Italian tax residence is a very important topic for foreign nationals who travel regularly to Italy, own houses and spend significant time with their family there, while living and working abroad, as well as for those who relocate to Italy and work, do business or just retire there.
For the former, it may be surprising to know that they may have crossed the line and become Italian tax residents, under Italian tax law, even though they have spent less than 183 (or 121 on average) days a year in Italy and would never be resident should the provisions of the Internal Revenue Code apply to their case.
For the latter, it is important to understand the need to plan in advance the establishment of their Italian tax residence, to fully understand the tax treatment they will be subject to once they have become resident, and make the proper adjustments to maximize the benefits and minimize the inconvenience of being subject to tax in Italy.
Now that Italy is the most formidable tax haven in the world for foreign nationals who plan to relocate there, Italian tax residence can be an opportunity, more than it has ever been, and an interesting topic to review with a positive state of mind.
In this area of international tax law, the disconnection between Italian internal law and U.S. domestic tax law is a significant as it can be, and can give rise to opportunities, or problems, depending on the taxpayer’s approach.
While the basic Italian rules are sufficiently clear, not surprisingly, there are still open issues, which arise in particular in the context of the interactions between Italian internal law and tax treaties.
In this article we offer a refresher of the basic rules while we stop and outline the open issues in the hope of rising awareness and create a basic knowledge of the system that can help any further and more detailed investigation of specific real-life situations.
Tax Residence Tests
Italy assigns tax residency to individuals based on one of three alternative criteria:
– registration on the list of Italian resident individuals,
– residence, as defined in the civil code (i.e. place of habitual abode),
– domicile, as defined in the civil code (i.e. main center of interests).
Tax residence is triggered whenever any one of those three criteria is met for more than 183 days in a given a year.
The Registration Test
The registration on the list of Italian resident people is carried out upon an individual’s application, which sets forth the individual’s home address in Italy and the date the individual moved to and started living regularly there. The application is filed with the local municipal office of the place where the individual’s home is located.
The effective date of registration, which will ultimately dictate the tax residence starting date (see the discussion of this topic below), may be tricky. The general rule is that the application takes effect from the date it is filed. The application paper, however, requires to set forth the date of the relocation to Italy (on which the individuals filing the application moved to and started living there), which can even be an earlier date.
In many instances, foreign nationals register inadvertently, or, rather, without fully knowing the tax implications of the registration, often encouraged by local notaries or accountants at the time of the purchase of a home in Italy, as suggested in order to benefit from abatement of transfer taxes granted by Italian law in connection with the purchase of a “first home” in Italy.
The registration, together with the ownership of a home in Italy, are matters of public record, and Italian tax offices carry out regular checks on the list of residents and real estate register and, when they do not find a matching Italian income tax returns on their file, they send inquiries about the tax status of those individuals who are registered as residents and own a home but appear to have never filed an Italian income return.
The Residence Test
Residence means place of habitual abode, that is, the place where an individual regularly lives, in a non transitory manner, and with the intention of living there for an indefinite time as it may be inferred from his or her social relations, activities, personal connections and family ties to that place. Residence is a fact and circumstances test based both on physical presence (which must be regular and not sporadic or temporary) and state of mind.
No fixed or minimum number of days of presence is required to meet the residence test, and traveling away for some temporary of transitory reasons, and staying outside of Italy for a long period of time, or even working primarily outside of Italy while traveling regularly back and maintaining personal ties and family life there, does not affect the location of someone’s place of habitual abode in Italy.
The Domicile Test
Domicile means main center of interests, which can be personal or economic. For the purpose of this test, the days of presence in Italy are completely irrelevant. One can have his for her domicile in Italy event without living there at all.
Case law is inconsistent on whether personal and family interests should be given more weight than economic or professional connections, for purposes of both the residence and domicile test.
A substantial body of case law and tax ruling exists in this area, and no meaningfully conclusion can be reached, without a carefully review of the facts of each particular case against the background of the reveal case law and administrative guidance.
First and Last Day of Residence and Change Of Residence During The Year
For Italian tax residence to begin, it is required that any of the three tests described above is met for more than 183 days in any particular year.
The first day of residence is the first day of the year in which either test is satisfied. Conversely, the last day of residence is the last day of the year in which either test is satisfied.
In other words, if someone establishes his or her residence or domicile in Italy sometime on or before June 30 of a given year, his or her tax residence would begin on the first day (January 1) of that year, and if someone moves his or her residence or domicile outside of Italy sometimes on or after July 1 of a given year, his or her last day of residence would be the last day (December 31) of that year year.
Conversely, if someone establishes his or her residence or domicile in Italy sometimes on or after July 1 of a given year, and moves his or her residence or domicile outside of Italy sometimes on or before June 30 of the following year, he or she would had never been be a tax resident of Italy, either in year one or the following year.
In light of the above, as a rest of the application of the Italian rules, there may be situations on double tax nonresidence, or double tax residence, with all the implications that would have.
Tax Treaties And Change of Residence During the Year
Italian internal tax law does not contemplate a case in which an individual can be a resident – or a nonresident – for part of the year. Tax residence, whenever established during the year, either retroacts to the first day of the year (if established within the first half of the year) or is postponed to the first day of the following year (if established in the second half of the year). Under that approach, an individual is either a resident, or a non resident, for the entire year.
An open issue concerns whether the application of a tax treaty may change the outcome dictated under Italian law and make somebody a part-year resident (or part-year non resident) of Italy for the purposes of that treaty. We refer to a case in which an individual, who is resident of Italy and another country which has a tax treaty with Italy, under their respective internal tax laws, moves from Italy to the other State during the second half of the year and successfully demonstrates that his or her residence should be assigned to the other contracting State, under the provisions of article 4 of the treaty between Italy and that State, from the time he moved there.
In that case, the issue is whether, pursuant to the treaty, the last day of residence in Italy (which, under Italian law, would be the last day of the year) should be set on the the day within the year on which the treaty test assigning residence to the other treaty country is met.
The Italian tax administration (in a tax ruling dating back to 2008) seems to take the position that part-year residence applies solely when expressly provided for in the tax treaty. However, as far as we know, there is very little direct guidance and clear case law on the issue, which is open to discussion.
Effects of Tax Residence
Italian tax residence has far reaching effects that cover income tax, gifted estate tax, international tax reporting and taxation of trusts.
Notably, under Italian law, and unlike in the U.S., the tax residence tests are the same for income tax as well as gift and estate tax purposes.
Once Italian tax residence is established, under any of the tests discussed here above, a taxpayer treated as an Italian resident individual:
– is subject to income tax in Italy on all of his or her or income, from whatever source derived, in Italy or abroad,
– is subject to Italian gift and estate tax, on all of his or her assets, wherever located in the world,
– is required to report, for information purposes, on his or her Italian income tax return, all of his or her assets, located outside of Italy, in which he or she has a financial interest, legal or beneficial ownership or legal control,
– is subject to foreign assets based taxes charged on the fair market value of foreign real estate (at the rate or 0.76%) or financial assets (at the frate of 0.2%), due on top of Italian personal income taxes,
Also – and equally important – any trust of which an Italian resident individual is a trustee, is presumed to be an Italian resident trust, subject to tax in Italy on its income (as attributed to the trust under Italian tax rules), from whatever sources derived.
Tax Treaty Residence And International Tax Reporting Of Foreign Assets
Under the typical tie breaker provisions of article 4 of Italian income tax treaties, an individual who is a tax resident of both Italy and another State, under their respective internal tax laws, can be treated as a resident of the other contracting State, for the purposes of that treaty.
Generally, a tax treaty applies only to income taxes, and solely for the purpose of computing a taxpayer’s income taxes due.
An unsettled issue is whether an Italian tax resident individual, under Italian internal law, who is treated as a non resident pursuant to the provisions of article 4 of an income tax treaty and, consequently, is not liable to tax in Italy on his or her foreign (i.e, non-Italian) income, for purposes of that treaty, would also be exempt from the duty to report his or her foreign (i.e. non-Italian) assets on his or her Italian income tax return.
The technical language of the treaty limits its application to the computation of income taxes due in either of the two contracting States, while, for all the tax purposes, an individual remains a resident of the contracting State under its own internal law.
The U.S. approach is that a resident alien individual, under U.S. internal tax laws, who files as a nonresident pursuant to article 4 of an income tax treaty, is treated as resident for all other income tax purposes and is subject to the duty to file his or her international informational returns (such as form 8938, 114a, 5471, and the like) as required under U.S. tax law.
In Italy, the issue is open. There is some case law that seems to suggest that the Italian tax administration would require that an Italian income tax return be filed, with section RW duly filled out with information on foreign assets, even when there is no income tax liability because the taxpayer is treated as a nonresident under a treaty (and does not have Italian source taxable income to report). That would be consistent with a recent administrative guidance according to which the Italian tax agency requires reporting also for foreign personal assets that do not produce any income taxable in Italy.
On the other hand, Italian international tax reporting rules seems to limit the reporting by making reference to foreign assets “which are capable of producing foreign source taxable income”, which clearly is not the case when the taxpayer in a nonresident under a treaty (and is never liable to tax in Italy on foreign source income). The language of the statute would appear to justify the absence of a duty to file an Italian tax return in the situations described above.
Since reporting is for information purposes only and there is no tax attached to it (and considering the penalties for failure to file) a conservative approach would suggest filing an income tax return whenever an individual is an Italian tax resident under Italian internal law.
Tax Treaty Residence And Non-Income Taxes
Another issue is whether an individual, who is treated as a nonresident under thew provisions of article 4 of an income tax treaty, should still be treated as a resident, for all other Italian non-income tax purposes.
As noted, Italy uses the same tests to determine an individual’s tax residence for purpose of the Italian estate and gift tax.
However, income tax treaties do not apply to estate and gift taxes, and typically estate and gift tax treaties (which Italy has with several countries, including the U.S.) do not set forth provisions on residence or domicile for estate and gift tax purposes.
As a result, the answer to our question should be a clear yes.
However, some tax experts opine that, since the residence test are the same, for income tax and estate and gift tax purposes, there seems to be a unitary tax residence concept in the Italian tax system, and it would set fair that, in the event that an individuals’ tax residence is assigned to another country, under the provisions of article 4 of an income tax treaty, that individual should be treated as a nonresident for any tax purposes, and also for the purpose of the Italian estate and gift tax.
Interestingly, the same issue arises with respect to certain asset-based taxes that have to be reported on the regular income tax return. They are the tax on the fair value of foreign real estate, charged at the rate of 0.76%, and the tax on the fair value of foreign financial assets, which is charged at the rate of 0.2%.
Italian resident taxpayers are subject to those taxes, which are computed on a separate section of the regular income tax return and are paid together with the regular income tax.
The question is whether a taxpayer who is treated as a nonresident under an income tax treaty, is exempt from those taxes, and therefore not required to file an income tax return, or due to the fact that they are non-income taxes falling outside the scope of the treaty, implies that a resident taxpayer under Italian internal law regardless of the treaty is still subject to those taxes and required to file the return.
Tax Residence and Trusts
Another implication – and potentially unintended consequence – of establishing the tax residence in Italy arises with respect of trusts. Under Italian tax rules on trusts, the tax residence of a trust is deemed to be in Italy, whenever the trustee is an Italian resident individual. The taxpayer has the burden to prove that the trust is effectively managed in a foreign country.
A Italian tax resident trust is taxed in Italy on any income which is allocated to the trust under Italian tax law (which does not need to be consistent with US law), whether from Italian or foreign source. In the case of a trust with identified beneficiaries, the trust’s income flows through the trust and is allocated and taxed to the beneficiaries. However, whenever it flows through an Italian resident trust, its source and character change, in a sense that it becomes Italian source income and is classified as income from trust. As such, it is taxable to foreign beneficiaries, unless it is exempt under a treaty (presumably, the other income provision of article 12).
Tax Residence And Special Tax Regimes For Foreign Nationals
Italy enacted several special tax regimes for foreign nationals (or Italian citizens living abroad) who move to Italy.
One regime is designed for high skilled workers, professionals and independent contractors and entrepreneurs, and provides for a 70% or 90% taxable income exemption for employment income, professional income and business income, for a period of five years that can be extended to ten years under certain circumstances.
Another regime is designed for retirees and provides for a 7 percent flat income tax rate applicable on all of the income of individuals who receive some retirement income.
Another regime is designed for high net worth individuals and provides for a fixed 100,000 euro tax on all of their foreign source income.
All those special tax regimes are predicated on the requirement that the taxpayer did not have his or her tax residence in Italy for a certain period of time before, and established his or her tax residence in Italy after, electing for the special tax regime.
In this context, the analysis on a taxpayer’s residence is critical to determine his or her eligibility for the preferential tax regimes.
Recently, the Italian tax administration has clarified that, whenever a taxpayer has been a resident of Italy under the registration test, and would not be eligible for the special tax regime, but maintained his or her residence or domicile in a foreign country, he or she can claim to be treated as a nonresident under article 4 of the income tax treaty with that country also for the purpose of claiming his or her eligibility for the special tax regime. The interpretative guidance addresses the very common situation of many Italian citizens who move abroad but never terminate their registration in Italy.
Even though the Italian tax administration has not dealt with it, also the opposite should be true: an individual who has never been registered in Italy, but maintained in Italy his or her actual domicile or place of habitual abode, within the relevant period of time before the election, might have become a resident under the domicile or residence test and could therefore be considered not eligible for the special tax regime.
Considering the attractiveness and rising popularity of the special tax regimes for new residents, it is not surprising that the concept of tax residence will receive additional attention and greater scrutiny.
In conclusion, the concept of tax residence in Italy has pervasive ramifications in many areas of Italian tax law and gives rise to challenging issues in a cross border context.
Careful tax planning on the issue of Italian residence can provide significant tax benefits, while taxpayers who ignore it do that at their own peril and may encounter severe troubles.