An offshore tax shelter in the European Union on the example of “Malta pensions plan” featured by Wall Street Journal

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The Wall Street Journal recently described quirks in the U.S. Tax Treaty with Malta that became a popular topic in the legal advice sector.[1] In the said article, WSJ describes an offshore tax shelter (a tax regulation in Malta) which promises rich Americans they can avoid lots of capital-gains taxes by setting up pensions in Malta. This issue is not only American struggle with tax abuse. For instance, Poland has also signed an international tax treaty with Malta (Agreement between the Government of the Republic of Poland and the Government of Malta for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income signed in La Valetta on 7 January 1994)[2] and in 2020 the Treaty was amended due to the necessity of closing loopholes in the international (bilateral) tax system[3]. Moreover as a restoration of the Polish industry after COVID-19 pandemic, the Polish Government and the Ministry of Finance prepared the new Tax Act which shall prevent the change of the entity’s tax residence to the offshore tax shelter [4].

Before we move to the tax abuse based on the U.S. bilateral tax treaty with Malta it is advisable to start with Treaty’s provisions treatment.

U.S. – MALTA TAX TREATY

The Treaty was done in 8 August 2008 and came into force in late 2010. As Jeffrey L. Rubinger wrote The Treaty contains very favorable provisions that can result in significant tax benefits to U.S. members of a Maltese pension. In order for such U.S. members to take advantage of these benefits, the pension must qualify as a resident of Malta under the Treaty and also satisfy the limitation on benefits (LOB) article of the Treaty. [5] In his article Rubinger enumerates the Treaty’s provisions that could become a victim of the interpretation tax abuse.

Article 4

RESIDENT

Section 2 The term “resident of a Contracting State” includes:

A pension fund established in that State; and
An organization that is established and maintained in that State exclusively for religious, charitable, scientific, artistic, cultural, or educational purposes. [6]

Notwithstanding that all or part of its income or gains may be exempt from tax under the domestic law of that State. In Rubinger’s opinion, a pension fund established both in the U.S. and Malta is a resident for the purpose of the Treaty, despite that all or part of the income or gains of such a pension may be exempt from tax under the domestic law of the relevant country.[7]

Article 22(2)

e) a pension fund, provided that more than 75 percent of the beneficiaries, members or participants of the pension fund are individuals who are residents of either Contracting State; (…)

Rubinger summarizes this provision in the following way: Thus, as long as a Maltese pension is formed pursuant to relevant Maltese law and more than 75% of its members are U.S. and/or Maltese residents, the pension plan should be eligible for Treaty benefits. [8]

Other crucial provisions are:

Article 18

PENSIONS FUNDS

Where an individual who is a resident of one of the States is a member or beneficiary of, or participant in, a pension fund that is a resident of the other State, income earned by the pension fund may be taxed as income of that individual only when, and, subject to the provisions of paragraph 1 of article 17, to the extent that, it is paid to, or for the benefit of, that individual from the pension fund (and not transferred to another pension fund in that other State). [9]

Article 17(1)(b)

PENSIONS, SOCIAL SECURITY, ANNUITIES, ALIMONY, AND CHILD SUPPPORT

Notwithstanding subparagraph a), the amount of any such pension or remuneration arising in a Contracting State that, when received, would be exempt from taxation in that State if the beneficial owner were a resident thereof shall be exempt from taxation in the Contracting State of which the beneficial owner is a resident. [10]

Taking into account the above, the following opportunity is emerging: if some highly-appreciated U.S. citizen (who has real estates, crypto- currency assets, shares, etc.) wishes to avoid the American tax system and high tax rates, he or she could decide to contribute these assets to a Maltese pensions fund. That American citizen is well-off thus the legal conditions are fulfilled. After that he/ she can sell the real estate and shares and have a pension fund (assuming that this person is at least 50 years old). Considering Maltese law regime, money from that fund can be distributed within 1 year (I stage), 4 years (II stage) and every next year (III stage) with a low tax burden (fiscal charge).

To read about and analyse the entire practical example with details and general conclusions, visit: https://www.jdsupra.com/legalnews/the-malta-pension-plan-a-supercharged-74273/

POLISH LEGAL FRAMEWORK PERSPECTIVE

As mentioned above, Poland also signed such tax Treaty with Malta government that shall prevent Polish tax system from the activities similar to Malta Pension Plan.

To read this Treaty: (link)

In this Act in its article 23 there is a provision on avoidance of double taxation and in article 24 – equal treatment provision that should provide no-loopholes in the bilateral tax legal system. Additionally, since 1^st January 2020 the Multilateral Convention implementing Measures of Treaty Tax Law to Prevent Tax Base Erosion and Profit Shifting, done at Paris on 24 November 2016 shall apply to this Treaty.

But the tax abuse danger comes from one more side – from the Controlled Foreign Corporation (CFC) which is a corporate entity that is registered and conducted in a different jurisdiction or country than the residency of the controlling owners. Control of the foreign company is defined according to the percentage of shares owned by citizens. The CFC legal regulations are intended to combating harmful tax competition on the part of certain countries (so-called offshore tax shelters), by preventing tax avoidance through the mechanism of shifting income to countries with preferential tax regimes. This assumption is implemented through taxation in Poland, as income attributed to a Polish entity, of income determined in relation to profits earned of a CFC, being a tax resident of another country, in which more favourable tax solutions are in force. [11]

These tax provisions are included in the: