Will Malta become the 'New' Ireland in International Tax Planning?

• Author: Rubinger, Jeffrey
• Position: Tax Law

Historically, U.S. taxpayers setting up operations in Europe (or elsewhere outside of the United States) have looked to Ireland as a result of its highly skilled workforce, its developed infrastructure, and membership in the European Union (EU). Perhaps even more important, however, were the tax benefits afforded to U.S. multinationals, including a 12.5 percent corporate income tax rate on active (i.e., "trading") income and lack of transfer pricing rules for related party transactions. (1)

The recent ratification of the U.S.-Malta income tax treaty (effective January 1, 2011), however, along with a 5 (and possibly zero) percent effective corporate income tax rate on active income (the lowest corporate income tax rate in the European Union), a new favorable regime for the tax treatment of intellectual property, and lack of transfer pricing rules, has clearly made Malta one of the most attractive jurisdictions from an income tax perspective with respect to inbound investments to, and outbound investments from, the United States. This article will discuss the U.S. tax planning opportunities available with Maltese corporations that have become more attractive given these recent developments.

U.S. International Tax Regime, in General

The U.S. federal income tax treatment of a corporation depends on whether such corporation is domestic or foreign. For this purpose, a corporation is treated as domestic if it is incorporated under the law of the U.S. or of any U.S. state. (2) All other corporations (i.e., those incorporated under the laws of foreign countries) are treated as foreign corporations. (3)

* U.S. Federal Income Taxation of Domestic Corporations--The United States employs a "worldwide" tax system with respect to U.S. persons, under which U.S. taxpayers generally are taxed on all their worldwide income, regardless of whether the income is derived from U.S. or foreign sources. In order to mitigate the double taxation that may arise from taxing the foreign-source income of a U.S. person, a foreign tax credit for income taxes paid to foreign countries is available to reduce or eliminate the U.S. taxes on such income, subject to certain limitations.

Income earned by a U.S. taxpayer from foreign operations conducted by foreign corporate entities generally is only subject to U.S. federal income tax when the income is distributed as a dividend to the U.S. shareholder. Until that time, U.S. federal income tax on the income is generally deferred. Nevertheless, anti-deferral regimes, such as the controlled foreign corporation (CFC) rules under Subpart F ([section][section]951-965) and the passive foreign investment company (PFIC) rules ([section][section]1291-1298), may cause the U.S. shareholders of a foreign corporation to be taxed on a current basis in the U.S. with respect to certain categories of passive income earned by its foreign subsidiaries, regardless of whether the income has been distributed. A foreign tax credit may be available to offset, in whole or in part, the U.S. federal income tax owed on this foreignsource income, whether repatriated as an actual dividend or included under one of the anti-deferral regimes. (4)

* U.S. Federal Income Taxation of Foreign Corporations--With respect to active business income, the United States taxes foreign corporations only on income that is "effectively connected" with the conduct of a U.S. trade or business. (5) Such "effectively connected income" is taxed in the same manner and at the same rates as the income of a U.S. corporation. An applicable tax treaty may limit the imposition of U.S. federal income tax on business operations of a foreign corporation to cases in which the business is conducted through a "permanent establishment" in the United States.

In addition, foreign corporations are generally subject to a gross-basis U.S. tax at a flat 30 percent rate on U.S. source income that is classified as fixed, determinable, annual, or periodical (FDAP) income, including interest, dividends, rents, royalties, and certain similar types of income, subject to certain exceptions. (6) The tax generally is collected by means of withholding by the payer of the income. The withholding rate on FDAP income is often reduced or eliminated by treaty.

Maltese Corporate Income Tax Regime, in General

Similar to the U.S. corporate income tax system, a company incorporated under the laws of Malta will be subject to corporate income tax in Malta on its worldwide income, regardless of the source of such income. The corporate income tax rate in Malta is currently 35 percent. Companies that are incorporated in Malta are considered "ordinarily resident and domiciled" in Malta and are eligible for benefits under Malta's expansive income treaty network.

A company that is incorporated outside of Malta but that is "managed and controlled" (7) in Malta will be treated as a Maltese "resident" corporation and subject to Maltese corporate income tax on a "remittance" basis only. Essentially, this means that...