Malta needs to depart from the myopic 5-year political cycle – Part 2

6 minute read.

In the first part of this series, we argued how both the International Monetary Fund and the European Commission identified certain aspects of the labour market as key challenges to Malta’s economic resilience. In this second instalment, we will look at taxation – another area flagged as a future challenge to Malta by both institutions in their reports.

The argument is simple. Malta’s public finances display a higher-than-average reliance on company income tax revenue. In 2015, for every  €100 collected in taxes, almost €7 originated from company income tax – putting Malta at the top of the EU league. The impressive outcome for the 2017 government surplus suggests that these trends have continued to strengthen in the last two years. According to both international institutions, the large proportion of company income tax is due to a combination of Malta’s tax efficient regime and a high presence of foreign-owned companies. Both the IMF and the Commission think that Malta could be unfavourably affected by the evolving trends in international corporate taxation.

Pressures on politicians to introduce changes in taxation gained traction in the wake of the austerity measures taken by most EU economies to repair their broken budgets caused by the economic crisis, its resulting devastating effects on society and the ensuing global calls for more social justice. For a number of years, European newspapers headlines flashed the worsening plight of the poor and unemployed on one page and the huge amount of monies multinational corporations saved through tax planning on the opposite page. A sense of balance had become imperative, if only to restore a fairer approach to taxation.

Since 2013, action was stepped up to reform tax rules first at an international level through the G20 and OECD and later at a European level. The aim of this effort is to remove legislative loopholes used by multinationals to make profits “disappear” for tax purposes or to shift their profits to low-tax jurisdictions where they have limited or no economic activity. Tax avoidance has thus become a top item on the global economic policy agenda.

It is within this context that the warning to Malta by the two institutions should be read. In a recent European Commission study, Malta’s tax regime together with that of other six EU countries was found to be extensively used by companies to funnel earnings as a way to aggressively cut their tax liabilities. Outbound dividends, interest and royalties do not incur withholding tax in Malta. Royalty payments made by one subsidiary of a company to another, interest payments on intercompany loans and the transfer of dividends to companies in a group are known ways employed by firms to shift profits from high tax to low-tax jurisdictions.

These and other features of Malta’s tax system have attracted increased scrutiny from international observers and decision-makers and we would not be surprised if this momentum will accelerate, going forward. The challenge that lies ahead is to align Malta’s structures with the global trend of shifting tax where value is created and counter the impact on public finances and, we think more importantly, on economic growth in the long-term.

Traditionally, Malta’s economic model has largely depended on offering a range of tax advantages to entice foreign companies to set up subsidiaries. In reply to critics who charge that this constitutes harmful tax competition, Malta has always argued that such incentives are necessary to ensure its competitiveness and compensate for the natural drawbacks the island-state suffers vis-à-vis its regional peers. Although in many ways this argument is logically sound, we anticipate that going forward it will become increasingly difficult for Malta to sustain this position in European and international fora.

Specific forces that militate in favour of this concern include:

(i) the implication the UK’s withdrawal from the EU will have on the balance of power of liberal-leaning countries, whose stance largely aligned with Malta’s interest, around the negotiating table;

(ii) certain aspects of Malta’s tax regime are considered to be too generous and therefore disproportionate to the economic handicaps they are purported to rectify; and

(iii) the interplay between the tax system and episodes of alleged money-laundering and sizeable financial inflows may be used as a pretext to increase the pressure to tighten tax rules. Therefore, recent political and economic dynamics both at a domestic and international level makes us conclude that taxation constitutes a structural weakness which merits an immediate strategic re-think of Malta’s economic model by the authorities. 

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