EUROPEAN COMMISSION

Brussels, 22.III.2006 C(2006)810 final

Subject: State aids E 6/2005, NN 26/2005, E 11/2005 and NN 35/2005 - incentives in favour of “International Trading Companies” and “Companies with Foreign Income”.

Sir,

1. The Commission wishes to inform Malta that, having examined the information supplied by the Maltese authorities on the measures referred to above, it has decided to propose appropriate measures pursuant to the procedure laid down in Article 88(1) of the EC Treaty.

2. As background, in 1997, the ECOFIN Council adopted a Code of conduct for business taxation with the objective of tackling harmful tax competition1. Following the commitment to this Code, the Commission published in 1998 a notice on the application of State aid rules to measures relating to direct business taxation2 emphasising its determination to apply them rigorously and to respect the principle of treatment equality among Member States in reviewing the tax arrangements in force in the Member States. The present procedure is carried out within this framework.

PROCEDURE

3. By letter dated 18 May 2004 (D/53564) the Commission requested the Maltese authorities to provide information about the Maltese tax schemes for International Trading Companies (ITC) and for the Maltese Companies with Foreign Income

1 OJ C 2 of 6.1.1998, p. 1

2 OJ C 384 of 10.12.1998, p. 3

On. Michael FRENDO Ministru ta' l-Affarijiet Barranin Palazzo Parisio Triq il- Merkanti Valletta CMR 02 Malta

Commission européenne, B-1049 Bruxelles – Belgique Europese Commissie, B-1049 Brussel – België Teléfono: 00-32-(0)2-299.11.11.

(CFI). By letter of 8 June 2004 (A/34413), the Maltese authorities provided the requested information.

4. By letter of 14 July 2004 (D/55143) the Commission requested the Maltese authorities to provide further information with respect to the two schemes. By letter of 25 August 2004 (A/36635), the Maltese authorities provided the requested information.

5. By letter dated 20 October 2004 (D/57558), the Commission requested the Maltese authorities to provide further specific information including the text of the relevant articles of the Act and Income Tax Management Act as they stood on 23 September 1994, when the ITC and the CFI regimes were introduced. The requested information was provided by the Maltese authorities by a letter of 15 November 2004 (A/38990).

6. On 17 November 2004 and 14 December 2004 two meetings at a technical level took place between the Maltese authorities and the Commission to clarify the functioning of the ITC and the CFI regimes and their possible nature as existing aid within the meaning of Article 1(b)(i) of Council Regulation N° 659/1999 laying down implementation rules of Article 88 of the EC Treaty3.

7. By letters of 28 February 2005 (D/51494) and 29 March 2005 (D/52384), the Commission informed the Maltese authorities of its preliminary assessment of the tax schemes in question. The requests were accordingly made under the cooperation procedure for existing aid. By these letters, the Commission invited the Maltese authorities to provide their comments with a view to reviewing the schemes, pursuant to Article 17(2) of the said Regulation N° 659/1999.

8. On 16 March 2005, a meeting took place between the Maltese authorities and the Commission services to further deepen the discussion on the functioning and operation of the two schemes.

9. By letter dated 19 March 2005 (A/32573), the Maltese authorities provided their comments with respect to the tax incentives for the ITC scheme, thus submitting their observations about the letter of the Commission of 28 February 2005. By letter of 6 June 2005 (A/34588), the Maltese authorities provided their comments with respect to the tax incentives for the CFI, thus submitting their observations about the letter of the Commission dated 29 March 2005. This answer followed an extension of the deadline for submitting comments made by letter of 25 April 2005 (A/33462) by the Maltese authorities about the regime for CFI, extension which had been accepted by the Commission on 4 May 2005 (D/53529).

10. By letter of 16 June 2005 (D/54621), the Commission reminded the Maltese authorities about the remaining information including the proposed amendments to the schemes in question with a view to eliminating the possible existing aid elements of such schemes.

11. By letter dated 27 June 2005 (A/35175), the Maltese authorities submitted a proposal for amending their tax system with a view to gradually replacing the specific regimes for ITC and the CFI with another system of taxation for companies in Malta within a transitional period. Two further meetings and a conference call took place at a technical level between the Maltese authorities and Commission’s services to discuss the content

3 JO L 83 of 27.3.1999, p. 1.

2 of the proposal, on 14 September 2005, 12 October 2005 and 26 September 2005 respectively.

12. By letter of 24 October 2005 (A/38783), the Maltese authorities submitted an amended version of their proposal to modify Malta’s income tax system with a view to gradually replacing the specific regimes for ITC and the CFI with another system of taxation for companies in Malta within a transitional period.

DETAILED DESCRIPTION OF THE SCHEMES

Background

13. On 23 September 1994, Malta enacted certain amendments to its general tax legislation of 1949 with respect to Chapter 123 - the “Income Tax Act” (ITA) - and Chapter 372 - the “Income Tax Management Act” (ITMA) – having the common objectives to support the development of Malta as an international financial and business centre, to promote international investments in Malta and to provide clarity on certain tax issues related to revenues from international operations.

14. By these amendments, Malta introduced two special regimes in favour of multinational enterprises or groups based outside Malta (having non-resident shareholders), which register special-purpose vehicles in Malta for commercial and asset trading purposes, provided they earn income from abroad on an exclusive or prevalent basis . Such special-purpose vehicles are Maltese companies, which either take the specific tax-related form of an “International Trading Company” or derive income from outside Malta, while being held by foreign shareholders, as Maltese “Companies deriving Foreign Income”. The activities exercised by such Maltese vehicles typically include intra-group financing and the provision of other intra-group services. The profits earned by such companies are effectively subject to minimal taxation in Malta by means of a refund of corporate paid there upon distribution of the profits outside Malta (to the foreign shareholders of the Maltese companies), as opposed to the ordinary corporate of 35% in Malta. The foreign shareholders typically take a corporate form, so that the companies placed in Malta constitute international holding companies.

15. More particularly, the schemes provide extraordinary refunds of the corporate tax ordinarily paid in Malta (35%) upon distribution of such companies’ profits to their shareholders residing outside Malta. Such refunds are available only to Maltese companies having both a specific legal status or earning income from foreign sources including trading, and distributing the profits earned to foreign shareholders including corporate shareholders, as indicated below.

16. Under the ITC regime, the Maltese companies solely engaged in carrying out business activities outside Malta benefit from two extraordinary refunds of the corporate taxes ordinarily imposed in Malta upon distribution of their profits to shareholders residing outside Malta. Thus, the ITC’s profits are effectively subject to 4,2% tax in Malta, when distributed to non-resident shareholders, in lieu of the normal 35% rate.

3 17. Under the regime for CFI, the Maltese companies carrying out business activities outside Malta benefit, first, from a (flat-rate) foreign relief even, possibly even if no foreign taxation is effectively incurred and, second, from a full or partial refund of the corporate taxes paid in Malta on the profits deriving from the foreign income earned by the CFI upon its distribution to foreign shareholders. The revenues accruing to a CFI are accordingly subject to very low or even zero taxation in Malta (in the case of a qualified participation shareholding), when the CFI’s profits are distributed as dividends to non-resident shareholders.

18. Upon Malta’s accession to the Community, the Council qualified such incentives as harmful tax measures within the meaning of the said Code of conduct on business taxation and requested their elimination. Malta however decided not to comply with such recommendations because, in Malta’s view, the schemes constituted regimes for which Malta is solely responsible under the Treaty.

19. After the accession, the Commission services initiated the preliminary review of the schemes pursuant to the Commission commitment to a strict application of State aid rules set forth by Article 87 and 88 of the EC Treaty to examine case by case the tax arrangements in force in the Member States on the basis of the criteria set forth by the said Commission notice on the application of State aid rules to measures relating to direct business taxation.

20. As most of the incentives in question were put in place before 10 December 1994, which is the ultimate date, under Annex IV.3 of the Accession Treaty, to consider a measure as existing aid within the meaning of Article 1(b)(i) of the said Regulation N° 659/1999, the review was conducted under the cooperation procedure for existing aid schemes. Certain limited extensions of the two schemes nevertheless took place after 1998, when the scope of the ITC regime was enlarged, by adding in the definition of ITC in Article 2(1) of the ITA, the following activities to the list of activities eligible to be exercised by an ITC: (i) the management of companies resident in Malta whose business is restricted to affiliated insurance; (ii) the provision of management, administration or other services to collective investment schemes resident in Malta and (iii) the provision of ship management services by certain companies. The scope of the CFI regime was also broadened by adding in the foreign income definition provided for in Article 2(1) of the ITA “the profits or gains from the business of insurance in relation to risks situated outside Malta” to include in the foreign income account. The Maltese authorities maintain that these extensions of the scope of the two regimes were never used by ITC or CFI companies.

21. Following the cooperation procedure initiated by the Commission to review the two tax schemes, Malta eventually proposed to suppress them both, by converting them into a refund system, under the full imputation credit method to avoid of companies’ profits, in favour of any shareholder receiving dividends distributed by a Maltese company. The new refund system would, in Malta's view, be independent from the type of business activity carried out by the Maltese companies distributing their profits and the residency of the beneficial shareholders and the source of the income derived by such companies. The abolition of the schemes is intended by Malta to gradually take place during a transitional period ending in December 2012.

4 The ITC scheme

22. An ITC is a company registered in Malta which is engaged solely in carrying on trading activities with non-resident persons outside Malta, having its objects expressly limited to such trading activities as well as to other activities being necessary for the conduct of its operations from Malta4.

23. ITCs are fully subject to corporate tax at the normal corporate tax rate on profits of 35%. The differential treatment between ITCs and other Maltese companies only arises upon distribution of its profits (dividends) to their shareholders being resident outside Malta. In this case, the profits of an ITC are effectively taxed at 4,2%, as opposed to the profits of other Maltese companies being taxed at 35%, even when distributed to the shareholders.

24. The Maltese company/shareholder taxation system is based on the integrated taxation between the corporate and the shareholder’s tax levels, under which the tax paid by a company distributing a dividend is credited against the shareholder’s tax liability on the dividend received (imputation credit system). According to this system, dividends paid to shareholders by Maltese companies carry a tax credit equivalent to the tax paid by the company on its profits (being distributed as dividends). Shareholders are taxed on the gross dividend at their individual tax rates, but are entitled to deduct the tax credit attached to the dividend against their total income tax liability.

25. Upon receipt of a dividend from an ITC, the non-resident shareholders5 are: a) taxed at a flat rate of 27.5% on the gross amount of the dividend (instead of 35% typically applicable to a Maltese shareholder), b) credited with the amount paid by the company on the profits out of which the dividend were paid (35%, thus being refunded the difference between the tax paid by the company and the flat rate tax paid by the shareholder, corresponding to 7,5% of the income), and c) automatically entitled to a refund of 2/3 of the Maltese tax paid by the company on the same profits (2/3 of 35% tax, corresponding to approximately 23,3% of the income). In conclusion, the effective company/shareholder taxation on the income earned by an ITC is 4,2% (35% + 27,5% – 35% - 23,3% = 4,2%). The functioning of the ITC tax system is clarified in the table.

4 A company may request the Inland Revenue to confirm its status as an ITC by means of a tax ruling to provide certainty as the tax treatment of the non-resident shareholder.

5 An equivalent is granted with respect to dividends distributed to Maltese resident companies wholly owned by non-residents (such companies are treated as non-resident shareholders).

5 26.

Taxation of an ITC

Taxation at corporate level Company profits 1000 Tax payable (tax rate 35%) (350) Profits available for distribution 650

Taxation at shareholder level non-resident resident Net dividend received 650 650 Add: Tax paid by ITC (full imputation) 350 350 Chargeable income 1000 1000 Tax thereon (at 27.5% non-residents) and (at 35% residents) (275) (350) Imputation credit to shareholder (for tax paid by ITC) 350 350 Refund to non-resident/tax payable by resident shareholder 75 0 Further refund to non-resident (2/3 of tax paid by ITC) 233 N.A. Total amount of tax refunds to non-resident 308 N.A. Total tax paid on profits (of 1000) payable in Malta 42 350 Effective combined level of taxation of corporate profits in 4.2% 35% Malta

The CFI scheme

27. For Maltese tax purposes, all the non-ITC companies divide their business earnings into two schedules including income from domestic sources and income from foreign sources. The foreign income account includes all income and capital gains derived from foreign assets and profits and from a branch, agency or located outside Malta.6 Maltese companies receiving foreign-source income allocate this income to a so-called foreign income account, which will be taxed at the standard corporate tax rate of 35%, similarly to the domestic income. However, unlike the domestic income, the foreign income is entitled to relief with respect to taxes incurred abroad. Furthermore, when a Maltese company further distributes the profits deriving from the foreign source income account to its non- Maltese shareholders, the latter receive an extraordinary tax refund on top of the foreign tax relief. The combination of the refund and the foreign tax relief on foreign- source profits may result in zero or minimal taxation (up to 6.25% effective tax rate) in Malta, in lieu of the ordinary 35% tax rate.

6 More precisely, the income attributable to foreign income account includes (i) dividends, interest, royalties, capital gains, rents and similar income derived from investments and assets situated outside Malta; (ii) profits and gains of a company resident in Malta, if liable to tax in Malta, attributed to a permanent establishment situated outside Malta; and (iii) the profits or gains from the business of insurance in relation to risks situated outside Malta.

6 28. In particular, when the dividends paid from foreign-source income account are distributed to non-residents, the latter will be entitled to a refund of 2/3 of the Maltese tax paid by company on that income. The refund is increased to 100% in the case dividends are paid to a participating holding company (corresponding to a parent company holding control of the Maltese company). For example, if a Maltese company earns income from investments in a zero-tax foreign country (e.g. a ), the combined effect of the flat rate foreign tax credit of 25% (one of the tax credit relief methods available in Malta) and the refund system is that the total Maltese taxation on such foreign income is 11% in lieu of the ordinary 35% taxation. Maltese taxation can be as low as 0% tax in case the Maltese company derives income from a non-resident subsidiary which can be qualified as a 'participating holding' (normally if more than 10% of the share are held by the CFI), which is typically the case for the special-purpose vehicles created under the Maltese scheme for CFIs. In this case the non-resident shareholder of the CFI is entitled to a refund of 100% of the MT tax paid by the CFI.

29. The Maltese system provides for full integration between corporate and shareholder levels of taxation because of the full imputation credit system. According to this system, dividends paid to shareholders by Maltese companies carry a tax credit equivalent to the tax paid by the company on its profits which are further distributed as dividends. Shareholders are taxed on the gross dividend at the applicable tax rates, but are entitled to deduct the tax credit attached to the dividend against their total income tax liability and any excess credit is refunded.

30. Under the Maltese full imputation system, non-resident shareholders normally receive a refund because they have no possibility to set their credit against their Maltese tax liability. However, the refund is only given for dividends distributed out of foreign-source income and it is not given for dividends distributed out of Maltese revenues in order to secure to Malta whole the tax revenues deriving from Maltese income.

ASSESSMENT OF THE SCHEMES

State aid within the meaning of Article 87(1)

31. In order to ascertain whether the measure at hand constitutes an aid within the meaning of Article 87(1) EC, the Commission has to assess whether the measure favours certain undertakings or the production of certain goods by granting an advantage that is of an economic nature, that such an advantage distorts or threatens to distort competition, that the advantage is granted through State resources and, that the advantage is capable of affecting between Member States.

Economic and financial advantage

32. First, to be considered an aid a measure must afford the beneficiaries an advantage that reduces the costs they normally bear in the course of their business. The main criterion in applying Article 87(1) of the Treaty to a tax measure is then to prove that the measure provides in favor of certain undertakings in the Member State an exception to the application of the tax system7. According to the case law of the Court, the tax system of reference should thus first be determined to decide whether

7 Paragraph 16 of the Commission notice, indicated in footnote 2. 7 an advantage has been granted and whether such an advantage is justified by the nature or general scheme of the system8, that is to say, whether the exception derives directly from the basic or guiding principles of the tax system concerned.

33. The Maltese authorities acknowledge that the Maltese corporate tax system is the tax system of reference. The Commission considers that the tax advantages involved do not derive from the nature or general scheme of Malta’s tax system. The Commission first notes that under the Maltese tax system the tax imposed on a company resident in Malta is normally not credited against the shareholders tax liability. This is for example the case for resident shareholders and for foreign shareholders receiving dividends distributed out of Maltese income. 34. The Commission accordingly considers that the tax refunds to non-resident shareholders payable upon distribution of dividends out of ITCs profits or out of the foreign profits of CFIs depart from the ordinary scope of the Maltese corporate tax system. The refund granted with respect to ITCs and CFIs income distributed to foreign shareholders therefore constitutes an extraordinary advantage because it reduces the charges normally borne by the companies in question in carrying out their business activities. 35. By its submissions, Malta suggested that the derogatory tax treatment in favour of ITC-s and CFI-s would be justified by the adaptation of Malta’s imputation regime to the specific situation of non-resident shareholders and would therefore correspond to a general measure. However, this justification cannot be accepted because, according to this logic, Malta should also give refund to foreign shareholders in relation to the dividends paid out of domestic income. It is therefore concluded that such an exception is not justified by the nature of the Maltese tax system. Nor the Commission may consider that the tax advantages in question are justified by the objective of awarding relief against foreign taxation, because no foreign taxation has to be incurred in order to benefit from the schemes9.

36. Malta maintains that all companies are formally subject to the same corporate tax rate of 35% in Malta and that a tax refund is granted to the shareholders cannot be considered to favour the participated companies. The Commission considers however that, pursuant to the settled case law of the Court10, a tax reduction in favour of the shareholders of a company constitutes an advantage in favour of the distributing company. Under the schemes in question an advantage is provided in favour of the company’s shareholders by means of an extraordinary refund of the taxes paid by the company upon distribution of its dividends. Pursuant to its constant practice11, the Commission considers that such a refund constitutes an advantage for the distributing company and the group to which such a company belongs. The Commission notes that the beneficiaries of the tax regimes in question typically are multinational groups setting up their special purpose vehicles in Malta taking the form of an ITC or a CFI.

8 Judgment of the Court of Justice of 2 July 1974, Case C-173/73, Italy v Commission 1974 [ECR], p. 709, paragraph 14. 9 See in this respect paragraph 26 in fine of the Commission notice indicated in footnote 2.

10 Case C-156/98. Germany v. Commission [2000] ECR I-6857, paragraphs 24-28 and Case T-93/02, Confederation nationale du Credit mutuel v. Commission of 18 January 2005, paragraph 95.

11 See, for example, the Commission Decision C(2003) 564 final of 17 February 2003 on the tax regime in favour of Belgium’s Coordination Centres, OJ L 282 of 30.10.03.

8 The Commission therefore considers that the shareholders including the corporate shareholders constitute unitary economic entities together with the ITC or the CFI because of the economic control such shareholders exercise over the companies and accordingly any advantage granted to the shareholders directly favours both the ITCs and the CFIs, and the group to which such companies belong as recognised by the recent case law of the Court12. 37. The Commission also observes that under the tax schemes in question, the tax refunds received by the shareholders of the ITCs and the CFIs constitute an additional return on the investments held in such companies. The Commission accordingly considers that the extraordinary lower taxation applied to the distribution of dividends in favour of the shareholders of the ITCs and CFIs constitutes an advantage in favour of these companies in terms of reduced financing costs for the ITCs and the CFIs being owned by non-resident shareholders compared to ordinary Maltese companies. Presence of State resources

38. Second, to be termed State aid a measure must provide an advantage granted by the State or through State resources.

39. The Commission observes that by granting tax refunds to foreign shareholders the measures forego tax revenues of the Malta’s Treasury and therefore involve State resources.

Favouring certain undertakings or productions

40. Third, the measure must be specific or selective in that it favours only certain undertakings or the production of certain goods.

41. The Commission first notes that the specific or selective nature of the schemes derives from the objectives of the 1994 legislation enacting certain amendments to Malta’s tax legislation of 1949 aimed at supporting the development of Malta as an international financial and business centre and promoting international investments in Malta. In this respect, the Commission notes that the schemes are only available to companies registered in Malta under the specific ITC form or being registered in Malta to carry out business activities with foreign persons and are therefore specific within the meaning of Article 87(1) EC.

42. The Commission considers that the measures in question are effectively specific because their advantages are limited to companies carrying out commercial and asset trading activities abroad on an exclusive or prevalent basis and whose shareholders (to whom the profits are distributed) are resident outside Malta. The Commission also notes that activities exercised by such Maltese companies typically include intra- group financing and the provision of other intra-group services such as coordination and managing of licences, as such companies are often part of multinational groups and since their benefits derive from refunding the corporate taxes paid there upon distribution of the profits earned outside Malta to the foreign shareholders of the Maltese companies they presuppose the existence of multinational groups in which intra-group activities and investments are carried out.

12 Judgement of 10 January 2006, Case C-222/04 Ministero Economia e Finanze v Fondazione Cassa di Risparmio San Miniato, not yet published, paragraph 114.

9 43. The Commission considers that although the granting of the said tax refunds is based on objective requirements and is not formally limited to certain economic sectors or industries, the schemes in question are specific because the schemes are available only to Maltese companies deriving income from activities carried out with respect to foreign persons. Furthermore, the Commission considers that for the reasons expressed above the schemes are de-facto limited to multinational groups and as such they do not constitute general tax measures available to the entire .

44. Pursuant to the settled case law of the Court, tax reductions targeting all of the sectors that are exposed to international competition constitutes selective State aid13 and the same is true for measures favoring only national products being exported14. Pursuant to the Commission prior practice, a reduction of the base corporate tax rate for an entire sector of the economy, for example, the whole manufacturing sector constitutes State aid and the tax benefits being restricted to certain types of functions, such as intra-group, intermediation, management or coordination may in principle constitute State aid15. The Commission accordingly concludes that the schemes in question are selective because they are limited to companies established in Malta, exercising business activities outside Malta and being part of multinational groups.

Absence of justification for specific character of the schemes

45. Under the settled case law16, the Court of Justice has held that the selectivity criterion is fulfilled where undertakings in a comparable situation are unevenly affected by a tax measure, with no objective justification stemming from the specific aim of the scheme. The Commission considers that it appears disproportionate for the scheme at hand to impose substantively different nominal and effective taxation on companies being in comparable situation just because some of them are generating income outside Malta and have foreign shareholders. The Commission accordingly concludes that the scheme is selective in that it only favours certain foreign-owned undertakings carrying on business abroad and that this specific character of the scheme is not justified by its nature.

Distortion of competition and trade between Member States

46. Fourth, the measure must affect competition and trade between Member States. Under settled case law17, for a measure to distort competition it is sufficient that the recipient of the aid competes with other undertakings on markets open to competition.

47. The Commission considers that the beneficiaries of the schemes potentially perform various economic activities and operate on various markets open to competition. In particular, it appears that the measures distort competition and trade between Member States, both in the internal market and internationally, because their objectives and

13 Judgment of the Court of 17 June 1999 in Case C-75/97 Maribel bis/ter scheme.

14 Joined Cases 6 and 11/69 Commission v France [1969] ECR 561.

15 Commission decision of 22 July 1998 concerning the Irish corporation tax (aid N° E 2/1998), JO 2000. See also point 20 of the Commission notice indicated in footnote 2.

16 Case C-143/99 Adria-Wien Pipeline, ECR 2001 I-8365. 17 Case T-214/95 Vlaams Gewest v. Commission, [1998] ECR II-717. 10 effects are specifically designed to improve trading conditions of the beneficiaries doing business in foreign markets and directly affect companies being active in international trade or in other business activities carried out in markets being open to competition. This is particularly the case with ITCs who may not, in normal circumstances, trade or carry on business in Malta or with Maltese residents. As the schemes are designed to provide multinational groups incentives to set up companies in Malta by granting them minimal taxation for their cross-border activities it is assumed that they may affect competition.

48. It is difficult for the Commission to precisely assess the economic impact of the regime given that most data is either confidential or has not been gathered by Malta. The relevance of the schemes can only be presumed from the fact that according to Malta’s submissions there were around 1 800 ITCs registered in Malta in 2004 constituting about 12% of all the registered companies in Malta. Although the Commission does not dispose of specific information as to the number of CFIs in Malta, the importance of the scheme is assumed to be comparable with that of the ITC’s considering the identical objective and the similar advantages provided by the two schemes.

49. On the basis of the above considerations, the Commission concludes that the scheme is susceptible to affect competition and trade between Member States.

Compatibility

50. The Commission considers that the state aid in question is incompatible with the single market. The Maltese authorities did not present any arguments to indicate that any of the exceptions provided for in Articles 87(2) and (3) of the EC Treaty, under which State aid may be considered compatible with the common market, applies in the present case.

51. The exceptions provided for in Article 87(2) of the EC Treaty, which concern aid of a social character granted to individual consumers, aid to make good the damage caused by natural disasters or exceptional occurrences and aid granted to certain areas of the Federal Republic of Germany, do not seem to apply in this case.

52. Nor does the exception provided for in Article 87(3)(a) of the EC Treaty apply, which provides for the authorisation of aid to promote the economic development of areas where the standard of living is abnormally low or where there is serious underemployment. In the same way, it seems that the regime cannot be considered to be a project of common European interest or to remedy a serious disturbance in the economy of Malta, as provided for by Article 87(3)(b) of the EC Treaty. Nor does it have as its object the promotion of culture and heritage conservation as provided for by Article 87(3)(d) of the EC Treaty.

53. Finally, the schemes at hand must be examined in the light of Article 87(3)(c) of the EC Treaty. This provision provides for the authorisation of aid to facilitate the development of certain economic activities or of certain economic areas, where such aid does not adversely affect trading conditions to an extent that is contrary to the common interest.

54. The Commission considers that tax advantages granted by the schemes are not related to specific investments eligible to receive aid under the Community rules and guidelines, to job creation or to specific projects and they seem to constitute a 11 reduction of charges that should normally be borne by the firms concerned in the course of their business and must therefore be considered as operating State aid. According to the constant practice of the Commission, such aid cannot be considered compatible with the single market in that they do not facilitate the development of certain activities or of certain economic areas, nor are the incentives in question limited in time, digressive or proportionate to what is necessary to remedy to a specific economic handicap of the areas concerned.

55. The Commission also notes that the simple fact that the schemes are available to companies registered in Malta constitutes a breach of the freedom of establishment of undertakings established in other Member States as well as in Malta18. In this respect, the Commission recalls that it cannot authorise aid which is contrary to a specific provision of the Treaty. State aid, certain conditions of which contravene other provisions of the Treaty, cannot therefore be considered by the Commission to be compatible with the common market19.

CONCLUSIONS

56. The Commission concludes that the schemes constitute State aid within the meaning of Article 87 (1) of the EC Treaty and that none of the derogation provided for by Article 87 (2) or Article 87 (3) of the EC Treaty apply. Considering that both schemes (except the minor extensions described above) were enacted before the date of 10 December 2004 upon which aids are considered as existing according to Annex IV.3 of the Accession Treaty between the European Union and Malta, the measures in question mainly constitute an existing aid within the meaning of Article 1 (b) (i) of Council Regulation (EC) No 659/1999.

57. Where an existing aid is found to be incompatible with the common market, such aid should be subject to appropriate measures under Article 88(1) of the EC Treaty, with a view to abolish or amend the scheme and that with respect to the principle of legal certainty pertaining to the elimination of existing aids, the Court of First Instance20 recognised that “the Commission is, as part of its constant review of existing aid, only empowered to require the elimination or modification of such aid within a period which it is to determine”. 58. As a result of the cooperation procedure initiated, the Maltese authorities proposed to the Commission that both the ITC and the CFI schemes are abolished and that they are replaced by a system of refund of the Maltese corporate tax, that according to Malta would be applicable to all companies distributing their revenues (as dividends) to their shareholders, both resident and non-resident and independently from their legal form or status, the business activity exercised and the source (Maltese or non- Maltese) of the income derived by such companies. 59. According to the Maltese proposal, companies in Malta will still be subject to 35% corporate tax. Upon distribution of their profits, companies will also pay a 35% Advanced Company Income Tax (ACIT), which is creditable against the corporate income tax, so that no ACIT is payable by a company that already paid the corporate

18 Case C-307/97, Compagnie de Saint-Gobain, Rec. [1997], p. I-6161.

19 Case C-156/98, Germany v Commission [2000] ECR I-6857. 20 Cf. joined Cases T-298/97, T-312/97, T-313/97, T-315/97, T-600/97 to T-607/97, T-1/98, T-3/98 to T- 6/98 and T-23/98, Alzetta v. Commission

12 tax. All shareholders of Maltese companies will be further entitled to credit part or all the ACIT paid against their tax liabilities and to eventually obtain the refund of the taxes paid in excess. Malta did not give any precise indication of the amount on the refund given, which will be set as a tax credit granted by Malta on equal terms to all companies distributing their revenues (as dividends) to their shareholders, both resident and non-resident and independently from their legal form or status, the business activity exercised and the source (Maltese or non-Maltese) of the income derived by such companies. However, when profits distributed are derived by the distributing company from a participating holding there will be a full refund21. If a company has already claimed double taxation relief, the shareholders’ refund will accordingly be reduced. .

60. According to the Maltese proposal, the new tax system will gradually take effect during a transitional period ending on 31st December 2012. In particular, the new ACIT tax system will take effect on1st January 2008with respect to the companies created after that date. The ITC and CFI companies already existing prior to 1st January 2008, will continue to apply the current refundable credit system until 31st December 2010. All the other companies created until 1st January 2008 (and not being an ITC or a CFI) will only apply the new full imputation system (based on the ACIT refund) starting on 31st December 2012, and will not benefit from any refundable tax credit until that date, according to the current rules. The proposed transitional regime aims at obtaining a gradual transition from a refund system solely available to ITC and CFI companies to a the new ACIT refund system that would according to Malta be granted by Malta on equal terms to all companies distributing their revenues (as dividends) to their shareholders, both resident and non-resident and independently from their legal form or status, the business activity exercised (with the exclusion of the full refund set for the participating holdings) and the source (Maltese or non-Maltese) of the income derived by such companies, and to spread the budgetary impact of the proposed refund system over a seven-year long period.

61. The Commission considers that the Maltese proposal would introduce a refundable tax credit system granted by Malta to all companies distributing their revenues (as dividends) to their shareholders, both resident and non-resident, independently from their legal form or status, the business activity exercised, their size, sector and from the source (Maltese or non-Maltese) and type of the income derived by such companies (with the exclusion of the participating holding situations, since the full refund would be granted solely to the shareholders of the distributing Maltese companies with participating holdings).

62. The Commission conclusively considers that appropriate measures can at this stage be proposed in line with the Maltese proposal. The Commission also considers that Malta should be allowed to gradually repeal the existing selective incentives during a transitional system ending by 31st December 2010 at the latest, in lieu of the current 31st December 2012. In particular, from 1st January 2007, Malta should refuse granting granting the ITC status to any new company registered in Malta. Furthermore the Commission considers that the latter companies, including the existing ITCs and the ITCs created until 31st December 2006 (new entrants) should

21 The full tax will be refunded in case of a participating holding company, in partial conformity with the EU parent/subsidiary Directive privilege – Council Directive N. 90/435/CEE of 23 July 1990 on the common system of taxation applicable in the case of parent companies and subsidiaries of different Member States, OJ L 225 of 20.08.1990, p. 6, as modified by the Council Directive N. 2003/123/CE of 22.12.2003.

13 be allowed to benefit from the current refund system until 31st December 2010 in accordance to the Maltese proposal. The Commission also considers that Malta should prohibit the formation of any new ITCs after 31st December 2006 and should limit the number of new ITCs created between the date of acceptance of the appropriate measures herewith proposed and 31st December 2006 to avoid any abuse. The Commission considers that the above-described conditions and the reduced transitional period would limit the competition and trade distortions and is sufficient to ensure a gradual elimination of the existing State aid regimes in favour of the ITC and CFI companies.

63. As to the above-described extensions of the existing State aid schemes in question, which constitute non-notified aid, the Maltese authorities are invited to confirm that they were never used by beneficiary ITC and CFI companies in Malta.

APPROPRIATE MEASURES

64. The Commission considers that in the light of the above-mentioned case law and taken account of the specificities of the schemes in question, the followings constitute appropriate measures to abolish the State aid schemes granted by Malta in favour of the International Trading Companies and the Companies with Foreign Income.

65. The Maltese authorities are hereby invited to:

a) and Abolish the existing State aid schemes in favour of the International Trading Companies and the Companies with Foreign Income established in Malta by 1st January 2007 at the latest and enact by the same date a new refundable Advance Corporate Income Tax credit system effectively in favour of all companies distributing their revenues (as dividends) to their shareholders, irrespective of the type of income or activity of the distributing company and effectively not favouring foreign owned companies over domestic-owned companies;

b) Prohibit the tax status of International Trading Company to any new company registered in Malta after 31st December 2006. The existing International Trading Companies and those being created until 31st December 2006 shall benefit from the current refundable tax credit system until 31st December 2010;

c) Limit the number of newly created ITCs during the period from the date of acceptance of the appropriate measures herewith proposed and 31st December 2006to the yearly average number of ITC companies having been created in the last five years;

d) Issue a public statement within 30 days from the date of acceptance of the present appropriate measures concerning the proposed amendments to bring to the Maltese legislation in order to abolish the State aid schemes granted by Malta in favour of the International Trading Companies and the Companies with Foreign Income

66. The Maltese authorities are invited to inform the Commission, in writing that Malta accepts, pursuant to Article 19(1) of Regulation (EC) n. 659/1999, unconditionally and unequivocally this proposal for appropriate measures in its entirety within one month from the receipt of this proposal, otherwise the Commission will proceed in accordance with the rules laid down in Article 19(2) of Regulation (EC) n. 659/1999.

14 67. The Maltese authorities are also invited to confirm that the minor extensions to the scheme introduced as of 1998, which were described in paragraph 20 were never used.

If this letter contains confidential information which should not be disclosed to third parties, please inform the Commission within fifteen working days of the date of receipt. If the Commission does not receive a reasoned request by that deadline, you will be deemed to agree to the disclosure to third parties and to the publication of the full text of the letter in the authentic language on the Internet site: http://europa.eu.int/comm/secretariat_general/sgb/state_aids/. Your request should be sent by registered letter or fax to:

European Commission Directorate-General for Competition Directorate State Aid II Rue de la Loi/Wetstraat, 200 B-1049 Brussels Fax No: +32-2-296.95.80

Yours faithfully, For the Commission

Neelie KROES Member of the Commission

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