For decades, the financial world has been characterised by cross-border collaboration, enabled by the existence of tax incentives and economic structures designed to attract investment to jurisdictions seeking to boost their coffers. This ecosystem – of which Malta has also benefitted – has resulted in a spate of multinational firms being able to shift their profits to low or no-tax locations to save on corporate income tax that might otherwise be due.

This phenomenon – referred to as Base Erosion and Profit Shifting (BEPS) – has, according to the Organisation for Economic Co-operation and Development (OECD), resulted in billions of euro lost for countries which have not managed to recoup the taxes due. It has also driven inequity across the globe, increased the wealth gap, contributed to rising corruption, and exposed gaps in transparency.

In order to combat some of these issues, the OECD implemented the OECD/G20 Inclusive Framework on BEPS, bringing together over 135 countries and jurisdictions to provide 15 action points, equipping governments with instruments to tackle tax avoidance. Through this, the importance of ‘establishing substance’ – such as the setting up of a physical office and the recruitment of employees – has taken centre stage, pushing global enterprises to add value to their relationships with their tax jurisdiction of choice. Indeed, the axiom ‘Substance over Form’ is, today, deemed pivotal to a firm’s success.

“Establishing substance is a matter that should be addressed seriously by companies in order to avoid a high tax burden and even tax disputes that might arise with tax authorities,” says Dr Deborah Vella, Client Relationship Manager and Head of Business Development at legal firm, E&S Group.

“The principle of establishing substance for the purposes of tax planning is fair, considering that businesses should pay their taxes at the location where they have their premises. However, there are cases when the physical premises is not available, and, as such, the area where the economic interest is located or the overall management of the business should be examined,” she explains.

Usually, Dr Vella continues, tax authorities require confirmation that the country where the company is registered is also where the business of the company takes place. “This brings about substance issues as the authorities want to see the actual presence of the company. Therefore, establishing substance in the jurisdiction where the company is registered is essential during inspections by tax authorities,” she outlines, praising the initiative for being “a good method for local authorities to fight tax evasion and for the businesses to reflect transparency and also avoid double taxation.”

Focusing more directly on Malta – one of the 135 jurisdictions which abides by the OECD’s legislation – Dr Vella says that companies seeking to register on the island need to consider the establishment of substance. “A management office and solid substance is what will be required in order for local tax authorities to understand that there is clear substance while they might be investigating the presence of the company,” she says.

Companies would also need to appoint Maltese resident directors to “make it easier for the business activity to be in line with the requirements of the law,” she adds. Moreover, the decisions of the Board of Directors will need to be taken in Malta through regular, minuted meetings. “Establishing substance would be considered as an increase of the value often overlooked from an administrative, banking and an Inland Revenue perspective,” she affirms.

Dr Vella refers back to the OECD’s action plan – based on the three main pillars of establishing coherence, increasing transparency and realigning substance with rights – to highlight its importance in the context of international trade and corporate structures, explaining that the BEPS strategy prevents companies from being established solely to enjoy the benefits of double taxation agreements.

“Many countries lose high amounts of revenue annually due to international enterprises exploiting gaps and mismatches to avoid paying tax. And, after the implementation of the PEBS package, governments are equipped with domestic and international instruments for tax avoidance,” she states.

The policy also creates “a much more certain and predictable environment for all citizens and businesses,” with the EU, more broadly, ending the use of shell companies or undue claims of tax treaty protection. “Therefore, the EU will be considered a much more secure environment and there will be an end to offshore tax evasion,” she says.

Moreover, “when taxpayers see multinational companies avoiding income tax, it might undermine their voluntary compliance. Therefore, it is only reasonable for OECD’s BEPS to guide countries towards fairness.

“Additionally, cross-border businesses might profit from BEPS opportunities, having competitive advantages over companies that operate only at domestic level. Lastly, businesses might be damaged by inefficient resource allocation through misleading investment decisions towards activities that have lower pre-tax rates of return, but higher after-tax returns. As a result, OECD’s BEPS will also protect them from illegal tax schemes,” she explains.

On the flip side, “in those cases where the companies do not show management, control and day-to-day decisions taken in the country where the company is based, it would mean that there is no substantial economic activity.

“Therefore, the relevant jurisdictions will not grant any benefits of the applicable double taxation treaty and also will apply domestic anti-abuse legislation or request that the company disclose aggressive tax planning structures to the home country tax authority.”

Here in Malta, there are myriad options for companies seeking to establish substance, Dr Vella further says.

“Usually, to have the minimum substance, we suggest our clients take business decisions in Malta and have regular Board minutes and annual general meetings recorded here. Also, with regards to the Board of Directors, we propose having a Board of Directors where at least 50 per cent are Maltese citizens or are residents in Malta. These meetings should be recorded and documented accordingly,” she outlines.

Of paramount importance, she reiterates, is “to have economic presence in Malta, such as renting a physical office space and engaging a number of employees.” E&S Group also recommends the relocation of the investor to Malta. “Usually a CEO relocation can be a very effective solution, as this can also avoid the need to have a specific number of employees in place, which might be a concern for small companies. We can assist our client with renting local offices, hiring local employees and even applying for residency programmes where required,” Dr Vella asserts.

Additionally, companies can also source a tax opinion prior to setting up their company in Malta. “This can also prevent mistakes and equip them with the advantages and disadvantages of their business activity and structure,” she says.

I ask whether an increase in the establishment of substance in Malta will lend towards improving the island’s struggling reputation, on an EU level, in light of recent criticisms of Malta’s tax ecosystem.

In response, Dr Vella asserts her confidence in the island’s financial structures and regulations. “Malta is one of the jurisdictions that has already deposited the instrument of ratifications for the implementation of OECD’s BEPS, underlining a strong commitment to prevent the abuse of tax treaties and base erosion and profit shifting (BEPS) by multinational companies.

Therefore, the companies that will establish their structures in Malta can be secure in knowing that their business is based in a secure financial economy,” she says.

She also points to the island’s broad connections with other countries for the purposes of information exchange, with the jurisdiction boasting 77 double tax conventions and four tax information exchange agreements.

“Malta is also part of a number of conventions and directives that reflect its cooperation with other countries for tax purposes. Therefore, the establishment of more structures in Malta will enhance the country’s reputation as it demonstrates that the country is already working towards transparency via the exchange of information with other competent authorities, including tax ones,” she describes.

Fundamentally, however, by establishing substance on the island, firms have an opportunity to add value to their enterprises and operations, Dr Vella concludes, while at the same time contributing to the jurisdiction in which they’ve made a home.

This interview first appeared in the November edition of iGaming Capital