Controlled Foreign Company (CFC) Rules

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Broadly speaking a controlled foreign company is a corporate entity that is registered and conducts business in a different jurisdiction or country than that where the controlling parent company or owners are resident. CFC regulations are anti-tax avoidance measures. Whereas it is perfectly reasonable and legal for entrepreneurs to set up business in different countries, it is considered, under certain conditions, abusive to do so in jurisdictions where the company tax is zero or lower than what it would be in the country of residence of the parent company or owners.

Not all countries have Controlled Foreign Company rules in place. The EU ATAD I Directive has now made these rules mandatory across all EU member states as from the 1st January 2019. These rules were introduced into Maltese law in 2018 and are effective as from the 1st January 2019. We are here looking at the main features of these regulations as implemented in Malta.

What constitutes a Controlled Foreign Company

The primary condition for an entity or a permanent establishment (branch) to be treated as a Controlled Foreign Company is the following:

An entity, or a permanent establishment the profits of which are not subject to tax or are exempt from tax in Malta and where the following conditions exist:-

  • Direct or indirect participation by taxpayer and any associated enterprises of more than 50% of voting rights OR capital in OR profit distribution from the CFC; AND
  • The actual corporate tax paid by the CFC is less than 50% of the tax that would have been charged  on the Controlled Foreign Company under the Malta Income Tax Acts. For the purpose of this condition the permanent establishment of a CFC that is not subject to tax or is exempt from tax in the jurisdiction of CFC shall not be taken into account.

Charge to tax

Where a Controlled Foreign Company exists, there shall be included in the tax base of the taxpayer the non-distributed income of the Controlled Foreign Company arising from non-genuine arrangements which have been put in place for the essential purpose of obtaining a tax advantage.

In this context an arrangement shall be regarded as non-genuine to the extent that

  • the CFC would not own the assets generating all or part of the income OR
  • the CFC would not have undertaken the risks which generate all, or part of, its income if it were not controlled by the taxpayer in Malta where the significant people functions, which are relevant to those assets and risks, are carried out and are instrumental in generating the CFC’s income.

Exceptions to the rule

A CFC that satisfies the following criteria would not be charged to tax in Malta:

  • CFC with accounting profits of no more than €750,000, AND non-trading income of no more than €75,000; OR
  • CFC of which the accounting profits amount to no more than ten per cent (10%) of its operating costs for the tax period, Provided that the operating costs may not include the cost of goods sold outside the country where the CFC is resident for tax purposes AND payments to associated enterprises.

Further considerations on the computation of Controlled Foreign Company income and tax

  1. the income to be included in the tax base of the taxpayer shall be limited to amounts generated through assets and risks which are linked to significant people functions carried out by the controlling company. The attribution of controlled foreign company income shall be calculated in accordance with the arm’s length principle;
  2. the income to be included in the tax base shall be calculated in proportion to the taxpayer’s participation in the Controlled Foreign Company entity;
  3. the income shall be included in the tax period of the taxpayer in which the tax year of the CFC ends;
  4. adjustments shall be made with regards to subsequent receipt of profit distributions from the CFC by the taxpayer in order to ensure there is no double taxation;
  5. where the taxpayer disposes of its participation in the CFC and any part of the proceeds from the disposal previously has been included in the taxpayer’s tax base, an adjustment shall be made in order to ensure there is no double taxation;
  6. there shall be allowed a credit of the tax paid by the CFC against the tax liability of the taxpayer.

 

This article is only intended to give a general overview of the legislation. Professional advice should be separately sought on the applicability of these rules to any actual company structure or situation.

Please contact David Marinelli, DM Europe, should you wish to discuss any matter relating to Companies registered in Malta.

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