Malta has enacted Notional Interest Deduction Rules in October, 2017 which will apply in respect of income derived from basis year 2017 onwards by Maltese companies, Maltese partnerships, and permanent establishments in Malta of foreign companies (the “Qualifying Entities”).
The rationale behind these rules is to enable deductions to be claimed by such Qualifying Entities for notional interest deemed to have been incurred on their “equity”, thereby bringing about a more level playing field on the tax front for equity financing when compared to debt financing. Such Qualifying Entities could already claim a deduction for tax purposes in respect of any debt financing costs incurred by them.
Calculation of deemed interest deduction
The rules provide for the method in which the notional interest deduction can be claimed for every financial year, this being a multiplication of:
- the Qualifying Entity’s “Risk Capital” as at the year end
- the Reference Rate, namely the risk free rate set by reference to the yield to maturity on Malta Government Stocks with a remaining term of approximately 20 years (currently around 2%) plus a premium of 5%.
The Qualifying Entity’s “Risk Capital” includes its share capital, share premium, positive retained earnings, non-interest bearing loans or other debt, and any other reserves resulting from a contribution to the Qualifying Entity, as well as any other reserve shown in the financial statements as “equity”.
Limitation on deduction to be claimed
For every financial year, a Qualifying Entity can – at its option – claim by way of a deduction against its chargeable income, a notional interest of up to 90% of its chargeable income (excluding any grossing-up of its income through use of the flat rate foreign tax credit).
Deemed income for shareholders/partners
When a Qualifying Entity claims a notional interest deduction in any year, an amount equal to such deduction is deemed for Maltese tax purposes to have been received by the shareholders or partners of the Qualifying Entity as deemed interest income. Such deemed income would be taxable in the hands of any individual recipient depending on whether or not that individual is subject to tax in Malta. The 15% rate of tax for investment income would not be applicable in such a case. The tax position of any non-resident individual would need to be analysed in his country of residence in respect of any such deemed interest income.
If the shareholder/partner of a Qualifying Entity is itself another Qualifying Entity, the deemed interest income is neutralised since the aforesaid shareholder/partner can claim a notional interest deduction which is equal to the deemed income, and without the 90% limitation.
No Tax Refunds available
If a Qualifying Entity claims a notional interest deduction, an amount equal to 110% of the profits which benefitted from the deduction are to be allocated to its final tax account. No tax refunds are available for the shareholders of the Qualifying Entity in respect of such amount.
Carry Forward of unutilised deductions
Where the notional interest deduction in any year exceeds 90% of the chargeable income of the Qualifying Entity, the excess can be carried forward indefinitely for use in future years.