Overview
There has been a growing trend of US taxpayers contributing non-cash assets, such as appreciated property, securities and cryptocurrency, into Maltese pension plans since the US-Malta Tax Treaty went into effect in 2011. These transactions were marketed to many US taxpayers as a way to cash in on their earnings without being subject to US federal taxation. The Internal Revenue Service (IRS) is now investigating these transactions as possible tax fraud and evasion.
In Depth
MALTA PENSION PLANS
One of the Malta pension plan transactions under investigation involved a US taxpayer who contributed highly appreciated assets to a Maltese pension plan and then relied on an interpretation of the US-Malta Tax Treaty to avoid incurring US taxes. Some taxpayers take the position that they can take distributions without imposition of US income tax. When the appreciated assets are then sold by the Maltese pension plan, some US taxpayers also take the position that the gains were not subject to income tax in Malta or the United States.
Because some participants in these transactions lacked any connection to Malta, the IRS has suggested that the transactions exploited the intentions of the US-Malta Income Tax Treaty. According to the IRS, “[b]y improperly asserting the foreign arrangement as a ‘pension fund’ for U.S. tax treaty purposes, the U.S. taxpayer misconstrues the relevant treaty provisions and improperly claims an exemption from U.S. income tax on gains and earnings in and distributions from the foreign individual retirement arrangement.”
CIVIL ENFORCEMENT EFFORTS
In July 2021, the IRS added the Malta pension plan transaction to its Dirty Dozen list, which identifies certain transactions that the IRS considers abusive. That same year, the United States and Malta entered into a Competent Authority Agreement to close this interpretation of the treaty by narrowing the definition of a pension fund for purposes of the treaty as follows:
Accordingly, U.S. citizens and residents may not claim benefits under paragraph 1(b) of Article 17 and Article 18 of the Treaty with respect to the type of fund, scheme or arrangement described in the paragraph immediately above, including a personal retirement scheme established in Malta under the Retirement Pensions Act of 2011. ,,, Additionally, these funds, schemes or arrangements may not apply paragraph 2(e) of Article 22 of the Treaty to be treated as a qualified resident and may not claim the benefits of paragraph 3 of Article 10 of the Treaty.
The IRS and the US Department of the Treasury then took efforts to discourage taxpayers. In June 2023, proposed regulations rendered the practice as a listed transaction. (See Prop. Treas. Reg. § 1.6011-12.) If the regulations are finalized, advisors or contributors to Malta pension plans will be subject to required recordkeeping, mandated reporting and possible civil tax penalties for failure to disclose these transactions to the IRS.
IRS CRIMINAL INVESTIGATIONS
Prior to June 2023, Maltese pension plan enforcement was mainly conducted through civil tax examinations. Recently, however, the IRS’s Criminal Investigation Division has begun in-person visits to taxpayers and advisors, presenting summonses and conducting criminal investigations into individuals who contributed to or promoted these transactions. Those under investigation include lawyers, accountants, estate planners and other financial advisors.
Some taxpayers receiving summonses are unsure if they are the target of a criminal investigation or merely a third-party witness in a potential case. Typically, when the IRS investigates whether transactions are tax evasion schemes, it focuses on the people who promoted and facilitated the transactions.
NEXT STEPS
In the interim, it is possible that the IRS will use civil tax examinations to address income tax deficiencies on unreported income from these transactions. The IRS will likely assert civil tax penalties (including negligence penalties) against participants in these transactions. Moreover, the IRS may also impose criminal penalties on taxpayers and the promoters of the transactions.
Practice Point: If you have participated in a Malta pension plan or a similar transaction, we recommend having a discussion with an experienced tax lawyer to understand any potential implications of these transactions and consider efficient ways to restructure before the IRS contacts you. Knowing your rights can ameliorate any civil and criminal tax penalties. With respect to potential criminal penalties, it is important to understand your rights, including your Fifth Amendment right against self-incrimination, before you speak and interact with the IRS. Moreover, taxpayers should consider ways to unwind these arrangements and avoid these risks going forward.
Olivia Sica, a summer associate in the Miami office, also contributed to this case note.
