Malta Inland Revenue Department issues guidelines on Profit Participating Loans

By virtue of Malta’s participation exemption, dividends and capital gains derived by a Malta company from a qualifying participating holding in a subsidiary would be wholly exempt from Malta tax. A Malta company would have a ‘participating holding’ in a subsidiary if:

1. The equity shares held by the Malta company in the subsidiary carry at least two of the following rights: (i) a right to votes; and/or (ii) a right to profits available for distribution; and/or (iii) a right to assets available for distribution in the event of a winding up;
2. At least one of the following 6 additional qualifying criteria is met:
   – The Malta company holds more than 10% of the shares in the subsidiary; or
   – The Malta company holds shares in the subsidiary having an acquisition value of at least €1,164,000 and should the Malta company retain the shares for an uninterrupted period of at least 183 days; or
   – The Malta company is entitled, at its option, call for and acquire the balance of shares in the subsidiary; or
   – The Malta company is entitled to first refusal in the event of the proposed disposal, redemption or cancellation of the shares in the subsidiary; or
   – The Malta company is entitled to sit on the board or to appoint a person to sit on the board of the subsidiary as a director; or
   – The Malta company holds shares in the subsidiary for the furtherance of its own business and not as trading stock;
3. The subsidiary does not own immovable property situated in Malta or any real rights over such property or, directly or indirectly, any shares or interests in any entity or person which owns immovable property situated in Malta or any real rights over such property where 5% or more of the total value of the said shares or other interests so held is attributable to such immovable property or rights.

In light of the above, hybrid instruments, which bear characteristics of both debt and equity, have caused some difficulty insofar as such instruments may carry rights akin to equity rights. As a result, a Malta company holding such an instrument issued by another entity could appear to be entitled to apply Malta’s participation exemption in respect of income derived by virtue of its holding the instrument (assuming that all qualifying criteria enumerated above would also be satisfied).

Such difficulties have been resolved against the Malta company holding a hybrid instrument by virtue of the publication of a specific guideline by the Malta Inland Revenue Department which, in turn, reflects the terms of a recommendation issued by the EU Code of Conduct which was subsequently endorsed by ECOFIN. The domestic guideline is accessible at: www.ird.gov.mt/taxguides/interestfromloan.aspx

In light of the domestic guideline, income from a loan shall be treated as interest in terms and for the purposes of the Income Tax Act, Chapter 123 of the laws of Malta, and irrespective as to whether the relevant loan bears characteristics of both debt and equity (such as when the lender is entitled to voting rights, to profits etc.). Such income would not, therefore, be treated as income from share capital or from an equity holding for the purposes of the said Income Tax Act.

The Malta participation exemption is accordingly unavailable when a financial instrument held by a Malta company bears characteristics of both debt and equity insofar as income accruing to the Malta company therefrom would fall to be characterised as constituting chargeable interest for Malta tax purposes.

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