By now, Italian tax practitioners and tax scholars have had the opportunity to report on Italian Supreme Court’s ruling n. 14756 of July 10, 2020 (Cass.14756-20), which ruled that interest paid by an Italian operating subsidiary to its Luxembourg direct holding company is eligible for the withholding tax exemption granted under article 26-quater of Presidential Decree n. 600 of September 29, 1973, which implemented the provisions of the E.U. Directive n. 2003/49/EC of June 3, 2003 on payments of intra-European Union interest and royalties.
We would like to add below some additional comments and our final take on it.
Outbound interest is subject to a 26 percent withholding tax under article 26 of Presidential decree n. 600 of 1973. However, interest paid by an Italian company to a company organized a E.U. Member State, in the form of corporation liable to tax in the State, and holding at least 25 percent of the stock of the interest-paying company, is exempt from withholding tax, in accordance with the E.U. Directive n. 2003/49/EC.
One requirement for the withholding tax exemption is that the recipient qualifies as beneficial owner of the interest.
According to article 26-quater of Presidential Decree n. 600 of 1973, the recipient is a beneficial owner of the interest, when it receives the interest as final beneficiary, as opposed to an intermediary such as an agent, fiduciary or person acting in a similar capacity.
Under the facts of the case, after a leverage buy-out transaction leading to the acquisition of an Italian industrial company, the Italian target carried a loan held by its Luxembourg holding company, and made payments of interest to the Luxembourg holding company under that loan for an amount of approximately 18 million euro, without applying any withholding tax.
The Luxembourg holding’s loan was part of a series of back-to-back loan arrangements extending along the ownership chain all the way up to the non-EU parent of the group. The terms of the Luxembourg holding’s loan mirrored those of the back-to-back loans outstanding along the ownership chain of the group.
The rates and timing of the payment of the interest owed under the various loans did not exactly coincide, in a sense that the Luxembourg holding maintained control of the interest it received from the Italian subsidiary, albeit for a short period of time, and it ultimately earned a net profit margin of 0.125%.
The Luxembourg holding company did not operate any active business in Luxembourg, and maintained no offices, employees or other organizational structure on the ground there. Rather, it was a “pure” holding company, which performed financing and treasury functions for various subsidiaries of the group. In that capacity, it received various funds from its parent or other affiliates and extended various loans to subsidiaries of the group in Europe, receiving and paying interest on those loans and reporting net income in Luxembourg on its financial returns.
The parties in the case stipulated that the Luxembourg holding company satisfied all other statutory requirements for the interest withholding tax exemption, and the only issues was whether it qualified as beneficial owner of the interest for the purpose of the exemption.
The Italian Tax Agency took the position that the Luxembourg holding company was a “passive” holding company, namely, an entity not engaged in any business activity in its country of organization, devoid of any organizational structure or “substance” in Luxembourg, which just held legal title to shares of stock in subsidiaries. As such, according to the Tax Agency, it had to be be regarded as operating solely as an intermediary or agent for the collection of the interest from the Italian borrower and and the repayment of it to the ultimate lender of the group. As a result, the Tax Agency assessed a withholding tax on the interest paid to the Luxembourg holding company, for an amount of approximately 4.7 million euro.
The tax assessment was challenged in the tax courts, and the Italian Supreme Court confirmed the appellate court’s decision, ruling against the Tax Agency and in favor of the taxpayer.
In support of its ruling, the Italian Supreme Court relied on the interpretation and meaning of the term beneficial owner as it applies in the context and for the purpose of international tax treaties. The Court referred to the Commentary of the OECD Model of Income Tax Treaty, according to which beneficial ownership requires that the recipient hold the full right to use and enjoy the income, unconstrained by a contractual or legal obligation to pass the payment it receives up to any other person not eligible fort the benefits of a treaty.
The Court also referred to the decisions of the European Court of Justice in the so called Danish cases, according to which a withholding tax exemption granted under a E.U. Directive does not apply whenever the recipient is a conduit, whose sole activity is the collection and repayment of the income to another person that is not eligible for the exemption.
Against that background, the fundamental holdings of Supreme Court’s ruling n. 14756 can be summarized as follows.
First, according to the Court, the fact that a holding company operates as a “pure” or “passive” holding company, namely, it is not engaged in any active business, and does not employee people, own or rent offices or establish and maintain any other physical footprint in its country of organization, in an on itself, is not dispositive of its status as beneficial owner of the income it receives from controlled entities.
Rather, according to the Court, focus must be placed upon whether or not the holding company enjoys sufficient independence in adopting decisions which concern its own governance, the direction, supervision, management and control of its shareholdings in subsidiaries and controlled entities, and the receipt, use and enjoyment of its income.
By making reference to its own jurisprudence in dividend withholding cases, the Court expressly pointed out that it had already held that a pure holding company can be the beneficial owner of the dividend, whenever it properly books the dividend in its financial statement, is the legal owner of the dividend, and the dividend income can legally be attached by its creditors.
Second, according to the Court, in determining the holding company’s status as beneficial owner, reference must be made to the activities and all items of income of the holding company, as a whole, rather than focusing only on the specific item of income in respect of which the status of beneficial is called in question.
Based on the above principles, the Court ruled that the Luxembourg holding company had to be regarded as beneficial owner of the interest, considering that it carried various loans on its books, with respect to which it collected and reported substantial income in Luxembourg, retained some non insubstantial profit, performed active financing and treasury functions to the benefit of the parent and other affiliated companies of the group, and took on an active role in various acquisition transactions carried out by the group.
Also, according to the Court, the Luxembourg holding company retained a sufficient level of control over the interest and made a sufficient net profit out of the loan to its Italian subsidiary.
Finally the Court found no evidence that, under the facts of the case as summarized here above, the Luxembourg holding company operated solely as a conduit for the collection and repayment of the interest.
We believe ruling n. 14756 is of particularly significance, in the part in which the Court focuses on the nature and scope of the legal arrangements involving the holding company, its governance structure, and its legal operation and activities, while it dismisses other factors such as employees, offices, or organization of the holding company in its country of organization (so called “substance”), which have a meaning with respect to traditional industrial or commercial companies, but not equal meaning with respect to holding companies.