Italian Taxation of Collective Investment Vehicles and Treaty Benefits

Posted on November 29, 2010 by Marco Rossi

Mutual funds give investors an opportunity to participate in diversified investment holdings and access to professional managent on the face of a relatively small investment.

The Italian tax treatment of domestic mutual funds is designed to provide portfolio investors with the same tax treatment they would receive if they owned directly the same investments that are held by the fund.

Under Italian law, when an Italian resident individual investor invest in portfolio stocks or bonds she is subject to tax at a preferential rate of 12.5% on the dividends or interest received or gain realized from her investments.

If the investment is carried out through an Italian mutual fund the tax rate of 12.5% is charged upon the fund. The tax is computed on the increase of the net asset value of the fund at the end of the tax year. No tax applies to the investor upon distribution of the income from the fund or redemption of fund shares.

If the investment is carried out through a foreign fund that is established and managed in accordance with the EU rules and regulations ("EU regulated fund"), the 12.5% tax is applied to the Italian investor at the time of the receipt of the income from the fund through distribution or redemption (or sale) of fund shares. 

If the investment is carried out through a foreign unregulated offshore fund, the income from the fund is included in the investor's income tax return when received (through distribution of fund profits or redemption or sale of fund shares) and subject to tax as ordinary income at the investor's marginal rate.

In case of investments in foreign stock and bonds, usually the dividends, interest or gains are subject to withholding tax in the foreign country at source, but the foreign withholding tax rate is reduced or eliminated under the tax treaty in effect between the foreign country and Italy as the investor's country of residence. The Italian resident investor is then subject to tax on the net amount received at the flat rate of 12.5% with no credit for the foreign withholding tax.

The same treaty benefits should apply whenever the same investments are held through a fund. However, the application of treaty benefits in that case may be controversial whenever the investor, by carrying out the investment through the fund, is able to defer the tax on the profit of the fund in her own country of residence or change the character of the income and benefit from the preferential rate that would otherwise not be applicable if she held the investment directly.

As a result, the application of the treaty benefits in case of investment through collective investment funds depends to a great extent upon the way in which the fund and its investors are taxed in the country of organization of the fund or the investors' country of residence. 

In the brief overview of Italian tax treatment of Italian mutual funds and Italian mutual funds investors that we attach herewith (Italian Taxation of CIV and Treaty Benefits.pdf) we would like to offer a background for a possible further discussions of the issue from the perspective on Italian law.       

           

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OECD Issued Report on Granting of Treaty Benefits In Respect of Income of Collective Investment Vehicles

Posted on July 19, 2010 by Marco Rossi

On 31 May 2010 the OECD Committee on Fiscal Affairs released a Report on “The Granting of Treaty Benefits with respect to the Income of Collective Investment Vehicles”. The Report contains  proposed changes to the Commentary on the OECD Model Tax Convention dealing with the question of the extent to which either collective investment vehicles (CIVs) or their investors are entitled to treaty benefits on income received by the CIVs. These changes are expected to be included in the 2010 Update to the Model Tax Convention (the draft contents of which were released on 21 May 2010) and the Report would then be included in volume II of the loose-leaf and electronic versions of the Model.
 

The Report is a modified version of the Report “Granting of Treaty Benefits with respect to the Income of Collective Investment Vehicles” of the Informal Consultative Group on the Taxation of Collective Investment Vehicles and Procedures for Tax Relief for Cross-Border Investors (“ICG”) which was released on 12 January 2009. In that original Report, the ICG addressed the legal and policy issues specific to CIVs and formulated a comprehensive set of recommendations addressing the issues presented by CIVs in the cross-border context.  The Committee referred the recommendations by the ICG to its Working Party 1 (“WP1”) on Tax Conventions and Related Questions (the Committee’s subsidiary body responsible for changes to the OECD Model Tax Convention) for further consideration. The WP1 Report was issued as a discussion draft on 9 December 2009 and modified in response to public comments.
 
The main conclusions and recommendations of the Report are similar to those in the ICG Report, with some modifications that reflect the varied experiences of the tax authorities of the OECD countries. Like the ICG Report, the Report therefore analyses the technical questions of whether a CIV should be considered a “person”, a “resident of a Contracting State” and the “beneficial owner” of the income it receives under treaties that, like the OECD Model Tax Convention, do not include a specific provision dealing with CIVs (i.e. the vast majority of existing treaties). Further, the Report includes changes to the Commentary on the Model Tax Convention to reflect the conclusions of the Committee with respect to these issues.
 
Although these changes to the Commentary will clarify the treatment of CIVs, it is clear that at least some forms of CIVs in some countries will not meet the requirements to claim treaty benefits on their own behalf. Accordingly, the Report also considers the appropriate treatment of such CIVs under both existing treaties and future treaties.
 
With respect to existing treaties, the Report concludes that, if a CIV is not entitled to claim benefits in its own right, its investors should in principle be able to claim treaty benefits. The Report reflects different views regarding whether such a right should be limited to investors who are residents of the Contracting State in which the CIV is organised, or whether that right should be extended to treaty-eligible residents of third States. In any event, administrative difficulties in many cases effectively prevent individual claims by investors. Accordingly, the Report concludes that countries should adopt procedures to allow a CIV to make the claim on behalf of investors.
 
With respect to future treaties, the Report endorses the ICG recommendation that  the Commentary on Article 1 of the Model Tax Convention should be expanded to include a number of optional provisions for countries to consider in their future treaty negotiations. Inclusion of one or more of these provisions in bilateral treaties would provide certainty to CIVs, investors and intermediaries. The favoured approach for such a provision would treat a CIV as a resident of a Contracting State and the beneficial owner of its income, at least to the extent that its investors would themselves be eligible for benefits from the source country, rather than adopting a full look-through approach. Because different views were expressed on the issue of whether treaty-eligible residents of third countries should be taken into account in determining the extent to which the income of a CIV should be entitled to treaty benefits, the proposed Commentary includes alternative provisions that adopt different approaches with respect to the treatment of treaty-eligible residents of third countries. The proposed Commentary also includes an alternative provision that would adopt a full look-through approach, under which the CIV would make claims on behalf of its investors rather than in its own name. The look-through approach would be appropriate in cases where the investors, such as pension funds, would have been eligible for a lower, or zero, rate of withholding had they invested directly in the underlying securities.
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