Malta/US Treaty on Tax-Free Roth & Maltese Pensions

Malta/US Treaty on Tax-Free Roth & Maltese Pensions

Maltese Pension Plan under US/Malta Tax Treaty 

Is the Maltese Treaty for Tax-Free Pension Illegal: At the current time, even though the Internal Revenue Service listed the Malta/US Tax Treaty on the Dirty Dozen list when it is being used for tax-free pension benefits by US Persons with a Malta pension plan — it was with a caveat, which is that at the current time it is not illegal. In other words, while the Internal Revenue Service may be taking a hard look at US Taxpayers who try to utilize the Malta/US Double Taxation Treaty for a purpose that it was (presumably) not intended for (e.g., certain tax-free pension withdrawals by US persons with questionable Malta Pension Plans) – Taxpayers have not necessarily run afoul of U.S. tax law — yet. The main issues surrounding the alleged Malta exemption for certain pension distributions is founded on the idea that there may have been a mistake with the Saving Clause and negotiation of the tax-free pension reciprocal language in the treaty — in comparison with its Roth IRA counterpart.

Example of How the Saving Clause Works

To set the tone of Malta/US treaty analysis and pension (private, non-public) — it is important to understand what the Saving Clause is. First, the US follows a worldwide income model based on US person status, and not the residence of the Taxpayer — the latter is how most countries do it. So when it comes to tax treaty laws, the saving clause is your typical buzzkill provision contained in nearly all tax treaties on matters involving private pensions (public pensions/social security) as well as other potential windfall provisions. With pensions, oftentimes the Saving Clause has the effect of preventing, for example — a US Citizen from taking advantage of tax-free pension distributions when they are a resident of another country.

Here is an example:

Article 23 Pension (Korea/US)

      • (1) Except as provided in Article 22 (Governmental Functions), pensions and other similar remuneration paid to an individual who is a resident of one of the Contracting States in consideration of past employment shall be taxable only in that Contracting State.

What does this mean?

It means that if a US Citizen resides in Korea — and is a resident of Korea — then only Korea can tax pension income received by the individual (shall vs may). If for example, Korea just happened to not tax the type of pension income that the resident is receiving, then the resident would receive that pension tax free — even though they are a U.S. citizen and would otherwise be taxed based on the worldwide income model (aside from Roth IRA under most circumstances).

Saving Clause Article (4) (Paragraph 4)

      • (4) Notwithstanding any provisions of this Convention except paragraph (5) of this Article, a Contracting State may tax a citizen or resident of that Contracting State as if this Convention had not come into effect.

      • (5) The provisions of paragraph (4) shall not affect:

          • (a) The benefits conferred by a Contracting State under Articles 5 (Relief from Double Taxation), 7 (Nondiscrimination), 24 (Social Security Payments), and 27 (Mutual Agreement Procedure); and

          • (b) The benefits conferred by a Contracting State under Articles 20 (Teachers), 21 (Students and Trainees), and 22 (Government Functions), upon individuals who are neither citizens of, nor have immigrant status in, that Contracting State.

What does this mean?

This means that aside from any provisions set forth in paragraph 5, either party to the treaty can still tax a Citizen or Resident as if there was no treaty in place.  Thus, a US Citizen residing in Korea would still be taxed by the US government on Pension distributions that the person received in Korea — despite the fact that article 23 exempts residents of Korea from certain pension taxes.


Because Paragraph five (5) identifies certain articles that are not limited by the saving clause, and article 23 is not an exception to the Saving Clause.

Result: When you mix this all up in a pot — it just means the US will still tax as US Citizen residing in Korea on pension distributions they receive.

US and Malta and the SAVINGS CLAUSE

The US and Malta Tax Treaty Saving Clause and Pension provisions may bring a different result, as follows:

Malta Tax Treaty Article 17 Pensions

      • (a) Pensions and other similar remuneration beneficially owned by a resident of a Contracting State shall be taxable only in that State.

      • (b) Notwithstanding subparagraph a), the amount of any such pension or remuneration arising in a Contracting State that, when received, would be exempt from taxation in that State if the beneficial owner were a resident thereof shall be exempt from taxation in the Contracting State of which the beneficial owner is a resident.

Article 18 Malta Tax Treaty Pension Fund

      • Where an individual who is a resident of one of the States is a member or beneficiary of, or participant in, a pension fund that is a resident of the other State, income earned by the pension fund may be taxed as income of that individual only when, and, subject to the provisions of paragraph 1 of Article 17 (Pensions, Social Security, Annuities, Alimony, and Child Support), to the extent that, it is paid to, or for the benefit of, that individual from the pension fund (and not transferred to another pension fund in that other State).

Article 17 Explained

      • Article 17 (a): It means that under paragraph 17, a Pension participant of a Pension Plan who resides in Malta for example would only be taxable only in Malta.

      • Article 17 (b): If the person resides in the US for example and earned income from a Malta Pension that was exempt in Malta — it would also be exempt from Tax in the US.

Article 18 Explained

If a Person who is a Resident of the US, is a member or beneficiary of pension fund in Malta (and the fund is a “resident” of Malta), then income earned from the pension, is only taxable (still subject to Article 17 limitations) when paid or of the benefit of that person.

Malta Tax Treaty Saving Clause

Here is where the problem comes in for the US Government — specifically, is how the treaty is written when it comes to the Saving Clause:

      • Except to the extent provided in paragraph 5, this Convention shall not affect the taxation by a Contracting State of its residents (as determined under Article 4 (Resident)) and its citizens. Notwithstanding the other provisions of this Convention, a former citizen or former long-term resident of a Contracting State may, for the period of ten years following the loss of such status, be taxed in accordance with the laws of that Contracting State.

        • The provisions of paragraph 4 shall not affect:

          • the benefits conferred by a Contracting State under paragraph 2 of Article 9 (Associated Enterprises),

          • paragraphs 1 (b), 2, and 5 of Article 17 (Pensions, Social Security, Annuities, Alimony, and Child Support), and Articles 18 (Pension Funds), 23 (Relief from Double Taxation), 24 (Non-Discrimination), and 25 (Mutual Agreement Procedure);

          • and b) the benefits conferred by a Contracting State under Articles 19 (Government Service), 20 (Students and Trainees), and 27 (Members of Diplomatic Missions and Consular Posts), upon individuals who are neither citizens of, nor have been admitted for permanent residence in, that State.

What does this mean?

Oddly enough, Article 17 (1b, 2, and 5) and Article 18 are parsed out of the Saving Clause. Therefore, the Saving Clause does not protect the US Government’s ability to tax the pension, as in the Korea example above.

Roth IRA from the US Perspective

The concept behind the tax-free pension (such as a Roth IRA) is that a US person living abroad would not lose their tax-free status.

Here is an example from the Technical Explanation:

      • “Thus, for example, a distribution from a U.S. “Roth IRA” to a resident of Malta would be exempt from tax in Malta to the same extent the distribution would be exempt from tax in the United States if it were distributed to a U.S. resident.

      • The same is true with respect to distributions from a traditional IRA to the extent that the distribution represents a return of non-deductible contributions.

      • Similarly, if the distribution were not subject to tax when it was “rolled over” into another U.S. IRA (but not, for example, to a pension fund in the other Contracting State), then the distribution would be exempt from tax in Malta.”

Reciprocal Tax Treatment on Maltese Side

Malta has a very generous pension system. It a allows contributions of appreciated property, which can then be sold and distributed out, tax-free – similar in concept to a UK SIPP.

This would significantly reduce the tax liability on the appreciated property. In addition, there are a wide range of contributions and only minimal limitations on withdrawal — leaving the US Person with a number of different strategies to contribute appreciated property to the pension and avoid tax.

Is it legal?

That is probably not the best way to frame the issue, since the Treaty was negotiated at arm’s length, so illegality is a stretch.

Rather, the question becomes:

Will the IRS dispute or acquiesce to this type of tax position?

The general concept is that a pension is the result of employment.  Some treaties refer to the language: borne by the employer to further hammer that fact home. The example used in the technical explanation is the Roth IRA – which has very limited contribution limitations and salary/earning caps (and even with the idea of the back-door Roth – is that there is an immediate tax consequence each year the back door is re-upped).

If a person suddenly contributes a whole bunch of a appreciated assets to a Maltese Pension; sells the property; pays no tax — and then takes a significant 30% tax-free distribution, along with subsequent tax deferred and/or exempt distributions — it would be hard to believe the IRS would acquiesce.

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