Interested in the conditions that should be satisfied in order for a professional investor fund to benefit from treaty protection in Malta?
Much has been written about the taxation of Malta's professional investor funds (PIFs), however, the applicability of tax treaties to PIFs is not as widely explored. When investing outside Malta via an alternative investment fund, clarity as to the application of treaty benefits to the fund is fundamental in order to establish its tax liability with any accuracy.
Malta's position as an onshore domicile of choice for funds is enhanced where a PIF qualifies for benefits under Malta's 60-plus double taxation treaties, reducing or eliminating withholding taxes by the Source state. The point that collective investment vehicles ought to be granted treaty protection was acknowledged by the OECD in its Report "The Granting of Treaty Benefits with Respect to the Income of Collective Investment Vehicles", issued in April 2010, the main conclusions of which were incorporated in the 2010 Commentaries to the OECD's Model Tax Convention. The OECD's position is that, even in the absence of express provisions, collective investment vehicles (Malta's PIFs) should benefit from treaty protection on condition they qualify as a "person", a "resident" and for some types of income as the "beneficial owner" thereof.
Criteria established by the OECD Report and Model Commentaries
As aforementioned, from an OECD perspective the following conditions should be satisfied to enable a PIF to qualify for treaty protection:
A PIF will benefit from treaty protection where it qualifies as "person" in terms of Malta's treaties. PIFs may be set up in corporate (usually for open-ended funds in the form of an investment company with variable capital, a SICAV, but they could also be limited partnerships, LP) or unincorporated form (a contractual or mutual fund, and a unit trust).
Domestically, the taxation of PIFs is not established by reference to their legal form. For treaty purposes, while a SICAV is considered a "person", given that it is incorporated, unit trusts, on the other hand, being unincorporated, require further consideration. Locally, the treatment of a trust for tax purposes is established by reference to the residence of the trustee and beneficiaries, as well as the nature of the trust income:
- Where its income is solely limited to investment income, a trust may opt to be treated as a company. As such it would be allocated a unique tax number, and subject to the same tax obligations as a company. In this scenario a unit trust could be a "person" for treaty purposes.
- A trust is deemed to be transparent for tax purposes where the beneficiaries are all resident outside Malta and on condition that all the trust's income arises outside Malta, or where arising in Malta, is exempt in terms of specific provisions. Where such conditions are met, unit trusts would be transparent for tax purposes.
- A trust other than the above is taxable as a person ordinarily resident and domiciled in Malta. Such trust must be registered with the tax authorities, who will assign it a unique taxpayer number. From a Maltese tax perspective, where a PIF actively runs from Malta it will derive business income considered as arising in Malta. Therefore, where it would have been set up as a unit trust, such PIF would be taxable in Malta under this scenario, that is, as a person who is resident and domiciled in Malta, a status that could make the unit trust qualify as a "person" for tax treaty purposes.
In order to benefit from treaty protection, a PIF must be tax resident in Malta. Generally, residence for treaty purposes is determined by considering whether a PIF is "liable to tax" in Malta.
At domestic law, a PIF, whether prescribed or non-prescribed, is taxable in Malta at least on income derived from immovable property situated in Malta, with prescribed funds being taxed also on investment income. Hence, for the purposes of domestic law a PIF is considered tax resident in Malta for treaty purposes. Nevertheless, some countries could adopt a different approach in considering whether such residence would be sufficient to satisfy residence for treaty purposes. Turning to the OECD's position aforementioned, a PIF should be deemed to be resident in Malta where it is in principle liable to tax therein as a resident, even if its income were to be fully exempt.
Identifying beneficial ownership is generally required with respect to income derived by PIFs consisting of dividends and interest. The definition of beneficial ownership is a particularly thorny issue in international taxation, more so when applied to collective investment vehicles. Given that a PIF is an investment vehicle for investors, questions arise as to whether the beneficial owner of the income is the PIF or the investor.
Determining beneficial ownership is particularly challenging where a PIF would have been set up in an unincorporated form, for instance a unit trust, in that the source State may not consider a trust as the beneficial owner of the income, even though the trust would taxable in its own name.
Where a PIF would have taken on an incorporated form, the determination of whether a PIF is the beneficial owner of the income will be made by the source State where the PIF would have income arising as a result of an investment therein. In terms of the OECD Report where a PIF subject to investor protection regulation is widely held, and the managers of such PIF have discretionary powers to manage and invest the assets on behalf of the investors – the PIF would be the beneficial owner of the income. Consequently, the more widely held a PIF, and the more discretion granted to its managers, advisors and directors, the greater the likelihood that the PIF would be considered the beneficial owner of the income.
Reference in Malta's Tax Treaties
Just like the vast majority of existing tax treaties, no specific reference is made to collective investment vehicles in most of Malta's treaties. Exceptionally, express reference to collective investment vehicles is made in Malta's treaties with Bahrain and Uruguay for the purposes of inclusion in the definition of the term: "person", and for the latter treaty also for the purposes of residence and beneficial ownership. Furthermore, in the exchange of letters following the conclusion of the Malta-US tax treaty, the US agreed to consider the application of Maltese PIFs (referred to as mutual funds) once the OECD project on collective investment vehicles would have been finalised, so the outcome of such further consideration by the US is a matter worth following.
The OECD Report strengthened the argument that PIFs ought to be entitled to treaty protection. Albeit no official reservations or observations were included in the OECD Commentaries, not all jurisdictions follow assiduously the OECD's approach advocated for existing treaties summarised above. Where express reference is made to collective investment vehicles in Malta's treaties, doubt is eliminated with regards to those treaties, but subsists in relation to the others. Where the practical solution – a PIF investing via a special purpose vehicle in order to enable treaty application – is not adopted, treaty qualification remains a matter for determination by reference to each specific Source state where treaty benefits would be invoked by a PIF.
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.