During the Covid-19 lockdown, it is obvious that state coffers are not exactly brimming with revenue so attempts by tax authorities to tighten the TM rules on cross border transactions become popular. So far in Maltese law, there is no legislation on transfer pricing rules pertaining to OECD guidelines. Yet, why is transfer pricing so important for cross border taxation? The answer is international pressure to deal with perceived tax avoidance by multinational groups, a desire for increased access to information that enables the audit of the full value chain and the pressure to increase tax revenues by often exploiting intra-group transactions’ audits.
One needs to assess whether prices are genuine having regard to all relevant facts and circumstances.
During the Covid-19 lockdown, it is obvious that state coffers are not exactly brimming with revenue so attempts by tax authorities to tighten the TM rules on cross border transactions become popular. In Malta, which relies heavily on international trade, we are not completely shielded from this rule because in accordance with Article 5 (6) of the ITMA this gives the discretion to the Commissioner to determine the transfer price following the OECD guidelines.
In this regard, the Regulations provide 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 and is not genuine having regard to all relevant facts and circumstances.
One may also find a reference to transfer pricing in the recently 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. Taxpayers have so far been spared the rigours of transfer pricing exercises even though there are embedded in the law.
The arsenal includes 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 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. Furthermore, the new anti-tax avoidance (ATAD) provisions recently introduced in Maltese tax law re-emphasise the general anti-abuse rule already existent in Maltese tax legislation. 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.
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. At this stage, 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, ATAD 2 was introduced 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, how indirectly transfer pricing rules do 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. That 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? Once agreement is reached then the necessary adjustment is passed in the countries’ respective domestic tax assessments. In the situation, where no agreement is reached then it is advised that a final report should still include all relevant facts and circumstances with a clear reference to the points on which the tax administrations managed to agree. One observes that a final report on a coordinated transfer pricing control does not have a legal value per-se, unless it is specifically empowered via national legislation.
It may also transpire that the facts subject to the audit result in an assessment under the arm’s length principle which does not alter the position during the tax periods before or after the respective audit period.
In conclusion, one cannot 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.