I’ll start this article with a digression which has utterly nothing to do with the topic of today’s discussion, which is that as an amateur military history I have always wanted to visit Malta. Not so much for the ancient history, the famed Knights of Malta don’t do much for me, but rather for the Maltese islands’ (there are three of them) rich history during World War II. Malta forms the Southeastern point of a equilateral triangle defined also by the Sicilian town of Palermo (Patton’s famous conquest), and the Tunisian city of Tunis (Bradley’s famous conquest). The British control of Malta was very problematic for the German and Italian resupply of their troops in North Africa (Rommel vs. Montgomery), and so the Germans and Italians bombed it, bombed it some more, and then kept bombing it for literally the four years of 1939 to 1943. Very quickly, the island was entirely pockmarked by bomb craters and the citizens of Malta had to live underground. This early period of World War II presented dramatic attempts by the Germans and Italians to suppress the Islands, and heroic attempts by the British navy to keep it supplied.
After the war, and now I am meandering back around to today’s discussion, Malta filled in the most inconvenient bomb craters, removed unexploded ordinance, and went back to being a rather quiet trading port between Southern Europe and North Africa. In 1964, Malta gained its independent from the United Kingdom and became the Republic of Malta. Then, things changed dramatically in the 1990s as the rise of global financial centers, and their hunger for tax havens, turned Malta into one of the world’s leading offshore jurisdictions where large international corporations and very wealthy folks could sock away their gains in a tax-free environment free from the reach of the local taxman. This became big business for Malta, and the sleepy port of Valletta turned almost overnight into a major banking center.
For U.S. residents, Malta was barely a distant blip on the radar screen, as Americanos looking to avoid taxes abroad tended either towards the Caribbean, where they could easily visit their money, or to that best-known tax haven called Switzerland. Like the two other major Mediterranean tax havens, being Gibraltar and Cyprus, Malta was only very rarely used by U.S. residents and thus attracted little attention in the States.
This state of affairs ended in 2011, when the U.S. and Malta adopted a sloppily-drafted tax treaty (at least from the U.S. perspective) which created a loophole soon to be exploited by tax professionals looking to save their U.S. clients some tax bucks. And exploit it they did, but maybe “exploit” is too strong of a word to be used here. One must realize that in the U.S. scheme of taxation, it is up to the IRS, the U.S. Treasury, the Administration, and Congressional committees like the Joint Committee on Taxation and the Senate Finance Committee to set the tax rules. Once those rules are in place, the tax professionals play by them, and they can’t be faulted for playing by the rules, even if some result obtains that was never anticipated by the drafters and which frequently happens.
And so it was with the Malta treaty, which was drafted such that a U.S. person could set up a pension arrangement on Malta, but then use it like a supercharged Roth IRA where highly-appreciated assets could be contributed to the pension without triggering any current U.S. tax, and then the assets could be liquidated and diversified without triggering any current U.S. tax. The difference between a Maltese pension plan and a Roth IRA is that the strict limitations on the latter do not appear for the former. Of course, Malta did not impose a local tax on these pension plans, but apparently was happily content to receive the financial benefits of opening and maintaining these pension accounts there. So, even if having a pension plan based in Malta didn’t make even the most minimal sense for a person living in the United States and with few or no other international contacts, it could indeed make sense from a tax perspective.
Now, I’ve never claimed to be anything like a tax professional, and I’ve probably just utterly butchered the tax benefits of the Maltese pension plan in my description above. But never fear, you can read all about these benefits and their technical supporting basis in the article Benefits of U.S. Retirement Plan Participants in the Malta-U.S. Tax Treaty, as published by TaxNotes on October 26, 2020. In fact, this article became the problem for the Malta pension plan.
There is an old saw to the effect that anytime a tax strategy gets reported by the Wall Street Journal, it is dead. Well, publishing an article in TaxNotes is even worse, because TaxNotes is regularly read by just about any tax professional who claims that title, including not just a few folks at the IRS, Treasury, and the aforementioned Congressional committees. While the rest of the tax planning community who were involved with Maltese pension plans were trying their darndest to lie low and keep it off the IRS’s radar screen, this TaxNotes article was like the Goodyear Blimp
You see, this is the problem with all edgy tax transactions. The tax professionals putting them together can make a boatload of cash selling these deals, but they can’t sell these deals in big numbers unless they get out and start marketing them. However, when these folks start marketing these deals, their marketing will inevitably end up killing the deal entirely. The smart tax planners will just quietly network and talk to prospective clients without a lot of fanfare, make some good bucks but without risking the deal popping onto somebody’s radar screen, while the dumb planners will get greedy and put it out there for the whole world to see and thus ensure its early demise. Or, as one nationally prominent tax attorney once confided to me, “If you find something that works for your clients in the Internal Revenue Code, the first thing you do is to shut the hell up about it.”
In fairness to the authors of the TaxNotes article, they were not the only ones who put the transaction firmly on Treasury’s radar screen, but aggressive marketing by other tax professionals helped make this transaction one that simply could not be ignored. Sure enough, in the IRS’s 2021 “Dirty Dozen” list of warnings “about promoted abusive arrangements”, IR-2021-144, published in July, the Maltese pension plan made its debut alongside other discredited transactions such as syndicated conservation easements, microcaptives, improper R&D business credits, and bogus installment sales to avoid capital gains taxes. A month later, on August 20, 2021, an article written by Laura Saunders for, of course, the Wall Street Journal all but unofficially proclaimed the Maltese pension plan to be dead.
All this time, those tax professional involved with Maltese pension plans expressed that their technical position was still correct, and that if the IRS didn’t like the arrangement, then the solution was for the U.S. Treasury to re-work the tax treaty with Malta. Again, I’m not a tax professional, but this position was probably correct. That is, ultimately, exactly what the U.S. Treasury did, and the IRS announced on December 21, 2021, in IR-2021-253 that the U.S. and Malta had entered into a Competent Authority Arrangement (CAA) which,
“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 operated 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. Because Maltese personal retirement schemes contain these features, they are not properly treated as a pension fund for Treaty purposes and distributions from these schemes are not pensions or other similar remuneration.”
This is the IRS’s official death certificate for Maltese pension plans, and they are now as dead (at least as a tax-savings supercharger) as aforementioned Knights of Malta and World War II generals. I certainly don’t know, and I hate to speculate, but it seems that transactions involving Maltese pension plans for tax years prior to 2021 seem to be relatively defensible, as the fact that the U.S. Treasury had to re-negotiate the U.S-Malta Treaty seems to be pretty good evidence that it was poorly drafted in the first place, at least as it related to these pension plans. For tax years 2021 and beyond, Maltese pension plans are not going to offer any special tax benefits and it would be the brave or foolish tax preparer who would sign off on a return involving this deal. There seems to be an issue as to whether existing Maltese pension plans can be “grandfathered” or not, but I’ll leave that issue to tax professionals who are a lot smarter than I am to figure that out.
It is interesting that the IRS has adopted a consistent routine of killing off tax transactions in mid-December, which is what the IRS did with both syndicated conservation easements and microcaptives. The IRS is doubtless aware that tax professionals put in a lot of work selling aggressive deals, getting transactional documents together, opening bank accounts, etc., and that by killing off a deal in mid-December the IRS basically lays all this work to total waste, plus tax and financial advisers have to go back to their putative clients, hat in hand, to explain why suddenly their wonderful transaction no longer works. Further, by putting the kibosh on tax deals so late in the year, it keeps those taxpayers who were looking to avoid tax from lining up an alternative arrangement to try to save taxes before the fireworks go off over Times Square. There is actually not just a little bit of artistry in the IRS’s timing which is worthy of admiration, the sudden onset of Tourette’s syndrome amongst some tax planners notwithstanding.
Finally, it must be noted that ⸺ other than well-established and long-validated tax strategies ⸺ anytime somebody shows up with a bunch of glossy materials and PowerPoints to describe a little-known tax transaction, you can probably figure out right then and there that if it works at all, it probably won’t work long for the very reason that it is being widely marketed, and it is only a matter of time before the IRS gets wind of it and shuts it down. Also, as I have previously urged many, many times, if a tax deal seems even the least bit edgy, you shouldn’t consider it seriously until you have obtained a truly independent second opinion from a tax professional who understands the deal (or can figure it out) and can rationally explain its risks and benefits, or whether it works at all. At the very least, getting an independent second opinion will give you penalty protection in case those selling the deal turn out to be something less than correct, or honest.
And, thus, did the IRS Grinch steal the Maltese Pension Plan in 2021. And a very Happy Holidays to you all.
IR-2021-253 (12/21/2021). https://www.irs.gov/newsroom/united-states-malta-sign-a-competent-authority-arrangement-caa-confirming-pension-fund-meaning