With Circular 17/E of May 23, 2017 Italy’s Tax Agency provided administrative guidance on the interpretation and application of the provisions on the elective preferential tax regime for Italian new-tax resident individuals.
New article 24-bis of Italy’s Unified Income Tax Code, enacted with Law n. 232 of December 2016, provides that foreign-resident individuals who establish their tax residency in Italy, after having been resident in a foreign country for at least nine of the previous ten tax years, may elect to pay a fixed-amount tax of euro 100,000 on all of their foreign source income, in lieu of the ordinary Italian personal income tax. Domestic source income would remain subject to the ordinary personal income tax, charged at graduated rates on income tax brackets.
The election can be filed within the second tax year after the year in which tax residency was established in Italy. For example, a foreign person which became an Italian tax resident individual in 2016, can make the election either with effect from the 2016 tax year, when filing her personal income tax return in 2017, or with effect from the tax year 2017, when filing her income tax return in 2018. The election may be withdrawn by the taxpayer solely within the second year after the year it was first filed. After that, the election is deemed automatically renewed year by year and expires automatically after 15 years.
The election can be extended to a taxpayer’s family members, who shall pay a fixed-amount tax of 25,000 euros in lieu of the regular personal income tax on their own foreign source income. The extension for family members can be filed at any time after the initial election has been filed, within the 15 year period of duration of the initial election.
Circular 17/E clarified that, for the elective regime to apply, no mandatory tax ruling is required. Taxpayers at their choice may still file a request for a tax ruling, prior to filing their election for the fixed-amount tax.
The election exempts taxpayers from the payment of Italy’s asset-based tax on foreign financial assets, charged any the rate of 0.2% of asset’s fair market value, and asset-based tax on foreign real estate, charged at the rate of 0.76% of property’s historical cost (adjusted tax basis) or fair market value.
Even more significantly, the election also exonerates taxpayers from the duty to report, on their Italian income tax return, the value of their financial and investments assets held outside of Italy during the tax year. Under Italy’s international tax reporting rules (the equivalent of the U.S. FATCA and FBAR rules), foreign assets are reported at their fair market value at the beginning or the end of tax year, or on the date of purchase or sale, which must be converted into euro at the average exchange rate of the month or purchase or sale. Also non financial assets such as real estate, cars, boats, jewelry, artworks, etc. must be reported. Especially in case of complex financial portfolios, the duty to report may be very wide in scope and administratively burdensome and costly for the taxpayer.
Finally, taxpayers who elect for the special tax regime are exempt from Italy’s estate and gift tax.
The two key tax concepts that determine the eligibility for the application of the elective regime are tax residency and source of income.
Tax residency for individual taxpayers is determined in accordance with any one of three alternative criteria, which must be met for more than half of any tax year, namely:
1. registration on the Italian register of resident individuals, held at the local municipality in the place where the taxpayer has established her own residence for general administrative and legal purposes,
2. place of habitual abode (residence),
3. main center of interests and affairs (domicile).
For a foreign person to become eligible for the elective tax regime, it is sufficient that she registers on the register of Italian resident individuals with a local home address in Italy, in the place where she owns or rents a house or maintains a fixed place of abode. When the registration is completed in the first half of a tax year, Italy’s tax residency retroacts to the first day of that year. When the registration is completed in the second half of a tax year, Italy’s tax residency takes effect on the first day of the following year.
The registration creates an irrefutable presumption of tax residency in Italy. However, as a condition for the registration, the law requires that a person actually maintain her principle, fixed place of living (i.e., place of habitual abode) at her registered address in Italy. During the registration process, or at any time after the registration process has been completed, local municipal police may verify that the condition for the registration is met, by way of multiple visits to the local home address, made at various intervals of time, to check whether a person actually regularly lives there. If the condition for the registration is not met, the local authorities may start a process for the mandatory cancellation of a person from the register of resident individuals, which may result in the retroactive loss of the elective tax regime.
Residence (place of habitual abode) requires that a persone regularly live in Italy (objective test) with the intention of living there for the indefinite future (subjective test).
Domicile (main place of interest) revolves around an individual’s personal, family, business and financial interests, and does not requires physical presence in Italy.
A foreign person who was not registered on the Italian register of resident individuals, in 2016 or 2017, may still take the position that she had her place of habitual abode or domicile in Italy, thereby being a tax resident of Italy in those years, and elect for the special tax regime. Since the residence and the domicile tests (as described above) depend on the facts and circumstances of each particular case, it may be appropriate to apply for a tax ruling, whenever the election is based on residence or domicile, in the absence of a formal registration on the register of resident individuals.
Article 165, paragraph 2 and article 23 of the Unified Income Tax Code sets forth the rules on the source of income for general income tax purposes. In general, income is foreign sources whenever it arises from activities performed or assets located outside of Italy, or the payor of the income is a non resident individual or entity, such as the case of interest, dividends or royalties. Capital gains are sourced based on the location of the asset (as opposed to the residence of the seller).
Circular 17/E clarifies that in case of income received through shell companies, revocable trusts, nominees, fiduciaries, intermediaries or other conduit arrangements, the source of the income is determined by looking at the source of the underlying income in the hands of the trust, nominee, fiduciary, intermediary or conduit. In all other cases, and, most notably, in case of income earned through a fiscally transparent entity, the source of income is determined by not looking through the entity or legal arrangement through which the income is earned. Italian income source rules provide that income from domestic partnerships is characterized as Italian source income, while income from foreign partnerships or other similar entities is characterized as foreign source income, regardless of the source of the income in the hands of the entity. As a result, whenever a foreign fiscally transparent entity is interposed, between the taxpayer and the income, that may have the effect of converting domestic source income into foreign source income subject to the special tax regime (and not subject to tax in Italy).
Circular 17/E provides valuable clarity on the application of the elective tax regime for the neo Italian tax residents, which appears to be very attractive. However, careful planning and handling of the election is required, both with respect to the tax residency requirement, as well as with respect to the source of income, marking the division between foreign source income, which is covered by the fixed-amount tax and excluded form the personal income tax, and domestic source income, which remains taxable under the general rules of Italy’s tax code.