Dr Priscilla Mifsud Parker explores the notion of notional interest deduction and outlines the legal rules applicable for a company to be able to apply this against its income.
The Notional Interest Deduction in Malta
Why was the NID provision launched in Malta?
The notional interest deduction was introduced in Malta as a reaction to the European Council Recommendation of 9 July 2013 on the National Reform Programme of 2013 of Malta and delivering a Council opinion on the Stability Programme of Malta, 2012-2016. It was noted that there was a need to reduce the bias towards funding with debt versus financing. The need to reduce the bias towards funding with debt is also a key aspect of the CCCTB (Common Consolidated Corporate Tax Base) proposal.
The Government of Malta introduced a notional interest provision in the tax legislation in 2016 that allows for a deduction of sums in respect of risk capital. This provision in Malta tax law that introduces the notional interest deduction is aimed at approximating neutrality between debt and equity financing. In this manner, both the cost of equity and debt will be allowed as a deduction and thus the tax distortions in financing and investing decisions made at the corporate level should be mitigated.
How does the Malta Notional Interest Deduction Work?
The Maltese Notional Interest Rules were published in October 2017. New superseding legislation was soon after published in January 2018.
The Notional Interest Deductions Rules apply to:
- any company or partnership that is resident in Malta; and
- any company or partnership that is not resident in Malta that derives income that is effectively connected with a permanent establishment of the company or partnership situated in Malta.
The Malta interest deduction on equity is calculated as a percentage (%) of the company’s “risk capital”. Risk capital is defined as follows;
- in the case of a company or partnership resident in Malta the applicable equity is the share or partnership capital, 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 company or partnership, and any other positive balance which is shown as equity in the financial statements of the company or partnership;
- in the case of a permanent establishment in Malta of a company or partnership that is not resident in Malta, the applicable equity is that part of the risk capital of that company or partnership that is attributable to the permanent establishment. To compute the NID the reference rate is applied to the risk capital of the company or partnership less the “invested risk capital” to the extent that such invested risk capital either produces income exempt from tax, or produces no income, but if any income was produced, such income could have been exempt from tax. The invested risk capital is the risk capital that is 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 company or partnership holds in or provides to any other person whether resident in Malta or otherwise.
Are there any limitations to the Malta notional interest deduction?
The Malta deduction for the notional interest may not exceed 90% of the Malta company’s chargeable income for the relevant year before taking into account the notional interest deduction. Any excess amount may, at the option of the company or partnership, be carried forward for deduction in the following years without a limit on the number of years it keeps on being carried forward. The remaining income is subjected to the tax at the standard corporate rate of 35% with refunds applicable in certain scenarios.
How is the Malta notional interest deduction calculated?
The reference rate is 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%. With a yield rate of 2,01% the rate of interest deduction on equity is 7,01%.
What is the effect of using the Malta notional interest deduction at shareholder level?
Where a Malta company or partnership has claimed the Malta NID, the shareholder or partner in the NID is deemed to have received interest income equal to the NID claimed by the undertaking (if there is more than one shareholder/partner in the undertaking, the interest income is deemed to have accrued to the shareholder/partner in proportion to the capital that they hold in the undertaking). The second paragraph of Rule 5(3) provides that a shareholder, partner or undertaking may make a request so that the deemed interest income is allocated on a basis other than the nominal value of the risk capital held by the shareholder or partner, as the case may be. This provisions addresses situations where it is clearly more reasonable to split the allocation of the deemed interest income on a different basis, for example on the basis of the actual profit sharing ratio, where this is different from the proportion of the nominal value of shares held by each shareholder.
During the past years Maltese tax legislation has been enhanced with features which bring it at a par with that of other European countries in order to allow businesses to operate more efficiently and reduce the disparity which was being created between debt financing and equity financing.