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.
Italian rules on EU cross-border mergers.
Italy implemented the EU merger directive (n. 90/434/CE) with Legislative Decree n. 544 of December 30, 1992.
More recently, Legislative Decree n. 199 of November 7, 2007 implemented the EU directive 2005/19/CE, which amended and extended the EU merger provisions to EU permanent establishments of EU companies. The Italian tax code provisions that incorporate the mergers directives are set forth in articles 178-181.
According to the above provisions, gains and losses realized on the transfer of the assets (including goodwill) of an Italian target company in a merger with an EU acquiring company are not recognized, if after the merger the foreign acquiring company operates through a permanent establishment in Italy to which the assets and liabilities of the Italian target company are attributed. The Italian permanent establishment takes a carryover basis in the assets transferred in the merger and recognition of gain or loss is deferred.
Definition of permanent establishment.
The Italian tax code provides a definition of permanent establishment at article 162. The definition is almost identical to the definition of permanent establishment contained in article 5 of the OECD's Model Tax Convention.
Paragraph 4 of tax code article 162 contain a list of activities that are not permanent establishment, even if they are carried out through a fixed place of business. The list corresponds to that contained in article 5, paragraph 3 of the OECD Model Convention.
Use of a permanent establishment for planning purposes.
A permanent establishment can be used for several planning purposes under Italian law.
Just to mention a few, a permanent establishment is entitled to the tax exemption for dividends and gains from the sale of stock of Italian and foreign companies, and can consolidate other Italian companies under the Italian domestic tax consolidation regime (with offset of profits and losses among the members of the group).
On the contrary, dividends and gain from stock directly owned by a foreign company do not qualify for the participation exemption, and a foreign company cannot consolidate directly-owned Italian subsidiaries.
Interest expenses allocated to a permanent establishment are deductible and can reduce the profits of consolidated Italian subsidiaries owned through that permanent establishment.
Italian permanent establishments may be entitled to tax treaty benefits or to the non discrimination protection of the EC treaty as Italian domestic companies.
If the Italian activities of a foreign taxpayer are not sufficient to create a permanent establishment in Italy within the definition of the tax code (as it is in the case discussed in the ruling), tax benefits can be lost.
Therefore, the actual existence of an Italian permanent establishment is an essential part of the planning strategy.
