As part of Malta's Recovery and Resilience Plan1, the Government of Malta has committed to reform the governance of the judiciary, anti-corruption, anti-money laundering and the fight against aggressive tax planning. In this respect, the plan includes crucial reforms to strengthen the judiciary's independence, to address some features of the tax system that facilitate aggressive tax planning and to strengthen the institutional framework in order to fight against corruption and money laundering. Consequently, the introduction of Specific Transfer Pricing Legislation and procedures to prevent loss of public revenues through international tax arbitrage was overdue.
What is Transfer Pricing?
Transfer pricing refers to the setting of the correct transfer price between associated enterprises forming part of a multinational enterprise (hereinafter referred to as MNE) group.
Transfer pricing by itself does not necessarily involve tax avoidance. It is where the transfer pricing does not accord with applicable international norms that mispricing or incorrect pricing occurs, and where issues of tax avoidance and fraud may arise. In order to ensure the determination of the correct transfer pricing between associated enterprises, Organisation for Economic Co-operation and Development (OECD) Member States have chosen to treat each entity in the MNE as a separate entity. The OECD has also published and subsequently revised by the finalisation of the BEPS project, the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2017.
This separate entity approach is the most reasonable means for achieving equitable results and minimising the risk of unrelieved double taxation. In order to apply the separate entity approach to intra-group transactions, individual group members must be taxed on the basis that they act at arm's length in their transactions with each other. However, the relationship amongst the members of the MNEs may permit that they establish special conditions between themselves, which do not reflect and/or differ from normal market conditions between independent enterprises.
To ensure the correct application of the separate entity approach, OECD member countries adopted the Arm's Length Principle (ALP), under which the effect of special conditions on the levels of profits should be eliminated.
The Arm's Length Principle
The general rule is that, profits derived by an enterprise of a contracting State are taxable only by the contracting State in which the enterprise has its residence. 14 Article 9(1) in the OECD Model Convention, allows the State to depart from these general rules by adjusting profits accruing to a domestic enterprise, which is associated with a foreign enterprise, to the extent that the business profits concerned were affected by terms and conditions differing from normal market conditions between independent enterprises. The ALP provides that, the conditions made or imposed between associated enterprises must be compared with those which would be agreed between independent enterprises, thus a comparability analysis taking into account functions performed, assets used and risks assumed, must be performed. There is above all a concrete possibility to make a comparison whenever a market price exists and can be ascertained, at a certain point in time and in a specific market for the, inter alia, goods and services received.
If there is no such possibility to make a comparison, an attempt must be made to estimate by other means what would have been agreed between third parties that are independent of each other in the absence of any influence under company law. This comparison is necessarily a hypothetical one.
What must be taken in consideration is that the price is founded on certain market situations independent of the association of the two enterprises. Another point to be observed in the comparability analysis is the function, which the dependent enterprise has within the group as a whole.
For providing concrete basis for comparisons, certain standard methods have been developed for establishing the Arm's Length price which are laid down in the above-mentioned OECD Transfer Pricing Guidelines.
Malta's Public Consultation
On the 22nd of December 2021, the Commissioner for Revenue issued the draft Transfer Pricing Rules for public consultation. The Commissioner for Revenue, through this document, is seeking feedback in relation to a set of transfer pricing rules drafted with a view to implement legislation prescribing the requirement for the application of the arm's length principle for the pricing of transactions between associated enterprises falling within the scope of the rules. The consultation period will end on 28 February 2022. Any submissions received after this date may not be considered. It is envisaged that the proposed transfer pricing rules (the rules) shall come into force with effect for financial years commencing on or after 1 January 2024.
This article was originally published on The Malta Business Weekly on 27th January 2022.
Footnote
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.