Page 229 - TaxAdviser_2022

Given the mechanics
of the imputation
system, a business
may benefit from
choosing to set
up two Maltese
corporations that are
in a parent-subsidiary

relationship.

accounts may entitle the shareholder U.S.–Malta income tax treaty and must eligible for treaty benefits to an entity
to a partial refund of the taxes paid on also be carefully analyzed in the context that is not eligible. In the U.S.–Malta
the distributed income, with the most of proposed U.S. anti-conduit regula- treaty, the base-erosion test is passed
common tax refund being six-sevenths tions under Prop. Regs. Sec. 1.881-3. if “less than 25 percent of the person’s
of the Maltese tax paid on active trad- gross income for the taxable year, as
ing income. This results in an effective Limitation-on-benefits articles determined in the person’s State of
Maltese tax rate of 5% (i.e., one- Looking first at the U.S.–Malta income residence, is paid or accrued, directly or
seventh of 35%). tax treaty, some businesses may be pre- indirectly, to persons who are not resi-
Given the mechanics of the imputa- sented with a conflict between taking dents of either Contracting State [i.e.,
tion system, a business may benefit advantage of the Maltese imputation of the United States or Malta] entitled
from choosing to set up two Maltese system and claiming benefits under the to the benefits of this Convention under
corporations that are in a parent- tax treaty. The reason involves a base- [certain subparagraphs] (other than in
subsidiary relationship, with the sub- erosion test in the treaty. the form of arm’s length payments in the
sidiary (OpCo) acting as the operating To be eligible for benefits under the ordinary course of business for services
company and the parent company U.S.–Malta treaty, a Maltese person or tangible property).”
(TopCo) acting as a holding company. must be considered a tax resident under Notably absent from the treaty provi-
To give a simplified numeric example, if Article 4 and must meet at least one sion is language stating that the pay-
OpCo generated $100 of active trading of the tests set out in Article 22, the ments taken into account for purposes
income, it should be subject to the 35% limitation-on-benefits (LOB) article. of the base-erosion test include only
Maltese corporate income tax. OpCo At first glance, the LOB tests in the those that are deductible for income
could then pay out the remaining $65 U.S.–Malta treaty are generally in line tax purposes in the person’s country of
to TopCo as a dividend. TopCo should with the 2016 U.S. Model Income Tax residence. By comparison, language set-
not be subject to tax on the $65 of Convention, as well as U.S. tax treaties ting out such a restriction is included
income and can also claim a refund of with other European jurisdictions. Im- in many other U.S. income tax treaties
six-sevenths (i.e., $30) of the $35 of portantly, however, a number of the tests, (see, for example, Paragraph (2)(f)(ii) of
tax previously paid by OpCo on the including the “active trade or business” Article 23 of the United States–United
distributed income (which generally test (Paragraph 4), the “publicly traded Kingdom treaty; Paragraph (2)(f)(ii)
would also not be taxable to TopCo). company” test (Paragraph 2c), and the of Article 26 of the United States–
Between TopCo and OpCo, therefore, “ownership/base erosion” test (Paragraph Netherlands treaty; and Paragraph (2)
$5 of tax is paid on $100 of active trad- 2f), each require Clause ii of Paragraph (f)(bb) of Article 28 of the United
ing income, without the income being 2f to be met. States–Germany treaty) but not in the PHOTO BY CHRISDORNEY/ISTOCK
distributed to TopCo’s shareholders. Clause ii, often referred to as the U.S.–Malta treaty.
As set out below, however, this ben- “base-erosion test,” is generally aimed This difference in wording is quite
eficial regime could create issues when at preventing taxpayers from stripping significant because dividends (e.g., paid
seeking to claim benefits under the earnings out from an entity that is by OpCo) are generally not deductible

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