On December 4, 2008 Italy’s tax administration issued resolution n. 471/E of December 4, 2008, in which it ruled on the change of tax residency of individuals during a tax year.
According to the ruling, if a foreign individual who is resident in Italy for tax purposes returns to his or her home country and terminates his or her residency in Italy during the second half of a year, his or her Italian tax residency continues through the end of that year and he or she continues to be taxable in Italy as resident on his or her worldwide income until the end of that year.
The ruling clarifies that the potential double taxation that arises in the above circumstances cannot be resolved under the tie breaker rules of a tax treaty between Italy and the taxpayer’s home country, pursuant to which the tax residency of the taxpayer for that year is allocated between Italy and the taxpayer’s home country and taxpayer is treated as partly resident in Italy and partly non resident in Italy (for the second part of the year, in which he left Italy and moved back to his or her home country) unless that tax treaty contains specific provisions that provide for the part time residency.
As a consequence, the only remedy to double taxation might be to claim the foreign tax credit granted in Italy for the taxes charges in the home country on income from sources within that country.
Ruling 471/E highlights the need of a careful planning before moving away from Italy to a foreign country during a tax year, in order to avoid a potential extended exposure to Italian taxation.
Italian Rules on Tax Residency for Individuals
Under Italian law, an individual taxpayer is treated as resident in Italy or tax purposes, and subject to tax in Italy on his worldwide income if he or she meets one of three alternative tests for more than 183 days during the tax year:
(1) he or she is registered in the official register of Italian residents;
(2) he or she maintains his or her residence in Italy, or
(3) he or she maintains his or her domicile in Italy.
For the purposes of test n. 2, residence is defined as the place where a person habitually lives. For the purposes of test n. 3, domicile is defined as the main center of an individuals interests and affairs (which include personal, social, business and economic interests).
Either test must be met for at least 183 days during a tax year.
First and Last Day of Residency Rules.
If a taxpayer moves to Italy during the first half of a year, he or she is treated a resident in Italy for tax purposes from the first day of the year. Conversely, if a taxpayer moves to Italy in the second half of a year, he or she is treated as resident in Italy for tax purposes from the first day of the following tax year.
If a Italian resident taxpayer moves to a foreign country during the first half of a year, his or her Italian tax residency terminates (and he or she is treated as a non resident) starting back from the first day of that year.
If an Italian resident taxpayer moves to a foreign country during the second half of the year, his or her tax residency terminates (and he or she is treated as a non resident) from the first day of the following year.
The first and last day of residency rules creates tremendous planning opportunity but also dangerous traps for the unwary.
If an individual arrives in Italy on July 1 of year 1 and leaves Italy on June 30 of year 2, he or she will never be considered resident in Italy for tax purposes at any time in either year 1 or year 2.
Conversely, if an individual arrives in Italy on June 30 of year 1 and leaves Italy on July 1 of year 2, he or she will be considered resident in Italy for tax purposes for the entire duration of year 1 and year 2
Tax Treaty Rules.
Under the typical article 4 of a double income tax treaty, if an individual is resident of both contracting states under the national rules of each of those state, the residency is attributed to the contracting state in which the taxpayer had his or her permanent home, main center of vital interests of place of habitual abode (or of which he or she is a national, as last resort rule).
If the taxpayer lived partly in one country and partly in another country during a year, the tax residency can be split between the two countries during a single year according to criteria set forth above.
Facts of the Ruling.
In 2002 a Swedish national individual moved with his family to Italy, where he started working as employee of the Italian subsidiary of a Swedish company. He registered as resident in Italy and was treated as resident in Italy for tax purposes, subject to tax in Italy on his worldwide income. In 2007 his employment with the Italian subsidiary terminated and, as a consequence on July 10, 2007 he canceled himself from the register of Italian residents and moved back to Sweden.
When filing for the year 2007, the taxpayer took the position that under article 4, paragraphs 1 and 2 of Italy-Sweden double tax treaty he should be treated for that year as resident in Italy for the period from January 1 to July 10 and resident in Sweden for the period from July 11 and December 31, and that as a non resident in Italy he was not subject to tax in Italy on his Swedish income earned in the second part of the year.
The tax administration clarified that, under Italian internal law, Italy’s tax residency continued through the end of 2007.
Dealing with the tax treaty issue, the Italian tax administration observed that certain Italian tax treaties contain an express provision that provides for a split of the tax residency between Italy and the other contracting state during a tax year in which an individual partly lived in Italy and partly lived abroad. That is the case, for instance, of the tax treaties with Switzerland (article 4, paragraph 4) and Germany (article 3 of the Protocol).
As a consequence, according to the tax administration, when a similar provision is not included in a tax treaty, it means that Italy has not agreed to waive from the application of its "once a resident, always a resident" rule extending the Italian tax residency to the entire year, in case the taxpayer leaves Italy in the second half of the year, and Italy in general is not bound by the interpretation of article 4, paragraph 2 of the treaty suggested in paragraph 10 of the Commentary to article 2 of the OECD model treaty.
In the case of Italy-Sweden treaty, the treaty does not contain such specific provision on the change of residency during the year. As a consequence, according to the tax administration, the taxpayer is subject to tax in Italy as resident in Italy for tax purposes also on his income earned from services performed in Sweden in the second half of 2007, and the only remedy to double taxation is the foreign tax credit.
Had the taxpayer moved to Sweden on June 30, 2007 his Italian tax residency would have terminated on January 1, 2007; as a consequence, he would not have been taxed in Italy on his Swedish income for the period July 1-December 31, 2007, and would have been taxed as a non resident on his Italian source income for the period January 1-June 30 2007.