In two very important decisions issued on December 23, 2008, the Italian Supreme Court for the first time held that the Italian tax system contains a general anti-avoidance principle deriving directly from the Italian Constitution, pursuant to which the tax administration can disregard a transaction entered into for no real economic reasons, but for the sole purpose of obtaining a tax advantage.
According to the Court, the general anti-avoidance principle derives from article 53 of the Italian Constitution, establishing that everybody must pay taxes according to their ability to pay, at higher rates for higher income, and it is a general principle of the tax system that applies on top of and above any other specific anti-avoidance provisions of the tax code.
The first decision, n. 30055 of December 23, 2008 (Supreme Court n. 30055-08.PDF) concerns a "dividend washing" transaction. An Italian company purchased stock from an Italian investment fund immediately before the payment of a dividend declared on the stock, at a purchase price reflecting the amount of the dividend declared and payable on the stock.
The Italian company collected the dividend and received a tax (imputation) credit for an amount equal to the underlying corporate taxes paid by the issuer of the stock on the profits out of which the dividend was paid, which eliminated the tax on the dividend for the buyer. If collected by the investment fund, the dividend would have been subject to a gross basis withholding tax.
Immediately thereafter, the Italian company sold the stock back to the investment fund at a price equal to the purchase price less the amount of the dividend, thereby realizing a taxable loss which reduced its taxable income.
The tax administration denied the benefit of the tax loss under the theory that the the real beneficial owner of the dividend was the investment fund and the Italian company acted merely as a conduit for the collection of the dividend on behalf of the fund.
At the time of the facts of the case, the provision of article 14, paragraph 6-bis of the tax code denying the dividend tax credit for dividend distributed to companies which have bought stock from investment funds after the declaration but before the payment of the dividend had no been enacted.
The second decision, n. 30057 of December 23, 2008 (Supreme Court n. 30057-08.PDF) concerns a "dividend stripping" transaction. A U.S. company not engaged in business in Italy owned stock of an Italian company and transferred the right of use of that stock (so called usufruct), including the right to collect the dividends on the stock, to another Italian company, at a price reflecting the amount of the dividends that were reasonably expected to be declared on the stock during the time of the contract.
Italian tax law treats the dividend equivalent amount paid to the transferor of the usufruct as foreign source income not taxable in Italy.
The Italian company collected the dividends and received a tax (imputation) credit for an amount equal to the underlying corporate taxes paid by the issuer of the stock on the profits out of which the dividend was distributed, which eliminated the tax on the dividend, and took amortization deductions for the the cost of the usufruct, which reduced its taxable income.
If paid to the U.S. company, the dividends would have been subject to a gross basis withholding tax.
The tax administration denied the amortization deduction on the ground that the Italian company was not the real beneficial owner of the income but acted merely as a conduit for the collection of the dividends on behalf of the U.S. company.
At the time of the facts of the case, the provision of article 14, paragraph 7-bis denying the tax credit for dividends collected by Italian companies which purchased the usufruct on the stock from foreign companies had not been enacted.
The Supreme Court held that the transactions lacked significant economic reasons other than the tax benefits and can be disregarded under the general anti-avoidance principle set forth above.
The Italian Supreme Court with the two decisions at issue has completed its controversial path towards the creation of a general anti avoidance principle in the Italian tax system.
Previously, in two decisions issues in 2005 (n. 20398 of October 23 and n. 22932 of November 14), the Italian Supreme Court had disregarded the tax benefits of a dividend washing and dividend stripping transaction on the ground that they lacked a valid legal cause and therefore were null and void under the general principles of Italian contract law, which should be interpreted consistently with a general anti-abuse of law doctrine deriving for EU law.
Subsequently, in other two decisions (n. 21221 of September 29, 2006 and n. 10257 of April 31, 2008) the Italian Supreme Court held that the anti-abuse doctrine deriving from EU VAT law, as interpreted and applied by the European Court of Justice in Halifax (for more comments, see Supreme Court order n. 21371.PDF) is directly applicable at national level also in the area of direct taxes.More recently, following Halifax the Supreme Court’s decision n. 25374 of October 17, 2008 confirmed the applicability of EU abuse of rights principle in the area of VAT.
Ultimately, with the two decisions referred to above, the Supreme Court took the final step and for the first time held the existence of a general anti avoidance principle directly embedded in the Italian tax system.
From now on, any transaction that generates a significant tax benefit must be tested under the general anti-avoidance rule of Italian tax law, which requires that the transaction be entered into for non insignificant economic reasons beyond that of obtaining a tax advantage, as well as under any of the specific anti abuse provisions of the tax code that may apply to that specific transaction.