22 August 2011

Cross-Border Business Should Benefit From Malta's User Friendly Tax System and US-Malta Income Tax Treaty


Malta has emerged as an increasingly attractive jurisdiction for multinational enterprises to manage international business operations.

During the last decade, Malta has entered the European Union (“*EU*”) and revised its banking and tax regimes to attract multinational businesses and cross-border investment. Despite a 35% corporate tax rate, the effective tax on Malta companies and investors is lessened considerably by various mechanisms that eliminate double taxation of corporate earnings.

In this setting, Malta and the United States entered into a new income tax treaty effective on January 1, 2011 (the “New Treaty”), following a 13-year hiatus without a governing treaty. The New Treaty and Malta's investor friendly tax regime should continue to encourage investment and business activity between the US and Malta.

Overview of Malta Taxation System

Malta offers relief from double taxation of corporate earnings through several measures that include the EU directives on dividends, interest and royalty payments, Malta's extensive treaty network and Malta's holding and trading company incentives. Malta does not impose withholding taxes on dividends paid by Malta companies to non-residents by virtue of credits allowed for corporate level taxes via an imputation system. Malta also does not withhold on interest and royalties not effectively connected with a Malta permanent establishment.


Malta's holding company incentives center around its participation exemption applicable to 100% of dividends and capital gain income received from a 10% participating equity shareholding in a non-resident company or similar entity. The participation exemption and Malta's zero withholding tax rate benefit resident companies that hold investments located outside of Malta and distribute income to non-resident shareholders.


The participation exemption generally applies to equity acquired after January 1, 2007 where the non€‘resident entity satisfies one of four anti-abuse safe-harbors – (i) the non-Malta entity is resident or incorporated in the EU, (ii) the non-Malta entity is subject to a local tax of at least 15%, (iii) less than 50% of the entity's income is derived from passive interest or royalties, or (iv) if the holding is not a portfolio investment of the Malta company, passive interest or royalty income of the non-Malta entity is subject to foreign tax of at least 5%.


Malta's trading company incentives include three refund mechanisms that return corporate-level taxes paid upon distributions to shareholders. First, a refund of six-sevenths (85.7%) of corporate taxes paid applies upon distributions to shareholders by companies engaged in an active trade or business. Second, a refund of five-sevenths (71.4%) of corporate taxes paid applies upon distributions to shareholders by companies that generate predominately passive income (i.e., royalties). These refund mechanisms could apply where the Maltese company investment does not meet the participation exemption. Third, a Maltese company with a qualifying participation holding — in lieu of claiming the participation exemption — may pay corporate tax at 35% and upon distribution the shareholders are entitled to a refund thereof.

Lastly, effective 2011, Malta offers an incentive tax rate for highly paid executives domiciled outside Malta but who stay in Malta for a limited period of time while employed in the banking, financial, investment and insurance sectors. Such executives qualify for a flat 15% income tax rate on employment income if they earn at least €75,000 and 0% income tax on earnings of over €5,000,000.

Highlights Of The New Treaty

The prior US-Malta treaty was terminated in January 1997 based on US concerns that Malta's domestic legal system had insufficient transparency and regulatory oversight — reservations largely mitigated by Malta's admission to the EU in 2004 and changes to Malta's tax and information exchange regimes. The New Treaty became effective in 2011 after Malta had both implemented the EU directives relating to mutual administrative assistance and compliance with international transparency norms and revised its domestic laws to allow Maltese tax authorities to share bank information with foreign tax authorities.

The New Treaty overall contains higher withholding tax rates than other recent US tax treaties for source country taxation of interest and royalties, a provision for application of treaty provisions to fiscally transparent entities, a more rigorous limitation on benefits (LOB) provision than contained in the 2006 US Model Income Tax Treaty to reduce the potential for forum shopping by third country residents, and comprehensive information exchange provisions.

Withholding Rates

A comparison of local Maltese withholding tax rates to the maximum rates permitted under the New Treaty and US Model Treaty on income not attributable to a permanent establishment is set forth below:


Maltese Domestic Rates

New Treaty Rates

US Model Treaty Rates

I. Dividends





0% Malta withholding tax

Tax Refund System 71.4%, 85.7% or 100% of corporate taxes paid (depending on the nature of income and whether participation exemption applies)

Tax Refund System 71.4%, 85.7% or 100% of corporate taxes paid (depending on the nature of income and whether participation exemption applies)

Malta may not impose a withholding tax at a rate greater than the corporate tax on profits giving rise to dividend

15% rate


Same as above

5% rate if paid by a US co. to a Malta co. that owns 10% or more of the distributing company voting stock

Malta may not impose a withholding tax at a rate greater than the corporate tax on profits giving rise to dividend

5% rate if company owns 10% or more of the distributing company voting stock

II. Interest


10% rate, but this could be increased to 15% if the payment is to a Malta resident of US source contingent interest “of a type that does not qualify as portfolio interest”

Exempt from source-country tax where beneficially owned by a resident of the other country

III. Royalties


10% rate

Exempt from source-country tax where beneficially owned by a resident of the other country

IV. Other Income

Applicable rate



The New Treaty limits withholding tax to a 15% rate on dividends paid by US companies to a resident of Malta and to a 5% rate on dividends paid to a Maltese company that owns 10% or more of the voting stock of the US dividend paying company. (There is no 0% rate as under other recent US tax treaties and protocols.) Further, a special rule applies with regard to Maltese company dividends that prevents imposition of withholding tax at a rate greater than the underlying corporate tax on such profits. This insures that Malta cannot impose a withholding tax greater than the imputational credit allowed at the shareholder level. In addition, there is a 5% rate for US branch profits tax purposes, consistent with the New Treaty 5% intercompany dividend withholding tax rate (see above),


The New Treaty permits a 10% withholding tax on interest, royalties and “other income” not attributable to a permanent establishment in contrast to several recent US treaties and the US Model Treaty that exempt these income categories from withholding tax. The Senate Committee on Foreign Relations Report dated June 30, 2010 notes that higher withholding rates for these three income categories were included in light of “Malta's unique tax system.”


Both the interest and royalty provisions permit recharacterization of payments between parties that bear a special relationship where the amount is not arms' length (i.e., the amount that would be payable absent the special relationship), following the US Model Treaty. In such case, the applicable withholding provisions apply to the portion deemed an arm's length amount and each treaty country may tax the excess amount according to the characterization resulting under its own tax laws.


Fiscally Transparent Entities


Income derived through an entity that is fiscally transparent is considered to be income of a treaty country resident only to the extent that the income is treated for purposes of that country's tax laws as the income of a resident. In other words, eligibility for a reduced withholding tax with respect to income derived through an entity considered fiscally transparent by a treaty country depends on whether such income is considered derived (through such entity) by a resident under such country's tax law.


Compensation For Services


Income earned as compensation for services performed by residents of the other treaty country are generally taxed as follows: (i) an exemption from source country taxation applies to services performed as an employee who was not in the source country for more than 183 days generally in any 12-month period (irrespective of the earnings amount) provided the compensation is not borne either by an employer resident in the source state or by a permanent establishment therein; (ii) directors of companies are fully taxable notwithstanding the exemption under paragraph (i); and (iii) entertainers and sportsmen generally are taxable unless gross receipts earned do not exceed $20,000 for the year of payment (irrespective of the number of days present during the year).


Limitations on Benefits

 The LOB Article effectively determines whether an entity has a sufficient nexus to a Contracting State to be treated as a resident for treaty purposes. The LOB provisions are designed to prevent third-country residents from forum shopping and generally reflect the provisions in the US Model Treaty and recent treaties, but are more stringent in a number of respects.

There are several alternative ways a company or other entity may qualify for benefits under the New Treaty including under the publicly traded company, private company, derivative benefit, active conduct of trade or business, and triangular branch tests

The public trading test is met provided (i) the company's principal (and any disproportionate) class of shares is listed and regularly traded on a recognized exchange in the company's country of residence (and, as to the company's principal class of shares, primarily traded there); and (ii) less than 25% of the company's gross income is paid or accrued to persons who are not resident in either the US or Malta (referred to as the “base erosion” test). (By comparison, other US treaty public trading LOB tests do not impose a base erosion requirement.) An alternative public trading test is met where generally at least 75% of each class of shares in the company is owned directly or indirectly by companies that meet the above public trading test and the company also meets the above base erosion test.

Non-public entities may qualify for benefits under the New Treaty based on a two-prong test consisting of an ownership and a base erosion test. The ownership prong requires that qualifying residents of either treaty country during at least half the taxable year own at least 75% of the entity's stock, without limit on the number of qualifying shareholders for this purpose. The applicable 25% base erosion test is the same as under the public trading test above. (In contrast, other US treaties apply a 50% threshold for both the ownership and base erosion requirements of the LOB test applicable to non-public entities.)


The LOB provision also contains a “derivative benefits” test that generally allows treaty benefits to a resident company if its owners would have been entitled to the same benefits had the income item flowed directly to them. To qualify, the company must have 7 or fewer owners meeting a 95% ownership test and also satisfy the 25% base erosion test. This would generally apply to a company that is owned by residents of members of the EU (including members of the EEA: Iceland, Liechtenstein and Norway), and parties to NAFTA, or Australia.


An alternative means of satisfying the LOB provision is through the active trade or business test. Investment and investment management activity generally are not eligible activities unless generally carried on by a bank or insurance company. The activity test is applied by including business activity of affiliates (generally, connected by 50% ownership). An unusual aspect of active trade or business test is that it contains a base erosion limitation (at the above 25% threshold) as contrasted with the US Model and other treaties.


The LOB provision also addresses triangular arrangements (also known as a “triangular branch rule”) where income is attributable to a permanent establishment in a contracting state other than the US or Malta of an enterprise that is a resident of one contracting state, potentially eliminating treaty benefits if the effect is to materially lower the effective tax rate. More specifically, if the combined tax paid in the enterprise's state of residence and in the state where the permanent establishment is present is less than 60% of the tax that would have been payable in the resident state if the income was not attributable to a permanent establishment in that third state, treaty benefits are denied. Similar provisions are found in other recent US tax treaties and protocols.


Exchange of Information and Administrative Assistance


The New Treaty exchange of information provisions closely track the US Model treaty provisions and require a comprehensive exchange of information between the US and Maltese authorities.

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The overview description of the Maltese tax system is not intended to be legal advice and the reader should consult Maltese legal counsel.

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