Recent amendments to Maltese income tax legislation which entered into force via Legal Notice 429 of 2010 provide for a tax exemption on royalty income derived from eligible patents, in respect of qualifying inventions. This exemption has been designed with the intention of motivating further investment in research and development by enterprises as well as encouraging and supporting the exploitation of intellectual property, particularly through the licensing of patent rights. The tax exemption applies regardless of the place where the patent is registered and of where any relevant research and development resulting in the qualifying patent may have been carried out. Furthermore, the exemption applies both in cases where there is an active trade of licensing of several patents and in the case of passive receipt of royalties from patents.
Patents which qualify for this exemption include those patents in relation to which specific work leading to the relevant invention is carried out. Such work includes research, planning, experimenting, testing, developing and other similar activities.
Both patents which are registered in Malta as well as overseas are considered as eligible to this exemption. This provided that the invention in question is considered to be patentable under Maltese law, or is the result of particular areas of research and development. The latter include patents related to the following work:
- Fundamental Research, which refers to experimental or theoretical work with no practical application, undertaken primarily for the purpose of acquiring new knowledge;
- Industrial Research, which is aimed at the acquisition of new knowledge and skills for the development of new products, processes or services, achieved through planned research or critical investigation;
- Experimental Development, which is directed towards the production of plans and arrangements or designs for new, altered or improved products, processed or services, through the use of existing scientific, technological, business and other relevant knowledge and skills.
Any individual or enterprise which grants the exploitation of knowledge protected under a qualifying patent through a licensing or similar agreement and is consequently in receipt of royalty payments or similar income, may opt to have such income exempt from tax. In order for this to be possible, the person claiming such an exemption must comply with a number of conditions. Primarily, where the owner of the patent is an individual, the individual must have been engaged in carrying out, solely or together with another person, the research, planning, processing, experimenting, testing, devising, designing, developing or some other similar activity. Such activities ought to lead to the invention which is the subject of the qualifying patent. Secondly, the license must be granted to an enterprise for using the patent in a productive economic activity, such as manufacturing, software development and data processing.
In order for the exemption in question to be availed of, an application form must be submitted to Malta Enterprise, the domestic agency responsible for the promotion of foreign investment and industrial development in Malta. An application must be submitted in respect of each licensing or similar agreement irrespective of whether previous approval had been granted to the patent holder. Upon review of the application, Malta Enterprise will issue an Entitlement Certificate which is valid for three years. Once it lapses, the applicant may resubmit an application for renewal.
The tax exemption on royalty income derived from patents acts complimentary to the Maltese fiscal regime by providing for tax efficient options to persons involved in intellectual property holding and licensing activities. Malta imposes no withholding taxes upon the paying out of outbound dividends, interest or royalties. Moreover, the Interest & Royalties Directive acts in conjunction with the exemption in question present under Maltese law. Among other considerations, via the domestic implementation of this directive, Malta grants a unilateral exemption on outbound royalties payable to a non-resident, irrespective of whether the recipient of the royalties is resident in an EU Member State or otherwise. Maltese companies also have access to an extensive double tax treaty network with over 60 countries whereby the maximum withholding tax rate is typically 10%. Additionally, persons who transfer their residence and/or domicile to Malta as well as companies resulting from a merger in terms of the EC Directive 2005/56/EC may opt to utilise a further incentive available under Maltese law. In fact, such persons may claim a step up in the tax base cost of assets situated outside Malta without any adverse fiscal consequences in Malta. The said persons may, for tax purposes, opt to revalue the assets from their historic cost to their fair market value at the time of the shift of residence or domicile to Malta or at the time of the merger, as the case may be.
The tax exemption available to this kind of royalty income may extend to capital gains derived from the disposal of intellectual property in a number of instances. Such an exemption may be availed of in the following scenarios:
- an intra-group transfer;
- upon the disposal of intellectual property by a Maltese resident entity which is not duly incorporated in Malta; and
- the migration out of Malta of the Maltese intellectual property company.
In the case of a company, the tax exemption applies at the level of that company's shareholders insofar as no tax would be levied upon the distribution of the exempt royalties by the company to its shareholders. In terms of the pertinent tax accounting rules provided for under Maltese income tax legislation, such profits are allocated to the final tax account of the company. In this way, the exemption is specifically preserved through successive dividend distributions and subsists even when the royalty income is ultimately distributed to individuals. Royalties and income derived from other (i.e. non-patented) intangibles continue to be taxed in Malta at the statutorily guaranteed maximum overall effective rate of 5%. This rate falls to 0% where the Malta resident entity is not incorporated under the laws of Malta and the income is not physically received in Malta.
The person claiming the exemption must file an income tax return for the pertinent year of assessment without declaring the royalty income. Failure to comply with such requirement will render the tax exemption ineffectual. A person may only claim such exemption if he has carried out activities leading to the invention as aforementioned. However, the exemption may not be claimed by an individual who derives royalties from an otherwise qualifying patent but which was acquired by such an individual who was not involved as required in the development of the patented invention. Nonetheless, no such restriction applies in respect of royalties derived by any other person, not being an individual.
Consequently, a person who derives royalty income through the ownership of a qualifying patent will, at his option, be wholly exempt from tax in Malta. For such to be possible, the royalties ought to have been received by way of consideration for the granting to another enterprise by that person of a licence to exercise rights under the qualifying patent. The particular rights must have been exercised directly or indirectly, in the course of a productive economic activity undertaken by that other enterprise, such as manufacturing, software development and data processing.
A further practical application of the tax exemption pertinent to qualifying royalty income is evidenced by its relevance within the pharmaceutical industry, particularly when seen in tandem with another available exemption, namely the Bolar Exemption, which allows firms to experiment on patented drugs before the patent expires. Consequently, manufacturers are able to complete all preparatory work on a new product, including production development and licensing, while the branded original is still under patent. They will then be ready to market it immediately when the patent expires, gaining up to a year on manufacturers in countries without the Bolar exemption. Moreover, royalties derived from qualifying work which is undertaken during such period are exempt from tax as previously indicated.
By way of elaboration as to the operation of the Bolar Exemption, the proprietor of a patent shall not have the right to enforce its exclusive rights over its patent against third parties when an act is done for purposes which can reasonably be related to the development and presentation of information required by the law of Malta or any other country that regulates the production, use or sale of medicinal or phytopharmaceutical products.
Other relevant points within the context of the above provision are two other exceptions which provide that the proprietor of a patent shall also not have the right to enforce its exclusive rights over its patent against third parties:
"(a) where the act is done privately and for noncommercial purposes, provided that such act does not significantly prejudice the economic interests of the proprietor of the patent;
"(b) where the act consists of making or using such product for purely experimental purposes or for scientific research;"
The Bolar Exemption, consequently, offers a significant competitive advantage as the generic medicine may be marketed immediately upon patent expiry. Such, in conjunction with the pertinent royalty income tax exemption serves to benefit companies operating within the pharmaceutical industry significantly, both on a financial as well as on an operational level. In fact, this provision allows third-party companies to conduct clinical trials and commercial testing on patented medications, with the intention of improving on the patent or producing a cheaper generic version, before the drug patent expires. In an industry where speed to market is crucial, generics companies situated on the island can complete preparatory testing in advance, and bring their products immediately after patent termination. The Bolar Exemption is instrumental in the consequent proliferation of generics manufacturers in the country, and Malta currently has more than 15 such operators, from all over the world.
In light of such domestic tax considerations as highlighted in this article, together with Malta's favourable effective tax rates and other additional non-tax considerations, Malta represents an increasingly attractive jurisdiction where enterprises may choose to undertake research and development activities or seek to relocate income generating patents or other such assets.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.