Mariah Dimech graduated in 2021 with a Bachelor of Commerce (Honours) in Economics from the University of Malta. She is currently work as an economist and is also reading for a Masters in Applied Economics from the University of Bath. Her research interests include monetary policy, investment and financial stability.
Below is her own view on the findings from her undergraduate disseration which is study to find out how foreign direct investment is related to the great corporate taxation for foreign companies in Malta.
The full dissertation can be downloaded at the end of the article!
Notwithstanding the small size of the domestic market, statistics show that Malta is a favoured destination for FDI (Foreign Direct Investment). As of the end of 2019, the stock position of inward FDI amounted to €187.9 billion, increasing by €8.5 billion from 2018. Meanwhile, the stock position of outward FDI amounted to €59.5 billion, decreasing by €1 billion from 2018. This trend can be observed over the past five years, where FDI inflows have surpassed outflows by a substantial amount, thanks to continuous efforts by the Maltese government and other institutions.
The host country benefits from higher FDI inflows since it is expected that it will feature directly in economic growth. When estimating FDI as a percentage of GDP, it can be noted that Malta classifies third after Luxembourg and Cyprus in terms of the FDI-to-GDP ratio. Such a high percentage is presumed to be partly due to the extensive use of Special Purpose Entities (SPEs). The financial services sector accounted for 97.6% of the final FDI stock position in December of 2019. Questions arise on the extent to which this amount is wholly attributable to brick-and-mortar investments that are reflected in the real economy. Some of it likely represents the registration of SPEs, used to shift profits from high to low tax jurisdictions. Foreign companies that are registered in Malta are subject to tax on income arising in Malta as per the Income-tax act. The Maltese corporate tax rate is presently 35%, however, companies can claim a 6/7ths refund, resulting in only 5% tax on profits, which is an attractive tax rate that is beneficial to foreign investors that wish to invest in Malta.
Distance is irrelevant if this means saving on Tax...
When estimating the gravity model for the final Maltese FDI stock in 2019, there appears to be a significant and positive relationship between GDP and FDI inflows. This sign shows that the country size, proxied by GDP, is important for FDI movements in Europe. A priori, it is expected that larger geographical distances between countries would lead to lower FDI since more costs will be involved. Contrary to expectations, geographical distance between countries is positively related to FDI inflows, such that larger distances are associated with higher FDI inflows. This positive relationship may be due to lower trade costs and improved shipping technology; however, it is surmised that it reflects the relationship between Malta and jurisdictions that offer a competitive tax rate, also known as tax havens. It is also likely that the positive result reflects the utilization of tax efficiency techniques used by multinational entities, where geographical distance is immaterial. This is attested by a significant relationship between Malta and European tax-havens.
The multinational entity has a complex structure and profit shifting can be concealed by transactions between tax havens themselves. When estimating the value of the tax rate, the results suggest that higher tax rate differences in the EU lead to higher FDI inflows in Malta, supporting the hypothesis that Malta is using a competitive tax regime. The map below shows that on average, countries had between €1 and €10 billion FDI stocks registered in Malta at the end of 2019. Intensive inflows emanate from Germany, the Netherlands, Ireland, and the UK, having more than €10 billion of FDI stocks held in Malta at year-end. On the other hand, countries in Eastern Europe such as Croatia, Romania and Bulgaria registered the lowest FDI in Malta. The map highlights the irrelevance of distance because aggregated together, tax havens that are geographically distant recorded €49 billion of final FDI stocks in Malta.
To Round It All Up
FDI is undeniably advantageous to a country, particularly to a small economy like Malta. If multinational entities set up subsidiaries in Malta, they can contribute to the expansion of economic growth via higher productivity and job creation. Moreover, they can invest in research and development, an area that cannot be fully explored in Malta without foreign investors. Nevertheless, it is essential for policymakers to analyze the investments that are being injected into their jurisdiction and disentangle the ‘real’ from the ‘phantom’ investment so that balance of payments statistics are transparent and show real economic growth.
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Any views or opinions presented in this article are personal and shouldn’t be taken/used as professional advice as we are not qualified financial advisors.
Any statistics mentioned have all been linked to their respective documents together with their ownership.
Lastly, we would like to note that this article has no tie to our professional jobs and was conducted in our free time.