Myths and misconceptions for Maltese investors - 1

AS A FINANCIAL adviser, together with my colleagues operating in the field of wealth management at Bank of Valletta, we are encountering a number of instances where investors are either not fully aware of the implications of the European Savings Directive (ESD), or have a vague or ill-conceived understanding.

First I would like to stress that the views I am about to express in layman's terms are aimed as an eye-opener to investors who have registered funds under the Investment Registration Scheme promoted by the government over the past three years. These views are also intended to highlight benefits that Maltese investors can draw from the Final Withholding Tax (FWT) regime in place and its application by authorised financial intermediaries.1

At the outset, one must be reminded that the ESD is applicable only to personal investors permanently resident in one of the 25 EU countries. It covers only interest payments as follows:

¤ Interest paid on deposit accounts;

¤ Periodical coupon payments on bonds, excluding 'grandfathered'2 bonds for a transitional period up to the end of 2010;

¤ Accrued interest originating from the sale or redemption of zero-coupon bonds;

¤ Income distributions by collective investment schemes when the income originates from interest earnings;3 and

¤ Income from the sale or redemption of shares in collective investment schemes relating to the income earned by the fund on interest bearing investments.

Withholding tax and final withholding tax

Maltese investors holding funds in any of the EU countries,4 dependent territories5 and third countries6 will have their interest income earned after July 2005 reported to the Maltese tax authorities unless they have adopted a withholding tax status.7 Unfortunately, many Maltese investors are under the impression that the withholding or retention tax that is being paid abroad is final, similar to the final withholding tax (FWT) regime applied by local authorised financial intermediaries.

They are under the impression that the need to declare the income in the annual income tax returns is removed. This is wrong. Maltese investors whose marginal rate of tax is higher than 15% are still obliged to pay the difference on their income tax arising from investments managed by financial institution situated overseas.

Of even greater concern is the fact that the individuals who pay retention tax in, say Jersey, and have registered their funds under the Investment Registration Scheme (IRS), but do not declare the income in their tax returns may be once again in breach of the local tax regulations if their marginal rates of tax exceed 15%.

This renders the benefits achieved and the expenses paid (by way of 3%, 4% or 5% IRS registration fees) practically useless! Such omissions are also subject to penalties that range from 3% of endangered tax per month for the first omission to 6% of endangered tax per month for the fourth and subsequent omissions!

It is being noted increasingly that this line of thinking is mainly driven by the obsession of keeping the money as far away from the taxman's sight as possible. Past experiences may somehow substantiate this line of thinking; however those who have used the IRS to 'clean' their money need not be concerned as current legislation provides them with robust solutions.

Alternative scenarios

There are two main routes out of the unwarranted circumstances highlighted above.

In the first instance the investor can opt out of withholding tax and authorise the foreign institution, with whom the funds are held, to disclose information to the tax authorities. This solution is plausible when the income is derived from deposits held with banks overseas. In such cases the deposit holder can produce evidence of the income received to an authorised financial intermediary, who will in turn collect the FWT to pass on to the Inland Revenue. A FWT certificate is issued to the deposit holder, which is in turn excluded from any further tax liabilities.

This is fine except for the fact that it poses a new problem; the taxman will now be fully aware of the funds the investor holds overseas. It has been argued that although no action can be taken on (past) undeclared funds that have been registered under the IRS, the tax authorities would have an indication of past earnings that can be used to gauge future earnings, especially if the individual is still engaged in similar activities!

The second alternative gives due consideration to the fact that the deposits can be held with local banks and that fixed income securities can be managed by local authorised financial intermediaries. In this case registered funds are 'repatriated' and managed accordingly. Once income, as defined by the ESD, becomes due, the investor will have the option to have FWT deducted at source. The option of repatriating the funds presents the investors with two important benefits that are at times overlooked:

A final tax in the form of FWT that immediately exhausts any tax liabilities due by the taxpayer on that income; and

Anonymity in that no further disclosures are made to the tax authorities and the 15% FWT is passed on to the Inland Revenue in a lump sum without any disclosure of the beneficiaries' names.

The views outlined above are derived from real life situations that we, as financial advisors, are encountering frequently when reviewing a client's financial situation. In the next contribution we will be able to review more specific scenarios relating to bond portfolios, equity investments and collective investment schemes. Here we will once again be able to consider a number pitfalls and opportunities that are of interest to most investors.

This two-part article is intended to provide information on tax issues with particular emphasis on the ESD and not to provide financial or tax advice. It is therefore recommended that investors contact their investment and tax advisers for a comprehensive overview of their investment and tax situation. Part two will be published in a fortnight's time.

Simon Azzopardi is Head of Wealth Management at Bank of Valletta plc, which is licensed to conduct investment services business by the MFSA.

References

1. An authorised financial intermediary is a person resident in Malta who is registered for this purpose with the Commissioner of Inland Revenue. He may apply for this registration if he holds a Category 2 or 3 Investment Services Licence.

2. Include debt claims issued before March 1, 2002, which have not been increased since March 1, 2002.

3. Income distributed by collective investment schemes set up as SICAVs does not fall within this definition.

4. Including Corsica, French Guiana, Guadeloupe, Martinique, Reunion, Sardinia, Sicily, the Aland Islands, the Azores, Madeira, the Balearic Islands, the Canary Islands, Spanish North Africa and Gibraltar.

5. Andorra, Anguilla, Aruba, BVI, the Cayman Islands, Guernsey, the Isle of Man, Jersey, the Netherlands Antilles and the Turks and Caicos Islands.

6. Switzerland, Andorra, Leichtenstein, Monaco and San Marino.

7. Applicable in Channel Islands, Austria, Belgium and Luxemburg and 'third countries'.