The tax on investment funds

This article will deal with the tax aspects of investing in collective investment schemes.

There are many offshore centres where you can invest tax free. The number of such centres is decreasing due to concerted efforts by the OECD and the EU. Sometimes, however, an investor may think that the investment in the fund is tax free but he or she is actually paying tax.

This usually happens because the securities in which the offshore fund invests are located in countries which impose withholding tax on non-residents which the fund is unable to reclaim. Funds in onshore jurisdictions, like the UK, for example, may be more tax-efficient than funds in certain other offshore centres because they can reclaim tax deducted at source. One has to be careful and try to ascertain what is actually happening to the money as it flows from the underlying securities, through the fund, and on to the ultimate investor.

A tax free investment in an offshore centre does not absolve an investor from paying tax in Malta on income and/or capital gains.

In Malta, the manner in which collective investment schemes are taxed was changed in 2001. The following is a summary of the main provisions of the regulations but investors, before transacting, should always seek professional assistance from their personal financial adviser. Their circumstances may be different from the general case described here and, furthermore, tax laws may change.

Funds are now classified in two main groups. A fund is said to be a "prescribed fund" if more than 85 per cent of the securities it holds are Maltese assets, usually listed on the Malta Stock Exchange. Let us first start with those funds which are based in Malta. If they are prescribed, for example, by being invested more than 85 per cent in shares quoted on the Malta Stock Exchange, then investors in such funds will have no tax liabilities on any capital gains which they realise when they eventually sell the shares in the fund.

This puts investors in such funds in a comparable position as someone who invests directly in listed securities.

If such a prescribed and Malta-based fund invests in Maltese bonds or bank accounts, the issuer of the bond would deduct 10 per cent tax from the interest due to the fund and a bank would deduct 15 per cent tax.

If a fund is Malta-based but is non-prescribed, because it does not have at least 85 per cent of its assets invested in Malta, Malta residents would have a 15 per cent final withholding tax deducted from dividends and from any capital gains realised. Non-residents continue to receive both dividends and any capital gains tax free but, if they are EU residents, their income, insofar as it is deemed to be "interest income", will in future be disclosed to their authorities.

Now, let us look at funds which are incorporated overseas. These are all considered to be non-prescribed. If these overseas-based schemes are either listed in Malta or listed on some other exchange but have a secondary listing in Malta, then they would qualify for the new tax regime.

If they are not so listed, or secondary listed, then any gains from them, be it dividend or capital gain, would have to be declared in the income tax return and charged at normal rates, at the normal maximum of 35 per cent.

For overseas-based, listed funds held by residents of Malta, any dividends or capital gains are subject to a 15 per cent final withholding tax. Where a fund comes to an arrangement with the Commissioner of Inland Revenue, it may be able to deduct the 15 per cent tax before it pays the dividend to the investor.

If not, then the investor must go to an Authorised Financial Intermediary, usually an investment adviser or bank, and pay the 15 per cent tax. He or she will be issued with a certificate which the investor must retain as proof that the tax has been paid.

If the Authorised Financial Intermediary is a nominee holder of the investor, then the Intermediary has the duty to deduct the tax, without being asked by the investor.

The 15 per cent tax on capital gains must be paid at the Authorised Financial Intermediary within 90 days of the sale contract note while the tax on dividends must be paid not later than April 30 of the following year, to be in time for the Final Settlement System (FSS) submissions.

The investor always has the option to take all proceeds gross and declare them in his or her tax return. This option is usually made use of by persons whose income does not attract income tax.

The cost of the shares, for the purpose of calculating capital gains, is taken as being the price of the shares in the fund either at March 1, 2001, or, if the shares were acquired earlier at a higher price, this higher price. Any capital gains realised prior to this date are not subject to tax.

Subsequent to this date, the actual cost of the shares or units in the funds is taken. If there is more than one purchase then the cost would be the average acquisition cost. Capital gains are in such cases calculated as the difference between the sales price realised after March 1, 2001, and the average cost of the shares at the time of the sale.

If an investor holds shares or units in an umbrella fund, which consists of various sub-funds within the same scheme, then any switches will not trigger a capital gain. The investor only pays tax when he or she leaves the umbrella.

This, then, is a summary of how collective investment schemes are taxed. The system is complicated and, depending on what arrangements are made, the collection of the tax can be costly on both practitioners and investors.

A simpler system may some day be introduced, perhaps involving a flat percentage duty on purchases of shares in funds. The less friction there is in any type of transaction, the better.

Tax can get complex very easily and it is therefore very important that investors check the tax implications of their actions carefully.