The Italian tax administration, in its Circular n. 34 of October 20, 2022, provided some new guidance on the international tax reporting obligations for assets held in foreign trusts. Domestic trusts report foreign assets held under the name of the trust on their own income tax return. In the case of foreign trusts, the reporting duty falls upon the beneficial owner of the trust. The term “beneficial owner” is defined in the anti-money laundering statute and includes the trust’s settlor, trustee, and beneficiaries. Still, it must be adapted when used in the income tax reporting context, considering the underlying purpose of the international reporting rules, which is that of disclosing the beneficiary of the income deriving from the assets of the trust that might be subject to income tax in Italy.

Therefore, by way of background, Circular 34 clarifies that the beneficial owner liable for the reporting must be identified by considering the following:

  • the provisions contained in article 1, paragraph 2, letter pp), in article 20, and in art. 22, paragraph 5, of Legislative Decree no. 231 of 2007 (anti-money laundering legislation);
  • the provisions adopted internationally within the Common Reporting Standard, according to which the information relating to the beneficiaries is subject to communication in all the periods in which the trust exists, regardless of whether it is a mandatory beneficiary or a discretionary beneficiary (for the former, the value of the proceeds received in the tax period and the total value of the account held by the trust are reported, while for the latter only the first data is disclosed);
  • the clarifications already provided in circular no. 38/E of 2013, according to which only those with the right to claim the assignment of income or assets from the trustee are considered beneficial owners of a trust and, therefore, required to fulfill the tax reporting obligations.

Then, Circular 34 draws a distinction between mandatory beneficiaries and discretionary beneficiaries.

Circular no. 38/E of 2013 limited the reporting obligation to mandatory beneficiaries, defined as those individuals who hold the right to claim the distribution of the trust’s income from the trustee. Under Circular 34, mandatory beneficiaries report “the value of the investments held abroad by the entity and of the foreign assets of a financial nature in its name, as well as the percentage of interest in the entity itself”.

With respect to discretionary beneficiaries, Circular 34 clarifies that “The beneficiaries of discretionary trusts, on the basis of the information available, such as, for example, the case in which the trustee communicates his decision to assign him the income and/or capital of the trust fund, are required to indicate in the RW part [of the return] the value of the related credit owed by the trustee, together with the investments and financial assets held abroad.” Therefore, the information required to be reported is two folds: the value of the discretionary distributions made to the beneficiary during the year (which is reported as a credit or receivable from the trustee) and the beneficiary’s interest in the investments and assets owned by the trust. Reporting the second piece of information, however, is problematic, considering that a discretionary beneficiary does not hax any right to any fixed percentage of the income or principal of the trust. The reference to the rules on the automatic exchange of information under the Common Reporting Standards, which for discretionary beneficiaries requires solely the information about the proceeds received during the tax year, and to Circular n. 38/E of 2013 limiting the tax reporting to mandatory beneficiaries supports an approach under which discretionary beneficiaries of a trust only report the distributions received from the trust during the year.

Finally, Circular 34 deals with the case of secondary beneficiaries or “subsequent interest holders” with respect to whom it clarifies the following: “With reference to ‘subsequent interest holders’, i.e., those who would become beneficiaries only when the first beneficiaries cease to exist, taking over from the latter, it is believed that they cannot be classified as ‘beneficial owners’ for the purposes of tax monitoring, provided that there are no statutory provisions or other clauses in the instruments of the trust such that they may be recipients of income or patrimonial attributions despite the presence of ‘antecedent interest holders’. With respect to these persons, any attribution arranged in their favor at the trustee’s discretion takes on relevance in the above terms”. Therefore, secondary beneficiaries only report the value of discretionary distributions that were made to them during the year as allowed under the governing law or instrument of the trust.

On September 1, 2022, the Italian Supreme Court issued a ruling (n. 25698) in a case concerning a distribution from a U.S. partnership treated as a taxable dividend in Italy. The dividend was taxed by way of a substituted tax, and Italian tax law did not allow a credit for the income tax paid the taxpayer in the U.S. on the partnership’s underlying profits. At the time of the facts of case, the Italian substituted tax was assessed at the rate of 12.5 percent. The current substituted tax rate is 26 percent. The Court held that the taxpayer was entitled to receive a foreign tax credit for the income tax paid in the U.S. on his share of the partnership’s income taxable in the U.S. pursuant to the provision of Article 23, paragraph 3 of the Tax Treaty between Italy and the U.S., which prevails on Italy’s domestic tax law.

Many commentators saluted the decision with hurrahs, welcoming it as a big victory for taxpayers. Instead, we believe the decision requires more careful consideration, leaves many important details out, and may be open to a big misunderstanding (and potentially constitute a minefield for the ill-advised).  

The Italian substituted tax is a final tax on certain types of income (generally, financial income in form of dividends, interest, and capital gain), when received directly by the taxpayer.  The income subject to the tax is separately stated on the Italian income tax return, and the substituted tax is self-assessed on the return and paid directly by the taxpayer. When the same income is collected through an Italian financial intermediary, the intermediary applies a withholding tax at the same rate and pays it to the Italian treasury.

The separately stated income subject to the substituted tax does not enter the computation of the general taxable income. Foreign-source income does not enter the numerator and denominator of the formula for the calculation of the amount of foreign tax credit. Therefore, no foreign tax credit is allowed on the return for any foreign income tax paid in respect of the income taxed in Italy by way of the substituted tax, potentially resulting into double taxation.  

As usual, the ruling lacks a proper, comprehensive, and organized explanation of the facts of the case. Under the limited facts set forth in the ruling, we understand that the taxpayer had self-assessed on its Italian personal income tax return a substituted tax computed at the rate of 12.5%, in effect at the time, for euro 137,849, which would correspond to an income of euro 1,102,792 (the exact amount of taxable income is not mentioned in the ruling). 

The ruling explains that  the taxpayer had provided substantial documentation evidencing that a tax of euro 299,820 had been paid in the U.S. on the taxpayer’s share of the partnership’s underlying profits. 

The ruling does not provide any information about the amount of income taxed in the U.S., compared to the amount of income taxed in Italy. The U.S. tax applies on the partner’s share of the partnership‘s underlying profits, when earned by the partnership and regardless of their distribution, while the Italian tax applies upon the partnership’s profits distributed to the partner, at the time of the distribution. The two amounts do not necessarily concide.

The taxpayer refrained from paying the amount of the Italian substituted tax he declared on his income tax returns, taking the position that he was entitled to a tax credit for the income tax paid in the U.S., which would entirely offset the Italian substituted tax due.

The Italian Tax Agency issued a notice of collection of the Italian substituted tax as self-assessed by the taxpayer on his Italian income tax return. The taxpayer filed a petition to the Tax Court (in Milan) and won the case. The Tax Agency lost on appeal (in the Regional Court of Lombardy) and filed a petition to the Supreme Court,  setting forth a singled defense in support of its tax collection notice: under the provisions of the Italian income tax code, no foreign tax credit is due for a foreign income tax paid in respect of income subject to a substituted tax in Italy.

The Supreme Court rejected the final appeal and held that the provision of Article 23, paragraph 3 of the tax treaty between Italy and the U.S., which prevails over Italy’s domestic tax law, requires that a foreign tax credit is allowed, except in a case in which the substituted tax applies at the taxpayer’s request. Under the Italian income tax code, the substituted tax is mandatory, and the taxpayer cannot elect that the income be subject the general income tax and claim a tax credit reducing the amount of Italian tax due.    

The ruling’s holding is set forth as follows: 

“For foreign-source capital income, directly received by the taxpayer, a natural person, holder of a non-qualified shareholding in a partnership governed by international law (in this case, US law), if the subjection to taxation by withholding tax – as in the case referred to in art. 27, paragraph 4, of the Presidential Decree no. 600 of 1973, or by means of a substitute tax, completely superimposable on the first due to the identity of the function, pursuant to art. 18, paragraph 1, of the Presidential Decree no. 917 of 1986 – does not take place “at the request of the beneficiary of [the] income”, but compulsorily, since the taxpayer cannot request ordinary taxation, the income tax paid in a foreign country (in the case, the United States of America) must be considered deductible as a credit”.

The ruling stops there and does not elaborate further. Importantly, nothing in the ruling is mentioned about the way in which the income should be taxed under the facts of the case. The logical implication of Article 23, paragraph 3 of the Treaty is that a foreign tax credit is allowed when (and provided tat) the income is taxed as ordinary income under the general income tax computed at graduated rates. 

When we read the ruling, we have the impression that the taxpayer wanted to have his cake, and eat it too: self-assessing the Italian income tax at the reduced substituted tax rate (which is the tax the applies on separately income not part of the ordinary income), and, at the same time, claim a tax credit for the income tax paid in the foreign country, and use it to offset directly substituted tax itself.

That would clearly be a wrong result. 

If the rationale of Article 23, paragraph 3 is that the foreign tax credit applies unless the taxpayer requests that the income is taxed by way of the reduced substituted tax, then a foreign tax credit can be allowed  solely when the income is reported as ordinary income and taxed under the general income tax at graduated rates.

In other terms, there are two possible tax regimes, one under the Italian income tax code and one under the code as modified by the Treaty: taxation by way of the substituted tax without foreign tax credit, or taxation under the general income tax at graduated rates with a foreign tax credit that reduces the amount of Italian tax due. 

Using the numbers mentioned in the ruling, the two alternative tax regimes would work as follows:

  1. First scenario (Italian income tax code): taxable income euro 1,102,792, final 12.5% substituted tax euro 137,849, no foreign tax credit, total tax (in Italy and the US) euro 437,669,
  • Second scenario (Italian income tax code and article 23, paragraph 3 of the treaty): taxable income euro 1,102,792, Italian regular tax before credit euro 474,200.56 (using a 43% marginal tax rate), foreign tax credit euro 299,820, Italian tax after the credit euro 174,380.56, total tax in Italy and the US euro 474,200.56.

In the case decided in the ruling, the substituted tax with no foreign tax credit still appears to be more favorable option.

With the substituted tax calculated at the current rate of 26%, the result would be the following:

  1. First scenario (Italian income tax code): taxable income euro 1,102,792, final 26% substituted tax of euro 286,725.92, no foreign tax credit, total tax in Italy and the US euro 586,545.92,
  • Second scenario (Italian income tax code and article 23, paragraph 3 of the treaty): Italian regular tax (before credit) of euro 474,200.56 (using a 43% marginal tax rate), foreign tax credit euro 299,820, Italian tax after the credit euro 174,380.56, total tax in Italy and the US euro 474,200.56.

In the latter case, the regular income tax with the foreign tax credit appears to be substantially more favorable than the substituted tax regime with no foreign tax credit.

Taxpayers should carefully consider their options, but should not reasonably expect to be able to simultaneously assess the Italian tax at the substituted tax rate and get a full tax credit for the foreign income tax directly deductible from the substituted tax 

In its Ruling n.83 of February 14, 2022, the Italian Tax Agency confirmed that Italy’s substituted tax regime (so-called flat tax, or forfeit) for high net worth individuals applies in a case in which international executives or managers of multinational companies perform their functions partly in Italy and partly outside of Italy, where the group’s local subsidiaries or business units are located. Italy operates a special tax regime by means of which a foreign or Italian national who has not been a resident of Italy in at least nine of the previous ten tax years, can move to and establish his or her tax residency in Italy, and elect to pay a fixed tax of 100,000 euro per year in substitution of the regular income tax on his or her foreign source income. The election is effective for fifteen years (but the taxpayer can opt out of the regime prior to the completion of the fifteen-year period without paying any additional tax). The repatriation of the income does not trigger any additional tax, and the taxpayer can work or engage in a business in Italy while being taxed under the substituted tax regime. In that case, any Italian source income is taxed under the regular income tax. For the purpose of the substituted tax, the source of the income is determined under the sourcing rules of the Italian income tax code. For employment or professional services income the source is the place where the employment is carried out or the services are performed. In ruling n. 83, the Tax Agency held that the employment income of an international executive or managerial personnel working partly within and partly without Italy for a multinational enterprise is allocated to Italian sources or foreign sources based on the number of days spent in Italy and abroad. The days in the computation can be calendar days or working days, with any fraction of a day spent in Italy counting as a full day. Depending on the nature of the functions performed (preparatory and ancillary work, compared to actual work performed on a project), the allocation based on “working” days can lead to a significant amount of income being allocated to a foreign source (or vice versa). The same is true in the case of a business or professional services carried out on specific projects. The tax administration also clarified that the same criteria apply for the purpose of determining the source of income arising from stock options, grants, deferred compensation, or similar incentives treated as employment income. In that case, the allocation is made with reference to the portion of the vesting period of the stock options or grants during which the employment was carried out in Italy and abroad. Upon exercise, the value of the stock allocated to the part of the vesting period in which the work was carried out abroad is foreign-source income falling within the scope of the substituted tax.

On October 20, 2022, Italy’s Tax Administration issued Circular 34/E providing final guidance on the Italian taxation of trusts. One section of the guidance discusses the new anti-abuse rule on the taxation of income distributions from foreign trusts to Italian resident beneficiaries. Article 44, paragraph 1, letter g-sexies of the Italian Income Tax Code, as amended by article 13 of law decree n. 124 of October 26, 2019 (effective from the year 2020) provides that income distributed to Italian resident beneficiaries from foreign trusts and other similar legal arrangements established in countries or territories which are considered fiscally privileged jurisdictions, with respect to the income of the trust, are subject to Italian income tax in the hands of the beneficiaries when distributed, even when they are distributed from fiscally opaque trusts. The general rule provides that foreign fiscally opaque trusts are treated as separate taxable entities, for Italian income tax purposes, and can distribute their income to Italian resident beneficiaries free from additional income tax upon the beneficiaries in Italy upon the receipt of the income from the trust. The provision of article 44, paragraph 1, g) sexies is designed to operate as an anti-abuse rule aimed at allowing the assessment of an Italian final income tax upon beneficiaries who receive trust income that has not been subject to a sufficient level of taxation in the foreign jurisdiction of the trust. The rule applies a nominal tax rate test pursuant to which a foreign country qualifies as fiscally-privileged jurisdiction, for the purpose of the anti-abuse rule, whenever the nominal rate of tax on the income of the trust in the foreign jurisdiction where the trust is established is not at least 50 percent of the tax rate that would apply in Italy to an Italian trust. The Italian-referenced tax rates are the 24 percent rate applicable to the general income of the trust or the 26 percent rate applicable to financial investment income (dividends, interest, and capital gains). The test focuses on the nominal tax rate applicable in the foreign jurisdiction of the trust and requires taking into account special tax regimes which are not structurally applicable to the generality of taxpayers but apply solely to specific classes of taxpayers selected in consideration of taxpayer’s specific subjective characteristics or for limited periods of time and which, without providing for a reduction of the nominal tax rate, grant exemptions or a reduction of the taxable base resulting in a total tax falling below the 50 percent threshold, and also provided that, when a special tax regime applies solely to specific items of income arising from specific activities included in those generally carried out by the trust, the activities eligible for the special tax regime must be predominant, as measured with reference to the income arising from those activities compared to the total revenue or income of the trust. In its final guidance, the Tax Administration clarifies that the term “established” must be interpreted as “resident”, for the purposes of the foreign jurisdiction’s income tax or, for trusts that are not taxed as “resident” in the foreign jurisdiction, even though they are established under that jurisdiction’s trust laws and administered there, the foreign jurisdiction where the trust is set up administered under local trust laws. Therefore, when a foreign jurisdiction does not tax a trust established and administered within its territory, the test is automatically failed. By way of an example, the Italian Tax Administration in its final guidance specifically refers to UK trusts (i.e,., trusts created and administered under UK laws), which are administered by two or more co-trustees, at least one of which is a non-UK resident or domiciliary, and have a non-UK resident or domiciliary settlor, and, as such, are treated as offshore trusts totally exempt from income tax in the UK either upon the trust os its beneficiaries. According to the guidance, under those circumstances, the UK trust fails the test and Italian resident beneficiaries are taxable upon receipt of income distributions from the trust in Italy. Consequently, Italian trust structures based on the use of UK offshore trust should be reconsidered in light of the Tax Administration’s stand as clarified in the guidance. A similar fate is reserved also for trusts established in traditional low or zero-tax jurisdictions. The UK example seems to differentiate from or stand in contrast with that of US foreign trusts, which are subject to a nominal 30 percent tax rate on their income and may qualify from a generally applicable tax exemption for income earned in the form of capital gains or interest which are not attributable to an office or a fixed place of business located in the United States. More generally, Italian taxpayers’ trust planning strategies should be reviewed in light of the guidance and the potential application of the anti-abuse rule as clarified therein.

On October 20, 2022 the Italian Tax Administration issued Circular n. 34/E (Circolare Trust n. 34 del 20 ottobre 2022) providing final guidance on Italian taxation of trusts. One issue addressed in Circular 34 deals with the application of the Italian gift tax with respect to a transfer of property into a foreign trust or distributions of property from a foreign trust to Italian resident beneficiaries. The Tax Administration conceded that the transfer of a property into a trust is a non-taxable transaction for Italian gift tax purposes. That view is consistent with the Italian Supreme Court’s ruling n. 8082 of 2020 according to which the gift tax applies only when there is a final and definitive transfer of property to a named individual, who acquires full ownership, direction, and enjoyment of the property and derives a direct economic benefit from it. According to the Supreme Court, the transfer of property into a trust and the appointment of a trustee with the power to administer, manage, and (possibly) dispose of the property and ultimately distribute the trust’s principal and income to a beneficiary, an “indirect gift” is set in motion, whereby the transfer of the property to the trustee is the first step, the holding, management or administration of the property by the trustee is the intermediate step, and the final distribution of the trust’s property out of the trust to the beneficiary is the final step. During the first two steps, the gift is still in progress and incomplete. At the time of step three, the gift is complete, and the gift tax becomes due. The gift tax, if due, is assessed on the fair market value of the trust’s property which is distributed to the beneficiary. If, according to the terms of the trust, a beneficiary has the right to receive distributions out of the trust’s principal that are not subject to the discretion of the trustee, that distribution, when carried out, is treated as a taxable gift. Under the Supreme Court’s “gift in progress” theory, which is now upheld by the Tax Administration, the original settlor is the donor, the trustee is the intermediary carrying out the transaction in accordance with the settlor’s intent as reflected under the terms of the trust agreeement, and the beneficiary who receives a final and definitive distribution of the trust’s property is the donee. According to the Tax Administration, the establishment of a trust is a complex but unitary transaction, which must be considered as a whole, namely, as comprising various steps that start with the transfer of property to the trustee (to be administered in the ultimate interest of the trust’s beneficiaries) and finishes with the distribution of the trust’ property to a trust’s beneficiary. In a cross-border context, the issue is how the Italian gift tax applies, considering that the Italian gift tax is due on a worldwide basis – namely, on any gifted property located either in Italy or abroad -, when the donor is an Italian resident individual, or on a territorial basis – meaning, solely on property located in Italy -, when the donor is a nonresident individual. In this respect, the Tax Administration in its Circular 34 clarifies that when the settlor of a trust is a resident individual, the gift tax applies to any distribution of property from the trust, wherever the property is located in the world, while, when the settlor is a nonresident individual, the gift tax applies solely to the distribution of a trust’s property located in Italy. Under the Supreme Court’s gift-in-progress (or indirect gift) theory (according to which the gift begins at the time of the initial transfer of a property into the trust), and the Tax Administration’s unitary transaction theory, the residence of the settlor with reference to which the potential application of the Italian gift tax is determined should be the residence of the settlor at the time of the (initial) transfer of property into the trust. In a simple situation, in which the transfer of property to the trust occurred entirely at a time in which the settlor was a nonresident individual, and the distribution of trust’s property to a beneficiary takes place after the settlor has become an Italian resident individual, it would seem reasonable to believe that, whenever the distributed property is located outside of Italy, no Italian gift tax should apply. In more complex situations, in which there have been multiple transfers of properties into a trust at different times, both before and after the settlor has become an Italian resident individual, and there are distributions of trust’s property after the settlor has become an Italian resident individual, tracking the various distributions to property trasferred before or after the starting of the settlor’s Italian tax residency may prove more complex. In conclusion, even after the issues of the final guidance of Circular 34, material issues remain that require taxpayer’s attention. Also, proper planning and careful review should be considered, with respect to foreign trusts created before or already in place after establishing Italian tax residency.

In its Ruling n. 359 of July 4, 2022 (Risposta n._359 of 04.07.2022), the Italian Tax Agency ruled that a trust which is disregarded for income tax purposes under the standards of Circular n. 61/E of December 27, 2010, is still respected as a complete and effective trust for Italian gift and estate tax purposes. As a result, the assets of the trust fall outside of the decedent’s estate, are not transferred by reason of death (but pursuant to the terms of the trust), and are not subject to Italian succession procedure or the estate tax.

Under Italian Tax Law, trusts are classified into three categories:

– disregarded trusts,
– fiscally transparent trusts,
– fiscally opaque trusts.

Disregarded trusts include revocable trusts (i.e., trusts which can be freely revoked by the settlor, the beneficiaries, or third parties during the settlor’s life) and irrevocable trusts with respect to which the settlor remains in control of the trust by directing the actions of the trustee or retaining substantial powers relating to the administration and disposition of the trust’s assets or the distribution or enjoyment of the trust’s assets or income. Circular n. 61/E of December 27, 2010, sets forth the standards which apply to determine whether a trust should be disregarded underrate the control or beneficial enjoyment test. A trust can be disregarded with respect to its beneficiaries when the beneficiaries are in control or retain a direct economic enjoyment of the assets or income of the trust. The income of a disregarded trust retains the same character and source that it has in the hands of the trust and is taxed upon the settlor (or the beneficiaries) as if he or she (or they) were the owner of the assets of the trust. Income in the nature of dividends, interest, and capital gains are taxed through the 26 percent substituted tax. Also, the settlor or the beneficiaries are required to report any assets of the trust which are located outside of Italy on their personal income tax return.

Fiscally transparent trusts are irrevocable trusts that identify the beneficiaries of the trust’s income and require that the trustee distributes the trust’s income to the beneficiaries currently (or under specific circumstances outside the trustee’s discretion). A fiscally transparent trust is respected for income tax purposes, but its income is allocated to and taxed directly upon the beneficiaries. The trust’s income is treated as Italian source or foreign source income depending on the tax residency (i.e., place of establishment or administration) of the trust, falls within its own category (income from the trust), and is taxed as general (or ordinary) income at graduated rates.

Fiscally opaque trusts are irrevocable, discretionary trusts that do not have identified income beneficiaries (i.e., no beneficiary has the right to claim the distribution of the trust’s income, which is left to the trustee’s discretion). Fiscally opaque trusts are separate taxpayers, subject to tax in Italy their worwldwide income in case of Italian residents in Italy, or on Italian source income in case of nonresident trusts. The trust’s income can be distributed to Italian resident beneficiaries free from any additional Italian income tax.

Ruling n. 359 concerns the case of a trust that the Italian Tax Agency, in a separate ruling (Risposta n. 796_of 01.12.2021), held should be disregarded for Italian income tax purposes because the Trustee in administering the trust was subject to the directions and consent of the Settlor, acting as Guardian, and the indirect control of the beneficiaries who had the power to revoke and replace the Trustee and the Guardian. Therefore, the trust’s income was attributed and taxed directly to the Settlor. In its Ruling 359, the Tax Agency dealt with the issue of whether the trust should be respected for inheritance purposes and whether the trust’s assets should be considered as falling outside the estate of the Settlor at the time of his death. On that issue, the Tax Agency ruled that the trust is respected for Italian gift and estate tax purposes. As a consequence, upon the death of the settlor, the trust’s assets are outside the settlor’s estate and are not subject to the Italian succession procedure (probate) or Italian estate tax.

Ruling n. 359 is consistent with Ruling n. 398 of June 10, 2021(Risposta n. 398 of 10 giugno 2021), in which the Tax Agency ruled simultaneously on the issue of the imputation of the income of the trust and the issue of the application of the Italian inheritance and gift taxes at the time of the final distribution of certain trust assets upon the death of the settlor.

Ruling 398 deals with two trusts, set up by Husband and Wife (settlors), in which the settlors had retained some substantial powers of control over the management, disposition and use of the trust assets and beneficial enjoyment of trust income. One trust (Trust 1) had been created and funded by Wife, an American and Italian citizen who was resident in the U.S. at the time of the creation and funding of the trust but had moved to and was resident in Italy at the time of her death. Another trust (Trust 2) had been created and funded by Husband, an American citizen who was living in the US at the time of the creation and funding of the trust. The trusts held US bank accounts and not assets located in Italy. Husband died and Trust 2 continued for the benefit of Wife and their children. Wife died, and Trust 1 terminated upon her death, with all trust assets being distributed to Italian resident beneficiaries outright. Upon Wife’s death, Trust 2 continued, with its assets being divided into shares and distributed to trust funds, which would be held and managed in the interest of the children until their final distribution to the beneficiaries.

The Tax Agency ruled that both trusts were disregarded for income tax purposes because the settlors retained extensive powers of the administration and the enjoyment of the trusts’ assets, and the trusts’ income was taxable directly to the settlor.

At the same time, the Tax Agency ruled that both trusts were respected for Italian inheritance and gift tax purposes. For Trust 1, which terminated upon Wife’s death and distributed all its assets to the Italian beneficiaries outright, the Agency ruled that the trust assets were part of Wife’s hereditary estate and subject to Italy’s inheritance tax, noting that Wife as settlor was an Italian tax resident at the time of her death (and therefore, the Italian inheritance and gift taxes applied on worldwide assets). For Trust 2, which continued by distributing its assets to the trust funds for the benefit of the children, the Agency ruled that the Italian inheritance tax applied solely upon trust assets that had been distributed to Wife, prior to her death and were part, as such, of Wife’s hereditary estate, while no inheritance or gift tax was due on the trust assets that had remained in trust at the time of Wife’s death.

With its Resolution n. 83 of 2-14-2022, the Italian Tax Agency ruled on interaction between the Italian special tax regime for high net worth individuals (so called “flat tax” or “lump sum tax” regime) and taxation of Italian source employment income under Italy’s general income tax.

The case involved certain international employees of an Italian financial institution who moved to Italy and elected to be taxed under the flat tax regime, while continuing working for the Italian employer and performing their functions partly in Italy and partly abroad.

Italy operates a special tax regime for individual taxpayers (Italian or foreign nationals) who establish their tax residency in Italy while they have not been Italian tax residents in at least nine of the previous ten years. In that event, upon taxpayers’ election, Italy charges a fixed tax amount of 100,000 euro on taxpayers’ foreign source income, in lieu of its general income tax. Italian source income is taxed under the general income tax regime. Taxpayers are free to repatriate their foreign source income and may cary on an employment or engage in a business, trade or profession while electing for the flat tax. In that case, Italian source business, employment or professional income is taxed separately under Italys’ general income tax regime (by brackets at graduated rates) while foreign source income falls within the scope of the flat tax and is not subject to a separate regular income tax. The election for the special tax regime is done with the filing of the Italian income tax regime for the first tax year in which taxpayers are eligible, or the immediately following year.

Ruling n. 83 addresses two issues: the criteria for the computation of the foreign source and Italian source portions of taxpayers’ employment income and employer’s withholding tax obligations. On the first issue, the Italian Tax Agency confirms that the computation must be done by making reference to the number of working days during which the employee performed his or her functions abroad, over the total number of working days of the year, with fractions of days spent in Italy counting as full Italian working days for the purpose of the computation. The Tax Agency also clarified that the burden of proof falls upon taxpayers, who must be prepared to provide adequate documentation to prove the exact number of working days spent abroad, in the absence of which all days would count against the Italian source portion of the income.

On the second issue, the Italian Tax Agency ruled that the employer must operate the full amount of income withholding taxes as if the special tax regime does not apply, until the employees have elected for the special tax regime and provided evidence of the election (i.e., copy of their income tax return in which the election has been made), together with a requested to be filed the employer. Any excess withholding taxes will be be refunded upon taxpayer’s request.

One of the most prominent features of Italy’s flat tax regime is its flexibility. International executives or entrepreneurs can move to Italy, shelter their foreign source income – generally, income from financial investment and capital gains – from the Italian regular income tax, continue with their business ventures or employment, and minimize their Italian regular income tax by making sure that most of the income arising from their businesses or employment is sourced outside Italy, thereby falling within the scope of the flat tax.

Ruling n. 83 provides some sensible answer to some of the issues which arises in a scenario like the one described above, and confirms that Italian income sourcing rules pay a crucial role in determining the final tax treatment and benefits that taxpayers achieve out of the flat tax.

With its ruling n. 693 of October 8, 2021 (Prassi – AGENZIA DELLE ENTRATE – Risposta 08 ottobre 2021, n. 693), the Italian Tax Agency held that a discretionary beneficiary of a foreign irrevocable trust, treated as a fiscally opaque trust under Italy’s tax classification rules, is required to report his beneficial interest in the trust on his Italian income tax return.

Italian international tax reporting rules requires that Italian resident taxpayers disclose their beneficial interest in (financial, tangible, intangible and real estate) assets held outside of Italy. Reporting is done by filling out section RW of Italian personal income tax return. The duty to report is established in article 4 of Law Decree n. 167 of 1990 In its original formulation, the provision of section 4 requires reporting of foreign assets that the taxpayer owns, directly or indirectly, and which can generate foreign income taxable in Italy. Later on, the reporting was extended to those who are the “beneficial owners” of the reportable foreign assets. For the meaning of the term “beneficial owner”, the amended statute refers to the anti money laundering legislation implementing the EU anti money laundering directives. Under the anti money laundering statute, in case of trusts, for anti money laundering purposes a beneficial owner includes the settlor, guardian, trustee and beneficiaries of the trust.

In some of its previous guidance, the Italian Tax Agency had clarified that the notion of “beneficial owner” for international tax reporting purposes has a narrower meaning, and requires a beneficial interest relationship between the taxpayer and the trust’s income or assets. Under its narrower meaning, a trustee or settlor of the trust do not qualify as beneficial owners and are not subject to reporting (see Circular 53/E of December 23, 2013, Resolution n. 53/E of May 29, 2019, Resolution 506 or October 30, 2020).

Ruling n. 693 concerns a foreign (non Italian) irrevocable discretionary trust, in which the trustee at his absolute discretion can decide to make distributions to certain individuals that belong to a certain class (settlor’s descendants). The trust would be classified as a foreign, opaque (fiscally non transparent) trust, whose income, in the absence of a beneficiary’s right to claim distribution of income from the trustee, is attributed to the trust for Italian income tax proposes and it is not directly taxable upon the trust beneficiaries. According to the taxpayer, the tax duty to report under Law Decree n. 167 requires that a trust beneficiary has control over or a right to receive distributions from the principal of the trust, or has a direct and current claim to the distribution of trust income. Consequently, there should not be duty to report with respect to a foreign irrevocable discretionary trust.

The Italian Tax Agency ruled against the taxpayer and held that a purely discretionary beneficiary of a discretionary trust, if sufficiently identified, also by reference to a class of beneficiaries, must report his beneficial interest in the trust. Reporting should include the value fo the trust and the beneficiary’s share of interest in the trust. In case of a discretionary income beneficiary who is not entitled to receive a specific share of the principal of the trust, reporting may proved to be practically impossible. Indeed, the Italian Tax Agency’s filing software requires that a share is always specified on the turn, and when no share is indicate the filing does not go through.

Ruling n. 693 is consistent with the position taken by the Italian Tax Agency in a draft Circular submitted to public discussion in August 2021, and about to be published in its final form. The draft Circular provides updated guidance on Italian taxation of trusts, and confirms the approach directed at expending the scope of reporting of Italian taxpayers’ beneficial interests with respect to foreign trusts. Penalties for failure to report are substantial, and taxpayers should continue. monitoring the developments in this area to make sure they will stay in compliance with their Italian tax reporting obligations.

With tax ruling n. 18/2022 of January 12, 2022 (Risposta_18_12.01.2022), the Italian tax agency ruled that for the foreign branch tax exemption to apply, a permanent establishment must exist in the foreign jurisdiction, fully taxable in the host country under both foreign country’s domestic tax law and any applicable tax treaty between Italy and the host country. The Italian Income Tax Code allows an Italian corporate taxpayer to elect that the profits attributable to a taxpayer’s branch in a foreign country be exempt from corporate tax in Italy. The default tax regime that applies in the absence of an election allows a tax credit against Italy’s corporate tax, for the amount of foreign income taxes accrued and due in the foreign country, in respect of the foreign branch’s taxable profits. Ruling n. 18/2022 involved an Italian manufacturer of electric and electronic equipment sold in Italy and abroad. The Italian company won the bid for a supply agreement with a foreign client, and in order to serve that agreement it registered a branch in the foreign country, and positioned there a warehouse with equipment and machines, and personnel which would provide technical measurements, testing and training services to its local customer. The Tax Agency argued that for the purpose of the foreign branch exemption of section 168-ter of Italy’s income tax code, a taxpayer must maintain an organization or set of activities in the foreign country which meets the definition of permanent establishment, as set forth under the internal tax laws of the foreign country and the applicable tax treaty, and the permanent establishment must be fully taxable in the foreign country, under local tax laws and the relevant tax treaty. With specific reference to the facts of the ruling, the Tax Agency ruled that the requirements for the exemption were met. The ruling seems to go beyond the scope of the statute governing the foreign branch exemption and require perfect symmetry between the recognition and tax treatment of the branch in the host and home countries.The statutory provision of the Code, on its face, only requires that the taxpayer maintain a permanent establishment in the foreign country, as defined under Italy’s tax code, and does not require any investigation as to whether a permanent establishment or other form of tax presence exist also under local law, and the foreign country actually asserts its tax power over the local branch. In the ruling, the Tax Agency does not address the issue of computation of local branch’s taxable income and amount of foreign tax credit, under host and home country’s and tax laws.

In a series of recent tax rulings, Italy’s Tax Administration ruled that “remote workers” who live in and work remotely in Italy for a foreign employer with no trade or business in Italy can still qualify for the benefits of Italy’s new-resident workers special tax regime.

In 2015, Italy enacted a special tax regime for global workers who move to, and establish their tax residency in Italy.The special tax regime grants a tax exemption for am amount equal to 70 percent of employment taxable income for a period of five tax years. The exempt amount increases o 90 percent if the workers residence is established in one of the country’s southern regions. The exemption period is extended for five more tax years, who the taxpayer has one or more dependent minor children or owner or purchases a real estate property in Italy at any time during the first five-year exemption period. The exempt amount in the second five-year period is equal to 50 percent of taxable employment income, and increases to 90 percent when the taxpayer has three or more dependent children. One requirement for the exemption is that the taxpayer performs his or her services primarily in Italy, and the exemption applies solely to Italian source income.

With effect from tax year 2020, Italy extended the special tax regime to professional income (i.e., professional income earned from personal services performed as independent contractor) and business income (i.e., income arising from a trade or business). The exemption has also been extended to workers who work for foreign-headquartered employers and professionals with foreign-based clients.

In a series of recent tax rulings, Italy’s tax administration, addressing an issued that had emerged during the initial phase of Covid-19 in 2020 and early 2021, has ruled that, as a general rule, the special tax regime applies also to “remote workers” who decide to move to and establish their tax residence in Italy, and work remotely for a foreign employer which has neither a place of business nor any trade or business activities in Italy.

Ruling n. 596/2021 of September 16, 2021 deals with the case of an Italian citizen who move to Italy in May 2021 to work remotely for a U.S. employer. Ruling n. 621/2021 of September 23, 2021 deals with the case of a Dutch employee of an Italian company, who moved to Italy and was employed under Italy’s special tax regime, but during 2020 was forced to remain in the Netherlands and perform his work for the Italian employer in remote mode from there, due to Civid related traveling restrictions. The tax agency ruled that the income earned while working remotely from the Netherlands was not Italian source income, based on Italy’s tax code’s place of performance source rule, and did to qualify for the exemption. Ruling n.2/2022 of January 7, 2022 deals Wirth the case of an Italian citizen who moves back to Italy from Switzerland to work remotely for her Swiss employer. Finally, ruling n. 32/2022 of January 19, 2022 deals with the case of an Italian citizen who moved to Italy to work remotely as independent advisor for several foreign companies (in addition to her for some Italian clients).

In all situations described above, a related issue arises, concerning the possibile existence of a permanent establishment of the foreign employer in Italy, as a result of foreign employer’s maintaining a permanent employee based and working within the Italy territory. The fact that the foreign employer does not otherwise do business in Italy, that the services of the Italian employee are not connected with or performed in furtherance of a business operated by the foreign employer in Italy, that the location of the employee in Italy is set up at the employee’s sole convenience, and that the foreign employee keeps a fixed base regularly available to its Italian employee outside of Italy, are all important factors to consider when addressing the issue. Perhaps, additional guidance will come in the future from the tax administration, considering the constantly growing cases of global workers and professionals moving to Italy and working remotely for foreign employer and customers from their Italian location.