Considerations on the taxation of property transfers in Malta
The transfer of immovable property has for many years been the subject matter of various amendments to Maltese tax legislation. This has resulted in the taxation of transfers of immovable property becoming one of the most developed areas of Maltese tax legislation with some very detailed and at times complex rules seeking to regulate the tax that should be paid on a transfer of property.
The rules have been developed over several years, often as a response to the prevailing conditions of the property market, and to an extent, the framework of the legislation must be understood within the context of its development.
The purpose of this article is to briefly outline the current landscape of the provisions regulating the taxation of property transfers in terms of the Income Tax Act and to consider some practical implications resulting from the application of those provisions.
A high-level overview of the system
The system of taxation on the transfer of immovable property situated in Malta is somewhat unique within the context of the Maltese tax system in that it departs to an extent from the general system of income tax chargeable on transfers of other types of assets.
The present system of taxation of transfers of property situated in Malta was adopted in 2006 (generally with effect from transfers of property taking place from 1 November 2005). Prior to the change, gains arising on the transfer of property were added to a person’s income and charged to income tax at the normal rates applicable to the transferor.
With the 2006 changes, the default system of taxation on transfers of property changed to one which imposes a final tax charged as a fixed percentage on the higher of the consideration payable on the transfer of the property or the market value of the said property.
Currently, the default final rate of tax is 8% of the transfer value of the property, increasing to 10%, when the property being transferred was acquired (or deemed, in terms of the legislation, to have been acquired) by the transferor before 1st January 2004.
A reduced final rate may apply to certain transfers of immovable property, which generally are applicable in the following circumstances:
- 5% when the property is transferred within 5 years from the date of acquisition, and it does not form part of a project;
- 5% on property that has been restored situated in an Urban Conservation Area or if the property is scheduled by the Planning Authority;
- 2% when an individual or two individuals that are co-owners transfer their sole ordinary residence within 3 years from the date of acquisition.
The application of the above rates is subject to the satisfaction of a number of conditions as set out in the relative provisions of Article 5A (5) of the Income Tax Act.
Although the system of final tax applies by default, the legislation contemplates particular instances where the transfers of immovable property can be taxed on the gain made by the transferor taking into account the cost of acquisition and any applicable deductions.
One instance in which this could occur is when a transfer is being made by a person who is not resident in Malta and who is subject to tax in his country of residence on the profit from the transfer of the property. However, such transfer remains subject to a minimum taxation in Malta of 7% of the transfer value of the property.
Another opt out possibility applies when a company has issued bonds to the public on a stock exchange recognised under the Financial Markets Act, and, subject to certain conditions, the bond proceeds are used specifically to develop a property project. In such case the company may elect to be taxed on the profits that it derives from the sale of property subject that a minimum final tax may also be payable on the transfer of the property.
When one transfers property which has been acquired through inheritance on or after 25th November 1992, such transfer is taxed on the difference between the value of the property declared when the property was acquired and the transfer value of the property. The difference is subject to a final tax rate of 12%.
Profits arising on the transfer of rights acquired under a promise of sale agreement are also chargeable to tax at the standard rates applicable to the person deriving the said gain.
Transfers of property which are situated outside Malta remain subject to the normal system of taxation of capital gains, i.e. the difference between the consideration and the cost of acquisition of such property (adjusted for deemed maintenance and inflation) is aggregated with the person’s income from other sources and charged to income tax at the normal applicable rates.
There are a number of instances where transfers of property are exempt from the final tax. To a great extent these replicate similar provisions that apply to transfers of other types of capital assets. For example, donations of property by an individual to his or her spouse, ascendants or descendants (or in the absence of descendants to his/her siblings or their descendants); transfers of property between companies forming part of the same group; property assigned between spouses as a result of a separation or divorce; and, transfers of property upon the liquidation of a company when the shareholder owns at least 95% of the said company (amongst others) are all exempt subject to the satisfaction of the applicable conditions.
Reflections on the final tax system
The final tax system arguably has made it simpler for taxpayers, notaries and the Commissioner for Revenue to calculate and collect tax on transfers of immovable property. Given that the tax is paid upon the transfer of the property (and therefore the signing of the deed) and is withheld from the total amount received by the transferor for the sale of the property, its administration is relatively straightforward.
Indeed, income tax paid on property transfers is in most cases a ‘final tax’, which means that the full amount of tax is payable upon the contract of sale and transactions are not taxed again as part of the tax return. Being a final tax, it is not subject to a credit or a refund.
This concept also extends to when the transferor is a company and distributes a dividend out of the profit that it derived from the sale of the property to the shareholder. Given that the profit that was derived from the transfer of the property would have been subject to the final tax, the company is required to allocate such profits to its Final Tax Account.
As a result, given that distributions of dividends out of this tax account are not considered to form part of the shareholder’s chargeable income, the shareholder is not exposed to further tax on those profits.
However, this administrative simplicity often belies a more complex set of rules particularly in view of the number of different rates that could possibly apply in different scenarios that one might encounter. Such complexity is arguably required to take account of different scenarios in order to provide a more equitable result for a taxpayer.
Indeed, there appears to be some level of correlation between the rate that applies on a transfer of property and the time that elapses from when the transferor acquired the said property. The correlation appears to indicate that the longer a person owns a property, the higher the rate of tax that applies on the sale of that property.
By way of example, when the property is owned for less than 5 years and does not form part of a project, the final rate is 5%, whereas if the property was acquired before 1 January 2004 (i.e. at least 14 years ago), then the final rate that applies is 10%. This correlation appears to be based on the presumption that the longer one owns a property, the larger the gain which such person is likely to make on its transfer and therefore should be subject to tax at a higher final rate.
The flipside to this is that if a person makes a loss or a small gain on the transfer of property, such person is nonetheless subjected to the final tax thereby either increasing the size of the loss or turning the small gain into a loss position after tax.
One additional characteristic of the final tax system is that it has eliminated (to a large extent) the distinction between profits that are derived from a person trading in property and capital gains derived from the sale of property. Indeed, prior to the introduction of income tax on capital gains in 1992, this distinction was extremely important given that capital gains on transfers of immovable property had hitherto not been taxable. The distinction remained important even after the introduction of tax on capital gains in 1992, given that a capital gain on a transfer of property was calculated differently to trading profit on the sale of property.
With the final tax system, this dichotomy has been largely removed, although the current system preserves some distinctions between transfers of property forming part of a project (which can be assimilated to profits derived from a trading operation) and property which does not form part of a project. By way of example, the reduced rate of 5% does not apply where the property transferred was held by the transferor for less than 5 years, when the property forms part of a project. In such a case, the transferor should typically be chargeable at the default rate of 8%.
Similarly, when a person receives property through a donation, and transfers that property after 5 years, such person should be taxable on the excess of the transfer value over the value of the property at the point of donation at a rate of 12%. This said, if the transferor develops the property that he/she received into a project, the general final tax rules apply.
The performance of the Maltese economy has continued to be inexorably linked to the property market. As a result, the taxation of immovable property has been and continues to be a key component of national fiscal policy.
The final tax system appears to be a system that is favoured given that since its introduction, it has been retained and amended by successive governments. Nonetheless, as with each system of taxation, there are winners and losers since the legislation might not cater for every particular scenario and thus could in certain instances give rise to unequitable results.
The challenge thus remains that of striking the right balance between the simplicity of the system and the ease with which it can be administered, and the sophistication of the system for it to ensure an equitable tax burden on property transfers. Arguably, finding that balance is something of a never-ending process in itself, given the ever-changing economic and social environment within which the tax system operates.