Opinion - George M. Mangion | Wednesday, 16 April 2008

Called to account

Let me dwell on the subject of taxes and see how Malta has used this financial tool to attract international business and generate wealth.
Many agree that the past 20 years have seen a measured yet invigorating growth as a financial centre. A lot of water has passed under the bridge.
I remember clearly how 1988 ushered the birth of MIBA as a new institution heralding the start of an offshore regime. This opened the way for a regulatory framework aimed at attracting reputable players in the international market while providing an aura of secrecy on their business affairs. It gave birth to a unique opportunity for lawyers and accounting firms acting as licensed nominees to appear in their name on behalf of a number of international investors.
The institution of ‘nominees’ rose to the occasion and within a short timeframe was able to compete with other centres such as Dublin, Cyprus, Gibraltar, Dutch Antilles, Isle of Man and Channel Islands. This period was the start of our offshore regime which gave us a leading edge over other centres even though we had taken every precaution at law to hold nominee firms fully responsible to vet and be accountable for their clients.
Six years later in anticipation of EU membership the regulations were revamped and in 1994 government introduced an onshore structure. This followed general criticism on the merits of tax havens associated with the offshore pattern of secrecy.
At the same time more than 20 new financial laws were promulgated to upgrade our legislation with EU directives. These were momentous times for lawyers and accountants since there was a paradigm shift which forced practitioners to go back to law books to study the changes. The effort was worth the trouble and out of the ashes was born an efficient regime which proved to be a welcome shelter to any overseas investor. Following EU accession in 2004 and now Eurozone, it is without a shred of doubt that Malta has made the grade and is currently reaping the fruits of its cautious and steady approach as an onshore regime. Another milestone was the agreement reached last year with the Commission regarding our tax imputation system and fine tuning of our holding company tax exemption rules. Such an incentive change is reflected in an increasing number of wealthy individuals who now live in or have retired here following the revision of the permanent resident scheme.
More success can be manifest by our expanding list of tax treaty networks exceeding 48 countries and lately the good news regarding the signing of the US double tax treaty. Look around you and you will find a quantum leap in all financial services sub-sectors although more needs to be done to reach our optimum levels.
All this is evidenced by heightened activity in mergers and acquisition, in formation of trusts and foundations, hundreds of collective investment schemes, fund management and in attracting captives in the international arena. Our legislation has been keeping pace with the dynamism of a fast changing financial environment.
Let us examine the primary factors that have led to our success achieved in sectors including funds, insurance, investment services and banking.
The crucial step was the negotiation and signing of tax treaties .
Tax treaties provide benefits to both taxpayers and governments by setting out clear ground rules that will govern tax matters relating to trade and investment between the two countries. A tax treaty is intended to focus the tax systems of the two countries in such a way that there is little potential for dispute regarding the amount of tax that should be paid to each country. The objective is to ensure that taxpayers do not end up caught in the middle between two governments, each of which would like to tax the same income. Once a treaty relationship is in place and working as it should, governments need spend little additional resources negotiating to resolve individual cases because the general principles for taxation of cross-border transactions and activities will have been agreed in the treaty.
Over the years this drive to negotiate and sign cross-border treaties has attracted inward investment. The reason is simply because one of the crucial functions of tax treaties is to provide certainty to a safe investment without the scare of double taxation.
Treaties solve this double taxation question by establishing the minimum level of economic activity that a resident of one country must engage in within the other country before the latter country may tax any resulting business profits.
In simple words it defines where in the two contracting states a taxpayer has established a permanent establishment.
In general terms, and without going into technicalities tax treaties which follow the OECD model provide that if the branch operations have sufficient substance and continuity, the country where the activities occur will point to the primary jurisdiction to tax.
In other cases, where the operations are relatively minor, the home country retains the sole jurisdiction to tax its residents.
This allocation of profits usually takes several forms. First, the treaty has a mechanism for determining the residence of a taxpayer that otherwise would be a resident of both countries. Secondly, the treaty provides rules for determining which country will be treated as the source country for each category of income.
Given that some investors are tempted to indulge in abusing the treaties that is why so much fuss is made in international waters to combat treaty shopping.
The reason is simple and a little legal background helps explain the ongoing crusade against treaty shopping. It all started in the early 1970s which saw a growth of tax avoidance strategies involving third-country nationals’ use of tax-haven entities to gain advantages typically under tax treaties involving claims by United States nationals. This practice referred to earlier as “treaty shopping” has irked many so called high tax countries both in EU and the United States. One bold attempt to combat treaty shopping was for the US to insist on inclusion of detailed “limitation on benefits” (“LOB”) provisions in tax treaties; these LOB provisions generally hamper treaty benefits. One notes that the issue of combating treaty shopping is particularly important for policing cross-border trade and minimising unfair tax competition.
Typically islands in the Caribbean with little or no self regulation were branded as whipping boys and black listed. Back to Malta, government was cautious to keep up the good reputation and set stiff regulations in place that discourage the setting up of ‘sham’ companies by owners of dubious origins.
One of measures by MFSA to fight treaty abuse is enforce strict rules that special vehicles or companies are not set up without properly setting up and having substance and management control there.
At an EU level we find many states that impose CFC (controlled foreign company) legislation to combat tax leakages principally through passive income.
Another important aspect is the provision addressing the exchange of information between the tax authorities. Such information is exchanged but only as may be necessary for the proper administration of that country’s tax laws, subject to strict protections on the confidentiality of taxpayer information.
As a member in the European Community Malta strives to eliminate economic distortions and help guarantee the principle of neutrality of taxation. It offers many advantages to investors such as the elimination of withholding taxes and capital gains on non-residents. It does not apply CFC transfer pricing or thin capitalisation rules.
Needless to say in the global slowdown due to the credit crunch it is becoming more challenging to attract blue chip investors albeit fly-by night operators are not welcome. Change in a globalised world is inevitable and we are all called to account as Malta needs to focus all its resources to match the needs of the discerning investor.

George M. Mangion
The writer is a partner in PKF an audit and business advisory firm