Generally double taxation treaties provide that any gains derived by a Maltese company from the sale of shares in a foreign subsidiary are taxable in Malta. However, the participation exemption regime grants a 100% exemption to companies registered in Malta which such capital gains from the disposal of a participating holding.
More importantly, the participation exemption regime exempts from tax any dividends derived by a Maltese registered company from a foreign participating holding.
The tests which must be satisfied in order for the participation exemption to apply:
The dividend income or capital gains must be derived from a participating holding which is generally a non-resident company (including some types of partnerships and branches) in which the Maltese registered company holds equity shares and:
- owns at least 10% of the equity shares; or
- has the option to acquire the remaining balance of the equity shares; or
- has an investment amounting to at least €1,164,700 which is kept for an uninterrupted period of at least 183 days; or
- has an entitlement for first refusal in the event of a proposed disposal, redemption or cancellation of the remaining balance of the equity shares;
- has an entitlement to sit on the Board; or
- holds shares for the furtherance of its business and not for the purpose of trading.
Test 2 for its applicability – Applicable ONLY in case of foreign dividends
- the participating holding is resident or incorporated in an EU member state; or
- the participating holding is subject to tax at a rate of at least 15%; or
- the participating holding has 50% or less of its income derived from passive interest or royalties.
Failure to satisfy any of these three conditions requires the satisfaction of both conditions set out in Test 3.
Test 3 for its applicability – Applicable ONLY in case of foreign dividends and if Test 2 is not satisfied
- the investment in the participating holding must not be held as a portfolio investment; and
- the passive interest or royalties derived by the participating holding would have been subject to tax at a rate of at least 5%.
Alternative to the Participation Exemption
Malta also offers the possibility of a 100% tax refund in respect of qualifying income. Whereas the participation exemption, not having to pay any tax, grants a cash flow advantage; in some instances the company may be required to provide evidence of tax paid in Malta, in which case it would use the full refund system.