Ever since the launch of BEPS Inclusive Framework, Malta has mostly complied with all the rules for tackling tax avoidance, improving the understanding of international tax rules and ensuring a more transparent tax environment.

With regard to transfer pricing rules pertaining to OECD guidelines, as yet there is no such legislation in Maltese law. Needless to say, we are not completely shielded from this rule because Articles 5, 6 and 7 of the Income Tax Management Act (ITMA) gives discretion to the Tax Commissioner to determine the transfer price following the OECD guidelines.

There is also a reference to transfer pricing in the recently published Patent Box Regime (Deduction) Rules, 2019. Here, specific reference is 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 the OECD's Transfer Pricing Guidelines. Bearing this in mind, taxpayers have so far been spared the rigours of transfer pricing exercises, even though there are embedded in the law, 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 should 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 are to be determined. Furthermore, the new anti-tax avoidance (ATAD) provisions introduced into Maltese tax law re-emphasise the general anti-abuse rule already existing under Article 51(1) of the Income Tax Act. 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.

It is necessary to assess whether prices are genuine, having regard to all the relevant facts and circumstances. 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 has not put in 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, which builds on the provisions of ATAD 1, was introduced to address hybrid mismatches with third countries. All Member States have until 31 December 2019 to transpose the ATAD 2 provisions, which will be ready to be applied from 1 January 2020, with an effective date of 1 January 2022.

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 could venture to enquire how transfer pricing rules indirectly creep into our legislation.

A typical case is the right of a country that is 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. However, here comes the rub. Such adjustments must be made on the basis of the arm's length principle which, 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 disputes may arise 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 the terms of the EU Arbitration Convention, of which Malta is a party.

Another remedy is provided by the Directive on Dispute Resolution Mechanism which was transposed into 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 out by respective countries to ascertain the arms-length, ie the true, commercial price.

In practice, this means that in order 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 a reduction of its tax base lightly. Having said which, it is clear that - in the field of transfer pricing - sincere form of collaboration is paramount. Therefore, it would be expedient to recognise that it is in the interests of everyone to avoid double taxation and double non-taxation, hence the reason for invoking the 'arm's length' principle.

To assist in reaching consensus, the OECD highly recommends that parties agree to a joint audit, with the findings of such an audit being incorporated in a concluding report. To the greatest 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 would not result in double taxation. Only this way can tax authorities reach a common understanding of how a true and fair arm's-length exercise works. Once agreement has been reached, then the necessary adjustment is passed in the countries' respective domestic tax assessments.

In a situation where no agreement is reached, then it is advised that a final report should still include all the relevant facts and circumstances, with a clear reference to the points on which the tax administrations managed to agree. It should be pointed out 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 may relax that the full burden of transfer pricing rules has not been activated in Malta. It is too early to assess how such rules will affect Malta and its financial sector in the future but what is important is that practitioners avoid taking an ostrich head-in-the-sand attitude. There is nothing that can halt the introduction of an all-embracing transfer pricing rule which will be applicable to local companies as recommended by the OECD.

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The writer is a partner in audit and business advisory firm PKF