Following Malta’s introduction of transfer pricing rules effective from 1st January 2024, the Maltese tax authorities issued specific transfer guidelines to clarify the application of such rules.
Specifically, the guidelines permit the application of the OECD Transfer Pricing Guidelines Chapter VII with respect to low value-adding services (LVAS). This article examines the specifics of LVAS in the context of transfer pricing regulations, in line with the OECD transfer pricing guidelines.
What are low value-adding services?
Low value-adding services are intercompany services that provide minimal economic value to the receiving entity. These services typically assist multinational corporations in their primary business activities without significantly contributing to the profitability or strategic direction. The OECD Transfer Pricing Guidelines provide for a simplified approach to price such services and document the adherence of such arrangements with the arm’s length principle. The OECD Transfer Pricing Guidelines define LVAS as services that:
- Are of a supportive nature.
- Do not form part of the core business activities of the MNE group.
- Do not require or involve the use of unique and valuable intangibles.
- Do not lead to the creation of significant risks for the service provider.
Moreover, the OECD Transfer Pricing Guidelines list a number of services that may qualify as low value-added services including:
- Accounting and auditing services, such as the preparation of financial statements.
- Human resources activities, including recruitment, training and employee development and remuneration services.
- Data collection and monitoring in the areas of health, safety, the environment, and other business-regulating standards.
- Information technology services (provided they are not part of the principal activity of the group), such as maintenance, and technical support required to keep an MNE's IT infrastructure operating smoothly.
- Legal services, such as general legal services, contract preparation and review, legal research, and legal consultations handled by the internal legal council.
- Activities related to tax compliance such as preparation of tax and vat returns, effecting tax payments and tax advise.
- General administrative assistance, including clerical and general office administration.
Additionally, the OECD Transfer Pricing Guidelines list several examples of actions that are not covered by the simplified approach, such as:
- Research and development services.
- Services related to manufacturing and production;
- Services related to manufacturing and production;
- Services related to sales, marketing, and distribution;
- Financial transactions;
- Services related to natural resources
- Insurance services
- Services of corporate senior management;
The OECD guidelines set out a simplified approach for LVAS to streamline compliance and reduce disputes, which includes:
- Identification and Allocation: Clear identification of LVAS and allocation of costs.
- Cost-Plus Methodology: A consistent use of the cost-plus method with a standard profit markup of 5%.
- Documentation Requirements: Simplified documentation requirements to substantiate the arm's length nature of the pricing.
Transfer Pricing in Malta
Malta’s Transfer Pricing rules are heavily in line with the OECD Transfer Pricing Guidelines, integrating these principles within the Maltese tax legislation. The Maltese transfer pricing framework aims to ensure that transactions between related parties are conducted at arm’s length, reflecting the pricing that would have been agreed upon by unrelated parties under similar circumstances.Malta does not have comprehensive transfer pricing regulations; however, it relies on general anti-avoidance rules and the principles set out in the OECD guidelines. Key elements include:
- Arm’s Length Principle: Ensuring that intra-group transactions are priced as if they were between independent entities.
- Documentation Requirements: In scope entities are required to maintain OECD standard transfer pricing documentation, that is local and master files to document adherence to the Maltese rules. Although such documentation does not need to be filed on a periodic basis, there is an expectancy emanating from the rules that such documentation is readily available upon request from the tax authorities.
Application of OECD Guidelines on LVAS in Malta
1. Identification and Allocation:
- Maltese entities must accurately identify LVAS and ensure that the costs associated with these services are appropriately allocated across the benefiting entities within the MNE group.
- Such allocation should be based on a reasonable and consistent basis, such as actual usage, time spent, or another relevant allocation key.
2. Cost-Plus Methodology:
- For LVAS, Malta follows the OECD's recommended simplified approach, using a cost-plus method with a standard 5% markup.
- This method is intended to reflect a fair return on the service provided, balancing simplicity and compliance.
3. Documentation:
- Taxpayers which opt to adopt the simplified approach of low value adding intra-group services shall prepare the information in terms of Chapter VII of the OECD Transfer Pricing Guidelines. The information shall be made available to the MTCA upon request.
- Documentation should include details on the nature of the services, the rationale for the cost allocation method used, and evidence that the mark-up applied is consistent with the OECD guidelines.
Practical Considerations and Compliance of applying the LVAS simplification rules
- Service Agreements: Draft clear intra-group service agreements detailing the services provided, cost allocation methods, and pricing policies.
- Cost Identification: Maintain detailed records of costs incurred in providing LVAS, including direct and indirect costs.
- Mark-Up Application: Apply the standard 5% markup on costs consistently unless a different markup can be justified based on a comparability analysis. Should the taxpayer opt for a different markup and not apply the LVAS simplification option, the taxpayer would be required to adhere the overall OECD Transfer Pricing Guidelines.
- Internal Controls: Implement robust internal controls to ensure that LVAS are correctly identified, allocated, and documented.
Compliance Challenges
- Consistency: Ensuring consistent application of the cost-plus methodology across all entities in the MNE group can be challenging, especially in complex or diverse operational environments.
- Documentation: While simplified, the documentation requirement still demands a diligent approach to record-keeping and justification of the pricing policies.
By adopting a simplified approach, the OECD aims to reduce the administrative burden and potential for disputes. For Maltese entities, it is crucial to adhere to these guidelines, ensuring proper identification, allocation, and documentation of LVAS to comply with the arm’s length principle and mitigate risks of transfer pricing adjustments by the tax authorities.
