The tax environment has experienced significant changes the past years, in view of the international consensus to combat harmful tax practices. Countries around the world are collaborating to improve the coherence of international tax rules and ensure a more fair tax environment, through the OECD recommendations.
Malta has adopted a number of such recommendations, and won the "tax compliant jurisdiction" position as announced by the OECD in 2017.
One of the most important initiatives of the OECD is the introduction of Transfer Pricing ("TP") Guidelines, which was proposed through Action 8-10 of the BEPS project. However, Malta has not yet adopted this recommendation.
Nevertheless, the current international practice in combination with the current developments, suggest that it is only a matter of time that TP rules will be introduced in the Maltese tax laws.
THE CURRENT PRACTICE AT INTERNATIONAL LEVEL:
TP is adopted by over 60 countries (including OECD and non-OECD members) and plays a prominent role in the effort made by tax authorities across the world, in combating aggressive tax planning.
The importance of the TP rules lies on the need to counteract the tax challenges raised from globalisation, by avoiding distortion of governmental tax revenues.
In particular, TP refers to rules and methods in determining the arm's length price of intragroup transactions, by considering the pricing, terms and conditions underpinning such transactions.
The Arm's Length Principle ("ALP") refers to the pricing of transactions between related enterprises that should not differ from what would have been charged by unrelated enterprises.
THE CURRENT PRACTICE AT MALTA'S LEVEL:
Even though the arm's length principle is used in its domestic legislation, Malta does not have TP rules to provide guidance on establishing how the arm's-length price of intra group transactions should be reached.
In particular, 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.
However, the above provisions of the law are rather vague and do not elaborate on an accepted methodology that can be used by all interested parties to reach to the arms' length profits.
In recent years, Maltese law made specific reference to TP rules in its local and in particular, in its Special Tax Regime – The Patent Box.
Malta provided for the application of TP rules in its 2019 revised Patent Box Regime, following recommendations based on the BEPS initiative and the EU Rules. The revision of the regime was necessary, as the previous version was found to be harmful due to the absence of a "substantial activity" criterion. However, the revised regime not only incorporated the substantial activity criterion (by matching the allocation of income with the economic activity that generates that income), but also went a step further and provided for the determination of the income/gains from the intellectual property in accordance to the OECD TP Guidelines.
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:
- Associated Enterprises - Article 9 of the OECD Model Tax Convention:
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 to the ALP.
The Commentary of OECD 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.
In the absence of legislation underpinning the application and interpretation of the ALP, in a possible situation where a cross boarder 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.
- The EU Directive on Dispute Resolution Mechanism
Malta transposed the EU Directive on Dispute Resolution Mechanism in its domestic legislation. The Directive provides that in a case of a possible dispute, the contracting Member States concerned shall endeavour to resolve the dispute by mutual agreement, subject to conditions.
A common dispute between the contracting Member States concerns the ALP. The internationally accepted principle of determining the ALP is the TP rules based on the OECD TP Guideline. Therefore, this may again be considered as an indirect application of TP rules in Malta.
THE FUTURE PRACTICE OF TP IN MALTA:
Apart from Malta and Cyprus, all other European countries adopted the OECD TP Guidelines with either little or no modification.
Cyprus introduced in June 2017 the need to perform TP studies on back to back finance arrangements between relates parties, and is about to introduce full TP rules in its legislation in 2020, leaving Malta the only EU country not following the TP Guidelines.
Clearly EU policies and Directives are influenced by the OECD and its recommendations. Therefore, in our view the introduction of TP rules in the domestic legislation of Malta is not far away.
Safeguarding Malta's position as financial centre is of great importance and requires compliance in all relevant aspects.
The EU support to the OECD TP Guidelines suggests that it is highly unlikely that Malta will not be able to escape implementation, so the application of the TP rules in Malta is only a matter of time.
In this respect, businesses should start evaluating the effect of possible imposition of TP rules on their intra group transactions and manage any associated risks well in advance.
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.