Malta has introduced new Notional Interest Deduction (NID) rules aimed at enhancing the tax benefits of financing business operations through equity hence offering a tax efficient alternative to debt financing.
The Company’s/Partnership’s/Branch’s perspective
With effect from 1 January 2017, Maltese tax resident companies or partnerships and Maltese permanent establishments (PE) of non-tax resident companies or partnerships are entitled to an interest tax deduction deemed to have been incurred on the said financing.
The NID is calculated by multiplying the deemed notional interest rate by the balance of risk capital that the company or partnership has at year end.
For the purpose of the rules:
The notional interest rate is the risk free rate set by reference to the current yield to maturity on Malta Government Stocks with a remaining term of approximately 20 years plus a premium of 5%;
The risk capital includes share or partnership capital of a company or partnership, any share premium, positive retained earnings, loans or other debt borrowed by the company or partnership which do not bear any interest (including shareholders loans), and any other reserves resulting from a contribution to the company or partnership. The risk capital for a Maltese PE of non-tax resident companies shall be based on the capital attributable to the Maltese PE.
Being a notional expense, there will not be any accounting entries and therefore it does not affect the accounting profit/loss or retained earnings.
The maximum deduction in any given year cannot exceed 90% of chargeable income. Any excess can then be carried forward to be deducted in subsequent years. The deduction is optional and should be claimed through the tax return on an annual basis, only if it is demonstrated that all shareholders or owners approve the claim of such deduction.
The rules outline the effects that such transactions should have on the Companies’ tax accounting, essentially by requiring the equivalent of 110% of the NID to be allocated to the Final Tax Account (FTA). If the amount of profits allocated to the FTA exceeds the total profits of the company or partnership, any such excess shall be ignored for the purposes of tax accounting allocation.
The shareholder’s/Partner’s/Financier’s perspective
Whenever such deduction is claimed, the shareholder or partner is deemed to have received in that year an amount of income equal to the interest on risk capital claimed as a deduction by the company or partnership. Such income shall be characterised as interest income for income tax purposes. However, it is clearly stated that the Investment Income provisions shall not apply to such deemed income.
Article 12(1)(c)(i) of the Income Tax Act (ITA) exempts from tax any interests accruing to or derived by any person not resident in Malta provided that such non resident person is not engaged in trade or business in Malta through a PE.
On the other hand, the interest deduction limitation in Article 26(h) of the ITA will still disallow such deduction if such interest is paid to a person not resident in Malta:
When the risk capital is used to finance the acquisition of immovable property in Malta;
The interest is exempt from tax in terms of Article 12(1)(c)(i) of the ITA;
The shareholder or partner is a non resident who has a relationship or more than 10% with the company or partnership.
How can we be of help?
At KSi Malta we believe that ethical and efficient NID tax planning could result in a lower effective tax rate for companies. Inter alia, our NID advisory services would include:
Review the group’s financing activities and structures and advising on the setup of substance-based financed entities;
Advising on the tax implications on personal shareholders/related parties.