As an international financial services centre, Malta provides for various fiscal incentives both to Malta companies and also to their shareholders. This makes Malta a very tax efficient jurisdiction where to set up companies to hold intellectual property such as patents, trademarks, trade names, copyrights and other intellectual property rights.
Taxation of royalty income
Tax payable by a Malta company which is in receipt of royalty income is subject to a flat rate of tax of 35%, irrespective of whether such profits are distributed or otherwise. However, Malta provides for various fiscal incentives which ensures that this rate of tax of 35% is reduced to lower rates of tax.
The full imputation system of tax ensures that dividends paid by the Malta company in receipt of royalty income will not be taxed again in the hands of the shareholders. The tax paid by the Malta company is imputed in full towards the shareholders’ tax liability, thus ensuring that the same income will not be subject to tax twice, first at company level and then at the level of the shareholder.
Furthermore, there will be no withholding tax on dividends distributed by the Malta company to its shareholders, while as explained below, Malta provides for various forms of relief from double taxation to ensure that the royalty income received by the Malta company will not be taxed twice in two different jurisdictions.
Exemption from income tax on royalties paid to non-residents
No tax is paid by non-residents who receive royalty income. Such income is exempt from Malta income tax when received by non-residents. Furthermore, no tax is withheld when effecting payment of royalty income to non-residents. Such an exemption from tax would not be applicable where the person receiving the income is engaged in a trade or business in Malta through a permanent establishment situated therein and such royalty income received is effectively connected with such a permanent establishment.
The exemption from income tax on royalty income would also not apply if the beneficial owner of the royalty income is a person who is not resident of Malta and such a person is owned and controlled by directly or indirectly or acts on behalf of an individual or individuals who are resident or domiciled in Malta.
Passive royalty income
Passive royalty income is defined as royalty income which is not derived directly or indirectly from a trade or business and which has not suffered or has suffered foreign tax at a rate which is less than 5%. The distinction between passive and active royalty income is of paramount importance when calculating refunds of tax to shareholders of Malta companies in terms of Malta’s refundable tax credit system (see below).
Relief from double taxation
Malta provides for various forms of relief from double taxation. In fact, it has concluded more than 70 double taxation agreements, all based on the OECD Model Convention. Malta also provides for unilateral relief provisions in its income tax legislation which grants relief from double taxation to Malta residents that suffer taxation in a jurisdiction with which Malta does not have a double taxation agreement for the avoidance of double taxation.
Malta also provides relief from double taxation by means of the Flat Rate Foreign Tax Credit (FRFTC). The FRFTC is only available to companies and is mainly used when the other forms of relief from double taxation (i.e. treaty relief and the unilateral relief) are not available. The FRFTC is available to both passive royalties which have not been derived from a trade or business and to royalties which have been derived from a permanent establishment which the company making the claim for relief has in a foreign jurisdiction.
This means that foreign royalty income on which foreign tax has been paid, will not suffer taxation again in Malta since Malta will grant relief form double taxation. For a Malta resident person to make a claim for relief from double taxation (treaty relief or unilateral relief), evidence of foreign tax has to be provided, while in the case of FRFTC, an auditor’s certificate confirming that the royalty income arose overseas is sufficient to claim relief from double taxation.
Refunds of tax to shareholders of Malta companies
Another important tax incentive provided to shareholders of Maltese limited liability companies is that which is mostly referred to as ‘the refundable tax credit system’, whereby part of the tax paid by a company on its profits is refunded back to its immediate shareholders on distribution of a dividend.
There are three tax refunds which are applicable in the case of a Malta company receiving royalty income.
5/7ths tax refund – this is generally applicable when the Malta Company is in receipt of income consisting of passive royalties. As stated above, passive royalty income consists of royalty income which is not directly or indirectly derived from a trade or business and which has not suffered or has suffered foreign tax which is less than 5%. This results in a net tax leakage in Malta of 10%.
2/3rds tax refund – this is generally applicable when the Malta Company distributing the dividends and which is in receipt of royalty income, has benefitted from one of the various forms of relief from double taxation, mainly treaty relief, unilateral relief or the Flat Rate Foreign Tax Credit (FRFTC). The FRFTC is a deemed credit which is only applicable to companies and which is available should the first two forms of relief from double taxation are not applicable.
The 2/3rds tax refund is calculated on the total tax paid on the royalty income (i.e. including the foreign tax) in case the Malta Company distributing the dividends claims either the treaty relief or the unilateral relief. The 2/3rds tax refund is calculated on the Malta tax only if the Malta Company distributing the dividends claims the FRFTC. This results in a net tax leakage in Malta of a rate which is between 0% and 6.25%.
6/7ths tax refund – this is generally applicable in cases where the above-mentioned two refunds are not applicable, which results in a net tax leakage in Malta of 5%. Examples where this type of refund would apply are where the Malta Company distributing the dividends derives royalty income from a trade or business, which is not considered to be passive as explained above. Furthermore, the Malta company must not have derived such royalty income from a foreign permanent establishment and it must not have claimed any form of relief from double taxation as explained above.
Taxation on capital gains derived from the transfers of intellectual property
Malta has a system of taxation which taxes capital gains derived from an exhaustive list of assets. Capital gains are only taxable if they are derived from a transfer of a capital asset and the capital asset is one which is mentioned in the applicable article of the Income Tax Act. Patents, copyrights, trade marks, trade names and other intellectual property are all mentioned in this article and therefore any transfers of such assets will be subject to Malta tax.
Transfers of intellectual property between two companies that form part of the same group are not subject to Malta tax. For two companies to form part of the same group, they must either have a parent subsidiary relationship, or both companies must be owned as to more than 50% by a parent company. Two companies that are owned as to more than 50% by the same shareholders (including individuals) also form part of the same group for the purpose of transferring intellectual property without the payment of any tax.
Roll over relief is also applicable in case an intellectual property which has been used in a business for at least three years, is sold and is replaced within one year from date of sale. In this case, the gain derived from the sale of the first intellectual property will not be taxed. Taxation on such a gain will be deferred to a date when the second or subsequently acquired intellectual property is sold without a replacement.
As stated above, Malta has concluded a number of double taxation agreements for the avoidance of double taxation. All these agreements are based on the OECD Model Convention.
The pertinent article in the OECD model convention dealing with royalty income states that royalty income arising in one state shall only be taxed in the country of residence of the beneficiary receiving such income. This means that the OECD Model Convention gives an exclusive jurisdiction to tax to the country of residence of the beneficiary. On the other hand, double taxation is avoided since the country in which the royalty income arises will not have any jurisdiction to tax over the royalty income.
Article 12 of the OECD Model Convention provides for an exclusive jurisdiction to tax to the country of residence of the person receiving the royalty income. Thus relief from double taxation will be granted by means of the exemption method wherein the source country will waive its right to taxation and grants it exclusively to the residence country.
This means that with respect to Malta’s double taxation agreements that grants exclusive right to tax to the country of residence of the beneficiary, similar to the manner in which it is granted in terms of Article 12 of the OECD Model Convention, foreign royalty income received by a Malta resident company or individual shall only be taxed in Malta, thus benefitting from the above-mentioned tax incentives.