In a decision announced on 19 December, the European Commission announced that it would be suspending its investigation into the Maltese Tonnage Tax Scheme and providing one of its first endorsements to such a structure, subject to a number of changes.

Proceedings had originally commenced in 2012, when the Commission launched an in-depth investigation into potential breach of state aid rules with respect to the Tonnage Tax Scheme offered by Malta to eligible shipping organisations. At the time, the Commission was particularly concenred that favourable EU tax treatment might have been extended by means of this Scheme to non-eligible entities. The investigation aimed at ascertaining whether distortion of competition ensued as a result of this situation.

However, in its December decision, the Commission ruled that the Scheme as amended by the Government was not only compatible with EU Law, but would “ensure a level playing field between Maltese and other European shipping companies, and will encourage ship registration in Europe.” It further noted that the benefits being offered by Malta were “appropriate” to maintain competitiveness within a global market and preserve jobs within the EU Single Market.


How does the Scheme work?

Under the Tonnage Tax Scheme, an eligible shipping organisation would be exempted from the obligations under the Income Tax Act and Social Security Act, and instead have its tax dues calculated on basis of the ship net tonnage. Consequently, actual profits of the organisation derived from shipping activities would not be subject to any further Malta tax. The principal legislation regulating the scheme is the Merchant Shipping Act, which defines “shipping activities” as being “the international carriage of goods or passengers by sea or the provision of other services to or by a ship as may be ancillary thereto or associated therewith including the ownership, chartering or any other operation of a ship engaged in all or any of the above activities or as otherwise may be prescribed.” A shipping organisation is further defined by the activities it pursues along with its structure, which must conform with one or more of the categories listed within Art.84Z of the Act.

The scheme exclusively applies vis-a-vis “tonnage tax ships” as designated by the Minister responsible, or EU/EEA ships with a net tonnage of 1,000 and over, and which are owned entirely, chartered, managed, administered or operated exclusively by a shipping organisation. Consequently, holding a Maltese flag is not a prerequisite for eligibility. It is however necessary that a substantial percentage of the shipping organisation’s total net tonnage be Community-flagged (licensed within any EU/EEA state). Furthermore, benefiting from the exemptions is contingent on payment of the relevant registration fees and tonnage taxes. It is also necesary that separate accounts be kept clearly distinguishing payments and receipts emanating from shipping activities from other non-related business (if any). If the shipping organisation’s income stems directly and exclusively from shipping activities, a declaration by a Certfied Public Accountant or Advocate may be submitted in lieu of a tax return.

Having satisified all the mandatory requiremenets, an exemption from payment on income tax could extend to profits derived from the sale or transfer of an eligible tonnage tax ship; as well as from the liquidation, redemption, cancellation or any other disposal of shares, securities or other interest (including goodwill) held in a licensed shipping organisation which owned, operated, administered or a managed a tonnage tax ship. The latter applies for the period during which the said tonnage tax ship was considered as such.

In addition, the distribution of profits derived from shipping activities are also eligble for exemption from tax under the Income Tax Act in the hands of shareholders. This applies regardless of whether such shareholder is a natural person or another company/entity, and remains applicable for as long as such profits are distributed by way of dividends.


What will change? 

The European Commission’s approval covers a period of ten years, and is contingent on a number of changes which were agreed with the Maltese Government. In particular, it was announced that “Malta agreed to restrict the scope of the scheme to maritime transport and to remove those tax exemptions for shareholders which constitute State aid.”

Indeed, several aspects of the Maltese tonnage tax scheme were found to be incompatible with the Commission’s Maritime Guidelines, and in breach of State aid rules. The following is a brief overview of some of the main issues flagged in the Commission’s report:


  • The principal commitment:

In its submissions, the Maltese Government undertook a commitment that shipping companies (except ship management companies) will not benefit from tonnage tax (except for ship management companies) unless they:

  • have at least 60% of the tonnage of their fleet under the flag of a Member State of the Union or of a State party to the EEA Agreement on entering the scheme; or
  • maintain or increase the share of tonnage of their fleet that they operated under the flag of a Member State of the Union or of a State party to the EEA Agreement at the moment that they entered the scheme.

In any event, by the third year of operation the organisation must have at least 60% of the tonnage taxed fleet EEA-flagged.

However, in connection with the initial entry of a shipping organisation into the Maltese tonnage tax system, the said applicable threshold may be reduced to 25%. Checks will also be employed to ensure that the share of EEA-flagged fleet has not decreased on average over a period of three years (both for existing and new beneficiaries).

Income from non-EEA-flagged vessels will only be eligible when these flagging criteria are met and shall apply only to fleets which are entirely managed from the EEA for commercial and strategic management. Ships which are not commercially and strategically managed from the EEA will be accepted under tonnage taxation only if flying an EEA flag.


  • Ministerial Discretion:

Up till now, the Minister responsible for maritime transport could, by ministerial act, designate new shipping activities as being eligible under the tonnage tax scheme. Furthermore, the Minister also enjoyed significant discretion in exempting ships from paying fees.

Both aspects were found to be incompatible with the Maritime Guidelines and Taxation Regulations, respectively. In response, the Maltese Government committed itself to curb ministerial discretion, particularly by limiting the waiver of fees in the ambit of philhantopic and humanitarian operations which do not involve the offer of goods and services on a market.


  • Fishing vessels and oil rigs:

The eligibility of fishing vessels and oil rigs was deemed by the Commission to be wholly incompatible with the Maritime Guidelines, falling beyond the definition of “maritime transport activities”.  With respect to the latter, the Commission reiterated that the Guidelines do not cover the exploitation of natural resources at sea.

In response, the Maltese Government has committed itself to specifically exclude fishing vessels from the operation of tonnage tax. Though the exclusion of oil rigs was not specifically listed among the Maltese Government’s commitments in the report, it is understood that similar measures would be adopted in this respect.


  • Non-propelled barges:

Despite stakeholders’ objections, the Commission confirmed its initial view that activities carried out by non-propelled barges do not constitute “maritime transport”, and should consequently fall beyond the scope of the scheme. It however accepted that vessels providing propulsion to such barges “may be described as engaged in maritime transport”.


  • Towage activities:

The Maritime Guidelines clearly establish that towage activities which are carried out in ports, as well as the assistance of self-propelled vessels to reach port does not fall within the definition of “maritime transport”. Up till now, Malta did not require at least 50% of the yearly towage activity to fall within such a definition in order to grant eligibility under the scheme. Practically, this means that at least half of a towage vessel’s yearly activity needs to consist of towing barges between ports or between a port and an off-shore installation/structure or towing of vessels which due to a technical failure cannot sail on their own).

In response, Malta has committed itself to specifically limit tonnage tax eligibility for towage to those vessels which meet the aforementioned criterion. Towage activities which are carried out inter alia in ports, or which consist in assisting a self-propelled vessel to reach port will not constitute maritime transport and only vessels registered in a Member State or the EEA will be eligible.


  • Dredging:

Similarly to towage, dredging is only considered to fall within the concept of “maritime transport” if at least 50% of the vessel’s yearly operational time consists of eligible activities. These include sailing between the port and the extraction site, sailing between different places of extraction, sailing between the place of extraction and the place where the extracted materials are to be unloaded, unloading of extracted material, and sailing between the place of unloading and the port. On the other hand, dredging and sailing while dredging are excluded.

In response, Malta has committed itself to specifically limit tonnage tax eligibility for dredging to those vessels which meet the aforementioned criterion.


  • Cruise vessels:

In its opening decision, the Commission publicly mulled whether cruise ships should remain eligible under tonnage tax schemes, given that a considerable source of profits is derived from activities other than maritime transport, including casino, spa, entertainment and package tours. While recognising that it would be counterintuitive to draw up a defined list of such ancillary services, the Commission also reiterated that it is important for Member States to ensure that tonnage tax is made available solely to “genuine maritime transport service providers”, and that ancillary services only be deemed eligible with caution. Consequently, the core revenue of such vessels should emanate from fees or ticket sales, letting of cabins, and the sale of food and drinks for immediate consumption on board. Other revenue streams must be only ancillary to this.

In this respect, the Maltese tonnage tax scheme was deemed to be incompatible with the Maritime Guidelines as it did not provide sufficient guarantees to limit tonnage taxation to genuine shipping companies, and clearly delineate the extent to which ancillary revenue could benefit from such.

In response, the Maltese Government has committed itself to specifically exclude stationary ships employed for hotel and/or catering operations (such as floating hotels/restaurants), as well as ships which are mainly employed for gambling or as casinos. Also notable is the Government’s commitment to separate accounting wherever a company is not solely engaged in shipping activities.


  • Capital gains from the sale or transfer of ships:

The exemption from taxation of capital gains arising from the lawful sale or transfer of ships is provided for by the Taxation Regulations and recognised by the Commission. However, the report did identify an issue with respect to the broad language utilised in the Maltese Merchant Shipping Act, which the Commission found to lack the necessary safeguards in order to limit such benefit both in terms of amounts as well as beneficiaries.

Most importantly however, the Commission determined that the current wording allowed for ships which had already been depreciated under local income tax rules to subsequently also benefit from capital gains exemption upon their sale or transfer. As a result, it was concluded that such an exemption could no longer be applied to Maltese residents, as this would in turn be constituting illegal state aid.

In response, Malta committed to ensure that the capital gains exemption on the sale of ships covers only ships operated under the tonnage tax regime by companies engaged in genuine shipping activities and to introduce a requirement that only ships acquired and sold whilst under the tonnage tax regime may benefit from such an exemption.


  • Other aspects:

There were a number of other aspects which the Commission dealt with in its report. Of particular note are the lack of dividend tax with respect to shares in shipping entities, which the Commission deemed to be equivalent with the standard Maltese taxation regime, as well as the exemption from capital gains tax with respect to the sale or transfer of such shares. With respect to the latter, the Commission did however rule that the divergence from the standard position applicable to Maltese residents provided a selective advantage shipping entities and conseuqently constituted state aid.


The team at Anthony P. Farrugia and Associates is able to guide you in making tailor-made decisions for your shipping investments by offering wide-ranging, comprehensive assistance. For further information on how we could be of assistance, kindly contact us here.