Taxation of Partnerships in Malta

  • By:Corrieri Cilia Legal
  • 0 Comment

In Malta, partnerships are regulated by the Companies Act 1995 [Chapter 386 of the Laws of Malta] (hereinafter the Act). The types of commercial partnerships that may be incorporated in Malta are the limited liability company, the partnership en nom collectif and partnership en commandite. Companies have become the preferred vehicles for operating businesses, both in the local and international context. However, partnerships still offer an attractive option since they are subject to less regulatory obligations when compared to limited liability companies. In fact, they are neither required to submit an annual return nor to file accounts with the Registry of Companies. Furthermore, partnerships are widely used for the purpose of operating Collective Investment Schemes (CIS) mainly due to their flexibility and their favourable tax treatment under Maltese fiscal rules.

The 2 types of partnerships

Partnership en nom collectif

A partnership en nom collectif, or a general partnership, is defined as consisting of two or more partners and which has its obligations guaranteed by the unlimited and joint and several liability of all the partners. Therefore, in the case of a partnership en nom collectif, there is no concept of limited liability and, consequently, each partner is personally liable for the debts of the partnership as a whole. As a general rule, a partnership en nom collectif is transparent for tax purposes in terms of the Income Tax Act (ITA) and the partners declare their share of profit in their personal tax returns. Tax is therefore chargeable according to the applicable personal tax rates.

Partnership en commandite

A partnership en commandite, or a limited partnership, may be considered as a combination of the characteristics of a limited liability company and a partnership en nom collectif. It consists of one or more partners, called general partners, and one or more partners, called limited partners. The concept of unlimited liability of the partners in a partnership en nom collectif also applies to the general partners in a partnership en commandite. However, the liability of the limited partners in a partnership en commandite is similar to the liability of shareholders in a limited liability company since it is limited to the amount, if any, unpaid on their contribution to the partnership. The administration and representation of such a partnership is vested in the general partners and the Act confirms that both individuals and bodies corporate may be appointed as general partners. Moreover, one of the particular characteristics which distinguishes a partnership en commandite from a partnership en nom collectif is that its capital may be divided into shares. In terms of the ITA, a partnership en commandite with its capital divided into shares will be treated as a company for Maltese income tax purposes.

In both types of partnerships, the existence of the partnership depends upon its registration with the Registrar of Companies. A partnership can be so registered by delivering a signed deed of partnership to the Registrar of Companies for registration. Upon the issue of the certificate of registration, both types of partnerships acquire a legal personality separate and distinct from that of their partners. In terms of Maltese law, having a distinct legal personality means having own rights and obligations, be capable of owning and holding property under any title at law and can sue and be sued in its own name. Such distinct legal personality subsists until the name of the partnership is struck off the register, whereupon the partnership ceases to exist.

Furthermore, both in the case of a partnership en nom collectif and a partnership en commandite, creditors must first exhaust all the assets of the partnership itself prior to having recourse against the personal assets of the general partners. As mentioned previously, both individuals and bodies corporate may be appointed as general partners. Before amendments to the Act, there was an added requirement for bodies corporate, as at least one member of a body corporate acting as a general partner must unlimitedly guarantee the obligations of the general partner and the partnership itself. This raised certain complications when the body corporate acting as general partner in a partnership en commandite was a limited liability company.

The introduction of two articles to the Act, namely Articles 7A and 51A created an exemption to the above requirement relating to bodies corporate, upon satisfaction of a certain number of conditions. These conditions include; filing a notice to the Malta Registry of Companies, appointing auditors to the partnership, financial reporting in terms of the Act and the filing of annual returns. Therefore, by application of Articles 7A and 51A, members acting as general partners in the partnership may be excluded from the direct liability formula.

Taxation of Partnerships under Maltese Law

The basic principle of partnership taxation is that a partnership is a body of persons assessable under the ITA and is therefore chargeable to tax on any income falling within the ambit of the Income Tax Acts as a separate person. However, the law provides for certain exceptions. In fact, for Maltese income tax purposes, partnerships can be divided into two categories: those taxed as a company on one side, and those deemed to be tax transparent and income is taxed in the hands of the partners on the other.

Article 2(1) of the ITA states that any partnership en nom collectif and any partnership en commandite constituted under the Companies Act, or under the Commercial Partnerships Ordinance, falls under the definition of ‘Company’. However, a partnership en commandite with its capital divided into shares constituted prior to the 1st of January, 2015 shall be deemed to have elected to be treated as a company in terms of article 27(6) of the Income Tax Management Act (ITMA) and is taxed as such.

The core provision of partnership taxation establishing the look-through model of partnerships for tax purposes is Article 27 of the ITMA, whereby the income of the partnership flows through to the partners who become liable for the payment of tax on their share of the partnership income. The provision therefore describes partnerships as tax transparent entities and states that:

27. (1) Where income from any source accrues to or is received by a partnership that is carried on by any two or more persons jointly ……… (including, for the avoidance of doubt, partnerships in respect of which no election in terms of subarticle (6) of this article is in force), the income of any partner from the partnership, shall be deemed to be the share to which he was entitled during the year preceding the year of assessment in the income of the partnership, such income being ascertained in accordance with the provisions of the Income Tax Acts and shall be included in the return of income to be made by such partner under the provisions of the Income Tax Acts.

Therefore, partnerships which are deemed to be tax transparent and where income is taxed in the hands of the partners include:

  • Partnership en nom collectif
  • Partnership en commandite the capital of which is not divided into shares

Provided that they have not elected to be treated in terms of sub-article 6 of Article 27 of the ITMA (discussed below).

It is important to note that, under Maltese tax law, a CIS established in the form of a limited partnership (partnership en commandite) with capital not divided into shares is, therefore, deemed to be a transparent vehicle, so that income and capital gains arising from the fund are taxed directly in the hands of investors according to their tax status and retain their character as income or gains.

Almost all of the rules and exemptions under the ITA are applicable to companies and therefore could not be applied to partnerships. Some of these include the tax accounting system which applies to profits available for distribution by a company registered in Malta, the full imputation system which applies to distributions of dividends made by a company registered in Malta, and exemptions applicable to group of companies. The situation changed with the enactment of The Budget Measures Implementation Act 2015.

The Budget Measures Implementation Act 2015

The introduction of these measures resulted in a series of amendments to the ITA and ITMA, and extended certain advantageous tax regimes to partnerships. Partnerships may now elect to be treated as a company for all purposes of the Income Tax Acts with effect from year of assessment 2016. Article 27 sub-article 6 of the ITMA states that:

(6) Any partnership ….. shall be entitled to make an election in writing to be treated as a company for all purposes of the Income Tax Acts, and in such case, the provisions of [Article 27] shall not be applicable thereto.

Such election may be made irrespective of whether the income derived by the partnership consists of income made during the course of a trading activity or from a passive activity.  The election is to be made within 60 days from the setting up of the partnership, but transitory arrangements have been agreed to with the Inland Revenue in respect of foreign partnerships which were already in existence prior to the enactment of the changes in law.

Partnerships that elect to be treated as companies would have the following applicable to them:

  1. The partnership will no longer be considered as transparent but would be subject to tax on its income at a rate of 35%.
  2. The Refundable Tax Credit System, whereby refunds of tax will be granted to the partners of such company.
  3. The possibility for the partnership to surrender its trading loss to other companies belonging to the same group of companies.
  4. The full imputation system on distribution of dividends, whereby tax paid at the level of the partnership is imputed in full towards the partners’ tax liability.
  5. The application of the Flat Rate Foreign Tax Credit (FRFTC) – this form of relief was only available to companies.
  6. articipation exemption whereby dividends and capital gains received by the partnership are exempt from Malta tax provided that the established criteria are satisfied.
  7. The special residence rule applicable to companies becomes applicable even to partnerships.

Due to the above change, the definition of dividend was also amended thereby including amounts distributed to partners and the amounts credited to them as partners.

Furthermore, amendments to the ITMA establish that a partnership no longer has to carry out a trade, business, profession or vocation so as to be considered as transparent for tax purposes. Partnerships will be considered as transparent no matter the way in which it derives its income. It is important to remember that in case that a partnership elects to be treated as a company it will no longer retain its transparent status, but as already stated would be taxed at the normal rate of 35%.

Capital Gains

Provisions were introduced in 2011 to address an important loophole which existed in partnership taxation, that is, the transfer of an interest in a partnership was previously disregarded for the purposes of Maltese tax.

A transfer, including a deemed transfer, of an interest in a partnership now constitutes a chargeable event for the purposes of Article 5 of the ITA and is accordingly chargeable to tax on capital gains. A deemed transfer occurs where a person acquires or increases a partnership share, in which case a transfer of an interest in a partnership is deemed to take place to that partner from the other partners.

The chargeability to tax on capital gains arising on a transfer of a partnership interest applies in so far as the partnership concerned falls within the definition of a partnership in terms of Article 5 of the ITA and which reads as:

5.(1)(b) In this article – “partnership” means –

(a) any partnership constituted under the Companies Act or under the Commercial Partnerships Ordinance, being either a commercial partnership en nom collectif or a commercial partnership en commandite the capital of which is not divided into shares;

Non-Resident Partners

On a final note, it is important to mention that as long as the partnership income retains its nature and source as it flows through to the partners, persons who are not residents and not domiciled in Malta for tax purposes should only be assessable on their share of the partnership income that is attributable to sources in Malta. Accordingly, foreign-source partnership income which flows through to foreign partners should fall outside the scope of Maltese tax. Furthermore, the transfer of an interest in a partnership by non-residents is exempt from income tax by virtue of Article 12(1)(c)(ii) of the ITA.

Posted in: Maltese Tax Law