Procter & Gamble Sdn. Bhd., is a Malaysian company engaged in the marketing and distribution of consumer goods, which purchased products from a related Singapore entity, Procter & Gamble International Operations Pte. Ltd., under a distribution agreement. The agreement guaranteed the Malaysian entity a margin of 2.25 percent. For the years of assessment 2004 to 2008, the taxpayer characterised itself as a limited risk distributor and supported the margin with transfer pricing documentation based on regional and local comparable companies.
Following a transfer pricing audit, the tax authorities rejected the taxpayer’s characterisation as a limited risk distributor and recharacterised it as a full fledged distributor. The tax authority relied on contractual clauses, the taxpayer’s control over marketing and advertising activities, and its bearing of certain commercial risks. It selected a new set of comparables, adjusted the taxpayer’s results to the median, disallowed certain grant payments, and imposed additional tax and penalties amounting to approximately RM 44.6 million, invoking section 140(6) of the Income Tax Act 1967 and the OECD Transfer Pricing Guidelines.
The taxpayer appealed to the Special Commissioners of Income Tax, arguing that the tax authority had failed to produce its own transfer pricing report, had not properly rebutted the taxpayer’s documentation, and had wrongly adjusted the results to the median contrary to the OECD Guidelines. The Special Commissioners allowed the appeal in full and set aside all additional assessments. The Director General of Inland Revenue then appealed to the High Court.
Judgment
The High Court dismissed the tax authorities’ appeal and upheld the decision of the Special Commissioners.
It held that the burden of proof rested on the tax authority to demonstrate that the controlled transactions were not at arm’s length and that this burden was not discharged merely by recharacterisation arguments and financial analysis without a proper transfer pricing report.
The Court agreed that the adjustment to the median was inconsistent with paragraphs 3.60 to 3.62 of the OECD Guidelines, particularly in the absence of proven comparability defects. As a result, the additional tax assessments and penalties for all years were definitively annulled.