In recent years the concept of 'beneficial ownership' has emerged as a major anti abuse rule applicable in the context of tax treaties and other important areas of international tax law. This article provides an overview of the recent interpretation and applications of the beneficial ownership rule as clarified by the OECD, pursued by tax administrations and courts in various countries, and carried out in Italy.
Italy operates specific provisions on tax treatment of trusts. Trusts formed under foreign law are recognized and enforced in Italy pursuant to the Hague Convention on Trusts dated July 1, 1985. To the extent they have Italian assets, or Italian grantor, trustees or beneficiaries or Italian source income, foreign trusts may be subject to Italy's trust tax provisions. Under certain circumstances, trusts are disregarded and trust assets are treated as owned by the grantor or beneficiaries. This is the case when the grantor has an unconditional power to terminate or revoke the trust or when the beneficiaries have an unconditional right to claim an anticipated distribution of all or part of the trust assets at any time during the life of the trust, or when the trustee lacks actual independent power to administer the trust and is under the directions or instructions of either the grantor or the beneficiaries of the trust. When respected for tax purposes, the trust is taxed on a fiscally transparent basis or as a separate entity, depending on whether and to what extent the income of the trust is attributed to identified beneficiaries specifically mentioned in the trust agreement or separately by the grantor during the life of the trust. When a trust is taxed on a fiscally transparent basis, income of the trust is allocated to and taxed directly upon the beneficiaries. When a trust is taxed as a separate entity, the trust itself pays the corporate income tax on its own income. A trust administered in Italy or by an Italian resident trustee is treated a a resident trust and subject to tax on its world wide income. A trust administered abroad or by a foreign resident trustee is treated as a foreign trust and taxed only upon Italian source income. For more details about Italian tax treatment of trusts as it applies to trusts formed under the laws of any State of the United States or any other foreign country, we refer to this article which was recently published on Tax Notes International.
The Italian Supreme Court in its Ruling 20285 dated September 4, 2013 held that an individual taxpayer claiming to have his tax residency outside of Italy had properly discharged his burden of proof and correctly established his tax residency abroad by producing copy of his residential lease, regular payments of rent and utility bills and use of personal bank account for day to day expenses, thereby proving that his actual and real residence and domicile was located in the foreign country.
Under Italian tax law, individual tax residency is determined pursuant to highly factual tests and can be established even when there are relatively minor contacts with Italy, such as a house, frequent visits to the country, or business interests located there. Once determined, it subjects the taxpayer to worldwide taxation in Italy both for income and estate tax purposes including the obligation to report all of taxpayer's assets wherever located in the world under a form that is the equivalent of the american foreign bank account report, except that it requires reporting of non financial assets (such as cars, houses, planes, artworks, etc.) as well as financial assets and accounts. Foreign persons with interests in Italy must pay particular attention to those rules to avoid to be trapped into unintended Italian tax residency.
Under the facts of the case decided by the Supreme Court, the taxpayer - a tennis player originally resident in Italy - claimed to have moved his tax residency to Monaco, while still traveling to Italy and other countries in connection with his business interests and professional activity.
Under Italian law, Monaco is a tax haven, black listed jurisdiction and Italian taxpayers who register as residents there are presumed to be still resident in Italy for Italian tax purpose, unless they prove that their actual residence and domicile is located in that country. For this purpose, residence identifies the taxpayer's habitual and regular place of living, while domicile identifies the taxpayer's main center of personal, financial and business interests.
Italy enacted a new law that significantly amends its rules requiring Italian resident individual taxpayers to report their foreign financial investment and accounts and other assets capable of generating foreign source taxable income.
SCOPE OF REPORTING
The fist significant change reduces the scope of the reporting. it eliminates the duty to report intra year transfers relating to reportable foreign assets, previously reported through sections III and I of form RW part of Italian tax returns. As a result, any transfers of money out of Italy for the purchase of foreign reportable assets, or into Italy as a result of a liquidation or sale of a reportable foreign assets, or foreign to foreign transfers relating to changes to the portfolio of foreign reportable assets, which occurred during a tax year, need not be reported.
The second significant change reduces the amount of applicable penalties. Under the old law, penalties could be assessed from a minimum of 10 percent up to a maximum of 50 percent of the value of unreported foreign assets. Under the new rules, the penalties are reduced to 3 percent minimum and 15 percent maximum respectively. Furthermore, taxpayers can settle any audit out of court by paying a penalty equal to 1/3 of the minimum (that is to say, 1 percent of the value of unreported assets).
The new rules have retroactive effect and apply to any situation in which penalties have not been assessed and paid yet. Therefore, past violations that are no longer sanctioned under the new rules have become moot.
The duty to report extends to taxpayers who are the "beneficial owners" of the reportable foreign assets, regardless of the fact that they may not be the owner of record or hold the legal title to those assets. The new law does not define the term "beneficial owner", but refers to the definition of the term that is provided by anti money laundering legislation. Accordingly, in case of companies, any shareholder, member or partner owning more than 25 percent of the company (by vote or value) is deemed to be a beneficial owner of the underlying investments or assets owned by the company. For other entities, such as foundations and trusts, beneficial owners are deemed to be the individuals who are the final beneficiaries or recipients of the entities' assets.
The elimination of the duty to report intra year transfers and the reduction of penalties for failure to report is surely good news.
On the other side, the extension of the duty to report to the beneficial owners of a reportable foreign assets is very concerning. How taxpayers will handle their reporting obligations under the new rules is not easy to predict and will likely require further clarifications and guidance from the tax administration.
Indeed, the term beneficial owner in the context of the anti money laundering rules is very wide in scope, and its automatic use also for foreign assets reporting purposes might have unintended consequences. If applied literally, it would require any shareholder owning more than 25 percent of the stock of a company to report his or her pro rata share of all of the company's underlying assets held outside of Italy. While this might make sense in case of closely held companies or conduits that are set up for the sole purpose of holding and managing foreign financial investments and accounts, it may be completely impossible to handle in practice in case of straightforward commercial companies and other business entities engaged in trade or business.
Further guidance on this issue is absolutely necessary
Italy does not have domestic rules on trust.
However, trusts created under foreign law are recognized and enforceable in Italy pursuant to the provisions of the 1985 Hague Convention on the Law Applicable to Trusts and Their Recognition, which has been ratified and implemented and is fully effective in Italy as part of Italian legal system.
The Hague Convention was signed on July 1, 1985 and ratified in Italy with law n. 364 of October 16, 1989 and entered into force on January 1, 1992. It is aimed at harmonizing the private international laws of the contracting states relating to trusts; provides that each contracting state recognizes the existence and validity of trusts created by a written trust instrument; sets out the general characteristics of a trust and establishes rules for determining the governing law of trusts with cross-border elements.
According to the Convention, as implemented in Italy, a trust created pursuant to and governed by the law of a country that has provisions governing trusts is recognized and valid in Italy, subject only to the overarching limitation of Italian public order principles.
Purely internal trusts, with Italian grantors, Italian beneficiaries and assets located in Italy are also recognized.
With the Finance Bill for 2007 Italy enacted, for the first time, specific provisions dictating the tax treatment of trusts for Italian tax purposes. They establish general principles on tax classification and treatment of trusts in Italy for income and indirect tax purposes and have significant cross-border implications
On August 6, 2007 Italy’s tax administration issued Circular n. 48/E that provides administrative guidance on the interpretation and application of the new tax provisions on trust. Circular 48/E clarifies the tax treatment of trusts both for income tax and transfer (indirect) tax purposes.
Subsequently, Italy’s tax administration issued additional interpretative guidance by way of Circular n. 61/E issued on December 27, 2010.
Generally, for a trust to exist as a legal and tax entity separate from the grantor, the trustee and its beneficiaries, there must be a real and effective legal separation of the trust’s assets from both the estate of the grantor and the beneficiaries of the trust and the trustee must be granted with real powers of administration of the trust, acting independently from and not being under the direct or indirect control of the grantor or beneficiaries of the trust.
Once it is positively established that a trust actually exists, as a general rule, for income tax purposes trusts are classified as separate taxable entities and taxed as corporations.
However, trusts with income beneficiaries that are identified and named in the trust agreement are treated as fiscally transparent entities - that is, income is attributed to the beneficiaries as provided for in the trust agreement, regardless of whether and how the trust distributes its funds, and the beneficiaries are taxed directly on their share of trust’s income. This fiscally transparent treatment applies also in the event that after the initial creation of the trust, the trustee determines the income beneficiaries of the trust pursuant to the authority granted in the trust agreement.
A trust is resident in Italy for tax purposes if its place of management or place of activity is located in Italy. Trusts formed in jurisdictions that do not allow exchange of information with Italy are treated as residents and subject to worldwide taxation in Italy, if certain connections with Italy exist (for example, if any grantor or beneficiary is Italian), unless taxpayers provide sufficient evidence that they are resident (that is, effectively managed) outside of Italy.
Trusts must keep tax books to compute their taxable income (taxed upon the trust in case of fiscally non transparent trusts, or passed through to and taxed upon the beneficiaries in case of fiscally transparent trusts).
A gratuitous transfer of assets to a trust is subject to gift or estate tax. The tax is charged at reduced rates (4 and 6 per cent) if beneficiaries named in the trust agreement or determined by the trustee at any time thereafter are close family members. Otherwise, the regular rate for trusts with no identified beneficiaries or beneficiaries that are not close family members or charitable trust is 8 per cent.
US Tax Administration Issued Final Regulations on FATCA Implementing International Tax Reporting and Compliance
On January 17, 2013 the IRS issued final regulations providing rules on information reporting by foreign financial institutions (FFIs) and withholding on certain payments to FFIs and other foreign entities.
Under the Foreign Account Tax Compliance Act of 2009 (FATCA), enacted as part of the Hiring Incentives to Restore Employment Act of 2010, P.L. 111-147, U.S. withholding agents are required to withhold tax on certain payments to foreign financial institutions (FFIs) that do not agree to report certain information to the IRS regarding their U.S. accounts and on certain payments to certain nonfinancial foreign entities (NFFEs) that do not provide information on their substantial U.S. owners to withholding agents.
The regulations finalize the proposed rules issued last February, making a number of changes in response to comments. As a result, the 389-page proposed regulations have become 544-page final rules, with a lengthy discussion of which comments prompted changes from the proposed regulations.
One area of simplification in the final regulations is the integration of model intergovernmental agreements into the reporting requirements of the regulations. There are two types of intergovernmental agreements: reciprocal agreements and nonreciprocal agreements, which are called Model 1 IGAs and Model 2 IGAs. A jurisdiction signing a Model 1 IGA agrees to adopt rules to identify and report information to the IRS that meets the standards in the Model 1 IGA. FFIs that are in Model 1 IGA jurisdictions report the information about U.S. accounts required by FATCA to their respective governments, which then exchange this information with the IRS. FFIs in Model 2 IGA jurisdictions must comply with the FATCA regulations except to the extent the relevant IGA provides otherwise.
The IRS announced that, to date, seven countries have entered into model agreements with the United States: Norway, Spain, Mexico, the United Kingdom, Ireland, Denmark, and Switzerland. Discussions with more than 50 countries are ongoing, and more agreements are expected to be signed in the near future.
In recognition of the burden that complying with FATCA entails, the final regulations, among many other things:
- Phase in over an extended transition period the timelines for withholding, due diligence, and reporting and align them with the IGAs.
- Expand and clarify the types of payments subject to withholding, particularly for certain grandfathered obligations that are not subject to the rules and certain payments made by NFFEs.
- Expand and clarify the treatment of certain low-risk institutions, such as government entities and retirement funds, provide that certain investment entities may be subject to being reported on by FFIs with which they hold accounts rather than being required to register as FFIs with the IRS, and clarify the type of passive investment entity that financial institutions must identify and report.
- Streamline the compliance and registration requirements for groups of financial institutions, including commonly managed investment funds.
The regulations have become effective when published in the Federal Register (scheduled for Jan. 28, 2013).
Reciprocal Inter Governmental Agreement Will Introduce Automatic and Reciprocal US-Italy Disclosure and Exchange of Information For Tax Purposes
The Foreign Account Tax Compliance Act (FATCA) was enacted by the United States Congress in March 2010 and became effective on January 1, 2013. It is intended to assist US efforts to improve international compliance with US tax laws and will impose certain due diligence and reporting obligations on foreign (non-US) financial institutions which hold financial accounts for US customers. Under the new law, foreign financial institutions will provide to the U.S. tax administration automatic information about their US customers' financial accounts.
On 26 July 2012, the U.S. Department of the Treasury published a Model Inter Governmental Agreement which will form the basis of bilateral IGAs with jurisdictions that wish to adopt this alternative means for their financial institutions to comply with FATCA while minimizing compliance burdens.
Italy joined the U.S. with a groups of other countries in a Joint Statement announcing that Italy will enter into and use the reciprocal agreement with the United States to implement FATCA and enact a system of reciprocal automatic exchange of information pursuant to which:
- Italian banks and financial institutions will provide the US tax administration with information about Italian banking and financial accounts held by U.S. customers with Italian banks in Italy,
- U.S. banks and financial institutions will provide Italy's tax authorities with information about US banking and financial accounts and investments held by Italian customers with US banks in the United States.
The Model IGA follows the U.S. Department of the Treasury and Internal Revenue Service's release of proposed FATCA regulations, and the simultaneous announcement of an intergovernmental alternative to FATCA implementation, on 8 February 2012.
On January 17, 2013 the Treasury Department and the Internal Revenue Services issued the set of Final Regulations implementing the information reporting and back up withholding tax provisions of FATCA, with far reaching implications for U.S. taxpayers with Italian bank and financial accounts, as well as Italian taxpayers with US bank and financial accounts, in addition to foreign financial institutions as well as US banks as explained above.
Italian resident taxpayers are required to report to the Italian tax administration their foreign financial investments and assets, which can generate foreign-source income subject to tax in Italy. They report their foreign investments by filling out a special part of their annual income tax return referred to as form RW. Taxpayers who are not otherwise required to file an income tax return (e.g., those who earn only salary income reported on form 730 equivalent to form W-2 in the United States) must file a full return just for the purpose of reporting their foreign investments on Part RW.
Italian international tax reporting through form RW is very extensive in scope and accompanied by very harsh penalties with very limited opportunities to rectify past mistakes or failures. It includes personal assets other than financial investments (e.g. personal residences, boats, jewelry, artworks). One section of form RW is used to report the value of the reportable assets at the end of the taxable year. Two separate sections are used to report outbound, inbound and foreign transfers of money or other assets relating to foreign assets subject to reporting (i.e. additional investments and disinvestments through purchases, sales or transfers of reportable assets).
Reporting may be particularly complicated when foreign investments and assets are held through trusts or other foreign entities. Depending on the tax classification and treatment of the entity or trust the taxpayer may be exempt from reporting, required to report his or her own interest in the trust or entity itself, or required to report his or her own undivided ownership interest in the underlying assets held through the entity, with totally different results.
The duty to report revolves around several fundamental tax concepts: tax residency of the taxpayer, ownership of the asset, and tax nature of the asset and associated income.
Italian tax residency rules are far reaching and often based on technical and heavily factual tests. As a result, many non-Italian nationals who spend significant time in Italy for personal or business purposes or have personal, investments or business interests in Italy should act very carefully, especially now that the Italian tax agency is stepping up its enforcement actions in the effort of collecting additional revenue.
Indeed, if it turns out that they should be treated as resident of Italy for Italian tax purposes, they would automatically face the issue of not having reported their non-Italian assets, with all potential penalties associated with it, in addition to the main issue of having failed to file and their tax returns and to pay any taxes due.
International tax reporting rules are very technical and complex to administer. Italy’s tax administration issued a general guidance on international tax reporting of foreign assets and investments with Circular n. 45 of September 13, 2010.Continue Reading...
With its Ruling n. 3769 issued on March 9, 2012, the Italian Supreme Court significantly departed from its previous line of decisions on the issue of characterization of a foreign-owned Italian company as the permanent establishment of its foreign parent.
The case in which the ruling has been issued involved Boston Scientific S.p.A., an Italian joint stock company ("BS SPA") whose stock is owned for 99 percent by Boston Scientific B.V. ("BS B.V.") a Dutch company and for the remaining 1 per cent by Boston Scientific Corporation, a U.S. corporation ("BS USA"), which in turn controls BS B.V.
BS USA was engaged in the business of designing, manufacturing and selling medical equipment and devices. BS SPA operated as commission agent for BS B.V. for the purpose of the marketing and sale of the products of BS USA in Italy and the EU.
From the summary of the facts as reported on the Supreme Court Judgment it appears that BS SPA acted under the management direction and control of BS B.V,, operated exclusively for BS B.V. as its only client and signed sales contracts with customers under its own name although in the interest of and pursuant to the final approval from BS B.V.
The Italian tax agency took the position that BS SPA lacked economic and legal independence from BS B.V. and it operated as agent of BS B.V. according to the substance of its business dealings with its principal and final customers, even though it normally signed the contracts in its own name. As a consequence, the tax agency re-characterized BS SPA as the permanent establishment of BS B.V. in Italy and assessed additional taxes and penalties on BS B.V., which should have accounted separately for its sales of products carried out in Italy through BS SPA, file its own Italian corporate tax return and pay the Italian corporate income tax on its net profits from its Italian sales accordingly.
Both the Italian Tax Court and the Appellate Court ruled in favor of the taxpayer and rejected the agency re-characterization and tax assessment, motivating their decisions with the fact that BS SPA had its own separate business organization of which it sustained all the costs, had assumed the economic risks of its business operations and was legally bound by the contracts it signed with the final buyers of the products under its own name as seller.
The Supreme Court affirmed the decision of the Appellate Court concluding that it was sufficiently and adequately motivated and that the grounds for appeal set forth by the tax agency were not sufficiently explained and could not be considered.
The Court in particular referred to the provisions of article 5 of U.S.-Italy tax treaty and argued that the Italian tax agency failed to explain the reasons why those provisions should be read in a way to create a permanent establishment when an Italian company contracts under its own name and risks and bears the economic cost of its business organization through which it conducts its business in Italy, for the sole fact that it is owned and controlled by a foreign company and operates under the supervision and directions of its foreign parent company.
Ruling 3769 is very encouraging. Indeed, the ruling seems to depart from the Supreme Court's previously established case law stemming form its 2002 decisions in the Philip Morris case and to provide more clarity for foreign businesses which plan to expand their operations into Italy.
Il 17 Settembre scorso ad un convegno organizzato dalla American Chamber of Commerce in Italy a Milano abbiamo illustrato i principali aspetti legali e fiscali che le imprese italiane che investono sul mercato americano si trovano ad affrontare. Gli Stati Uniti, grazie alla loro competività e flessibilità, ad un mercato dei capitali estremamente evoluto, alla totale assenza di discriminazioni e barriere e a una grande propensione a premiare le capacità, lo spirito imprenditoriale ed il merito, offrono formidabili opportunità di crescita e sviluppo del business alle numerose imprese italiane di piccole e medie dimensioni dotate di prodotti o servici unici o di alta qualità e di know how e tecnologia che le pongono in posizione di vantaggio competivo rispetto alla concorrenza. Allo stesso tempo, il sistema legale e fiscale USA richiede estrema attenzione e professionalità sia al momento dell'ingresso sia nella fase successiva della gestione del proprio business negli USA, e non tollera improvvisazione. Tra gli aspetti da curare vi sono quelli contrattuali, relativi ai contratti di distribuzione, agenzia o collaborazione commerciale stipulati con partners commerciali e ai contratti con i clienti, gli aspetti societari, amministrativi e organizzativi (scelta della migliore forma societaria, costituzione e capitalizzazione della società, apertura conti bancari, assunzione del personale e libri paga, assicurazioni, gestione della contabilità e dei bilanci, licenze e permessi, eccetera), e gli aspetti fiscali relativi alle imposte sul reddito, federali e statali, e alle imposte indirette sulle vendite e sui consumi. Alleghiamo la nostra presentazione con la discussione dei suddetti aspetti, su cui è bene sollevare il livello di allerta ai fini di una corretta gestione ed esecuzione del proprio piano di business negli Stati Uniti.