Search This Blog

Monday, April 20, 2015

GST, Transfer Pricing and Money Laundering

From Day 1 the Govt had announced the implementation of GST to replace SST, proponents (myself included) of GST had been highlighting how implementation of GST would minimize or eradicate transfer mispricing. However, I noted that most of the articles covering this pertinent topic (myself is guilty as well) are written in a very technical language that the message missed the target audience (whether the target audience is willing to listen is a moot point).

Before I go any further, allow myself to explain what is transfer pricing. I will try to explain this in the most laymen term as possible.

Transfer Pricing

Transfer pricing is the act of assigning value to a cost of operation, be it in completed product (goods), or services between related companies located in different tax jurisdictions. Th cost assigned to these goods or services should be the based on an arms length deal (meaning the assigned cost should be as if the goods or services are obtained from a non-related business). An illustration of transfer pricing in an ideal environment would be as follows.

Ali owns My Company Sdn Bhd which manufactures frozen putu mayam for export. He also owns Sg Company Pte Ltd which operates in Singapore to sell his product in Singapore. His former partner, Muthusamy owns MutuPutu Sdn Bhd which also sell putu mayam. As MutuPutu is selling putu mayam at RM10 per packet, Ali priced the cost of putu mayam made by his company for sales to Sg Company Pte Ltd at RM9. While the price is RM1 cheaper than what Muthusamy is selling, the pricing can still be considered as at arms length as Ali did not seriously underpriced his putu mayam and the difference can easily be attributed to savings from promotional activities (Ali doesn't need to promote to his own company to sell his own products).

In the real business world, transfer pricing are mostly applied on multinational corporations or MNC. We have lesser concern with MNC's conduct in transfer pricing as they would be very sensitive of transfer mispricing. What we are concerned are small and medium size industry owners, like Ali.

Using the same example as above, now we consider the effect of corporate income tax. The corporate tax rate for Malaysia and Singapore respectively are 24% and 17%. Say Ali receives an order of RM9,000,000 of putu mayam to be exported to China. Instead of selling to China via My Company Sdn Bhd to China at RM9 per packet, he now sells it to China at RM5, which is only RM1 lower than his actual cost. At RM5 per packet, his tax incurred is RM240,000 (assuming 100% of his cost is tax deductible). In Singapore, he bills the Chinese company his putu mayam at RM9 (let's keep it to ringgit to better illustrate it). Thus, he incurs tax of RM680,000. This totals up to RM920,000. Had Ali exported everything from Malaysia, he would have to fork out RM1,200,000 over the same deal.

With GST in place, the government can afford to lower down the corporate tax rate to attract more investment into Malaysia. One of the key reasons MNC are investing in Singapore today is because of its lower corporate tax rate compared to Malaysia. You can say infrastructure and human capital, but infrastructure can be built, while Singapore's human capital are largely powered by Malaysians and other foreign talents from countries like China, India and Philippines.

Money Laundering - The GFI Report

The last five years saw the emergence of an international lobbyist group called Global Financial Integrity. It had twice labelled Malaysia globally as the 3rd highest outflow of funds suffered from purported money laundering. The report had prompted Bank Negara officials to check with the group on how they had derived the figure. The group had sheepishly confirmed that they had obtained the figure from calculating the bill difference of products exported from Malaysia to overseas, and most of the figures if not all are exports via Singapore. Unfortunately, Singapore govt was reluctant to release the figure how much of the exports to Singapore had actually passing Singapore and later being repriced higher. Much like what Ali did in his export of putu mayam to China.

With the corporate tax rate lowered, this would provide disincentive to people like Ali to evade corporate tax in Malaysia via transfer mispricing. Effectively, this is creating a self-imposed barrier to have the products or services exported via Singapore.

How does lowering corporate tax rate helps me? I still pay the same tax.

As mentioned, lowering tax rate for corporation would attract more investment into the country. In fact, we have places like Bayan Lepas Free Trade Zone and Kuantan Free Trade Zone built solely to provide pioneer status for corporate investment into Malaysia, where they get to enjoy pioneer tax status at the rate of 10% for 10 years.

Using the same template as the second scenario, say now Malaysian corporate tax rate is at 19%. Ali would be paying only RM950,000 in tax. If he exports through Singapore and tries to misuse transfer pricing, he would be paying tax of RM870,000. While he still saves RM80,000, his cost of delivery and exposure to 2 to 3 exchange rates (RM to USD to SGD to RMB), would discourage him from using the same method (export to China via Malaysia would only incur 1 conversion rate as Malaysia and China have special trade relationship).


While the scenario that I have explained above shows how GST will help to minimize transfer mispricing, there is another 2 component that would lead to transfer mispricing.

Currency Flunctuation - SGD

While most Malaysians see the strengthening of SGD as proof of a better managed Singapore economy (which in a way is true), many do not realize that SGD is not a fully trade-able currency. It is in fact tightly controlled by Singapore's MAS in order to control inflationary effect in Singapore.

To maintain Singapore's competitive advantages, SGD is being traded based on a basket of currencies, with the weight-age for each currency, including RM being classified as national secret. Thus, the one possible mean for Singapore to sabotage the weakening reexporting from Malaysia is by strengthening her currency against RM, which would still attract transfer mispricing to occur. However, this is unlikely as how far does Singapore is willing to go? The very act is like ingesting a poison pill. This action would only make cost of operating in Singapore far too expensive for companies and might even backfire against Singapore royally.


Lets face it. Corruption is rampant in Malaysia. Some people claim you need to grease some hands for things to move.

Some of these people who are more than willing to pay to grease some hands too are more than likely to be miffed when the enforcement officers do not want to accept their bribe. So whose fault is it?
For corruption to go, don't give. Two wrongs doesn't make one right.


We are all one the same boat. We live and we sink together. For the last 40 plus years (I'm counting from 1973, when Petronas was formed), the burden to fund the development of Malaysia had fell on the shoulders of Sarawak, Sabah and Terengganu. Now that GST is being implemented and petroleum revenue is slowly diminishing, time for the rest of Malaysia to repay back to the 3 states for their contribution.

No comments:

Post a Comment