With ruling n. 54/E of March 3, 2009 the Italian Tax Administration clarified the treatment applicable to debt instruments issued by Italian limited liability companies. According to the ruling, the instruments can be characterized as debt obligations and enjoy the same tax treatment of debt obligations issued by joint stock companies, namely a reduced 12.5 percent tax on interest and complete exemption for certain foreign investors, if the requirements established in the code for this purpose are met.
Article 2483 of Italian Civil Code (as amended with law n. of January 17, 2003) provides that limited liability companies (SRLs) can issue debt instruments to finance their operations of investments, subject to certain limitations. Previously, only joint stock companies (SPAs) could issue debt instruments.
Debt instruments issued by SRLs cannot be offered to the general public and can be subscribed only by professional investors (banks, insurances and financial institutions). If sold to private investors in the secondary market, the seller is liable in the event the buyer fails to make the payments required under the instrument. Seller’s secondary liability can be eliminated by way of an agreement between seller and buyer.
The entity’s articles or organization or certificate of formation must expressly provide for the possibility that the entity issues debt instruments and confer the power to issue debt instruments either upon the members or the managers, as well as establish the terms of the issuance including the number and amount of the instruments, issuance procedures and voting requirements.
The tax administration in ruling n. 54 clarified that, for tax purposes, debt instruments issued by SRLs are characterized as debt obligations if they satisfy the definition of debt obligation contained in article 44, paragraph 2, letter (c)(2) of the tax code, according to which three tests must be met:
– the instrument is part of a series of transferable instruments issued under same or similar terms pursuant to a single economic transaction;
– the instrument provides for the unconditional reimbursement of an amount that is at least equal to its issue price or face value, with or without payment of interest or other remuneration, and
– the instrument does not confer to the holder any power to control or participate in the management of the issuing enterprise or the transaction pursuant to which it has been issued.
If the three tests are met, the debt instrument is a classified as a debt obligation.
Interest paid under a debt obligation is subject to 12.5 percent withholding tax, provided that the maturity date of the instrument is at least 18 months or longer and the interest rate does not exceed the official discount rate increased by 2/3rd (or 200% is the instruments is regularly traded in a regulated securities market). In all other cases, the withholding tax rate is 27 per cent.
For interest paid to private individuals or foreign investors who hold the instruments outside of a trade or business that is part of an Italian permanent establishment, the 12.5 per cent is a final tax.
However, for debt obligations held by non resident investors who are resident or organized in certain approved jurisdictions (white-listed countries), interest is totally exempt from tax.
Interest on debt instruments that fail to qualify as debt obligation is subject to the ordinary 27 percent tax rate and is not eligible for the foreign investors exemption.
In the light of the above, for foreign investors the characterization of the instrument as debt obligation is particularly important in order to qualify for the exemption.