Malta taxes – How the EU’s Unshell/Shell Companies Directive affects businesses
So-called tax havens, such as Malta, have long been a thorn in the side of tax authorities. In particular, the establishment or operation of shell companies has been pilloried. With the EU’s new Unshell/Shell Companies Directive, the authorities want to eliminate this problem and introduce a standardized procedure. In this article, we outline what impact the new regulations will have on the Maltese corporate and financial services sector and explain why a professionally executed relocation is worthwhile for you with regard to taxes in Malta.
Tax revelations by the Panama Papers revealed the problem
Since the scandal surrounding the so-called Panama Papers, the word shell company (alternatively letterbox company) has established itself as a settled term in the media and among the public. These Panama Papers are synonymous with confidential documents and records that were published exactly on April 3, 2016.
In so doing, they revealed the tax tricks and financial sins of numerous prominent figures from politics, economics, and society, who smuggled tax money past tax offices by setting up letterbox companies. You can contact such a letterbox company, but you will not find any employees or management directly on site.
The company’s headquarters are usually not even in Germany but, for example, in the Bahamas, Dubai, Liechtenstein, Luxembourg, or Malta. Such a company is governed by the tax laws of the country in which it is domiciled. Consequently, a company of this kind is legally fully existent, but de facto does not carry out any business operations.
What exactly makes a shell company so appealing to its founders?
These shell companies are usually founded in English-speaking countries, which make case-specific decisions based on case law. The common law legal system serves as the framework. As a rule, the newly formed company does not even need to own office or business premises. A rented mailbox is sufficient for incorporation. In this respect, a letterbox company is merely a shell for an organization that exists only on paper.
By using such a company, tax advantages can be claimed and various laws circumvented. The founders of letterbox companies benefit from the different international rules and regulations concerning data handling, data transmission and, above all, tax laws. In particular, the different taxation regimes from country to country make the formation of a shell company very attractive.
As a rule, such a company is always founded in a country that only levies low taxes. Preferred financial centers with few tax regulations include Panama, Bermuda, the Bahamas, Barbados, the Cayman Islands, and the British Virgin Islands. In Europe, the most popular countries are the Isle of Man (Irish Sea), Ireland, Switzerland, Luxembourg, Liechtenstein, Holland, and Malta.
EU Unshell/Shell Companies Directive has a significant impact on tax structuring practices
With the new EU Unshell/Shell Companies Directive of December 22, 2021, as part of the „Unshell“ initiative, the European Union is taking targeted action against so-called letterbox companies (in the original „shell entities“). This is intended to send a further signal against what the EU sees as harmful tax arrangements and to prevent the tax abuse of these same shell companies.
The new regulations will affect all companies, regardless of their legal form, which have their registered office in an EU member state and carry out business activities from there.
The new regulations under the EU’s Unshell/Shell Companies Directive are to be implemented in national laws by June 30, 2023. The regulations will then apply from January 1, 2024. If the draft is actually implemented in its current form, it will significantly impact the tax structuring practices of affected companies. However, all EU member states must first approve the EU’s Unshell/Shell Companies Directive and thus the new directive on letterbox companies.
Special test procedure to identify companies with weak substance
At the heart of the new EU directive on shell companies is a two-stage substance test, which is mandatory in all EU member states. The aim of this directive is to filter out or identify companies with weak substance. Companies that do not meet these criteria are deemed to have weak substance. For these companies, the new regulations under the EU’s Unshell/Shell Companies Directive will result in amended tax declaration obligations. In addition, they will be deprived of previously valid tax benefits.
Test Part 1: Identification of potential shell companies
The first step of the two-step substantive test specifies a total of three cumulative criteria in accordance with the EU’s Unshell/Shell Companies Directive, which can be used to identify potential shell companies. Specifically, these criteria are as follows:
- At least 75 percent of the revenues of the reviewed companies must consist of „relevant income“ in the respective preceding two years (financial years). This is income of a passive nature, such as dividends, interest, and royalty income, but also, for example, income from services outsourced by the reviewed companies to affiliated companies.
- In addition, the company must be active or operating on a cross-border basis in accordance with the EU’s Unshell/Shell Companies Directive. Two options are available to meet this criterion. First, with the exception of cash, securities, and shares, the book values of non-business movable and immovable assets abroad must account for a total of 60 percent of the company’s assets in the two years preceding the audit. Second, the new directive on shell companies allows a company to derive or be paid at least 60 percent of its relevant income from cross-border transactions.
- If a company has outsourced decision-making with respect to relevant functions and the management of day-to-day operations, the company does not have sufficient substance. However, this does not apply to the outsourcing of individual or specific activities, such as accounting.
The third criterion is crucial for the identification of shell companies
The third criterion is considered the central element in the first stage of the substance test. This is because companies with weak substance in particular would tend to outsource administrative and management tasks, as well as correspondence and legal services, to third parties (external service providers or affiliated companies). However, if the core activities remain with the company itself and only ancillary services are outsourced, this is basically not sufficient for a company to meet the relevant criterion of the Shell Companies Directive.
However, if the EU’s Unshell/Shell Companies Directive is implemented in this form as planned, there is still a clear time window that needs to be defined here. Therefore, when the new regulations come into force on January 1, 2024, the period since the beginning of 2022 may already be included. In this regard, a corresponding provision of evidence is currently indicated.
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Important: The first test level does not apply to all companies
Certain companies are excluded from the scope of the first stage of the substance test from the outset. These include, for example, regulated financial companies, listed companies, companies with at least five employees of their own, or certain holding companies.
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Test Part 2: Provide evidence of certain requirements in the tax return
If a company or entity meets all three criteria of the first stage, it must provide additional information in the tax return. This is to be understood as a transition to the second stage of the substance test. The following requirements must be demonstrated by the companies concerned by providing the relevant information in the tax return:
- The company concerned has exclusively used or even owned land in the country of residence (in this case Malta).
- The respective company must maintain an actively used bank account with an EU bank.
- In addition, the company or companies must have certain characteristics regarding the organizational structure. In concrete terms, this means that both employees and management must reside in Malta or the respective country of domicile, or at least in the vicinity. Furthermore, they must not be additionally employed by an affiliated company and must have sufficient decision-making powers.
Counter-evidence is possible – focus on economic motives
If your company does not meet these three criteria, the authorities will assume that it is weak in substance. However, you can rebut this presumption or assumption. This is expressly permitted by the EU’s Unshell/Shell Companies Directive. To do so, you must, for example, provide evidence that the company’s involvement in Malta is for economic reasons and not for the purpose of obtaining tax advantages. If you can successfully prove the contrary, this will be recognized for a total of five years.
New regulations: You can expect these tax consequences
If you fail to meet the three criteria under the second stage and are also unable to provide proof to the contrary, your company will have to reckon with various tax consequences as a company with weak substance. We have compiled the most important facts for you to consider.
- If the company is a weak-substance company according to the EU’s Unshell/Shell Companies Directive, its domicile in Malta or another EU country is not recognized internationally from a tax perspective. This means that the EU directives (Parent-Subsidiary Directive, etc.) and the Double Taxation Treaty (DTA), which have integrated tax residency in a member state of the EU as a prerequisite, do not apply in this case.
- The state (in this case Malta) in which the company and its assets are located applies taxation under its national law as if all the assets were held directly by the shareholders. If the company is deemed to have weak substance, taxation is applied on the assumption that the shareholder generates the company’s income himself. If the shareholder is resident outside an EU country, the DTAs or even the EU directives do not come into play. Instead, local withholding tax law is then applied in the respective member state where the source of income is located.
- Companies identified as having low substantiality will no longer receive residence certificates from EU member states. You may also receive a certificate to this effect, but it will be accompanied by a notice stating that the benefits of DTAs and other directives may not be claimed.
- EU tax authorities exchange all information and data on audited companies on an ongoing and automated basis. This is done in accordance with the EU’s Unshell/Shell Companies Directive, regardless of whether a company has been classified as an insubstantial company or not.
- The EU’s Unshell/Shell Companies Directive also provides for an EU state to initiate an audit in another member state of companies affected by the audit.
Looking to the future: The directive on shell companies reveals inconsistencies
It has not yet been conclusively clarified whether the new directive for shell companies in its present form is actually already the final version. However, if the EU’s Unshell/Shell Companies Directive does indeed correspond to the current draft, then it will be up to the individual EU member states to compare the not always clearly defined terms in the Shell Companies Directive with their national laws and flesh them out accordingly.
There are still many questions to be answered here. For example, in the current version of the EU’s Unshell/Shell Companies Directive, it is unclear when the threshold is reached in the first stage of the substance test with regard to harmful outsourcing of decision-making and day-to-day business. The same applies to the formulation and definition that exclusively used or owned premises are required. Several interpretations are possible in this regard.
Some provisions can be interpreted differently
You must take into account, for example, that companies with capital investments, in particular, only conduct a limited amount of active day-to-day business. As a rule, they do not need their own office space in Malta. According to the current draft, a company without its own or exclusively used premises is considered to be abusive and lacking in substance. However, the example illustrates that this idea falls far too short.
And how is the circumstance of a company bundling the office space used and the management activities for reasons of cost or efficiency to be assessed? In this case, too, the EU’s current Unshell/Shell Companies Directive leaves plenty of room for different interpretations and thus causes confusion when it comes to implementation.
EU states have a duty here to apply the EU’s Unshell/Shell Companies Directive with a sense of proportion with regard to national legislation. After all, it would be unfair if stricter standards were applied to companies‘ cross-border activities than to economic activities under national jurisdiction.
Malta taxes: You should not miss out on this opportunity
However, it is clear that ATAD 3 and the new directive for letterbox companies will have a considerable impact due to the leeway for interpretation in the form of the broad scope of the current version of the directive. The essential point here is that if your Malta-based company lacks substance and you are unable to provide an economic justification for the establishment or existence of a company that is acceptable to the tax authorities, you will have to pay taxes in Malta according to other criteria.
You will then no longer be able to enjoy the previous tax benefits. Against this background, internationally operating companies especially should analyze the planned new directive for letterbox companies promptly and in detail. In this way, they can assess for themselves whether their own company is affected by the new regulations. Should this be the case, appropriate optimization steps must be taken in good time to expand the company’s substance.
Save taxes in Malta: We can help you relocate professionally
On the other hand, ATAD 3 or the EU’s Unshell/Shell Companies Directive offers a great opportunity. If your Malta-based company is not classified as being low-substance, this also means in effect that Malta will fully recognize your company as the shareholder’s state of residence or the source state of the assets. This also depends on the respective compliance effort because this secures the tax status quo.
Even if the tax authorities continue to tighten the thumbscrews on Malta and other countries dubbed as tax havens due to the EU’s Unshell/Shell Companies Directive, it may still be worthwhile for entrepreneurs from Germany to establish a company in Malta. On the other hand, those who already operate a company domiciled in Malta may have to implement mandatory substance enhancing measures to avoid conflict with the new regulations of the EU’s directive on shell companies.
As one of the largest German law firms in Malta, we provide you with competent and legally sound support in relocating and dealing with ATAD 3 or the EU’s Unshell/Shell Companies Directive. This will pay off for you, especially with regard to the Malta taxes to be paid.