The Italian Desk of Ernst & Young in New York has published comments on the new US-Italy Tax Treaty. The new Treaty entered to force with the exchange of instruments of ratification on December 17, 2010.
The pending 1999 U.S.-Italy Tax Treaty entered into force on December 16, 2009, when Italy and the United States exchanged the instruments of ratification.
The new U.S.-Italy Tax Treaty (PDF) is effective from February 1, 2009, for income subject to withholding tax and from January 1 2010, for all other provisions of the treaty.
The 1999 U.S.-Italy Tax Treaty remained pending for ten years due to certain general anti abuse provisions for the application of the reduced withholding tax rates on dividends interest and royalties, and some other issues concerning the exchange of information provision of the treaty and the arbitration procedure to resolve treaty disputes. Italy waived the anti abuse provisions by means of the exchange of diplomatic notes in April 2006 and February 2007 and ratified the treaty in April 2009.
The new treaty includes provision on the creditability in the United States of the Italian Regional Tax on Production Activities (IRAP), the application of the US branch profits tax and new withholding tax rates on dividends, interest and royalties, plus a limitation of benefits provision in the protocol.
The new withholding tax rates are 5 percent for inter-company dividends (namely, dividends paid to a company which owned at least 25 percent of the stock of the distributing company for more than twelve months), 10 percent on interest and zero percent on royalties from copyrights.
The OECD Committee on Fiscal Affairs has released as a discussion draft a Report on “The Granting of Treaty Benefits with respect to the Income of Collective Investment Vehicles”(PDF) which 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. The Report is a modified version of the Report “Granting of Treaty Benefits with respect to the Income of Collective Investment Vehicles” (PDF) 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 Report by WP1 which the Committee has now released as a discussion draft is the result of the subsequent work on these recommendations. 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 WP1 delegates. Like the ICG Report, the WP1 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 proposed changes to the Commentary on the Model Tax Convention to reflect the conclusions of the Working Party with respect to these issues.
Although these proposed 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 in both the ICG and WP1 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.
The Committee invites interested parties to send their comments on this discussion draft before 31 January 2010. Comments should be sent electronically (in Word format) to jeffrey.owens@oecd.org.
The Italian parliament on March 3, 2009 enacted law n. 20 which authorizes the ratification of the new U.S.-Italy tax treaty signed in 1999.
Law n. 20 of March 3, 2009 was published on the Official Gazette on March 18, 2009 and is now into force. The U.S. had ratified the treaty on December 28, 1999.
The new treaty will enter into force at the time of the exchange of the instruments of ratification. It will apply and take effect for taxable periods beginning on or after January 1, 2010 and for withholding taxes on payments made or accrued on or after the first day of the second month following the date of entry into force. A grandfathering provision allows a taxpayer to elect for the application of the old treaty for a period of 12 months following the entry into force of the new treaty, should the old treaty result in a better treatment.
The new treaty reduces the withholding tax rates on dividends, interest and royalties; authorizes the collection of a dividend equivalent tax on the repatriated profits of a branch, includes a provision limiting the benefits of the treaty to certain qualified residents of the other contracting state, addresses the creditability in the U.S. of the Italian regional tax on production activities, and provides that the competent authorities of the two contracting states may agree to refer a case to special arbitration procedure if they fail to reach an agreement within two years of the date on which the case was referred to one of them.
Background
The current U.S.-Italy tax treaty entered into force on December 30, 1985. On August 25, 1999 Italy and the U.S. signed a new treaty and protocol (the "1999 Treaty"). On November 5, 1999 the U.S. Senate consented to the ratification of the 1999 Treaty, subject to a reservation and understanding.
The reservation required the elimination of following language which appears as the final paragraph of the withholding tax provisions of articles 10 (Dividends), 11 (Interest), 12 (Royalties) and 22 (Other Income):
"The provisions of this Article shall not apply if it was the main purpose or one of the main purposes of any person concerned with the creation of assignment of the" (respectively, shares or other rights; debt claim, rights, and rights) "in respect of which the" (respectively, dividend, interest, royalties and income) "is" (are) "paid is to take advantage of this Article by means of that creation or assignment".
That language established the so-called main purpose tests aimed at tackling possible abuses of the treaty or treaty shopping arrangements.
The understanding concerned the exchange of information provision of Article 26, which, according to the U.S. Senate, should grant to the competent authorities of the two contracting states the authority to obtain or provide information held by financial institutions, nominees, or persons acting in an agent or fiduciary capacity, or respecting interests in a person.
President Clinton signed the U.S. instrument of ratification on December 28, 1999, subject to the above mentioned reservation and understanding. The reservation required approval from the Italian government, which held the ratification process in stand by.
The 2006-2007 Exchange of Diplomatic Notes
By way of diplomatic note n. 291 of April 10, 2006, the Embassy of the United States of America reiterated the above-mentioned conditions to the ratification of the 1999 Treaty.
The Italian Minister of Foreign Affairs issued a note on February 27, 2007 by means of which it formally agreed with the reservation requiring the deletion of the main purpose tests and the understanding on exchange of information.
That step eventually paved the way to the final ratification of the new treaty.
The Italian Law Authorizing the Ratification of the Treaty
Eventually, the Italian Parliament enacted law n. 20 of March 3, 2009 which authorizes the Italian Minister of Foreign Affairs to exchange the instrument of ratification of the new treaty.
Effective Dates and Grandfathering Provision
The 1999 Treaty enters into force on the date on which the instruments of ratification are exchanged.
In general, the 1999 Treaty shall apply to taxable years beginning on or after the the first day of the year in which it entered into force. Therefore, if the instruments of ratification are exchanged in 2009, the Treaty shall take effect for taxable years beginning on or after January 1, 2010.
In the case of withholding taxes at source, the 1999 Treaty shall apply to payments made or accrued on or after the first day of the second month following its entry into force. Therefore, if instruments of ratification are exchanged on March 24, 2009 the Treaty shall apply to withholding taxes due on or after May 1, 2009.
A grandfathering provision allows a taxpayer, for a period of 12 months following the entry into force of the 1999 Treaty, to elect for the application of the 1985 Treaty should it provide a more favorable tax treatment.
Highlights of the New Treaty
Under the 1999 Treaty, the withholding rates on dividends are 5 percent for inter-company dividends (that is, dividends paid to a person owning at least 25 percent of voting shares of the payer for at least 12 months as of the time of the declaration of the dividends) and 15 percent for portfolio dividends. Dividends paid by a US RIC are subject to 15 percent withholding. Dividends paid by a US REIT may be subject to 15 percent withholding only if specific requirements are met.
The withholding rate on interest is reduced to 10 percent.
Royalties for patents and software are subject to a 5 percent withholding and all other royalties are subject to 8 percent withholding rate.
The 1999 Treaty authorizes the application of a branch profits tax. Italy does not have a branch profits tax. However, all Italian companies operating in the U.S. through a branch shall be subject to the U.S. branch profits tax.
Article 23 of the 1999 Treaty (Elimination of Double Taxation) contains specific provisions for the computation of the amount of the foreign tax credit in the U.S. for Italian regional tax on production activities (IRAP) paid to Italy.
Article 2, paragraphs 1-5 of the Protocol to the 1999 Treaty contains the new limitation of benefits provisions of the treaty.
A Memorandum of Understanding signed with respect to article 25 of the 1999 Treaty (Mutual Agreement Procedure) provides that the competent authorities may agree to invoke arbitration in a specific case, if they fail to reach and agreement within two years of the date on which a case was submitted to one of them. The Memorandum of Understanding sets forth the main aspects of the arbitration procedure and refers to the EU Convention on Arbitration Proceeding in transfer pricing matters and the US tax treaty with Germany.
The 1999 Treaty also contains specific provisions on application of treaty benefits to income derived or paid by partnerships or other fiscally transparent entities.
The Italian Supreme Court issued an important decision concerning the application of tax treaty benefits to partnerships.
The judgment (n. 4600 of 2009) will be deposited soon and we will publish it with additional comments as soon as it is available.
Under the facts of the case, a US Limited partnership received the payment of a dividend from an Italian company. A Japanese fund, member of the US limited partnership, claimed the reduction of the Italian withholding tax on the dividend pursuant to the Italy-Japan tax treaty. The Italian dividend withholding tax rate is 27 percent. The Italy-Japan treaty reduces it to 10 percent for inter-company dividends (paid to shareholders owning at least 25 percent of voting shares of the payer) and to 15 percent for portfolio dividends.
Italy's tax administration rejected the treaty claim on the ground that the Japanese fund is not the legal recipient of the dividend. The treaty grants the benefits if "the recipient" of the dividend is a company that qualifies to treaty benefits.
In the case at hand, the US LP, which was the recipient of the dividend, was transparent and did not qualify for treaty benefits under the US-Italy treaty, while the Japanese fund was the final economic owner but not the legal recipient of the dividend.
The Court accepted the position of the tax administration and observed that other Italian treaties, granting treaty benefits to a treaty partner who is the beneficial owner of the dividend, would command a different result.
MARCO Q. ROSSI & ASSOCIATI is an international tax boutique law firm with offices in New York and Italy, offering EU and Italian legal advice and planning to foreign individuals living, working or investing in Italy and the EU and foreign companies doing business in or with Italy and the EU.
The firm's services include:
Marco Rossi is the founder of the firm and is based in New York. He can be reached at 212-918-4875 or 646-764-1095 or by e-mail at mrossi@lawrossi.com
My name is MARCO ROSSI and I am an international lawyer specialized in EU and Italian international tax law for foreign individuals and companies investing or doing business in Italy and the EU.
I am based in New York and have offices in Italy (Genoa and Milan).
My law firm, Marco Q. Rossi & Associati, is an international tax boutique serving individuals, private companies, institutional clients and investing firms involved in transactions connected with Italy and the EU.
I focus on providing advice on the international tax issues and planning of cross border transactions and investments in Italy and the EU.
On December 19, 2008 I launched the EU AND ITALIAN INTERNATIONAL TAX LAW BLOG, which provides up to date information and comments on the latest developments in EU tax law and Italian international taxation for foreign investors in Italy and the EU.
The blog includes news on EU tax legislation and the most recent decision of the European Court of Justice in the area of direct taxes, which profoundly affect the way in which EU member states enact and administer their tax systems and investors plan their investments and business throughout the EU. It also reports on developments in Italian international tax law in the areas of income tax, VAT and other indirect taxes that affect foreign individuals or companies investing or doing business in Italy.
I will work to make sure that the blog will be the primary resource for foreign individuals, companies, law firms, tax counsels, CFO's and tax executives interested in staying up to date with the latest developments in the areas of EU tax law and Italian international taxation affecting their investments or clients.
The blog will be also a forum for discussion on EU and Italian tax issues of interest for colleagues and clients and your comments, inquiries and feedback will be greatly appreciated.
I look forward to speaking with you in the future.
MARCO ROSSI started practicing law in Italy in the early 1990s, when he worked for a local law firm assisting American and foreign clients and acting as Italian correspondent for U.S. and foreign law firms.
He set up his own practice in Italy 1998 and established its U.S. office in New York as Marco Q. Rossi & Associati in 2005.
Mr. Rossi publishes articles on international tax issues both in Italy and U.S. and is correspondent for Tax Analysts for Italy and the E.U. He has been a speaker and panelist on various international tax matters before professional groups including American Bar Association, International Fiscal Association, International Bas Association, California State Bar and Texas State Bar.
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