With its ruling n. 32255 issued on December 13, 2018 (“Ruling 32255”), the Italian Supreme Court, Fifth Department (Tax) held that a dividend paid by an Italian subsidiary to a parent company established in a EU Member State is not eligible for the dividend withholding tax exemption granted under the provisions of Directive 90/435/EC (the “EU Parent Subsidiary Directive”, transposed into Italian domestic tax law by way of article 27-bis of Italy’s Presidential Decree n. 600 of September 29, 1973), unless the dividend is actually subject to corporate income tax in the parent company’s home country.
Ruling n. 32255 is consistent with a previous decision of the Supreme Court (n. 25264 of October 25, 2017), which we commented on this blog.
By requiring that the dividend is actuality taxed in the parent company’s home country, Ruling 32255 adds a requirement for the application of the dividend withholding tax exemption (the “double taxation requirement”), which is not part of the literal language of the EU Parent Subsidiary Directive, and – especially if adopted by national tax courts in other jurisdictions – may have far reaching implications on taxation of EU cross-border dividends.
Summary of the Law
Under Italian domestic tax law (article 27 of presidential decree n. 600 of September 29, 1973), outbound dividends are subject to withholding tax at the rate of 27 percent. The withholding tax can be reduced pursuant to a tax treaty between Italy and the recipient the dividend (provided that all treaty’s requirements for the withholding tax relief are satisfied).
However, outbound dividends are exempt from the 27 percent withholding tax, under the EU Parent Subsidiary Directive, provided that certain requirements are met, namely, that the recipient of the dividend, at the time the dividend is declared, is an entity that:
(i) is organized in one of the forms specifically set forth in an Annex to the Directive (the “legal form requirement”),
(ii) is resident of a EU Member State, under the domestic tax laws of that State, and is not treated as a nonresident entity pursuant to a tax treaty between that State and any third (non-EU) country (the “tax residency requirement”),
(iii) is subject to corporate income tax, in its own jurisdiction, and does not benefit from a general tax exemption or tax exclusion regime which is not geographically or temporarily limited (the “subject to tax requirement”), and
(iv) has been owning, directly and for an interrupted period of at least one year, 10 percent (15 percent, prior to 1/1/2009, or 20 percent prior to 1/1/2007) or more of the stock of the company that distributes the dividends (the “stock ownership requirement”).
Under the provision of article 27, paragraph 3-ter of the Presidential Decree n. 600 of September 29, 1973, dividends paid to a company which does not qualify for the exemption under the EU Parent Subsidiary Directive, but:
(i) is organized in the form of a corporation or other equivalent legal form,
(ii) is resident in a EU Member State, and
(iii) is subject to corporate income tax in its State of residence,
are subject to a reduced withholding tax of 1.20 percent. The reduced withholding tax rate is aimed at equating the taxation of outbound dividends to that of domestic inter company dividends, whereby dividends are not subject to withholding and are partially exempt, under Italy’s participation exemption regime, resulting in an effective tax rate of 1.20% in the hands of the corporate shareholder (in compliance with the non discrimination principle and free movement of capital provision of the EC Treaty).
Facts of the Case
Under the facts of the case, an Italian corporation paid a dividend to its Luxemburg parent, charging a 27 percent withholding tax of euro 1,059,921.45 upon distribution. The Luxemburg company filed a claim for refund of the withholding tax with the Italian tax agency, pursuant to the EU Parent Subsidiary Directive’s withholding tax exemption. The Italian tax agency failed to respond within the statutory deadline (90 days). Under the applicable statute, the lack of timely response to the refund claim which is treated as a deemed rejection of the claim. As a result, the Luxembourg company filed a petition with the tax court, challenging the rejection of the refund claim. The tax court ruled in favor of the taxpayer. The tax agency appealed, and the regional (appellate) tax court ruled in favor of the tax agency, reversing the trial court judgement and validating the withholding tax. The Luxembourg company then filed a petition with the Supreme Court.
In light of the reasoning of the Supreme Court’s judgement, it is apparent that the Luxemburg company satisfied all the statutory requirements for the withholding tax exemption under the EU Parent Subsidiary Directive. Specifically, it parers to be stipulated (or undisputed) that the Luxembourg company is a corporation resident in Luxembourg and subject to corporate income tax there.
However, the Supreme Court held that the dividend withholding tax exemption cannot apply, because the Luxembourg company benefitted from a dividend tax exemption under a participation exemption regime provided for under Luxemburg law. According to the Supreme Court, the fact that the Luxemburg company is a taxable entity and is subject to Luxemburg corporate income tax does alter that conclusion, because the exemption from tax on the dividends in Luxemburg is sufficient to avoid any double taxation of the dividends which would otherwise result from the application of the Italian withholding tax.
The Supreme Court argues that the ratio of the EU Directive’s dividend withholding tax exemption is that of preventing a double taxation of the dividends (first, by way of a withholding tax charged in the country of source, at the time of the distribution of the dividends, and then by way of the income tax charged in the shareholder’s country of residence upon receipt of the dividends). According to the Court, when there is no double taxation of the dividends as a result of the dividend exemption in the shareholder’s country of residence, the withholding exemption has no reason to apply, considering that the Directive’s withholding exemption cannot result in a double non taxation of the dividends.
The Supreme Court does not directly discuss the meaning of the term “subject to tax” used in the EU Parent Subsidiary Directive. That term, in the Directive, is used in reference to the recipient of the dividend, which must be a taxable entity liable to tax in its country of residence. Generally, two alternative interpretations of the term have been debated, one interpretation requiring that the entity itself be “liable to tax”, that is, be classified as a taxable entity and falling within the scope of a corporate income tax, in its own jurisdiction (regardless of the fact that it actually pays a tax, on the income it receives and for which it claims a tax relief), and another interpretation requiring that the entity be “subject to tax”, that is, it actually pay a tax, on the specific item of income it receives and for which the tax relief is claimed.
Rather, the Court seems to inject an additional, overarching requirement for the application of the Directive’s dividend withholding exemption, namely, that the dividend be subject to double taxation (in the country of source and in the country of residence), while exemption should not apply when it would result in a double non taxation of the dividend.
Previous Case Law
Ruling 32255 is directly in line with The Italian Supreme Court’s ruling n. 25264 of October 25, 2017, also from the Fifth Department (Tax), in which the Supreme Court held that the actual payment of the corporate income tax in the parent company’s home jurisdiction is required for the parent company to benefit from the dividend withholding tax relief under the EU Parent Subsidiary Directive, and that no exemption applies to a dividend paid by an Italian company to its Dutch parent which benefits from a participation exemption regime resulting in the exemption of the dividend from corporate income tax in the Netherlands.
Possible Developments and Open Questions
The Italian Supreme Court did not discuss the possible application of the reduced 1.20 percent withholding tax. Indeed, the dividend in question was distributed in 2003, prior to the enactment of the reduced withholding tax rate. As discussed in the summary of the law paragraph, above, also for the purpose of the application of the reduced withholding tax rate, it is required that the corporate recipient be subject to corporate income tax in its EU Member State of residence (indeed, the language of the statute, on that particular requirement is very similar to – and drawn from – the language of the Directive). The reduced withholding rate is aimed at equating the Italian taxation of an outbound dividend to the taxation of a domestic dividend, whereby the company which receives the dividend is exempt on 95 percent of the amount of the dividend, and is taxed on 5 percent of the amount of the dividend, at the corporate tax rate of 24 percent, resulting in an effective tax rate of 1.2 percent. It is not clear whether the Court would reach a similar conclusion, under similar facts, when the issue is that of the application of the reduced withholding tax.
Another legitimate question is whether the Court would reach the same conclusion, with respect to the application of the Directive’s full exemption, when the EU parent company is at least partially taxed on the dividend, under a partial exemption regime.
Furthermore, it is interesting to see whether the Italian Supreme Court’s novel interpretation of the EU Parent Subsidiary Directive, as requiring a double taxation of the dividend for the withholding exemption to apply, is followed by other courts, in other EU jurisdictions, leading to more far reaching challenges to the tax treatment of inter company dividends throughout the EU, and further challenging tax planning structures for EU inbound investments, based on the use of EU holding companies located in favorable taxing jurisdictions.
Finally, readers should note that Italian Supreme Court’s decisions are not binding precedents, and that the Court can rule differently on the same issue arising in separate cases. If contrasting decisions on the same issue emerge within the Court, a case can be referred to the full bench for a decision resolving the contracts and establishing a uniform interpretation of the law on that particular matter.