A. CHARGE TO TAX
Chargeability of corporate profits to Maltese income tax is determined on the basis of the general principles relating to the link between (i) taxpayer status and (ii) situs of the income, as discussed under "Charge to Tax" in our article "An Overview of the Income Tax System (1) - General Principles".
Referring to the notion of taxpayer status in this context:
(i) A company which is incorporated in Malta is, in practice, considered to be domiciled in Malta.
(ii) The Act does not define the term 'ordinarily resident'. It does however define 'residence' with reference to companies - a company is in fact considered to be resident in Malta if (1) it is incorporated in Malta, or (2) where the company has been incorporated outside Malta, if the control and management of its business is exercised in Malta.
The following table illustrates the relationship between a company's tax status and the charge to Malta tax:
COMPANY STATUS LIABILITY
1 Domiciled and ordinarily resident World-wide basis.
(Re. domicile - since Maltese
domicile is acquired when a company
is incorporated in Malta, this
category can only include
Maltese-incorporated companies).
2 Lacking either ordinary Income arising in Malta, plus
residence or domicile remittances of foreign income.
Capital gains arising outside
Malta are exempt from tax,
whether remitted to Malta or
not.
3 Non-resident Malta-source income only.
(Ref. the manner in which Maltese
domicile is acquired - this Malta-source interest and
category can only include royalty income are generally
foreign-incorporated companies exempt from Malta tax.
having the control and
management of their business Capital gains realised on the
outside Malta) sale of units in collective
investment schemes and of
securities in companies which do
not have local immovables as
their sole or main asset are
also exempt from Malta tax.
B. COMPUTATION OF INCOME
1. Income
The audited accounts of the company (which may request permission from the Revenue in order to have its tax year match its financial period) form the basis of the company's tax computation for the year.
2. Deductions
The company's accounting profit or loss figure for the period may require certain adjustments for items which are not deductible for tax purposes, on the one hand, and for allowable deductions, on the other.
The guiding principle in this context, once again, is the rule that expenses are deductible "to the extent to which [they were] wholly and exclusively incurred in the production of the income" - apportioning of expenditure incurred for a dual purpose is thus possible. One should also note that expenses, apart from trade losses (discussed below), may only be deducted against the specific income in the production of which they are incurred - should there be no such income, the expense is lost; should the expense exceed the income generated, the excess amount is also lost.
Those deductions which are not allowable for tax purposes include:
(i) Expenses incurred prior to the production of the income, such as company formation expenses, costs incurred in issuing equity, plant installation costs, and so forth;
(ii) Expenses which involve the application of income produced by the company, such as charitable contributions;
(iii) Provisions, such as provisions for depreciation and/or depletion of assets, provisions for bad debts - expenses are deductible only when actually incurred.
(iv) Items of expenditure which are of a capital nature (subject to specific statutory exceptions to this principle) - another general tax law principle.
The Income Tax Act specifically provides for a number of deductions for tax purposes. These include:
(i) Interest payable upon capital employed in acquiring the income;
(ii) Expenses in the nature of repairs of premises, plant, machinery used in producing the income, as well as for the renewal, repair or alteration of certain items so employed;
(iii) Bad debts, in the year in which such debts are deemed to have become bad;
(iv) Capital allowances on assets used in the production of the income:
(a) An initial allowance on new acquisitions, of 10% in the case of hotels and industrial buildings and structures, and 20% on other assets, and
(b) An annual wear and tear allowance (additional to the initial allowance in the first year of the asset's life), at rates which vary according to the category of equipment in question, computed on the reducing-balance method. Wear and tear allowances for hotels, industrial buildings and structures are computed at 2% per annum, on a straight-line basis.
Total allowances over the asset's life cannot exceed 100% of its cost. Adjustments are made upon disposal of the asset for a balancing allowance (if the disposal value is lower than the written-down value) or for a balancing charge (if the disposal value is higher).
(v) Tax losses resulting from trade can be set off against any other gain or profit generated by the company, including capital gains.
3. Tax computation
A basic tax computation of a company whose only source of income is trade is likely to include three main 'steps':
(i) Establishing the company's taxable income for the period: a company's taxable income figure is equivalent to its total income, after allowing any statutory exemptions and all allowable deductions (after adjusting for prohibited deductions).
(ii) The company's taxable income figure for the year may possibly be reduced by any tax losses (not being capital losses which can only be set-off against capital gains) brought forward from previous years (see also "Group Relief" below).
(iii) Should any such tax losses be fully absorbed by the company's taxable income for the period in question, the resultant figure is then reduced further by any capital allowances for the year, plus any unabsorbed capital allowances brought forward from previous years. N.B. Unabsorbed capital allowances may only be carried forward against income from the same source.
4. Double taxation relief
Double taxation is avoided through the four forms of double taxation relief currently available, namely:
(i) Commonwealth relief, which is very rarely availed of in practice;
(ii) Relief in terms of the various double taxation treaties currently in force;
(iii) Unilateral relief, which is available when double taxation relief in terms of a treaty is not available. Unilateral relief for underlying tax is also possible, in certain circumstances; and
(iv) The Flat-Rate Foreign Tax Credit, which may be availed of subject to the production of documentary evidence as to the fact that the income / gains in question do fall to be allocated to the company's Foreign Income Account (a certificate to this effect issued by an auditor is considered satisfactory documentary evidence).
Reference is made to our article "Malta - An International Financial Services Centre" for more information as to these various forms of double taxation relief.
5. Tax rates
The corporate tax rate is a flat rate of 35%.
One should however keep in mind the fact that lower rates of tax may be applicable in a number of cases, for instance in terms of:
(i) Final withholding tax systems, such as the 15% final withholding tax applicable to certain forms of investment income; or
(ii) Exemptions from tax, such as distributions received by a company out of its subsidiary's exempted income (e.g. investment allowances distributed by 'qualifying companies' under the Industrial Development Act, which distributions are also tax exempt in the hands of the ultimate shareholder - see our article "Industrial Development Act, 1988); or
(iii) Special tax regimes: e.g. non trading offshore companies - 0%; trading offshore companies - 5%; export-oriented companies under the Industrial Development Act - 10-year tax holiday; licensed companies under the Malta Freeports Act - tax holiday (see our articles "Malta - An International Financial Services Centre", "Industrial Development Act, 1988", and "The Malta Freeports Act, 1988" for more details)
C. 'GROUP OF COMPANIES' CONCEPT
The concept of a group of companies for tax purposes was only recently introduced into Maltese income tax law. The group concept is especially relevant with reference to two types of relief:
1. Group Relief
A group of companies is defined as follows: two Maltese-resident companies shall be deemed to be members of a group of companies if one is a 51% subsidiary of the other or both are 51% subsidiaries of a third Maltese-resident company.
It is noted that a company shall be deemed to be a 51% subsidiary if its parent company owns, directly or indirectly, over 50% of the subsidiary's ordinary share capital and of its voting rights. It must furthermore be beneficially entitled, directly or indirectly, to over 50% of any profits available for distribution to the ordinary shareholders of the subsidiary, including any distributions of assets to the subsidiary's ordinary shareholders on a winding up.
In order for group relief to be available, a number of conditions must be satisfied, including the important requirement that the 'claimant company' and the 'surrendering company' both be companies resident in Malta, but neither of which is resident for tax purposes in any other country.
The following are a few of the most salient features of group relief:
(i) The claimant company may, should it so wish, claim total tax losses incurred by the other group company for that year, even should such losses exceed the claimant company's taxable income for the year in question. Any excess amount may be carried forward by the claimant company to be set off against profits generated in subsequent years.
(ii) Tax losses which, had they been taxable profits, would have been allocated to the Maltese Taxed Account, may only be used by the claimant company against profits allocated to its Maltese Taxed Account. Similarly, tax losses 'attributable' to the surrendering company's Foreign Income Account may only be offset against any profits of the claimant company allocated to its Foreign Income Account. These rules apply also to the possibility of carrying forward excess losses to be offset against the claimant company's profits in subsequent years (see our article "Malta - An International Financial Services Centre" for more details regarding the various corporate tax accounts).
(iii) Any such payment of group relief is not taxable in the claimant company's hands, nor is it regarded as a distribution to the claimant company for tax purposes.
2. 'Capital gains tax' Relief
(i) Gains realised upon the transfer of an asset between group companies:
This form of relief makes reference to the same definition of a group of companies utilised for the purposes of group relief. It also contemplates an alternative definition of a group, so to say - namely a situation where two companies are controlled and beneficially owned, directly or indirectly, as to over 50% by the same shareholders.
This relief works so as to exempt capital gains realised by one group company upon the transfer of an asset to another group company from tax.
(ii) Gains realised upon the exchange of shares as part of a restructuring exercise:
Incidentally, this form of relief does not make an express reference to the existence of a group structure. The relief given is in the form of an exemption from tax relative to any gains realised upon a transfer involving the exchange of shares on restructuring of holdings upon mergers, demergers, amalgamations and reorganisations.
D. DISTRIBUTIONS OF DIVIDENDS / TAXATION OF SHAREHOLDERS
1. Full imputation system of taxation
When a resident company distributes a dividend, it is entitled to deduct (subject to a few exceptions) from such dividend the tax it has paid on the income out of which the dividend is distributed - we shall assume that the tax rate in question is the current standard corporate tax rate of 35%.
When the dividend is taxed in the shareholder's hands, the dividend is grossed up with the tax deducted by the company, i.e. the 35%, and tax is charged in the shareholder's hands upon the gross figure at the tax rate applicable to the shareholder. The tax which has been deducted by the company is available as a credit against the shareholder's own tax liability. Seeing the shareholder's own tax liability can only be a maximum of 35% (keeping in mind that the maximum individual tax rate is also 35%), the shareholder is not subject to any further tax upon receipt of the dividend. An individual shareholder may actually be entitled to a refund of tax deducted at source if a lower tax rate is applicable to that shareholder.
One therefore notes that distributed profits are taxed once only, namely in the shareholder's hands and at the shareholder's personal tax rate. Moreover, the imputation system is applicable to resident and non-resident shareholders alike.
2. Tax Refund system
An additional feature was introduced into the imputation system in 1994, available limitedly to non-resident shareholders.
Non-resident shareholders may opt for an 'alternative' to a credit of the tax deducted by the company on the basis of the full imputation system of taxation, namely for a refund of part or all the Malta tax paid by the company on the profits distributed by way of dividend. The Tax Refund regime is available on the following basis:
(i) The distribution made by the company must be one made out of profits allocated to the company's Foreign Income Account.
(ii) The non-resident shareholder may claim a Tax Refund equal to two-thirds of the Malta tax actually paid by the company upon such profits.
(iii) Where the income in question is income derived from a 'participating holding' of the distributing company, the non-resident shareholder is entitled to claim a Tax Refund equal to a 100% of the Malta tax actually paid by the company upon such income.
(iv) The Tax Refund is exempt from Malta tax in the hands of the non-resident shareholder.
It is important to note that the Tax Refund regime applies in a slightly different manner where the distributing company is an International Trading company (ITC), in that it also combines the possibility of obtaining a credit on the basis of the full imputation system. Indeed, a non-resident shareholder is entitled to two Tax Refunds upon receipt of a dividend distributed by an ITC (with the exception of distributions from the ITC's Untaxed Account), namely to: (1) an amount equal to the difference between the tax deducted by the company (i.e. 35%) and the non-resident shareholder's own tax liability (i.e. 27.5%), and (2) two-thirds of the Malta tax actually paid by the ITC on such profits.
Reference is made to our article "Malta - An International Financial Services Centre" for more information as to the Foreign Income Account and the Tax Refund Regime.
THIS ARTICLE IS INTENDED TO PROVIDE GENERAL INFORMATION ON THE SUBJECT MATTER. IT IS THEREFORE NOT A SUBSTITUTE OF PROFESSIONAL ADVICE AND IS NOT BE ACTED UPON WITHOUT PRIOR CONSULTATION WITH SPECIALISED CONSULTANTS.
