Malta implemented the EU Directive 2016/1164 of 12 July 2016 laying down rules against tax avoidance practices that directly affect the functioning of the internal market (ATAD) by means of Legal Notice 411 of 2018 EU ATAD Implementation Regulations, 2018. The below provides an overview of the different new tax measures which will become applicable as from 1 January 2019, except for the exit taxation rule which will become applicable as from 1 January 2020.
The aim of ATAD is to implement at EU level the BEPS (Base Erosion and Profit Shifting) recommendations made by the OECD and the G20 in October 2015. ATAD lays down anti-tax avoidance rules in the following fields:
- Deductibility of interest payments,
- General anti-abuse rule (“GAAR”),
- Controlled foreign companies (“CFCs”), and
- Exit taxation.
The regulations apply to taxpayers including companies as well as other entities such as trusts and similar arrangements that are subject to tax in Malta in the same manner as companies. The definition also applies to entities that are not resident in Malta but have a permanent establishment (PE) in Malta provided these are subject to tax in Malta as companies.
Limitation to the Tax Deductibility of Interest Payments (Rule 4)
Regulation 4 of L.N. 411 aims at limiting the deductibility of interest payments as it was recommended in the Final Report on BEPS Action 4 (interest deductions and other financial payments) and included as a minimum standard in ATAD. The objective of this rule is to discourage multinational groups from reducing their overall tax base through financing group companies in high-tax jurisdictions with debt. Notably, the scope of the interest limitation rule encompasses both related party borrowing and third party borrowing.
As from 1 January 2019, subject to certain conditions and limitations, “exceeding borrowing costs” shall be deductible only up to 30% of the corporate taxpayers’ earnings before interest, tax and amortization (“EBITDA”) or up to an amount of EUR 3 million, whichever is higher. Corporate taxpayers who can demonstrate that the ratio of their equity over their total assets is equal to or higher than the equivalent ratio of the group can fully deduct their exceeding borrowing costs (so called “escape clause”).
“Exceeding borrowing costs” correspond to the amount by which the deductible “borrowing costs” of a taxpayer exceed taxable “interest revenues and other economically equivalent taxable revenues” that the taxpayer receives. Thus, in order to determine the amount of exceeding borrowing costs, it is necessary to understand which costs fall within the scope of borrowing costs and what is considered as interest revenues and other economically equivalent taxable revenues.
Borrowing costs to take into account are interest expenses on all forms of debt, other costs economically equivalent to interest and expenses incurred in connection with the raising of finance, including, without being limited to:
- payments under profit participating loans,
- imputed interest on instruments such as convertible bonds and zero coupon bonds,
- amounts under alternative financing arrangements, such as Islamic finance,
- the finance cost element of finance lease payments,
- capitalised interest included in the balance sheet value of a related asset, or the amortisation of capitalised interest,
- amounts measured by reference to a funding return under transfer pricing rules where applicable,
- notional interest amounts under derivative instruments or hedging arrangements related to an entity’s borrowings,
- certain foreign exchange gains and losses on borrowings and instruments connected with the raising of finance,
- guarantee fees for financing arrangements, and
- arrangement fees and similar costs related to the borrowing of funds.
As far as interest revenues and other economically equivalent taxable revenues are concerned, neither ATAD nor the LN 411 of 2018 clarifies what is to be considered as revenues which are economically equivalent to interest. However, since the definition of borrowing costs also refers to “other costs economically equivalent to interest”, there should be a symmetry in the interpretation of the two concepts.
The optional provision of ATAD according to which EBITDA and exceeding borrowing costs can be determined at the level of the consolidated group (in case of tax consolidation) has also been introduced in this regulation.
Entities which are out of the scope of the rule
Financial undertakings are out of the scope of the interest limitation rule. Financial undertakings are the ones regulated by the EU Directives and Regulations and include among others credit institutions, investments firms, insurance and reinsurance companies, certain pension institutions, alternative investment funds (“AIF”), undertakings for collective investment in transferable securities (“UCITS”), as well as central counterparties and central securities depositories.
In addition, standalone entities, i.e. entities that are not part of a consolidated group for financial accounting purposes and have no associated enterprise or PE are able to fully deduct their exceeding borrowing costs. In other words, these entities are not subject to the new interest limitation rule.
Loans which are out of the scope of the rule
Malta chose to limit the scope of the new rule through the inclusion of the following two optional provisions under ATAD:
- loans which were concluded before 17 June 2016 (i.e. a grandfathering rule) are excluded. However, the exclusion does not apply to any subsequent modification of such loans. Accordingly, when the nominal amount of a loan granted before 17 June 2016 is increased after this date, the interest in relation to the increased amount would be subject to the interest deduction limitation rule. Likewise, when the interest rate applicable on a loan granted before 17 June 2016 is increased thereafter, only the original interest rate would benefit from the grandfathering rule. Nevertheless, when companies are financed by a loan facility that determines a maximum loan amount and an interest rate, the entire loan amount should be excluded from the scope of the interest deduction limitation rule, irrespective of when the drawdowns have been made;
- loans used to fund long-term public infrastructure projects (where the project operator, borrowing costs, assets and income are all in the EU) are also excluded.
Carry forward of unused exceeding borrowing costs and unused interest capacity
Exceeding borrowing costs which cannot be deducted in one tax period because they exceed the limit set in the rule, can be carried forward in whole or in part without any time limitation.
In addition, unused interest capacity can be carried forward over 5 tax years. The regulations do not define what falls under unused interest capacity.
Exit Taxation Rules (Rule 5)
As from 1 January 2020, re-domiciliation’s and shift of tax residency to other jurisdictions will trigger exit taxes. The aim is to even out discrepancies in the valuation of assets in the country of origin and the valuation of assets in the country of destination.
The exit rules transposed through rule 5 of L.N. 411, provide for tax on capital gains which are triggered when a taxpayer:
- transfers assets from its head office in Malta to a PE in another country;
- transfers assets from its PE in Malta to its head office or another PE in another country;
- transfers its tax residence from Malta to another country, or
- transfers its activities made through a PE in Malta to another country.
The capital gain will be equivalent to the difference between the market value of the assets at the time of the exit and their value for tax purposes. The capital gain will be subject to the provisions of the Income Tax Act. The income tax on the capital gain becomes payable by not later than the taxpayer’s subsequent tax return date. In case of transfers within the EU or European Economic Area (“EEA”), the taxpayer may request to defer the payment of exit tax by paying in equal installments over 5 years.
Exit taxes do not apply if the assets are set to revert back to Malta within a period of 12 months and the assets relate to the financing of securities, assets posted as collateral or an asset transfer that takes place in order to meet prudential capital requirements or for the purpose of liquidity management.
General Anti-Abuse Rule (Rule 6)
Any arrangements 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 shall be disregarded. Arrangements are considered as non-genuine to the extent that they are not put into place for valid commercial reasons which reflect economic reality.
Article 51 of the Income Tax Act already includes general anti abuse provisions which explicitly states that any series of arrangements which are put up solely for taking benefit of any tax advantage is ignored for tax purposes. The GAAR transposed in regulation 6 of L.N. 411 prescribes that, for the purposes of calculating the corporate tax liability, there shall be ignored an arrangement or a series of arrangements which, having 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, are not genuine having regard to all relevant facts and circumstances. An arrangement or a series thereof is regarded as non-genuine to the extent that they are not put into place for valid commercial reasons which reflect economic reality.
CFC Rule (Rule 7)
ATAD provides for CFC rules to discourage the attribution of income in a low-taxed jurisdiction. Malta opted to adopt the non -genuine arrangement CFC rule, thus, as from 1 January 2019, Malta will tax the non-distributed income of an entity or PE which qualifies as a CFC.
The income of a CFC will be taxed in Malta if, and to the extent that, the activities of the CFC that generate this income are managed by the Maltese corporate taxpayer as the people functions in relation to the activities of the CFC are performed by the Maltese corporate taxpayer.
An entity or a PE will qualify as a CFC if the following conditions are met:
- The taxpayer by itself, or together with its associated enterprises, holds directly or indirectly more than 50% in the entity. Holding includes equity holding, voting rights and right to profit; and
- The actual corporate tax paid by the entity or PE is lower than the difference between the tax that would have been charged on the entity or PE computed in accordance with the Maltese Income Tax Act and the actual corporate tax paid on its profits.
If an entity or PE is deemed to be a CFC, then the non-distributed income arising from non-genuine arrangements of a CFC which are put in place for the purpose of gaining a tax advantage shall be included in the tax base of the taxpayer and hence will be brought to charge in Malta. The CFC rule applies only if:
- The CFC’s accounting profits exceed €750,000 and non-trading income exceeds €75,000, or
- The CFC’s accounting profits amount to more than 10% of its’ operating costs.
Allocation rules and methods to avoid double taxation
The income of the CFC to be included in the tax base of the Maltese taxpayer shall be limited to amounts generated through assets and risks which are linked to significant people functions carried out by the controlling Maltese corporate taxpayer. The attribution of CFC income shall be calculated in accordance with the arm’s length principle. The income to be included in the tax base shall be computed in proportion to the taxpayer’s participation in the CFC and is included in the tax period of the Maltese taxpayer in which the tax year of the CFC ends. Any tax paid by the CFC is allowed as a tax credit to the taxpayer in accordance with the provisions of articles 77 and 82 of the Act. Whilst the legislation provides for general guidelines as to how the income to be brought to charge will be calculated, in practice, various issues may arise which may require further clarifications from the tax department.
Following the launch of the BEPS recommendations by the OECD and the G20 in 2015, Malta has now implemented the EU directive to address tax avoidance schemes though ATAD. This follows the implementation of the MLI and the end of the single malt structures.
Most measures introduced through ATAD are new concepts to the Maltese tax framework. For the first time, Malta has interest deduction limitations, CFC rules and within two years, exit taxes. Being a new tax framework, various clarifications will be necessary to ensure that the rules are properly adhered to. It is indeed unfortunate that these rules have been released only a few days before these enter into effect as this gives very little time to taxpayers to assess the impact of these rules on current structures and assess whether changes are needed to mitigate the impact of these rules.