During 2022, Malta introduced a formal transfer pricing framework by means of Legal Notice 284 of 2022 (the Transfer Pricing Rules, ‘TPR’), enacted by the Minister for Finance under the authority of article 51A of the Income Tax Act (‘ITA’).
The TPR are included in the 2024 syllabus for ATX-MLA and are examinable from June 2024 onwards.
Future candidates should note that the content of this article indicates the extent to which the transfer pricing rules are examinable at Strategic Professional (ie ATX-MLA) level. Candidates at this level are expected to have an understanding of the rules contained in the legislation, but they will not be required to quote any legislative references in the exam. For the purposes of Applied Skills (ie TX-MLA), the TPR are not examinable and are an excluded topic.
For the purposes of this article:
The arm’s length principle refers to the price which might have been expected if the parties to a transaction or arrangement had been independent persons dealing with each other in a normal commercial manner unaffected by any special relationship between them. Its principal objective is to safeguard against the artificial shifting (generally cross-border) of profits in controlled transactions. Profit shifting may result from related party pricing policies that depart from those that would be expected between independent enterprises.
Notwithstanding the absence of an express domestic provision to this effect, in terms of Maltese law it is generally expected that associated enterprises transact with one another in accordance with the arm’s length principle.
The TPR have three principal aims:
a. They require affected taxpayers, in determining their total income, to substitute the arm’s length amount for the amount incurred, due, accrued or derived by said taxpayers under a cross-border arrangement where the latter amount is not in accordance with the arm’s length principle. The affected taxpayer must adjust its own profits under self-assessment.
b. They oblige affected taxpayers to prepare and retain transfer pricing documentation that can support the arm’s length amount asserted in the determination of their total income.
c. They provide for a transfer pricing ruling framework, both unilateral (unilateral transfer pricing rulings) and multilateral (advance pricing agreements).
Unilateral transfer pricing rulings and advance pricing agreements are not examinable in ATX-MLA.
In what circumstances do the TPR apply?
Not all taxpayers or types of arrangements are affected by the legislation. For the purposes of ATX-MLA, the rights and obligations emanating from the TPR would only find application upon the satisfaction of the following five conditions cumulatively:
a. Condition 1: The taxpayer is a covered taxpayer
b. Condition 2: The tested arrangement is entered into between associated enterprises
c. Condition 3: The tested arrangement is a cross-border arrangement
d. Condition 4: The tested arrangement is not grandfathered, and
e. Condition 5: The de minimis thresholds are exceeded by the taxpayer in a particular basis year.
Candidates should note that there is a further condition relating to securitisation transactions however this condition is not examinable because securitisation transactions are an excluded topic at ATX-MLA level.
Condition 1: The taxpayer is a covered taxpayer
Rule 3 of the TPR is the primary rule governing a taxpayer’s obligation to determine its total income in accordance with the arm’s length principle. However, rule 3 of the TPR only applies to ‘companies’ as defined by the TPR.
The term generally has the meaning assigned to it in the definition of ‘company’ found in article 2(1) of the ITA. However, the term excludes any micro, small or medium-sized enterprise (‘SME’).
The term SME means undertakings fulfilling the criteria laid down in Annex I of Commission Regulation (EU) No 651/2014 of 17 June 2014 declaring certain categories of aid compatible with the internal market in application of Articles 107 and 108 of the Treaty, as in force at the relevant time. In assessing whether a company is excluded under the SME exclusion, regard should be had to the relevant indicators at a group level, as opposed to isolating the analysis at the level of the tested company.
For ease of reference, the SME criteria are shown below. An SME is an enterprise which:
Condition 2: The tested arrangement is entered into between associated enterprises
An arrangement refers to any transaction, agreement or dealing of any kind, where, at the relevant time, the parties to such an arrangement are associated enterprises. An arrangement also includes a series of transactions, agreements, and dealings of any kind.
The degree of relatedness between the transacting parties is a key element of the definition of an arrangement. Accordingly, an arrangement is not affected by the TPR unless it is made between associated enterprises.
Association is determined by reference to a statutory control test. Two or more persons are associated enterprises in either of the following scenarios:
a. One of the bodies of persons controls the other body of persons whether as a result of the fact that it holds, directly or indirectly, a participation of more than 75% in the voting rights, or the ordinary capital, of the other body of persons or by virtue of any powers conferred by the articles of association or other document regulating the other body of persons, or
b. The same person or persons controls two or more bodies of persons whether as a result of the fact that it holds, directly or indirectly, a participation of more than 75% in the voting rights, or the ordinary capital, of the two or more bodies of persons or by virtue of any powers conferred by the articles of association or other document regulating the two or more bodies of persons.
Condition 3: The tested arrangement is a cross-border arrangement
The TPR only apply to cross-border arrangements. Purely domestic arrangements are not subject to the TPR. The definition of cross-border arrangement should be studied carefully. There may be instances where an arrangement would initially appear to purely domestic (for example, a transaction entered into between two companies that are both resident in Malta), but upon closer examination would have a cross-border element (for example, one of the parties to the transaction maintains a permanent establishment overseas to which the income/expense is attributable).
A cross-border arrangement means an arrangement between associated enterprises where any one of the following conditions is satisfied:
a. At least one party to the arrangement is not resident in Malta and at least one party to the arrangement is a company resident in Malta and the arrangement is relevant in ascertaining the total income of that company
b. At least one party to the arrangement maintains a permanent establishment situated outside Malta to which the arrangement is effectively connected and at least one party to the arrangement is a company resident in Malta and the arrangement is relevant in ascertaining the total income of that company
c. At least one party to the arrangement is not resident in Malta and at least one other party, not being resident in Malta, is a company which maintains a permanent establishment situated in Malta to which the arrangement is effectively connected, or otherwise derives income or gains arising in Malta, and the arrangement is relevant in ascertaining the total income of that company.
EXAMPLE 1
Company A is a company resident in Malta. It enters into a loan agreement with Company B, which is a company tax resident in the UK. Under the loan agreement, Company A incurs annual interest of €100. In ascertaining its total income for Malta income tax purposes, Company A is entitled to claim a deduction with respect to its borrowing costs in terms of article 14(1)(a) of the ITA.
The tested arrangement (the loan agreement) constitutes a cross-border arrangement, because:
EXAMPLE 2
Company A is a company resident in Malta. It enters into a loan agreement with Company B, which is also a company resident in Malta. Company B borrows the capital sum in order to finance a capital project in Country X. Under the loan agreement, Company A accrues annual interest of €100. The interest on the loan agreement is borne by the permanent establishment of Company B in Country X.
In ascertaining its total income for Malta income tax purposes, Company A brings to charge the interest income.
The tested arrangement (the loan agreement) constitutes a cross-border arrangement, because:
EXAMPLE 3
Company A is a company resident in Country X. It enters into a loan agreement with Company B, which is a company resident in Country Y. Company B borrows the capital sum in order to finance a capital project in Malta. Under the loan agreement, annual interest of €100 is payable. The interest on the loan agreement is borne by a permanent establishment of Company B in Malta.
In ascertaining its total income for Malta income tax purposes, Company B claims a deduction with respect to the borrowing costs incurred under the loan.
The tested arrangement (the loan agreement) constitutes a cross-border arrangement, because:
Condition 4: The tested arrangement is not grandfathered
Arrangements that were already entered into on 1 January 2024 do not fall within the scope of the TPR, unless these arrangements are materially altered on or after that date.
The expression ‘materially altered’ is not defined in the TPR.
Condition 5: The de minimis thresholds are exceeded by the taxpayer in a particular basis year
The TPR do not apply where an otherwise affected taxpayer does not exceed the de minimis threshold. The de minimis threshold is comprised of two cumulative tests:
Candidates should note that an affected taxpayer that would otherwise be exempt from applying the TPR on account of the de minimis threshold not being met, may in any event request the Commissioner for Tax and Customs to issue a determination stipulating that the TPR apply.
In ascertaining the total income of an affected taxpayer, an arm’s length adjustment is required with respect to any income accrued or derived, or any expenditure incurred or due, for a given tax period, but only where such income or expenditure is at variance with the arm’s length amount.
The adjustment is an adjustment to a company’s profit before tax that is only relevant for the purposes of the ITA (ie the TPR are not intended to impact, for example, the accounting recognition of such cross-border arrangements).
For the purposes of TPR, the expression ‘arm’s length amount’ in relation to a cross-border arrangement is the amount that independent parties would have agreed to in relation to the arrangement had those independent parties entered into that arrangement in comparable circumstances.
The arm’s length amount shall be determined on the basis of approved methodologies. The Commissioner for Tax and Customs is expected to outline approved methodologies in upcoming guidelines to be issued.
It is expected the OECD Transfer Pricing Guidelines will constitute an approved methodology. Future candidates should note that the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations are not examinable in ATX-MLA.
Transfer pricing documentation
An affected taxpayer is obliged to prepare on a timely basis, as well as retain, such records as may reasonably be required for the purposes of determining whether, in relation to the cross-border arrangement, the total income of the affected taxpayer has been ascertained in accordance with the provisions of the TPR.
No further information concerning the form and content of transfer pricing documentation has been made available by the Commissioner for Tax and Customs to-date.
Ascertaining the total income of a permanent establishment
The TPR makes special provision for the ascertaining of the total income of a permanent establishment. The rule applies both to permanent establishments situated in Malta, as well as permanent establishments situated outside of Malta.
Rule 10 of the TPR does not holistically govern profit attribution to permanent establishments. On the contrary, its scope is limited to applying the TPR by analogy to notional arrangements entered into between the permanent establishment and the body of persons (ie the head office of the enterprise).
Notional arrangements are conceptually related to the requirement of paragraph 2 of article 7 of the OECD Model Tax Convention to consider dealings between a permanent establishment and other parts of the enterprise of which the permanent establishment is part. This is designed to emphasise the separate and independent fiction and requires notional arrangements to be treated the same way as similar transactions taking place between independent enterprises.
In applying this fiction in the context of the TPR:
The 2010 Report on the Attribution of Profits to Permanent Establishments is considered to be a special source of interpretation when applying rule 10 of the TPR but is also excluded for ATX-MLA purposes.
Written by a member of the ATX-MLA examining team