Notional Interest Deduction Rules
October 1, 2017
In October 2017, a new Legal Notice (L.N. 262 of 2017) regarding Notional Interest Deduction Rules, was published.
This Legal Notice introduces the concept of interest on risk capital which is deductible against the income for the year of an undertaking. These rules apply as from calendar year 2017 (year of assessment 2018). Such a deduction can be claimed by local companies and partnerships resident in Malta and by permanent establishment of non-resident companies or partnerships.
The interest on the risk capital of an undertaking for a particular year of assessment should be worked out by applying the formula below:
Y = A x B
"Y" represents the interest on risk capital that an undertaking is entitled to claim in the relevant year of assessment;
"A" represents the reference rate;
"B" represents the risk capital of the undertaking for the accounting period ending in the year preceding the year of assessment.
The legislation defines "risk capital" as:
‘(a) where the undertaking is a company or partnership resident in Malta, the share or partnership capital of the undertaking, any share premium, positive retained earnings, loans or other debt borrowed by the undertaking which do not bear interest, and any other reserves resulting from a contribution to the undertaking, and any other item which is shown as equity in the financial statements of the undertaking; and
(b) where the undertaking is a permanent establishment of a company or partnership that is not resident in Malta, the term shall mean the capital of that undertaking which is attributable to the permanent establishment;’.
The "risk capital" shall be computed by taking the total risk capital at the end of the particular accounting period ending in the year preceding the year of assessment.
Therefore, the deductible interest is worked out on the amount of capital and any interest-free loans. In fact, the aim of this legal notice was to reduce the mismatch that there is between financing investment through debt (i.e. such as financing by issuing bonds) and financing investment through capital.
On the other hand, the reference rate is defined in the Legal Notice as ‘the risk free rate set by reference to the current yield to maturity on Malta Government Stocks with a remaining term of approximately 20 years plus a premium of 5%’.
The undertaking shall be entitled to a deduction against such income for sums that are deemed to be payable by way of interest on risk capital or such part thereof as may be determined by the undertaking for the particular year.
Such a deduction may be claimed at the option of the undertaking provided that all shareholders or owners give their consent.
In the cases, where in respect of any year preceding a year of assessment, interest resulting from the above computation exceeds ninety per cent (90%) of the company’s chargeable income for the said year prior to taking into account such deduction, the amount of such excess shall not be available for deduction against the profits for the said year, but may, at the option of the undertaking, be carried forward for deduction in the following year.
When the company or partnership make a claim for deduction of notional interest, the shareholders or partners shall be deemed to have received interest income. However, the investment income provisions would not apply to such notional interest.
These provisions could be useful for businesses engaged in international business.