Transfer Pricing

Comparability and benchmarking in a small island state

The arm's length principle necessitates that controlled transactions' terms and conditions are based on those applicable between independent parties for similar transactions. 

On a fundamental level, comparability serves a key function in the process of establishing whether a transaction is on arm's length basis.

What is comparable?

Comparability in a transfer pricing study requires the analysis of the five factors below:
  1. The characteristics of property or services
  2. Functional analysis, considering the funcitons carried out, assets used, and risks assumed
  3. The contractual terms
  4. Econominc circumstances
  5. Business strategies
Two transactions are comparable only if they are carried out between parties operating within similar commercial and financial relations and under similar circumstances. In addition, the OECD Transfer Pricing Guidelines mandates the use of good quality comparables which in turn necessiates that the transaction being benchmarked against, is between independent parties performing similar functions and bearing similar risks.

In a small state like Malta, the number of transactions which simultaneously satisfy the same functionality analysis test and at the same time are carried out between independent enterprises  is significantly limited, if at all existent. Although one may achieve a larger quantity of potential comparables by extending the benchmarking search criteria to a European or other state level, one cannot compensate for low quality comparables through a larger quantity (in particular due to the very different economic circumstances in continental EU vis a vis Malta) of comparables.

Actions that can be taken to address situations of lack of data

The OECD Transfer Pricing guidelines advocate that the intra group entity which carries out the least complex operations should be the tested entity in a comparability analysis. However, a MNE with an entity in Malta, will understandbly encounter difficulties to identify comparables involving Maltese entities. In such cases, it may be opportune to consider carrying out the benchmarking exercise utilising the more complex entity in the transaction.

The IMF, OECD, World Bank Group  and United Nations collaboratively published a guide ('A toolkit for addressing difficulties in accessing comparables data for transfer pricing analysis') that suggests the following potential actions to address situations of lack of data:
  • Increase the sources of primary data such as publicly available information from financials of independent enterprises
  • Explore the use of other data to determine the arm's lenght price such as testing the benefit received, thereby assessing arm's lenght on the basis of the willingness to pay concept
  • Granting the possibility to enterprises to utilise safe harbours, fixed margin and other prescriptive approaches
  • Utilise the transactional profit split method, in particular when both tested entities provide valid and joint contributions to the transaction
  • Utilise valuation techniques (most appropriate in the case of intangibles); and
  • Taking advantage of advance pricing arrangements (APA) afforded by the tax authorities

Whereas the Maltese Transfer Pricing rules have already provide for the use of APAs and certain safe harbor exclusions for SMEs and de minimis rules, it is still to be seen whether the still to be issued Maltese Transfer Pricing Guidelines will introduce additional safe harbor rules, in particular from intra group loans and certain service provisions.

How can BDO help?

BDO Malta offers valuable assistance in the area of transfer pricing by providing expertise in the application of the arm's length principle. By leveraging BDO's knowledge and guidance, you can ensure compliance with tax regulations, promote equitable treatment between multinational enterprises and independent entities, and navigate the complexities of international trade and investment.

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