updated 10:36 PM CET, Dec 3, 2022

IRS announces crackdown on certain American taxpayers' mis-use of Maltese pensions

Valletta, Malta Valletta, Malta

The U.S. and Malta have signed an agreement that will end the alleged mis-use of certain provisions in the existing U.S./Maltese income tax treaty by Americans seeking to avoid paying tax on income generated by pension schemes domiciled there, the Internal Revenue Service said this week.

The IRS said the fix took the form of a "competent authority arrangement", or CAA, which "confirmed their understanding of the meaning of 'pension fund' for [the] purposes of the United States–Malta income tax treaty."

It added: "The competent authorities [of the U.S. and Malta] entered into this agreement after becoming aware that U.S. taxpayers with no connection to Malta were misconstruing the pension provisions of the [income tax] treaty, to avoid income tax on the earnings of, and distributions from, personal retirement schemes established in Malta.

"The CAA confirms the U.S. and Malta competent authorities' understanding that – except in the case of a qualified rollover from a pension fund in the same country  a fund, scheme or arrangement is not operating principally to provide pension or retirement benefits if it allows participants to contribute property other than cash, or does not limit contributions by reference to income earned from employment and self-employment activities." 

In announcing the agreement with Malta's government on the matter, the IRS also said it was “actively examining” taxpayers who set up Maltese pensions, suggesting there could be issues ahead for those Americans found to have taken advantage of what may have seemed, to them or their tax advisers, a valid ta efficiency. 

In July, the IRS put U.S. taxpayers on notice that it was reviewing the use by an undisclosed number of U.S. taxpayers of an interpretation of the U.S.-Malta income tax treaty that, it suggested, could land them in trouble with the American tax authorities. 

In this week's statement, the IRS said that "taxpayers who have set up these arrangements, and... other taxpayers [who] may have filed tax returns claiming [income tax] treaty benefits as a result of their participation in these arrangements... should consult an independent tax advisor prior to filing their 2021 tax returns, and take appropriate corrective actions on prior filings." 

It also cautioned U.S. taxpayers "against entering into any substantially similar arrangements that would seek to misconstrue the provisions of a bilateral income tax treaty of the United States [in order] to avoid income tax.

"IRS enforcement, both the civil and criminal divisions, is committed to pursuing abuse and those who market and participate in abusive transactions." 

Those American taxpayers who had opted to move their pensions to Malta had reportedly been attracted by claims that if they were 50 years of age or older, they could avoid federal capital gains tax of 23.8% on earnings through the use of a Maltese pension scheme, which they could not do elsewhere. 

Un-surprised in Dubai

One tax adviser who said she was unsurprised by the IRS's announcement was Dubai-based Virginia La Torre Jeker, who devoted her weekly USTax.org blog to the topic on Wednesday.

"Some US tax advisers were recommending use of these schemes," she wrote.

"[But] I, along with other more circumspect tax professionals, would not work with such plans, and cautioned against their use, because in our view it was doubtful that these personal retirement schemes would be treated as 'pension funds' in substance, for purposes of applying the [tax] treaty."

La Torre Jeker went on to note that the Maltese pension schemes targeted by the IRS had been "hot with quite a few wealthy Americans, since promoters claimed they could slash tax bills by making clever use of the treaty," but concluded: "The bottom line is that the purported benefits of Maltese pensions in personal schemes that disregarded certain principles (such as not limiting contributions, or permitting contributions of such assets as crypto [currencies] or shares in start-ups) were not intended by Treasury in negotiating the treaty, and therefore the use of 'pensions' in this manner [was] indeed 'too good to be true'.”

Popular with retirees 

Although the IRS's statement this week made it clear that the Americans who owned the ill-conceived Maltese pension plans it was referring to had "no connection to Malta," it is nevertheless true that Malta is one of a number of jurisdictions that have begun attracting American retirees in recent years in a way they previously didn't, in spite of its distance from the U.S. 

Among its attractions to such American retirees are its climate and ambiance – it's located just south of the Italian island of Sicily in the Mediterranean – as well as the fact that, owing to its history as a British colony, it still counts English as one of its two official languages. (It became independent in 1964, and joined the European Union in 2004.) 

As reported, Malta made its way onto International Living's ten "best places" to retire earlier this year, as set out in the magazine and website's annual Global Retirement Index. (LatAm countries accounted for five of the top six.)