US-Malta Tax Treaty: Key Provisions and Changes

An international tax treaty is an agreement between two countries designed to address the taxation of income that flows between them. Its primary functions are to prevent the same income from being taxed by both jurisdictions, a concept known as double taxation, and to create a framework for exchanging taxpayer information to combat tax evasion. The United States and Malta have such an agreement, which entered into force on November 23, 2010. This treaty establishes clear rules for taxing various types of income, including business profits, dividends, and interest, to strengthen the economic relationship.

Determining Treaty Eligibility

A component of the US-Malta tax treaty is the definition of “resident,” as only residents of one or both countries can claim benefits. For an individual, residency is determined by factors that establish a person’s primary tax home. For a company or other entity, residency is based on its place of incorporation or management.

Situations can arise where an individual qualifies as a resident of both countries under their respective domestic laws, creating a dual-residency issue. The treaty provides a series of “tie-breaker” rules to resolve this conflict and assign residency to a single country for treaty purposes. These rules are applied sequentially, starting with determining where the individual has a permanent home available. If a permanent home exists in both or neither country, the focus shifts to the individual’s “center of vital interests,” which considers personal and economic ties.

To prevent “treaty shopping,” where residents of third countries gain unintended access to treaty benefits, the agreement contains a Limitation on Benefits (LOB) article. This provision is more restrictive than in many other U.S. tax treaties, a response to specific features of Malta’s tax system. The LOB article specifies who qualifies for treaty benefits, creating a list of “qualified persons.”

An entity is considered a qualified person if it is a publicly traded company on a recognized stock exchange in either country or a subsidiary of such a company. Government entities, pension funds, and tax-exempt organizations also qualify. For other entities, qualification depends on meeting specific tests related to ownership and income, ensuring the entity has a genuine economic nexus to its country of residence.

Key Provisions for Passive Income and Business Profits

The treaty establishes specific withholding tax rates on cross-border payments of passive income which are lower than the statutory rates in either country. For dividends paid by a company in one country to a resident of the other, the treaty sets a maximum withholding tax rate of 15% for most portfolio investments. A lower rate of 5% applies if the beneficial owner is a company that owns at least 10% of the voting stock of the dividend-paying company.

For interest and royalty payments flowing from one country to a resident of the other, the treaty sets a maximum withholding tax rate of 10%. This provision differs from the U.S. Model treaty, which often eliminates source-country tax on such payments, but was deemed necessary to address particular aspects of Malta’s tax system. These reduced rates are a benefit of the treaty, lowering the tax burden on cross-border investment.

The treaty’s “Business Profits” article dictates that the business profits of an enterprise from one country are only taxable in the other country if the enterprise carries on its business through a “Permanent Establishment” (PE) situated there. A PE is a fixed place of business through which the enterprise’s operations are wholly or partly carried on. Examples include a branch, an office, a factory, or a workshop.

If a PE exists, the host country may tax the profits attributable to that PE, but only those profits. The definition of a PE is specific and includes certain exceptions for preparatory or auxiliary activities. An example of an exception is maintaining a stock of goods solely for storage or display.

Clarification of the Pension Article

A recent development concerning the US-Malta tax treaty was a mutual agreement to clarify its pension article. In December 2021, the U.S. and Maltese competent authorities entered into a Competent Authority Arrangement (CAA) to address the definition of a “pension fund” for treaty purposes. This action was taken to stop the misuse of the treaty by some U.S. taxpayers through certain Maltese personal retirement schemes.

These arrangements often involved contributions of property other than cash, such as appreciated securities, and lacked limitations based on earned income. The CAA specified that such personal retirement schemes are not considered “pension funds” under the treaty. Consequently, distributions from them do not qualify as “pensions” for treaty purposes.

The direct consequence of this clarification is that certain retirement arrangements established in Malta no longer qualify for the benefits previously claimed under the treaty. U.S. taxpayers who have used these specific schemes can no longer claim a U.S. tax exemption on the income earned within the scheme or on its distributions. For other cross-border pension payments that fall within the treaty’s intended scope, the original rules for avoiding double taxation continue to apply.

How to Claim Treaty Benefits

For a non-U.S. person who is a resident of Malta receiving income from a U.S. source, the claim is made directly to the U.S. withholding agent. This is accomplished by providing a properly completed IRS Form W-8BEN for individuals or Form W-8BEN-E for entities. By completing the form, the Maltese resident certifies their residency and identifies the specific treaty article that justifies a reduced rate of, or exemption from, U.S. withholding tax. The U.S. payor relies on this form to apply the correct tax rate at the time of payment.

For a U.S. person who wishes to take a position on their U.S. tax return that a treaty provision modifies U.S. tax law, the procedure involves filing Form 8833, Treaty-Based Return Position Disclosure. This form is attached to the taxpayer’s annual income tax return. It is necessary for disclosing positions like a claim that a U.S. resident is a resident of Malta under the treaty’s tie-breaker rules or that a U.S. business does not have a permanent establishment in Malta. Failure to file a required Form 8833 can result in penalties.