The Impact of Proposed EU Anti-Tax Avoidance Directives on Maltese Tax Regimes
Table of Contents
- Aims & Objectives
- Chapter One: Developing EU Directive 2016/1164
- Controlled foreign company (CFC) rule
- Exit taxation
- Interest limitation
- General anti-abuse rule
- Chapter Two: Maltese Tax System
- The Domestic Personal Tax System
- Corporation & Business Taxes
- Chapter Three: Perspectives on Taxation
- Taxation: Perspectives and Ideologies
- Tax Harmonisation: Theoretical Overview
- Tax Harmonisation: Technical Issues
- Mario Monti: Addressing Common Tax Avoidance
- Chapter Four: Malta & ATAD – A Discussion
- Chapter Five – The impact on Maltese legislation
- The Interest Deductibility Rule as against Notional Interest Deduction Clause in Maltese Legislation
- The General Anti-Abuse Rule (GAAR)
- The Controlled Foreign Company Rule (CFC )
- The Exit Tax Rule
- Hybrid Mismatches
- Conclusions Chapter 5
- Findings & Conclusions
- Personal Commentary of the author
- Recommendations for Further Research
Introduction to EU Anti-Tax Avoidance Directives on Maltese Tax Regimes
The 2016 EU Anti-Tax Avoidance Directive creates a number of regulations that aim to mitigate the continuation of tax avoidance because of the direct impact that this has upon the internal market. These regulations take effect on January 2019 and are intended to develop, for the first time, a communal system that offers minimum levels of protection against the usage of corporate tax avoidance systems (European Commission (EC), 2017). The intent of these new anti-tax avoidance regulations aims to develop a sustainable and stable business operation environment that is fiscally fairer for all constituent members of the economic system (EC, 2017).
Yet, whilst this directive has been agreed across the EU space, there is an indication that the Maltese legislative system will have to be amended in order to comply with the directive in order to ensure compliance (KPMG, 2017). Yet, KPMG recognise that the Maltese jurisdiction has not been subjected to claims of infringement of EU regulations and directive regarding any peripheral tax system, such as BEPs or the Economic and Financial Affairs Council (ECOFIN) configuration, and, as such, this reinforces the legal reformation issue. Yet, concerns remain that the country may experience a number of multinational headquarters moving away from its territories, thereby having a negative impact upon the national fiscal performance (Guarascio & Strupczewski, 2017). Yet, within this narrative, Malta has continued to experience an improved economic performance in recent years.
The CIA (2017) reports that Malta has been forecasted to realise a high level of state and personal income; this outcome is supported by high consumer activity. With regards to the tax base, it is of note that the country operates a full imputation tax system which results in the informal economy realising a high level of tax burdens being placed upon the formal wage-earning cohort. As such efforts to resolve tax evasion remain weak and ineffective (CIA, 2017). Yet, within this same process and system the domestic corporate tax liability remains relatively high, and has seen targeted tax incentives being reduced in order to help rebalance the source of domestic public finance sources (CIA, 2017). Via this approach, the Maltese public purse has improved substantially, and the national budget deficits has decreased to levels that are sustainable, yet domestic and personal debt remains relatively high (CIA, 2017). Since this sea change in the fortunes of the country, it is recognised that the European Commission has removed Malta from a list of member states that are at risk of realising an unsustainable economic imbalance although the Commission does see a possibility that Malta is likely to experience an erosion of its level of competitiveness because of a weaker export market (CIA, 2017). However, whilst Malta has turned a corner, in economic terms it is its domestic tax system that is the focus of this paper, namely in respect of the impending EU regulations regarding tax harmonisation.
Aims & Objectives
It is the intent of this proposed paper to identify and assess the impact of the Directive 2016/1164 upon Maltese tax regimes, upon financial disputes, and in respect of tax transparency with the country and its economic and financial system. To achieve this intent, this paper utilises fourcore aims and objectives; these comprise of a need to:
- Highlight and critique the components of Directive 2016/1164.
- Assess the response from EU member states, specifically Malta.
- Identify areas of weakness and conflict between the Maltese jurisdiction and the EC.
- Highlight the impact on Maltese legislation
Fully responding to these three aims and objectives will lead this paper to fully respond to the overarching research question, namely “the impact of proposed EU Anti-Tax Avoidance Directives on Maltese tax regimes”.
Malta is the smallest member state in the EU and possesses a population that resides around the half million mark. The country has benefitted from hosting the EU Presidency during the first half of 2017, with the result being that Malta has experienced becoming a focal state within the EU during that time (Politico, 2017). The benefit of undertaking the EU Presidency role, however, has resulted in additional light being shed upon Malta’s domestic tax affairs. This is an issue which has been provided with additional interest given the increased publicity that is created via an enhanced presence on the international and regional stage (Politico, 2017).
The CIA (2017) notes that the country has a lower unemployment rate, when assessed against that of other EU member states, and continues to experience growth rates in advance of those experienced in the era prior to the recession of 2009. Indeed, the CIA (2017) also notes that in 2015, Malta experienced strong growth which, when assessed against its Euro zone peer group. This level of economic growth has been underpinned by low unemployment. Yet, it is the domestic tax regimes that see the Maltese economic system being subject to undermine the sanctity of the Maltese economic position. This narrative sees over seventy-thousand companies being registered in the country, with this figure increasing by an average of twelve per cent per annum (CSB, 2015). The current political elites argue that the Companies Act has been a factor in this level of success. This is an issue that is addressed later in this paper but does indicate that the Maltese political system is actively encouraging companies to register in the country and sees the promotion of this system as part of its domestic economic and fiscal policy. Yet, it is this same process and practice that is being directly challenged by the realities of current EU intentions regarding the creation of a common tax regime. It is this area of practice which is of concern to this paper and sees the implications of the EU Tax Harmonisation Directive being a core concern to the EU and Malta, as well as companies, third-party international bodies, and EU member states.
This study utilises Willis’ (2007) methodological process which comprises of an analytical framework. This approach helps to increase the importance of the qualitative research process, and allows for further perspective being incorporated via the works of Cohen, Mannion, and Morrison (2000) whose works have proactively encouraged the usage of case study and desk-based interpretist research as a process for gathering additional core information. This can be achieved through analysing prior known information and assessing these against new, pertinent, and up-to-date data and information in order to undertake an informed analysis (Cohen, et al., 2000). Koul (1997) is supportive of this approach and offers that it is possible for researchers to gather the required relevant data and information in order to advance the core research which is being undertaken. Added to this, this approach can also allow for the creation of a completed research study that allows for a more accurate assessment of the core issues that are central to any research study (Willis, 2007).
Added to the above, the Centre for Reviews & Dissemination (2008) holds a perspective that the underpinning research process is capable of being enhanced via an assessment process that includes improving the efficacy of a range of prior and known issues. Using this tactic sees a possibility that the conflicting outcomes within the divergent European tax systems are of consequence to this study (Centre for Reviews & Dissemination, 2008).
Chapter One: Developing EU Directive 2016/1164
The Anti-Tax Avoidance Directive (ATAD) comprises an attempt by the EC to reform and develop an EU space wide taxation policy. This Directive forms the overarching policy that is derived through the Anti-Tax Avoidance Package (ATAP), and was a process that had been originally developed in early 2016 (EC, 2016). The core narrative that is contained within the Directive is to seek communal agreement through all EU member states being required to raise a number of legislative packages that are intended to enact laws that adopt earlier G20 criteria regarding base erosion and profit shifting (BEPS) outcomes regarding a range of taxation and interest issues, as well as addressing further issues with regards to hybrid mismatches and controlled foreign companies (CFCs). Further concerns that the ATAD aims to address include issues related to the impact of exit taxation upon jurisdictional tax burdens and the development of a general anti-abuse rule (GAAR).
Controlled foreign company (CFC) rule
CFCs are essentially identified as a foreign company that is a non-resident to the domestic market and jurisdiction, but which is controlled by a group that is based, or located, within the same country (UK Government, 2013). The United Kingdom (UK) Government developed this legal definition via influence from the EU in respect of four key areas of legal and administrative control, namely, the legal controls that are exerted at the domestic level; the process for advancing economic controls; the absorption of the Joint Venture (JV) test into the domestic corporate or business practice context, and the application of appropriate accounting standards (UK Government, 2013). Expanding upon this framework, JV’s are indicative of a corporate partnership but can utilise any structure that is consistent with the legal structure of the domestic legislative process (Investopedia, 2017). Corporations, partnerships, limited liability companies and other business entities can all be used to form a JV. Here, it is of note that Prescott and Swartz (2010) argue that the JV approach is largely determined by the proposed and subsequent shape of the JV venture.
It is also suggested that the adoption of a corporation, as the preferred evolution for a JV is undesirable given that tax regulations tend to be different for corporations, but instead what occurs sees tax regulations and obligations being passed via the governing body and onto the partnership (Prescott & Swartz, 2010). What occurs as a result sees the JV, or ‘company’, paying little tax in the domestic jurisdiction, with the obligation transfer. Consequentially, CFC regulations comprise the vanguard of anti-avoidance procedures and are intended to prevent the diversion of profits from the home territory to that of a territory that offers low taxation regimes (Prescott & Swartz, 2010) territories. This premise is used within the UK and is a factor that the EU developed within its 2016/1164 Directive.
The EC (2016: 2) believes that the above description helps to combat what it refers to as a “hybrid mismatch.” It is also argued that internal EU space taxpayers have been known to practice cross-border arrangements that employ third-party jurisdictions in order to benefit from a reduced overall tax liability within the EU (EC, 2016). As such, what emerges is a need for the EU to recognise the usage of hybrid mismatches and counter the third-party jurisdiction issue. With this, therefore, third-party jurisdictions are a target for Directive 2016/1164. For the EC, the failure in addressing the hybrid mismatch process concretises an exploitation of EU space tax systems and helps to achieve what is referred to as “double non-taxation” where, there, not only the company, but also the partnership benefit from tax avoidance (EC, 2016: 2). Consequentially, the regimes that are operated within the EU space, and which is administered at the domestic level, allows for a possibility in which profits that are diverted from; for example, the UK can be readdressed through the application of charge gateways that are intended to identify those profits that are being diverted from the UK and charged accordingly to respective UK-based stakeholders (UK Government, 2013).
The EU recognises that a number of member states base their tax requirements upon a combination of liabilities that are borne out of resident individual and corporate assets (Eur-Lex, 2016). This system, it is suggested, sees the local capital gains tax being charged following the sale of assets. That said, it is also of note that when individuals move their residency to a secondary member state, the subsequent sale of assets results in the original member state losing its right or ability to apply capital gains taxes that have been accrued since the previous billing period (Eur-Lex, 2016). In addition, it is also recognised that where a company moves its registered headquarters in a similar manner to another EU member state, the outcome is also risky, given that taxed-based revenues from these companies are also at risk of being lost (Eur-Lex, 2016). It is also recognised that a number of EU member states have sought to address this weakness within the divergent tax base systems that exist within the EU space.
Recognition of this internal EU and EC weakness has been a contentious issue for a prolonged period of time and, for Price Waterhouse Coopers (PWC) (2016) is an issue that has finally been settled. PWC (2016) argue that Directive 2016/1164 is the settlement of the exit taxation issue. What is suggested by PWC (2016). Here it is suggested that member states are now required to review their current taxation policies and their GAAR rules and this may require the development and ratification of a number of new taxation laws in order to strengthen anti avoidance procedures. As such, PWC (2016) believes that it is unlikely that a number of member states are likely to be fully compliant with the EU and EC aspirations that are developed via Directive 2016/1164 and that this issue will result in considerable changes to the domestic tax base. Essentially, the Directive, when assessed against exit criteria, is intended to reduce or prevent the potential for an erosion of the domestic tax base. It is for this reason that Directive 2016/1164 seeks to raise tax demands, based upon market value, when transfers of assets are created that see these same assets move out of the domestic jurisdiction, or where tax residence is transferred to a secondary member state either in part or as a whole.
he adoption of interest payment criteria has been largely developed in line with the recognisable premise that financial gain from interest is, under normative circumstances, tax deductible within the EU space (EC, 2016). This process sees a number of companies that are registered within domestic jurisdictions within the EU space developing set inter-company loans that collate their debts within high-tax jurisdictions, with the result being that interest payments can be subject to tax deduction. While this practice develops, it is also noted that any interest that is accrued in respect of a debt will be paid to the group’s main lender company (EC, 2016). The outcome of this practice also sees this arm of the corporate entity being based in a low taxation jurisdiction, with the outcome being that overall interest rates are subject to a lower rate of taxation than would normally be billed should the interest limitation process not be applied. Given the above narrative it is possible for companies to reduce their overall tax burden.
In effect, what occurs sees companies paying a greatly reduced tax bill through shifting their funds, loans, and debts not only between its groups of companies, but also between jurisdictions. PWC (2016) argue that the outcome of Directive 2016/1164 is intended to make this loophole narrower by creating conditions within which a limit is placed upon the level and amount of net interest that can be considered as being deductible as taxable income. This, it is suggested can be used as part of a fixed earnings ratio and helps make these same outcomes less attractive for companies that have undertaken this interest limitation process in the past. Ultimately, Directive 2016/1164 creates conditions in which companies will be unable to use the issue of debt as a vehicle for shifting profits from one location to another in an attempt to reduce the overall tax burden.
PWC (2016: 3) argue that the overall aim of the interest limitation component is intended to discourage companies from reducing their tax burdens via what they call “inflated group financing.” Given this premise, PWC (2016) is critical of this particular policy given that the limitation issue does not extend to net interest but also to issues concerning excess borrowing costs. Essentially, the cost side of the interest limitation issue overall, with the impact of additional and equivalent costs that companies incur when they are borrowing funds in order to cater for a number of areas and issues. These include, but are not limited to payments that have been made in consideration of profit participation loans; imputed interest that it is gained in respect of, e.g. convertible or zero-coupon bonds, alternate financing systems, e.g. Islamic financing and loan systems, and the financial cost of lease payment systems (PWC, 2016).
PWC (2016) also assert that further issues can be found in respect of capital interest that is found within the corporate balance sheet in respect of the value that is placed upon related assets, or in respect of the paying off of capital interest. Additional issues are also found that concern funding returns found within transfer pricing guidelines. And with regards to notional interest, hedging arrangements, gains made from foreign exchange, and regarding the need to raise finance for internal investment.
General anti-abuse rule
Perhaps, the GAAR requirements comprise of the more contentious of the EC’s (2016) proposals. Here, the EC (2016) proposed a communal GAAR as a way of addressing the gaps that appear within the EU space’ numerous jurisdictions anti-abuse rules. Consequentially the EC (2016) intends that member states adopt a communal GAAR policy so that particular types of tax avoidance can be countered. To be effective, the GAAR systems require specific criteria that reflect jurisdictional requirements in respect of national law (Deloitte, 2016). This process offers sympathy when assessed against the core aims of GAAR, but the requirement that the EU membership adopts a communal, and therefore, fixed, definition of the GAAR process, can be construed as being unhelpful when intending to administratively defeat artificial corporate taxation arrangements (Deloitte, 2016).
For Deloitte (2016) it is of note that EU member states have already got in place a system for addressing GAAR. The outcome of this policy, therefore, sees EU-focussed anti-tax avoidance Directive, such as 2016/1164, being employed as a primary tool for initiating a flaunted EU-wide taxation policy, although this is limited to the corporate environment and sees the creation of a context in which harmonization of a range of base erosion and/or profit shifting. Essentially, one can assess that the EC (2016) is intent upon developing a common consolidated corporate tax base (CCCTB). This premise is based upon an EC (2016) proposal that allows for central adoption of a CCCTB which is borne out of a standardisation process, but which is in line with the anti-tax avoidance Directive (Deloitte, 2016).
Criticism of Directive 2016/1164
The drafting and unveiling of Directive 2016/1164 has been criticised by a plethora of accountancy partnerships and other interested parties. For example, Deloitte (2016) argues that the draft, which the EC (2016) has developed, offers for a prospect within which non-genuine arrangements should be ignored. These arrangements, it is suggested, are intended to avoid corporate tax demands and imply that further arrangements are not developed and ratified until the policy reflects the realities of economic activity. Added to this, PWC (2016) state that the Directive is also misleading. Here, it is suggested that the adoption of the ATAD is not limited to tax that is denied to the movement of monies and incomes to areas and jurisdictions that lie outside of the EU space. This reality possesses an impact when, for example, assessing the impact of exit taxation or with regards to impacting or avoiding double taxation.
Building upon this perspective, both PWC (2016) and Deloitte (2016) are adamant that interest limitation rules possess grandfathering rules which place a time limit on retrospective tax claims. This means, in effect, that a debt limit of June 17th, 2016 will apply (Deloitte, 2016; EC, 2016; PWC, 2016). This process will also see a range of interest considerations being used to fund long-term public infrastructure projects and, therefore, lie outside of the Directive criteria. That said, it is also of note that the interest limitation rule sees EU member states being able to place a fixed limit upon the levels of corporate interest deductions with the remainder being subject to taxation, thereby maintaining interstate flexibility.
Yet, it is suggested that this same process will be sufficient for discouraging companies from moving debts and reducing their tax burdens (EU, 2016; Deloitte, 2016). Indeed, it is also recognised that EU member states will be provided with a set of responsibilities that allow them to continue with these same regulations until parity is achieved via the Organisation for Economic Cooperation and Development (OECD) intention of developing international parity in respect of a minimum standard of interest limitation rules. This requirement, it is noted, will take almost a decade to achieve and, in the meantime, it is feasible that a set of loopholes and inter jurisdictional ‘cracks’ could appear, within which it will be possible for corporations and partnerships to circumvent EC (2016) Directive requirements (Trades Union Congress (TUC), 2016).
Finally, PWC (2016) recognises that work remains in this area of EC practice. Here, it is suggested that a large number of EU member states are not in favour of a CCCTB-styled system for gathering taxation. However, it is also noted that the EC has yet to fully draft a set of alternate measures that gain full agreement that fully correlate with the requirements of BEPS.
Recent years have seen the EU adopt an aggressive stance in respect of cross jurisdictional tax liabilities at the high-end personal and corporate levels. What results in ATAD 2016/1164. This Directive seeks to address fluctuations and loop holes that exist at the member state level, in respect of a number of variable tax regimes which allow for tax avoidance. The above narrative explains that Directive 2016/1164 is nowhere near completion, when assessed against the merits of a coherent system for addressing common tax provisions, income, and avoidance measures. Yet, with the EU seeking to address regional anomalies in respect of CFC’s, exit taxation, and interest limitation, as well as intending developing a common GAAR, the systems that are being proposed are criticised by a number of sector agents. Naturally, these agents include large accountancy partnerships and finance houses. The core arguments that are being projected here largely fail to correlate with similar proposals that are emerging from the OECD where, there, the intent is to develop an international taxation regime that offers a minimum standard of tax as part of a global approach to structural weaknesses.
It is these phenomenological issues that form the basis for the next Chapter. There the core focus sees the incorporation of the Maltese tax system into this discussion, and allows for a more focussed discussion regarding the tax systems that are employed within Malta and which are sanctioned by Acts of Parliament. Consequentially, chapter two reviews the domestic personal as well as corporate and business tax systems. This approach allows for the prospect of a latter conversation regarding the impact of proposed EU ATAD on Maltese tax regimes.
Chapter Two: Maltese Tax System
Malta has long been an attractive location for corporations and wealthy persons because of their ability to create a number of tax and cost-efficient benefits. The evolution of the Eurozone jurisdiction has aided this outcome given that regional and global trade in financial services and holding activities now form part of the normative financial landscape (CCPS, 2017). This outcome has been assisted by the creation of a domestic tax system that helps Malta benefit from an economy that has been proved to be open, sufficiently for it to be in line with the hardest of liberal interpretations of the purpose of taxation. Given this premise it is worthwhile noting that the country and its economy directly benefit from foreign direct investment that can be found across a range of economics sectors (CCPS, 2016).
What results is a country that possesses and promotes a positive investment climate that is supported by governmental and parliamentary legislation but also is one that actively supports and encourages inbound investment. These, it is suggested, are targeted in line with political strategic areas including the financial services and its related services and industries (CCPS, 2016). CCPS (2016) notes that the domestic market is, however, heavily regulated via the Malta Financial Services Authority (MFSA). This regulation sees the MFSA acting as an agent that is wholly responsible for overseeing the management of all licensed financial services activity in the country (CCPS, 2016). Arguably, this sees a contradiction in the utility of targeted regulation and which sees active co-operation with international bodies, such as the OECD and the EU. It is for this reason that this Chapter aims to highlight the tax systems used within Malta at the personal and corporate level, and assesses these against appropriate tax theory.
The Domestic Personal Tax System
Malta’s tax system is viewed as being beneficial for businesses and entrepreneurs, many of whom possess investment portfolios (No More Tax, 2016). Consequentially, the Maltese tax regime is viewed by some as offering an attractive environment for undertaking investments. This system, it is to be noted, is based upon a two-staged process that results in residents of Malta benefitting from two types of income tax thresholds (No More Tax, 2016).
Malta has retained the remittance-based tax system which was in situ during the era when it was ruled from London. What results is a regulatory process that sees non-Maltese individuals, i.e. those who possess an alternate nationality, can benefit from preferential taxation programmes which mean, in effect, that these same residents are liable for taxation in one of the two aforementioned stages (International Business Publications, 2013). In effect, foreign residents within Malta can qualify a special residence taxation system in which a tax-based remittance basis applies. What results is foreign Maltese residents are taxed against two types of income. The first of these incomes are those that are sourced from within Malta, in line with domestic income and capital gains tax (No More Tax, 2016), i.e., as an employee that is subject to personal tax liabilities, or via a business that sells to the local citizenry (IBP, 2013).
The second stage of the local Maltese tax system focuses upon foreign sourced income. The premise here is that this second process applies only where income is remitted to Malta. Essentially, this state sees those foreigners that are resident within Malta not being subject to domestic income tax regulations where any income has been gained outside of the Maltese jurisdiction (IBP, 2013). Here, it is of note that this same income is irrelevant where it is remitted to a bank account that lies outside of the domestic system. The reality of this regulation also means that foreign residents that make full usage of their tax rights are not liable for a tax bill where capital gains has been sourced externally (IBP, 2013; No More Tax, 2016). This is also the case where these same funds are transferred to a Maltese bank account.
As such, it is possible for partners of a multinational to shift externally gained profits onshore and not be liable against taxation (No More Tax, 2016). Corporate lawyers, Bradley Hackford (2016), argue that what results via the Maltese tax regime sees foreign residents financially benefitting from a number of business-friendly benefits. This can be achieved, it is argued, through overseas residents being free to create a tax residency status within Malta with the result that they are only taxed on income that is earned internally (Bradley Hackford, 2016). The culmination of these tax rights which foreign residents benefit from lies within the High Net Worth Individual (HNWI) tax criteria (Bradley Hackford, 2016). The application of this regime sees income that is landed within Malta being taxed at 15%, a differential of 20% when assessed against the indigenous populace whose incomes are taxed at 35% (Bradley Hackford, 2016).
Other tax-related benefits that can be accessed within the Maltese jurisdiction include being able to set up a company that allows for dividends to be received via participating holding that are tax exempt (CCPS, 2016). CCPS (2016) also note that the Maltese tax system allows for this benefit to be accessed as long as the company possesses a proper structure that is compliant with local laws, in line with the guidance of the MFSA. Compliance in this respect sees companies being enabled in a number of scenarios that include the financial gains made in respect of the sale of a participating holding (CCPS, 2016). Here, tax exemptions apply.
The culmination of the above narrative sees Malta possessing perhaps the lowest OECD-compliant tax system and rates in the EU (CCPS, 2016). Subsequently it is possible for inbound investors to create onshore tax-efficient structures and, as a result, benefit from the existence of a fiscal system that assists with full interaction in respect of corporate tax charging systems. What results via this process allows for dividends to utilize a tax credit that is based upon an equivalent rate when assessed against the taxes that are due via acquired profits (CCPS, 2016). This credit system is also extended to other forms of taxation, including but not limited to, general tax refund systems. This represents the active usage of a double taxation system that (currently) possesses the support of European Commission and has been the case for over a decade (CCPS, 2016).
Corporation & Business Taxes
The above framework concentrates solely upon personal tax liabilities. Where overseas companies register within Malta under its Companies Act (Government of Malta, 1995) sees companies that have been incorporated in Malta in line with domestic regulations are considered to be akin to ordinarily resident and, as such are domiciled in Malta. This is the normative outcome and applies in cases outside of those that see managerial control being undertaken within another country (Government of Malta, 1995). Subsequently, tie-breaker and double tax rules apply where, there, fiscal residence is applied to these companies. The result of this process sees companies that are resident and domiciled within the Maltese jurisdiction will be liable to the Maltese tax regime in respect of their global incomes. Yet, despite this objective regulatory system, these same companies are also entitled to claim financial benefits via extraterritorial treaties, such as EU Directives (3AMalta, 2016).
These companies also benefit from additional entitlements regarding their ability to claim against fiscal benefits that have been developed via the domestic Income Tax Act (Government of Malta, 1994). Here, it is noted that where a foreign company operates within the Maltese jurisdiction, but retains its fiscal residence overseas, then what results is these companies not being subject to the domestic tax regime (3AMalta, 2016). This outcome is derived via the aforementioned remittance regime. When applied, the remittance tax system results in those foreign sourced incomes not being subjected to domestic tax regulations and only apply to incomes that originated within the Maltese jurisdiction. As such, in respect of capital gains that is sourced outside of Malta, these do not fall under the domestic tax Act (Government of Malta, 1994; 1995). This is the case even where these same revenues are received within Malta (Bradley Hackford, 2016). Indeed, given these frameworks one can assess that the issue of domiciliation in Malta is largely financially advantageous for those companies that are now incorporated within Malta, given that they are largely subject to legislation that is grounded within CFC frameworks (3AMalta, 2016).
Added to this, it is also of note that whilst share holding of foreign registered companies may not qualify for this exemption, the tax requirements that are raised via dividends and gains are likely to be reduced because of the application of double taxation relief, unilateral relief, and when a flat rate foreign tax credit has been applied (CCPS, 2016). Indeed, it is also of note that non-Maltese residents also benefit via not being taxed on financial gains that have been realised via the sale of Maltese company securities. This is the case, it is argued, as long as these same securities do not belong, or are held, in a company where the assets comprise of immovable property that is both situated and registered within Malta (CCPS, 2016). What emerges from this narrative sees non-domicile companies being able to financially benefit from taxation paid via foreign incomes, where this has been remitted within Malta. This outcome helps to reinforce this paper’s recognition that foreign financial gains remain untaxed within Malta and, as such, it is possible that companies could continue to be re-domiciled to Malta whilst also seeing no compliance in respect of exit taxation (CCPS, 2016).
The CCPS (2016) also notes that it is possible to repatriate profits on a tax-free basis since the Maltese state does not charge a withholding fee on the payment of dividends to shareholders that are not Maltese residents. Added to this, it is entirely possible for interest and royalties to be paid to this same cohort on a non-tax basis (CCPS, 2016). Indeed, the CCPS (2016) also argues that the local jurisdiction also possesses systems that possess an increased potential to benefit from efficient tax planning. This sees the adoption of transfer pricing practices being used as a matter of course, as well as thin capitalisation regulations, CFC regulations. Indeed, this freedom culminates in low annual wealth taxes being an added bonus for non-resident investors These, the CCPS (2016) argues, is the culmination of the two-tier tax structure within the Maltese system and benefits the investor, wealthy non-resident, holding companies, and subsidiaries.
To explain this myriad of tax allowances, the CCPS (2016) developed a simplistic model. Using a manufactured company as an exemplary case study, EU Co, the example indicates that it is possible for it to possess shares in Malta Co. This process sees the inclusion of an assumption in which Malta Co’s trading profits are calculated at 100 Euros. The tax payable within Malta comprises 35%, or 35 Euros. To address this, Malta Co can distribute all of its post-tax profits, thereby allowing EU Co to claim a rightful rebate of 30 Euros. This system and structure is unable to work because although dividends are not likely to be taxed because of exposure to the participation exemption provisions, but what emerges is the creation of a rebate to EU Co being taxed and classed as other income (CCPS, 2016). This premise is based upon the tax rebate not being a dividend but does result in the employment of the double tier structure as a tool for reducing the overall corporate tax bill to only 5%, (5 Euros, resulting in the organisation paying only 5% in tax (CCPS). This is outlined within Table 5.
Overall, a review of Maltese tax systems sees overseas companies that register their domiciliation to Malta benefit in a number of areas. These include, but are not limited to, the reality of there being no income tax consequences when assessed against inbound migration. Added to this, there is no system in place to address the tax basis of corporate assets (Bradley Hackford, 2016). These companies also are provided with access to the domestic tax refund system, the participation exemption regime, Malta’s’ membership of double tax treaty networks, as well as a plethora of supportive EU Directives (3AMalta, 2016). These benefits are experienced within a jurisdiction that sees companies also gaining from not being subject to certain exit taxes, and where it is possible to reside outside of CFC, anti-tax haven regulations, and where it is entirely possible to migrate to another jurisdiction without the possibility of financial punishment, as is the case within peer EU member state tax regimes (Ernst & Young, 2015).
As a country it is fair to assess that Malta both possesses and promotes a system of positive inbound investment. This is achieved through the perpetuation of a business and finance-friendly atmosphere via the support of both the Maltese government and parliament. Much of the landscape development that is required to develop this system has been outsourced to a specific arm of the Maltese state. The MFSA operates as the sole agent for regulating all licensed financial services activities that take place within the country. What results is a two-pronged tax system that oversees and regulates the personal tax system and the corporate and business tax system. It is within the combination of these two tax regimes where the reality of an attractive environment is found. Essentially, those exposed to the local tax system gain from a number of preferential tax regulations in respect of fiscal residence, capital gains, double taxation relief, unilateral relief, and in respect of a flat rate foreign tax credit.
Systems such as these, the EU argues, provide the justification for pressing ahead with Directive 2016/1164. The reason for this is that many corporations, large businesses, and wealthy individuals utilise the Maltese tax system in order to avoid tax liabilities which would normally be found elsewhere in the EU and Eurozone space. This next Chapter builds upon this reality and assesses a number of issues in respect of taxation theory, harmonisation, and the various steps that have been muted within the EU to address the issue of common tax avoidance.
Chapter Three: Perspectives on Taxation
Taxation: Perspectives and Ideologies
Cochrane, Duffy, and Selby (2003) hold a perspective that the global financial system is regularly contested. Their development of this perspective is based upon a premise that global aspects of finance, with particular regards to offshore finance being contrary to the normative global tax regulation. Consequentially, with Small Island tax havens, such as that utilised within the Maltese jurisdiction, resists the global approach via agencies which include the OECD (Cochrane et al., 2003). Here it is noted that the previous four decades has seen a number of small island economies (SIEs), i.e., those that possess a population of less than 1.5 million populations are increasingly likely to host offshore finance centres (OFCs). Cochrane et al. (2003) argue that OFCs are increasingly likely to be based around the European space and include, but are not limited to, the Channel Islands, Cyprus, and Malta.
Other examples are found elsewhere in the world, specifically in the Caribbean, and the Indian Ocean. Because of this trend, Cochrane et al. (2003) argue, what emerges results in SIEs being increasingly dependent upon hosting OFC in order to finance the administration of government. They cite the Channel Island as one such example where, there, the local government is reliant upon OFCs for around 90% of income and around 20% of domestic employment (Cochrane et al., 2003). De Ruggiero (1957) earlier argued that this approach also has an impact upon parallel concepts of social democracy and individualism but also sees a correlation with latter works, such as that offered by Friedman (1962) who asserted that the taxation issue has also had an impact upon the direction of contemporary liberalist thinking. For Boas and Gas-Morse (2009) what results is a number of theoretical and practical overlaps between individualism and mercantilism, and results in the employment of engrained practices that advance free trade, much of which is supported at the jurisdictional level and supported by legislative, fiscal, and economic regulations (Boas & Gans-Morse, 2009).
Arguably, what occurs as a result sees the realisation of Nozick’s earlier (1974) hypothesis concerning the viability and illegitimacy of redistributive taxation systems, when used as a vehicle for funding state activity. Nozick (1974) argued that an excessive tax system was morally illegitimate and was akin to a form of forced labour. Within this perspective, one can argue that the idea of illegitimacy lies within a belief that with the state structures its own income and revenue collection system, what emerges is a predefined concept whereby an individual’s labour is undermined by the state in order that it is able to finance its own activities. Nosick (1974) argued that the forced labour issue emerges as a result of this policy and that, in effect, the state is undertaking practices that are not dissimilar to an involuntary work programme within which the removal of personal finances, which are essentially the fruits of one’s labour, is enforced in a way that helps to ensure that every individual can benefit from a state-centric notion of welfare (Nozick, 1974). This, Nozick (1974) argued, undermined the ideal of universal and personal rights (Vaughn, 1978). It is in this context that EU-based harmonisation processes are largely found, and which are intended to address.
Tax Harmonisation: Theoretical Overview
At the outset it is to be noted that Ussher (2012: 5) argues that the process of tax harmonisation largely focuses upon the “deliberate convergence of tax regimes, including rates of taxation.” This process, it is suggested, mostly concerns the development of principles for action that are intended to address and alleviate the possibility for tax evasion at the personal and corporate levels. This premise is supported by Kopitz (1992) who suggests that the policy area that leads to tax harmonisation helps to create a process in which it is possible to adjust national and regional tax systems in order to develop a common tax policy. In this sense, therefore, the processes that lead to tax harmonization largely focus upon the removal of several inherent distortions that directly impact upon the ability of states to collect sufficient revenues in order to under-deliver upon a set of predetermined services (Ussher, 2012). Failure to do so has a direct impact upon the ability of the state to deliver these same services but also has an impact that affects several commodity movements so that a more efficient process for state-led resource allocation can be created (Kopitz, 1992). Indeed, it is this same resource and income issue which Nozick (1974) railed against when arguing that the underlying ethos of taxation was akin to a form of enforced slavery, given that personal labour was being used to benefit those that had not yet attained to a similar set of personal economic outputs.
Nozick’s (1974) premise aside, Florin (2016) suggests that the creation of a common income tax base that directly affects multinational companies whose operations span many jurisdictions could be central to enhancing organisational and corporate efficiency. This outcome, it is suggested, can be achieved through helping to prevent a number of fiscal overlaps in corporate tax claims within a number of jurisdictions which, for Kopitz (1992) can be undertaken simultaneously as part of an erroneous internal fiscal policy. It is here, it is suggested where the aforementioned internal inefficiencies are found. Consequentially, Florin (2016) argues that the harmonisation process leads to a critical issue where fiscal integration is considered, both at the state and organisational level. Where this issue is not addressed at the political policy level, what also results is an ability to shift tax burdens around jurisdictions in order to realise a reduced total tax bill. Arguably this is the justification for the components of Directive 2016/1164 and is an issue which Mitchell (2004) asserts in respect of the functions which corporations and wealthy individuals undertake as part of a tax reduction programme.
Mitchell (2004) believes that the processes that assist the perpetuation of tax-based competition lies within a system in which people and corporations are able to reduce their tax liabilities through moving money and capital around jurisdictions. This perspective represents a level of congruence with the perspectives offered via the likes of Floris (2016), Kopitz (1992) and Ussher (2012). Mitchell (2004) argues that, essentially, the process sees money being moved from a high-tax locale to one that offers a reduced rate but that this financial migration promotes those states that possess lower tax rates, to the detriment of those states that operate on a higher system of taxation (Mitchell, 2004). Essentially, this forms the basis for a discussion concerning tax competition which is a dominant issue within the globalised corporate market. This reality, for Ussher (2012), underpins the dynamics of the global economic and fiscal system and is an issue that has resulted in the creation of common policies such as Directive 2016/1164.
Benassy-Quere (2014) argues that some states, primarily those that possess higher tax rates, do not appreciate the financial dynamics that result in tax competition; although, in fairness, given that theories including that of Nozick (1974) now form part of the accepted theories of taxation and help to shape respective policies, this process is somewhat archaic (Mitchell, 2004). Consequentially, the development of a common tax policy now sees the involvement of a number of disparate international organisations being involved in the development of policies. This includes, but is not limited to, the EU, the United Nations (UN), the OECD, and the World Trade Organisation (WTO) (Benassy-Quere, 2014). Mitchell (2004: 1) argues that these institutions are actively promoting the feasibility of tax harmonization schemes as a way of inhibiting “the flow of jobs and capital to market-oriented economies.”
The development of such proposals, it is suggested, is largely inconsistent with the development of a coherent tax regime and sees further congruence with the early works of Nosick (1974). Here, for example, it is suggested the result of a tax harmonization policy will only result in higher rates of tax rates that are caused via unregulated and failed double taxation policies (Mitchell, 2004). Indeed, it is of note that Mitchell (2002) also argues that peripheral issues, such as extra-territorial taxation, also leads to further increases in taxation rates because the majority of harmonization policies are purposely intended to assist states and governments receive a taxable income from activity that lies outside of their economic zone, i.e. as part of a cross-border process, which, it is suggested, these same states are not normally entitled to (Mitchell, 2004). Indeed, this is an issue which De Mooij (2008) further addresses in his research into EU member state income levels realised by developing effective communal tax competition systems.
De Mooij (2008) promotes a perspective that sees the current EU corporate tax competition regime leading to a reduction in overall tax rates. This process has been undertaken as part of a unilateral policy development process and has seen a number of individual member states shifting its domestic tax rates to a reduced level. This policy, it is argued, has taken place as part of a continual shift that began in the 1980s and has seen overall tax liabilities being reduced by around one fifth of those rates that were in place in the 80s (De Mooij, 2008). However, De Mooij (2008) also notes that the resultant tax revenue has not experienced a decline but instead has seen an increase. This anomaly is emphasised within table 6 which indicates the comparison between corporation tax revenues from the 1980s to the present day and indicates that tax has increased from roughly 2 percent of GDP to over 3 percent in 2008 (De Mooij, 2008). De Mooij (2008) explains that this anomaly can be explained via the result of the tax base being broadened to include a reframing of the legal definition of what constitutes as a business, with the outcome being that the fiscal net being spread wider.
The calculations that De Mooij (2008) utilised in his studies saw that corporate tax liabilities and rates had been lowered to a level that was lower than the top rates of personal taxation but has since led to a number of unincorporated firms being classed as corporations, and it is here where the widened tax base is to be found (De Mooij, 2008). One further side effect of this policy development is a similar alteration in tax revenues in respect of personal tax where, there, actual state revenues have decreased since the 1980s (De Mooij, 2008). Consequentially, it is arguable that what has occurred overall is shift in the tax burden from personal to corporate spheres, albeit as an EU-wide average. That said, the core focus of De Mooij’s (2008) study was not the EU or its affiliate institutions, such as the European Free Trade Area (EFTA) per se, but instead the states that partake in the Eurozone (De Mooij, 2008), and see the shift from personal to corporate levels increasing at an average of twenty-four Euro cents. This alteration, however, has not seen an upturn in government revenue because, overall, what has been gained in the upswing in corporate tax revenues have been counter-balanced by the reductions in personal rates with the outcome being that there is no overall governmental or exchequer financial gain (De Mooij, 2008).
Tax Harmonisation: Technical Issues
The previous discussion, for Nerudova (2008) sees tax harmonization policies comprise of a process that results in EU tax systems converge in order that a common member state policy is created. For Kubatova (1998) this process also sees the identification and utilisation of three core phases being used to develop these policies, although this same process does not rely on a three-stage process. Indeed, Kubatova (1998) asserts that it is possible to create a system of harmonization via simply developing a common tax base. This issue aside, Kubatova (1998) argues that the first stage in the developmental process sees taxes being identified as being subject to harmonization. Once identified, the harmonization process can begin, and it is form here that tax rates are harmonized (Kubatova, 1998). This is a simplistic process but is made more complicated by the plethora of tax frameworks that exist within the EU and which ultimately lead to the creation of a complex harmonization process that results in common policies in respect of CFC regulations, exit taxation, interest limitations, and GAAR, as discussed within chapter one.
The level of complexity that has been created within the EU Directive 2016/1164 creates several differing levels of taxation, as originally argued via Simon (2000). Simon (2000) had argued that the adoption of a common tax policy that had been based upon alternate policies and agendas helps to create a two-tier system, namely at the regional (EU) level and the domestic state level. The outcome of this, therefore, sees the harmonization process being incomplete because what occurs is a partial harmonisation that creates inbuilt loopholes at the domestic level. That said, what does occur is a process that sees double taxation being removed from the tax landscape so, arguably, the partial process does see some positive progress along the harmonization route (Simon, 2000). Total tax harmonization, as defined by Nerudova (2005), is based upon accepted taxation theories such as those discussed earlier in this chapter, and sees the creation of a harmonization structure and common tax rates. What emerges, Nerudova (2005) argues, is the creation of an administrative system of tax harmonization and it is via this creation that sees process evolve towards actual common based tax legislation. This legislation Nerudova (2005) combined with the administrative structure, and common tax rates, sees the creation of total tax harmonisation. Arguably, given the corporate and personal systems that are being developed via Directive 2016/1164 are congruent with that perspective. What can be created following this creation are the origins of fiscal integration (Floris, 2014).
Fiscal integration, for Florin (2014), comprises of the various processes that result in a number of states and governments settling on an agreement that sees them develop convergence over national budgets. The main aim, it is suggested, results in the creation of a fiscal union (Floris, 2014). Consequentially, what occurs as a result is the natural conclusion of a tax harmonization process, in line with the perspectives of Nerudova (2005), and is a part of a deeper strategy for policy transfers that are intended to create a fully developed programme of harmonization in other areas, such as legislation and intervening institutions, hence the aforementioned administrative requirement. The perspective that Floris (2014) and Nerudova (2005) advance, therefore, allows for a more comprehensive definition being developed that sees the fiscal integration process being based upon tax harmonization via preset common tx bases that is supported by legislation which, essentially, creates bindings agreements upon the domestic state and government as a process for attracting inbound foreign investment which, in essence, concretises the merits of the single market, as is the case in the long standing EU set-up (Benassy-Quere, 2014). Yet, the real contentious issue is these binding multilateral agreements which are political in nature and which create political tensions between aspiring signatory states (Benassy-Quere, 2014). In effect, therefore, the idea that tax harmonisation is an end in itself is an incorrect argument since what actually occurs is a process of devolution from the domestic state to the main regional body, in this case, the EU.
Mario Monti: Addressing Common Tax Avoidance
Ussher (2012) notes that the creation of a common taxation system within the EU can be traced back to earlier policy aspirations within the European Economic Community (EEC), the forerunner to the EU. Policy development at that time was an aspiration that had been considered as sensible given that the EEC space was dominated and shaped by core issues to tax competition. Ussher (2012) recognises that these early sentiments occurred in the late 1970s and that it took over two decades (until the late 1990s) when the EU single market developed for tax harmonisation to develop as a realistic policy base to which the EU could progress politically and evolve as an institution. It is for this point onwards, Ussher (2012) argues, that the concept of tax harmonisation has increased in political, economic, and fiscal importance. Ussher (2012) also notes that the concept of the contemporary common tax policy has direct association to former Commissioner Mario Monti. Monti, it is suggested, had sought to address weaknesses within the single market which allowed corporations and individuals to possess investments and savings outside of the domestic state as a way of evading tax (Ussher, 2012). Monti (2010) argued that the current plethora of competing tax systems that exist across the EU space equated only to a common policy of tax avoidance.
As stated, the early years of the EU’s evolution had seen tax harmonisation being an aspiration as opposed to an active policy agenda. What Monti (2010) had proposed, therefore, comprised of a set of measures that were intended to abolish the domestic member state tax systems via addressing cross border weaknesses in areas such as the payment of interest and royalties that occur naturally between corporate entities, such as subsidiary companies and their associates (Monti, 2010). This approach also saw a need for EU ministers to identify and eliminate the realities of tax policies that had been utilised in order to grant a number of tax exemptions. These exemptions, Monti (2010) had suggested, resulted in some corporations benefitting from preferential systems that were largely industry specific and included, but was not limited to, the pharmaceutical industry (European Federation of Pharmaceutical Industries and Associations (EFPIA, 2016). From here, the EU Commission published details of the tax exemption practices that took place across the EU space which allowed corporations to mitigate their tax burdens through the existing tax competition systems that were, or, in place in the EU space.
This process has also seen attempts to address structural weaknesses in areas such as Value Added Tax (VAT). Convergence in the case of VAT also concretises the aforementioned issue of a common fiscal policy via developing further regulation of domestic income adjustments. Currently, however, there is no political appetite for creating a common income tax policy and this omission from Monti’s (2010) proposals indicate that the lack of policy on harmonised income tax sees the focus being placed upon the elimination of tax exemptions and avoidance via shifting monies around member states. Arguably, therefore, it is the corporate and investment systems that have been identified as a as weakness in the EU financial system, hence the utilisation of this policy area as a vehicle for concretisation of the harmonisation process (Ussher, 2010). One further point of note concerns the earlier discussion regarding the administration of tax harmonisation systems because what also occurs, by default, is the convergence of private accounting systems in a manner that sees the creation of a common private financial management system within the EU space.
Ussher (2012) argues that the above evolutionary narrative is in line with the Maastricht Treaty of 1992. This Treaty, Civitas (2013) argues, comprised of the Exchange Rate Mechanism (ERM), as well as enhanced economic integration, and financial convergence which, this paper asserts, has been realised via the focal issue of tax harmonisation. It is these three areas, Civitas (2013) argues, that formed the basis for the current thrust towards tax harmonisation and confirms the idea that the tax proposals are merely a step towards a common financial and fiscal income policy across the EU space. Yet, despite being a critic of these policies, it is of note that Ussher (2012) recognises that these same policy aspirations are necessary for furthering the idea of long term economic stability of the single market. Indeed, Ussher (2012) also argues that if the tax harmonization proposals are viewed as a vehicle for realising this ideal of economic stability then the tax harmonization proposals can be divided into two core areas, namely positive and negative.
The positive tax harmonization perspective, Ussher (2012) argues, is indicative of a system that employs processes that are intended to encourage enhanced fiscal convergence of domestic tax regimes and systems via Directives, regulations and legislation. Essentially, the aforementioned administrative tools of tax harmonisation are seen as positive, whereas the negative tools see the inclusion of the European Court of Justice (ECJ) into this debate via the enforcement of the administrative system via a legal form of coercion (Ussher, 2012). In this sense, therefore, what passes as positive and negative is indicative of Berlin’s (1958) earlier notion of positive and negative liberty which saw benefits being forced upon peoples became of a utilitarian notion of the common good but, it can be assessed, in who’s benefit were the idea of predetermined liberties? Using this analogy, the positive and negative idea of tax harmonisation sees only the EU as being the sole beneficiary of this common fiscal system and sees the ECJ as the body that is solely responsible for enforcement of tax harmonisation (Ussher, 2012).
At the heart of the taxation debate lies the issue of who possesses a right to tax, for what purpose, and in respect of the state to access individual’s fruits of labour, namely their earnings and income. What results is a divergent academic and ideological system which no single theory or approach can offer a holistic perspective on the core issue of taxation. EU leaders have assessed the merits of such a common policy several decades and, arguably, it was Mario Monti who first penned the framework that has evolved in to the Directive that lies at the heart of this debate. What results is a common EU tax policy that focuses upon corporate and business tax systems. It has been argued that the EU is also aiming to develop a common VAT policy although, in fairness, such a policy is unlikely to arise any time soon given that the impact of ATAD upon member states, such as Malta, is yet to be fully assessed. Indeed, it is this very issue which is discussed within the next chapter. There, the developing discussion surrounding Malta and ATAD assesses a number of core issues, such as weaknesses that are found within, for example, BEPS frameworks. Additionally, this next chapter aims to assess and analyse the impact of inconsistencies within EU ATAP policies, when assessed against similar regulatory system being developed via the OECD.
Chapter Four: Malta & ATAD – A Discussion
In February 2017, Malta acquired the Presidency of the Council of the European Union and, in the course of this prime position, published a roadmap regarding how it would address the aforementioned issues regarding tax competition and BEPS (Ernst & Young, 2017). This coming of age for the Maltese state occurred at a time when SIE’s, such as Malta, are more likely to benefit from inbound investments via the employment of OFCs (Cochrane et al., 2003). This approach, for De Ruggiero (1957), is based largely upon the incorporation of true liberal market economics into the domestic setting and is in line with the theories of social democracy and individualism that were advanced by the likes of Friedman (1962). Where the Maltese state benefits from this process lies within the large influx of corporate and private wealth in order to benefit from a remittance-based tax system.
This process allows for non-Maltese individuals benefiting financially from preferential taxation regimes that undercut those regimes that would be found within the home jurisdiction (International Business Publications, 2013). It is here where the ATAD proposals that are found within Directive 2016/1164 are found to be controversial since through the usage of CFCs, systems for addressing exit taxation, and interest limitations are found. Added to this the creation of a common GAAR policy arguably limits the ability of the Maltese state to develop its fiscal regime. This has been a long-standing issue for Grech (2015) who indicates that Maltese economic growth since the turn of the Century has been based upon four main components; these comprise of the trends in taxation policy in respect of tax structures and reforms and their consistency with wider EU requirements for addressing local growth requirements. This outcome, for Hines (2005) allows for a process that sees Malta being heavily involved in processes of tax competition. This process, Hines (2005) suggests, is beneficial when aiming to raise a state’s total tax intake thereby stimulating economic growth. Were the ATAD be applied to Malta it is feasible that the country would experience a growth regression should it adopt the proposed EU Directive in full. This outcome, it is assessed, would occur via a distortion in the use of tax instruments when assessing the feasibility of this area being a core factor in Malta achieving economic growth (Grech, 2015).
The issues which Grech (2015) discussed above recognise that Malta is in a relatively weak position given that it has the smallest economy in the EuroZone (CIA, 2017). For example, production across the country is relatively small; indeed, it produces only around one fifth of its total food needs, as well as benefits from a limited supply of domestic energy and fresh water (CIA, 2017). It is for these reasons, the CIA (2017) hedges, that Malta is heavily reliant upon its financial services sector in order to sustain economic growth, social services, as well as a number of fiscal and financial commitments. Given this perspective, one could argue that any external reshaping of the tax base via reducing the levels of competition that exist in the international or European market will have a negative impact upon the Maltese state and economy. Yet, for the CIA (2017) despite the potential of harm to Malta because of the potential for ATAD and ATAP roll out, inbound investment has not been harmed. This sees the Maltese economy continuing to grow through 2015 and 2016; this performance, it is suggested reinforces Mitchell’s earlier (2004) assessment that the Maltese economy is heavily reliant upon inbound investments in order to bolster its economic performance. The value of financial services to the Maltese economy has since been evidenced by the CIA (2017) which argues that increased tax revenues have helped to modernise the country’s energy infrastructure, with additional improvements in growth being expected as a result. Yet, the CIA (2017) also assesses that Malta is also vulnerable to financial shock. The reason for this is that the country suffers from a high cost of borrowing and the potential for economic restructuring or reform is limited due to possessing a small labour market. As such, the reliance upon preferential tax regimes offers as the mainstay of the Maltese economic and fiscal system.
This area of concern has also been recognised by the International Monetary Fund (IMF) which argued that the Maltese economy would be adversely damaged as a result of the alignment of domestic tax policies to one that is based upon a common structure (IMF, 2016). The IMF (2016) argue that the negative impact that will is likely to befall Malta will originate via increased household debt and reductions in property values. The culmination of this, it is assessed, is likely to form the basis for a long term sluggish economic performance (IMF, 2016). These concerns are in line with Grech’s earlier (2015) assessment which argued that the local Maltese system have largely mirrored the trends that have emerged via the EU. However, this mirroring could be viewed as a form of smoke and mirrors since Grech (2015) also notes that Maltese leaders offer their own divergence in areas including tax structures and tax shifts that are contrary to which have since been proposed via Directive 2016/1164. Essentially, it is fair to assess that Grech promoted the possibility that Malta would need to promote an alternate system of taxation rather than have one imposed upon it and, in effect, the recommendations that had been developed in his (2015) paper reflect the need for Malta to adopt those components of Directive 2016/1164 that can be viewed as being pro-growth.
The CIA (2017) also analyse that Malta’s economy is dependent on foreign trade and tourism. This perspective sees Malta being heavily dependent upon two streams of income as a way of financing both state and society and further indicates that the Maltese system is determined by a number of events and policies that lie largely outside of the direct control of the Maltese state. This is an issue which the CIA (2017) argue was a reason as to why the country joined the EU in 2004 and latterly adopted the Euro four years later. Indeed, this economic policy has proven to be relatively successful and, thereby, indicated that the Maltese system of economic, financial, and fiscal operations suits the state’s vision for its country. This premise is based upon a reality that Malta was able to ride over the recent financial, banking, and Eurozone crises better than the majority of its EU peers. This, the CIA (2017) argues, was due to Malta possessing a low debt to GDP ratio that revolved around the reality that Malta possesses a sober and coherent banking sector which contains the relevant level of regulation. This assessed outcome differs from that of Grech (2015) who believes that the core reason for Malta’s continued economic success lies in the fine balance that has been created in respect of its tax and growth policy. Here, Grech (2015) believes that Social Security Contributions (SSC) is relied upon as an indicator of economic viability in the country. This, it is argued, is a shrewd move since SSCs are the least distortive tax instrument available to government and, therefore, offers a truer picture of the domestic economic climate and performance when assessed against consumption or production levels.
For Grech (2015) it is fair to assess that the reliance upon the monitoring of SSCs and indirect taxes that are acquired via tourism offers an improved prospect for better growth rates and performance in the Maltese sector. This, it is argued, allows for an improved outcome when assessments are undertaking using a more normative direct tax and income approach which other EU member states, such as the UK (currently) rely upon. Consequentially, one can argue that the implications exist in respect of fiscal and economic policy largely revolves around using SSC as levers for increasing and decreasing local consumption and production in a bid to control local inflation and interest rates, this policy process also sees the Maltese economic system heavily employing production import taxes at the same as it minimises income and capital taxes.
Therefore, it can be deduced that the Maltese system is not only financially reliant upon its preferential tax base but also sees these fiscal tools being used to improve upon the regulation of financial services (CIA, 2017). Indeed, the CIA (2017) also notes that recent financial legislation which had been introduced in 2014 and 2015, as discussed previously, was intended to improve upon the systems that help detect money laundering within both the financial sectors and in respect of the gaming sector which Malta is increasingly benefitting from (CIA, 2017). At this juncture it is worth noting that of the forty-nine standards for assessing country systems for money laundering, Malta was complaint in forty, whilst improvements are needed in the remaining nine calculative practice regimes (Know Your Country, 2017).
These compliance regulations are developed by the Financial Action Task Force (FATF) and have led to Malta improving its regulation in recent years. Indeed, the inclusion of the FATF within this discussion also is a factor in Maltese political leaders using bilateral EU discussions to further develop its anti tax avoidance framework. This process, arguably, is a centrepiece of the ATAP that has been developed via Directive 2016/1164 and sees the Maltese political establishment recognising that there is more that is needed to be done if Malta is to remain as a tax friendly state. Arguably, however, the recent shift in the Maltese perspective towards ATAD and the ATAP is borne out of a realisation that those financial services that are located within Malta are coming under increased EU scrutiny, with the result being that the state, country, and economy could suffer as a result of a combination of positive and negative regulations being imposed upon it from external sources.
Ernst & Young (2017) argues that when undertaking the EU Presidency, Maltese politicians developed an alternative to the AATP which included a response to hybrid mismatches. In developing this proposal, the possibility of a system for dispute resolution was raised. This system is based upon the feasibility of third party state non-cooperative jurisdictions in respect of several tax regimes that impact upon the corporate tax base, intellectual property patent boxes, a new form of CCCTB, new frameworks for addressing the tax issues surrounding interest and royalties, outbound payments. This area, it is to be noted is an attempt at mitigating expected damage caused to the Maltese economy via the influx of EU wide regulations including the components of Directive 2016/1164 (Lohvansuu, 2017).
The above narrative indicates that there is unease in Malta to the forthcoming tax reforms. Indeed, the Maltese government is not alone in adopting this perspective. For example, the IFC (2017) notes that Ireland is promoting a similar political stance but, here, it is argued that Directive 2016/1164 is at odds with the policy directives that are emerging from the OECD. This is the case despite the OECD being proactive in seeking to address BEPS weaknesses (OCED, 2017). Indeed, the IFC (2017) note that Malta is not the only EU member state which has reservations regarding the economic impact of Directive 2016/1164. The Irish have also been critical of the developing CCCTB system. Here it is argued that the EU Directive is contrary to the recommendations that are emerging via the OECD (IFC, 2017). Irish political representatives argue that the proposed EU framework creates a “formulary apportionment” to the issue of corporate taxation whilst the preferred OECD model in which taxes are paid within those jurisdiction in which they are earned (IFC, 2017). Arguably, for the Irish, and by extension the Maltese, would prefer the OECD option since this proposal allows for the perpetuation of BEPS within the global financial system. It is for this reason that during its tenure of the EU Presidency, Maltese politicians developed a number of counter roadmap systems.
This recent alteration in the approaches that are employed by Maltese politicians, for Grech (2016), has been borne out of a fear that a lack of engagement with EU Directive architects will lead to the country’s full tax system being targeted as part of a process for alleviating a number of pressures within states, at the global level, to curb aggressive corporate tax policies that sees them using letterbox loopholes in order to avoid liabilities in third party jurisdictions (Grech, 2015). This outcome, for Grech (2015), has forced the Maltese political establishment to develop a number of proposals that are intended to tackle the frameworks proposed within the Directive 2016/1164. Essentially, Grech (2015) argues, what emerges as a result sees an attempt to avoid a complete dismantling of the Maltese tax system and instead focus upon addressing a number of structural issues that lead to loop holes that can be used for aggressive tax avoidance and mitigation. Indeed, Maltese fears over its ability to retain the domestic status quo arguably were raised when, recently, the EU drafted legislation intended for blocking a number of off shore trusts jurisdictions (Garside, 2017). Garside (2017) reports that seventeen states from around the world have been blacklisted by the EU. In addition, there are another forty-seven states and jurisdictions that make up a grey list. These include, but are not limited so the Cayman Islands, Guernsey, Jersey, and the Isle of Man (Garside, 2017).
What emerges from this particular episode is that whilst the EU has its sights firmly set upon the area of tax avoidance; its core approach sees tax competition as a weakness within that system, of which the EU is able to exploit politically. It is here, arguably, where one of the weakness within the Maltese system can be found an of which, allows for Malta to be subject to direct intervention in the future should Directive 2016/1164 not have the desired impact. At this juncture it is to be remembered that the ATAD has been mandated by the EU as a way of reforming and developing an EU led tax policy and includes policy recommendations in respect of a number of tax systems which Malta directly benefits from, including CFC’s, exit taxation, and interest limitation, in line with an overarching GAAR.
The adoption of the ATAD is not limited to tax that is denied to the movement of monies and incomes to areas and jurisdictions that lie outside of the EU space. This reality possesses an impact when, for example, assessing the impact of exit taxation or with regards to impacting or avoiding double taxation. It is also recognised that EU member states will be provided with a set of responsibilities that allow then to continue with these same regulations until parity is achieved via the OECD intention of developing international parity in respect of a minimum standard of interest limitation rules. Indeed, was the reader to be in any doubt as to the implications of EU policy towards Malta, one should look no further than the aspirations of the chief architect of the Directive, Mario Monti. It is to be remembered that Monti (2010) had initially argued for reform based upon the reality that the EU space possessed a tax competition base which aided the reality of tax avoidance, with states such as Malta being a prime agent for realising that same process. In essence, one can assess that Malta is right to possess reservations regarding its current tax policy base given the possibility that it may come under attack by the EU. Indeed, with there being a common consensus that Malta offers an attractive tax adverse investment environment for undertaking investments. This system, it is to be noted, sees the employment of a two-staged taxation process that helps Maltese residents benefitting from two different income tax thresholds, as well as numerous tax exemptions for companies in respect of dividends (No More Tax, 2016). Arguably, however, the core issue is the tax competition issue given that Malta is identified as the lowest OECD compliant tax system and offered the lowest rates within the EU space (CCPS, 2016).
EY (2016) notes that the ATAD is mandated via an aim that seeks the provision of a common framework which in layman terms allows for the OECD’s BEPS tax framework to be implemented across the EU space. Consequentially it is arguable that eh EU is merely responding to changing global conditions as opposed to being proactive in altering the tax structure across the EU space. What results, therefore, is a set of policies that are intended not simply as an aggressive attack upon Malta via the EU but, in reality, the EU responding to these changing global conditions in order to remain competitive across the globe. In some ways one could argue that the EU is attempting to protect and future proof its members against external alterations in operational taxation conditions whilst also seeking to provide a level playing field for the EU’s internal market as a whole (EY, 2016). To achieve this outcome, EY (2016) considers that the core element of the EU’s strategy lies within the proposal contained within its CCCTB. This approach largely differs from the OECD BEPS requirements and requires all member states, including Malta, to agree prior to the Directive being enacted as European law. Because of this issue, EY (2016) believes not only will the ATAD may be radically different to the current proposals but it is unlikely that it will be ratified in line with the ascribed timelines. Yet, whilst Malta has been subject to international and regional criticism in respect of its continuing to provide external companies with a set of competitive tax rates, this policy platform has been perpetuated without there being an increased level of either openness or uniformity of core tax rates (Grech, 2016). Yet, this issue does not appear to be one that the Maltese political leadership thinks will undermine the levels of competitiveness that exists within the domestic tax system but, instead, could allow for an erosion of the ability of those companies and individuals that utilise Malta in order to curb the levels of tax evasion or abuse that takes place as a result of the lack of accountability of transparency (Grech, 2016).
SGI (2017) undertook an assessment of the Maltese economic and fiscal system and assessed that an enduring issue lies with the continued perception of corruption with its financial services. It was also assessed that the country is experiencing continued dependence on its financial services sector. This issue is indicative of structural dependency upon financial services and sees issues, such as letterbox companies, being a dominant issue which, once addressed via the EU Directive 2016/1164 will alter the shape of Malta’s economic system. Indeed, it is also feasible that this same issue could have a detrimental impact upon state incomes in a manner that leaves Malta experiencing a downturn in its economic fortunes (SGI, 2017). Yet, SGI (2017) also argue that the measures that are possessed within Directive 2016/1164 are based upon the intent of not needing Malta to dismantle its taxation system= but, instead, to close the various loop holes that have helped to create the perception of tax abuse and corruption. It is here where letter box companies flout the tax system but, based upon current recommendations via the ATAD will see these same companies being trapped via regulations that stop them from moving their registered addresses to other jurisdictions, such as those recently blacklisted, which continue to offer preferential tax rates (SGI, 2017). One such company that would be adversely affected is the energy company NPower, which is registered in Malta and has avoided a large UK tax bill through posting an operational loss whilst also shifting its money to Malta (Independent, 2013). In such cases, the ATAD criteria now places the onus upon the Maltese system to ascertain whether companies, such as NPower, are using that jurisdiction in order to benefit from lower tax rates.
SGI (2017) also argue project that Maltese economy needs to be structurally reformed in order to experience increased diversification. Yet, this issue resides alongside further concerns that the Maltese tax system is being proactively targeted as a way of addressing abuses such as the aforementioned NPower case. It is for this reason, Grech (2017) argues, that EU member states have been determined that member states retain control over tax rates, levels, and taxable areas, whilst also seeking to combat proactive or aggressive tax avoidance practices. Were this approach to be realised it is feasible that Malta will avoid a possible adverse economic outcome because, essentially, it will retain control over the type and shape of tax regime that suits its economic structure. Indeed, it is also arguable that the Maltese jurisdiction could benefit from the reality of gaining the taxable incomes from a number of global companies that subsequently, would be locked into the local tax regime and be unable to ship their declared incomes elsewhere in order to continue to benefit from preferential tax regimes.
The trends that emerge from the evolution of the EU’s ATAD agreement, in respect of its building a system of building a holistic tax system for the entire EU space can be considered as a complete reversal of Nozick’s earlier (1974) hypothesis in which the viability and illegitimacy of redistributive taxation systems were framed as being one that was borne out of excess. This excess, it is suggested, now creates a new vehicle for advancing the funding of state activity. Given this perspective, it is evident that Nozick (1974) had also argued that this same process was indicative of excessive tax system and, therefore, is similar to the practices of states that employ forced labour (Nozick, 1974). As such, the inclusion of alternate academic theories to this narrative imply that the underpinning process of tax harmonisation can be used as a way of creating a system that allows the adjustment of an array of national and regional tax systems, in line with what is perceived as being of a utilitarian nature and, therefore, in the common good (Kopitz, 1992). What results, Kopitz (1992) suggests, sees states now possessing a genuine fiscal infrastructure that possesses an increased ability of states, such as Malta, to deliver upon a number of social and infrastructural projects knowing that the delivery of supporting finances are largely secure. Indeed, it is also of note that Mitchell’s (2004: 1) perception of such systems are based upon the constraining of companies and institutions via the creation of a process that actively promotes tax harmonization schemes, such as Directive 2016/1164 as a process for inhibiting “the flow of jobs and capital to market-oriented economies”.
Where Mitchell’s (2004) perspective does hold leverage lies in the inability of registered companies, such as NPower, to avoid hefty tax liabilities by shifting their incomes and liabilities to third party jurisdictions. This is the slavery which Nozick (1974) first railed over. Yet, SGI (2017) notes that with Malta having a proactive economic planning structure, it is also arguable that the Maltese state possesses a strong governmental system. This same process sees the internal state working offer a number of strong ties that improve communication and inter departmental working between numerous public institutions, those that undertake the practice of local economic planning, and those third sector social partners that are found within bodies, such as the Malta Council for Economic and Social Development. It is this proactive relationship, SGI (2017) argues, that allows Malta to possess a strong economy. This translates into an unrivalled set of GDP results, such as an expansion of 4.7% in 2015 which resulted in overall growth increases of 3% in real terms (SGI, 2017). Added to this, SGI (2017) also records that the Maltese labour market is resilient since it continues to benefit from one of the lowest unemployment rates across the entire EU space. In reality, one can assess that the forewarning of Directive 2016/1164 upon the Maltese economy and tax system has provided the state and its various institutions the ability to reform and strengthen its practices and policies in order that it can cater for the new tax frameworks that will arise out of ATAD based reforms.
Chapter Five: The impact on Maltese legislation
The Interest Deductibility Rule as against Notional Interest Deduction Clause in Maltese Legislation
As per Directive, the interest deductibility rule must be implemented by 1st January ’19. A derogation is offered only to those member states whose rules are in line or effective at targeting BEPS; such delay can take up to 2024. In the case Malta, it has to ensure that the interest deductibility rule be introduced fully and in line with ATAD Art 4.
In presenting the Malta Budget 2017, the Minister for Finance announced the introduction of the Notional Interest Deduction (NID) – a fresh concept in Malta, which aims to simplify the Maltese tax system and approximate the tax treatment of equity with that of debt.
The legal notice outlining the rules was published on 5 October 2017 as legal notice 262 of 2017.
Key features of the NID
- Election for the NID is at the discretion of a company or partnership.
- The NID is calculated by multiplying the deemed notional interest rate by the balance of risk capital that the undertaking has at year end.
- The notional interest rate is the risk-free rate set on Malta Government Stocks with a remaining term of approximately 20 years plus a premium of 5%.
- The risk capital of the undertaking includes mainly share capital, share premium, reserves and interest free loans as at year end.
- The NID may also be claimed by a Maltese permanent establishment of a non-Maltese resident undertaking. In that case, the risk capital is taken to be the capital attributable to the permanent establishment.
- The NID may be claimed as a deduction by the undertaking against its chargeable income for the year.
- The maximum deduction in any given year cannot exceed 90% of chargeable income. Any excess can then be carried forward to the following year. Any remaining chargeable income is subject to tax at the standard rates.
- Uniformity of the classification of the nature of the deduction at the level of the person providing the equity finance.
- Certain anti-avoidance rules apply to prevent abuses of the NID.
This is partially available but needs to be looked further into and transposed in the legislation.
The aim of the interest deduction condition under ATAD is to incentivise for the allocation of interest costs in accordance with companies’ individual contribution to intra-group value creation and to lower the potential tax planning arrangements of multi-national companies.
In Malta, the issue of introducing the NID was from a tax perspective, to bring in line on a level playing field those companies that provide equity and investments without applying the interest charge as opposed to those that go for debt financing; many entities find that debt financing is more efficient to raise finance for business investment and operations as opposed to equity. This is because finance costs incurred by companies upon the granting of loans may be allowable as a deduction against chargeable income.
In this respect, the introduction of the NID aims to bring on par the tax treatment of equity financing with that of debt financing by providing entities with a deduction of interest they are deemed to have incurred on the said equity.
What is being proposed in ATAD limits the interest tax deduction to one-third to what the Maltese legislation has introduced recently. One also needs to understand, for example, costs for financial leasing, fictitious interest with respect to derivatives or hedging agreements, guarantee fees for finance agreements, whether these will also be subject to the ‘limited’ interest deductibility. One needs to look into whether Maltese corporations tend to have high debt ratios in comparison to corporations in other Member States.
For the purposes of implementation, the Maltese current existing provision with respect to a higher amount of interest deductibility of interest payments will create a complete shift towards Art 4 of ATAD. Malta needs to take legislative action so as to comply. Whilst what is being proposed in Art 4 of ATAD where deductible borrowing costs in the financial year suffered shall be the higher of 30% before EBITDA or €3m, thus eliminating the possibility that multi-national companies inflate the group companies’ borrowing costs, the Notional Interest Deduction as introduced this year by the Maltese legislator stipulates that in any year the notional interest deduction claimed will be limited to 90% of the chargeable income, which is threefold higher than what ATAD is proposing. The remaining unclaimed portion, under the Maltese legislation, can still be carried forward indefinitely to be deducted against chargeable income.
For Maltese tax purposes, where the NID is claimed, the company’s shareholder will be deemed to have received the notional interest income in the same amount to that being deductible as a notional interest borrowing cost. If the shareholder is a non-resident person, the deemed interest will be exempt for Malta tax purposes subject to certain requirements.
Any dividends distributed out of profits relieved from tax where an NID claim is made, will not be chargeable to further tax in the hands of the shareholder; however, in order to avoid abuse, the Maltese law lists down specific ant-avoidance rules. This goes to show that, with regards to ATAD’s proposal under Art 4 – rules limiting interest claims – the scope is to avoid abuses in charging excessive interest, the same goes with the Maltese ITA where certain abuses are entirely defeated.
Certain provisions as contained in ATAD are less fair than what is proposed in the Maltese ITA under the Notional Interest Deduction. For fairness sake, the ITA stipulates what is the deemed notional interest rate. This is explained as being the risk-free interest as set on Malta Government Stocks that have a remaining term of approximately 20 years plus a premium of 5%. According to the latest update of 29th March 2018 of the Central Bank of Malta – Market Operations – Indicative Rates based on Malta Government Benchmark Stocks, the yield to maturity for Q1/2018 for a 20-year term is 1.96%. Topped with the premium as stipulated in the Income Tax Act, the notional interest to be charged on share capital, share premiums, reserves and any other interest-free loans can be, upon the decision taken by the company’s shareholders, applied with a 6.96% interest charge and this can be claimed as a deduction for tax purposes up to a maximum of 90% of the annual chargeable income.
Perhaps an illustration will help:
|Malta ITA – allowed NIR||ATAD – max. allowed interest deduction||Capitalisation|
( Base Debt Amount )
Whilst under the Maltese ITA all the €3m will be deducted from the chargeable income, and for the sake of keeping it simple we are basing our chargeable income to EBITDA, under ATAD rules only a portion can be allowed as deductible as borrowing costs. This leaves an unfair scenario to any corporate body with good intentions where its aim is to prosper in business but is not ready to be penalised for any abuses that might be entertained by other rogue companies.
In principle, any form of capital that is interest free, like share capital, share premiums and capital reserves, has a cost attached to it and the notional cost approach by the Maltese legislators makes more sense since the prevailing interest yields are applied together with a premium to arrive to a more fairer approach.
Under the current Maltese tax laws, interest is allowed as a deduction on any borrowed funds if it is paid on ‘capital employed in acquiring income’, however, the law would allow this interest to be deductible only against the income so derived in the same year from the employment of that capital.
As can be noted, it looks that the EU wants to incentivise those entities to allocate interest costs in accordance with their contribution towards intra-group value creation, but at the same time the EU wants to mitigate any tax-planning of multinationals.
The interest limitation rule is expected to be more significant on some sectors operating in Malta, like the asset leasing sector. Companies in this sector of business, example aircraft leasing, are expected to take full consideration of the provisions adopted under this rule. Having said this, we must point out also the de-minimus exemption and equity carve-outs which are likely to be important in this respect.
This rule will be transposed into Maltese law by next January 2019 and I cannot see any derogation to be applied in this case, as per Art 11(6), where the implementation can be postponed till 2024 if Malta, in its existing laws, prevents base-erosion and profit shifting.
The General Anti-Abuse Rule ( GAAR)
Art 6 of ATAD is the shortest Article found in the Directive, yet it sweeps all and wide any deemed abuses contemplated by corporate bodies in their tax arrangements. The Directive deems to ignore any arrangement or a series a of arrangements by corporate bodies that are intended for acquiring fiscal benefits that go against the objective of the tax rules. The Directive lays down that an arrangement or series of arrangements are not considered as genuine in so far as they are not established for valid commercial purposes in an economic reality. The designation of such Article is to tackle what the EU Council considers as abusive tax-practices that are not addressed through other specific anti-avoidance rules. It rests with the Maltese authorities to see and ignore any non-valid commercial purpose of economic-activity.
In the Maltese Income Tax Act Chap 123, the general anti-abuse provision has been entrenched under Art 51 of the Act as recent as 2015. It clearly lays down the provisions that the Commissioner of Tax has to take, i.e., ignoring such instances that he deems that the corporate body has planned such schemes with the sole aim of, directly or indirectly, avoiding or reducing tax obligations. It needs to be commented here, on a personal level, that whilst on the one hand we see a growing globalisation as an ever-impressive collection of opportunities for tax planning, on the other hand, several anti-avoidance tax measures have been the target of ECJ’s decisions. This means that whilst it is imperative to leave the operations on a global scenario a freedom of activity, yet the ECJ, through its decisions, rightly or wrongly, have put such freedom in jeopardy. In such a scenario, perhaps one has to come up with a clear definition of what ‘avoidance’ would mean therefore providing a more reliable guidelines of explaining the arrangements that fit into this scope.
The Maltese legislator, like several other EU Member States, did recognise the importance to tackle tax avoidance; mainly this was to eliminate any distortion between law-abiding citizens that pay their taxes regularly and timely and who may have a less possibility to avoid taxes and multi-national corporations that employ specialised personnel to carry out aggressive tax planning. Such distortion promotes inequality and Malta, I believe like anywhere else, has a constitutional requirement to protect equality principles.
As already pointed out above, tax-avoidance measures as proposed in ATAD and the entrenching Art 51 of the Maltese ITA are majorly common in their intentions, yet there may be a different application by the ECJ since, unless the terms are given specific meanings, these may be interpreted on the basis of form rather than on the basis of an economic valid reason. This therefore means that there could be ‘conflicts of interpretation’ since a taxpayer may have succeeded, unknowingly, in total or partially, to avoid tax or perhaps obtains a tax credit or a benefit through such planning in which the ECJ would differ in its delivery of interpretation.
In my opinion, Article 6 of ATAD has already been successfully transposed into the Maltese Tax legislation and not much else needs to be done here as Malta appears to be already compliant with ATAD requirements.
The Controlled Foreign Company Rule ( CFC )
The CFC Rule is contemplated under Art 7 of ATAD and basically its scope is to put an end to the aggressive tax planning of shifting income to low-tax jurisdictions where the transferring company does not have what the EU considers to be a genuine economic activity and such income that was subjected at lower tax-rates is eventually transferred to its parent company. Again, such a rule is non-existent in the Maltese Income Tax Act and therefore has to be amended to reflect the CFC rule as required by ATAD.
Art 7 of ATAD, paragraph 1, lays down the criteria of what constitutes a controlled foreign company:
- Where an entity or together with its associated companies holds, directly or indirectly, more than 50% of the voting rights, or capital or profit-entitlement;
- The actual corporate tax paid on the entity’s profits or a permanent establishment is less than the difference between the tax that would have had to be charged on the entity, or the PE under the domestic rules of the member state where the taxpayer resides, and the actual tax paid on its profits by the entity, or PE.
Whilst point (i) above is quite clear to understand, point (ii) is better explained by a simple illustration. When the foreign tax paid is lower than the difference between the tax rates of the state of the parent company and the state of the subsidiary company, then it is considered as a controlled foreign company. That is: State A – Tax Rate at 40%; State B – Tax Rate at 10%. The difference between the two tax rates applied is 30%. Since the tax rate in State B (10%) is lower than the difference (30%), the criterion is therefore fulfilled.
This practically means that certain types of foreign income that is ‘passive,’ will be taxed in the state of the parent company if the subsidiary, or the permanent establishment, is not subject to tax or exempt from tax in the state it resides. It is evident that this rule seeks to tax ‘passive’ income of low-tax foreign jurisdictions on a current year basis rather than when such income is remitted as is currently the case. The impact on multi-nationals will depend on the nature of activity it is involved in, the distributions made, the income earned and above all the effective tax-rate. Underlining the word ‘effective’ is intentional since in Malta whilst the corporate tax rate is 35%, yet this can be effectively 5% or even, under certain circumstances, 0%.
Paragraph 2 of Art 7, ATAD, on the other hand, provides exclusion clauses where member states are not expected to apply paragraph 1 as stated above if the entity that is being controlled carries out a meaningful , or as the law terms as ‘substantive’ economic activity and that such activity is supported by staff, the entity owns equipment and other fixed assets that enable it to run the activity it is intended to do and such activity is carried out from established premises. These have to be evidenced by facts and circumstances. ATAD further lays down whether such arrangements are genuine or not even though there appears prima facie a substantive economic activity. If it is established that certain arrangements that have been put in place are not genuine and were only established with the scope in mind of obtaining tax-advantage, the substantive requirement will no longer hinder the attribution of income of the CFC to its parent.
In my view, this is one of the major challenges to be faced by the local tax legislator. Whilst Art 51 of the Income Tax Act, as already explained above, provides a basis of ignoring instances that deems that the corporate body has planned a scheme similar to the CFC rule, yet the CFC rule as applied by ATAD is more direct, specific and precise in terms of qualifying a foreign company as a CFC and leaves no leeway whatsoever. This is, in my opinion, one of the reasons why the ITA Chapter 123 has to contemplate further on this rule and apply in a similar way.
The Exit Tax Rule
Article 5 of ATAD proposes four scenarios where exit tax on cross-border transactions have to be applied:
- When a parent company transfers assets to a subsidiary company with a permanent establishment in another member state or in a third state where the state of origin of the asset does not have the right to impose tax on such asset being transferred; or
- Inversely to (i) above, when an entity or a permanent establishment, transfers assets to its parent company; or
- The taxpayer transfers its tax residence to another state; or
- A taxpayer transfers the business carried on by a permanent establishment to another state.
Art 5 under paragraph 2 of ATAD provides the possibility to pay over a 5-year instalment-period if tax results from the uncovering of hidden reserves.
Paragraph 2 of Art 5 defines several circumstances in which the deferral will be “immediately discontinued”, including the transfer of the transferred assets, the taxpayer’s tax residence or the business carried out by its permanent established entity to a third country. The “receiving” Member States must accept the value of the assets established by the “exit” state for tax purposes unless this value does not reflect “market value” (that is “the amount for which an asset can be exchanged or mutual obligations can be settled between willing unrelated buyers and sellers in a direct transaction”).
Paragraph 6 of Art 5 defines what constitutes a taxable gain: as “the market value of the transferred assets, at the time of exit of the assets, less their value for tax purposes”.
The scope of this rule is to uncover any hidden reserves that are usually transferred from parent to subsidiary or inversely which could escape the tax-net in the member state. The exit tax rule provides a common framework for taxing capital gains generated in the territory of the Member State of origin at the time of the exit. The exit charge will be levied on certain cross-border transfers of assets, tax residence or business carried out by the permanent establishment within the EU or in the third-country context. In the Maltese Income Tax Act Chapter 123, such transfer of assets, be it movable or immovable, between a parent company in one member state, to its subsidiary in another country, as per Art 5 (9)(i) (b) shall be deemed that no loss or gain is registered by such transfer.
This goes to show that, in this regard, Malta does not provide for any such scenarios and is therefore obliged to introduce amendments to the ITA and charge exit tax in all the situations as described above and as contemplated by ATAD.
In my opinion, although it is the shortest, Article 9 as provided in ATAD is yet one of the most important provisions. Hybrid mismatches deal with qualification issues; if, say, a certain instrument is treated as ‘equity’ in MS A and as a debt in MS B. This qualification would lead to a cost-deduction for tax purposes in MS B ( like, a qualified interest payment ) but a tax exemption in MS A ( ex. a dividend ). Art 9 of ATAD is intended to address such situations and this is explicitly laid down as following:
- hybrid mismatches resulting in double deduction, the deduction should only be allowed in the source state of the payment; let us call this the ‘double deductibility’ scenario.
- hybrid mismatches resulting in a deduction without inclusion, the source member state has to refute the deduction of such payment; we call this the ‘non-inclusion’ scenario.
What is meant by ‘inclusion’ in point (2) above? This is precisely the example given immediately above, meaning that only the payment at the source member state should lead to a deduction.
It is not yet clear as to how the ant-hybrid rule will be transposed into Maltese Tax laws and this immediately brings to our attention the participation exemption condition, which in the ITA Chapter 123, was revised in 2016 to bring in line with the requirements of the EU Parent-Subsidiary Directive. The Maltese tax regime was improved by making fine adjustments to the participation exemption conditions just to bring them in line with the requirements of the EU Directive. The participation exemption aims to avoid taxing twice on the same income whilst the hybrid mismatches avoids in a payment to be deducted twice in two separate jurisdictions.
Under the participation exemption, if a distributing company incorporated in the EU derives no more than 50% of its income from passive income, like royalties or interest, then the participation exemption regime kicks in. Therefore, subject to certain conditions being met, income to a Holding Company can be exempted from tax if the Holding Company qualifies as a ‘participating holding’. This would lead to that ‘passive income’ which would be exempted from tax in the hands of the participating holding company and will also be allowed as a deductible expense in the hands of the source payment country.
Based on such scenarios, in my view there is a need for the Maltese Tax Legislator to address the deduction and exemption mismatches as contemplated in Art 9 of ATAD. Income that is deductible in a foreign country cannot be subject to the Maltese ‘participation exemption’.
Conclusions of Chapter Five
Speaking at a meeting of the EU – ECOFIN Council – in Luxembourg on 17th June 2016, the Maltese Minister of Finance Edward Scicluna stated that Malta can accept the ATAD and promised to amend the local tax laws. Malta tax-avoidance legislation will therefore be amended accordingly.
Malta does not have an effective CFC rule, hybrid mismatch and exit tax rules and these, somehow, have to be transposed in the tax law. The intention is that any profits placed in the low-taxed jurisdictions are effectively taxed. Note again the term ‘effective’ as this will surely be the bone of contention with the EU Council in the future on the basis of tax harmonisation.
Such measures as required under ATAD will have the effect of removing some of the tax advantages that presently have helped in attracting foreign direct investment. Still, I believe, Malta has a lot to offer apart from its tax code to attract FDI, although, must admit, tax implications are topmost of the list that any potential investment would find its way to the island.
Whilst the call to ATAD was to combat abuse, especially by those multi-national companies that transfer profits in huge amounts to low-tax jurisdictions or by claiming double tax-deductions – one through income in the hands of the entity that is treated as exempt and the other the same payment income made by the source company is accepted as a deductible expense for tax purposes – EU economies were going through a phase of fiscal imbalances that resulted in unfair tax competition and distort cross-border trade.
The EU is forcefully proposing, for example, to tax dividends coming into the EU if they have not already been properly taxed. The word ‘properly’ taxed has wide connotations. Who will determine what is ‘proper’ or not? What constitutes ‘proper’? If the activity of the base company is the only activity, therefore proper tax is used, why should the parent company pay further tax in its home country? This is where I fear the ECJ might apply interpretations on words as written down in the laws rather than on the substance of the economic- activity.
Maltese holding companies benefit from the application of all EU directives as well as Malta’s growing network of double-tax treaties, mainly based on the OECD model tax convention. However, Malta does not have net wealth tax rules or similar taxes on capital, no CFC rules and no transfer pricing rules. All this will be changing in the coming months as some of the rules have to be enforced from 1st January 2019 whilst some others much later.
As already explained in my introductory paragraph above, ATAD was triggered due to BEPS which, as I notice, the latter had one intention – that to influence the corporate tax harmonisation throughout EU member states – ATAD offers a more realistic approach that are not all new to the Maltese point of view. Notwithstanding such belief, the Maltese legislator still has quite a long way to go to modify the existing tax laws in order to implement in a proper way the Anti-Avoidance Tax Directive.
Malta has to re-visit the interest limitation rule, which according to ATAD, is more restrictive; also, on the CFC and the hybrid mismatch rules which come in force in 2019 and the exit tax rule by 2020. Only GAAR seems to require less attention since, as already noted, there are close similarities, hence limited amendments to the tax laws are required.
Findings & Conclusions
In summary, this paper sought to respond to four core aims and objectives. These comprised of a need to highlight and critique the components of Directive 2016/1164 and offer an assessment of the various response provided from EU member states, specifically Malta. This approach furthers a need to identify areas of weakness and conflict between the Maltese jurisdiction and the EC and via offering an assessment of the requirements of Maltese tax regimes in adopting the EC Directive. In approaching this paper in this manner, the core narrative sees the overarching process of realising an effective tax harmonisation also has an adverse impact upon the possibility of future commodity movements that are based within Malta. This process arguable is the fallout of a harmonisation process that actually improves state fiscal resource allocations. As such, the creation of a common tax policy will now see Malta losing some elements of its sovereign rights in respect of taxation because the Maltese state will be subject to the whim of a number of disparate international organisations being involved in the development of domestic financial policies. Consequentially, one could argue that this same process is not limited to the EU Directive, but also the OECD and the WTO. Yet, with recent decades seeing the common base tax regime being lowered whilst also expanded to cover more areas of economic practice, this policy agenda too has been developing over a number of decades and does not offer as a distinct departure for Maltese tax regimes. Instead, this same evolutionary process has not seen a decrease in tax revenues and, instead, states (including Malta) have experienced an increase in revenues.
One area of genuine concern lies in the possibility that the core end game for a common tax harmonisation policy is the creation of an EU wide public finance and budget policy. This possible eventuality is likely to have a greater impact upon all states, including Malta, and sees the incorporation of a number of EU wide Directives as common policy. Therefore, one needs to ask where the harmonisation red line for Malta lies. Indeed, it has not been forgotten that EU Directives, such as 2016/1164, needs the agreement of all member states. Without it this process will not occur. As such, in terms of red lines the Maltese position can be considered in simpler terms, namely that if the current Maltese political establishment does not agree to the Directives that emerge out of Brussels and Strasburg then it does not need to agree to them. This reality, therefore, places the future economic and fiscal requirements of the Maltese state in the hands of the domestic political cohort, and if it is assessed that harmonisation policies and Directives are likely to negatively impact Malta, then these political elites retain the power to either negotiate changes or simply refuse to ratify these same Directives. Yet, currently, there is little sign that Malta will undertake such a stance. As such, one could assess that the reality of the current crop of tax harmonisation policies are conducive to the fiscal requirements of the Maltese state.
In essence, from a critique the core components of Directive 2016/1164 in respect of Malta it is evident that the country is likely to experience little difference in its overall economic performance as a result of the harmonisation proposals. Where an impact will be found lies with at the corporate level and it is this agency which is the intended target. There will be an impact upon letterbox companies, however this same impact will increasingly be found across the globe as the OECD develops its anti-avoidance framework. On the whole, the Maltese economy will be best served via these same affected companies being locked in to the Maltese taxation jurisdiction and, as such, will allow for a wider tax base should the Maltese decide upon such a possibility. Essentially, therefore, in relation to Malta it is difficult to assess what possible weaknesses exist via its ratification of the Directive, aside from the possibility that the next stage would naturally include the creation of a common fiscal Directive that dictates jurisdictional budgets. It is at this stage where a real impact upon Malta will be found, particularly should a need arise for widespread public investment for addressing structural weaknesses. In addition, it is also feasible that a positive outcome will see the local finance system becoming more open and accountable and, as a consequence, it may address the current perception of corruption in that same system. Overall, therefore, the impact of the EU tax Directives upon Malta are mostly borne out of the unknown of external tax controls. The creation of a fiscal union is the core issue which Malta needs to consider because it is here where the true impact will be found.
Personal Commentary of the author
This paper was written with an arguably critical pen. It is to be clarified that this has been one of the key notions of the author in order to reflect the “non-Maltese” view, from a political, legal and academical point. As pressure mounts from outside Malta is was important for the author to look Malta’s critics in the eye and appreciate their concerns. The author, who is a resident of Malta and who works in the domestic financial services industry believes most of the pressure that is being mounted upon Malta results from a simple reasoning: In the current age of digitalisation, what Malta has to offer actually works. Not just from the perspective of multinational companies moving (for example) finance operations to Malta. The current and prospective global economy is changing. And small countries like Malta might have an actual edge over bigger countries. Admittedly, tax plays an important role in any entrepreneurial planning. But tax alone, no matter how low, these days, is hardly the only exclusive criteria. And the ATAD might eventually and in the long term, despite all challenges Malta faces through it, be of great benefit for Malta. It might after all result in the departure of “letter box” companies and the local settlement of “real” companies. Not intergroup lenders or “IP boxes”, but companies with a substantial, physical and active presence in Malta, that create real value in and from Malta. Admittedly that appears now to be forced upon the Maltese jurisdiction but in the age of digitalisation, of bitcoin, of online marketing, block chain and of highly mobile individuals and businesses the package that Malta can offer, will still have a competitive edge. The author is therefore of the opinion that the recent criticism (mainly ignited by the “Panama” and “Paradise” papers), that led to the widespread political and legislative changes which have been analysed in this paper will result in structural changes in Malta. The tax structural changes have been the topic of this paper. But there will be also changes to the business, transport, social, economic and political structure. And in the long-term Malta will benefit from all those changes. And that might be the biggest impact of the proposed EU Anti Avoidance Directive.
Recommendations for Further Research
- An investigation that focuses upon the likelihood for OCED and WTO agreements on base corporate and personal tax rates.
- An assessment of the impact upon expected incomes because of lock in corporate registration in specific jurisdictions, including Malta.
- The likelihood for the creation of a common fiscal policy which determines jurisdictional budgets?
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