|ATAD will change domestic laws in all members states, including Malta|
Following the European Council's adoption of the Anti-Tax Avoidance Directive (ATAD), EU member states are required to have certain anti-tax avoidance measures implemented into their domestic law and applying from January 1 2019 (with certain exceptions).
ATAD provides for the minimum harmonisation of rules in the areas of interest deductions, controlled foreign corporations (CFCs) and hybrid mismatches, and the introduction of a corporate general anti-abuse rule (GAAR). In addition, exit taxation rules must be introduced by member states.
Due to the fact that, according to Article 3 of ATAD, the Directive sets only a minimum level of protection, member states may introduce or retain rules that are stricter than the rules prescribed by ATAD, subject to compatibility with primary EU law, such as the fundamental freedoms.
The EU's ATAD is expected to have a significant impact on Maltese tax law since Malta, currently, does not have rules in all the areas covered by the Directive. For those areas already catered for in Maltese domestic law, these rules will need to be amended only to the extent that they do not meet the minimum level prescribed by ATAD.
Interest limitation rule
The interest limitation rule under Article 4 of ATAD limits exceeding borrowing costs to 30% of earnings before interest, taxes, depreciation and amortisation (EBITDA). However, a taxpayer may be given the right to deduct exceeding borrowing costs up to a threshold of €3 million ($3.6 million) or to fully deduct exceeding borrowing costs if the taxpayer is a standalone entity. The notion of 'exceeding borrowing costs' is defined as the excess of deductible borrowing costs of a taxpayer over taxable interest income and 'equivalents'.
Under this rule, member states also have the following four options:
- To carry forward or backwards exceeding borrowing costs;
- To exclude financial undertakings from the scope of this rule;
- To exclude loans used to fund long-term public infrastructure within the EU; and
- To allow taxpayers to deduct in full or in part exceeding borrowing costs subject to the satisfaction of group gearing ratio conditions.
The current Maltese income tax rules allow a tax deduction for interest on any borrowed money if it is paid on capital employed in acquiring income. The expense is allowable even though the borrowing would have been made for a capital purpose, but it is deductible only against the income derived in the same year from the employment of that capital.
This special rule is in addition to the deduction for interest paid on money due in relation to the company's trading activities, such as interest on trade debts or charged on normal business overdraft facilities – such interest should be deductible under the general rule of deductibility. To date, domestic case law on interest deductibility tends to be quite strict.
There is also a restriction in respect of interest deductibility where the relevant advance is in connection with the financing of Maltese immovable property and subject to certain other conditions.
If one had to look at Malta's current position, it may possibly be argued that the domestic law already caters for some limitations on interest deductions and ATAD may end up being more generous since it contemplates the deductibility of exceeding borrowing costs.
However, in October, the concept of a notional interest deduction was introduced. As a result, the deduction of interest could reach a maximum of 90% of the chargeable income of an entity. This concept would be first applicable to financial periods/years ending in 2017.
From January 1 2019, our expectation is that the interest deduction limitation under ATAD will only override the notional interest deduction rules in limited cases as a result of the number of options and derogations under Article 4 of ATAD.
Exit taxation rules
In this area, Malta is currently not compliant with the minimum level of protection required by Article 5 of ATAD since Malta does not levy an exit tax. As a result, it is expected that there will be changes in domestic law and that these will come into effect by January 1 2020.
Malta will have to charge an exit tax in all the situations described in Article 5(1) of ATAD, that is, on a transfer of assets or business between a head office and a permanent establishment (PE), or between PEs, or where a taxable entity transfers its tax residence.
It is still unclear as to whether and how an anti-hybrid rule will be transposed into Maltese law and Malta should have quite a broad discretion in implementing such a rule
Amendments in domestic law are expected to be introduced to cater for those situations where Malta would, as a result of any one of the situations mentioned above, lose its right to tax the assets or the taxable entity.
Even though an exit tax will be introduced, one would expect that the same exemptions and deferrals that are currently contemplated in the law when transfers are made from one entity to another, would also apply in the context of an exit tax, that is when the transfers would take place from Malta to a different member state or to a third country.
If one had to consider for instance a transfer of assets or business between entities in different countries that form part of the same group of companies, it is likely that Malta would introduce the possibility of deferral of the payment of the exit tax, similar to the deferral of tax on capital gains that currently applies to transfers between local group entities.
As regards to assets entering into the Maltese taxing net, Malta has rules in place that allow the entity to step up the value of the assets being transferred to Malta from another country to their current market value. There are no prescribed rules on how the market value will be determined and such rules apply to all transfers of assets from other countries, irrespective of whether an exit tax would have been charged in the other country. To ensure the avoidance of double taxation, ATAD requires member states to take into account the value of an asset that was subject to the exit taxation rules as the starting value for tax purposes, that is the asset will be deemed to be acquired at such a value for the purposes of calculating tax amortisation and subsequent capital gains. Thus, Malta might need to amend the current rules slightly to link the starting value for Maltese tax purposes to the value of the asset in the exit country.
Malta has a long-standing GAAR in its domestic tax law (Article 51 of the Maltese Income Tax Act).
The mandatory requirements of Article 6 of ATAD is that member states are obliged to ignore any arrangements that have been put into place for the main purpose of obtaining a tax advantage that defeats the objects of the applicable tax law and are not genuine.
This requirement fits in well with the provisions of Article 51(1) and 51(2) of the Maltese Income Tax Act which state as follows:
- "[W]here any scheme which reduces the amount of tax payable by any person is artificial or fictitious or is in fact not given effect to, the Commissioner shall disregard the scheme and the person concerned shall be assessable accordingly"; and
- "[W]here any person, as a direct or indirect result of any scheme of which the sole or main purpose was the obtaining of an advantage which has the effect of avoiding, reducing or postponing liability to tax, or of obtaining any refund or set-off of tax, has obtained or is in a position to obtain such an advantage, the Commissioner shall by, order in writing, determine the liability to tax the person, or of any other person, for any year of assessment, in such manner and in such amount as may be necessary, in the circumstances of the case, to nullify or modify the said scheme and the consequent advantage."
As a result, Malta appears to be already compliant with the mandatory requirements of ATAD in the area of GAAR.
Through these rules under Articles 7 and 8 of ATAD, member states can treat an entity or a PE as a controlled foreign company (CFC), and thus have the right to tax such profits as per domestic tax rules.
These rules apply where the following conditions are met:
- The taxpayer itself or together with their associated enterprises hold a direct or indirect participation of more than 50% of the voting rights, capital, or right to profit distribution; and
- The actual corporate tax paid on the profits of an entity or a PE is lower than the difference between the corporate tax that would have been charged on the entity or PE under the domestic rules of the member state of the taxpayer and the actual corporate tax paid on its profits by the entity or PE – for this purpose, a PE of the CFC, the profits of which are not taxed in the member state of the CFC are not taken into account.
Member states may apply certain carve outs, such as cases of substantive economic activity and certain de minimis cases.
In terms of ATAD, there can be the possibility of excluding the CFC's income under the following two scenarios:
- Member states should not include CFC income in the taxpayer's tax base where it can be established that the CFC carries on substantive economic activity and such activity is supported by staff, equipment, assets and premises as evidenced by relevant facts and circumstances; or
- Member states should not include CFC income in the taxpayer's tax base if such income arises from arrangements that have not been put in place for the essential purpose of obtaining a tax advantage – in this case, the genuine nature of an arrangement is to be determined by considering the significant people functions relevant for the income generating activities and the risks undertaken by the CFC.
Indeed, it is a question of substance, which has always been given a lot of importance in a local context. However, Maltese domestic law would have to be amended to adopt CFC legislation as required by ATAD.
Rules addressing hybrid mismatches have also been included as a minimum requirement under Article 9 of ATAD, whereby it is stated that a deduction shall be given only in the member state where such payment has its source.
It is still unclear as to whether and how an anti-hybrid rule will be transposed into Maltese law and Malta should have quite a broad discretion in implementing such a rule.
It is worth noting that, from January 1 2016, Malta tweaked its participation exemption conditions to bring them in line with the requirements of the EU Parent-Subsidiary Directive. As a result, if a parent company resident in Malta had to receive a dividend from a subsidiary resident in another member state, the participation exemption on that dividend would only apply to the extent that the distributed profits are not deductible by the relevant subsidiary in the other member state.
The measures described in ATAD will bring about significant changes to Maltese domestic law. It is unlikely that all the measures will be introduced into Maltese tax law at the same time – Malta will have to adopt the interest limitation rule, CFC rules and anti-hybrid rule by January 1 2019, and exit taxation by January 1 2020.
The wide GAAR in the Maltese Income Tax Act is very similar to the GAAR required by ATAD and, therefore, very limited amendments, if any, will be required in this regard.
Going forward, there will continue to be significant focus on 'substance', 'significant people functions', 'genuine arrangements' and 'valid commercial reasons' in companies established in Malta.
On an EU level, it is likely that the debate around the compatibility of exit taxes with the EU fundamental freedom of movement will continue.
Furthermore, on a local level, it will be interesting to understand how the notional interest deduction rules that were very recently announced will be affected by the introduction of an interest limitation rule in accordance with ATAD.
In conclusion, one will have to adopt a 'wait and see' approach to determine the impact of ATAD on Malta based on the transposition of the requirements of the Directive by Malta and by the other EU member states. Dispute resolution mechanisms between member states are likely to become more relevant after the implementation of ATAD by all member states.
Nicky Gouder, tax partner of ARQ Group, completed his Association of Chartered and Certified Accountants (ACCA) course in 2010. Following that, he specialised in taxation and completed a diploma in taxation offered by the Malta Institute of Taxation in 2011 and read for the advanced diploma in international taxation provided by the Malta Institute of Management. He also graduated in business management from the University of Malta in 2007.
He is one of the three founding partners of the Capstone Group, which was set up in 2010, specialising in accountancy, tax, audit and advisory.
Nicky specialises in international taxation with a focus on domestic legislation and has significant experience in handling a wide portfolio of local and international clients operating in various industry sectors. He also lectured the advanced taxation module for the Association of Chartered Certified Accountants course provided through the Malta Institute of Accountants and participates in a number of tax conferences both on a domestic and international level.
Luana Scicluna, tax manager at ARQ Group, specialises in international taxation and has considerable experience on corporate restructuring projects and succession planning. She assists several local and international clients with handling their tax affairs in Malta and provides advice on the tax implications of a wide range of transactions.
Prior to joining ARQ Group in April 2017, Luana worked within the tax service line of one of the Big 4 firms. Luana is an accountant by profession, concluding her Bachelor of Accountancy (Hons) at the University of Malta in 2009, following which she furthered her studies in taxation through a diploma in taxation offered by the Malta Institute of Taxation and an advanced diploma in international taxation offered by the Chartered Institute of Taxation (UK).