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.
With Law n. 102 of August 3, 2009 Italy amended its controlled foreign companies rules (CFC rules) in several important respects. As a result of the changes, deferral of Italian tax on foreign income will be much more challenging.
In general, Italian CFC rules apply to controlled or connected foreign companies established in low tax jurisdictions listed in a ministerial decree (so called black list). A controlled or connected foreign company is a foreign company in which Italian shareholders (individuals or companies) own more than 50% of the voting stock or a sufficient share of voting stock to exercise a significant level of control over the company. If the above conditions are met, the Italian shareholders are taxed currently on their share of the profits of the CFC (adjusted under Italian law).
The first two changes concern the active trade or business exception to the rules. Formerly, the CFC rules would not apply if the CFC was engaged in a real industrial or commercial activity in the country in which it was established. For this purposes, as clarified by the tax administration in several rulings on this issue, the CFC should have a sufficient organization in the foreign country of establishment, including premises, equipment and personnel, as required for the effective conduct of its trade or business. The economic location of the business of the CFC was not relevant. Therefore, a trading company organized in the British Virgin island, with a sufficient organization (office, personnel, telephone lines), which purchased goods from the Italian parent and sold them to customers around the world, was not subject to the CFC rules.
Under the new rules, for the exception to apply it is necessary that the economic activity of the CFC is carried out in the local market of the country in which the CFC is established. Therefore, there must be a direct connection between the business of the CFC and the local economy or market of the country in which the CFC is organized. In the former example, if the CFC sells its goods primarily to customers located in the country in which it is organized, the exception would apply.
Pursuant to the second change, the active trade or business exception will not apply to companies more than 50 percent of whose income is passive income. For this purpose, passive income includes dividends, interest, capital gains, royalties and income from intra group services (that is, services provided to affiliated entities).
The third change extends the application of the CFC rules to foreign companies that are not established in black listed jurisdictions, when two tests are met: (1) the foreign company is subject to an effective tax in its country of residence which is less than 50 percent of the Italian tax that would apply on its profits, and (2) more than 50 percent of the profits of the foreign company are passive income. For this purpose, passive income includes dividends, interest, capital gains, royalties or income from services to affiliated companies. For the tax test, reference is made to the effective foreign income tax rate that applies on the foreign company's profits, compared to the Italian rate. The provision extending the application of the CFC rules to companies organized in non-black listed countries under the above circumstances does not apply if the taxpayer can prove that the foreign company is not a wholly artificially arrangement designed to obtain a reduction in taxes.
The changes to the CFC rules are going to severely impact the planning structures of many Italian companies. In particular, holding companies in the EU controlled by Italian shareholders are now CFC subject to CFC rules, and their income (dividends and stock gains from operating subsidiaries) is potentially subject to full taxation upon the holding company's Italian shareholders in Italy.
The new rules are effective for tax years beginning on or after January 1, 2010.