Just recently in December 2018, Malta has transposed the Anti- Tax Avoidance Directive (ATAD) into Maltese law. Consequently, four new rules were introduced, these being: the interest limitation rule; the exit taxation rule; the controlled foreign company rule; and the general anti-abuse rule (GAAR). With the exception of the exit taxation rule which is to become enforceable from 1st January 2020, all of these rules became effective on 1st January 2019. They may seem like a lot of rules to take in one go, but in reality, businessmen should not worry excessively as the main aim behind such rule is to thwart abusive practices. Moreover, in an effort to minimise the impact of such rules, the Maltese legislator has ascertained that they are accompanied by a number of exceptions, ensuring that Malta takes a ‘focused’ approach, and that legitimate businesses undertaking legitimate transactions are not or are solely mildly affected.
The interest limitation rule
Companies sometimes engage in base erosion and profit shifting (BEPS) through excessive interest payments. This rule prescribes that exceeding borrowing costs (i.e. the amount by which the deductible borrowing costs of a taxpayer in terms of the Income Tax Act, Chapter 123 of the Laws of Malta (‘ITA’), were it not for the provisions of the regulations, exceed taxable interest revenues and other economically equivalent taxable revenues that the taxpayer receives) shall be deductible in the tax period in which they are incurred only up to 30% of the taxpayer’s earnings before interest, tax, depreciation and amortisation (hereinafter referred to as “EBIDTA”). Prima facie this seems a bit harsh, however, do not fret just yet as a number of exemptions apply to this rule which may be applicable;
v Firstly, this rule does not apply if the exceeding borrowing costs add up to three million euro (€3,000,000). It shall also not be applicable in the case of a standalone entity (thus, an entity which is not part of a consolidated group for financial accounting purposes and has no associated enterprise or permanent establishment (PE)). Nevertheless, in the case that the taxpayer forms part of a consolidated group, it may, subject to certain conditions, still enjoy exemption from this rule if it can demonstrate that the ratio of its equity over its total assets is equal or higher than the equivalent ratio of the group.
v Lastly, financial undertakings, and costs incurred on loans concluded before 17 June 2016 or used to fund a long-term public infrastructure projects are also excluded from the scope of such rules.
If this rule applies, any unutilised exceeding borrowing costs can be carried forward, as a taxpayer, and be deducted in future periods. Moreover, any unused interest capacity that cannot be deducted in a tax period may be carried forward for a maximum 5-year period.
The role of exit taxes is to ascertain that when a taxpayer moves assets from its head office or permanent establishment (PE) in Malta to a foreign PE or foreign head office, Malta taxes the economic value of any capital gain created in its territory, even if the gain has not yet been realised at the time of the exit. The same rule applies when a taxpayer transfers the business carried on by its PE from Malta to a foreign State; and when a taxpayer transfers its tax residence from Malta to a foreign state, excluding however from the equation assets which remain effectively connected with a PE in Malta.
Taxpayers may have the right to defer the payment of the amount of tax by paying it in instalments over 5 years, although this would be subject to the payment of interest and, potentially the provision of a guarantee.
Controlled Foreign Company (CFC) Rule
Essentially, the CFC rule has the effect of protecting Malta’s domestic tax base from erosion by reattributing the income of a low-taxed controlled subsidiary in a foreign jurisdiction to its Maltese parent company. This would be done notwithstanding the fact that the CFC would not have made a distribution of dividends and it is considered to be a separate entity for tax purposes. While such a rule acts in Malta’s interests, the legislator has still sought to protect the taxpayer’s interests by imposing a number of thresholds to such rule:
v The control threshold essentially clarifies that the CFC rules are only applicable in the case of an entity wherein the taxpayer by itself, or together with its associated enterprises holds a direct or indirect participation of more than 50 percent of the voting rights, or owns directly or indirectly more than 50 percent of capital or is entitled to receive more than 50 percent of the profits of that entity.
v Then the low-tax threshold ascertains that the corporate tax paid by the entity or PE must be lower than 50% of the tax that would have been ‘charged’ on the entity or PE in terms of the ITA.
v A quantitative threshold is also implemented by which an entity or a PE would be excluded from the CFC rule, if its accounting profits amount to €750,000 or less, and its non-trading income add up to €75,000 or less; or if its accounting profits amount to 10% or less of its operating costs for the tax period.
If such conditions are not met, then the entity or PE shall be treated as a CFC. Malta has introduced a test known as the genuine economic activity test, whereby the income to be included in the tax base of the taxpayer is that which arises from “non-genuine arrangements” which have been executed with the objective of obtaining a tax advantage.
General Anti-Abuse Rule (GAAR)
Lastly, there is also the general anti-abuse rule (GAAR). This is by no means an innovative rule in Malta; it just continues to complement the existing GAAR in Article 51 of the Maltese Income Tax Act. Basically, its effect is to disregard artificial schemes used by the taxpayer to limit the amount of tax payable by the company.
These rules do not lessen in any manner Malta’s allure for businessmen to set up an office here and they are solely intended to tackle aggressive tax planning. An effort has been made to ascertain that the inconvenience caused by such rules is kept to a minimum. Moreover, Malta’s attractive tax regime overshadows any of the adverse effects introduced by the establishment of such rules.