Maltese pension plans under the Malta/US Income Tax Treaty

The catalyst for these plans is the Malta/US Income Tax Treaty (effective in 2011) which addresses double tax and primary taxation rights of the two Contracting States. The definition of a “pension fund” in this treaty is broader than in most other US treaties, simply stating that “the term ‘resident of a Contracting State’ includes ... a pension fund established in that State ... notwithstanding that all or part of its income or gains may be exempt from tax under the domestic law of that State”. It further provides that a pension fund established in Malta must be “a licensed fund” which is “operated principally ... to administer or provide pension or retirement benefits”.

The Treaty adds that “Pensions and other similar remuneration beneficially owned by a resident of a Contracting State shall be taxable only in that State”, and states that “Notwithstanding ... the amount of any such pension or remuneration arising in a Contracting State that, when received, would be exempt from taxation in that State if the beneficial owner were a resident thereof shall be exempt from taxation in the Contracting State of which the beneficial owner is a resident”. This tax treatment is further confirmed in subsequent treaty articles. In short, these treaty articles provide two key points:

• A US taxpayer is not subject to US tax on income earned within a Maltese pension fund until it is distributed; and
• The receipt of a distribution, if tax-exempt to a resident of Malta, is also tax-exempt if distributed to a US taxpayer.

In terms of US tax law, investmentbased pension plans are generally treated as grantor trusts – they are tax transparent, and the income, gains or losses within the plan are passed onto its owner. These plans require the filing of trust-related tax forms Form 3520-A Annual Information Return of Foreign Trust With a U.S. Owner and Form 3520 Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts. Some US taxpayers have then claimed treaty benefits exempting income and gains of their pension funds. To be effective, this exemption position must be disclosed by filing Form 8833 Treaty- Based Return Position Disclosure with their US individual income tax return.

On 01 July 2021, the IRS announced it would evaluate transactions involving Maltese pension plans to determine if the benefits claimed should be allowed under the Treaty. Then in December 2021, the competent authorities of Malta and the US entered into a competent authority arrangement (CAA) under the Treaty. This CAA states that US taxpayers have been establishing “personal retirement schemes in Malta under the Retirement Pensions Act of 2011 with no limitation based on earnings from employment or self-employment and are making contributions to these schemes in forms other than cash”, leading to questions “about whether these personal retirement schemes are ‘pension funds’ for purposes of applying the Treaty”.

The CAA concluded that where a pension fund is allowed to accept contributions from a participant in a form other than cash or does not limit contributions by reference to earned income from personal services, such a fund is “not operated principally to administer or provide pension or retirement benefits within the meaning of paragraph 1(k) of Article 3 of the Treaty and is therefore not a ‘pension fund’ ”.

There has been significant commentary and criticism of the CAA, notably on administrative and constitutional law grounds, but that discussion is for another article.

On 01 July 2022, the IRS issued its “Dirty Dozen” tax scams for 2022, which included avoiding US tax by making contributions to certain foreign individual retirement arrangements in Malta, and improperly asserting the foreign arrangement is a “pension fund” for Treaty purposes, with the US taxpayer thereby misconstruing the relevant treaty to improperly claim an exemption from US income tax.

The IRS is now actively examining taxpayers who participate in Malta pension funds. Various examinations have been initiated, with information document requests issued, and it seems that any current treaty benefit claims will be denied if the return is audited. Past benefit claims will also likely be denied and may result in tax adjustments being assessed against taxpayers. Taxpayers should consider whether to take a Treaty-based return position for the 2021 tax year given the IRS announcements and issuance of the CAA. It is also advisable to assess any past Treaty-based positions and disclosures to decide whether to proactively amend past returns or make arguments to the reasonableness of their position if examined.

The IRS has not provided any guidance on how a taxpayer who has taken a Treaty position on a Malta pension might proceed, but the good news is that by definition Form 8833 is a disclosure of that position and that prior to the CAA, the Treaty position should be reasonable given the special status which was provided to Malta pension funds in the Treaty.

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