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

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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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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