Malta’s fiscal regime – Facts & Fiction

 

Austrian Chancellor, Christian Kern has recently revealed that multi-national corporations including Starbucks and Amazon pay less corporation tax in Austria than a local sausage stall. It would be interesting to understand how he has arrived at this conclusion which would lead one to believe that either sausage stalls in Austria are extremely popular and profitable or that the Amazons’ and Starbucks’ of this world have employed some pretty aggressive tax planning measures to so drastically reduce the level of chargeable income arising out of their commercial activity in Austria and subsequently, their resulting tax liability.

No doubt Chancellor Kern’s tongue in cheek remark was meant to draw attention to the tax liabilities paid by huge multi-nationals when compared exponentially to the tax liabilities of domestic,  micro enterprises such as, sausage stalls. Multi-nationals, as the name implies, are companies which are physically present in multiple jurisdictions. One of the basic principles by which companies are charged to tax is that in general, any income arising in a country, is subject to tax in that very same country. Therefore, if for example Starbucks open a franchise in Malta, any profit that it would generate from its permanent establishment in Malta would be subject to tax under domestic (Maltese) provisions. This is both fair and logical however the key element to any tax system is the taxation of profit or to use the proper technical term, ‘chargeable income’ which adjusts accounting profit by removing any disallowed expenses and allowing for any tax relief that may be applicable. Therefore, reducing a company’s profit, would automatically result in the company paying less tax since there would be less ‘chargeable income’ to bring to ‘charge’.

A strategy frequently used by corporations is to establish holding or management companies in low tax jurisdictions which then charge fees to group or subsidiary companies resident in higher tax jurisdictions. These charges would generally consist of royalties, management fees, license fees and similar. The overall result of introducing these layers of additional fees is to reduce the chargeable income (profits) of the subsidiaries or related companies based in other jurisdictions and shifting profits to a jurisdiction which would tax these profits at a far more favourable rate. Some jurisdictions apply a low rate of tax (some as low as 5%) which is then charged against taxable profit whilst other jurisdictions apply a fixed, annual tax to be paid by the corporate regardless of extent of chargeable income. This system is used widely in a number of jurisdictions including Luxembourg, Ireland, the UK and Switzerland and some notable cases involving blue chip companies such as Apple, Starbucks, Google and FIAT, have been widely reported in the media forcing some governments to reassess existing deals and reviewing potential future agreements applying this same methodology. In some cases, these so termed ‘sweetheart’ deals reduce the effective rate of tax to values which are negligible or at best highly insignificant when compared to the corporations’ profitability. This is of course all good news for the shareholders and investors of such businesses however as we have seen with the Apple case, these deals are being scrutinised by the EU which view them as tantamount to state aid and therefore not allowed. Other similar cases including familiar names such as Starbucks, Google, Amazon and Fiat have also made headlines over these past few months. Most of these companies in fact have management or holding structures located in jurisdictions such as Luxembourg and Holland. Of course this does not mean that there are any nefarious or underhand dealings going on but simply that each of these countries and others as well, have applied their sovereign right to provide multinational corporations attractive tax terms to facilitate their establishment in their country. This facilitation must be viewed in the wider context of what these companies bring with them which includes in most cases, significant investment, termed as ‘Foreign Direct Investment’ (FDI) and the significant multiplier effect that they have on the local economy as these entities employ personnel, acquire or lease property and source materials, services and products from local suppliers.

If these legitimate measures that are taken by sovereign states to favourably tax FDI in their countries have been applied unfairly or even abused of is not a question that can be answered in simple terms however, they clearly can lead to an imbalance and the creation of a distorted playing field when measures such as these result in large corporations paying comparatively less tax than as the case may be, a sausage stall. This is in fact one of the principal motives behind the OECD’s Base Erosion and Profit Shifting (BEPS) project which seeks to regulate instances where profits may be shifted from one country to the next arbitrarily and where the intention is to shift the bulk of profits from a high tax to a low tax jurisdiction with no commercially viable motive otherwise for the transaction.

Malta’s tax system does not contemplate ‘sweetheart’ deals and it is not correct to describe our country as a low tax jurisdiction. In fact with a corporation tax rate of 35% on chargeable income, Malta has one of the highest levels of corporate tax within Europe. The UK for example applies a tax rate of 20% whilst the Netherlands have a tax rate which varies from 20% to 25% depending on value of chargeable income. Where Malta’s tax regime differs to most is in its tax refund mechanism which provides the recipient of a dividend paid from taxed sources the ability to apply and obtain a partial refund of tax paid by the company. The level of this refund will generally vary from 5/7 to 6/7ths of the corporation tax depending on whether the underlying commercial activity of the company is considered to be passive or active. Therefore, the rate of effective tax may be reduced to 5% and 10% in the hands of the shareholder.

What does this mean? A shareholder receives a dividend out of which corporate tax at 35% has been paid at company level. On application he can obtain 30% of the 35% tax back in the shape of a refund therefore reducing the effective, overall tax leakage in Malta to a theoretical 5%. However it is an important yet often overlooked fact that the recipient of any such tax refund is obliged to declare this same refund in his personal tax affairs in the country where he is tax resident. Tax refunds are generally classed as ‘other income’ therefore in the vast majority of cases will be subject to additional domestic tax in the hands of the recipient provided he or she does not reside in a ‘0’ tax jurisdiction.

Therefore once again using the country’s sovereign right to develop its own tax framework, Malta has introduced and successfully applied this tax refund mechanism for well over 20 years with the scope of attracting FDI. Taxing resulting FDI at 35% and returning the theoretical 30% back to the shareholder to be taxed in the country where he or she is physically and fiscally resident is transparent and actually returns tax dollars into the coffers of the country from which this FDI has originated.

Can the system be abused? Of course like with any system it is possible to exploit weaknesses or gaps despite the scrutiny and best intentions of the legislator. Over the years any such gaps have been progressively reduced particularly over the past few years and will be further reduced to becoming virtually negligible with the ongoing introduction of CRS and BEPS initiatives and the drive towards greater tax transparency, of which it must be noted, Malta has always been at the forefront.

Therefore, criticism of tax mechanisms are only fair and legitimate when done in the proper context and after ensuring that one’s understanding is complete which may not always be the case with Malta’s particular fiscal regime.

David Borg FCCA FIA Dip. Tax CPA

David is a partner within Capstone’s Advisory Unit, a Chartered Accountant and a Fellow of the Association of Chartered Certified Accountants (UK) and the Malta Institute of Accountants. He is also a Member of the Malta Institute of Taxation and the Malta Institute of Financial Services Practitioners.

David has several years’ experience working in the private sector where he held senior management positions with some of the larger international companies to operate out of Malta. In this capacity he has gained extensive experience particularly in the oil and gas, offshore manning, international tourism and real estate sectors.

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