Application of Tax Treaties To Fiscally Transparent Entities: US-Italy Perspective

The application of tax treaties to fiscally transparent entities is controversial. Two requirements for the application of the benefits of a tax treaty (that is, the elimination or reduction of the source country tax on payments made by a person resident in one Contracting State, to a person resident in the other Contracting Sate) are that the person receiving the payment is a "resident" of the other contracting state, and the "beneficial owner" of the payment.

Residence is usually defined in tax treaties (typically, under article 4, paragraph 1), as requiring that a person be "liable to tax" in the other Contracting States, by reason of his residence, domicile, place of management, place of incorporation or other criterion of a similar nature (article 4, paragraph 1).

According to the OECD, whenever an entity is treated as fiscally transparent in a State, the entity is not "liable to tax" in that State, within the meaning of article 4, paragraph 1, and so it cannot be a resident thereof for purposes of a treaty. In such case, the entity's partners or owners should be entitled to the benefits of the treaty entered into by the State of which they are residents, with respect to their share of the income of the entity, to the extent that the entity's income is allocated to them under the tax laws of their State of residence (see OECD Commentary to the Model Tax Convention, on Article 1, paragraph 5).

The current Tax Treaty between Italy and the United States adopts a slightly different approach and assigns tax residency to a an entity that is treated as fiscally transparent entity in the United States, for the purposes of the treaty, to the extent that the entity's income is taxed in the U.S in the hands of its parents or beneficiaries. In fact, Article 4, paragraph 1, letter b) of the Convention, with reference to partnerships, estates and trusts, provides that in the case of income derived or paid by a partnership, estate of trust, this term applies only to the extent that the income derived by such partnership, estate or trust is subject to tax in that State, either in its hands or in the hands of its partners or beneficiaries”. Article 1, paragraph 5, letter d) of the Protocol extends the same provision to fiscally transparent entities, by providing that d) The provisions of subparagraph 1(b) of Article 4 (Resident) of the Convention shall apply to determine the residence of an entity that is treated as fiscally transparent under the laws of either Contracting State.

Under the provisions referred to here above, a U.S. entity that is treated as fiscally transparent under US tax laws, receiving dividends from an Italian subsidiary, should be entitled to the 5% withholding tax on inter company dividends, provided that it satisfies the other requirement (minimum 25% ownership for a period of at least 12 months at the time of the payment of the dividends). For that purpose, the documentation provided to the Italian subsidiary must include tax certificates for both the entity and it shareholders or beneficiaries, providing that the shareholders or beneficiaries US residents and are taxed on the entity's income in the United States.    

As for the second requirement, the term "beneficial owner" is generally not defined in tax treaties. However, the 2014 Update to the OECD Model Tax Convention issued by OECD the Committee on Fiscal Affairs on June 26, 2014 clarifies the meaning of beneficial owner as requiring that a person have "the right to use and enjoy" the income, "unconstrained by a contractual or legal obligation to pass on the payment received to another person". Sometimes, the term is interpreted as meaning that the beneficial owner is the person to whom the income is attributed for tax purposes under the tax laws of a Contracting State. 

The EU Directive 2003/49/EC of June 3, 2003 provides a definition of the term “beneficial owner” for the purposes of the withholding tax exemption of interest and royalties paid to a EU parent or affiliate corporation, according to which “A company of a Member State shall be treated as the “beneficial owner” of interest or royalties only if it receives those payments for its own benefit and not as an intermediary, such as an agent, trustee or authorized signatory, for some other person”. Circular 47/E of November 2, 2005, which at paragraph 2.3.2 clarifies that in order for a company to be considered the beneficial owner of the interest or royalties, “it is necessary that the company receives the payment as the ultimate beneficiary, not as an intermediary such as an agent, a fiduciary, or collector of the payment for another person, … and that the company receiving the interest or royalties derives a direct personal economic benefit from the income from the transaction”.

Clearly, the tax treatment of an entity in its country of organization is key to determine whether the entity, or its shareholders, partners or members, are entitled to the benefits of a treaty with respect to a parent made by a resident of the other Contracting State. The residence and beneficial owner requirements, whose meaning is not entirely free from doubt, and depends on the facts and circumstances of the particular case, call for extensive analysis of the tax classification and treatment of the entity and its owners, under the laws of their country or organization or asserted residence, as well as the organizational structure, role and functions of the entity receiving the payment. Under that scenario, the payer of the income bearing withholding agent obligations is usually under pressure, and must make sure that the documentation provided by the payee establishes with sufficient certainty the payee's eligibility for treaty benefit.               

 

 

 

  

   

Italy's Tax Residency for Foreign Investors

Italy's tax residency for foreign taxpayers buying Italian real estate, and spending significant time in Italy for pleasure or business continues being a very critical and challenging issue. Italy assigns tax residency of individuals based on residence, which means fixed place of living ; domicile, which means main center of interests, or registration on the list of Italian resident individuals for administrative purposes. Whenever one of the three tests is met for more than 183 days in any given year, an individual is resident of Italy for Italian tax purposes for that particular year. Italian tax residency triggers worldwide income taxation and obligation to report worldwide financial and non financial assets to Italian tax authorities on taxpayer's Italian income tax return. 

In case of tax residency under the internal laws of Italy and another treaty country, Italy applies the tie breaker provisions of article 4 of the tax treaty to resolve the double residency problem, which assign tax residency based on the location of of permanent home, center of vital interests, habitual abode or nationality. The treaty "center of vital interests" test requires a comparative analysis of the taxpayer's contacts or ties in Italy and the other treaty country. According to one view, personal and family ties should prevail, while another interpretation gives relative weight to economic and business interests.

A recent decision of Italy's Supreme Court, which we comment here, seems to support the second interpretation. Proof of business and economic interests abroad while living or spending significant time in Italy for personal pleasure may help taxpayer demonstrate that that she kept her center of vital interest and tax residency in her own country.

This area of Italian international tax law is in flux and needs attention. Foreign taxpayers who transfer money to Italy to purchase homes, spend regular time there, register their administrative residency in Italy at their Italian address for convenience, open Italian bank accounts to handle the funds needed to manage their Italian house and living expenses are under the radar screen on Italian tax authorities, which check the real estate database, receive automatic information about the cross border transfers of the funds and often send inquiry letters asking for explanations on the taxpayer tax position in Italy in the absence of past filed Italian income tax returns.                

Such inquiries and related audits requires careful consideration, including the provision of carefully selected and explained tax documents and information, to avoid the risk of an Italian tax residency determination that would trigger far reaching and very troubling consequences.  
       

Interview with MQR&A on Italian financial newspaper Italia Oggi

Imprese italiane con clienti e contratti negli USA: rischi e potenziali oneri fiscali

Riteniamo utile segnalare una serie di situazioni che stiamo seguendo sempre più frequentemente per conto dei nostri clienti. Le imprese italiane che vendono beni e servizi a clienti americani devono porre particolare attenzione agli eventuali obblighi e oneri fiscali cui potrebbero essere soggette negli USA, anche quando non hanno una società controllata, filiale o sede secondaria sul territorio degli Stati Uniti. Infatti, salvo i casi di pura esportazione di beni senza alcun ulteriore contatto con gli USA, è altamente probabile che vi siano situazioni tali da generare tali oneri e che eventuali distrazioni possono anche essere costose.    

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