MODULE 2.07 MALTA OPTION

THE ADVANCED DIPLOMA IN INTERNATIONAL TAXATION June 2018 MODULE 2.07 MALTA OPTION SUGGESTED SOLUTIONS

PART A Question 1 Profit FTA MTA UA (a) Profits from Cyprus Lease 1,000,000 (b) Pre-liquidated damages 500,000 (c) Profits from UK PE 1,000,000 (d) Profits from sale of mansion 5,000,000 (e) Profits from sale of palazzo 500,000 (f) Profits from franchise 3,000,000 agreement (g) Brokerage fee 50,000 (h) Gross bank interest 50,000 (i) Net bank interest 10,000 (j) Foreign bank interest not 30,000 remitted Total 1,010,000 4,050,000 6,080,000 Tax at 0% 0-0 Tax at 35% - 1,417,500 - Tax due 0 1,417,500 0 Note: For Malta income tax purposes, CL is considered to be ordinarily resident in Malta (considering that all Board meetings are held in Malta) and not domiciled in Malta (as it is domiciled in Cyprus). The sum of EUR1,000,000 which was due to it in terms of a lease agreement referring to the rental (mere leasing) of an office block in Cyprus. This sum of money was transferred to the company s bank account in Malta. Profits are taxable in Malta because they were received in Malta. Allocated to MTA because rental income does not constitute passive investment income for CL and because of the absence of a PE outside Malta. The sum of EUR500,000 due to CL by way of pre-liquidated damages because of a supplier s failure to deliver materials on time. Pre-liquidated damages not representing actual loss of future earnings are considered to be out of scope of tax and consequently allocated to the UA. The sum of EUR1,000,000 which was due to it in terms of a lease agreement referring to the rental of an apartment block in London. In addition to provide mere leasing, CL s personnel inspected and maintained the leased premises retaining the leased premises under their responsibility and control. This sum of money was transferred to the company s bank account in Malta. Page 2 of 15

In principle, the sum of EUR1,000,000 which was due to CL in terms of a lease agreement is taxable in Malta because it was received in Malta. CL s activities created a PE in the UK. The participation exemption would apply. The sum of EUR10,000,000 from the sale of a mansion in Edinburgh. CL had bought this mansion in 2015 from an impoverished Scottish nobleman. CL had bought the property for only EUR2,000,000 but carried out extensive renovation costs which took 2 years to complete and came at a cost of EUR3,000,000. This sum of money was not transferred to the company s bank account in Malta and was retained in CL s bank account in London. The circumstances of the deal incorporate several badges of trade indicating that the ensuing profit was a profit of a trading nature. The activities performed are attributable to a foreign PE and as such the profit is deemed to be foreign source. Given that the funds were not received in Malta, income is not taxable in Malta. The sum of EUR2,000,000 from the sale of a palazzo close to Rome. CL had bought this Palazzo in 2015. CL had bought the property for EUR1,500,000. Renovation works were minimal but were entirely done by CL s Maltese employees who travelled to Italy, working on the project for a whole year. This sum of money was not transferred to the company s bank account in Malta and was transferred to CL s bank account in London. Not taxable in Malta because it is foreign source trading income attributable to a foreign PE that was not received in Malta. A payment of EUR3,000,000 representing business income due in terms of a franchise agreement CL had entered into with a Chinese resident franchisee. Settlement of the amount due was done in two tranches: the first EUR2,000,000 tranche was paid in cash by bank transfer to CL s bank account in London, but and the remaining balance was paid in kind. The Chinese franchisee had provided CL with marble worth EUR1,000,000. The marble was exported directly from Sichuan, China to Edinburgh and was used to renovate the Scottish mmansion referred to in (d) above (and included in the renovation costs). In principle, the entire EUR3,000,000 represents taxable income. Given that the company is an active trading business and the activities generating the revenue cannot be linked to activities performed in a foreign country, the company s income from the franchise is deemed to arise where the company s management and control is located (i.e. Malta). The profit is allocated to the MTA. A commission (brokerage fee) of EUR50,000 from the sale of an apartment in London. The brokerage fee was recorded in CL s books but it was received in Mr. X s personal bank account in London. The brokerage fee is foreign source because it is linked to property situated outside Malta. It was not received in Malta, implying that it is not taxed in Malta and is allocated to the UA. Bank interest of EUR50,000 arising from funds held with a Maltese resident banking institution (MLT Bank Account 1). Interest was received gross of Maltese tax. This item is allocated to the MTA and taxed at 35%. Net bank interest of EUR10,000 arising from funds held with a Maltese resident banking institution (MLT Bank Account 2). Bank interest was received net of Maltese tax. Net interest is allocated to the FTA. Bank interest of EUR30,000 arising from funds held with a UK resident banking institution. Withholding tax was not charged on bank interest and was not transferred to Malta. This item is treated as foreign source passive income that is not taxed in Malta because it was not received in Malta. It is allocated to the UA. Page 3 of 15

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Question 2 The transfer of the following assets to Greg Vella: (1) Cash held at a London bank; (2) Cash held at a Maltese bank; (3) Securities listed on the Malta Stock Exchange; (4) Securities in British companies which are listed on non-maltese stock exchange. The British companies business interest are held wholly outside Malta; (5) The full ownership of a large plot of land in Tuscany, Italy; (6) The full ownership of a farmhouse in Tuscany, Italy; (7) The contents of the farmhouse in Tuscany including works of art, antiques and precious metals. Income Tax Implications Transfers of cash are not subject to income tax. The transfers of shares listed on the MSE are tax exempt. The transfer of UK shares by a non-resident (The Z Trust) to a Maltese resident is not subject to income tax in Malta. The transfer of immovable property situated in Italy by a non-resident (The Z Trust) to a Maltese resident is not subject to income tax in Malta. The transfer of the movables mentioned (which is not done by way of trade) is not subject to income tax in Malta. Duty Implications Transfers of cash are not subject to duty. The transfers of shares listed on the MSE are exempt from duty. The transfer of shares by a non-resident (The Z Trust) to a Maltese resident is in principle subject to duty in Malta at 2% (or at 5% in the case of shares deriving their value as to at least 75% from immovable property) if the transfer document is executed in Malta or used in Malta. The transfer of immovable property situated in Italy by a non-resident (The Z Trust) to a Maltese resident is not subject to duty in Malta. Nonetheless, should the document effecting the transfer be executed or used in Malta, it would become subject to duty. The transfer of the movables mentioned is not subject to duty. VAT Implications All the transfers mentioned are out of scope of tax. The transfer of the following asset to Rita Vella: (8) The full ownership of a villa in Madliena, Malta which Joe had transferred to The Z Trust in 1975. Income Tax Implications The transfer is subject to Property Transfers Tax. The Z Trust would have to pay property transfers tax at the rate of 8% of fair market value. Duty Implications Page 5 of 15

The transfer is subject to duty. Rita Vella must pay duty on documents and transfers at the rate of 5%. No tax exemption is applicable. VAT Implications None The transfer of the following assets to Wioletta: (9) The full ownership of a terraced house in Hamrun, Malta which Joe had transferred to The Z Trust in 1973. Unlike the rest of the properties owned by The Z Trust, the Hamrun house is not free and unencumbered. It is subject to a right of habitation in favour of Ekaterina, Wioletta s mother, a Polish citizen who moved to Malta in 1973. Ekaterina is a resident of Malta but is not domiciled in Malta; (10) 99% of the redeemable (non-voting) preference shares in Z Company Ltd, a company that was incorporated in Malta in 1999. The shares are subject to a fixed rate of return. Income Tax Implications The transfer of the terraced house is subject to Property Transfers Tax at 8% (payable by the Trustee). The shares being transferred do not fall under the definition of securities for capital gains purposes, so that the transfer of the shares is not subject to income tax. Duty Implications The transfer of the terraced house is subject to duty on documents and transfers (payable by Wioletta) at the rate of 5%. The transfer of shares to Wioletta is exempt from duty because the company s business interests are outside Malta and transferee is a non-resident. VAT Implications None. Page 6 of 15

PART B Question 3 Report To: Daniel From: Tax Advisor Re: Tax Compliance Unit investigation Date: xx/xx/2018 Advise Daniel with respect to the tax risks arising from the way he has been conducting his affairs and managing his assets. Each asset is examined separately: (1) Shares in MHL MHL is a Maltese company falling within the purview of the deemed distribution order provisions. If the Commissioner for Revenue is of the opinion that dividends were not distributed for the avoidance of tax, Daniel could be assessed on the undistributed profits derived by MHL. (2) 99% of the equity shares in Operating Ltd ( OP ), a company that was incorporated in Malta in 1980. OP has never paid income tax in Malta, reporting losses carried forward from year to year. OP is fully entitled to incur expenses and carry forward any tax losses indefinitely, but the fact that this company has never reported income chargeable to tax and paid tax is a cause for concern, especially in view of the rest of the information available. There is a high risk that the tax authorities will question whether the losses claimed are genuine losses. (3) 5 shops located in Maltese cities, all of which are operated by OP MHL is fully entitled to own the shops but, considering Daniel s low income declarations, questions may be raised as to how a person falling in such a low income earning bracket has managed to accumulate sufficient wealth to own a company that, in turn, owns 5 shops. All the equity shares in Lux Ltd, a company incorporated in Luxembourg. Lux Ltd owns a number of luxury apartments in Sliema, Malta which it rents out, paying tax at 15%. Lux Ltd never distributed dividends but, every year, it lends material sums of money to Daniel without charging him any interest. Page 7 of 15

The Fringe Benefit Rules provide for imputed interest on an interest-free loan provided to an officer of the company. Daniel was meant to be declaring chargeable income and paying tax in respect of this interest-free loan. Information relating to the holding of shares in an EU Member State could be shared in terms of local laws on the exchange of information. Lux Ltd s failure to distribute dividends does not, however, fall under the purview of the provisions on deemed distribution orders because Lux Ltd is incorporated and resident outside Malta. (4) Equity shares held in Bahamas Ltd, a company incorporated in the Bahamas in 1997. Income derived by Bahamas Ltd consists in management fees charged to Maltese resident companies owned by third parties. Maltese tax law does not incorporate a tax haven black list, but there is a risk that the tax authorities will questions why a special purpose vehicle has been incorporated in such a remote jurisdiction. It is also very possible that questions may be raised on the place of management and control (and hence tax residence) of Bahamas Ltd. The risk that the Revenue will apply the general anti-avoidance rule in Article 51 of the Income Tax Act is mitigated by the fact that the Bahamas Company appears to be distributing dividends to MHL. The fact that MHL has applied FRFTC with respect to dividends received from Bahamas Ltd does not of itself create a risk because the company is availing itself of a tax advantage which it appears to be fully entitled to. (5) Around a million euros in cash held in a number of Swiss Bank Accounts. This asset creates a significant risk. Information will be/has been shared and the fact that this income has not been declared in multiple successive tax returns over several years creates a significant risk. As a director of a company which appears to have evaded tax, Daniel is personally liable to criminal proceedings for tax evasion. Explain to Daniel his rights and obligations at investigation stage Obligations The Income Tax Management Act prescribes that the Commissioner for Revenue has the power to require any person to provide documentation, with powers to call for books and records. The Commissioner has powers of access to information too. Failure to comply with a notice (including a notice to provide information) is a criminal offence punishable with a fine for every day of default. Under the Income Tax Acts, a taxpayer has a duty to comply with a request for information. Rights The taxpayer has a right to be heard and must be granted the right to produce documents within a reasonable time. If the taxpayer is not informed of his right not to incriminate himself, information collected may not be used in the course of criminal proceedings. The Constitutional Court has also affirmed that tax investigations must be concluded within a reasonable time. Explain his rights and obligations in the eventuality that the Inland Revenue Department will issue an assessment, explaining his rights and obligations in the event of an appeal If the Inland Revenue Department will issue an assessment against Daniel, Daniel will have the right to object to the said assessment by filing a notice of objection within 30 days. At objection stage, the case will be re-examined once more. If the objection will be accepted, the assessment will be cancelled or revised and the case would be closed. If the Inland Revenue Department disagrees with the objection, the Inland Revenue Department would issue a notice of refusal, which it must issue within a reasonable time. The taxpayer would have the right to appeal from the Commissioner s assessment within 30 days from date of receipt of the notice of assessment. The taxpayer s appeal would be lodged to the Administrative Review Tribunal, which is bound to act impartially and independently. The Administrative Review Tribunal must grant taxpayer the right to a fair hearing, granting him full Page 8 of 15

access to all information collected by the Department at investigation stage. Appeals from decisions of the Administrative Review Tribunal may be filed to the Court of Appeal on points of law only. The legal consequences which could arise in the eventuality that Daniel is found to have evaded or avoided tax. Should a tax assessment be raised against Daniel, he would be liable to pay endangered tax and administrative penalties in the form of omission tax. In addition, punitive interest would be charged on the late payment of tax. In cases of evasion, fraud and materially incorrect tax returns, assessments could be raised for dates earlier than the standard 6-year peremptory term. Given the particular circumstances of the case of Daniel and MHL (in particular the use of an offshore structure and non-declaration of potentially material amounts of income), it is not excluded that criminal proceedings under the Criminal Code and the Income Tax Management Act would be instituted too. Page 9 of 15

Part C Question 4 Income FTA IPA FIA MTA UA 1) Dividend from FIA of Trading Ltd X 2) Tax refund X 3) Italian dividend X 4) Cayman dividend X 5) Dutch dividend X 6) Dividend from Non-EU subsidiary X 7) Swiss Bank Interest X 8) German royalty X 9) US Dividend X 10) FTA Dividend X 11) MTA Dividend X 12) Pakistani Dividend X 13) Indian dividend X Page 10 of 15

Question 5 Profit as per financial statements 3,900,000 Add back: Donations 1,000 Additional tax for omission (income tax) 3,000 Additional tax for default (income tax) 1,500 Penalty interest for late tax payment (income tax) 1,000 Administrative penalty for incorrect VAT return (VAT) 2,000 Rent paid with respect to DL s premises in Italy 50,000 58,000 3,958,000 Less: Tax Exempt Income 20% of profits (Chargeable income attributable to DL s Italian branch eligible for the Participation exemption) (780,000) Chargeable Income 3,178,000 FTA IPA FIA MTA UA 780,000 nil nil 2,065,700 (net of 35% tax) (58,000) Page 11 of 15

Question 6 (1) MIOL operates a cotton farm in Albania. MIOL does not own the land occupied by the farm but operates the land in terms of an exclusive 20 year concession from the Government of Albania. MIOL built a processing facility on the Albanian farmland, installing its own plant and machinery. Although the definition of Permanent Establishment (PE) contained in Malta s double tax treaty with Albania does not expressly refer to farmland, MIOL s processing facility (albeit built on land which is merely rented) of itself does constitute a PE. The installation of the processing facility also indicates that the fixed place of business is not kept for activities of a merely preparatory or auxiliary character. (2) MIOL owns a sales outlet and storage facilities in Bahrain. The sales outlet and storage facilities are used wholly and exclusively to sell textiles. This activity falls within the definition of PE contemplated in Malta s double tax treaty with Bahrain. (3) MIOL owns a small processing plant in Bulgaria; the processing plant has been rented out to MIOL s Bulgarian subsidiary. Given that MIOL has rented out the processing plant to another company, MIOL does not have a PE in Bulgaria. (4) MIOL owns and operates a shop in Canada. This is clearly an activity within the definition of PE contained in the double tax treaty. (5) MIOL does not own or occupy immovable property in Croatia but two of MIOL s employees spend 10 months a year in Croatia supporting MIOL s Croatian franchisee. MIOL has created a PE in Croatia because Malta s double tax treaty with Croatia contemplates a Services PE article and, in this respect, the criterion relating to timing (nine months out of 12 months) is met. (6) MIOL does not own or occupy immovable property in Cyprus but 10 of MIOL s employees spend 11 months a year in Cyprus supporting MIOL s Cypriot franchisee. Given that Malta s double tax treaty with Cyprus does not contemplate a Services PE provision, the activities rendered in Cyprus are not sufficient to create a PE. (7) MIOL does not own or occupy immovable property in the Czech Republic but MIOL provides its Czech franchisee with the services of a Manager. The Manager spends seven months a year in Croatia. Malta s double tax treaty with the Czech Republic contemplates a Services PE provision, and the condition for the creation of a PE is met (activities for more than six months). (8) MIOL owns a warehouse in Egypt. MIOL uses its Egyptian warehouse for the storage of textiles. MIOL does not have a PE in Egypt because its warehouse there is only used for storage of goods and Malta s double tax treaty with Egypt does not comprise a stock PE provision. (9) MIOL has entered into a franchise agreement with an Estonian agent. MIOL s Estonian agent is entirely independent from MIOL but would require technical assistance from time to time. Nonetheless, all technical assistance needed is offered from Malta by videoconference. Page 12 of 15

This activity of an independent agency nature is not a PE for the purposes of the Treaty. (10) MIOL is the sole shareholder of a holding company in Guernsey. MIOL s directors sit on the board of the Guernsey company. This activity does not create a PE for the purposes of the Treaty. (Issues of effective management and control may potentially arise). (11) MIOL rents a warehouse in Hong Kong in which it stores its products. MIOL does not have a PE in Hong Kong because its warehouse there is only used for storage of goods and Malta s double tax treaty with Hong Kong does not comprise a stock PE provision. (12) MIOL owns a plantation in Malaysia but does not carry out any trade in Malaysia. Malta s double tax treaty with Malaysia incorporates an express reference to the fact that a plantation is deemed to constitute a PE. (13) MIOL owns a warehouse in Pakistan but the warehouse has not been used for several years. The fact that the warehouse is not in use implies that MIOL does not have a PE in Pakistan. Furthermore, Malta s double tax treaty with Pakistan does not provide for a stock PE. (14) MIOL performs services in Russia through an individual who is present in Russia for a period exceeding in the aggregate 183 days in any 12 month period but does not carry out any active services in Russia because MIOL s activity in Russia relates to income of a passive nature. MIOL does not have a PE in Russia. Although the presence test in the PE definition is met, the active test is not met. (15) MIOL owns and operates a warehouse in Saudi Arabia where it keeps stocks for export to the Middle East. For the purposes of the double tax treaty with Saudi Arabia, the maintenance of a warehouse band stock is not sufficient to create a PE. Page 13 of 15

Question 7 In 2017, the Constitutional Court ruled that the 1998 Maltese tax penalty system (in force before 2009) was in breach of the right to property. The judgment has been described as being extremely important because, for the first time, the Maltese Courts have struck down a tax penalty system on the basis of its lack of proportionality. In Farrugia v. Prime Minister et delivered on 8 May 2017, the Constitutional Court ordered a significant mitigation of tax penalties, annulling a number of judgments delivered by the Criminal Courts because it felt that the penalties imposed on Farrugia had been excessive. Farrugia had failed to pay around EUR180,000 in VAT on time and for his failure, he was punished with a series of administrative penalties and interest totalling over EUR260,000. The penalties imposed were significantly higher to the tax that was not paid on time. Farrugia had tried to pay his tax bill, but payments made were being applied against accruing penalties, and Farrugia was caught in a vicious circle. To make matters worse, Farrugia was prosecuted criminally for not paying his tax on time. In 2002, Farrugia was prosecuted criminally for the same facts that had been previously punished by the hefty tax penalties. Farrugia was found guilty and given a deadline within which to pay tax due. Failure to pay tax within the strict timelimit established by the Court could expose Farrugia to an effective prison term. Farrugia filed constitutional proceedings challenging the whole tax penalty system both because of its lack of proportionality as well as on the basis of the double jeopardy rule. The Court of First Instance decided for Farrugia on the basis that Farrugia had been punished twice for the same offence. The Constitutional Court acting as an appellate Court went a step-further. It confirmed that VAT law was in breach of the double jeopardy rule (albeit for different reasons to those of the first Court) and, more importantly, it struck down the 1998 penalty regime as being disproportionate and consequently in breach of the right to property. The Constitutional Court held that, with respect to enforcing its taxing rights, the State has wide powers but this did not mean that a State is free to impose exorbitant penalties. The fact that States have wide margins of appreciation in determining their tax policy does not mean that they can ignore the value of proportionality. The Constitutional Court was critical of the system of late payment penalties in force before 2009 because it created an excessive burden on taxpayers. In this respect, the Constitutional Court ordered a communication of the judgment to the House of Representatives. The section in the Farrugia judgment dealing with non bis in idem does not come as a surprise because it is based on a number of previous judgments of the Constitutional Court, but the Court s pronouncement on the right to property makes the judgment extremely important. Farrugia succeeded in persuading the Court that the unpopular 1998 penalty regime was illegal because it was disproportionate. Cases when Courts conclude that tax regimes create excessive burdens tend to be exceedingly rare. The Constitutional Court s judgment in Farrugia is the only case when the Constitutional Court has found that a Maltese tax system is in breach of the right to property. Since Farrugia submitted his case, the law has been changed and the harshest features of the 1998 regime have been mitigated by legislative intervention, but legislative changes were prospective and non-retrospective implying that the case load pending in front of the Maltese Courts includes several disputes under the old 1998 regime. Accordingly, the Farrugia case is expected to impact on most pending judgments. Farrugia s ramifications will not be circumscribed to the short-term future. After the Farrugia case, it is highly unlikely that Malta will revert to a system similar to the punitive regime of 1998. Legislative interventions mitigating the harshness of the 1998 penalty regime were introduced in the context of an economic boom and it was feared that, in the contingency of an economic downturn, the tax system would revert to the old system of 1998. The Constitutional Court s judgment creates a set of rules which are likely to condition the evolution of tax policy in Malta. Page 14 of 15

The Constitutional Court s comments on punitive interest have a great deal of practical significance. The Court did not only mitigate punitive interest but referred to it as a criminal charge, a penalty in itself. The classification of punitive interest as a criminal charge suggests that the processes followed in connection with the imposition and collection of such interest should be re-considered. Page 15 of 15