Anti-Tax Avoidance Directive (ATAD I)

Malta implemented the provisions of Council Directive (EU) 2016/1164, often referred to as the Anti-Tax Avoidance Directive (ATAD I) on 11^th December 2018 by means of Legal Notice 411 of 2018.  The EU Directive was adopted in the global context of the fight against base erosion and profit shifting and introduced four changes into the Maltese fiscal landscape. 

The Legal notice features four measures:

1. Interest deduction limitation (effective as from 1 January 2019)
2. Exit taxation (effective as from 1 January 2020)
3. Controlled foreign company rules (effective as from 1 January 2019)
4. General Anti-Avoidance Rules (effective as from 1 January 2019)

The legislation applies to all companies and other entities, trusts and similar arrangements that are subject to tax in Malta in the same manner as companies and also to local permanent establishments (PE) having a taxable presence in Malta of foreign entities.

Malta will soon introduce rules on hybrid mismatches as part of its commitment in terms of Council Directive (EU) 2017/952, the ATAD II Directive.  The rules will apply as from 1 January 2020 with the exception of reverse hybrid mismatches, the implementation of which may be delayed to 1 January 2022.

Interest deduction limitation (Rule 4)

The general rule is that borrowing costs on all forms of debt, profit participating loans and other instruments net of taxable interest and other equivalent revenues are only tax deductible up to 30% of the taxpayer’s earnings before interest, tax and tax adjusted depreciation and amortisation (EBITDA).  Tax exempt income is excluded from EBITDA.

In the case of a group, the rule is calculated on the consolidated results.

Net borrow costs exceeding this limit are not tax deductible in the tax year in which they were incurred but may be carried forward for a maximum period of 5 years.

However, the legislation provides for certain “escape clauses”, these being:

1. The rule does not apply to stand alone companies;
2. The rule does not apply to financial institutions such as banks, insurance and reinsurance undertakings, pension funds, UCITS and AIFs and similar bodies;
3. The rule does not apply where the net borrowing costs do not exceed € 3 million and where the taxpayer is a member of a group, the said amount applies on a group basis;
4. A grand-fathering clause where the rule does not apply to loans concluded before 17^th June 2016 provided that the loan was not modified thereafter;
5. Net borrowing costs on loans used to finance long-term public infrastructure projects;
6. In the case of a group, a company is entitled to deduct all its net borrowing costs if its equity – total assets ratio is not less than 2 percentage points below the equivalent ratio of the group.

Exit tax (Rule 5)

Exit taxation is chargeable on the following operations:

• Transfer of certain assets from HO in Malta to its PE outside Malta, whereby Malta no longer has the right to tax capital gains upon the transfer of such assets due to the transfer;

• Transfer of certain assets/business from a PE in Malta to the HO/ PE outside Malta in so far as Malta no longer has the right to tax capital gains from the transfer of such assets due to the transfer; or
• Transfer of tax residence from Malta to a place outside Malta except for those assets which remain effectively connected with a PE in Malta.

The capital gain subject to tax is the market value of the transferred assets less their base cost for tax purposes.  The tax becomes payable by not later than the taxpayer's subsequent tax return date.

Malta gives however the right to defer the payment by paying it in installments over five years in specific circumstances, though interest may be charged.

Controlled foreign company rule (CFC) - article 7

CFC rules aim at allocating undistributed income of a low-taxed controlled subsidiary to its Maltese parent company.  Applicability of the CFC provisions hinge on (i) the level of control by the Maltese Co., (ii) the level of taxation of the controlled subsidiary and (iii) the carrying out in Malta of significant people functions in relation to the income-producing assets.  

A foreign subsidiary will qualify as a CFC if:

1. The Malta company together with its associated enterprises holds directly or indirectly more than 50% of either the voting rights, or, the share capital, or, is entitled to receive more than 50% of the profits of the foreign subsidiary; and,
2. The actual corporate tax paid by the said subsidiary is less than half the tax that would be payable in Malta on its profits determined in accordance with Malta’s domestic tax rules.

When the subsidiary qualifies as a CFC in terms of the above-mentioned rules, any undistributed income in proportion to the holding by the Malta company is taxable in the hands of the Malta company to the extent that the said profits are derived from non-genuine arrangements which have been put in place for the essential purpose of gaining tax advantages.  The concept of non-genuine arrangement endorses the principles used in transfer pricing and seeks to allocate (more) profit to the entity where the key drivers are managed.  Thus, undistributed income generated through assets belonging to the CFC is to be included in Malta’s tax base to the extent that the significant people functions in relation to the said assets are carried out in Malta.

The rules also provide for a carve out provision which excludes from the scope of CFC rules when:

1. The accounting profits of the foreign entity do not exceed € 75,000 and its non-trading income does not exceed € 75,000; or
2. The accounting profits of the foreign entity amount to no more than 10% of its operating costs for the tax period.

Each foreign entity is examined on its own merits as aggregation is not required where there are 2 or more foreign entities.

General anti-abuse provision (GAAR) - article 6

The GAAR is not new for Malta.  Indeed, this provision is very similar to the rules contains in article 51 of the Income Tax Act. 

The said provision gives right to the tax authorities to ignore arrangements put in place for the main purpose of obtaining a tax advantage that runs counter to the objects of the applicable tax law and are not genuine.  An arrangement will be regarded as non-genuine to the extent that it is not put into place for valid commercial reasons which reflect economic reality.   

ATAD, which has been implemented by all EU member States, constitutes a first and important step towards the harmonisation of anti-abuse provisions amongst EU Member States within a context of global changes in the tax landscape. It requires attention of businesses and investors.  Our tax advisors can help you to ascertain that your business is compliant with these developments and to explore any new opportunities that may arise.