CHAPTER IX - Intragroup Financing

Intragroup financing is another form of service between associated persons, which falls under subsection 140A(2), in the form of financial assistance that include loans, interest bearing trade credits, advance or debt and the provision of any security or guarantee. The financial assistance arrangements between associated persons can arise from the following situations:

  1. Where a taxpayer, directly or indirectly, acquires from or supplies to an associated person financial assistance for a consideration; or
  2. Where a taxpayer supplies financial assistance directly or indirectly to an associated person without consideration.

In both situations, the taxpayer should charge or pay the associated person interest at a rate which is consistent with the rate that would have been charged in a similar transaction between independent persons dealing at arm's length.

As provided under the Rules, where the interest rate imposed or would have been imposed on a controlled financial assistance is not at arm's length, the DGIR may make an adjustment to reflect the arm's length interest rate or impute interest on the controlled financial assistance. Adjustments will be made where:

  1. For the supply of financial assistance, the consideration is less than the consideration that would have been received or receivable in an arm's length arrangement;
  2. For the acquisition of financial assistance, the consideration is more than the consideration that would have been given or agreed to be given in an arm's length arrangement; or
  3. No consideration has been charged to the associated person for the supply of the financial assistance

Example 1

Substitution of non arm's length interest

Company A has obtained a fixed-rate 10%, medium term loan from an associated person which embeds an option to repay the loan prematurely without penalty. In the third year the market interest rate began to decline to 5%, a rate lower than the fixed-rate agreed upon with the associated person. In an arm's length situation, Company A would execute its option to repay the loan as it would not make sense to continue paying the high interest rate of 10%. However, Company A did not exercise the option and continued to pay at the higher interest rate.

In this case, the IRBM may substitute the financial assistance arrangement with an interest rate that reflects the current market situation as if Company A had exercised the option at an appropriate time and entered into similar arrangement at a lower rate.

An arm's length interest rate is an interest rate charged, or would have been charged, at the time the financial assistance was granted in uncontrolled transactions with or between independent persons.

In determining an arm's length interest rate for financial assistance, the comparable uncontrolled price (CUP) method is considered to provide the most reliable measure. In this context, the CUP method determines an arm's length interest rate by reference to interest rates between independent parties on loan with highly similar terms and conditions. Where differences exist, adjustments should be done to eliminate these differences.

Comparability factors to consider when searching for and analyzing financial transactions and the determination of arm's length interest rate include:

  1. the nature and purpose of the financial assistance;
  2. the amount, duration and terms of the financial assistance;
  3. the type of interest rate (eg: fixed or floating interest rate);
  4. embedded options;
  5. guarantees involved in the financial assistance;
  6. collateral for the financial assistance;
  7. creditworthiness of the borrower;
  8. location of the lender and borrower.

When ascertaining the arm's length interest rate, appropriate indices such as Kuala Lumpur Inter Bank Offered Rate (KLIBOR), prime rates offered by bank and/or specific rates quoted by banks for comparable loans can be used as a reference point. Adjustments are then made on the rates used as reference point based on the outcome of comparability analysis to arrive at the arm's length interest rate.

Taxpayers are required to substantiate and document that the terms of an intercompany financial assistance, specifically the interest rate applied, are arm's length. This encompasses preparation of an analysis on the setting of the correct level of underlying interest and documentation on other factors of comparability such as loan structure, etc. Taxpayers also need to review existing inter-company agreement on a periodic basis to ensure that all the terms and conditions of the loan remain at arm's length.