Notional interest deduction (NID) rules

During 2017, Malta introduced a new NID regime, which is effective from the 2018 year of assessment.

The NID rules are included in the 2019 syllabus for both TX and ATX (MLA) and are examinable from June 2019 onwards.

Future candidates should note that the content of this article indicates the extent to which the NID rules are examinable at Strategic Professional (ie ATX (MLA)) level. For the purposes of Applied Skills (ie TX (MLA)), the full content of this article is examinable, except where stated otherwise.

The NID is designed to align the tax treatment of the cost of equity with that of the cost of debt. You will probably already be aware from your studies to date that dividends are not tax-deductible, whereas interest on financing is a tax-deductible expense. The NID, therefore, aims to bring equity financing on a par with debt financing.

This is achieved by allowing a deduction for interest on risk capital. For this purpose, risk capital is defined to include share or partnership capital of a company or partnership respectively, any share premium, any positive retained  earnings, loans or other debt borrowed by the undertaking which do not bear interest (typically including shareholders’ loans), and any other reserves resulting from a contribution into the company or partnership.

For the purposes of TX (MLA), future candidates simply need to recognise that the definition of risk capital effectively consists of share capital, reserves and interest-free debt.

The published NID rules provide that, in computing the chargeable income of a company or partnership, the undertaking may opt to take a deduction for interest on risk capital. The deduction is taken at a rate established by reference to the current yield to maturity on Malta Government Stocks which have a remaining term of approximately 20 years, plus a premium of 5%. This deduction is capped at a maximum of 90% of chargeable income (before grossing up for flat rate foreign tax credit), with the excess being carried forward to be deducted in subsequent years. The deduction is claimed through the tax return and requires that, on an annual basis, all shareholders or owners of the undertaking approve the claiming of this deduction.

It is important to note that whenever a company or partnership claims the NID, each shareholder or partner, as applicable, is deemed to have received their proportional share of the notional interest deduction on the risk capital (namely, equity, reserves, share premium, shareholders’ loans, etc) they have invested. This receipt is classified as interest income in the hands of the taxpayer.

Deemed interest income at shareholder level is not examinable in TX (MLA).

In this regard, the NID rules specifically preclude the application of the investment income provisions (which generally provide for an optional 15% final tax) on such deemed interest income. It is also pertinent to note that the classification of such income as interest income implies that the income could qualify for exemption from tax in terms of Article 12(1)(c)(i) of the Income Tax Act (ITA) when paid to a non-resident. Of course, this tax exemption would not apply if the non-resident is engaged in a trade or business in Malta through a permanent establishment situated therein, and the risk capital which gives rise to the deemed interest income is effectively connected with this permanent establishment situated in Malta.

You should also bear in mind that since the NID is classified as interest for the purposes of income tax, the interest deduction limitation set out in Article 26(h) of the ITA can also be triggered to disallow the deduction when:

a) the risk capital is used to finance the acquisition of immovable property in Malta, and

b) the shareholder or partner is not resident in Malta (and hence benefits from the aforementioned tax exemption in terms of Article 12(1)(c)(i) of the ITA), and

c) the shareholder or partner has an interest, direct or indirect, of more than 10% in the undertaking.  

Future candidates should note that Article 26(h) of the ITA is only examinable in ATX (MLA) and not in TX (MLA).

Future candidates should also note that for tax accounting purposes, whenever a company avails itself of the NID, the company is required to allocate an amount equal to 110% of the deduction availed of to the Final Tax Account (FTA). This allocation is subject to a maximum of the profits allocated to the other taxed accounts (with any excess being ignored). Accordingly, dividend distributions made out of profits relieved from tax through a NID claim will not be chargeable to further tax at the level of the shareholder or partner. The NID rules also contain specific anti-avoidance rules to prevent abusive application of the system.

As previously noted, the NID applies as from the 2018 year of assessment. This means that, at the earliest, qualifying taxpayers are eligible to claim the NID on the profits relating to the fiscal year ending in 2017 (ie basis year), which are assessable to income tax in 2018 (ie year of assessment).

As a reminder for TX and ATX (MLA) exam purposes, the NID rules are examinable from June 2019 onwards.

EXAMPLE
ABC Limited is a company incorporated and effectively managed and controlled in Malta. During year of assessment 20XX, it derived a chargeable income of €100,000. The example below illustrates the interaction between the NID Rules and the refundable tax credit system in Malta in the following three scenarios:

a) No NID election (Scenario a);

b) NID election with a NID of €20,000 – assumed reference rate of 6% on a risk capital of €333,333 (Scenario b);

c) NID election with a NID of €60,000 – assumed reference rate of 10% on a risk capital of €600,000 (Scenario c).
 

Written by the examining teams for TX (MLA) and ATX (MLA)