So far transfer pricing (TP) rules are not in force locally even though we know that about sixty other countries use it. There is an indirect reference to transfer pricing in the concept of “arms-length principle” (ALP). In particular, we find that Article 5(6) of the Income Tax Management Act provides that if a non-resident person carries on business with a resident person, and due to their special relationship, the transaction does not produce arm’s length profits for the resident person, then taxation will be imposed on the ordinary profits that would be expected to arise from the business.
Also, Articles 2 and 12(1)(u)(2) of the Income Tax Act provide for arm’s length provisions in relation to the permanent establishments. In the absence of legislation underpinning the application and interpretation of the ALP, in a possible situation where a cross-border transaction is not in accordance to the ALP, the determination of the ALP will refer to various sources of international law implying the use of the TP. In such a scenario, Malta will apply TP, due to the international obligation raised from the conclusion of the relevant Article in its treaties.
Needless to say, we are not completely shielded from this rule because of Article 5(6) of the ITMA referred to earlier. This gives the discretion to the Commissioner to determine the transfer price following the OECD guidelines. One finds reference to transfer pricing (TP) in the published Patent Box Regime (Deduction) Rules, 2019.
Here, there is a specific reference made to the fact that the determination of income or gains shall be made on the basis of a transfer pricing method in terms of OECD’s Transfer Pricing Guidelines. Bearing this, taxpayers have so far been spared the complexity of transfer pricing exercises even though there are embedded in the law, general anti-avoidance provisions and brief references to transactions at arm’s length.
There is an unwritten rule that regulates transactions between residents and non-residents which as stated earlier must adhere to the arm’s-length principle. This means that prices quoted between parties ought to reflect the commercial rates usually charged by non-related parties. Having said that, so far there are no fixed rules to establish how such prices can be determined. In this regard, the law provides that for the purposes of calculating the tax liability of a taxpayer, an arrangement or a series of arrangements can be ignored where it has been put into place for the main purpose or one of the main purposes of obtaining a tax advantage that defeats the object or purpose of the applicable tax law.
One needs to assess whether prices are genuine having regard to all relevant facts and circumstances. The spirit of the law that regulates transfer pricing under OECD rules is therefore somewhat mimicked in our legislation. Effectively, it argues that any arrangement can be regarded as non-genuine to the extent that it is not put into place for valid commercial reasons that reflect economic reality.
In addition, it can be argued that Malta has indirectly introduced TP rules by adhering to international conventions and relevant EU directives and in particular in the following considering that Malta’s double tax treaties use the OECD Model Tax Convention. Therefore, Article 9 “Associated Enterprises” of the OECD Model Tax Convention is included in Malta’s double tax treaties.
This Article provides that any transactions between associated enterprises that are not at arm’s length shall be adjusted for tax purposes in accordance with the ALP. Reading of the Commentary of OECD this refers to the application of the ALP through the OECD TP Guidelines. Further, the majority of the countries following the ALP use as means of application and interpretation of ALP, the provisions of the OECD TP Guidelines. Moving on to other related rules, let us give some background on the journey that took us to adopt ATAD. It was on 12 July 2016, that the Council of the EU unanimously adopted the Council Directive.
Later, Malta transposed ATAD 2 which builds on the provisions of ATAD 1. Another important rule requires Malta to apply the arm’s length principle in cross-border transfer pricing issues. This can be found in the Associated Enterprises Article of the OECD Model Tax Convention, which Malta accepted in its double taxation treaties. One may venture to comment on how indirectly transfer pricing rules creep in our legislation.
A typical case is the right of a country that is a party to a tax treaty to adjust the taxable profits arising from transactions between related parties and binds the other country to make corresponding adjustments to avoid double taxation. Here comes the rub. Such adjustments must be made on the basis of the arm’s length principle that again refers us back to the OECD standard. The latter regulates how transfer prices for tax purposes can be computed. As can be imagined, in similar circumstances there may arise disputes in the interpretation of how such prices are determined.
In such instances, OECD rules allow for disputes to be referred to arbitration. This follows in terms of the EU Arbitration Convention, of which Malta is a party. Another remedy is provided by the Directive on Dispute Resolution Mechanism – this was transposed to Maltese law this year. As can be expected, Malta has so far not been subjected to such dispute resolution since transfer pricing rules are not applicable. For most member states, such disputes can be common and arise when exercises are carried by respective countries to ascertain the arms-length – ie the true commercial price.
In practice, this means that to prevent double taxation, a primary (upward) adjustment by one tax administration should be followed by a corresponding (downward) adjustment by the other. Needless to say, no administration takes lightly to a reduction of its tax base. This said it is clear that in the field of transfer pricing, a sincere form of collaboration is paramount.
Therefore, it would be expedient to recognise that it is in everyone’s interest to avoid double taxation and double non-taxation hence the reason to invoke the arm’s length principle. To assist in reaching consensus, OECD highly recommends for parties to agree to a joint audit. The findings of such an audit should be incorporated in a concluding report.
To the extent possible, tax administrations should endeavour to arrive at a common interpretation of how the arm’s length principle applies to the findings of a specific audit based on a scientific analysis of all the facts and circumstances. Such an agreed outcome would give an undertaking that the audit does not result in double taxation. Only thus, can tax authorities reach a common understanding of how a true and fair arm’s length exercise works?
In conclusion, one may relax that the full burden of transfer pricing rules is not yet activated in Malta. How such rules will affect Malta and its financial sector in the future is too early to assess. What is important is that practitioners avoid taking an ostrich head-in-sand attitude. There is nothing to halt the introduction of an all-embracing transfer pricing rule which will be applicable to local companies as duly recommended by OECD. In this respect, businesses should start evaluating the effect of the possible imposition of TP rules on their intragroup transactions and manage any associated risks.