Italy’s Supreme Court’s ruling n. 26965 of November 26, 2020 provides a clear example of how things can quickly turn for the worse, for an ill-advised taxpayer who fails to report a foreign financial account on his Italian income tax return, and then fails to properly handle the following tax inquiry and audit stemming from it.

According to the facts reported in the ruling, the Italian Tax Agency, pursuant to the provisions of the Directive of the Council of the European Union n.77/799/CEE of 19/12/1977 concerning the mutual tax assistance between the competent authorities of the member states (and article 27 of the Convention against double taxation between Italy and the United Kingdom of 5 November 1990 and article 26 of the Convention against double taxation between Italy and Australia of 18 November 1984), was able to obtain foreign documentation evidencing that the taxpayer was the only beneficiary of the “Massago Etablissement fund”, established in Vaduz (Liechtenstein), the value of which, as of 31/12/2000, amounted to € 2,381,015.00.

The Italian tax office assessed an additional income tax on the amount of the increase in the value of the account in the years 1999 and 2000, treating it as residual category of capital income which is classified as ordinary income taxable at graduate rates. Usually, income from capital in the form dividends, interest or capital gains is subject to substituted tax charged at the flat rate fo 26 percent.

The taxpayer appealed the regional tax court’s decision – which ruled in favor of the tax agency’s determination – to the Supreme Court, with no luck.

The Supreme Court ruled that, in the case of financial assets not declared on part RW of taxpayer’s Italian income tax return, the tax office can legitimately assume that the entire increase in value of the financial assets held on a foreign financial account represents taxable income. In particular, the increases of the value of the assets on the account, withdrawn and/or deposited abroad, are not considered capital income from foreign sources to be subjected to substitute tax (at 26 percent flat rate), but “interest and other income relating to the use of capital” pursuant to article 44, paragraph 1 letter. h) of the Tuir, which is subject to ordinary income tax at graduate rates.

On the procedural issue, the Supreme Court ruled that the national tax agency can rely on the documentation collected from a foreign tax authority pursuant to international statutory provisions on international cooperation and exchange of information for tax purposes, which, in the absence of meaningful and substantiated challenges from the taxpayer, deserves the highest degree of deference and constitutes sufficient evidence for the assessment of the additional tax.

The lesson for taxpayers is two fold: the duty to report foreign accounts is to be taken seriously, and, more importantly, taxpayers have to be careful in preparing for a possibile tax audit, during which they are expected to provide solid explanations on the nature and sources of funds and sources of income arising from their foreign accounts, in order to avoid extremely hateful tax assessments base don a presumption of evidentiary value of any information in the hands of the tax administration.