Notional Interest Deduction

In the presentation of the 2017 Malta Budget, the Minister for Finance announced the introduction of the Notional Interest Deduction (NID), which aims to approximate the tax treatment of equity with that of debt.

NID was introduced by means of legal notice 262 of 2017 published on 5 October 2017. NID came into force with effect from year of assessment 2018.

Paradoxically corporate income tax systems usually discriminate between the different sources of finance. They favour debt over equity financing:  return (interest) on debt is deductible for tax purposes whereas the return on the equity is not, yet the latter is the riskier of the two. This unequal treatment could be the cause of certain problems such as excessive leverage and an increased vulnerability to economic crises, disadvantages for firms with restricted access to external funds and profit shifting incentives.

NID was introduced to achieve an equal treatment of debt and equity financing, by granting an additional deduction for the return on equity financing.

• Claiming the NID is at the option of the company or partnership.
• The NID can be claimed by companies and partnerships resident in Malta (including Maltese permanent establishments of foreign entities) against their chargeable income for the year.
• The NID is calculated by multiplying the deemed notional interest rate by the balance of risk capital that the undertaking has at year end.
• The notional interest rate is the risk free rate set on Malta Government Stocks with a remaining term of approximately 20 (which is currently approximately 2%) years plus a premium of 5%. The NID would thus currently be expected to be about 7%.
• Risk capital includes share capital, share premium, reserves, interest free loans and any other item that is shown as equity in the financial statements as at year end.
• The maximum deduction in any given year cannot exceed 90% of chargeable income before deducting the NID. Any excess can then be carried forward to the following year. Any remaining chargeable income is subject to tax at the standard rates.
• When a company or partnership claims a NID, the shareholder or partner is deemed (for tax purposes) to have received the corresponding notional interest income from the company or partnership. Distribution of profits relieved from tax by the NID however will not be charged to tax.
• The rules include an anti-abuse provision to prevent abuses of the NID.

Apart from approximating the debt to equity tax treatment by providing a notional interest deduction on equity, the NID may simplify matters within Malta’s full imputation system in view of the resulting reduction in the imputation credits resulting from claiming the NID.