EU & Italian International Tax Law Blog : International Tax Lawyer & Attorney : Marco Rossi Law Firm : Italy, New York, European Union, EU

Italy's tax administration issued the new consolidated corporate income tax return form for the year 2009, with its instructions, which deals with the new rules for interest deductions in tax consolidated groups.

The Finance Law for 2008 repealed the thin capitalization rules and enacted new provisions on limitation of interest deductions for business and corporate taxpayers. Under the new rules, interest expenses exceeding interest income are deductible up to 30 percent of borrower's gross accounting profit or earnings before interest, taxes, depreciation and amortization (EBITDA). Excess interest (that is, interest expenses exceeding the 30 percent threshold for a year) and excess limitation (that is, the excess of 30 percent limitation over net interest expenses for a year) can be carried over to and deducted in future tax years up to the limitation amount available in those years. 

In tax-consolidated groups, excess interest and excess limitation can be transferred among the members of the group, enhancing the ability to deduct interest expenses within the group.

The new tax form and instructions for 2009 confirm that each member of the group computes their own interest deductions and excess interest and limitation amounts, and any excess interest or excess limitation of any member of the group can be transferred to the parent, which would calculate the additional interest deduction and adjust the taxable income of the group accordingly.

For example, if group member A has excess interest of 100, group member B has excess interest of 50, and group member C has excess limitation of 120, the parent can deduct additional 120 of interest by using the excess limitation of group member C to offset the excess interest of group member A and B.

It is still not clear whether the transfer of the excess limitations and excess interest is mandatory or elective, and whether it should be done proportionally or for the entire amount.

With a proportional rule, 80 of excess interest would be transferred from group member A and 40 of excess interest would be transferred from group member B; a total of 120 excess interest would be offset with a total excess limitation of 120 transferred from group member C, and excess interest of 40 and 10 would be carried over to future years individually by group members A and B.

With an all inclusive rule, 30 would be excess interest of the group that the parent would carry over and deduct in future years.  

In general, the new rules as implemented in the new tax form for 2009 facilitate the deduction of interest expenses within a tax consolidated group. For this purposes, the group includes foreign subsidiaries that meet the domestic tax consolidation requirements.                

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In ruling n. 21/E of January 27, 2009 (Resolution 21/E-2009.pdf), Italy's tax administration ruled on whether a merger of an Italian company into a Spanish parent would qualify for tax-free treatment under the EU merger directive.

Under the facts of the ruling, a Spanish company engaged in the business of distribution and sale of clothing and accessories would acquire the stock of an Italian company, which perform the following services:

- receipt of goods from Italian manufacturers and suppliers;

- storing and warehousing;

- quality and conformity control;

- packaging, shipping and delivery of goods to the parent or customers;

- collection and provision of information and other auxiliary services.

Immediately after the acquisition, in order to avoid administrative costs the Italian company would be merged into the Spanish company and would continue to operate as a permanent establishment in Italy of the Spanish company.

According to the taxpayer, the transaction should qualify as a tax free merger under the provisions of the EU merger directive as implemented in Italy.

Also, the Spanish company through its Italian permanent establishment should be able to purchase stock of other Italian companies and include them in a domestic tax consolidated group in Italy, with offset of profits and losses among the members of the group.

The Italian tax administration disagreed and ruled that the merger would be a taxable transaction and the Spanish company could not consolidate other Italian subsidiaries under Italian domestic tax consolidation rules.

According to the tax administration, after the merger there would be no permanent establishment of the foreign parent company in Italy, because the activities performed in Italy are excluded from the definition of permanent establishment provided for in the tax code.

Consequently, since the permanent establishment requirement is not met, the tax deferral treatment granted by the EU merger directive would not apply, and any gain or loss realized in the merger would have to be recognized for Italian tax purposes.  

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The Tax Section of the Italian Supreme Court in its judgment n. 1465 of January 21, 2009 held that the tax administration bears the burden to prove that a transaction is carried out solely to obtain a tax advantage, in order to disregard the transaction and deny the tax benefits obtained by the taxpayer under the general anti avoidance rule.

The Supreme Court in joined chambers had established the general anti avoidance principle in its judgments n. 33055 and 33057 of  December 23, 2008.

According to the Court, a transaction can be disregarded when the intention to obtain tax advantages is the essential and predominant element of the transaction, taking into account the purposes of the parties and all the facts and circumstances and the specific structure and design of the transaction used by the taxpayer.

The taxpayer can prove that the transaction pursues alternative or concurrent economic objectives of real significance, which justify the transaction and its structure.

The case decided by the Court concerns a corporate joint venture in which a company purchased industrial machinery and equipment that it leased to related companies for non consideration, and then acquired vehicles from the lessees at a reduced market price. The structure of the transaction generated a tax saving.

However, the transaction was aimed at enabling the group to gain market shares by selling goods at discounted price and was considered sufficient to reject the challenge brought under the general tax avoidance principle.                 

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Italian Regional Tax Court found that a Madeira company engaged in the business of purchasing and selling goods had its permanent establishment in Italy, were the contracts were negotiated and the business was supervised by its shareholders (CTR Toscana 88/18/08 of 7.11.2008.pdf).

As a result, in judgment n. 88/18/08 of November 7, 2008 (which affirmed the trial court judgment) the Regional Tax Court of Tuscany held that the Madeira company was liable to tax in Italy for an amount of over 5 million euros.

The Madeira company (previously organized in Gibraltar) purchased and sold goods (with an annual turnover of several million euros). It was subject to zero or low tax in Madeira. The company had one office and one part time employee in Madeira. Its contracts were negotiated and executed and its business was supervised by its shareholders in Italy.

The Regional Tax Court applied the analysis of the Supreme Court in the seminal Philip Morris cases (see Supreme Court judgment n. 7682 of 2002.pdf) and found that the Madeira company had a permanent establishment in Italy, were contractual negotiations were conducted and the business of the company was supervised, and held that all of the profits of the company were attributable to its Italian permanent establishment and subject to tax in Italy.

The Court also noted that it was not credible that an active business for an annual revenue of several million euros could be conducted through one part time employee out of one office in Madeira, which reinforced the conclusion that the company had its permanent establishment in Italy through which it actually carried out its business and realized its profit.

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With judgment issued on December 22, 2008 in Les Vergers du Vieux Tauves (C-48/07) the European Court of Justice (ECJ) held that Directive 90/435/EEC of July 23, 1990 (the EU parent-subsidiary directive), which exempts dividends paid by a EU subsidiary to its EU parent from withholding tax, does not apply to dividends paid to the holder of a right of usufruct on the shares for which the dividends are paid.

In the case decided by the Court, a Belgian company held a usufruct in the shares of another Belgian company, while a different Belgian company held legal title to the shares.

The usufruct conferred to the holder the right to receive the dividends paid on the shares, but it did not confer full legal title on the shares or the status of shareholder.

Article 3, paragraph 1 of the EU parent-subsidiary directive requires that, for the benefits of the directive to apply (exemption from withholding), the dividend recipient have a minimum holding of 25 per cent of the capital of the dividen payer (reduced to 15 per cent for dividends distributed from 1.1.07 and to 10 per cent for dividends distributed from 1.1.09).

The usufruct does not represent a participation to the capital of the company, and does not confer the status and rights of shareholder. As a result, the parent-subsidiary directive does apply to dividends paid to the holder of the usufruct on the shares.  

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In two very important decisions issued on December 23, 2008, the Italian Supreme Court for the first time held that the Italian tax system contains a general anti-avoidance principle deriving directly from the Italian Constitution, pursuant to which the tax administration can disregard a transaction entered into for no real economic reasons, but for the sole purpose of obtaining a tax advantage.

According to the Court, the general anti-avoidance principle derives from article 53 of the Italian Constitution, establishing that everybody must pay taxes according to their ability to pay, at higher rates for higher income, and it is a general principle of the tax system that applies on top of and above any other specific anti-avoidance provisions of the tax code.

The first decision, n. 30055 of December 23, 2008 (Supreme Court n. 30055-08.PDF) concerns a "dividend washing" transaction. An Italian company purchased stock from an Italian investment fund immediately before the payment of a dividend declared on the stock, at a purchase price reflecting the amount of the dividend declared and payable on the stock.

The Italian company collected the dividend and received a tax (imputation) credit for an amount equal to the underlying corporate taxes paid by the issuer of the stock on the profits out of which the dividend was paid, which eliminated the tax on the dividend for the buyer. If collected by the investment fund, the dividend would have been subject to a gross basis withholding tax.

Immediately thereafter, the Italian company sold the stock back to the investment fund at a price equal to the purchase price less the amount of the dividend, thereby realizing a taxable loss which reduced its taxable income.

The tax administration denied the benefit of the tax loss under the theory that the the real beneficial owner of the dividend was the investment fund and the Italian company acted merely as a conduit for the collection of the dividend on behalf of the fund.

At the time of the facts of the case, the provision of article 14, paragraph 6-bis of the tax code denying the dividend tax credit for dividend distributed to companies which have bought stock from investment funds after the declaration but before the payment of the dividend had no been enacted. 

The second decision, n. 30057 of December 23, 2008 (Supreme Court n. 30057-08.PDF) concerns a "dividend stripping" transaction. A U.S. company not engaged in business in Italy owned stock of an Italian company and transferred the right of use of that stock (so called usufruct), including the right to collect the dividends on the stock, to another Italian company, at a price reflecting the amount of the dividends that were reasonably expected to be declared on the stock during the time of the contract.

Italian tax law treats the dividend equivalent amount paid to the transferor of the usufruct as foreign source income not taxable in Italy.

The Italian company collected the dividends and received a tax (imputation) credit for an amount equal to the underlying corporate taxes paid by the issuer of the stock on the profits out of which the dividend was distributed, which eliminated the tax on the dividend, and took amortization deductions for the the cost of the usufruct, which reduced its taxable income.

If paid to the U.S. company, the dividends would have been subject to a gross basis withholding tax.

The tax administration denied the amortization deduction on the ground that the Italian company was not the real beneficial owner of the income but acted merely as a conduit for the collection of the dividends on behalf of the U.S. company.        

At the time of the facts of the case, the provision of article 14, paragraph 7-bis denying the tax credit for dividends collected by Italian companies which purchased the usufruct on the stock from foreign companies had not been enacted. 

The Supreme Court held that the transactions lacked significant economic reasons other than the tax benefits and can be disregarded under the general anti-avoidance principle set forth above.

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