The US and Malta have signed an agreement confirming their understanding of the meaning of pension fund under the United States-Malta income tax treaty, in a statement by the US Internal Revenue Service.

This came to light after both authorities found that US taxpayers with no connection to Malta were misconstruing the pension provisions of the Treaty to avoid income tax on the earnings of, and distributions from, personal retirement schemes established in Malta.

The agreement confirmed the US 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, the US authority said.

The IRS put taxpayers on notice earlier this year that it was reviewing the use of Maltese personal retirement schemes.

It further said it is actively examining taxpayers who have set up these arrangements and recognizes that other taxpayers may have filed tax returns claiming treaty benefits as a result of their participation in these arrangements. These taxpayers should consult an independent tax advisor prior to filing their 2021 tax returns and take appropriate corrective actions on prior filings.

The IRS also cautioned taxpayers against entering into any substantially similar arrangements that would seek to misconstrue the provisions of a bilateral income tax treaty of the United States to avoid income tax.

EY said in a briefing note that this new competent authority arrangement between the US and Malta was "an example of a tool available to the US and its tax treaty partners in preventing unintended uses of tax treaties. It also illustrates that the IRS is not limited to resources under domestic law but can invoke its tax treaty network in its tax enforcement efforts".