In its ruling no. 267, dated March 27, 2023 (Risposta-n.-267_2023.pdf), the Italian Tax Agency addressed a case involving a trust where the Settlor reserved the power to revoke and replace the Guardian and retained certain powers related to the shares of a company he transferred to the trust, including the power to appoint the majority of the company’s directors and the company’s auditors. The Guardian, in turn, held significant powers to advise the trustee, direct some of the trustee’s decisions regarding the administration of the trust, and the power to amend and terminate the trust. In a 2015 ruling, the Tax Agency determined that such a trust would be considered interposed and disregarded for all tax purposes.

In Italy, a trust is considered interposed when the Settlor directly or indirectly maintains a sufficient level of control over the administration and enjoyment of the trust’s principal and income, resulting in the Settlor still being treated as the owner of the trust’s principal and income for both income and inheritance tax purposes. The taxpayer modified the trust and submitted a new ruling request.

With the amendments to the trust agreement, the Settlor relinquished his power to change or add new beneficiaries, issue recommendations to the trustee, and vote for the election of the company’s directors and auditors. The amended trust agreement also mandates the consent of a beneficiary (or the majority of the beneficiaries in case of disagreement among them) for the Settlor’s decision to revoke and replace the Guardian. The Settlor designated his descendants as the sole beneficiaries of the trust. Notably, the power to replace the Guardian did not necessitate that the Settlor appoint a new Guardian who is independent of and not subservient to the Settlor.

In ruling no. 267, the Tax Agency determined that the amended trust should still be considered interposed and consequently disregarded for all tax purposes. According to the Tax Agency, a trust where the trustee acts upon the direction of the Guardian, and the Settlor possesses the unconditional and unlimited power to replace the Guardian, subject only to the consent of a beneficiary, remains under the substantial, albeit indirect, control of the Settlor. As a result, the trust assets are part of the Settlor’s estate and subject to inheritance tax, and the income generated from the trust property is directly taxed to the Settlor.

In light of this ruling, taxpayers should reevaluate their trust planning structures and ensure that the combination of provisions governing the powers of trustees, trust advisors, trust protectors, guardians, and other individuals or entities involved in the administration of the trust, distribution of trust principal and income, and changes to or termination of the trust, are appropriately drafted and coordinated to avoid the risk of the Settlor ultimately being considered the dominus of the trust, causing the trust to fail in achieving its objectives.

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The Italian Tax Agency recently issued a ruling (n. 251 of March 16, 2023) that provides guidance on the Italian tax classification of Family Trusts and Testamentary Trusts and the taxation of Italian beneficiaries on the trusts’ income.

Background

The settlor, an Australian national, established the trusts while he was a resident of Australia. He later moved to Italy, where he passed away. The trusts owned rental real estate and other financial investments located in Australia.

When he was alive, the settlor treated the trusts as fiscally interposed and reported the property and income of the trusts on his Italian personal income tax return. The settlor was also one of the beneficiaries of the trusts and the owner and manager of an Australian company that acted as the trustee of the trusts.

After the settlor’s death, his children were appointed as executors of his will, trustees, and beneficiaries of the trusts. One of the children filed a ruling request with the Tax Agency, asking for clarification on the trusts’ tax classification and the taxation of the trusts’ income.

Tax Classification of the Trusts

The Tax Agency ruled that both trusts should be considered fiscally interposed with respect to the beneficiaries, who had retained the function of trustees of the trusts after the death of the settlor. In that regard, the fact that the petitioner had waived his appointment as executor of the will and had not performed any function with respect to the administration of the trusts was considered irrelevant.

Taxation of Trust Income

The Tax Agency ruled that the real estate income should be computed with reference to the gross rents without any deduction. The Italian beneficiaries would be entitled to deduct a foreign tax credit for a portion of the income taxes paid in the foreign country on that income, in proportion to the amount of income they have declared in Italy.

Conclusion

This ruling provides important guidance on the tax treatment of Family Trusts and Testamentary Trusts in Italy. It clarifies the tax classification of trusts and the taxation of trust income for Italian beneficiaries. This ruling will be of interest to individuals and businesses with cross-border investments and trusts in Italy.

The Italian Tax Agency recently issued Ruling n. 237 of March 2, 2023 (Risposta-n.-237_2023.pdf), which clarifies foreign trusts’ tax treatment concerning Italian tax resident beneficiaries.

Under the ruling, when the trustee of a foreign trust is required to make an annual distribution to beneficiaries based on a predetermined percentage of the fair market value of the trust, calculated at a fixed date, the trust must be considered fiscally transparent. In this case, beneficiaries are taxed in Italy on the income of the trust proportional to their interests in the trust, as specified in the trust agreement, on a fiscally transparent basis. This applies regardless of the actual distribution of income to the beneficiaries during the tax year.

The ruling considers a case in which a foreign national created a trust for her husband and three children. Her husband was entitled to a 25% share, and the three children were entitled to equal shares of the remaining 75% (or 100% if the husband predeceased her). Upon their death, their shares were held in separate trusts to benefit each child or their descendants. The trust was governed by US law and administered by an institutional trust organized in the US. The trustee was required to make an annual distribution of as much income or property of the trust that represents 4.5% of the total fair market value of the trust as of the last day of the third year preceding the year of the distribution.

The taxpayer who filed the ruling request took the position that (1) she was not required to file any inheritance income tax return with respect to her share of the assets of the trust she received in trust upon her father’s death, (2) she was not required to report the value of her trust on her Italian income tax return, and (3) the annual distribution she was entitled to should be reported as income from capital, for an amount equal to the value (in cash or other property) that is actually distributed by the trustee to the beneficiary during the year and is taxed by way of the substituted tax at the fixed rate of 26%.

The Tax Agency ruled that the assets that were distributed upon the death of the primary beneficiary to the secondary beneficiaries were not part of the decedent’s estate and were not subject to inheritance tax in Italy. The Tax Agency ruled that the petitioner is required to disclose the value of the trust and her interest in the trust in her Italian income tax return, considering that she is a mandatory beneficiary with the right to receive the distribution of at least 4.5% of the value of the trust annually.

On the issue of whether the annual distribution should be reported as income from capital, the Tax Agency ruled that the entire trust should be classified as fiscally transparent. This means that the taxpayer would be subject to tax in Italy on her share of the trust’s income, which is attributed and taxed to the taxpayer on a look-through basis, regardless of its distribution. The trust income is part of the taxpayer’s general taxable income and is taxed at progressive rates. The amount of distribution that the taxpayer receives each year from the trust is ignored for Italian income tax purposes.

It’s important to note that the ruling on the third issue is questionable and may be affected by how carefully the taxpayer presented her case. Under Italian tax law, a trust is partially fiscally transparent and partially fiscally opaque when the trust agreement does not provide that a beneficiary has the right to the distribution of the trust income as such, but instead provides that a certain percentage of the value of the trust must be distributed to the beneficiary. In that case, the trust is fiscally transparent regarding a portion of the trust income not exceeding the share of the trust.

With its Ruling n. 237 of March 2, 2023 (Risposta n. 237-2023), the Italian Tax Agency ruled that when the trustee of a foreign trust is required to make an annual distribution to the beneficiaries of the trust of cash or other property of the trust that represent a predetermined percentage of the fair market value of the trust calculated at a fixed date, that trust must be considered fiscally transparent, and the beneficiaries are taxed in Italy on the income of the trust which is proportional to their interests in the trust, as specified in the trust agreement, on a fiscally transparent basis and regardless of the actual distribution of income to the beneficiaries during the tax year. The case considered in the ruling concerns a trust constituted by a foreign (non-Italian) national in favor of her husband for a share of 25% and her three children in equal shares, for the remaining 75% (or 100% if her husband predeceased her), and upon their death, to their descendants. The children’s or their descendants’ shares will be held in a separate trust to benefit each of them. The trust is governed by the laws of the State of the United States and is administered by an institutional trust organized in the United States. The trust agreement provides that until a beneficiary reaches the age of 35, the trustee is authorized to distribute to that beneficiary all or part of the income of his or her trust as required for the beneficiary’s health, education, maintenance, and support and when a beneficiary reaches the age of 35, the trustee is required to distribute currently to that beneficiary the annual income of his or her trust for life. Upon the grantor’s death, the trust was divided into two trusts to the benefit of the settlor’s children. Upon the death of one of the children, his trust was divided into two equal shares held in trust in favor of the decedent beneficiary’s children. Upon the trustee’s petition, the Court in the U.S. with jurisdiction over the trust issued an order amending the terms of the trust and requiring that the trustee makes an annual distribution of as much income or property of the trust that represents 4.5% of the total fair market value of the trust as of the last day of the third year preceding the year of the distribution. The taxpayer who filed the ruling request took the position that (1) she was not required to file any inheritance income tax return with respect to her share of the assets of the trust she received in trust upon her father’s death, (2) she was not required to report the value of her trust on her Italian income tax return, and (3) the annual distribution she was entitled to should be reported as income from capital, for an amount equal to the value (in cash or other property) that is actually distributed by the trustee to the beneficiary during the year and is taxed by way of the substituted tax at the fixed rate of 26%. On the first issue, the Tax Agency ruled that the assets that were distributed upon the death of the primary beneficiary (the grantor’s child) to the secondary beneficiary (the decedent beneficiary’s children) were not part of the decedent’s estate and were not subject to inheritance tax in Italy. The Tax Agency does not elaborate, but the conclusion on that issue is likely predicated upon the facts that the grantor was not an Italian domiciliary at the time of the creation and initial funding of the trust, and the trust assets were not located in Italy at the time of the primary beneficiary’s death. On the second, the Tax Agency ruled that the petitioner is required to disclose the value of the trust and her interest in the trust in her Italian income tax return, considering that she is a mandatory beneficiary with the right to receive the distribution of at least 4.5% of the value of the trust annually. Tax Agency ruled that the trust should be classified as fiscally transparent on the third issue. Consequently, the taxpayer would be subject to income in Italy on her share of the trust’s income, which is attributed and taxed to the taxpayer on a look-through basis, regardless of its distribution. The trust income is part of the taxpayer’s general taxable income and is taxed at progressive rates. The amount of distribution that the taxpayer receives each year from the trust is ignored for Italian income tax purposes. The ruling on the third issue is questionable and may be affected by how carefully the taxpayer presented her case. Under Italian tax law, a trust is partially fiscally transparent and partially fiscally transparent when the trust agreement does not provide that a beneficiary has the right to the distribution of the trust income as such, but, rather, it provides that a certain percentage of the value of the trust must be distributed to the beneficiary. In that case, the trust is fiscally transparent regarding a portion of the trust income not exceeding the share of the trust value that must be distributed to the beneficiary. The ruling, on its face, seems to conclude that the entire trust is fiscally transparent, and the beneficiary is taxed on her share of 25% of the entire income of the trust. Under the partially fiscally transparent-partially fiscally opaque trust, she would be subject to tax on a share of the income of the trust not exceeding 4.5%.

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.