In 2015, Italy enacted a special tax regime for high skilled workers who move to Italy to work there for an Italian employer, on assignment to an Italian affiliate of a foreign multinational, or on their own as independent consultants and service providers. Eligible taxpayers (who include Italian citizens, and foreign nationals who are citizens of a country with a tax or exchange of information treaty with Italy) must not have been Italian tax residents at any time during the five years prior to their relocation to Italy, must establish and maintain their tax residence in Italy for at least two years, must own a higher degree or perform managerial or high skill functions, and must work primarily (that is, more than 183 days) in Italy. The 50 percent taxable income deduction is limited to a period of five years and does to apply to other income, not arising from employment or performance personal services.

We reported previously about the special tax regime for foreign high skilled workers in a post issued on July 14, 2018, to which we refer for more details.

The draft legislative decree with urgent measures for economic growth put forward by the Italian Government a few days ago, and referred to as the Growth Decree, would enhance the special tax regime for foreign high skilled workers in many significant respects, including the following:

– eligible taxpayers would include foreign entrepreneurs who move to Italy to carry out a trade or business;
– the taxable income exemption (extended to business income) would increase from 50 to 70 percent, and up to 90 percent for taxpayers who establish their residence in the Italian southern regions,
– the tax exemption period would be extended for additional 5 years, with a 50 percent tax exemption, for taxpayers who, in the 12 months before, or at any time during the first five years after, establishing their residence in Italy, have purchased a residential real property in Italy,
– the tax exemption would also be extended for additional 5 years, with a 50 percent tax exemption for taxpayers with at least one, or 90 percent tax exemption for taxpayers with at least three, minor dependents in Italy claimed on their income tax return.

The special tax regime for high skilled people working or doing business in Italy, coupled with the simplified and visa free procedure for the assignment of foreign personnel to Italian affiliates of foreign-based enterprises, appears to be very attractive, and coupled with the special forfait tax regime for hight net worth individuals and the new 7 percent flat rate tax regime for foreign retirees, makes Italy a very attractive jurisdiction for globally-minded people, entrepreneurs and investors and for foreign multinational groups interested in expanding their business and workforce in Italy.

The legislative process for the draft decree to be become law requires the approval of the Government, and the final passage into law by the Parliament.

With its ruling n. 25219 of October 11, 2018, the Italian Supreme Court held that the capital gain realized by a German company from the sale of its shares of stock of an Italian company is exempt from corporate income tax in Italy, pursuant to Article 13, paragraph 4 of the Tax Treaty between Italy and Germany, except in the case the German holding company has engaged in tax evasion by way of abuse of the Treaty.

Law

Under articles 23 and 151 of the Italian Tax Code, the gain from the sale of stock of an Italian company is Italian source income, and is subject to corporate income tax in Italy to the foreign corporate seller.

However, Article 13, paragraph 4 of the Tax Treaty between Germany and Italy exempts such gain from tax, and allocates the power to tax the gain to the contracting State of which the seller is a resident.

Facts

A German company owning all of the stock of an Italian company sold the stock and realized a gain. Pursuant to an exchange of information request to the German tax authority, the Italian tax agency ascertained that the gain had not been reported on the German company’s financial statement or corporate tax return in Germany and had not been subject to tax there. As a consequence, in the absence of any actual double taxation, the Italian tax agency asserted a tax on the gain due in Italy. The Tax Court in the first instance and the Appellate Court on appeal ruled in favor of the Tax Agency.

Supreme Court’s Holding

Based on the ruling, the fact that the German company is a resident of Germany and qualifies for the benefits of the German-Italy Tax Treaty is not in dispute. According to the Court, the absence of tax on the gain in Germany does not, in and on itself, and without further evidence of abuse, authorize Italy to apply its own tax, considering that the German-Italy Tax Treaty (at paragraphed 4 of Article 13) reserves the taxing power on the gain to the country of residence of the seller.

However, the Court added that the conclusion might be different (and Italy may have a case in asserting its own taxing power on the gain) if, pursuant also to the exchange of information between the taxing authorities of the two Contracting States, it appears that the German company is an artificial arrangement that engaged in tax evasion by abusing the benefits of the Treaty.

Unfortunately, the ruling is extremely brief and does not provide any further detail. Most likely, the Italian Tax Agency did not advance the tax evasion or treaty abuse argument and based its claim solely on the absence of double taxation due to the non taxation of the gain in Germany.

Conclusion

A reasonable takeaway from the ruling is that the exemption of the gain from tax in the country of residence is not sufficient to prevent the application of the Treaty and allow the taxation of the income in the country of source (Italy), unless the stock holding company in the country of residence is abusive and set up solely for the purpose of getting the benefit of the tax exemption under the Treaty.

The ruling is not entirely consistent with two other rulings from the Supreme Court, which – in a different legal context – held that the withholding tax exemption for EU inter company dividends does not apply when the dividends are not tax in the country of residence of the recipient.

With its ruling n. 32255 issued on December 13, 2018 (“Ruling 32255”), the Italian Supreme Court, Fifth Department (Tax) held that a dividend paid by an Italian subsidiary to a parent company established in a EU Member State is not eligible for the dividend withholding tax exemption granted under the provisions of Directive 90/435/EC (the “EU Parent Subsidiary Directive”, transposed into Italian domestic tax law by way of article 27-bis of Italy’s Presidential Decree n. 600 of September 29, 1973), unless the dividend is actually subject to corporate income tax in the parent company’s home country.

Ruling n. 32255 is consistent with a previous decision of the Supreme Court (n. 25264 of October 25, 2017), which we commented on this blog.

By requiring that the dividend is actuality taxed in the parent company’s home country, Ruling 32255 adds a requirement for the application of the dividend withholding tax exemption (the “double taxation requirement”), which is not part of the literal language of the EU Parent Subsidiary Directive, and – especially if adopted by national tax courts in other jurisdictions – may have far reaching implications on taxation of EU cross-border dividends.

Summary of the Law

Under Italian domestic tax law (article 27 of presidential decree n. 600 of September 29, 1973), outbound dividends are subject to withholding tax at the rate of 27 percent. The withholding tax can be reduced pursuant to a tax treaty between Italy and the recipient the dividend (provided that all treaty’s requirements for the withholding tax relief are satisfied).

However, outbound dividends are exempt from the 27 percent withholding tax, under the EU Parent Subsidiary Directive, provided that certain requirements are met, namely, that the recipient of the dividend, at the time the dividend is declared, is an entity that:

(i) is organized in one of the forms specifically set forth in an Annex to the Directive (the “legal form requirement”),

(ii) is resident of a EU Member State, under the domestic tax laws of that State, and is not treated as a nonresident entity pursuant to a tax treaty between that State and any third (non-EU) country (the “tax residency requirement”),

(iii) is subject to corporate income tax, in its own jurisdiction, and does not benefit from a general tax exemption or tax exclusion regime which is not geographically or temporarily limited (the “subject to tax requirement”), and

(iv) has been owning, directly and for an interrupted period of at least one year, 10 percent (15 percent, prior to 1/1/2009, or 20 percent prior to 1/1/2007) or more of the stock of the company that distributes the dividends (the “stock ownership requirement”).

Under the provision of article 27, paragraph 3-ter of the Presidential Decree n. 600 of September 29, 1973, dividends paid to a company which does not qualify for the exemption under the EU Parent Subsidiary Directive, but:

(i) is organized in the form of a corporation or other equivalent legal form,

(ii) is resident in a EU Member State, and

(iii) is subject to corporate income tax in its State of residence,

are subject to a reduced withholding tax of 1.20 percent. The reduced withholding tax rate is aimed at equating the taxation of outbound dividends to that of domestic inter company dividends, whereby dividends are not subject to withholding and are partially exempt, under Italy’s participation exemption regime, resulting in an effective tax rate of 1.20% in the hands of the corporate shareholder (in compliance with the non discrimination principle and free movement of capital provision of the EC Treaty).

Facts of the Case

Under the facts of the case, an Italian corporation paid a dividend to its Luxemburg parent, charging a 27 percent withholding tax of euro 1,059,921.45 upon distribution. The Luxemburg company filed a claim for refund of the withholding tax with the Italian tax agency, pursuant to the EU Parent Subsidiary Directive’s withholding tax exemption. The Italian tax agency failed to respond within the statutory deadline (90 days). Under the applicable statute, the lack of timely response to the refund claim which is treated as a deemed rejection of the claim. As a result, the Luxembourg company filed a petition with the tax court, challenging the rejection of the refund claim. The tax court ruled in favor of the taxpayer. The tax agency appealed, and the regional (appellate) tax court ruled in favor of the tax agency, reversing the trial court judgement and validating the withholding tax. The Luxembourg company then filed a petition with the Supreme Court.

Analysis

In light of the reasoning of the Supreme Court’s judgement, it is apparent that the Luxemburg company satisfied all the statutory requirements for the withholding tax exemption under the EU Parent Subsidiary Directive. Specifically, it parers to be stipulated (or undisputed) that the Luxembourg company is a corporation resident in Luxembourg and subject to corporate income tax there.

However, the Supreme Court held that the dividend withholding tax exemption cannot apply, because the Luxembourg company benefitted from a dividend tax exemption under a participation exemption regime provided for under Luxemburg law. According to the Supreme Court, the fact that the Luxemburg company is a taxable entity and is subject to Luxemburg corporate income tax does alter that conclusion, because the exemption from tax on the dividends in Luxemburg is sufficient to avoid any double taxation of the dividends which would otherwise result from the application of the Italian withholding tax.

The Supreme Court argues that the ratio of the EU Directive’s dividend withholding tax exemption is that of preventing a double taxation of the dividends (first, by way of a withholding tax charged in the country of source, at the time of the distribution of the dividends, and then by way of the income tax charged in the shareholder’s country of residence upon receipt of the dividends). According to the Court, when there is no double taxation of the dividends as a result of the dividend exemption in the shareholder’s country of residence, the withholding exemption has no reason to apply, considering that the Directive’s withholding exemption cannot result in a double non taxation of the dividends.

The Supreme Court does not directly discuss the meaning of the term “subject to tax” used in the EU Parent Subsidiary Directive. That term, in the Directive, is used in reference to the recipient of the dividend, which must be a taxable entity liable to tax in its country of residence. Generally, two alternative interpretations of the term have been debated, one interpretation requiring that the entity itself be “liable to tax”, that is, be classified as a taxable entity and falling within the scope of a corporate income tax, in its own jurisdiction (regardless of the fact that it actually pays a tax, on the income it receives and for which it claims a tax relief), and another interpretation requiring that the entity be “subject to tax”, that is, it actually pay a tax, on the specific item of income it receives and for which the tax relief is claimed.

Rather, the Court seems to inject an additional, overarching requirement for the application of the Directive’s dividend withholding exemption, namely, that the dividend be subject to double taxation (in the country of source and in the country of residence), while exemption should not apply when it would result in a double non taxation of the dividend.

Previous Case Law

Ruling 32255 is directly in line with The Italian Supreme Court’s ruling n. 25264 of October 25, 2017, also from the Fifth Department (Tax), in which the Supreme Court held that the actual payment of the corporate income tax in the parent company’s home jurisdiction is required for the parent company to benefit from the dividend withholding tax relief under the EU Parent Subsidiary Directive, and that no exemption applies to a dividend paid by an Italian company to its Dutch parent which benefits from a participation exemption regime resulting in the exemption of the dividend from corporate income tax in the Netherlands.

Possible Developments and Open Questions

The Italian Supreme Court did not discuss the possible application of the reduced 1.20 percent withholding tax. Indeed, the dividend in question was distributed in 2003, prior to the enactment of the reduced withholding tax rate. As discussed in the summary of the law paragraph, above, also for the purpose of the application of the reduced withholding tax rate, it is required that the corporate recipient be subject to corporate income tax in its EU Member State of residence (indeed, the language of the statute, on that particular requirement is very similar to – and drawn from – the language of the Directive). The reduced withholding rate is aimed at equating the Italian taxation of an outbound dividend to the taxation of a domestic dividend, whereby the company which receives the dividend is exempt on 95 percent of the amount of the dividend, and is taxed on 5 percent of the amount of the dividend, at the corporate tax rate of 24 percent, resulting in an effective tax rate of 1.2 percent. It is not clear whether the Court would reach a similar conclusion, under similar facts, when the issue is that of the application of the reduced withholding tax.

Another legitimate question is whether the Court would reach the same conclusion, with respect to the application of the Directive’s full exemption, when the EU parent company is at least partially taxed on the dividend, under a partial exemption regime.

Furthermore, it is interesting to see whether the Italian Supreme Court’s novel interpretation of the EU Parent Subsidiary Directive, as requiring a double taxation of the dividend for the withholding exemption to apply, is followed by other courts, in other EU jurisdictions, leading to more far reaching challenges to the tax treatment of inter company dividends throughout the EU, and further challenging tax planning structures for EU inbound investments, based on the use of EU holding companies located in favorable taxing jurisdictions.

Finally, readers should note that Italian Supreme Court’s decisions are not binding precedents, and that the Court can rule differently on the same issue arising in separate cases. If contrasting decisions on the same issue emerge within the Court, a case can be referred to the full bench for a decision resolving the contracts and establishing a uniform interpretation of the law on that particular matter.

In 2017, Italy introduced a special tax regime intended to attract Italian and foreign nationals who have been resident outside of Italy for at least nine of the previous ten years, to transfer their tax residence to Italy and pay a fixed amount of €100,000 in lieu of the Italian regular income tax on their foreign source income. Taxpayers qualifying for the special regime are taxed on their Italian source income at usual graduated rates. The fixed amount tax paid under the new regime also substitutes all national and local wealth taxes and Italy’s estate and gift taxes on foreign assets. In addition, taxpayers who elect for the special tax regime are exempt from the duty to report their foreign financial accounts and investments on their Italian income tax return as required under Italy’s international tax reporting rules.

On March 8, 2017, the Italian Tax Administration issued the Regulation n. 47060 setting forth technical provisions for the application of the special tax regime.

On May 23, 2017, the Italian Revenue Agency issued Circular n. 17/E providing administrative guidance in the interpretation and application of the special tax regime.

The special tax regime is not limited to Italian nationals, does not limit a taxpayer’s ability to work, invest or do business in Italy, and does not provide for any mandatory remittance of the foreign income that is subject to the lump-sum tax.

Since the world-famous soccer player Cristiano Ronaldo decided to leave Real Madrid in Spain and join the Italian top team Juventus in Italy (a decision some speculate was predicated also on his ability to benefit from the attractive new Italian special tax regime), Italian’s lump-sum tax for new-resident high net worth individuals has attracted more attention. Less than two years after it was enacted, it is probably still too early to fully assess its impact and the tax agency’s approach in administering it. However, now that it is settled as a permanent feature of the Italian tax system, a further review appears to be worthy.

Class of Taxpayers for Whom It is Designed.

The special tax regime is not limited to a particular class of taxpayers. It extends to both Italian national and foreign nationals, it does not put any limit on the activities a taxpayer can be engaged in while resident in Italy, and does not require that the income subject to the lump-sum tax be remitted back to Italy. A taxpayer who elects for the special tax regime is free to work, invest or operate a business in Italy and earn Italian wages, investment or business income, in respect of which he or she is going to be taxed under the regular income tax.

As a practical matter, since the lump-sum tax applies in lieu of the regular income tax on taxpayer’s foreign source income, the special tax regime is designed in particular for foreign individuals with significant investments, activities or business interests outside of Italy, who earn large amounts of foreign source income subject to zero o low income taxes in the country from which it is derived.

Fiscal Residency Requirements

The special tax regime is offered to Italian or foreign national individuals who have not been Italian tax resident individuals for at least nine of the previous ten years, and are Italian tax residents in the tax year for which they make the election.

Tax residence is determined under Italian tax law, pursuant to one of three alternative criteria that must be met for more than 183 days during a given tax year: registration on the register of Italian resident population, place of habitual abode (intended as a regular place of living where taxpayer intends to stay indefinitely, rather than temporarily or for some specific and limited-time purpose), and domicile (intended as the main place of an individual’s personal, professional and economic interests). Once one of those criteria is met, tax residence retroacts to the first day of the tax year during which any of those criteria is met.

The registration test is completely within the taxpayer’s control and easy to apply. Instead, the residence and domicile tests depend on the facts and circumstances of each particular case, and are more controversial and open to interpretations. In some recent rulings, the Italian Supreme Court took the position that, for the purpose of the domicile test, under certain circumstances the presence of significant economic interests in Italy may prevail over the location of all personal and family ties in a foreign country, while, traditionally, personal ties were given more weight than economic interests.

It is reasonable to argue that Italian nationals who were resident of Italy at one point in time and transferred their residency to a foreign country will receive special scrutiny, and the disclosure of information about their non-Italian tax residence and possible continuing contacts with Italy in the past may expose them to potential audit over their past non-Italian resident tax years (in addition to making them ineligible for the tax regime). Those who transferred their residence to tax havens will have to overcome the presumption that their tax residency is in Italy unless they demonstrate that they actually moved and lived there.

Foreign nationals who purchased resale estate in Italy and, upon the suggestion from local notaries and accountants (without considering its international tax ramifications), registered themselves as Italian resident individuals at their Italian home’s address in order to benefit from an abatement of the transfer taxes at the time of the purchase, triggered Italian tax residency under the registration test and may be ineligible for the special tax regime. Those foreign nationals are often able to tie break themselves to their home country, where they actually lived and kept all their interests, under their home country’s tax treaty with Italy, and avoid any tax liability in Italy (on non-Italian income) for the years in which they have inadvertently been Italian tax residents under the registration test. However, a tax treaty’s tie breaker rules cannot be used to overcome Italian tax residency, as determined under Italian internal law, and claim the special tax regime.

Foreign nationals who never registered as resident in Italy but regularly visited the country, own homes, run businesses or hold other investments in Italy, will have to provide information about their presence and activities in Italy to allow the Italian revenue agency to assess whether they have ever been Italian tax resident under the residence or domicile test.

Election Requirement

The special tax regime is elective. Eligible taxpayers must file an election with their income tax return for the first year in which they are Italian tax residents, or the immediately following tax year.

Taxpayers can, but are no longer required to, apply for an advance ruling on their eligibility for the special regime. If they file for an advance ruling, taxpayers must provide specific information on the relevant facts and circumstances that concern their possible tax residence in Italy in the prior ten-year period. The tax agency has 120 days to respond to the ruling request and failing to respond is equivalent to a positive answer. If the agency asks for additional information, a new 120-day period starts running from the date of the request. SAs a result, taxpayers must carefully prepare their ruling applications to avoid delay.

The Italian tax administration issued a checklist of twenty items that must be properly disclosed and documented, either in the advance ruling application, or by way of an attachment to the tax return electing for the special regime. Taxpayers must use the check list when they review their facts and circumstances and assess their eligibility with their tax advisors, before making the election.

Nothing is said in the law or the administrative guidance issued by the tax administration about a possible situation in which a tax return electing for the special tax regime does not provide, in its attachment, a complete and sufficient set of information in response to all of the items on the check list. To avoid the risk that the election is treated as ineffective, taxpayers should work carefully in preparing a complete response to the agency’s questionnaire.

The election is valid for and automatically expires after 15 years.

Special Election for Family Members

The election for the special tax regime can be extended to a taxpayer’s family members. Whenever a family member becomes an Italian tax resident, within the 15-year period of the initial election, the taxpayer who filed the initial election, and his or her family member that then qualifies, can file the election for the special tax regime. Following the election, the family member is subject to a lump-sum tax of 25,000 euros on his or her foreign source income and enjoys all other benefits of the special tax regime. The family member’s election remains in place, for the remaining part of the 15-year period, even when the principal taxpayer’s initial election is revoked or earlier terminated.

Termination of the Election

Taxpayer is free to terminate the election any time. The election automatically terminates when the taxpayer moves her tax residence outside of Italy or fails to pay the lump-sum tax. Finally, the election expires after fifteen years.

Scope of the Special Tax Regime

The scope of the special tax regime extends to foreign source income and foreign assets and has three important effects: exclusion of foreign source income from the scope of the regular income tax, exclusion of foreign assets from the scope of the Italian estate tax and exemption from the duty to report foreign assets and financial accounts on the Italian income tax return.

No Regular Income Tax On Foreign Source Income

The 100,000 euros fixed-amount tax applies in lieu of the regular income tax on foreign source income. The source of income is determined under the provisions of article 23 of the Italian Unified Tax Act.

Italian tax law source rules differ from US source rules in many important respects and offer great tax planning opportunities to maximize the benefits of the special tax regime.

The first and most prominent example is that of royalties. The source of royalty income is determined by reference to the residence of the payer (licensee), rather than the place of use of the license. As a consequence, royalties paid to a sports athlete for the right to use his or her image in sports products advertising campaigns, or by an artist for the rights to publish or sell his or her music, books, etc. by a foreign sponsor, production or publishing company, are entirely foreign source income, regardless of the place of use of the license and the fact that the use of the image or the sales may be carried entirely or partly out in Italy. Cristiano Ronaldo will be able to license his image rights to a foreign company and receive foreign source tax free royalties for the use of his image in advertising campaigns run entirely in Italy. Conversely, he will be better advised not to license his image rights to an Italian company as a remuneration for foreign run advertising campaigns, which would generate Italian source royalties fully taxed under the Italian regular income tax.

The source of capital gains is the place in which the property is located, rather the residence of the seller. For gains from the sale of stock or ownership interest in non-corporate entities, the gain is sourced with reference to the place of incorporation or organization of the entity. As a result, gain from the sale of stock of a U.S. corporation would be non-US source income, not taxable in the U.S., and foreign source income falling within the scope of the fixed amount tax in Italy.

Dividends and interest are sourced by reference to the residence of the payer. However, dividends and interest earned through mutual funds, which are not treated as fiscally transparent entitles, are separately characterized as income form mutual funds and sourced by the place of organization of the fund. As a result, even investments in Italian stock and bonds can generate nontaxable foreign source financial income if held and managed in a foreign organized mutual fund.

Similarly, income earned through trusts and similar arrangements, is classified as income from trust and sourced by the place of administration of the trust (rather than with reference to the source of the underlying items of income), which, in turn, is presumed to be the place in which the trustee is domiciled (unless taxpayer proves that the actual administration of the trust is carried out in a different place). A revocable trust is disregarded and the settlor is treated as the owner of the assets the income of the trust, which, in turn, is sourced with reference to the source of the underlying items of income deriving from the trust assets. Non-revocable trusts are generally treated as opaque, unless the settlor retains certain control powers over the trust that result in the trust being treated as fiscally transparent. As a result, a taxpayer has the opportunity to lump his (Italian or foreign) investments into a foreign administered trust, and earn entirely foreign source income not taxable under the regular income tax.

Income from services is sourced with reference to the place of performance. As a result, a soccer player playing games inside and outside the country, must allocate part of his salary to Italian games and treat it as Italian source income taxed under the regular income tax, and part of his salary to foreign played games and treat it as foreign source income nontaxable under the regular income tax. Italian law does not set forth any clear rule setting for the methods for the allocation of the income. In case of wages paid for general services, the allocation is made on the basis of the time spent in Italy compared to time spent abroad while performing those services. However, for remuneration paid for work on specific projects or tasks, the allocation should be made with reference to the place where the project or task is carried out.

In a case like the one of Cristiano Ronaldo, there may be a fair argument to sustain that a substantial part of his salary should be allocated to games plaid in the International competitions such as the European Champions League (considering that Juventus has acquired him just for that purpose, having barely missed to win it in the last three seasons, when it reached the finals and lost to superior teams such as Barcelona and Real Madrid), most of which are plaid outside of Italy, and allocate a big chunk of his salary to those games plaid outside of Italy, treating it as foreign source not taxable under the regular income tax. A rock musician receiving compensation for recording a record or performing at concerts outside of Italy would clearly earn foreign source services income not taxable under the regular income tax.

No Estate and Gift Taxes On Foreign Assets

Italy operates an estate tax, which is charged on Italian-situs properties of non resident individuals, or worldwide properties of resident individuals, transferred at death. For individuals who are resident in Italy at the time of death, the Italian estate tax applies on their worldwide estate.

Similarly, the Italian gift tax applies to any transfer for no consideration of any Italian-situs property, when the transferor is a non resident individual, or any property wherever located in the world, when the transferor is a resident individual.

Fiscal residency, for Italian estate and gift tax purposes, is determined pursuant to the same rules that apply to determine Italian fiscal residency for income tax purposes (to which we referred earlier in this article).

The special tax regime exempt foreign assets from the application of Italian estate and gift taxes.

No International Tax Reporting of Foreign Assets

Under Italian tax law, a resident taxpayer is required to report, on section RW of his or her Italian income tax return, all of his or her financial as well as non-financial assets (such as homes, luxury boats, jewelry, artwork, and the like), regardless of whether they generate income (as in the case of rental real estate), or not (as in the case of primary residence, vacation homes, etc.).

The international tax reporting of foreign assets is often very expensive and time consuming.

The election for the special tax regime exempts the taxpayer from the duty to report his or her foreign assets under Italy’s international tax reporting rules.

No Asset-Value Taxes On Foreign Assets

Italy applies a tax on the fair market value of foreign real estate, at the rate of 0.76%, and a tax on the fair market value of foreign financial assets, at the rate of 0.2%.

Both taxes do not apply in case of an election for the special tax regime.

Special Tax Regime and Tax Treaties

One issue that emerged in the context of the enactment of the special tax regime concerns whether a taxpayer who elects for the special tax regime is eligible for the benefits of a tax treaty between Italy and the foreign country of source of the income.

The Italian tax administration in its Circular N. 17/E took the position that a taxpayer should be eligible to treaty benefits, considering that he or she is tax on his or her worldwide income, by reason of being a resident of Italy for income tax purpose, albeit through the regular income tax, as far as his or her Italian source income, and a fixed amount tax that applies in lieu of the regular income tax, as far as his or her foreign source income. As a result, the Italian tax administration announced that it will issue certificates of tax residency to Italian taxpayers who elect for the Italian tax regime.

It must be noted that a taxpayer can always decide to exclude certain countries from the application of the special tax regime. In that event, he or she would qualify for a foreign tax credit in Italy for the amount of any income tax charged on income from sources in that country, and would definitely be able to claim the benefits of the treaty between Italy and that country to limit any source country tax on that income.

Constitutional Issues

The special tax regime poses some constitutional issues. Clearly, it is a departure from the general principle according to which each taxpayer should contribute to the country’s public budget in proportion to his or her paying capacity, set forth at article 53 of the Constitution. A measure of taxpayer’s paying capacity is taxable income, and the Constitutional provision of article 53 has historically been carried out through a progressive income tax.

However, it is not clear how a constitutional challenge might be brought to the Italian Constitutional Court. To bring a claim to the Constitutional Court, a taxpayer must have standing, and standing exists when a taxpayer is subject to a provision of law that subjects him or her to a less favorable tax treatment than that which applies to another category of similarly situated taxpayers. In the case of the special tax regime, a taxpayer who is subject to the regular income tax might challenge the general provisions of the regular income tax, under which he is taxed less favorably (on his foreign source income) that a similarly situated taxpayer subject to the fixed amount tax. That would assume (and require the taxpayer to demonstrate) that he or she possess an amount of foreign source income that, under the special tax regime, would entail a tax that would be lower that the regular income tax on that income. For such challenge to be upheld the Court should rule the constitutional invalidity of the regular income tax, across the board, which seems a very remote and unrealistic proposition. Moreover, a taxpayer who elects for the special tax regime is not in the same position as a taxpayer who is not eligible for the special tax regime (the former being a nonresident, not subject to tax on non-Italian source income, who voluntarily transfers his or her tax residency in Italy in exchange for being taxed under the special tax regime on his or her foreign source income), and the special regime is temporary and expires automatically after 15 years.

Other Issues

One interesting issue concerns the way in which Italy will administer the exchange of information systems it operates with foreign countries which may ask for tax information concerning individuals who have moved their residency to Italy to benefit from the Italian special tax regime. By providing taxpayers who elect for the special tax regime with a full exemption from reporting their foreign assets, Italy would not possess information, out of a taxpayer’s return, to share with a foreign tax jurisdiction. In addition, a taxpayer is not requested to separately state, on his or her Italian tax return, his or her foreign source income, which is not taxable with the regular income tax.

Conclusions

The Italian forfeit tax regime for nonresident high net worth individuals (who become Italian tax residents) has some very interesting features, which make it very attractive, compared to similar regimes applied in other countries, both presently and in the past.

The election for the special tax regime requires specific planning, both to determine the taxpayer’s eligibility for the regime, before it is filed, and to determine the best way to structure the taxpayer’s affairs (with specific regard to the sources of his or her income) to maximize the benefits of the regime, once the filing has been made. Every time a taxpayer moves his or her residence to Italy under the Italian registration test, while keeping significant contacts and interests in other foreign countries, the tax planning will always require an investigation into those countries’ tax laws, to determine whether the taxpayer might still have his or her residency in any of those countries, pursuant to the residence or domicile test that may apply in those countries, and to determine the taxation of local source income in combination with the Italian lump sum tax.

While some more time will need to pass before any case law or administrative tax ruling is available as to the interpretation and application of the special tax regime, the Italian tax agency so far has adopted a pro taxpayer approach, aimed at encouraging the use of the regime, which is seen as a way to attract wealth individuals to Italy ultimately resulting in a contribution to the local economy.

The preferential tax regime for the new resident workers, enacted by way of Article 16 of the Legislative Decree 147 of 9/14/2015, is now permanent and extended to non-EU citizens and independent consultants and service providers (while, originally, it was limited to EU citizens working in an employee capacity).

Given its wider scope and increasing relevance, for foreign enterprises which plan to move personnel to Italy, or foreign consultants who consider the opportunity to relocate to Italy, it is worth providing a review of the basic tax advantages of the preferential tax regime.

Eligible taxpayers include dependent workers and independent consultants and service providers, who are allowed a 50 percent deduction from the amount of taxable wages and salary or compensation for personal service performed in an independent capacity, with the personal income tax (IRPEF) applying on the remaining 50 percent portion of that income at graduated rates.

The special tax regime applies to the following categories of taxpayers:

A. dependent workers (employees) possessing a three or five year of five graduate degree, provided that:

1. in case of a foreign degree, a certificate is issued by the Italian consulate in the taxpayer’s home country, certifying that the degree is equivalent to an Italian graduate degree,

2. the taxpayer has carried out a studying or working activity outside of Italy for at least 24 months (or more) prior to his or her relocation to Italy,

3. the taxpayer is a EU citizen or citizen of a non-EU country with which Italy has an income tax convention or a tax information exchange agreement,

4. the taxpayer works as an employee or a independent consultant or service provider (for private or public organizations, and regardless of whether the work or activities are consistent with the taxpayer’s degree),

B. taxpayers who are employed in a managerial capacity of specialized skill capacity, provided that:

1. they have not been Italian tax residents in the last 5 years preceding their relocation to Italy,

2. they are employed with an Italian employer or a foreign enterprise’s permanent establishment located in Italy, or are employed on secondment or assignment to an Italian affiliate of a foreign company or enterprise,

3. they carry out their work primarily in Italy (the requirement is satisfied whenever the work is performed in Italy for more than 183 days of the year),

4. they perform managerial or specialized skill functions.

The managerial or specialized function requirement is deemed to be satisfied for taxpayers who are in possession of an 3+ year undergraduate degree in the area of management, liberal arts, scientific or high skilled professions, or technical jobs (such as software and IT developers, computer programmers, data base and computer systems programmers, program managers, etc.).

To qualify for the special tax regime, a taxpayer (1) must establish his or her tax residency in Italy during his or her employment there, and (2) must maintain his or her tax residency in Italy for at least two (2) years.

The maximum period for which the benefit applies is five (5) tax years, starting with the first year in which the taxpayer becomes an Italian tax resident.

The benefit consists in a 50 percent deduction of employment and personal services income. Assuming a total income of euro 100,000 in Italy the taxable income after the 50 percent deduction would be reduced to euro 50,000 and the Italian personal income tax (IRPEF) – without taking into account personal deductions or exemptions – would amount euro 15.320 (equal to an effective tax rate of 15.32 perfect).

Any other income, different from wages and compensation for services, continues to be taxed in full or according to the general rules.

Relocating to and establishing tax residency in Italy would still result in taxation in Italy on worldwide income, and carry with it the obligation to report foreign financial accounts and other reportable assets on the Italian income tax return. Consequently, specific pre-immigration tax planning would still be needed to make sure the employees are not subject to an overall adverse tax treatment and Italian taxation is properly coordinated with taxation still applicable in their home country.

The 50 percent income deduction appears to be very attractive and should facilitate foreign direct investments in Italy, in connection with which a foreign investor needs to move managerial or high-skilled personnel from its home country to Italy, and employe it at its Italian subsidiary or place of business.

The Italian Supreme Court with its ruling n. 25264 of October 25, 2017 (Cassazione n. 25264 of 10-25-2017) held that actual payment of the corporate income tax in the parent company’s home jurisdiction is required for the parent company to benefit from the dividend withholding tax relief under the EU Parent Subsidiary Directive (the “EU Directive”) or Italy-The Netherlands Double Tax Treaty (the “Treaty)”.

FACTS

Under the facts of the case, an Italian company controlled by a Dutch company (organized as a “naamloze vennootschap” or N.V., which is a type of entity falling within the scope of Dutch corporate income tax) paid a dividend to its parent and applied the 5 percent reduced dividend withholding tax rate under the Italy-The Netherlands Double Tax Treaty.

The Dutch parent filed a request for refund of the 5 percent withholding tax, pursuant to the EU Parent Subsidiary Directive n. 2003/123/EC of December 22, 2003 amending Directive 90/435/EEC (EUR-Lex – 31990L0435 – EN).

The Italian tax agency assessed the full 27 percent dividend withholding tax under article 27 of Presidential Decree n. 600 of 9/30/1973, on the theory that the Dutch parent company failed to satisfy the requirements for the withholding tax relief, under the EU Directive as well as the Treaty, because (1) it had not been subject to tax in the Netherlands on the dividend it received from its Italian subsidiary, and (2) it did not submit any valid evidence that it was the beneficial owner of the dividend.

According to the Italian tax agency, “subject to tax” requires evidence of the actual accrual of the tax liability and payment for the corporate income tax, as opposed to just a potential tax liability associated with the legal form and general tax status of the entity in its home country.

The Supreme Court ruled in favor of the tax agency on the “subject to tax” issues, thereby denying the benefits of the Directive and the Treaty.

LAW

Under the EU Directive, profits distributed by a company of a EU member state to a company of another EU member state which owns at least 10 percent of the capital of the company distributing the profits, are exempt from withholding tax in the distributing company’s member state.

Pursuant to article 2 of the Directive, for the exemption to applies it is required that the recipient of the dividend is subject to corporate income tax in its home country (vennootschapsbelasting in the Netherlands).

Under article 10 of the Treaty (nethe-en), a Dutch company is entitled to a 5 percent reduced withholding tax rate on inter company dividends received from its Italian subsidiary, provided that it a resident of the Netherlands, which, in turn, requires that it is liable to tax there.

ISSUE AND RULING OF THE COURT

The case revolved around the contraction and exact meaning of the terms subject to tax, used in the Directive, and liable to tax used in the Treaty.

According to one interpretation, those terms require solely potential taxation, meaning that, based on its legal form and tax status, an entity is generally treated as a taxpaying entity falling within the scope of the corporate income tax, while the fact that it may not be actually subject or liable to a tax as a result of a participation exemption or similar tax regime applicable in its home country is not relevant.

According to another interpretation, those terms requires the actual rising of a lability for the corporate income tax in connection with the receipt of the dividends, and the actual payment of that tax.

The Supreme Court observed in its ruling that the Dutch company recipient of the dividends had furnished a tax residency certificate issued by the Dutch tax authorities, but failed to demonstrate that it actually met all the requirements for the withholding tax relief, such as the proof of the “actual payment of the corporate income tax, in connection with the distribution of the dividend”.

The ruling is not entirely consistent with the tax administration’s guidance on the issue, which we refer to below.

ADMINISTRATIVE GUIDANCE

Circular 26/E of May 21, 2009 provides clarifications on the “liable to tax” requirement that applies for the purposes of the reduced withholding tax on Italian dividends paid to EU companies.

The first clarification reads as follow: “With reference to the second requirement” (the subject to tax requirement) “it must be pointed out that the condition of passive subject of the local corporate income tax must be interpreted as a general liability to tax, which occurs in all those situations in which a company is potentially liable to a corporate income tax, even though in certain circumstances it may benefit from beneficial tax regimes that are compatible with EU legislation”. As a result, all companies or entities to which is assigned general liability for the corporate income tax should qualify for the reduction, including those entities that do not owe the tax by virtue of special tax exemption regimes linked to the type of income they earn (e.g. passive income) or the place where they operate. On the other hand, companies and entities that do not fall within the area of application of the corporate income tax, do not qualify for the reduction.”

Circular 26/E refers to Circular n. 47 of November 2, 2005, which provides clarifications on the liable to tax requirement that applies for the purposes of the exemption from withholding tax for interest and royalties paid to a EU affiliate under the EU interest and royalties directive. Circular 47/E (referred to in Circular 26/E), in the relevant part, reads as follows: “With respect to the last requirement [the liable to tax requirement], it must be interpreted as a general or potential liability to tax. Therefore, according to what is clarified above, the benefit [of the exemption from withholding tax on interest and royalties] must be considered applicable to all those companies that, despite being potentially subject to corporate income tax, in fact benefit from special tax regimes compatible with EU law”.

The tax administration with its Circular 32/E of July 8, 2011 confirmed the above interpretation of the term liable to tax, when providing guidance on the refund of past withholding taxes charged on dividends to EU companies in excess of the new 1.375% rate instated pursuant to the decision of the European Court of Justice that declared the 27% outbound dividend tax in violation of the non discrimination principle of the EU Treaty. In Circular 32/E the administration clarified that EU companies eligible for the refund include all entities that “are passive subject of the local corporate income tax. Such condition must be interpreted as a general subjectivity to the tax, and it is satisfied for all companies potentially liable for the tax, regardless of the fact that they may benefit from special favorable tax regimes compatible with EU law. As a result, the reduced rate can apply to all companies or entities to which a general liability for the corporate income tax is assigned, including those that do not pay the tax due to exemptions linked to the type of income they earn (e.g. exemption of passive income) of the place in which their activity is carried out. On the other end, foreign companies and entities that do not fall per se within the scope of the tax do not qualify.”

CONCLUSIONS

The Supreme Court’s ruling is not well explained or thoroughly elaborated. That may very well be a direct result of lack of clarify and comprehensive briefs or a defective discussion of the case on behalf of the taxpayer.

As a result, it may be prudent to wait before reading too much into it going beyond the specific case and the way in which it was litigated and argued in court.

Still, the rather harsh conclusion of the Court, holding that evidence of the actual payment of the corporate income tax in connection with the receipt of the dividends to benefit from the withholding tax relief under the EU Directive (or the Treaty), is troubling, and sufficient to raise the level of awareness on a very sensitive and not entirely settled issue of international tax law.

With its ruling n. 975 issued on January 18, 2018 Italy’s Supreme Court held that the transfer of an asset (real estate property) to an irrevocable trust falls outside the scope of Italy’s registration, cadastral and mortgage taxes (transfer taxes), charged at the aggregate rate of 10 percent, on the theory that it is a transitory step before the final transfer of the property to the beneficiaries of the trust actually occurs, at which time the transfer taxes should apply.

The ruling is consistent with a previous decision of the Supreme Court on the same issue, that is, ruling n. 21614 of October 26, 2016 (which we also commented upon on this blog).

The question is whether the ruling extends to the gift tax, which replaces the registration tax for gratuitous transfers taking place from October 25, 2006.

The ruling concerns facts occurred before the reenactment of Italy’s estate and gift tax. The issue in front of the Court was to determine whether the transfer of real property to a trust was subject to the registration, cadastral and mortgage taxes (usually referred to as transfer taxes or indirect taxes), which are charged at the rates of up to 7 percent, 2 percent and 1 percent of the value of the transferred property.

The property was transferred to an irrevocable trust that specifically identified the beneficiaries of the corpus of the trust, their shares of the principal of the trust and the time at which the trustee would be requested to distribute the trust’s assets to the trust’s beneficiaries.

The Court ruled that the transfer of the property fell outside the scope of the transfer taxes because it did not fit within any of the enumerated categories of legal arrangements to which the transfer taxes should apply, namely (1) transfers for consideration (“atti traslativi a titolo oneroso”), (2) other transfers concerning legal or contract performances with an economic value (“atti diversi aventi ad oggetto prestazioni a contenuto patrimoniale, or (3) acknowledgements (“atti di natura dichiarativa”).

According to the Court, the transfer of the property to the trustee with instructions to hold and administer it in trust in the interest of the trust’s beneficiaries, for a certain period of time and until the conditions are met to proceed with the final distribution of the property to the trust’s beneficiaries, is a transitory step that is part of a legal arrangement designed to procure the final and definitive transfer of the property to certain beneficiaries at a future time. With reference of such a legal arrangement, the Court held that the transfer taxes should apply solely at the time of the actual, final transfer of the property from the trustee to the beneficiaries of the trust.

According to one interpretation, the ruling supports the principle according to which the gift tax (which applies in lieu of the registration tax with respect to gratuitous transfers completed after the re-enactement of Italy’s estate and gift tax with effect from October 25, 2006) should apply only at the time of the final distribution of a trust’s property to the beneficiaries of the trust, when the beneficiaries eventually acquire the unconditional legal ownership rights to the property and receive the full enjoyment of the economic value of the gift, rather than at the time of the transfer of the property to the trust, when the property is temporarily held in trust and administered in the interest of the beneficiaries.

Article 2, paragraphs 47 and 49 of Legislative Decree n. 262 of 2006 (finally enacted into law by way of Act n. 286 of 2006), reinstated Italy’s estate and gift taxes, as originally instituted and governed under Legislation Decree n. 346 of 1990 effective from 1/1/1991 and temporary repealed in October 2001. For gratuitous transfers from a donor to a donee, the gift tax applies at the rate of 8 percent, in lieu of the registration tax. For real estate properties, the cadastral and mortgage tax, at the rate of 2 and 1 percent, are still due on top of the gift tax. For close family members (spouse, parent, children, grandparents, grandchildren), a lifetime exemption of up to one million euros for each beneficiary applies, and the gift tax is charged at the reduced rate of 4 percent.

The gift tax historically applied only to straightforward gifts, as defined in the Civil Code, that is, gratuitous transfers of a property or other valuable economic interests from a person – the donor – to another person – the donee, whereby the recipient of the gift, or donee, would have immediate legal rights to and enjoy the full economic benefit of the gift.

Under the original estate and gift tax statute, the application of the gift tax in the event of a transfer of property through a trust, was unclear. The transfer of a property to the trustee of a trust was not be subject to the gift tax, because the trustee, as the immediate recipient of the property, typically does not have full legal rights to and economic benefit from the property, which he administers in trust for the ultimate benefit of the beneficiaries of the trust, while the beneficiaries of the trust do not receive the property until it is distributed to them out of the trust pursuant to the terms of the trust agreement.

At the time of distribution of the property from the trustee to the beneficiaries of the trust, the gift tax would not apply because the trustee distributes the property to the beneficiaries pursuant to a legal arrangement that does not fall within the legal definition of gift that is subject to the gift tax.

The original estate and gift tax statute, resurrected in 2006, was amended with the addition of a specific reference to deeds or other legal arrangements resulting in the creation of a legal restriction to or constraint on the final disposition of property (“atti costitutivi di vincoli di destinazione”).

The main purpose of the amendment was to bring trusts within the scope of the reenacted gift tax.

The tax administration, in its administrative guidance on the application of indirect taxes to trusts (provided with Circular n. 48/E of August 6, 2007 and n. 3/E of January 22, 2008), took the position that the new category of “legal arrangements resulting in the creation of a legal restriction to or constraint on the final disposition of property” refers to and includes the transfer of a property into a trust, whereby the property is subject to the legal restrictions set forth in the trust agreement, with respect to its administration and disposition, before it can be distributed to there beneficiaries of the trust. As a result, according to the Italian tax administration’s position, the gift tax applies at the time of the transfer of the property into the trust. Later, when the property is distributed out of the trust to the trust’s beneficiaries, no second tax would apply.

The Supreme Court agreed with the tax administration in a number of decisions issued in respect of transactions taking place under the newly reenacted and amended estate and gift statute. Those decisions include ruling n. 3735 of February 24, 2015 (concerning a self settled trust subject to gift tax at the full rate of 8 percent); ruling n. 3737 of February 24, 2015; ruling n. 3886 of February 25, 2015 (also concerning a self settled trust taxed at the full rate of 8%); ruling n. 5322 of March 18, 2015 and ruling n. 4482 of March 7, 2016.

More recently the Supreme Court, when addressing cases concerning transactions completed before the reenactment of the amended estate and gift tax statues, held that in light of the temporary and transitory nature of the transfer of a property to a trust, whereby the property is placed and held in trust, and is not immediately transferred to the intended final recipient and beneficiary, outright, the registration tax at the rate of 8 percent should apply. Ruling n. 975 is the last one on the issue, following previous ruling n. 25478 of December 18, 2015 and ruling n. 21614 of October 26, 2016.

According to one interpretation, the rational of those rulings extends to the realm of the newly reenacted gift tax and con-validates the principle according to which the gift tax should apply at the time of the final transfer of the property out of the trust to its final beneficiary. According to this interpretation, the new language added to the revised gift tax statute does not create an additional stand alone category of transactions subject to gift tax but, rather, it has the sole function of making it clear that the gift tax actually applies also to gratuitous transfer of property made through a trust, as it applies to straightforward gifts.

Clearly, the narrow interpretation of the scope of the Italian gift tax with respect to transfer of properties through trusts, is inconsistent with the way in which the gift tax applies in the U.S. Under U.S. principles, generally the transfer of property into an irrevocable trust is a complete gift, which falls within the application of the federal gift tax. Simultaneously, under Italian law, according to the interpretation illustrated here above, a complete gift would occur solely at the time of the final distribution of the property out of the trust, to the trust’s beneficiaries.

As a consequence, Americans with properties held in irrevocable trusts might be inadvertently exposed to Italian gift tax, at the time the property is distributed to the beneficiaries of the trust. That would happen whenever the original settlor is resident in Italy, for Italian gift tax purpose (in which case, all of the properties held in trust, wherever located in the world, would potentially be subject to Italian gift tax, based on the tax residency or domicile of the settlor), or some or the properties held in trust are located in Italy (in which case those properties might be subject to Italian gift tax, based on the location of the property and regardless of the tax residency or domicile of the settlor).

In conclusion, trust planning for individuals who have establish or are planning to move their tax residency or domicile into Italy, or held Italian properties in trust, should be reviewed to address Italian estate and gift tax issues in a very uncertain area of law.

With the Budget Law for 2018 (Law n. 205 of December 27, 2017), Italy amended the definition of the term “permanent establishment” set forth in article 162 of the Italian Tax Code.

The term permanent establishment now covers situations in which a foreign enterprise does not have a physical nexus with Italy, but it has a regular and continuous economic presence in the country; engages in ancillary activities that are an essential component of its corse business, or operates through commissioners or other agents who do not enter into contracts in the name of the enterprise, but procure the conclusion of contracts that are eventually signed by the principal with no material modifications.

As a result of the amendments enacted with the Budget Law, the scope of the term permanent establishment as defined under domestic law is significantly expanded, creating more situations in which a foreign enterprise may be subject to tax in Italy.

The domestic law definition of the term permanent establishment does not overrule that of article 5 of Italy’s tax treaties. Under Italian constitution law, tax treaties are international law and prevail over domestic law. To the extent that a tax treaty contains a narrower definition of the term permanent establishment, the tax treaty definition applies.

The first change concerns the enactment of the economic nexus rule, pursuant to which a permanent establishment of a foreign enterprise in Italy exists whenever the foreign enterprise’s activities result in a “regular, continuous and significant economic presence within the territory of the country”. Physical presence is no longer required for the existence of a permanent establishment and the consequent taxation of a foreign enterprise in Italy. Simultaneously, the tax code provision that excluded the presence of a permanent establishment for the sole reason of the location in Italy of electronic equipment used for the collection and transmission of data relating to the sale of goods and services has been repealed.

The new provision on the economic nexus would seem to originate from and be consistent with the OECD final report on the tax challenges of the digital economy (Action 1), released under OECD’s Action Plan on Base Erosion and profit Shifting (BEPS) on October 15, 2015.

The second change concerns the enactment of an additional requirement to the negative list of activities which are excluded from the definition of permanent establishment. For the exclusions to apply, it is required that each of those activities be preparatory or auxiliary in nature. A preparatory activity precedes the enterprise’s core business activities, while an auxiliary activity supports, but is not an essential and significant part of, the activity of the enterprise as a whole.

The new provision is consistent with clarifications provided in the Commentary to Article 5 of the 2017 OECD Model Income Tax Convention, at paragraph 60(“2017 OECD Model Treaty”), and with option A of Article 13 of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base erosion and Profits Shifting, signed on June 7, 2017 (“Multilateral Tax Convention”)

The third change concerns the enactment of the anti fragmentation rule pursuant to which the preparatory or auxiliary exception does not apply whenever the combination or aggregation of auxiliary or preparatory activities, together with other activities performed by the same or a closely related enterprise, in the same space or fixed place of business, constitute a permanent establishment. For the purpose of the anti fragmentation rule, two enterprises are closely related if one directly or indirectly controls the other or the two are directly or indirectly controlled by the same enterprise.

The anti fragmentation rule seems to be consistent with article 13 of the Multilateral Convention and reflects the clarifications provided in the Commentary to Article 5 of the 2017 OECD Model Treaty, at paragraph 79.

The fourth change concerns the definition of "dependent agent" permanent establishment. A permanent establishment now includes a dependent agent who habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise, and these contracts are: a) in the name of the enterprise; or b) for the transfer of the ownership of, or for the granting of the right to use, property owned by that enterprise or that the enterprise has the right to use; or c) for the provision of services by that enterprise. The new provision covers commissionare arrangements, whereby the agent does not sign contracts in the name of the enterprise, but promote the conclusions of contracts that are entered into by the enterprise without material modifications.

The new rule reflects the provisions of article 12 of the Multilateral Tax Convention, and implements the Action 7 of BEPS.

Although the new definition of the term permanent establishment in the Italian Tax Code does not overrule article 5 of Italy's existing tax treaties, Italy will move towards a renegotiation of its tax treaties pursuant to the Multilateral Tax Convention, ultimately enforcing the same concept and achieving consistency between international tax law of treaties and domestic tax law.

In the meantime, the Italian tax administration may be tempted to interpret and apply the permanent establishment provisions in Italy's current tax treaties taking into account the new rules, pursuant to a general anti abuse principle, to expand the potential taxation of foreign enterprises in Italy.

As a result of the significant reduction of U.S. corporate income tax rates pursuant to the tax reform of the TCJA enacted on December 22, 2017, the Unites States now has a lower corporate tax rate than many of its trading partners, meaning that, in many instances, the profits of foreign owned or controlled-U.S. subsidiaries shall be taxed more favorably than the profits of their foreign parent companies or affiliates in their home jurisdictions. That creates an incentive for foreign companies to channel more profits through their U.S. subsidiaries, in order to benefit from lower U.S. income taxation compared to that applicable in the parent company’s home country.

Starting in 2018, the U.S. taxes the profits of its corporations at the generally applicable corporate tax rate of 21 percent, with a preferential effective tax rate of 13.125 percent applicable on certain income deriving from foreign sales of goods and services (“foreign derived intangible income”). Those rates compare to the Italian combined corporate tax rate of 27.9 percent.

Italian companies with U.S. and international sales may benefit from a significant tax reduction by increasing their workforce and activities in the U.S. and handling more of their U.S. and internationals sales through their U.S. subsidiaries. Once the U.S. subsidiary has been taxed on its profits in the United States, it can repatriate those profits to its Italian parent virtually tax free, thanks to a substantial reduction of the inter company withholding tax rate under the U.S.-Italy income tax treaty (5 percent) and an almost complete exemption of the dividends from Italian tax in the hands of the Italian parent, pursuant to Italy’s participation exemption rules.

Under the new scenario described above, renewed attention should be given to Italy’s corporate “anti-inversion” rules. Under Italian income tax code, a company incorporated or organized in a foreign country is treated as an Italian resident company, for Italian corporate income tax purposes, and is subject to tax in Italy on its worldwide income, if it maintains its place of administration or its principle place of business in Italy. Also, a company owned or controlled by Italian shareholders, and owning or controlling a foreign company, is presumed to be an Italian resident company, unless the taxpayer proves that it is effectively managed and controlled in its own country of organization.

A company’s place of administration is the place where the company’s day to day management activities are carried out. According to the general guidelines issued by the Italian tax administration on this matter (see Protocol n. 2010/39678 of 3/19/2010 and 2010/157346 of 12/20/2010), several factors are looked at to determine a company’s place of administration, including:

– the place where the company’s directors and officers meet and vote upon company’s affairs;
– the place where the company’s directors and officers actually and regularly carry out their administration and management functions and duties for the company;
– the place where the company’s day to day legal, administrative, accounting and tax management functions are performed.

Italy’s Supreme Court ruled that a company’s place of administration is the place of effective management of the company, namely, the place where the day to day administrative activities for the company take place, shareholders’ and directors’ meetings are held, and company’s business activities are carried out, putting the company is connection with customers, business partners and third parties (see Supreme Court’s ruling n. 2869 of 2/7/2013).

The company’s place of administration should be distinguished from the place where the supervision, coordination and direction of a company’s business is performed, typically, at the headquarter of the parent or holding company. The sole fact that a company’s is wholly owned or controlled by another company, does not, in an on itself, produce the automatic effect of locating the company’s place of management at the same place as its parent’s headquarter, and day to day managements activities should not be confused with key direction, supervision and coordination activities that fall within the parent or holding’s company’s duties and functions (see ruling n. 61 of 1/18/2008 of Regional Tax Commission of Tuscany, Section XV).

A company’s principal place of business is the place where the company’s main business activities are performed. For example, a manufacturing company has its place of business where it perform most of its manufacturing activities; a marketing or selling company has its principale place of business where its principal sales office conducting most of its sales is located, and a services company has its principally place of business in the place where it performs most of its services to its customers.

Italy’s tax administration has been enforcing the place of management or principal place of business rules in situations involving U.S. companies owned of controlled by Italian companies, despite the fact that those U.S. companies were subject to a 35 percent corporate tax rate on their profits taxable in the United States, and no apparent tax saving was involved. Typically, those U.S. companies never file any income tax return in Italy. As a result, Italy’s tax administration assesses failure to file penalties, equal to minimum 120 percent and maximum 240 percent of any Italian tax due, on top of the Italian corporate income tax on all of the profits of the U.S. company. Furthermore, since no foreign tax credit is allowed under the Italian tax code when no Italian income tax return has been filed, the claim for a credit for the U.S. taxes paid by the U.S. company on its U.S. taxable profits is denied, leading to complete double taxation.

It is reasonable to expect increased enforcement activity of the place of administration rule, from the Italian tax administration, now that the corporate rate differential between Italy and the United States create a clear incentive to concentrate more profits in the United States, achieving a potentially significant tax saving.

Many small and mid size U.S. subsidiaries owned or controlled by Italian companies share their Italian directors and officers with those of their parent company, have a very limited governance structure and actual administrative activities carried out in the U.S., and perform accounting and administrative functions for their U.S. companies from Italy. Those companies should establish a more robust corporate governance, which includes local directors or officers; set up and carry out local administrative, legal, accounting and tax functions through local professionals reporting to local management; have the proper set of contracts with their parent or holding company, governing any inter company supporting administrative or commercial services they receive from their parent or other affiliates in the same group, and maintain accurate records of all functions and activities pertaining to the company’s administration performed in the United States, to rely upon in a possible audit.

Pursuant to the Tax Cuts and Jobs Act (“TCJA”) passed on Dec. 22, 2017, the U.S. will tax U.S. corporations with the following tax rates:

– 21 percent general corporate income tax rate,
– 13.125 effective tax rate on U.S. corporation’s foreign derived intangible income (“FDII”), for taxable years from 2018 through 2025;
– 10.5 percent effective tax rate on the U.S. corporation’s pro rata share of global intangible low taxed income (“GILTI”) of a controlled foreign corporation (“CFC”).

FDII is the portion of U.S. corporation’s net income (other than GILTI and certain other income) that exceeds a deemed rate of return of the U.S. corporation’s tangible depreciable business property and is attributable to foreign sales (i.e., property sold to a non-U.S. person for foreign use) and foreign services (i.e., services provided to any person outside of the U.S.). The U.S. corporation is entitled to a deduction equal to 37.5 percent of its FDII. The application of the 21 corporate tax rate on the 62.5 percent taxable portion of FDII results in an effective tax rate of 13.125 per cent (for taxable years after 2025, the deduction is reduced to 21.875 percent, equal to an effective tax rate of 16.406 percent).

GILTI is the portion of a CFC’s net income (not otherwise taxed currently to its U.S. shareholders) that exceeds a deemed rate of return of the CFC’s’s tangible depreciable business property. GILTI is included in the taxable income of U.S. corporate shareholders of the CFC and taxed at an effective tax rate of 10.5 percent. The U.S. corporation is entitled to a deduction equal to 50 percent of the amount of GILTI. The application of the corporate tax rate of 21 percent to the 50 percent taxable portion of GILTI results in an effective tax rate of 10.5 percent. The profits of the CFC that have been included into the taxable income of the U.S. corporation and taxed as GILTI can be paid as dividends without any additional U.S. tax.

A potential implication, in Italy, of the new corporate income tax rates applicable in the U.S. is the classification of United States corporations as “black listed” controlled foreign corporations subject to Italy’s anti deferral rules.

Until 2015, Italy operated its CFC rules by limiting their application to foreign corporations controlled by Italian shareholders and organized in one of the countries included in a specific list of tax favorable foreign jurisdictions, usually referred to as “black list”.

Starting with tax year 2016, the “black list” has been replaced by a general test based on a comparison between Italy’s and foreign countries’ corporate income tax rates.

The general test provides that a foreign country is considered a black-list jurisdiction, for purposes of Italy’s CFC rules, whenever its nominal corporate income tax rate is less than half of Italy’s corporate tax rates. For this purpose, reference is made to Italy’s 24 percent corporate tax (IRES) rate and 3.9 percent regional tax (IRAP) rate, which combine for a total rate of 27.9 percent.

A special test requires to take into account any special corporate tax regime applicable in a foreign country with respect to taxation of corporate profits. The term “special tax regime” is defined to include any favorable tax provision that results in a lower effective corporate income tax rate, due to exemptions or deductions that reduce the tax base for the application of the general corporate income tax rate. Exemptions or deductions with respect to profits deriving from foreign activities falls within the definition of “special tax regime”.

When a foreign country operates a corporate tax system that provides for a different tax treatment of different categories of income, such as, for example, a system in which foreign income is taxed more favorably than domestic income, an “all or nothing rule” applies pursuant to which, if more than 50 percent of the foreign corporation’s income is subject to an effective tax rate which is lower than the foreign country’s general corporate tax tax rate and less than half of Italy’s nominal corporate income tax rates, the foreign corporation is deemed to be organized in a black listed country and all of its income is treated as income of a controlled foreign corporation taxable to its Italian shareholders on a current basis. For the purpose of the all or nothing rule, a determination is required to be made on a company by company and tax year by tax year basis.

The U.S. general corporate tax rate of 21 percent does not fall below the “less than half of the Italian corporate income tax rates” standard for the general CFC test. However, the 13.125 percent effective tax rate on FDII clearly does (13.125 is less than half of the 27.9 combined Italian tax rates). As a result, when more than 50 percent of the taxable income of a U.S. corporation directly or indirectly controlled by Italian shareholders is FDII and is subject to an effective tax rate of 13.125 percent in the U.S., then all of that U.S. corporation’s income is treated as income of a CFC taxable currently to its Italian shareholders. The fact that the income derives form genuine business transactions carried out with unrelated parties does not matter.

Italian shareholders are entitled to prove that a U.S. corporation is engaged in an active trade or business, representing its principal business activity, within the United States, and exclude the application of the CFC rules. A tax ruling may (but need not) be filed and a positive response would be binding upon the tax administration.

Now that the corporate tax rate differential between Italy and the United Sates makes it advantageous, for Italian taxpayers, to conduct international business activities through their U.S. subsidiaries or affiliates, and allocate more profits to the U.S. where they would be taxed at lower rates, it is reasonable to expect increased enforcement of Italy’s CFC rules by the Italian tax administration.

Italian taxpayers should review their U.S. controlled companies and take the proper steps to make sure they do not run afoul of Italian CFC rules.