Professional Level Options Module, Paper P6 (MLA)

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1 Answers

2 Professional Level Options Module, Paper P6 (MLA) Advanced Taxation (Malta) June 212 Answers 1 (a) Tax consultant No 1, Main Street Valletta 15 June 212 Mr Albert Long Street Square City Free Republic Dear Sir Maltese income tax and stamp duty implications of your proposals regarding C Ltd (i) First scenario (1) Transfer of land by A Ltd to C Ltd Income tax implications The transfer of the land from A Ltd to C Ltd is by default subject to a final withholding tax of 12%, calculated on the higher of the market value and the consideration. However, the Income Tax Act (ITA) provides for an exemption in the case of a transfer of immovable property situated in Malta from one company to another, where the individual direct or indirect beneficial owners of the two companies are the same and each one holds substantially the same percentage interest in the nominal share capital and voting rights in each of those companies. Since both A Ltd and C Ltd, when it is incorporated in June 212, are to be fully owned by yourself, these conditions will clearly be satisfied. However, where the immovable property to be transferred is not held as a capital asset, the exemption only applies if the transfer is part of a restructuring involving the transfer of the whole or part of a company s business, and the property transferred has been owned by the transferring company for a period exceeding seven years. The land is not held by A Ltd as a capital asset but as trading stock, therefore these conditions are applicable. Since the transfer of the land constitutes the transfer of the whole of the land development business of A Ltd and the land has been owned since 22, i.e. for over nine years, both these conditions are also satisfied. The proposed transfer of the land from A Ltd to C Ltd, to take place soon after the formation of C Ltd in June 212, will therefore be exempt from income tax. Stamp duty implications The Duty on Documents and Transfers Act (DDTA) provides for an exemption from duty in the case of a transfer of immovable property situated in Malta from one company to another, where the individual direct or indirect beneficial owners of the two companies are the same and each one holds substantially the same percentage interest in the nominal share capital and voting rights in both of those companies. Since both A Ltd and C Ltd, when it is incorporated in June 212, are to be fully owned by yourself these conditions will clearly be satisfied. As a result, the transfer of the land from A Ltd to C Ltd, to take place in June 212, is exempt from stamp duty. The additional conditions that apply for income tax purposes when the property is held for resale (referred to above) do not apply for stamp duty purposes. (2) Sale of shares in C Ltd by Albert to David (Option 1) Income tax implications of the deemed transfer and reacquisition of land by C Ltd When a transfer of property has qualified for the exemption discussed in (1) above, the ITA brings into the charge to tax a deemed transfer of immovable property situated in Malta in the event that the group which existed at the time when the exemption was claimed ceases to exist within a period of six years from the date of the exempt intragroup transfer. The proposed acquisition by David of 5% of the ordinary share capital of C Ltd in July 212 will result in the individual direct beneficial owners of A Ltd and C Ltd no longer remaining the same. As a result, A Ltd and C Ltd will cease to be a group within a period of six years from the exempt transfer of the land, and C Ltd will be treated as if, immediately after it acquired the land from A Ltd in June 212, it had transferred and re-acquired that land. This deemed transfer is taxable at the rate of 12% on the value at which C Ltd acquired the property from A Ltd, i.e. 75,. C Ltd will be required to pay 9, ( 75, x 12%) to the Commissioner of Inland Revenue within 15 working days from the date the group ceases to exist, that is, the date on which David acquires the shares. Income tax on the sale of the shares in C Ltd The sale of 5, shares in C Ltd will constitute a transfer of a controlling interest since the aggregate nominal value of the shares held by you represents at least 25% of the issued nominal share capital of C Ltd. This means that for the purpose of calculating the capital gain or loss arising from the transfer, the transfer value of the shares 17

3 will be the higher of their market value and the actual consideration. Since the transfer is to take place during C Ltd s first financial year, the market value of the company is taken to be the nominal value of its issued share capital (i.e. 1,), adjusted by replacing the book value of the land by its market value. Since the land is already stated at market value no adjustment is required. Also no goodwill adjustment is required. The market value of C Ltd is therefore 1, and the market value of the 5, shares transferred is 5,, which is equal to the consideration that has been agreed between you and David. Thus, no tax will be payable since the transfer value is equal to the cost of acquisition of the shares transferred, resulting in a zero gain. Stamp duty on the sale of the shares in C Ltd Duty is payable at the rate of 2 or 5 for every 1 or part thereof of the amount or value of the consideration or the real value, whichever is the higher, of the shares transferred. The 5% rate applies when the company in question owns immovable property whose value is at least 75% of the value of the company, excluding the value of current assets other than immovable property. The value of C Ltd s assets is 75, and the value of the immovable property is 75,, that is, 1%. As this is higher than 75%, the applicable stamp duty rate is 5%. The real value of shares for stamp duty purposes is determined in the same manner as for capital gains purposes (as explained above) except that, for stamp duty purposes, no account is taken of any liability in excess of the value of all assets excluding the value of any such immovable property or any real right thereon, other than a bank loan or a registered debt relating to the acquisition of the property. C Ltd is to fully finance the acquisition of the land by means of a bank loan which represents its only liability. This liability does not exceed the asset value, meaning that in determining the real value of the shares transferred by yourself no adjustment is required to be made. The duty payable on the transfer of the shares will, therefore, be 25 ( 5, x 5%). (3) Income tax and stamp duty implications if C Ltd issues new shares to David (Option 2) If David acquires 1, shares in C Ltd by way of an issue of new shares, instead of buying 5% of the existing shares from you, the value shifting provisions under both the Income Tax Act and the Duty on Documents and Transfers Act will apply. The value shift is the difference between the amount payable for the new shares and their market value, and this is treated as a taxable transfer subject to both tax and duty. The market value per share in C Ltd is 1 (because the value of the land is exactly offset by the loan taken out to acquire it) and David will be paying 1 per share issued, which means that no value will be shifted from your existing 1, shares to David s 1, shares and as a result no tax or duty would be payable. Also, in accordance with the Capital Gains rules, since the market value of C Ltd immediately before the share issue does not exceed the value of the paid up share capital, any value transferred or acquired is deemed to be zero. The only difference from Option 1 is that David would not have to pay any stamp duty if he acquires a 5% interest in C Ltd by way of a new share issue. (ii) Income tax treatment of the transfer of residential units by C Ltd Under the final tax system, the transfer of immovable property situated in Malta is charged at the rate of 12% on the higher of the market value of the property and the consideration. However, if the transfer of property is made not later than seven years after the date of its acquisition, the transferor may opt out of the final withholding tax system and instead pay the standard rates of income tax on the chargeable gain or profit. When the property in question has been acquired under an exempt intra-group transfer, the seven year period is reckoned from the date of the last transfer that was subject to tax. C Ltd will acquire the land from A Ltd under an exempt transfer, but as discussed above (under (i)(2)), once David becomes a 5% shareholder in C Ltd, the group ceases to exist and, as a result, C Ltd will be deemed to have transferred and reacquired the land in June 212, being the date of the intra-group transfer. This deemed transfer is subject to tax, therefore the seven year period will be reckoned from the date of this transfer. As C Ltd is expected to sell the first unit in 212, the transfer will be made within seven years from the date of the acquisition of the land in June 212, and C Ltd may opt out of the final tax system. In such case, the transfer will be chargeable as a trading transaction and the resulting profit taxed at 35%. Since C Ltd is transferring property that forms part of a project, the tax treatment applicable to subsequent transfers of units made by C Ltd will depend on whether C Ltd opts out of the final tax system on the transfer of the first unit. If the option is taken up, the final tax system will not apply to any subsequent transfers of units made by C Ltd not later than seven years from the date of the transfer of the land in June 212, and such transfers will be chargeable as trading transactions with the resulting profit taxable at 35%. Any transfers made after the seven year period will be subject to the final tax system. If the option is not taken up, both the first and all subsequent transfers will be subject to the final tax system. Please do not hesitate to contact me if you have questions about the matters discussed herein. Yours sincerely, A N Other Tax Consultant 18

4 (b) Calculation of the income tax and stamp duty payable on the transfer of shares in A Ltd by Albert Market value (Note 1) of shares in A Ltd (using the balance sheet for the year ended 31 December 211): Net asset value 5, Calculation of goodwill Profits for the previous five years: 285, Two years average profits 114, Book value of land 53, Market value of land 75, 22, 834, Market value percentage is 5%. Market value at 417, is higher than the agreed consideration of 4,. Market value of shares transferred 417, Inflation deduction: 5% x (53, x (( )/624 85)) (65,799) Cost of acquisition (Note 2) (1,) Taxable gain 251,21 Income tax payable by A Ltd at 35% 87,92 Notes 1. As Albert owns 1% of the shares, the sale is a transfer of a controlling interest and the transfer value is the higher of the market value and the price (consideration). 2. Albert holds 2, fully paid-up ordinary shares of 1 each in A Ltd, 1, of which were acquired on issue during 2 for 1, while the other 1, shares were acquired in 29 for 2,. In accordance with the Capital Gains rules, shares acquired at an earlier time are deemed to have been disposed of before shares acquired at a later time. The cost of acquisition is therefore 1,. Calculation of disallowed liabilities: Total assets 1,25, Immovable property (53,) 72, Total liabilities (75,) Bank loan/registered debt Disallowed liabilities 3, Market value 834, Real value 864, Real value of shares transferred (5%) 432, Stamp duty payable by David at 2% of 432, (Note) 8,64 Note: The value of the property is (53,/1,5, x 1%) = 5 48% of the assets of the company, excluding current assets other than immovable property. Since this is less than 75%, the rate of duty is 2 for every 1 or part thereof. 2 (a) MEMORANDUM To: Managing Director, Forco Group From: Tax accountant Date: 15 June 212 Re: Maltese tax treatment of the income of Subco A Ltd and the tax implications arising on the income received by Holdco Ltd (i) Income tax treatment of Subco A Ltd s income Subco A Ltd is domiciled and resident in Malta by virtue of its incorporation, with the consequence that it is taxable in Malta on its worldwide profits at 35%. Trading profits derived by Subco A Ltd s branch in Country Z In terms of Malta s treaty for the elimination of double taxation with Country Z, based as it is on the OECD model, business profits derived by a company resident in Malta will not be taxable in Country Z unless they arise through a permanent establishment situated in Country Z. Subco A Ltd has a branch in Country Z. For the purposes of the treaty, a branch constitutes a permanent establishment and the profits that Subco A Ltd derives through its branch will therefore be taxed in Country Z. Tax has been paid on those profits in Country Z at the rate of 15%. 19

5 Business income derived by a company from a permanent establishment situated outside Malta stands to be allocated to its foreign income account (FIA). Subco A Ltd may claim treaty relief in respect of this income, in which case it will be subject to Malta tax on the business profits before foreign tax, as adjusted to take into account capital allowances in accordance with Maltese law, and the foreign tax will then be credited against the Maltese tax liability. The foreign tax amounts to 14 63% of the chargeable income ( 12,/ 82,). This leaves an amount of 2 37% (35% 14 63%) of the gross income that will be payable by Subco A Ltd in Malta. If treaty relief is claimed, a distribution of the profits will entitle Holdco Ltd to a refund of two-thirds of the Malta tax paid by Subco A Ltd gross of treaty relief, but not exceeding the Malta tax paid after relief. Since a refund of 23 33% (2/3 x 35%) would be higher than the 2 37% tax payable by the company in Malta after relief, the tax paid in Malta by Subco A Ltd, on such profits which are allocated to and distributed from the foreign income account, will be fully refundable to Holdco Ltd. Instead of claiming treaty relief, Subco A Ltd may claim the flat rate foreign tax credit (FRFTC). Under this option, foreign tax is deemed to have been paid at 25%, and relief is granted after grossing up at this rate. If the FRFTC is claimed, the refund due to Holdco Ltd will be two-thirds of the Maltese tax after relief and not, as in the case of treaty relief, at two-thirds of the Maltese tax before relief. A third option is for Subco A Ltd not to claim any relief at all for the foreign tax paid in Country Z. In this case, the foreign tax can be deducted from its taxable income and Maltese tax will only be charged on the net amount. Holdco Ltd would then be able to claim a refund of six-sevenths of the Malta tax paid. Under the second and third options, there will be a non-refundable balance of Maltese tax. Treaty relief is therefore the best option of the three, as only this alternative produces a full refund of the tax paid in Malta on profits distributed out of the FIA of Subco A Ltd to Holdco Ltd. Trading profits derived by Subco A Ltd s Malta business The double taxation agreement between Malta and Country X states the maximum rate of tax applicable on dividends that are paid out of profits that have qualified for tax incentives in Malta is 15%. Under the Maltese full imputation system, the benefit of the reduced rate may be claimed by the shareholder. If the shareholder reports the dividend in a Maltese tax return, he becomes liable to Maltese tax on the gross dividend at 15% and, at the same time, he becomes entitled to a credit for the company tax paid. If the company paid Maltese tax on the distributed profits, the shareholder qualifies for a refund of 2%. The Income Tax Act provides that where, under a double taxation agreement, dividends distributed by a company resident in Malta to shareholders who are resident in the other treaty country are taxable in Malta at a rate that is lower than 35%, that company is entitled to apply the reduced treaty rate to the profits which are distributable (but not necessarily distributed) to those shareholders, and which would on distribution be subject to the reduced treaty rate. The reduced treaty rate applies also to the company profits that are distributable to a shareholder which is a Maltese incorporated company, if its own shareholders are resident in the other treaty country. This provides a cash flow benefit, since otherwise the benefit of the reduced treaty rate would be available only after the profits in question are distributed up to the non-resident shareholder and the shareholder reports the dividend in Malta and claims the refund. This benefit is optional and can only be availed of by a company which does not sell by retail. If the option is taken up, no person in receipt of a dividend paid out of profits which have been subject to tax at the reduced treaty rate is entitled to claim a refund of tax in respect of that dividend, other than the 6/7ths refund. Since Subco A Ltd is entitled to investment tax credits, does not sell by retail and is owned by a company which, in turn, is fully owned by persons resident in Country X, it satisfies all the prescribed conditions and may therefore opt to have the profits that it derives from its manufacturing and distribution business in Malta taxed at the rate of 15%, being the rate stated in the Malta/Country X treaty. Tax accounting As stated above, business income derived by Subco A Ltd from its permanent establishment situated in Country Z stands to be allocated to its foreign income account (FIA). Business income derived by Subco A Ltd from its Maltese business stands to be allocated to its Maltese Tax account (MTA). However, that portion of the chargeable income derived from its Maltese business which is relieved from tax as a result of the investment tax credits must be allocated to its Final Tax Account. Since Subco A Ltd owns immovable property which is used for the purpose of its activities, it is required to allocate annually to its immovable property account (IPA) an amount of annual market rent. This is calculated by multiplying the aggregate surface area of the property (5 square metres) by 25, and amounts to 125,. This allocation is to be made after all other allocations have been made, and is effected by transferring distributable profits to the IPA, first from its MTA, with any balance from its FIA. Any balance of annual market rent which is not transferred because there are no or insufficient profits which have suffered tax, must be carried forward to the following year and added to the amount of annual market rent for the following year. The annual market rent allocation reduces the amounts of tax refunds that would otherwise have been claimed by Holdco Ltd, since a shareholder cannot claim the two-thirds refund of tax paid on profits distributed from the IPA. 2

6 (ii) Tax implications arising from the distribution of Subco A Ltd s profits to Holdco Ltd Holdco Ltd is domiciled and resident in Malta by virtue of its incorporation, with the consequence that it is taxable in Malta on its worldwide profits at 35%. Holdco Ltd is registered with the Commissioner of Inland Revenue to be eligible for refunds of tax on dividend distributions and is therefore eligible for a two-thirds refund in respect of tax paid on the profits derived by Subco A Ltd through its branch in Country Z which are distributed from the FIA of Subco A Ltd. Holdco Ltd is also entitled to a six-sevenths refund in respect of tax paid on profits allocated to the MTA; however, as explained above (under Tax accounting), no profits are available to be distributed out of such an account. It does not qualify for such a refund in respect of the dividend paid by Subco A Ltd out of its IPA. Holdco Ltd is required to allocate the dividends received from Subco A Ltd to the same tax account as that out of which the dividends were distributed. The dividend received from Subco A Ltd out of its FTA will not form part of the chargeable income of Holdco Ltd and so will not be subject to further Maltese tax in its hands. (b) Tax computations for the year of assessment 212 SUBCO A Ltd Branch in Malta Country Z business Tax account FIA MTA IPA FTA UTA Reserves Accounting profit before tax 8, 1, 9, Add Back: Accounting depreciation 2, 15, 1,, 25, Deduct: Capital allowances 18, 1, Chargeable income 82, 15, Applicable tax rate 35% 15% Tax at applicable rate 287, 22,5 Relief of double taxation 12, (12,) Investment tax credits utilised 22,5 Tax payable 167, (167,) Chargeable income relieved by ITCrs 1 15, Distributable profits 533, 15, (7,) 613, Annual market rent allocation 2 (125,) 125, Distributable profits final allocation 48, 125, 15, (7,) 613, Distributed to Holdco Ltd 48, 125, 8, 613, 7, (7,) Note 1: 22,5/15% = 15, Note 2: 5m 2 x 25 per m 2 = 125, HOLDCO Ltd Tax account FIA MTA IPA FTA UTA Reserves Gross dividends 627, ,38 8, Malta tax 127,835 39,165 Relief of double taxation 91,857 28,143 Net dividend 48, 125, 8, 613, Tax refund 1 127, , ,835 Chargeable income 627, ,38 Applicable tax rate 35% 35% Tax at applicable rate 219,692 67,38 Tax at source credit (219,692) (67,38) Tax payable Distributable profits 48, 125, 8, 127,835 74,835 Note 1: 2/3 x 219,692 = 146,462, limited to Malta tax paid, i.e. 127,835 21

7 3 (a) The term property company was introduced in the Income Tax Act by Act I of 21 and amended by Act IV of 211. Many provisions of the Income Tax Act (ITA) now make reference to the term Property Company for the purposes of determining whether certain tax exemptions or reliefs apply. A property company is a company that owns immovable property in Malta or any real rights thereon, or that owns, directly or indirectly, shares or any other interest in another company, person or entity that owns such property or rights. However, the definition includes certain exceptions. Firstly, shares or other interests in an underlying entity or person which owns immovable property situated in Malta or any real rights thereon are to be ignored in determining whether a company is considered to be a property company, if less than 5% of the total value of the shares or other interests held in that entity or person is attributable to immovable property situated in Malta or any real rights thereon. Secondly, there is a proviso to the definition of property company: where a company or another person or entity owns immovable property, it will still be treated as not owning immovable property if a number of conditions are satisfied. These tests need to be applied to the company in respect of whom the definition is applied, as well as to each underlying entity or person in which it owns shares or any other interest, if that other entity or person owns immovable property situated in Malta or any real rights thereon which has or have been taken into account as a result of not satisfying the 5% share/interest value threshold referred to above under the first exception. The conditions are as follows: the company, entity or person carries on a trade or business; and the immovable property consists only of a factory, showroom, warehouse or office; and the factory, showroom, warehouse or office is used solely for the purpose of carrying on its trade or business; and not more than 5% of the value of the assets of the company, entity or person consists of immovable property situated in Malta or any real rights thereon; and the company, entity or person does not carry on any activity, the income from which is derived, directly or indirectly, from immovable property situated in Malta. If the company and all its underlying companies, other persons and entities satisfy all the above conditions, it will not be treated as a property company. (b) (i) ABC Ltd transfers all its shares in XYZ Ltd Participation exemption The ITA grants an exemption from tax on gains that are derived from the transfer of a participating holding if certain conditions are satisfied. In order for a holding of shares to be treated as a participating holding it must be a holding of equity shares in a company whether resident in Malta or outside Malta. The ITA defines an equity holding as being a holding of the share capital in a company which is not a property company where the shareholding entitles the shareholder to any two out of three equity holding rights, being the right to profits available for distribution, the right to vote and the right to assets available for distribution on a winding up. XYZ Ltd owns immovable property situated in Malta and is therefore considered to be a property company, unless it satisfies all the conditions mentioned in the proviso to the definition of a property company. The property consists of an office, and it therefore satisfies one of the conditions. But the value of the office represents 62 5% ( 25,/ 4,) of the value of the company s assets. Therefore, it does not satisfy the condition that the value of immovable property situated in Malta does not exceed 5% of the value of the assets, This means that XYZ Ltd remains to be treated as a property company and that the holding of shares by ABC Ltd in XYZ Ltd is not considered to be an equity holding. Consequently, the participation exemption cannot be availed of and the transfer will be chargeable to tax. Double taxation agreement No double taxation agreement is applicable in this case. (ii) DEF Ltd transfers all its shares in ABC Ltd Participation exemption As explained above, in order for the participation exemption to be available the shares held by the transferor company, in this case DEF Ltd, must be a holding of equity shares (a holding of the share capital) in a company which is not a property company. Even though ABC Ltd does not own any immovable property situated in Malta, it is still considered to be a property company as a result of its holding of shares in XYZ Ltd which, as explained in (i) above, is considered to be a property company. The participation exemption is therefore not available and the transfer will be chargeable to tax. Double taxation agreement between Malta and Country R The Income Tax Act provides that the provisions of a double taxation agreement shall have effect notwithstanding anything stated in the ITA or any other law. The double taxation agreement between Malta and Country R is based on the OECD Model Convention. Article 13 (Capital gains) of that Model Convention is therefore relevant in order to determine whether Malta, being the state of source, has a right to tax capital gains derived by DEF Ltd, resident in Country R, on the transfer of the shares in ABC Ltd. 22

8 Paragraph 4 of article 13 states that gains derived by a resident (DEF Ltd) of the other state (Country R) from the alienation of shares deriving more than 5% of their value, directly or indirectly, from immovable property situated in Malta may be taxed in Malta. Since the shares held by DEF Ltd in ABC Ltd derive more than 5% of their value indirectly from immovable property situated in Malta, Malta has a right to tax any gains derived from a transfer of shares in ABC Ltd. Country R must, however, allow DEF Ltd relief from double taxation by way of a credit or an exemption. (c) A dividend certificate is to show separately, in respect of the dividend distributed to the particular shareholder, the following information: the gross taxed amount of the distributed profits, in respect of each taxed account; the total tax chargeable on the company in respect of the distributed profits, showing separately the Malta tax payable after all reliefs for double taxation have been given and the amount which has been set off against Malta tax pursuant to a claim for relief of double taxation; where applicable, the 15% tax payable on distributions from the untaxed account and distribution of profits previously taxed at a rate lower than the current 35% tax rate (top up tax); the net amount of the dividend paid to the shareholder; the net Malta rate of tax paid or payable by the company after taking relief for double taxation into account; where the profits being distributed have been exempt from tax and the distribution of such profits by the company is exempt from tax in the hands of the shareholder, a note quoting the relevant law giving such exemption; where applicable, a statement declaring that the company is entitled to make a claim for a refund under the Income Tax Management Act; and profits, out of which the dividend is paid, chargeable to tax before the year of assessment 28 are to be shown separately from the profits chargeable to tax in year of assessment 28 and subsequent years of assessment. 4 Anthony and Kevin (a) Chargeable income and tax liability for years of assessment 213 and 214. (i) The business is carried out through a partnership en nom collectif In accordance with the Income Tax Management Act, the income of any partner from a partnership en nom collectif is deemed to be the share in the income of the partnership to which he was entitled during the year preceding the year of assessment. The income of the AK partnership en nom collectif is to be ascertained in accordance with the provisions of the Income Tax Acts, but it will be taxable as the income of Anthony and Kevin at their personal tax rates, even though they will not actually be withdrawing any profits from the partnership/company during 212 and 213. They must therefore report their respective shares of the income/allowable losses in their tax returns and self assessments. Wear and tear allowances for years of assessment 213 and 214: Capital expenditure: Electronic equipment 25% 1, 2,5 Motor vehicle 2% 14, 2,8 Computer 25% ,525 The deduction in respect of wear and tear with respect to the motor vehicle is to be computed as if the cost of acquisition were 14,. The consideration paid for the motor vehicle (VAT included) is 23,6, which exceeds the maximum amount. Tax computations of the AK partnership for years of assessment 213 and 214: AK Partnership en nom collectif Year of assessment Period ending 31 December Profit for period 17,41 48,6 Add: Consultancy fees 1,5 Deduct: Capital allowances (5,525) (5,525) Chargeable income 13,385 43,75 Apportioned: Anthony 5% 6,693 21,538 Kevin 5% 6,692 21,537 23

9 (ii) Although the consultancy fees will be paid by the AK business, they cannot be deducted in determining the chargeable income since this expense has been incurred before the AK partnership began to carry on its business and is considered to be a pre-trading expense. Tax computations of Anthony for the years of assessment 213 and 214: Share of partnership profit 6,693 21,538 Deduct: Interest expense (438) (1,5) 6,255 2,488 Employment income 12,5 Total income 18,755 2,488 Tax at individual rates 1,964 2,496 Tax computations of Kevin for years of assessment 213 and 214: Share of partnership profit 6,692 21,537 Employment income 24, 9,6 Total income 3,692 31,137 Tax at married rates 3,967 4,123 Dividends distributed out of the final tax account are not charged to further tax and do not form part of the chargeable income of any person. The net dividend of 2, received by Kevin has been distributed from the final tax account and is not chargeable to tax. The business is carried out through a limited liability company. AK Limited is domiciled and resident in Malta by virtue of its incorporation, with the consequence that it is taxable in Malta on its worldwide profits at 35%. The method for determining the chargeable income is identical to the method applied for the partnership en nom collectif. However, the income is taxed in the company s hands at the company rate of tax. AK Limited is required to allocate the distributable profits derived from its repair servicing business to the Maltese taxed account (MTA). AK Limited Year of assessment Period ending 31 December Profit for period 17,41 48,6 Add: Consultancy fees 1,5 Deduct: Capital allowances (5,525) (5,525) Chargeable income (as in (i)) 13,385 43,75 Tax at 35% 4,685 15,76 Tax computations of Anthony for years of assessment 213 and 214: Employment income 12,5 Total income 12,5 Tax at individual rates 6 The interest paid by Anthony cannot be claimed as a deduction (since no dividends have been received from AK Limited) and is not carried forward. The interest paid would only be allowed as a deduction against dividends received from AK Limited. Tax computations of Kevin for years of assessment 213 and 214: Employment income 24, 9,6 Total income 24, 9,6 Tax at married rates 2,95 (b) (i) As provided in the second schedule to the Value Added Tax Act (VATA), the provision by a person of goods for the purpose and in the course of maintenance or repair services supplied by that person are to be treated as part of the supply of those services. The supplies made by AK, including the supply of parts/components, will be considered to be supplies of services. 24

10 (ii) In accordance with the fourth schedule to the VATA, the tax on a supply of services becomes chargeable on the earlier of the following two dates: (1) the date when the chargeable event takes place which, in the case of the supplies made by AK, is the date when the services are performed; and (2) the date when a payment is made for the supply to the extent covered by that payment. However, if a tax invoice is issued within 3 days from the earlier of the dates above, the tax becomes chargeable on the date of the invoice. Since AK is to issue all its tax invoices within a maximum of seven days from the date the services are performed, the tax will become chargeable on the invoice date. Calculation of the input/output tax and the VAT payable/refundable for the first tax period. OUTPUTS VAT at 18% Disallowed Services rendered 25, 4,5 4,5 INPUTS Materials 1, Advertising 1, Consultancy fees 1 1,5 27 (27) Repairs and maintenance Stationery Fuel (136) Rent 3 2, Electronic equipment 1, 1,8 1,8 Motor vehicle 4 2, 3,6 (3,6) Computer ,898 VAT payable 1,62 1: No amount is to be treated as input tax of a person unless it is supported by a tax invoice in respect of the tax relating to the goods or services supplied to him. The consultancy service was provided to Anthony and Kevin and not to the AK business, and the tax invoice was issued in the name of Anthony and Kevin, it is therefore excluded. 2 & 4: VAT paid on the motor vehicle and fuel is not treated as input tax and is therefore excluded. 3: The letting of property by a limited liability company to a person registered under article 1, for the purpose of the economic activity of that other person, is a taxable supply, which means that VAT has to be charged by RS Ltd on the rent. 5 GHL Ltd, TRM Ltd and FTR Ltd (a) Implications of the present group structure GHL Ltd and TRM Ltd do not form a group for the purpose of the group relief provisions since the shares in both companies are held directly by individuals and there is no parent-subsidiary relationship. This means that losses incurred by GHL Ltd which are linked to the Maltese tax account (MTA) cannot be surrendered to TRM Ltd to be offset against its chargeable income allocated to the immovable property account (IPA) or MTA. GHL Ltd is entitled to carry forward its tax losses indefinitely to be offset against future profits. However, given the substantial capital allowances to be carried forward to 214, it may still not be in a position to recover all its tax loss after that year, whereas TRM Ltd will still be liable to tax on its profits for those years. GHL Ltd is expecting to receive a dividend of 3, (net of 35% corporate tax) during 213 from FTR Ltd. This dividend should not be subject to withholding tax in Country F as a result of the EC Parent Subsidiary Directive. The Income Tax Act prohibits the carry forward of tax losses if a person has other sources of income chargeable to tax that could absorb those losses. This means that the dividend received from FTR Ltd must first be used to absorb the losses incurred and carried forward by GHL Ltd, even though GHL Ltd is entitled to claim underlying tax relief in respect of that dividend. Since the underlying tax is equivalent to the Malta tax on the gross dividend both Malta and Country F apply a 35% company tax rate the dividend does not expose GHL Ltd to any Maltese tax and the offset of the dividend against its losses therefore results in an offset of non-taxable income against 3, of tax losses that could have been utilised against other taxable income to save 15, in tax. It is therefore advisable for the companies to consider alternatives Under the present structure, as at 31 December 213 GHL Ltd will have available 2, tax losses to carry forward to 214. TRM Ltd s tax liability will be 15,33 for each of the years 212 and for 213, a total of 3,66. 25

11 Present group structure Tax account GHL Ltd Loss for the year (1,) (15,) (7,) Loss brought forward (1,) (25,) Loss transferred to foreign income account (FIA) 3, Loss carried forward MTA (1,) (25,) (2,) Dividend (FTR Ltd) FIA 3, Loss transferred from MTA (3,) Chargeable income TRM Ltd Rent 4, 4, Further deduction of 2% (N1) (8,) (8,) IPA 32, 32, Interest MTA 1, 1, Chargeable income 42, 42, Tax at 35% 14,7 14,7 Withholding tax on bank interest Total tax paid 15,33 15,33 3,66 Note 1: Deduction of Expenses in respect of Immovable Property (Legal Notice 1 of 1993) (b) Proposed group structure and other measures If Mark and Elisa each transfer their shares in TRM Ltd to GHL Ltd and, in exchange, GHL Ltd issues shares to them, Mark and Elisa will own all of the share capital of GHL Ltd while GHL Ltd will own all of the share capital of TRM Ltd. As an exchange of shares this transaction, since it would satisfy the relevant conditions imposed under the Income Tax Act and Duty on Documents and Transfers Act, would be exempt from both tax and duty. As a result, GHL Ltd and TRM Ltd will form a group for tax purposes, since both TRM Ltd and GHL Ltd are tax resident only in Malta, both have accounting periods which begin and end on the same dates and TRM Ltd will now be a 51% subsidiary of GHL Ltd. GHL Ltd will therefore be able to surrender its losses to TRM Ltd. However, group relief is only available if the surrendering company and the claimant company are both members of the same group throughout the year preceding the year of assessment for which relief is claimed. As the restructuring is to take place during October 212, GHL Ltd will only be able to surrender losses incurred during basis year 213 and subsequent years and cannot surrender the losses of 25, carried forward to basis year 213. Since GHL Ltd will be entitled to transfer tax losses to TRM Ltd from basis year 213 onwards, TRM Ltd should inform the bank not to withhold the 15% tax on the gross bank interest for the calendar year 213. The situation should, however, be revisited in 214 if GHL Ltd is expected to make profits from 214 onwards, as it may be best to inform the bank to resume withholding tax at 15% because the 15% withholding tax is less than the standard company tax rate. GHL Ltd will be entitled to transfer to TRM Ltd the full 7, tax losses incurred during basis year 213. This will be sufficient to fully reduce to zero the chargeable income of TRM Ltd for basis year 213, and the balance of 23,8 will be carried forward to the basis year 214 to be offset against the chargeable income for that year. This will result in a tax saving of 15,33 ( 63 withholding tax on bank interest and 14,7 tax at 35% on its chargeable income) for 213. In addition, if GHL Ltd transfers its shares in FTR Ltd to TRM Ltd and, in exchange, TRM Ltd issues shares to GHL Ltd, the dividend distributed by FTR Ltd which, as explained above, carries sufficient underlying tax credit to offset fully the tax chargeable on the dividend, will be received by TRM Ltd and not GHL Ltd. Thus any tax losses available to GHL Ltd will not be wasted and can be either surrendered to TRM Ltd or carried forward to be offset against its own future chargeable income. This exchange of shares should also qualify for income tax and stamp duty exemption since it is a restructuring of the holdings in the companies that does not involve a change in the ultimate ownership. Under the above proposals, as at 31 December 213 GHL Ltd will have available 25, tax losses carried forward to 214. TRM Ltd will pay 15,33 tax for 212 only and will have 23,8 of tax losses available to carry forward to

12 Proposed group structure Tax account GHL Ltd Loss for the year (1,) (15,) (7,) Loss brought forward (1,) (25,) Loss surrendered to TRM Ltd 7, Loss carried forward (1,) (25,) (25,) TRM Ltd Rent 4, 4, Further deduction (8,) (8,) IPA 32, 32, Bank interest MTA 4,2 Interest MTA 1, 1, 42, 46,2 Loss claimed from GHL Ltd (7,) Chargeable income 42, Loss carried forward to ,8 Tax at 35% 14,7 Withholding tax on bank interest 63 Total paid 15,33 15,33 Net dividend received from FTR Ltd FIA 3, Underlying tax 161,538 Gross dividend 461,538 Tax at 35% 161,538 Relief of double taxation 161,538 Tax payable/refundable The difference between the results for the three companies arising under the proposed measures and those arising under the present structure for 211, 212 and 213 is a total tax saving of 15,33, as well as a potential future tax saving at 35% of 95,83 as a result of tax losses carried forward by GHL Ltd and TRM Ltd of 25, and 23,8, respectively. 27

13 Professional Level Options Module, Paper P6 (MLA) Advanced Taxation (Malta) June 212 Marking Scheme Marks 1 (a) (i) (1) Income tax and stamp duty implications arising from the transfer of the land to C Ltd Income tax implications: Transfer by default subject to a final withholding tax of 12% 5 Intra-group exemption available 1 Conditions for claiming the exemption 1 5 Implications of immovable property held as trading stock 2 Stamp duty implications: Intra-group exemption available 1 Conditions for claiming the exemption 1 7 (2) Option 1 Transfer of shares in C Ltd by Albert Income tax implications: Exemption requires continued existence of group (six years) 1 Group ceases to exist upon David acquiring shares in C Ltd 5 Deemed transfer is taxable at the rate of 12% 5 Taxable value 5 Time limit for payment 5 Transfer of a controlling interest 1 Transfer value is the higher of the market value and the actual consideration 1 Determination of market value of C Ltd 1 5 Determination of market value of shares transferred 5 Determination of cost of acquisition of shares 5 Stamp duty implications: Rate of duty 1 Determining the real value of shares transferred 1 Calculation of the stamp duty payable 5 1 (3) Option 2 C Ltd issues new shares to David Applicability of value shifting provisions 1 Basis for determining the reduction in value 5 Explanation of why no value shifted/transferred 5 No tax or duty payable 5 Any value transferred or acquired is deemed to be zero 5 Difference no duty payable by David 1 4 (ii) Transfer of the residential units by C Ltd By default taxable at 12% of the higher of the market value and the consideration 5 Entitlement to opt out of the final withholding tax system 5 Determining the holding period of the property 1 5 Transfer of property forming part of a project 5 Transfer of first unit made within seven years from the date of the acquisition 1 Treatment of subsequent transfers 2 6 Appropriate format and presentation of letter 1 Effectiveness of communication

14 (b) Marks Calculation of the income tax and stamp duty payable on the transfer of shares in A Ltd by Albert Computation of market value of A Ltd 1 5 Computation of market value of shares transferred 5 Calculation of inflation deduction 5 Determining the cost of acquisition 1 5 Computation of tax payable 5 Computation of real value of shares transferred 1 5 Computation of duty (a) (i) Maltese income tax treatment of each of Subco A Ltd s items of income: Subject to tax on worldwide income at 35% 5 Trading profits derived by Subco A Ltd s branch in Country Z Branch is PE in Country Z 1 Business profits allocated to foreign income account 5 Alternatives for relief of double taxation 1 5 Effect of different reliefs on refund available 1 5 Conclusion re best option to claim treaty relief 1 Trading profits derived by Subco A Ltd s Malta business Benefit of the reduced rate may be claimed by the shareholder 5 Entitlement to apply the reduced treaty rate directly to the profits of Subco A Ltd 2 Option results in a cash flow benefit 5 Company must not sell by retail 5 Not entitled to claim a refund of tax other than the 6/7ths refund 1 Business profits allocated to Maltese taxed account 5 Income relieved from tax as a result of investment tax credits allocated to its Final Tax Account 1 Profits allocated to the immovable property account 5 Annual market rent allocation required 1 Annual market rent allocation reduces the amount of tax refunds otherwise available 5 14 (ii) Tax implications for Holdco Ltd arising from the distribution of profits by Subco A Ltd Holdco Ltd taxable in Malta on its worldwide profits at 35% 5 Eligible for a 2/3rds refund in respect of tax paid on profits distributed from the FIA 5 Eligible for a 6/7ths refund in respect of tax paid on profits distributed from the MTA 5 No distribution available from MTA 5 No refunds claimed in respect of tax paid on profits distributed from the IPA 5 Dividends received from Subco A Ltd allocated to the same tax account 1 Dividend received from Subco A Ltd s FTA does not form part of its chargeable income 5 4 Appropriate format and presentation of the memorandum 1 Effectiveness of communication 1 2 (b) Computation of chargeable income of Subco A Ltd 2 Offset of investment tax credits 5 Computation of tax on chargeable income of Subco A Ltd 1 Annual market rent allocation 5 Allocation of profits to tax accounts of Subco A Ltd 1 Computation of tax and allocation of profits to tax accounts of Holdco Ltd 2 Calculation of 2/3rds refund of Holdco Ltd and allocation to untaxed account

15 Marks 3 (a) Explanation of the term property company Applicable in determining whether certain exemptions or reliefs apply 5 Ownership of immovable property situated in Malta or shares in a property company 1 Exception to general rule less than 5% of the total value of the shares or other interests 2 Exception to general rule the five conditions ( 5 x 5) (b) (i) ABC Ltd transfers all of its shares in XYZ Ltd Discussion of possible application of the participation exemption 1 Definition of equity holding 1 XYZ Ltd owns immovable property in Malta 5 Holding of shares by ABC Ltd in XYZ Ltd is not considered to be an equity holding 1 Transfer is chargeable to tax 5 4 (ii) DEF Ltd transfers all of its shares in ABC Ltd Participation exemption is not applicable 1 Double taxation agreement takes precedence over ITA 5 Consideration of Article 13 (Capital Gains) of the DTA between Malta and Country R 2 Transfer is chargeable to tax 5 4 (c) Information that is required to be shown on a dividend certificate ( 5 x 8) (a) (i) Business is carried out through a partnership en nom collectif Income of partner from a partnership deemed to be the share in the income of the partnership 5 Income of partnership ascertained in accordance with the provisions of the Income Tax Acts 5 Anthony and Kevin taxable on share of profits at their personal tax rates 5 Consultancy fees not tax deductible 5 Wear and tear capping on motor vehicle 5 Tax computations of AK partnership for years of assessment 213 and Tax computations of Anthony for years of assessment 213 and Tax computations of Kevin for years of assessment 213 and Tax treatment of dividends distributed out of the final tax account 5 6 (ii) Business is carried out through a limited liability company AK Limited taxable in Malta on its worldwide profits at 35% 5 Method of computation as for partnership 5 Distributable profits derived from business allocated to the Maltese taxed account 5 Tax computations of AK Limited for years of assessment 213 and Tax computations of Anthony for years of assessment 213 and Interest paid not deductible unless dividends received 5 Tax computations of Kevin for years of assessment 213 and (b) (i) Supplies, including the supply of parts/components, are considered to be supplies of services 5 Rules for determining the date when VAT on supplies becomes chargeable (ii) VAT paid on consultancy service not treated as input tax 1 VAT paid on the motor vehicle and fuel is not treated as input tax 1 The letting of property by RS Ltd is a taxable supply 1 Computation of VAT payable

16 Marks 5 (a) Present group structure GHL Ltd and TRM Ltd do not form a group for the purpose of the group relief provisions 1 Losses incurred by GHL Ltd cannot be surrendered to TRM Ltd 5 GHL Ltd is entitled to carry forward its tax losses indefinitely 5 Not in a position to recover its tax loss immediately due to the substantial capital allowances 5 Dividend to be received from FTR Ltd not subject to withholding tax in Country F as a result of the EC Parent Subsidiary Directive 1 ITA prohibits the carry forward of tax losses if a person has other sources of income 5 Dividend does not expose GHL Ltd to any Maltese tax due to underlying tax relief 5 Losses offset against dividend received from FTR Ltd wasted 5 Computation of tax loss carried forward to Computation of tax payable by TRM Ltd 1 7 (b) Proposed group structure and other measures Mark and Elisa to transfer their shares in TRM Ltd to GHL Ltd in exchange for shares in GHL Ltd 1 Exchange of shares exempt from tax and duty 1 GHL Ltd and TRM Ltd will form a group for purposes of the group relief provisions 5 GHL Ltd can only surrender losses incurred during basis year 213 and subsequent years 1 TRM Ltd to inform bank not to withhold 15% tax on the gross interest for the calendar year Situation re bank interest to be revisited in GHL Ltd entitled to transfer to TRM Ltd the full amount of tax losses incurred during basis year GHL Ltd to transfer its shares in FTR Ltd to TRM Ltd in exchange for shares in TRM Ltd 1 Dividend distributed by FTR Ltd carries sufficient underlying tax credit to offset fully the tax chargeable on the dividend, and tax losses available to GHL Ltd are not wasted 5 Exchange qualifies for income tax and stamp duty exemption 5 Computation of tax loss carried forward to 214 by GHL Ltd 5 Computation of tax payable by TRM Ltd 1 5 Calculation of actual and potential future tax saving