


In this case, the Arm’s Length Principle plays a critical role in deciding the transfer pricing principles.  

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Definition of Arm’s Length

In simple words, at arm’s length means that a transaction between associated entities represents the conditions and pay set compared to the transaction between unrelated entities. 


All OECD member countries have agreed upon the Arm’s Length Principle and adopted it as a standard guideline for multinational enterprises to deal with tax-related rules and regulations.


The OECD defines the Arm’s Length principle as:


“This valuation principle is commonly applied to commercial and financial transactions between related companies. It says that transactions should be valued as if they had been carried out between unrelated parties, each acting in his own best interest.” 


The Role of Arm’s Length Principle in Transfer Pricing

When one legal entity inside your firm transacts with another, you must establish a transfer price. This transfer fee should be competitive.


Its purpose is to guarantee that your firm reaps the benefits of intercompany interactions equally. But, in terms transfer pricing implies that when a firm buys products or services from a related corporate entity, the price it pays should be the same as if the two companies were unrelated. 


In other words, merely because the parties are related legal entities, there should be no price adjustment or unique criteria for the transaction.


Importance of the Arm’s Length Principle

The arm’s length principle ensures that firms with several legal entities in various countries are tax compliant and do not benefit unjustly (inadvertently or maliciously) from transactions between their connected entities.

It gives businesses a straightforward rule for assessing fair, tax-compliant pricing and conditions for intercompany transactions, as well as giving tax authorities the tools they need to combat base erosion and profit shifting in multinational corporations (MNEs).

Calculating the transfer pricing and using the arm’s length principle can be challenging, so it is better to rely on professional accounting services in Malaysia to perform this important measure.

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Calculating Arm’s Length Transfer Prices

There are a variety of transfer pricing strategies you may employ to estimate arm’s length transfer costs for your transactions.

Some of the most common methods include the comparable uncontrolled price (CUP), the resale price method, and the cost-plus method.

A company can choose and implement the best method by considering its own unique conditions and getting help from an accounting firm for transfer pricing in Malaysia.

As long as you have access to trustworthy comparable data, the CUP technique is regarded as the most straightforward way to apply the arm’s length principle.

It entails assessing the royalty rates established in similar licensing agreements between unrelated businesses and utilizing them as a starting point for calculating fair transfer prices for the intercompany transactions being studied.

If an organization wants to modernize or grow its private healthcare facility, it can apply for tax exemption. However, the healthcare facility must benefit at least 5% of the healthcare travelers from all patients. In this case, it can apply for an exemption of 100% of QCE for five years.

Final Thoughts

The bottom line is that understanding and calculating the arm’s length transfer pricing is important to create a thorough and reliable transfer pricing document. 


It is critical for organizations, especially multinational companies, to deal with transfer pricing for taxation purposes and import-export laws. 


Hiring professional accounting services in Malaysia to handle transfer pricing is one of the best and most efficient ways to complete this process.