Sustainable development of EU’ economies requires taking into account several issues, which are related to the increased scale of international trade. Globalization has led to a substantial increase of cross-border transactions between related parties and has exceeded 50% of all global trade. The tax rates and accounting principles are different in various countries. Multinational companies often increase the after-tax profits by shifting taxable income from high tax countries to low tax countries such as Malta. Under this strategy, the MNEs (Multinational Enterprises) set transfer prices that differ from market prices, i.e. prices applied in similar transactions by unrelated parties under similar circumstances.
Changes in transfer prices can significantly affect the tax revenue of the state where a company operates. However, many countries adopt the arm’s length principle as a means of regulating and controlling these profit manipulations arising from the Transfer Pricing (TP) practices. Where the companies’ transfer prices are not in line with the arm’s length principle, the tax authorities have the prerogative to adjust these prices and impose a relevant penalty. The Transfer pricing is based on OECD guidelines and are similar in EU countries. However, the methods, principles, and rates of transfer pricing penalties differ between EU member states.
The designed penalty regimes depend on the differences in tax and judicial system of each country. There are diverse reasons why penalties should be given particular attention in the context of TP. In more detail, penalties affect the level of trade between related companies, required compliance procedures by the tax authorities and the administration of tax rules in EU.
Malta does not operate a sophisticated transfer pricing regime. However, there are brief references to arm’s length transactions. The purpose of this article is to determine the operation and regulation of transfer pricing in Malta. This study aims to analyze the current practices in Malta in light of the lack of formal transfer pricing regulations. Given the increased importance that transfer pricing has gained internationally, the article seeks to understand the role of OECD Guidelines in Malta. In the absence of a robust TP framework, will the Maltese tax authorities still consider desirable that transactions between residents and non-residents broadly adhere to the arms-length principle?
Transfer pricing requirements
As already mentioned, there are no detailed TP rules in Malta. Adherence to the arms-length principle is introduced by the Income Tax Act (ITA) and Income Tax Management Act (ITMA), namely Article 51(1) of the ITA and articles 5(6) and 5(7) of the ITMA (introduced in 1994). The primary purpose of TP guidelines is the allocation of profit tax base between the countries in which transaction parties are performing their activities. The fundamental principle of TP is the arm’s length statement as referred in article 9 of the OECD, which forms the basis of bilateral tax treaties. The arm’s length principle ensures the right of each country to tax the profit accrued under its market conditions. In addition, TP legislation provides that the results from the same activity will not be imposed in tax in several countries, allowing adjustments on taxable profits under the arm’s length principle.
Although there is no specific regime in Malta, there are some general tax anti-avoidance provisions and brief references to transactions at arm’s length. However, the Maltese tax authorities typically still consider that transactions between residents and non-residents broadly comply with the arms-length principle. Therefore, no specific rules are available in order to establish the arms-length price on a reliable manner.
Legitimation of transfer pricing rules in Malta
The fundamental reason why TP rules were not legitimized till 2009 in Malta (although the arm’s length principle was introduced into the tax law) are due to the low-profit tax rates and various tax exemptions for multi-national companies provided by the tax laws. Therefore, it is not likely for the multinational companies to shift taxable income from Malta – a low tax country – to high tax countries by altering transfer prices.
It should be noted that the TP rules in most EU countries are based on OECD guidelines. Thus, the transfer prices in these countries shall be determined set applying the same pricing methods. However, Maltese tax law does not prescribe any detailed TP procedures, as such, no transfer pricing method requirements are defined for both international and domestic transactions.
Transfer pricing penalties
TP penalties lower than 10% on unpaid taxes, are applied in countries with low tax rates, such as Malta. The rationale behind this is that the multinational companies rarely shift taxable income from low-tax countries to high-tax rate countries, by manipulating their controlled transfer prices. The low penalties are only applicable in countries where the TP requirements are not strictly legitimated.
Certain penalties are contemplated when the reporting Maltese UPE, SPE or CE fail to comply with, inter alia, due diligence, data collection, retention and reporting obligations in accordance with the obligations set out in the EU Administrative Cooperation Directive. Also, Article 52 of the Income Tax Management Act includes general penalties.
Several types of transfer pricing penalties are applied in different countries around the world. The EU transfer pricing forum provides the classification of penalties into groups as:
- Other specific penalties
A taxpayer may be charged with an administrative penalty for non-compliance with the TP documentation requirements, regardless if the transfer prices are in line with the arm’s length principle.
Penalties are also imposed for unpaid taxes (e.g., income tax, VAT, customs duties) due to the TP adjustments. The total burden depends on the amount of delinquent taxes and the various EU countries overall tax scheme.
It is essential that the penalty should not be applied in case the taxpayer made transfer pricing adjustments voluntarily without any requirement of tax authorities. In this context, it is considered unreasonable to impose significant penalties on taxpayers that made an effort to adopt an approach consistent with the arm’s length principle, setting competitive conditions on their controlled transactions. In particular, it would be of no sense to penalize a taxpayer for failing to collect and review not publicly available data.
Maltese law does not provide laws to the pricing of controlled transactions involving intangibles rules or special measures regarding hard to value intangibles (HTVI). However, there are other rules outside transfer pricing rules that are relevant for the tax treatment of transactions involving intangibles. Provisions to this rules are stipulated in the Income Tax Act (Cap 123 of the Laws of Malta) that are relevant for the tax treatment of transactions involving certain categories of intangibles. These include provisions relating to:
- Taxable capital gains or profits arising from intellectual property (Article5(1);
- The re-domiciliation of a company (Article 4A);
- Deductible expenses on scientific research and on patents/patent rights(Article 14(1)(h) and (m))
In addition, Article 8 (3) (a) of the Malta Enterprise Act (Cap 463 of the Laws of Malta) provide for investment tax credits.
Intra group services
Maltese law provide regulations which provide guidance specific to intra-group services transactions, but in limited circumstances. Article 14(4) of the Income Tax Act (Cap 123 of the Laws of Malta) refers to services carried out on or in relation to immovable property where such property. Is owned by a related person Article 26(h) of the Income Tax Act (Cap 123 of the Laws of Malta) refers to certain interest, discount or premium paid to a related person in relation to immovable property. In Malta there are no simplified approach for low value-adding intra-group services and there are no other rules outside transfer pricing rules that are relevant for the tax treatment of transactions involving services
Transfer pricing documentation
Maltese tax law does not contemplate detailed transfer pricing documentation rules; it only applies high-level transfer pricing principles. However it should be Country-by-country report consistent with Annex III to Chapter V of the TPG The annual preparation of transfer pricing documentation is not statutory, the maintenance of such documentation is recommended. The Cooperation with Other Jurisdictions on Tax Matters (Amendment) Regulations, 2016 (The Regulations) require Maltese tax resident ultimate parent entities (UPEs) of multinational entity groups (MNEs) and certain constituent entities (CE), which has been appointed as the Surrogate Parent Entity (SPE) to file with the Commissioner for Revenue (CFR) a Country-by-country report (CbCR) in respect of Reporting Fiscal Years starting from 1 January 2016. The Regulations also appear to cater for the so-called ‘secondary mechanism’, whereby a CE which is tax resident in Malta and which is not the UPE will be required to submit the CbCR itself subject to satisfying certain conditions. This secondary mechanism will apply as from periods beginning on or after 1 January 2017, unless the CE has been appointed as the SPE. The CbCR needs to be submitted by the reporting Maltese UPE, SPE or CE within 9 months from the last day of the fiscal year of the MNE GroupThe CFR shall automatically exchange information gathered from the CbCRs to any other EU Member State in which one or more CE of the MNE group is either tax resident or by virtue of a permanent establishment created therein at prescribed intervals. Malta’s current legislation in relation to CbCR relates solely to EU Member States, as contemplated in Council Directive (EU) 2016/881. Such exchange of CbC Reports will be extended to Non-EU Jurisdictions during 2017, with an amendment to the existing Cooperation Regulations and work on this is currently underway. Currently, no changes in legislation are envisaged. However, due to the fact that reference is made to the OECD Transfer Pricing Guidelines.
Transfer pricing Audit by Local Authority
In Malta, the likelihood of TP-related audits is low, under the general provisions. Given that there are no detailed TP guidelines, the chances that the Maltese tax authorities will initiate a TP audit on their own prerogative (i.e., not consequent to a request by a foreign tax authority) are, at least for the time being, low.
Base Erosion and Profit Shifting (BEPS)
The OECD introduced a new interactive tax map which was signed by Malta alongside 71 other countries. These actions were taken to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting, which are intended to help combat BEPS. The main scope is to offer an effective way for tax treaties measures to be developed as part of the BEPS agenda into prevailing bilateral tax treaties. Top of Form Indicators published by OECD portray Malta as a tax compliant jurisdiction which makes it one of the more competitive business choices in the Mediterranean. The report further revealed that Malta is resolute to comply with the best international standards and the necessary exchange of information needed for investigations on tax-related issues.
As an overview, Malta is a quite successful country in BEPS’ regard, based on the shown result. More specifically, the OECD indicators regarding BEPS report lack of harmful tax practices, as well as a strong commitment to tax cooperation. As for the Automatic Exchange of Information, Malta has commenced exchanging information in line with the Common Reporting Standard and maintains an activated information exchange network with Country by Reporting for multinational enterprises. Moreover, Malta is ranked as being highly compliant when it comes to the Exchange of Information on Request.
The OECD assesses tax regimes concerning intellectual property rights, financing and leasing, banking and insurance, distribution and service centers, shipping, holding companies and fund management. The assessment results for Malta reveal that there are no “harmful features” for base erosion and profit shifting.
Malta Company Taxation Structure
Malta’s tax system is based on three main pillars:
- The imputation tax system of tax;
- The various forms of relief from double taxation and
- The refundable tax credit system.
Malta Companies are taxed at the rate of 35% rate on their capital gains and worldwide income. Although, the tax rate can be considered to be relatively high compared to those in other jurisdictions, it is actually reduced through incentives applicable to both Maltese companies and their shareholders.
Malta Companies – tax residence determination
A company is deemed to be resident in Malta once it has been incorporated in Malta and is subject to tax on its worldwide income, irrespective where the effective management is exercised. If the control of a company takes place in Malta but it is incorporated outside Malta, such a company can be still considered as a tax resident of Malta.
The full imputation system
The tax paid by a Maltese Company is imputed in full towards the shareholder’s tax liability upon receipt of a dividend under this system. The tax rate applicable to individual shareholders is equivalent to Malta’s corporate rate of tax being 35%. This means that shareholders dividends will not be subject to other tax on payment of dividend, given the verity that the tax paid by the company will be imputed in full towards the shareholders’ tax liability.
The refundable tax credit system
Shareholders are eligible for a refund of part of the tax paid by the company upon receipt of the dividend. The refund rate amounts to 5/7, if the profits generated by the company consist of royalties or passive income. The rate of refund is reduced to 2/3, if the Malta Company claims relief from double taxation.
Other features of Malta’s tax system
- Malta does not implement thin capitalization rules, which means that a Malta company may be entirely funded by loans, except for the minimum share capital required by Malta’s company law.
- Malta adopts a participation exemption regime. Any income or gains derived from a participating holding, or from the disposal of such a holding, exempt from income taxation, if certain conditions are satisfied. The same treatment also applies for income or gains derived from foreign establishments and from the disposition of such establishments, subject to certain conditions being met.
- Capital gains obtained from the transfer of certain assets are subject to tax in Malta. Such list of assets includes immovable property, securities, goodwill, interests in partnerships, business, licenses, patents, trademarks and other intellectual property amongst others, under some exemptions.
- Royalties and interest derived by non-residents exempt from Malta tax; therefore payments of interest and royalties to non-residents are not subject to any Malta withholding tax. The same applies to payments of dividends, given the imputation system described above.
- Companies owned by individuals who are neither resident nor domiciled in Malta, which hold overseas investments and maintain more than 90% of their business interests situated outside Malta, are not liable to pay a stamp duty.
The intra-group transfer prices can significantly affect the MNE’s profitability and the tax revenue of the states. Thus, many countries regulate transfer pricing arrangements requiring the application of arm’s length principle in order to control the possible manipulation of the business profit. Malta has not introduced a rigid transfer pricing regime in spite of making references to transactions at arm’s length. In more detail, no specific rules are available on a manner establishing an arm’s-length price. Although, the TP requirements are quite similar in EU countries, the types, principles, and rates of TP penalties may differ significantly. The substantial differences between the applicable penalty regimes within EU should be eliminated in order to limit significant distortions of the arm‘s length principle.