Transfer Pricing Rules have been introduced in Malta with effect from 1 January 2024. The Maltese Transfer Pricing Rules refer to the arm’s length principle. In this regard, the methodologies set out in the OECD Transfer Pricing Guidelines are the preferred methodologies to determine the arm’s length price.
In this article we explore Transfer Pricing considerations for intra-group financial transactions and Permanent Establishments.
Intra-group financial transactions
Almost all groups will have intra-group services of some kind. Often, such intra-group services arise because it is more efficient and economic to centralise certain activities. Financial transactions include:
- Treasury function
- Financial guarantees
- Intra-group financing
These activities are typically carried out by the parent company, by a group service centre or by the Head Quarters.
Transfer pricing in various jurisdictions would require that transactions between related parties are conducted by reference to the arm’s length principle. When evaluating whether the arm’s length principle has been adhered to in respect of such intra-group services all the facts and circumstances of the transaction must be taken into account, in particular in cross-border situations.
Financial transactions
- Treasury function
- Financial guarantees
- Intra-group financing
Treasury function
The manner in which a group has organised its treasury function may vary. There are groups with a centralised treasury function and others with a more decentralised form.
When evaluating the transfer pricing issues related to treasury activities it is important to consider the actual transactions and determine as precisely as possible which functions an entity is performing.
In transfer pricing it is important to evaluate the functions actually performed by the entity and the risks to which it is exposed to. After analysing the transaction, it should then be possible to reach conclusions about the proper arm’s length price for the functions performed and risks assumed by the entities involved.
Financial guarantees
In general, a financial guarantee provides for the guarantor to meet specified financial obligations in the event of a failure to do so by the guaranteed party.
From the perspective of transfer pricing, the analysis should be directed towards the guarantees that constitute a legally binding commitment on the guarantor’s part. Due to such a commitment, the guarantor assumes a specified obligation of the guaranteed party if the latter defaults on its obligation.
It is also important to gain an understanding of the characteristics and scope of the guaranteed obligations and the impact of the guarantee commitment for all parties involved.
Intra-group financing
In principle, interest rates on loans between group companies should be charged at a rate that would have been charged in similar circumstances in loan arrangements between independent, unrelated parties.
The arm’s length interest rate is determined by comparing intra-group loans with similar loan arrangements between independent parties. The applicable comparables can be internal as well as external.
Also in certain circumstances, in order to determine the appropriate return (if any) and the type of return in respect of the finance provided, an analysis should be carried out to establish whether the such financing is debt or equity in nature.
Permanent Establishment
Companies are dedicating an increasing amount of time to managing the existence of and the allocation of income to permanent establishments.
Companies operate their business globally in various ways. This adds more complexity and raises new questions, which were not necessarily anticipated when international law concepts were initially developed.
- What is a Permanent Establishment (PE)?
- When does a PE exist?
- How are profits attributed to a PE?
What is a Permanent Establishment (PE)?
A PE is a taxable presence which generally gives rise to corporate income tax or other taxes on business activities in a country or tax jurisdiction, for example a branch.
When determining whether a PE exists any double tax treaty in place between the respective tax jurisdictions must also be considered. The tax treaty should assist in determining the right of a “Contracting State” to tax the business profits of an enterprise of the “other Contracting State”.
When does a PE exist?
Typically, a permanent establishment is considered to exist when:
- a company has a fixed place of business through which the business of an enterprise is wholly or partly carried on;
- a person (other than an independent agent) is acting on behalf of a company and habitually exercises and has the authority to conclude contracts in the name of that company;
- employees / personnel of an enterprise render services or are involved in a project in another country for a period exceeding that specified in the treaty/ applicable rules.
How are profits attributed to a PE?
The attribution of profits to a PE is probably one of the most complex subjects of transfer pricing. The attribution of profits to PEs sometimes leads to unacceptable results such as double taxation or double non-taxation. So how should profits be attributed to PE?
The profits attributable to a PE are those profits that the PE would have derived if it were a separate and independent enterprise engaged in the same or similar activities under the same or similar conditions, taking into account the functions performed, assets used and risks assumed by the enterprise through the permanent establishment.
The illustration below outlines the manner in which profits may be attributed to a PE.
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