Introduction – Malta’s Taxable Base
Persons ordinarily resident and domiciled in Malta (including companies incorporated in Malta) are chargeable to tax in Malta on a worldwide basis in terms of the Income Tax Act, Chapter 123 of the laws of Malta (the ‘ITA’).
On the other hand, persons not ordinarily resident and domiciled in Malta (including persons resident but not ordinarily resident or domiciled in Malta such as companies incorporated outside Malta but managed and controlled from Malta) are chargeable to tax in Malta on Malta source income and gains and foreign source income (not gains) which is received in Malta.
In turn, royalties derived by a taxpayer from patents would represent chargeable income in terms of the ITA, irrespective as to whether such royalties represent passive income or, alternatively, active income derived from a trade or business.
Accordingly, royalties accruing to a person ordinarily resident and domiciled in Malta would be subject to royalty tax in Malta – regardless of the source of such royalties. However, should non-Malta source royalties accrue to a person who is not both ordinarily resident and domiciled in Malta, such royalties would not be chargeable to tax in Malta except to the extent that they are received in Malta.
Malta Tax Exemption
Whilst royalties represent chargeable income in terms of the ITA as aforesaid, an exemption from Malta tax was recently introduced and is available in respect of all royalties derived by a person that owns and grants rights to use a qualifying patent.
The tax exemption was introduced with a view to assisting creative research and development resulting in the registration of patents and, additionally, in order to encourage researchers to exploit intellectual property through the licensing of patent rights. As such, the Malta tax exemption applies regardless of the place or places where any relevant research and development resulting in the qualifying patent may have been undertaken.
Accordingly, by virtue of the said tax exemption, royalties accruing to any person (including a company) who owns a qualifying patent would, at that person’s option, be wholly exempt from tax in Malta if such royalties are receivable by way of consideration for the grant by that person of a licence to an enterprise to exercise rights under the qualifying patent in the course, directly or indirectly, of a productive economic activity undertaken by that enterprise – such as manufacturing, software development or data processing.
However, an individual in receipt of royalties from a qualifying patent would only be entitled to the Malta tax exemption should s/he have been involved, alone or otherwise, in the research, planning, processing, experimenting, testing, devising, designing, developing or other similar activity leading to the relevant invention which is the subject of the said qualifying patent. The Malta tax exemption is accordingly unavailable in respect of royalties derived by an individual from an otherwise qualifying patent but which was acquired by that individual who was not, therefore, involved as required in the development of the patented invention.
No such restriction applies in respect of royalties derived by any other person (not being an individual). As a result, royalties accruing to a company (or other body or persons) may be exempted from tax in Malta, at the option of the company, even if such royalties are receivable merely pursuant to the acquisition of the qualifying patent and the grant of a license to an enterprise to exercise rights thereunder in the course of a productive economic activity.
The enterprise acquiring rights to exploit a qualifying patent may be independent or affiliated to the licensor. However, if the licensor and licensee are affiliated enterprises, the licensor would only be entitled to the benefits of the Malta tax exemption if the amount of royalties receivable under the relevant license would not exceed the amount that would have been paid at arm’s length between independent enterprises and, additionally, provided that the affiliated licensee would be directly involved in the required productive economic activity.
Qualifying patents comprise patents registered in Malta or elsewhere. However royalties derived from a patent registered outside Malta would be eligible for exemption if the invention which is the subject of the relevant patent is patentable under applicable Maltese law or is the result of fundamental research or industrial research or experimental development.
The benefits of the Malta tax exemption are available only pursuant to receipt of confirmation from Malta Enterprise that royalties which may accrue in terms of a given license agreement (granting rights of use over a patent) would qualify for the said exemption. Such confirmation would be obtained in the form of a certificate pursuant to the submission of a prescribed application to Malta Enterprise for consideration together with all required supporting documentation.
In addition to the aforesaid, should any tax exempt royalty income accrue to a company, the Malta tax exemption would be preserved at the level of that company’s shareholders insofar as no Malta tax would be levied or withheld upon the onward distribution of the underlying exempt royalties by the company in favour of its shareholders. The Malta tax exemption is, in fact, specifically preserved through successive dividend distributions even when the relevant royalty income is finally distributed to individual shareholders.
Expenses incurred by a taxpayer wholly and exclusively in the production of income would represent deductible expenses for domestic tax purposes. Accordingly, insofar as expenses are deductible if they are incurred in the production of the income, capital expenses and pre-income earning expenses incurred in setting up a source of income are, as a rule, not deductible except by virtue of specific exceptions allowing deductibility.
In this respect, the ITA specifically allows the deductibility of capital and pre-income earning expenses incurred by a taxpayer engaged in business on patents and patent rights for the use and benefit of the said business. Accordingly, costs incurred in acquiring patents rights (being capital in nature) and costs incurred in developing and then patenting an invention (typically incurred prior to the production of income) would represent deductible expenses for domestic tax purposes.
Capital expenses incurred on patents and patent rights must be spread over the life of the said patents or patent rights in a reasonable manner to the satisfaction of the local tax authorities. It is understood that the spread of such expenditure should be in equal annual instalments over the lifetime of the patent or patent rights. However, current expenditure incurred in developing and then patenting an invention (including, in practice, costs of materials, overheads, wages and registration fees) would be deductible as and when incurred.
At any rate, capital and current expenditure incurred on patents and patent rights would be deductible against income derived from such patents or patent rights. As a result, a person incurring and deducting such expenditure would not also be entitled to benefit from the Malta tax exemption described in Section 2 above and which may otherwise be available in respect of royalty income receivable from patents.
Patents as Capital Assets
Insofar as capital and current expenditure on patents and patent rights would be deductible by taxpayers carrying on a business and, additionally, if the expenditure was incurred for the purposes of that business, a person acquiring a patent to hold the same as a capital asset and to earn income therefrom, pursuant to the grant of one or more licenses to use the patent, would not be entitled to deduct the acquisition cost of the patent from royalty income receivable (although that income may be exempt as aforesaid).
However, the said patent would represent a chargeable asset for the purposes of Malta tax on capital gains levied under the ITA. Accordingly, Malta tax would be chargeable upon the disposal of any such patent which was held as a capital asset. The amount of tax payable would be computed by the deduction of the acquisition cost of the patent from the consideration received from the transferee pursuant to the disposal thereof. As a result, whilst the acquisition cost of the patent would not be allowable as a deduction against royalty income received from the patent, that acquisition cost would eventually be deducted from the consideration received pursuant to the disposal of the patent in order to compute the extent of chargeable gains derived as a result.
Interest & Royalties Directive and Treaties
Maltese limited liability companies are entitled to the benefits of the EC Interest and Royalties Directive and, accordingly, royalties derived from associated companies in other Member States should not suffer withholding tax in the source state.
In this respect, whilst the provisions of the said Directive have been transposed into domestic law, Malta grants a unilateral exemption on outbound royalties payable to a non-resident (whether the recipient of the royalties is resident in a EU Member State or otherwise). In fact, Malta does not levy or withhold tax on any outbound royalties payable to a non-resident except where such royalties are effectively connected with a permanent establishment through which the non-resident carries on business in Malta and provided that the non-resident is not owned or controlled by, directly or indirectly, nor acts on behalf of an individual or individuals who are ordinarily resident and domiciled in Malta.
Malta also has a large and expanding network of double tax treaties with 58 treaties currently in force. Whilst Malta’s treaties are based on the OECD Model, a limited right to tax outbound royalties is reserved to the country of source in many of Malta’s treaties. The maximum withholding rate is typically 10%.
In light of the domestic tax considerations highlighted above and Malta’s generally favourable effective tax rates and furthermore, in view of additional non-tax considerations including Malta’s comparatively low establishment and operating costs, strategic location at the centre of the Mediterranean and hard working professional tradition (with English being a national language), Malta should represent an increasingly attractive jurisdiction for enterprises undertaking research and development or seeking to relocate income generating patents or such other assets.
Companies are liable to tax in Malta at the flat rate of 35% whilst individuals pay tax in Malta at progressive rates (35% being the maximum marginal rate).
Two enterprises would be affiliated in terms of the relevant rules regulating the Malta tax exemption when:
- one enterprise holds a majority of the shareholders’ or members’ voting rights in the another; or
- one enterprise is entitled to appoint or remove a majority of the administrative, management or supervisory body of the other; or
- a contract between the enterprises, or a provision in the memorandum or articles of association of one of the enterprises, enables one to exercise a dominant influence over the other; or
- one enterprise is able, by agreement, to exercise sole control over a majority of shareholders’ or members’ voting rights in the other.
Patents and Designs Act, Chapter 417 of the laws of Malta.
Fundamental research is defined in the relevant domestic rules as constituting experimental or theoretical work undertaken primarily to acquire new knowledge of the underlying foundations of phenomena and observable facts, without any direct practical application or use in view.
Industrial research is defined in the relevant domestic rules as involving planned research or critical investigation aimed at the acquisition of new knowledge and skills for developing new products, processes or services or for bringing about a significant improvement in existing products, processes or services. Such research also comprises the creation of components of complex systems, which is necessary for the industrial research, notably for generic technology validation.
Experimental development involves acquiring, combining, shaping and using existing scientific, technological, business and other relevant knowledge and skills for the purpose of producing plans and arrangements or designs for new, altered or improved products, processes or services. Such development may also include other activities aiming at the conceptual definition, planning and documentation of new products, processes and services. The activities may comprise producing drafts, drawings, plans and other documentation, provided that they are not intended for commercial use. The development of commercially usable prototypes and pilot projects is also included in the definition of ‘experimental development’ where the prototype is necessarily the final commercial product and where it is too expensive to produce for it to be used only for demonstration and validation purposes (in case of a subsequent commercial use of demonstration or pilot projects, any revenue generated from such use must be deducted from the eligible costs). The experimental production and testing of products, processes and services are also eligible, provided that these cannot be used or transformed to be used in industrial applications or commercially. Experimental development does not include the routine or periodic changes made to products, production lines, manufacturing processes, existing services and other operations in progress, even if such changes may represent improvements.
 Malta Enterprise is the domestic agency responsible for the promotion of foreign investment and industrial development in Malta.
The said certificate would be valid for a period not exceeding three years. However, upon the lapse of three years, an application for renewal may be submitted to Malta Enterprise for consideration.
Council Directive of 3 June 2003 on a common system of taxation applicable to interest and royalty payments made between associated companies of different Member States (2003/49/EC).