A loan between two related companies is often seen as a simple contractual arrangement, no different from any other loan on paper. However, the name given to a transaction does not decide how it is treated for tax purposes. What matters is whether the arrangement truly works like a loan or whether it is, in substance, an equity contribution presented as a loan.

This distinction is at the heart of Malaysia's transfer pricing rules for intra-group loans. Several features help distinguish a genuine loan from disguised equity. A genuine loan has a clear obligation to repay, a fixed repayment date, an interest rate that does not depend on the borrower's business performance, and a lender who has priority over shareholders if the company is wound up. Equity, on the other hand, has no fixed return, no repayment date, and is only repaid after all creditors have been paid. No single feature decides the outcome. Instead, the tax authorities look at the overall arrangement, including whether the written agreement matches how the parties actually behave.

Where a loan does not have these features, especially where there are no fixed repayment terms, no arm's length interest rate, and no security or conditions that an independent lender would normally require, the transaction may be treated as equity instead of a loan. If this happens, any interest claimed as a tax deduction may be disallowed in full. This can result in additional tax, together with surcharges on the transfer pricing adjustment.

For businesses with related companies lending to one another, the safest approach is to make sure the loan not only looks like a genuine loan on paper, but also continues to operate like one throughout its life.

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