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Archives for Corporate Taxation

Anti-Tax Avoidance Directive (ATAD)

During the Budget speech for 2019 presented on 22 October 2018, it was announced that Malta, like other EU Member States, will be implementing the EU Directive on Anti-Tax Avoidance, more commonly known as ATAD1.

 

Although no detailed provisions are available yet, the following is a brief summary of the expected changes which will be introduced with effect from 1 January 2019 as a result of ATAD1.

  

Interest Limitation

 

When interest and similar borrowing costs of a company exceed interest receivable, the maximum tax deduction that can be claimed in a tax period in respect of the excess costs will be 30% of EBITDA (that is, earnings before interest, tax, depreciation and amortisation). Unutilised costs may be carried forward (subject to any further limitations that may be applicable under the normal provisions of the Income Tax Act). The new restrictions will not apply in cases where the exceeding borrowing costs do not exceed €3,000,000 (three million Euros).

 

In line with the EU Directive, the regulations envisage the possibility of this limitation being calculated and applied at group level.

 

The limitation will not apply to financial undertakings. Nor will it apply to costs on loans used to fund long-term public infrastructure EU projects or loans concluded before 17 June 2016.

 

Exit Tax

 

A change of residence of a company, or the movement of its assets or of its business to another territory will be treated as a taxable exit event. In such a case, the company will become subject to tax in the same manner as if it has disposed of its assets. The accrued gains will be calculated by reference to the market value of the asset at the time of the exit. Where the country of the new residence of the taxpayer or of the new location of the assets is another EU Member State, the payment of the tax can be deferred.

 

No exit tax will be chargeable in the case of a temporary movement of assets that is linked to certain financial transactions as long as the assets are returned within 12 (twelve) months.

 

Controlled Foreign Company (CFC) Rules

 

An entity will be considered a CFC where it is subject to more than 50% (fifty per cent) control by a parent company that is tax resident in Malta and its associated enterprises and the tax paid on its profits is less than half the tax that would have been paid had the income been subject to tax in Malta.

 

The measure will not apply:

 

  • To a CFC with accounting profits of no more than €750,000 (seven hundred and fifty thousand Euros), and non-trading income of no more than €75,000 (seventy-five thousand Euros); or
  • To a CFC whose accounting profits amount to no more than 10% (ten per cent) of its operating costs for the tax period.

 

The parent company will be entitled to double taxation relief for the tax paid by the CFC on the included income. The regulations should also provide for the avoidance of double taxation that could arise if the CFC subsequently distributes its profits or the parent company disposes of its interest in the CFC.

 

General Anti-Abuse Rule (GAAR)

 

The Income Tax Act already contains a general anti-abuse provision (article 51) that empowers the Commissioner for Revenue to ignore tax avoidance schemes. The new regulations will add to this rule by applying the definition of tax avoidance schemes as used in the Directive. The measure will accordingly apply to arrangements which are not genuine, meaning that they are not put into place for valid commercial reasons that reflect economic reality, and which have been put in place with a main purpose of obtaining a tax advantage that defeats the object or purpose of tax law.

 

EU Dispute Resolution Mechanism (DRM)

 

The EU Directive on ERM will be implemented by the end of June 2019 and it will be instrumental in providing Maltese taxpayers with access to a new dispute resolution framework in relation to disputes with other EU tax authorities that may come about given the changes that are being implemented in the international tax arena.

 

EU Mandatory Disclosure Directive (DAC 6)  

 

Regulations for the transposition of DAC 6 are being prepared and will meet the implementation deadlines set out in the Directive but no further details are available yet.

 

ATAD 2 effective as of 1 January 2020 and 1 January 2022

 

Apart from ATAD1, Malta will also have to implement the provisions of ATAD2 although these will take place on 1 January 2020 and 1 January 2022.

 

ATAD 2 will replace the original anti-hybrid provisions of ATAD 1 by extending them to include mismatches involving third countries and expanding the definition of hybrid mismatches to include hybrid permanent establishment mismatches, hybrid transfers, imported mismatches, reverse hybrid mismatches and dual resident mismatches.  It is still premature to make any further comments on ATAD2.

 

 Patent Box Regime

 

Malta will introduce a new patent box regime that complies with the EU Code of Conduct (Business Taxation) and the OECD proposals on preferential intellectual property regimes (the so-called Modified Nexus approach).  Once again, no further details are available at this stage.

 

Conclusion

 

ATAD will introduce new concepts into the Maltese tax legislation such as exit taxes and CFC rules.  However, the changes should not have a dramatic effect to the tax system especially the principles of the full imputation system and the tax refunds which shareholders may claim upon a distribution of certain taxed profits.  We expect no changes to the participation exemption regime and we’ll have to see whether the step-up provisions already contained in our tax legislation will be affected.  If not, the step-up provisions and the participation exemption should continue to provide interesting opportunities.

 

It will be interesting to see how the interest limitation provisions will ‘interact’ with the newly introduced rules on Notional Interest Deduction which had an extremely positive effect on a number of Maltese companies

 

Very limited amendments are expected for the implementation of GAAR as required by the Directive since it is very similar to that already included in the Maltese Income Tax Act.

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Corporate Taxation

Malta has been an EU Member State since 1 May 2004 and the adoption of EU Directives coupled with a unique full imputation system of taxation as well as tax refunds has developed the country into an international financial centre.  Malta is the country of choice for foreign investments into the EU. However, several companies in a multitude of sectors have set up in Malta for several reasons. Although the country and the local market are small, companies have no restrictions in accessing the EU market and beyond.  Malta has developed an advanced IT infrastructure, very good telecommunications and connections, an extensive treaty network, a professional and business friendly atmosphere amongst professionals and regulators, and a can-do attitude all of which have contributed to Malta’s success beyond its relative size.

 

Corporate taxation and the full imputation system

Maltese registered companies are subject to income tax on chargeable income at a standard rate of 35%. Companies incorporated in Malta are subject to tax on their worldwide income but companies incorporated outside Malta but are tax resident in Malta by virtue of their effective management and control are subject to tax on income arising in Malta and income remitted to Malta.  One may also claim that companies are not effectively subject to tax because of the full imputation system of taxation whereby the tax paid by the company is credited in full to the shareholder/s following a distribution of profits. This ensures that there is no double taxation as often happens under the classical system.  Moreover, a system of tax refunds which shareholders may claim depending on the source of income leads to an effective tax rate which may be well below the 35% tax rate applicable to companies.

 

Tax accounting

Every Maltese company is required to allocate its profits to five tax accounts.  The allocation of profits to the tax accounts is a very important aspect of the Maltese tax system as it determines the tax treatment applicable to shareholders and the tax refunds which may be claimed upon a distribution of profits. The following is an overview of the five tax accounts, the type of income or gains allocated to each tax account and the tax refunds which may be claimed by shareholders:

wdt_ID Tax Account Allocation Refund
1 Foreign Income Account (FIA) Foreign source passive income such as dividends, interest, royalties, rent etc. and all capital gains from foreign sources (unless exempt). 5/7ths in the case of passive interest and royalties. 2/3rds where company claims double taxation relief including FRFTC. 100% in the case of income from a Participating Holding.
2 Maltese Taxed Account (MTA) Profits from trading activities and profits which are not allocated to the FIA, IPA or FTA. 6/7ths in the case of trading income. 5/7ths in the case of passive interest and royalties.
3 Immovable Property Account (IPA) Profits resulting from the use of immovable property situated in Malta and which have not suffered the final withholding tax, as well as profits from rent, accommodation and activities related to immovable property situated in Malta. None. No tax refunds
4 Final Tax Account (FTA) Profits subject to a final withholding tax and income exempt from tax (e.g. participation exemption). None. No tax refunds.
5 Untaxed Account (UA) The difference between the company’s accounting profits or losses and the total of the amounts allocated to the other four tax accounts. None or a FWT.

Participating holding and the participation exemption

A comparative study shows that Malta has one of the best participation exemption regimes. A Maltese company in receipt of dividend income or capital gains from a participating holding may claim the participation exemption.  Alternatively, the company may elect to be subject and pay tax and this would enable the shareholder to claim a full refund.

A participating holding must be an equity holding which is defined as a holding of the share capital in a company which is not a property company and entitles the shareholder to at least any two of the following rights:

  1. A right to vote;
  2. A right to profits available for distribution, and
  3. A right to assets available for distribution on a winding up of that company.

A participating holding arises when any one of the following criteria is met:

  1. A company holds directly at least 5% of the equity shares of a company whose capital is wholly or partly divided into shares, which holding confers an entitlement to at least 5% of any two of the above-mentioned rights; or
  2. A company is an equity shareholder in a company and is entitled at its option to call for and acquire the entire balance of the equity shares not held by that equity shareholder company; or
  3. A company is an equity shareholder in a company and the equity shareholder company is entitled to a first refusal in the event of the proposed disposal, redemption or cancellation of all of the equity shares of that company not held by that equity shareholder company; or
  4. A company is an equity shareholder which holds an investment representing a total value of at least €1,164,000 (or the equivalent in a foreign currency) in a company and such investment is held for an uninterrupted period of not less than 183 days; or
  5. A company is an equity shareholder in a company and where the holding of such shares is for the furtherance of its own business and the holding is not held as trading stock for the purpose of trade.

A capital gain derived from a participating holding automatically qualifies for the participation exemption, however, in the case of dividends derived from a participating holding they will be exempt from tax provided that the body of persons in which the participating holding is held satisfies any one of the following three conditions:

  1. it is resident or incorporated in the EU; or
  2. it is subject to foreign tax of at least 15%; or
  3. it does not have more than 50% of its income derived from passive interest or royalties.

Where none of the above three conditions are satisfied, then both of the following conditions must be satisfied:

  1. the equity holding in the non-resident company is not a portfolio investment, and
  2. the non-resident company or its passive interest or royalties are subject to tax of not less than 5%.

A portfolio investment is an investment in securities such as shares, bonds and such like instruments, held as part of a portfolio of similar investments for the purpose of risk spreading and where such an investment is not a strategic investment and is done with no intention of influencing the management of the underlying company.  Also, the holding of shares by a Maltese company in a foreign body of persons which derives more than 50% of its income from portfolio investments is deemed a portfolio investment.

The participation exemption may also apply to a participating holding in certain partnerships, collective investment vehicles and European Economic Interest Groupings.

 

Summary and illustrations

The mechanics of the full imputation system, the allocation of profits to the various tax accounts and the tax refunds and the overall effect of their interaction may be illustrated in the following examples:

wdt_ID At Shareholder Level Participating Holding (PH) PH + FRFTC No PH and claims FRFTC Passive Interest and Royalties Trading Income
1 Gross dividend 1,000.00 1,250.00 1,250.00 1,000.00 1,000.00
2 Tax @ 35% 350.00 437.50 437.50 350.00 350.00
3 Credit for TAS -350.00 -437.50 -437.50 -350.00 -350.00
5 Refund amount 350.00 187.50 125.00 250.00 300.00

COMET % wdt_ID refund Participating Holding (PH) PH + FRFTC No PH and claims FRFTC Passive Interest and Royalties Trading Income
COMET % 2 COMET % 0% 0% 6.25% 10% 5%

PH: Participating Holding

TAS: Tax at Source. The credit of the tax paid by the company given to the shareholder is the effect of the full imputation system.

COMET: Combined Overall Malta Effective Tax.  This is the net effect of the tax paid by the company and the tax refund received by the shareholder in Malta.

 

It is pertinent to point out that a tax refund becomes due to the shareholder by the Inland Revenue Department within 14 days from when the company’s audited financial statements (accounting for the dividend distribution) and a complete and correct income tax return are submitted to the tax authorities, the tax liability is paid in full and an application for refund on the prescribed form, together with the dividend certificate and other documents as requested by the International Tax Unit are submitted by the shareholder or his tax representative.

Income tax is paid in the same currency as the company’s share capital, which is also the currency in which the company prepares and submits its audited financial statements.  The tax refund is also paid in the same currency, thus eliminating any forex risks.

 

Branches and oversea companies

A branch or a permanent establishment (PE) of a foreign company is subject to tax at the standard rate of 35% on the profits attributable thereto.  It is interesting to note that the shareholders of the foreign company may still claim tax refunds provided the foreign company distributes profits which have been subject to tax in Malta (at the level of the branch or PE).  This may also apply to a foreign company which is tax resident in Malta by virtue of its effective management and control. Such foreign companies registered in Malta are referred to as an ‘oversea company’ because of the same terminology used in The Companies Act.

 

Advance revenue rulings

Maltese legislation provides for Advance Revenue Rulings (ARR) which may be obtained by application from the International Tax Unit of the Inland Revenue Department.  ARRs are valid for a period of five years and are renewable. The ARR is still valid even if there is a change in legislation although in this case the ARR expires once two years are over from the legislative change.

The attractiveness of ARRs has somewhat decreased following the EU Directive whereby the Maltese tax authorities provide information related to ARRs to the EU Commission and other EU Member States.

 

Notional interest deduction

Malta has recently introduced the concept of a notional interest deduction (NID) aimed at mitigating the differences in the tax treatment between equity and debt financing.  Before the introduction of these rules, debt financed entities could claim a tax deduction equivalent to the interest however no similar deduction was available for equity financed companies.  NID entitles companies to claim a tax deduction equivalent to the notional interest calculated on its equity thus making equity financing on the same level playing field as debt financing for taxation purposes.

 Salient features of these rules: 

  • NID is optional and may be claimed if all shareholders approve the claim for such a deduction.
  • These rules are applicable to Malta registered companies, permanent establishments situated in Malta as well as partnerships.
  • NID is determined by multiplying the reference rate to the invested risk capital.  The reference rate is the risk-free rate set by reference to the current yield to maturity on the Malta Government Stocks with a term of approximately 20 years plus a premium of 5%, and the invested risk capital of the undertaking is the share capital, share premium, retained earnings, and non-interest-bearing loans an any contributions made by the shareholder/s. Any capital directly employed in the production of income which is exempt from tax does not fall part of the invested risk capital. 
  • NID is limited to 90% of chargeable income.  Any excess above the capped amount may be carried forward for deduction in future years.
  • When an undertaking claims NID, the shareholder / partner is deemed to have received income equal to the NID and the provisions relating to the taxation of interest income shall apply with the option to apply NID against the deemed interest brought to charge.
  • An amount equal to 110% of the profits relieved from tax through the NID shall be allocated to the undertaking’s final tax account.  The amount allocated to the final tax account is limited to the total profits of the undertaking and any such excess shall be ignored for allocation of tax profits.

One of the main advantages of NID is that the COMET may be reduced and eliminates the need for the shareholder to claim tax refunds.

Other benefits

The salient features highlighted above are coupled with other benefits including:

  • No withholding taxes;
  • No thin cap rules or debt-to-equity ratios;
  • No capital duty and wealth taxes;
  • No stamp duty on share transfers in companies whose activities are outside Malta;
  • Non-resident persons are exempt from capital gains arising on certain share transfers;
  • Participation exemption regime applicable to branches, certain partnerships and other entities;
  • An extensive treaty network with over seventy treaties currently in force;
  • No exit taxes not even on an outward redomiciliation;
  • Step-up upon an inward redomiciliation.

How can we help you?

Avanzia Taxand is a corporate service provider licensed by the Malta Financial Services Authority and may also act as tax representative with the Inland Revenue Department.  Tax advice and tax compliance remain our core focus and we ensure that clients are always in compliance with the myriad filing obligations and notifications.

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Double Taxation Relief

Malta does not impose any withholding tax on outgoing dividends, interest and royalties irrespective of the recipient’s tax residence and status.  However, income received from foreign sources may be subject to a withholding tax and suffer other foreign taxes and therefore Malta offers three main types of double taxation relief to ensure that any double taxation is mitigated as much as possible.  Apart from the relief under Malta’s treaty network, Malta also gives relief for any double taxation on unilateral basis and allows a flat rate foreign tax credit on foreign source income and capital gains.

 

Unilateral Relief

Any overseas tax suffered may be allowed as a credit against the tax chargeable in Malta which is levied on the gross amount.  The credit shall not exceed the total tax liability in Malta on the receipt.

Unilateral relief for underlying tax is also available where the taxpayer is a person that holds more than 10% of the voting power of the overseas company paying the dividend.  

To claim unilateral relief, the recipient of the income must prove:

  • that the income arose from overseas;
  • that the income suffered overseas tax; and
  • the amount of that tax.

 

Flat Rate Foreign Tax Credit

A Flat Rate Foreign Tax Credit (FRFTC) may be claimed by a Maltese company which receives income from overseas.  A certificate from the auditor stating that the income arose overseas will be sufficient for this purpose.

The flat rate foreign tax credit is calculated at 25% of the amount of the overseas income or gain received by the company, before allowable expenses.  The income plus the credit less allowable expenses will be subject to full Malta income tax with relief for the deemed credit (up to a maximum of 85% of the Malta Tax payable).  The mechanics of the flat rate foreign tax credit are demonstrated in the following example:

 

Even if the company has no deductible expenses, the rate of tax is reduced from 35% to an effective rate of 18.75%.  Upon a distribution of taxed profits, refunds will apply and so the net effective tax is reduced to 6.25% or lower.

 

Tax Treaties

Malta has an extensive double taxation treaty network with over 70 double taxation agreements most of which are based on the OECD model convention.  The maximum reduced withholding tax rates on dividends, interest and royalties paid to residents of Malta are as indicated hereunder. Since Malta is an EU Member State, the Parent Subsidiary Directive and the Interest and Royalties Directive may also apply and the withholding tax rate could be reduced even further.

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