In 2018, the Government of Malta had issued new rules which provide for a notional interest deduction (NID) against the chargeable income of an undertaking for sums that are deemed to be payable by way of interest on risk capital.
The NID is designed to align the tax treatment of the cost of equity with that of the cost of debt (i.e. dividends are not deductible, whereas interest on financing is a tax-deductible expense) and, therefore, bring equity financing on a par with debt financing. This will be achieved by allowing Malta companies and partnerships (including Malta permanent establishments of foreign companies or partnerships) to claim a deduction for “interest on risk capital.” Specifically, such companies will be able to claim a deduction against their chargeable income for notional interest deemed to be incurred on their equity capital.
The deduction for the notional interest may be taken by companies or partnerships which are resident in Malta and by any other companies or partnerships which are not resident in Malta
and that derive income that is effectively connected with a permanent establishment of the company or partnership situated in Malta.
In the case the undertaking is a company or a partnership resident in Malta, the risk capital is defined as the share or partnership capital of the undertaking, any share premium, positive retained earnings, loans or other debt borrowed by the undertaking which do not bear interest, and any other reserves resulting from a contribution to the undertaking, and any other reserves resulting from a contribution to the undertaking and any other positive balance which is shown as equity in the financial statements of the undertaking.
Where the undertaking is a non-resident company or partnership, the risk capital is that part of the risk capital as defined above of the undertaking that is attributable to the permanent establishment situated in Malta.
The deduction may be claimed at the option of the undertaking and such deduction may only be claimed if all shareholders or owners of the undertaking approve the claiming of such deduction in respect of the particular year of assessment.
The entitlement to a deduction shall only apply in respect of profits which stand to be allocated to the company’s Foreign Income Account (FIA) or the Maltese Taxed Account (MTA). If the undertaking is not a company, the deduction will only apply to those profits which would have been allocated to the MTA or FIA had the undertaking been a company.
The interest on risk capital is calculated as follows: Y = A X B where
“Y” represents the interest on risk capital that an undertaking is entitled to claim in the relevant year of assessment;
“A” represents the reference rate, which means the risk-free rate set by reference to the yield to maturity on Malta Government Stocks with a remaining term of approximately 20 years plus a premium of 5%;
“B” represents the risk capital of the undertaking for the accounting period ending in the year preceding the year of assessment less any risk capital directly employed in the form of securities, interest in a partnership, contributions and any other loans or debts that do not bear interest that the undertaking holds in or provides to any person that is:
- Not employed by the undertaking in producing any income in the year, which if produced could have been exempt from income tax; or
- Employed in producing income for the year which is exempt from income tax.
Where the interest on risk capital exceeds 90% of the undertaking’s chargeable income, for any year prior to taking into account such deduction, the amount of such excess shall not be available for deduction against the profits for the said year, but may, at the option of the undertaking, be carried forward to be deducted against future taxable profits. Any amounts carried forward shall also be increased by such rate as may be prescribed by the Commissioner for Revenue.
Where an undertaking claims this deduction, the shareholder or partner of the undertaking shall be deemed to have received in that year an amount of income equal to the interest on risk capital claimed as a deduction by the undertaking for the said year of assessment, corresponding to the proportion of the nominal value of the risk capital which each shareholder or partner, holds in the undertaking at the end of the year. The income shall be characterized as interest and all the provisions relating to the taxation of interest income (with the exception of the ‘investment income provisions’ found in Articles 32 to 42 of the ITA) shall apply to such deemed income.
Where the NID is claimed, the company’s shareholder (or partner in the case of a partnership) will be deemed for Malta tax purposes to have received notional interest income in the same amount. Where a shareholder or partner of the undertaking is not resident in Malta, the deemed interest will be exempt from tax in Malta provided certain requirements are met.
Where a shareholder or partner of an undertaking that is a company is deemed to have received interest income as explained above, the shareholder or partner will be entitled to deduct any interest on risk capital which it is deemed to have incurred in terms of this rule against such deemed interest income without the 90% limitation mentioned above.
Where any risk capital results in a deduction being claimed by the undertaking in terms of other provisions of the Income Tax Act, the undertaking shall be entitled to make a choice whether to claim a deduction in terms of these rules or in terms of the other rules.