04 May 2020
This article was first published in International Tax Review.
Since the publication of the ATAD I and ATAD II directives at EU level, Malta has gradually started to adopt the provisions prescribed in the EU legislations and implement them into its domestic legal system.
While the provisions of ATAD I came into effect as of last year by means of the EU Anti-Tax Avoidance Directives Implementation Regulations, the provisions of the ATAD II, dealing with hybrid mismatches, were transposed in Malta in December 2019, through a revision of the same regulations (ATAD II regulations). The ATAD II regulations entered into effect as of January 2020, with the exception of the provisions on reverse hybrid mismatches, which shall take effect as of January 2022.
ATAD II regulations apply to Malta’s taxpayers, including permanent establishments (PE) situated in Malta, and to entities which are treated as transparent for tax purposes in Malta. Its principal aim is to determine and correct mismatch outcomes which result directly from hybrid mismatch arrangements.
Considering the outcomes
In terms of ATAD II regulations, a mismatch outcome is deemed to arise in the following circumstances:
(i) A double deduction – where a deduction of payment, expense or loss is claimed both in the source state and the investor’s state; or
(ii) Deduction without inclusion – where a deduction of payment is claimed in the jurisdiction of the payer and no corresponding inclusion is made in the jurisdiction of the payee.
ATAD II regulations also cover an array of arrangements which are considered as hybrid mismatches including payments made under hybrid financial instrument, payments made by or to hybrid entities, hybrid PEs, and imported mismatches.
Tackling mismatch outcomes
ATAD II regulations provide for measures which address mismatch outcomes resulting from hybrid arrangements by disallowing a claim for deduction in Malta or imposing the inclusion of certain income, depending on the nature of the mismatch.
Under ATAD II regulations however, a disallowed deduction may be set-off against dual inclusion income which arises during a current tax period or a subsequent one.
A deduction is also restricted for any payments made by a taxpayer where such payments directly or indirectly fund deductible expenditure and give rise to a hybrid mismatch as a result of a transaction or a series of transactions. The transactions in question must be made between associated enterprises or entered into as part of a structured arrangement, unless one of the jurisdictions involved in the transactions has made an equivalent adjustment in respect of the hybrid mismatch. Certain mismatch outcomes, resulting from an arrangement involving a payment of interest under a financial instrument to associated enterprise may however, fall outside scope of the rules.
Furthermore, a Malta-based taxpayer is under the obligation to include to its tax base income attributable to its disregarded PE unless the same income is exempt from tax by means of double tax treaty between Malta and the respective third country.
ATAD II regulations also require that where a hybrid transfer is designed to produce a relief for tax withheld at source on a payment derived from a transferred financial instrument to more than one of the parties involved, the benefit of the relief is to be limited proportionally to the net taxable income regarding the payment in question.
Reverse hybrids mismatches and its components
ATAD II regulations provide for instances where an entity, due to its unique characterisation in different jurisdictions, is seen as transparent in one jurisdiction and opaque in the other. Under the regulations, an entity may be considered as resident in Malta for tax purposes, if one or more foreign investor entities hold a substantial interest in the Malta incorporated hybrid entity and the jurisdiction of the investors treat it as a taxable entity. This general principle, however, provides for an exception in relation to collective investment vehicles, which are exempt from the scope of reverses hybrid mismatch rules.
Dual residence mismatches
Where a taxpayer is deemed resident for tax purposes in two jurisdictions, the taxpayer ends up utilising its status in both jurisdictions to benefit from a dual deduction on payment, expenses or losses from its tax bases.
With the implementation of ATAD II regulations, however, this is limited, as the claim for deduction may be denied where one of the jurisdictions claiming tax residency is Malta. Where the other jurisdiction is an EU member state, the deduction can be denied only if the taxpayer is deemed as not resident in Malta under the double tax treaty between Malta and the other member state.