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Malta Pension Plans, the Dirty Dozen, and IRS enforcement

The Internal Revenue Service (IRS) annually compiles a list known as the “Dirty Dozen,” which highlights the most egregious tax scams and schemes that taxpayers might encounter. This initiative, which began in 2002, serves to inform and protect taxpayers from falling victim to fraudulent activities that could lead to significant financial loss or legal complications. Among the various schemes that have been spotlighted over the years, Malta Pension Plans have garnered particular attention due to their complexity and potential for misuse.

The U.S.-Malta income tax treaty, officially signed on August 8, 2008 was a significant development in the tax relations between the U.S. and Malta. This treaty was designed to facilitate trade and investment between the two countries by providing for reduced withholding rates on cross-border payments of dividends, interest, royalties, and other income, as well as the elimination of withholding taxes on cross-border dividend payments to pension funds. The 2008 treaty replaced a previous agreement from 1980, which the U.S. terminated in 1997 amid concerns over treaty shopping and Malta’s tax law incentives. The 2008 treaty was carefully crafted to address these issues, incorporating elements from the OECD’s Model Tax Convention and reflecting the tax treaty practices of both countries at the time. Despite these precautions, certain interpretations of the treaty, particularly regarding Malta Pension Plans, let to their inclusion in the IRS’s “Dirty Dozen” list for the first time in 2021. This inclusion highlighted the IRS’s concerns over the potential for these plans to be used in tax avoidance schemes.

The U.S.-Malta Income Tax Treaty includes a broader definition of a “pension fund” compared to most other U.S. tax treaties. It states that a pension fund includes any person (such as a trust, partnership, or company) established in Malta that is a licensed fund or scheme subject to tax only on income from immovable property. Under the treaty, U.S. taxpayers were not subject to U.S. tax on income earned within a Maltese pension fund until it was distributed. Furthermore, if the distribution was tax-exempt to a resident of Malta, it was also tax-exempt to a U.S. taxpayer. This provision allowed for the deferral of U.S. taxes and, in some cases, complete avoidance of U.S. taxes on distributions. U.S. taxpayers capitalized on these treaty provisions by transferring highly appreciated assets into Maltese pension plans without triggering U.S. tax on the transfer. The plans could then sell these assets, and the gains would accumulate within the plan, tax-deferred. Distributions could potentially be structured in a way that minimized or eliminated U.S. taxes.

In December of 2021, the U.S. and Malta entered into a Competent Authority Arrangement (CAA), which significantly narrowed the definition of what qualifies as a pension under the treaty, thereby limiting the tax benefits previously exploited through Malta Pension Plans. Throughout 2022, Malta Pension Plans remained on the IRS “Dirty Dozen” list. The IRS later issued proposed regulations that would classify Malta Pension Plan arrangements as “listed transactions” in June 2023. This classification subjects these arrangements to additional disclosure requirements, increased penalty exposure, and record-keeping requirements for material advisors. The IRS Criminal Investigation Division began in-person visits to taxpayers and advisors involved with Malta Pension Plans, issuing summonses for documents as part of a nationally coordinated investigation.

Otherwise benign U.K. pension transfers under the Qualifying Recognized Overseas Pension Scheme (QROPS) are considered by the IRS to be improper and the Service is targeting these middle-class retirees from the U.K. with their enforcement activities, including unenforceable summonses to gather information. The IRS’ current tactics are focused on getting individual taxpayers to turn on facilitators such as their attorneys, accountants, financial advisors, and pension administrators for further enforcement action.

If you or someone you know has been contacted by the IRS, the first and most crucial step is to contact a tax attorney to review your rights and prepare a proper response. A legitimate IRS summons is sent via Form 2039, so any summons received through other means (e.g., text, email, or phone call) is likely fraudulent. If there’s any doubt about the legitimacy of the summons, you should consult with a tax attorney. Taxpayers should be aware that many of the IRS summonses requesting information on the facilitators of Malta Pension Plans are unenforceable, but they should proceed under the assumption that the summons is enforceable unless and until they receive competent counsel from a tax attorney to the contrary. Further, there may be legal defenses to the summons where an experienced attorney can provide counsel. Lastly, if a taxpayer determines that it is in their best interest to comply with the summons, the advice of an experienced tax attorney can assist with preparing an organized response that is complete and complies with all legal requirements.

Disclaimer: Hone Maxwell LLP articles and blogs are not intended as legal advice. Additional facts, facts specific to your situation or future developments may affect subjects contained herein. Seek the advice of an attorney before acting or relying upon any information herein.

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