OPINION - George Mangion | Wednesday, 05 March 2008

A premium financial centre?

The USA-Malta Double Taxation Agreement is now expected to be signed soon and formal concluding negotiations have officially begun in accordance with an announcement by the US Treasury Department.
Other taxation agreements were signed in the past four years with the United Arab Emirates, Singapore, Spain, Greece, Iceland and San Marino. Agreements with Switzerland and Jordan are now concluded and ready for signature. Our wealth of bilateral agreements was accelerated as a result of the 1994 fiscal reform.
The message was clear that we should refrain from pushing Malta as a location purely on the strength of its tax advantages but as a financial centre with good communications, high calibre of professional staff and good legal/banking infrastructure.
What makes us attractive for non-resident investors?
The answer is partly because of the local fiscal incentives and favourable framework for conducting international business through the new Maltese corporate vehicles. Certainly this has stood the test of time and cannot be classified as harmful tax competition. Such benefits included the exemption from transfer duty on share issues and the possibility of postponing payment of tax due. A system of partial refund of the Malta tax paid by the onshore company to its non-resident shareholders is available in the case of a trading company upon distribution of dividends. In the case of a Holding company registered in Malta with a participating holding in an overseas investment it is entitled to a full refund on tax suffered by its non-resident shareholders. In certain cases holding companies may also avail themselves of new tax exemption which is even more attractive provided the income is not classified as passive.
These schemes can be seen in favourite light when taking into perspective other territories such as the Channel Islands, Gibraltar and Luxembourg. Of interest to the participants is that non-resident persons are exempt from tax on interest, royalties and capital gains arising in Malta. The closely guarded secret is that we used a one-tier full imputation system whereby tax paid by a company is credited in full to the shareholders on receipt of a dividend. The tax benefits from the use of an onshore are non-discriminatory in that the shareholders need no longer be non-residents.
Through a novel system of tax rebates the shareholders of such companies are taxed at 35% but are eligible to a 6/7 th refund once such profits are issued as dividends. Typically, the company pays at the corporate rate of 35% on its profits which can be denominated in any foreign currency. In a hypothetical example a gross profit of €100 would carry a €35 tax charge in the hands of the company. When the €100 is distributed as a dividend the non-resident shareholder will receive a refund of €30 which constitutes an effective tax of 5%. This contrasts with the rate of 10% charged by Cyprus.
This has removed any criticism associated with the old tax regime which in some circles was considered as ‘ring-fencing’ of the fiscal legislation intended to give advantages to non-residents while retaining a full tax regime for the locals. Thus the island has joined the list of reputable financial centres with multiple tax treaties, mainly to avoid double taxation. As can be expected tax competition between competing financial centres raises a number of questions.
Tax cutting governments are occasionally motivated by hopes of poaching economic activity from other countries.
What makes us attractive to investors? The answer is not a simple one but surely investors are attracted to countries offering a comprehensive use of tax treaty network with an added advantage of no/minimal capital tax and little or no exchange control.
So where can we improve our ways?
The answer lies in changing our mentality that government owes us a living. We seem to have lost the urge to work hard and live by the fruits of our exports. Going supple after hearing so many electoral promises we can be excused for believing that there is a soft underbelly to every problem. Politicians are blowing their trumpets from the high bastions heralding the good times of less work, less taxes and more state benefits. Deep down we know that a reality check awaits us next week.
There have been a number of articles and comments in the press over the past few days suggesting that personal taxation should be replaced by a flat tax. Others lament that the level of corporation tax in Malta is too high compared to rates charged in other EU member states. A major disincentive is the cash flow constraints of a high tax rate.
In UK there is a double tier system for corporate tax which recognizes the incentive effect of small businesses being taxed at a lower rate which may reduce to 19% in certain circumstances.
Therefore it is academic to defend our “ imputation “system when in practice, seldom can the companies pass its full benefit to shareholders. Again saying that the imputation system is benevolent is not disputed but what is disputed is the high rate that was only justified in boom years in early 1990’s. It is time that the elected party next week revisits this chapter and comes out with a practical solution which does not destabilises our tax base while encouraging growth. Only then can we enter the race to qualify as the premium financial centre of the Mediterranean.