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Like every other citizen I relish the prospect of lower taxes. But, as an economist, I shudder at the very thought of recommending this to a government whose primary target is now set on the reduction of the nation’s fiscal imbalance within a short span of only three years in such a way as to inflict the minimum of pain on the smallest number of the citizenry.
And, incredibly, that’s what one side of the social partnership has just done. This country, it maintains, is overtaxed, particularly in the field of corporate taxation where we top the list of all new ten EU members and eleven of the old, rendering our company tax regime the fourth highest in all the EU. Even our foremost Labour European parliamentarian ingenuously swallowed this half-truth and lamented that “companies investing in Malta end up being taxed double what they are paying in Hungary…or in Cyprus, Latvia and Lithuania.”
Everyone quotes Eurostat or the Institute of Official Credit Data. Reliable as these certainly are, they cull their information to fit various headings as they see them. The result is that one is often easily misled into making illogical comparisons. The tax conundrum is a classical case in point.
To state that corporation tax does not really exist in Malta is not a heresy. For the last 55 years we have had an ‘income’ tax and nothing else remained by way of direct taxation after the disappearance of the inheritance and estate duty 12 years ago. In other countries, company tax is totally separate and different from income tax and is purely a tax collection for fiscal purposes, whereas income tax has as much a social distributive functional dimension as financial/fiscal.
So, when politicians or social partners compare our 35 percent standard rate with Cyprus’s 15 percent, Hungary’s 16 percent, Poland’s 19 percent, Germany’s 38.3 percent and so on, they fail to add that these countries have an additional income tax regime on the earnings of individuals, treated separately from profits tax. Ours is not.
This is not to say, however, that ours is necessarily the better way of taxing earnings, whether profits or salaries or dividends or whatever. But, certainly, it is ludicrous to compare our maximum 35 percent to much lower rates of profits taxes without also mentioning other direct taxes, chiefly income tax.
In Malta, a commercial persona pays the 35 percent tax (or less if benefiting from the Business Promotion Act) on behalf of its shareholders. All profits are destined either eventually to be distributed as dividends or to be retained by way of reinvestment in acquiring further assets for expansion, thus enhancing the shares’ value. Whichever form it takes, the shareholder is exempted from paying any further tax on the receipt of dividends, irrespective of his other income. Indeed, if he/she is within a low-income bracket, a tax refund is claimed when dividends are received or when capital gains are taxed on sale of enhanced value shares (not applicable so far on shares quoted on the Malta Stock Exchange, a benefit which has outlived its value to the economy).
In contrast, when dividends are received by shareholders in the other EU countries, having been already taxed at corporate rates, they are considered to form part of the individual’s private income and taxed again separately in accordance with that country’s income tax regime. Purely as a tax collection exercise there is hardly any superiority between the two strategies. As an economic measure meant to incentivise growth through reinvestment, the separation of the two systems is manifestly superior. And that’s precisely where we are missing out on opportunities in attracting more foreign direct investment (FDI). It is about time we change our strategy, despite the inevitable opposition from our commercial community used to thinking only in terms of ‘family businesses’ that hardly distinguish the corporation from its shareholders and only resort to it for the limited liability shelter it provides without paying anything for the privilege.
For many years Maltese companies were charged 32-1/2 percent upfront and another equal rate if and when profits were distributed (65percent in total). This was intended to encourage their retention for investment and expansion. The Aids to Industries Ordinance of the late ‘50s provided a ten-year total tax exemption on all profits earned from exports, even if they were eventually distributed in dividends after the ten years. Maltese companies, understandably, hardly ever qualified for tax exemption unless they managed to export and only on that proportion of profits computed to have been earned there from.
In 1988 the tax ceiling was lowered from 65 percent to 35 percent which became a standard tax rate. Companies started being taxed at 35 percent instead of 32-1/2 percent, but without any further taxing on dividend payouts. Thanks to the Industrial Development Act which was meant to modernise the previous Aids to Industries Ordinance and which itself was updated by the Business Promotion Act relatively lately, we managed to grant exemption to FDI for most, if not all, of the impact of the 35 percent.
As members of the EU we have now to avoid blatant discriminatory tax advantages. However, we desperately need to offer a much lower tax level to new FDI, which we can only possibly do by adopting the regime which is universal throughout the other 24 EU member states: a relatively low corporate tax, say 15percent, on its own merits and independently of any income tax charged on earnings from dividends or, for that matter, any other source. This rate will need to be adjusted upwards even to 50 percent when a company is considered to be operating in a tight oligopolistic market where effective competition is inhibited, eg banks and telecommunications. We could then consider raising the ceiling of the citizen’s total exempted earnings, but simultaneously impose a surtax, even if only temporarily until we manage to set our fiscal house in order, on incomes, say, in excess of Lm10,000 pa.
Only then would we be in a position to avoid telling a partial truth on Malta’s direct tax regime vis-à-vis other EU countries.
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