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

On December 17, 2009 the Italian Government passed a decree which extends the deadlines for the Italian voluntary disclosure program.

The new deadlines are February 28, 2010 and April 30, 2010. Taxpayers who repatriate or regularize their undeclared foreign assets within February 28, 2010 pay a 6 percent flat tax on the fair market value of the repatriated or regularized assets. Taxpayers who repatriate or regularize their undeclared foreign assets within March 31, 2010 pay a flat 7 percent tax.

According to the latest statistics, foreign assets in excess of E 100 billion have been declared pursuant to the current voluntary disclosure program enacted in September this year.

In connection with the unreported foreign assets disclosure program, new penalties have been enacted for failure to report foreign investments. The new penalties are equal to minimum of 200 to a maximum of 400 percent of the unpaid tax on unreported foreign investments and 50 percent of the fair market value of the unreported foreign assets.

Also, any foreign asset which has not be reported is deemed to be unreported income subject to tax.

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On August 18, 2009 Italy's tax administration issued resolution n. 226/E (published only on December 6, 2009), which concerns the application of the Italian participation exemption rules to gains from sale of stock of an intellectual property holding company (Rul_ 226_E - Aug_ 18, 2009.PDF).

Italy operates a very favorable participation exemption regime, pursuant to which 95 percent of the amount of gains realized from the sale or exchange of stock is exempt from tax. The remaining 5 percent is taxed at the corporate tax rate of 27.5 percent (equivalent to an effective tax rate of 1.375 percent). The exemption applies also to gains from the sale of partnership interests or participating financial instruments that are treated as stock for tax purposes (for an analysis of Italy's participation exemption rules, see Italy's Participation Exemption Rules.PDF).  

One of the requirements of the participation exemption is that the company whose stock is sold is engaged in the conduct of a commercial enterprise (as defined in the commercial code). The commercial code definition of commercial enterprise is very wide in scope. Under the tax code, any activity conducted by a commercial company is deemed to be a commercial activity generating business income.

Under the facts of the resolution, an Italian company owns 50 percent of stock of a Dutch B.V., who holds intangible properties (trademarks and trade names). The Dutch holding company is responsible for the registration and legal protection of the intangible properties and licenses those properties to other affiliated companies and third parties in exchange for royalties.       

In the resolution n. 226/E, the tax administration clarified that the active business requirement for the participation exemption must be interpreted strictly and is not met when the activity of a company is limited to the mere holding of the legal title to intellectual property and licensing of that property to affiliated companies. To benefit from the exemption the company must be engaged in an active licensing business, which includes actively managing and developing the intangibles by way of research and development activities and its active licensing to third parties.

The distinction between passive intellectual property holding activity, which does not qualify for the exemption, and active licensing business, which qualifies for the exemption, depends of the facts and circumstances of each specific case. For this reason, the tax administration, after clarifying the general principle that applies to the matter, refused to rule on the specific case submitted by the taxpayer.

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Italy amended its CFC rules with effect from 1/1/2010.

Under the new provisions, the active business exception to the CFC rules applies only when the controlled foreign company carries on a business in the local market of the country in which the company is established, and it never applies to companies more than 50 percent of whose income is passive income (dividends, interest, gains and income from services to affiliated entities).

Also, the CFC rules apply to foreign companies that are established in white listed jurisdictions, when (1) the foreign company is subject to an effective income tax in its own country of organization that is less than 50 percent of the Italian income tax on its profits, and (2) more than 50 percent of the foreign company's income is passive income (dividends, interest, gains and income from services to affiliated entities.

As a result of the changes, many tax planning structures for Italian companies ding business abroad shall have to be revisited. In particular, many EU holding companies used by Italian companies to handle their outbound investments may become CFC and their income could become taxable currently upon their Italian shareholders in Italy.       

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Italy's tax administration issued circular n. 26/E of May 21, 2009 (Circ_26E/2009.pdf), which provides clarifications on the application of the reduced withholding tax on EU dividends.

EU dividends are dividends paid to companies that are resident in a EU Member State or in a State that belongs to the European Economic Area and is included in a special list of approved countries (white list). EU dividends distributed out of earnings and profits accumulated in tax years which began on or after January 1, 2008 are subject to the reduced 1.375 percent withholding tax.

Circular 26/E clarifies that the provision which allocates dividends in reverse chronological order beginning first with profits accumulated in older tax years does not apply. Therefore, the distributing company is free to allocate the distribution to profits accumulated in tax years which began on or after 1.1.2008 and apply the reduced withholding tax.

Also, circular 26/E clarifies that the recipient of the dividend qualifies for the reduced withholding tax if it organized as a company subject to a corporate tax under the laws of its State of residence, even though it does not actually pay any tax as a result of a  exemption that is compatible with EU law or is granted in connection with the particular nature of the entity's income (e.g., passive income earned by investment companies).  

Therefore, investment funds organized as companies in their state of residence, but not subject to tax on their invstment income (such as certain Luxembourgh or Irish investment funds), could qualify for the reduced EU dividend withholding tax rate.

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The Italian Supreme Court in judgment n. 8487 issued on April 8, 2009 held that taxpayers bear the burden to prove that a transaction is entered into for legitimate economic reasons beyond the mere possibility to obtain tax benefits.

The above decision contradicts a previous ruling, n. 1465 of January 21, 2009, in which the Court placed yon the tax administration the burden of proof that a transaction lacks economic substance and is entered into for the essential purpose of obtaining a tax advantage.

Judgment n. 8487 concerns a case in which an Italian company transferred the stock of a wholly owned subsidiary to its parent, as part of a reorganization which was designed to enable the parent to go public.

Under those circumstances, Italian law taxed the gain realized from the transfer of stock of the lower tier subsidiary to the parent to a reduced 10% tax, instead of corporate income tax at ordinary rate. Eventually, the parent was not publicly traded.

The Court applied the anti avoidance provisions of article 37-bis of Presidential Decree n. 600 of 1973 and held that, for those provisions to apply, it is sufficient that a even a single contractual transaction or legal arrangement that is legitimate, on its face, is used in a way that is inappropriate or abusive, and is essentially entered into for no valid economic reasons except for obtaining a tax advantage.

That interpretation, according to the Court, is supported by the Italian constitution, which does not permit tax avoidance.

According to the Court the taxpayer has the burden to prove the specific economic reasons that justify the transaction, in order to be granted the contemplated tax benefits.   

The above decision is the last of several decisions issued in the last few months on the topic of tax avoidance and demonstrates that this area is in a constant flux and needs constant monitoring.         

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A new law (Decree n. 5 of 2009 enacted on Feb. 11, 2009 and finally approved by the Parliament on April 9, 2009) targets the tax abuse of sale and repurchase agreements (commonly referred to as repos) and securities lending transactions.

According to a new provision added to article 2, par. 2 of Legislative Decree n. 461 of November 21, 1997, in case of sale and repurchase agreements or securities lending transactions, or any other arrangements having the same or equivalent economic effects, the repo buyer or borrower is entitled to a tax benefit such as credit for withholding taxes or foreign taxes or other similar benefits in respect of the securities transferred or loaned, only if the repo seller, lender or beneficial owner of the securities would be eligible for those tax benefits had it retained the legal ownership of the securities. 

A similar provision denies to the repo buyer or borrower of the securities the benefit of the participation exemption for  dividends paid on the securities transferred or loaned unless the repo seller or lender would be entitled to it.

Finally, Tax Code article 109, par. 3-bis provides that a loss from sale of stock is non deducible, to extent of the amount of dividends paid on the stock during the 36 months preceding the sale.

The new law establishes that transactions entered into prior to the enactment of the new provisions,  can still be challenged under the general anti abuse rules of article 37/bis of Presidential Decree n. 600 of 1973. 

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The Italian government is working at a bill which would enact a new tax amnesty. The bill should be introduced to the Parliament as early as next week.

Based on certain anticipations on the contents of the new bill, undeclared foreign earnings that are reported and repatriated would be subject to 10% flat tax. Unreported foreign earnings that are reported but reinvested or kept abroad would be subject to a higher tax. In either case, the tax would apply in lieu of any other taxes due on the undeclared earnings and would definitely settle the taxpayer's position.

A similar amnesty was enacted in 2001-2022, together with tougher rules on failure to report foreign bank accounts and other foreign investments that can generate foreign income taxable in Italy. That tax amnesty had a limited success and in general foreign earnings remained significantly unreported.

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In ruling n. 92/E of April 2, 2009 Italy's tax administration ruled that stock received through the exercise of stock options granted by a foreign company is income taxable in Italy, if the options are  exercised after the taxpayer has moved to Italy and become a resident of Italy for tax purposes, even though the stock options vested mainly in respect of services performed outside of Italy when the taxpayer was not resident of Italy for tax purposes. 

The taxpayer argued that a portion of the stock options which vested in respect of services performed outside of Italy when the taxpayer was not a resident of Italy has no connections with Italy and should be excluded from Italian tax.

The tax administration held that all of the stock is taxable in Italy since received when the taxpayer had become resident of Italy for tax purposes, and a credit would be granted for any foreign taxes charged on stock attributable to services performed in a foreign country.

Under the facts of the ruling, the taxpayer worked as an employee of a UK company from October 1, 2004 to September 30, 2007. On October 1, 2007 he moved to Italy where he started working for the Italian parent company of the group. On February 28, 2005 he was granted stock options that would vest in three years. On March 3, 2008, he exercised the options and received the stock. 

The taxpayer argued that the sock represented a compensation for services performed between Feb. 28, 2005 and March 1, 2008, when the options vested, including services performed in the UK from Feb. 28, 2005, to October 1, 2007, when the taxpayer was a resident of the UK for tax purposes.

As a result, according to OECD principles on taxation of  stock options, the value of the stock should be divided into two portions:

- one portion, which accrued in respect of services performed in the UK between Feb. 28, 2005 and September 30, 2007;

- another portion, which accrued in respect of services performed in Italy, between October 1, 2007 and March 3, 2008.  

According to the taxpayer, the first portion should be treated as income for services performed outside of Italy by a non resident individual and should be excluded from Italian tax. Alternatively, Italian tax code article 51, paragraph 8-bis should apply, according to which income of a taxpayer who performs services outside of Italy on continuing basis and as the exclusive object of his employment is limited to a conventional amount determined by way of ministerial decree. The conventional amount would absorb the value of the stock, which would not be separately taxable.        

The tax administration disagreed and held that the entire amount of stock is taxable in Italy, because the taxpayer is taxable on a cash basis, and the stock is income received when the taxpayer was resident in Italy for tax purposes.

The provision of tax code article 51, paragraph 8-bis applies exclusively to taxpayers who work abroad but maintain their tax residency in Italy, which is not the case for the taxpayer in the ruling.

The tax administration agreed that, if the UK charges any tax on stock attributable to services performed in the UK, the taxpayer will receive a credit in Italy which would offset the Italian tax and avoid double taxation.     

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The Italian parliament on March 3, 2009 enacted law n. 20 which authorizes the ratification of the new U.S.-Italy tax treaty signed in 1999.

Law n. 20 of March 3, 2009 was published on the Official Gazette on March 18, 2009 and is now into force. The U.S. had ratified the treaty on December 28, 1999.

The new treaty will enter into force at the time of the exchange of the instruments of ratification. It will apply and take effect for taxable periods beginning on or after January 1, 2010 and for withholding taxes on payments made or accrued on or after the first day of the second month following the date of entry into force. A grandfathering provision allows a taxpayer to elect for the application of the old treaty for a period of 12 months following the entry into force of the new treaty, should the old treaty result in a better treatment.

The new treaty reduces the withholding tax rates on dividends, interest and royalties; authorizes the collection of a dividend equivalent tax on the repatriated profits of a branch, includes a provision limiting the benefits of the treaty to certain qualified residents of the other contracting state, addresses the creditability in the U.S. of the Italian regional tax on production activities, and provides that the competent authorities of the two contracting states may agree to refer a case to special arbitration procedure if they fail to reach an agreement within two years of the date on which the case was referred to one of them. 

Background

The current U.S.-Italy tax treaty entered into force on December 30, 1985. On August 25, 1999 Italy and the U.S. signed a new treaty and protocol (the "1999 Treaty"). On November 5, 1999 the U.S. Senate consented to the ratification of the 1999 Treaty, subject to a reservation and understanding.

The reservation required the elimination of following language which appears as the final paragraph of the withholding tax provisions of articles 10 (Dividends), 11 (Interest), 12 (Royalties) and 22 (Other Income):

"The provisions of this Article shall not apply if it was the main purpose or one of the main purposes of any person concerned with the creation of assignment of the" (respectively, shares or other rights; debt claim, rights, and rights) "in respect of which the" (respectively, dividend, interest, royalties and income) "is" (are) "paid is to take advantage of this Article by means of that creation or assignment".

That language established the so-called main purpose tests aimed at tackling possible abuses of the treaty or treaty shopping arrangements.

The understanding concerned the exchange of information provision of Article 26, which, according to the U.S. Senate, should grant to the competent authorities of the two contracting states the authority to obtain or provide information held by financial institutions, nominees, or persons acting in an agent or fiduciary capacity, or respecting interests in a person.

President Clinton signed the U.S. instrument of ratification on December 28, 1999, subject to the above mentioned reservation and understanding. The reservation required approval from the Italian government, which held the ratification process in stand by.

The 2006-2007 Exchange of Diplomatic Notes

By way of diplomatic note n. 291 of April 10, 2006, the Embassy of the United States of America reiterated the above-mentioned conditions to the ratification of the 1999 Treaty.

The Italian Minister of Foreign Affairs issued a note on February 27, 2007 by means of which it formally agreed with the reservation requiring the deletion of the main purpose tests and the understanding on exchange of information.

That step eventually paved the way to the final ratification of the new treaty.

The Italian Law Authorizing the Ratification of the Treaty

Eventually, the Italian Parliament enacted law n. 20 of March 3, 2009 which authorizes the Italian Minister of Foreign Affairs to exchange the instrument of ratification of the new treaty.

Effective Dates and Grandfathering Provision

The 1999 Treaty enters into force on the date on which the instruments of ratification are exchanged.

In general, the 1999 Treaty shall apply to taxable years beginning on or after the the first day of the year in which it entered into force. Therefore, if the instruments of ratification are exchanged in 2009, the Treaty shall take effect for taxable years beginning on or after January 1, 2010.

In the case of withholding taxes at source, the 1999 Treaty shall apply to payments made or accrued on or after the first day of the second month following its entry into force. Therefore, if instruments of ratification are exchanged on March 24, 2009 the Treaty shall apply to withholding taxes due on or after May 1, 2009.

A grandfathering provision allows a taxpayer, for a period of 12 months following the entry into force of the 1999 Treaty, to elect for the application of the 1985 Treaty should it provide a more favorable tax treatment.

Highlights of the New Treaty

Under the 1999 Treaty, the withholding rates on dividends are 5 percent for inter-company dividends (that is, dividends paid to a person owning at least 25 percent of voting shares of the payer for at least 12 months as of the time of the declaration of the dividends) and 15 percent for portfolio dividends. Dividends paid by a US RIC are subject to 15 percent withholding. Dividends paid by a US REIT may be subject to 15 percent withholding only if specific requirements are met.

The withholding rate on interest is reduced to 10 percent.

Royalties for patents and software are subject to a 5 percent withholding and all other royalties are subject to 8 percent withholding rate.

The 1999 Treaty authorizes the application of a branch profits tax. Italy does not have a branch profits tax. However, all Italian companies operating in the U.S. through a branch shall be subject to the U.S. branch profits tax.

Article 23 of the 1999 Treaty (Elimination of Double Taxation) contains specific provisions for the computation of the amount of the foreign tax credit in the U.S. for Italian regional tax on production activities (IRAP) paid to Italy.    

Article 2, paragraphs 1-5  of the Protocol to the 1999 Treaty contains the new limitation of benefits provisions of the treaty.

A Memorandum of Understanding signed with respect to article 25 of the 1999 Treaty (Mutual Agreement Procedure) provides that the competent authorities may agree to invoke arbitration in a specific case, if they fail to reach and agreement within two years of the date on which a case was submitted to one of them. The Memorandum of Understanding sets forth the main aspects of the arbitration procedure and refers to the EU Convention on Arbitration Proceeding in transfer pricing matters and the US tax treaty with Germany.  

The 1999 Treaty also contains specific provisions on application of treaty benefits to income derived or paid by partnerships or other fiscally transparent entities.

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The Italian Supreme Court issued an important decision concerning the application of tax treaty benefits to partnerships.

The judgment (n. 4600 of 2009) will be deposited soon and we will publish it with additional comments as soon as it is available.

Under the facts of the case, a US Limited partnership received the payment of a dividend from an Italian company. A Japanese fund, member of the US limited  partnership, claimed the reduction of the Italian withholding tax on the dividend pursuant to the Italy-Japan tax treaty. The Italian dividend withholding tax rate is 27 percent. The Italy-Japan treaty reduces it to 10 percent for inter-company dividends (paid to shareholders owning at least 25 percent of voting shares of the payer) and to 15 percent for portfolio dividends.

Italy's tax administration rejected the treaty claim on the ground that the Japanese fund is not the legal recipient of the dividend. The treaty grants the benefits if "the recipient" of the dividend is a company that qualifies to treaty benefits.

In the case at hand, the US LP, which was the recipient of the dividend, was transparent and did not qualify for treaty benefits under the US-Italy treaty, while the Japanese fund was the final economic owner but not the legal recipient of the dividend.

The Court accepted the position of the tax administration and observed that other Italian treaties, granting treaty benefits to a treaty partner who is the beneficial owner of the dividend, would command a different result. 

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With ruling n. 54/E of March 3, 2009 the Italian Tax Administration clarified the treatment applicable to debt instruments issued by Italian limited liability companies. According to the ruling, the instruments can be characterized as debt obligations and enjoy the same tax treatment of debt obligations issued by joint stock companies, namely a reduced 12.5 percent tax on interest and complete exemption for certain foreign investors, if the requirements established in the code for this purpose are met.  

Article 2483 of Italian Civil Code (as amended with law n. of January 17, 2003) provides that limited liability companies (SRLs) can issue debt instruments to finance their operations of investments, subject to certain limitations. Previously, only joint stock companies (SPAs) could issue debt instruments.

Debt instruments issued by SRLs cannot be offered to the general public and can be subscribed only by professional investors (banks, insurances and financial institutions). If sold to private investors in the secondary market, the seller is liable in the event the buyer fails to make the payments required under the instrument. Seller's secondary liability can be eliminated by way of an agreement between seller and buyer.

The entity's articles or organization or certificate of formation must expressly provide for the possibility that the entity issues debt instruments and confer the power to issue debt instruments either upon the members or the managers, as well as establish the terms of the issuance including the number and amount of the instruments, issuance procedures and voting requirements.

The tax administration in ruling n. 54 clarified that, for tax purposes, debt instruments issued by SRLs are characterized as debt obligations if they satisfy the definition of debt obligation contained in article 44, paragraph 2, letter (c)(2) of the tax code, according to which three tests must be met:

- the instrument is part of a series of transferable instruments issued under same or similar terms pursuant to a single economic transaction;

- the instrument provides for the unconditional reimbursement of an amount that is at least equal to its issue price or face value, with or without payment of interest or other remuneration, and

- the instrument does not confer to the holder any power to control or participate in the management of the issuing enterprise or the transaction pursuant to which it has been issued.

If the three tests are met, the debt instrument is a classified as a debt obligation.

Interest paid under a debt obligation is subject to 12.5 percent withholding tax, provided that the maturity date of the instrument is at least 18 months or longer and the interest rate does not exceed the official discount rate increased by 2/3rd (or 200% is the instruments is regularly traded in a regulated securities market). In all other cases, the withholding tax rate is 27 per cent.

For interest paid to private individuals or foreign investors who hold the instruments outside of a trade or business that is part of an Italian permanent establishment, the 12.5 per cent is a final tax. 

However, for debt obligations held by non resident investors who are resident or organized in certain approved jurisdictions (white-listed countries), interest is totally exempt from tax.

Interest on debt instruments that fail to qualify as debt obligation is subject to the ordinary 27 percent tax rate and is not eligible for the foreign investors exemption.

In the light of the above, for foreign investors the characterization of the instrument as debt obligation is particularly important in order to qualify for the exemption.      

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With Circular 1E of January 26, 2009 (Cir. 1 of Jan 26, 2009.pdf) Italy's tax administration explained that taxpayers must provide a clear evidence of the specific economic interest of a transaction, in order to deduct the costs, losses or expenses arising from transactions with foreign enterprises domiciled in tax haven ("black-listed") jurisdictions. 

Tax Code article 110 provided that "no deductions are allowed for costs and other negative items of income deriving from transactions entered into between a resident enterprise and enterprises with their fiscal domicile in countries or territories not belonging to the European Union, having a privileged tax regime. They are deemed to be privileged the tax regimes of those countries and territories identified with a decree of the Ministry of the Economy and finance to be published on the Official Gazette, in consideration of their level of taxation significantly lower than the level of taxation applied in Italy, or of a lack of exchange of information, or other equivalent criteria".

With the budget law for 2008, the above provisions have been amended and now the non-deductibility rule applies to transactions entered into with enterprises domiciled in countries that are not included in a list of approved countries ("white list"), selected primarily on the basis of the lack of exchange of information with Italy. The "white-list" has still to be approved by the Ministry of Finance.

The non-deduction rule applies also to costs for professional services performed by firms organized in low-tax jurisdictions.  

Deduction is allowed if costs, losses or expenses are separately stated on the tax return and either of two requirements are met: the foreign enterprise primarily carries out a real commercial activity (active trade or business) in its country of domicile, or the transactions fulfills a real economic interest (economic substance) and has been actually executed. The burden of proof is upon the taxpayer, who can apply for an advance ruling that certifies the applicability of either exemption.

The real commercial activity exception requires that the foreign enterprises uses an adequate organization (office, staff) for its trade or business in its country or organization.

With circular 1E, the tax administration clarified that the real economic interest exemption requires a specific evidence of the fact that the particular transaction actually and directly serves the economic interest and purposes of the resident enterprises and is directly related to the enterprise's trade or business.

Proof of general economic substance based on a general connection between a transaction and the enterprise's business, as reflected and confirmed in information, data and experience generally applicable to enterprises in the same line of business is no longer allowed, and ruling n. 127 of June 6, 2003 is revoked.

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The economic crisis measures enacted with Legislative Decree n. 185/2008 include special provisions for big taxpayers. Big taxpayers are defined as companies with annual revenue or receipts equal to or exceeding 300 million EUR, gradually phased down to 100 million EUR through December 31, 2011.

Big taxpayers are subject to automatic audit based on selective lists within one year from the filing of their tax return. The audit automatically extends also to the verification that taxpayers actually complied with the interpretative solutions and advice provided by the tax administration in rulings issued to those taxpayers.

Finally, all requests for a tax ruling will be filed and processed according to the same procedure that applies to the special tax avoidance ruling. The procedure requires that the ruling application be filed with the Regional Department and then passed on the Central Department, which must issue its reply within 120 days from the application. If the ruling is not issued within the 120-day deadline, the taxpayer can file a final reminder and the tax administration has additional 60 days to respond. If the tax administration fails to respond within the extended deadline the position taken by the taxpayer in the application for the ruling is deemed approved. 

The procedure referred to above applies to all three types of rulings currently available under Italian law, namely the ordinary interpretative ruling, the tax-avoidance ruling and the ruling for the exemption from the application of tax-abuse provisions limiting the deductions of costs and expenses incurred in transactions with low-tax jurisdiction enterprises .                  

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With Circular n. 5/E of February 24, 2009, Italy's tax administration clarified the new procedure for the request of tax avoidance rulings.

Taxpayers can apply for a special tax avoidance ruling in order to obtain guidance from the tax administration on specific transactions listed in the tax code that provide tax advantages and are perceived as potentially abusive. The listed transactions include conduit arrangements; tax free mergers, liquidations, change of corporate type, return of capital distributions or transfer of assets or going concerns; transfer of receivables; deductible interest and royalty payments to EU related companies controlled by non EU parents; payments charged between related companies one of which is a controlled foreign company, and costs and deductions arising from transactions with companies organized in low-tax jurisdictions.

The request for the ruling is addressed to the Direzione Centrale Normativa e Contenzioso (Central Department on Rules and Litigation) and filed through the Direzione Regionale (Regional Department). It must provide a detailed summary of the facts and an explanation of the position taken by the taxpayer on the issues of law, together with any relevant documentation relating to the transaction.

The Regional Department checks that the request is complete and in order and passes it on to the Central Department within 15 days from the receipt of the request. The Central Department must issue the ruling within 120 days from the filing of the request. 

In the event the tax administration fails to issue the ruling within the 120-day deadline, the taxpayer can send a final reminder. Failure to issue the ruling within 60 days following the receipt of the final reminder is equivalent to an approval of the position taken by the taxpayer on the relevant issues of law in the request for the ruling. As a result, the period of time for the issuance of the ruling cannot exceed 180 days or six months.

The ruling (or the silent approval of taxpayer's position) is binding for the tax administration (but not for the taxpayer).

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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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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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On December 3, 2008 Italy's tax administration issued ruling n. 470/E, by which it clarified that cross-border mergers between non-EU companies with permanent establishments in Italy can be carried out tax free.

Italian law provides for nonrecognition treatment of mergers between domestic companies, in which all of the assets of the target company are transferred to the acquiring company in a statutory merger, and the target company's shareholders exchange their stock in the target company for stock of the acquiring company. No boot can be exchanged in the transaction. The acquiring company takes a carryover basis in the assets of the target company, and the target company's shareholders get an transferred basis in the stock of the acquiring company received in the transaction.  

The EU directive 90/434/CEE (the mergers directive) provides for a tax deferral treatment of mergers that are carried out between companies resident in two different EU member states. In this case, ten per cent of the consideration can be cash.

In the ruling, the tax administration clarifies that the Tax Code non recognition treatment of domestic mergers can apply also to cross border mergers that fall outside the scope of application of the EU mergers directive.

The ruling is extremely important because it facilitates the possibility to carry out cross-border reorganizations involving Italian assets or Italian companies without immediate recognition of gain.

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