Tax Audit & Tax Investigation in Malaysia: Key Differences and Common Pitfalls

In Malaysia, tax audits and tax investigations are key compliance measures carried out by the Inland Revenue Board of Malaysia (IRBM) to ensure taxpayers accurately report their income and pay the correct amount of tax. While a tax audit is generally a routine review of submitted records, a tax investigation is a more detailed examination conducted when tax evasion or serious discrepancies are suspected. Both processes play a vital role in promoting transparency, fairness, and voluntary compliance within the Malaysian tax system.

What is a Tax Audit?

In Malaysia, a tax audit is an Inland Revenue Board of Malaysia (IRBM) process to check that the right amount of income is reported, and the correct tax is paid. Tax audits are conducted as either:

• Desk audit — review performed at the IRB’s office, typically focused on specific items or issues disclosed in the return and supporting documents.
• Field audit — broader review conducted at the taxpayer’s premises, with interviews and examination of source records, systems, and processes.

These definitions appear consistently in the IRBM’s tax audit frameworks and guides. 

Objectives of a Tax Audit

• Tax audit encourages voluntary compliance in line with the implementation of the Self-Assessment System (SAS).
• Tax audit also enforces compliance of tax laws ensuring that correct income reporting and appropriate tax payment has been made to avoid leakages of national revenue.
• Educate and provide awareness to taxpayers on  on their rights and responsibilities under the provisions of the tax laws that are currently in force.  

The IRBM periodically updates its audit frameworks (including sector-specific versions, like finance and insurance). Based on tax audit framework issued on 1st May 2022, IRBM has clarified that, when there are technical adjustments raised as issues, the said adjustment shouldn’t be subjected to penalty for under payment of tax. 

Tax Audit Activities

In year 2025, LHDN has issued a new Tax Audit Framework Income Tax and Employer (TAF ITE),  this framework comprises of income tax audit, withholding tax audit, capital gains tax audit, Labuan business activities audit and employer audit activities. 

Audit Review Methods

 IRBM carries out two (2) methods of audit reviews for all audit activities namely :-

a)  general review

refers to document review activities carried out at the IRBM’s office only. It involves issues or adjustments of income, review of compliance with employer’s responsibilities and review of Labuan business activities as well as taxation matters that can be resolved through correspondences.  

b)  comprehensive review

review of tax audit activities that involves an interview session on to the modus operandi of the business and can be conducted either at the taxpayer's premise, IRBM’s office (including the conduct of online interviews), or any premises or places as agreed by the taxpayer and IRBM.

1. business records related to income reporting;
2. business records related to expenses claims and allowances computation
3. review of the agreement document to ensure that the implementation of the terms and conditions of the agreement is true as stated (substance over form)
4. compliance with the conditions and eligibility of approved incentive claims
5. compliance related to deductions and remittances of withholding taxes 
6. review of documents and information related to the employment of employees to ensure that the employer makes the appropriate deduction of MTD / CP38 and remit the payment of MTD / CP38 to the IRBM within the stipulated period as stated in the ITR.

What triggers a Tax Audit in Malaysia?

While selection is risk-based and not all triggers are published, common risk indicators include:

• Large fluctuations in revenue, margins, or claims year-on-year
• Recurring losses or thin margins compared to peers/industry
• Inconsistencies between tax returns and third-party data (e.g., withholding tax forms, CP58/CP204, customs data)
• Related-party transactions without robust transfer pricing documentation
• Aggressive positions unsupported by public rulings or guidelines
• Participation in cash-heavy sectors or unusual cash movements

The IRB has reinforced its enforcement focus (including domestic transfer pricing and cross-border transactions) in public forum and professional updates. 

What is the penalty for non-compliance?

Under Section 113(2) of the Income Tax Act 1967 (ITA), the statutory penalty rate for tax under-charged due to incorrect return is 100%. However, the recent Tax Audit Framework (effective 1 May 2022) has replaced the previous “concession rate of 45%” used by the IRBM with tiered penalties as follows:

• First offence: 15%
• Second offence: 30%
• Third and subsequent: 45%

The new framework also reaffirmed that no penalties to be applied where audit findings involving technical adjustment (i.e., reasonable differences in interpretation of law, not contrary to public rulings/guidelines). 

For intentional incorrect returns, the statutory rate penalty is 100%. Nevertheless, for cases under voluntary disclosures, the penalty rate imposed is 15%. However, if the voluntary disclosure is made within six months of the filing return, the penalty rate is 10%.

What is Tax Investigation?

A tax investigation by the Inland Revenue Board of Malaysia (IRBM) involves examining a taxpayer’s business and personal documents to verify that income is accurately reported and taxes are properly paid.

The IRBM may request statements or documents from any relevant party to support the investigation. If tax evasion is uncovered, the taxpayer may face court prosecution.

IRBM officers are also empowered under the Anti-Money Laundering, Anti-Terrorism Financing and Proceeds of Unlawful Activities Act (AMLATFPUAA) to freeze, seize, or forfeit assets linked to tax evasion.

Taxpayers will be informed whether the investigation is conducted under the Income Tax Act, AMLATFPUAA, or both — and an ITA investigation can later extend to AMLATFPUAA at any time.

Duration of the Investigation

Unlike tax audit, there is no time limit for investigations involving fraud, wilful evasion, or negligence. Assessments may be raised at any time pursuant to subsection 91(3) of the Income Tax Act (ITA).

Why it’s different:

• Purpose: move from verifying compliance (audit) to collecting evidence of deliberate non-compliance (investigation).
• Tone: can be coercive; rights and obligations of both parties apply, and legal consequences may be instituted against taxpayer. 
• Outcome: may lead to prosecution; penalty exposure is governed by offences such as Section 114 (evasion),  where courts can impose fines and imprisonment, on top of tax and civil penalties.

Common pitfalls that trigger audit (or investigations)

1. Weak / bad record keeping, documentation and reconciliations

• Missing source documents, unreconciled sales vs banking, undocumented credit notes/contra entries, and stock movements invite adjustments.
• Fix: Perform monthly monitoring, maintain complete documents, and reconcile figure between business records (e.g. sales or purchases with ledger) 

2. Transfer pricing (TP) blind spots

• Domestic and cross-border related-party dealings without contemporaneous TP documentation, or misaligned economic substance vs reported functions/risks.
• Fix: ensure TP files (master/local), intercompany agreements, and benchmarking are current; align with IRB TP audit framework guidance.

3. Employment tax & benefits-in-kind

• Misclassification of allowances/benefits, shadow payroll gaps for secondees.
• Fix: use IRB public rulings/benefit valuation rules; align HR, payroll, and finance data.

4. Capital vs revenue misclassification

• Over-claiming capital allowances or treating capital items as deductible expenses.
• Fix: maintain a consistent fixed asset register (FAR) and policy notes.

How we can help

If you need specialist help, explore Grant Thornton Malaysia’s Tax Audit & Investigation services and broader Tax services.