On November 20, 2020 Italy’s Minister of Economy and Finance published its ministerial decree dated November 17, 2020, which contains specific provisions on the meaning and enforcement of the main benefit test of COUNCIL DIRECTIVE (EU) 2018/822 of 25 May 2018 on mandatory reporting of cross border arrangements (commonly referred to as “DAC6”).
Following the ministerial decree, on December 28, 2020 Italy’s Tax Agency published on its website a draft tax circular which provides administrative guidance on the interpretation and application of the Italian legislation that implements DAC6. Taxpayers and their advisors can provide comments on the draft circular until January 15, 2021.
Under DAC6, certain cross border agreements must be reported whenever they contain certain generic or specific “hallmarks” (meaning, a characteristic or feature that presents an indication of a potential risk of tax avoidance) and, simultaneously, meet the “main benefit test” (meaning, the main benefit or one of the main benefits of the arrangement is the obtaining of a tax advantage).
Generic hallmarks linked to the main benefit test include the following:
1. An arrangement where the relevant taxpayer or a participant in the arrangement undertakes to comply with a condition of confidentiality which may require them not to disclose how the arrangement could secure a tax advantage vis-à-vis other intermediaries or the tax authorities;
2. An arrangement where the intermediary is entitled to receive a fee (or interest, remuneration for finance costs and other charges) for the arrangement and that fee is fixed by reference to:
(a) the amount of the tax advantage derived from the arrangement; or
(b) whether or not a tax advantage is actually derived from the arrangement. This would include an obligation on the intermediary to partially or fully refund the fees where the intended tax advantage derived from the arrangement was not partially or fully achieved;
3. An arrangement that has substantially standardized documentation and/or structure and is available to more than one relevant taxpayer without a need to be substantially customized for implementation.
Specific hallmarks linked to the main benefit test include the following:
1. An arrangement whereby a participant in the arrangement takes contrived steps which consist in acquiring a loss-making company, discontinuing the main activity of such company and using its losses in order to reduce its tax liability, including through a transfer of those losses to another jurisdiction or by the acceleration of the use of those losses;
2. An arrangement that has the effect of converting income into capital, gifts or other categories of revenue which are taxed at a lower level or exempt from tax;
3. An arrangement which includes circular transactions resulting in the round-tripping of funds, namely through involving interposed entities without other primary commercial function or transactions that offset or cancel each other or that have other similar features;
4. An arrangement that involves deductible cross-border payments made between two or more associated enterprises where the jurisdiction of which the recipient is a resident either does not impose any corporate tax or imposes corporate tax at the rate of zero or almost zero;
5. The payment benefits from a full exemption from tax in the jurisdiction where the recipient is resident for tax purposes;
6. The payment benefits from a preferential tax regime in the jurisdiction where the recipient is resident for tax purposes;
For a more detailed discussion of the provisions of DAC6, we refer to our presentation (NYU ITP Tax Presentation 11-7-2020) at the NYU’s International Tax Program of November 7, 2020.
The ministerial decree’s provisions on the main benefit test (“MBT”) are set forth at articles 6, 7 and 8, while the draft circular provides guidance on the application of the MBT at sections 3.3 and 3.4. Based on the decree and draft circular, the MBT is met when two conditions occur:
– there is a tax benefit from a cross-border arrangement,
– the economic value of the tax benefit exceeds the other economic (non-tax) benefits of the arrangement.
The ministerial decree provides that a tax benefit is determined with reference to the difference between the taxes due on the basis of one or more cross-border arrangements and the taxes which would be due in the absence of such arrangement or arrangements.
The draft circular clarifies that a tax benefit can derive from a cross-border arrangement which, compared to a transaction in which that cross-border arrangement is not employed, allows the taxpayer to:
– obtain reduction of the taxable base,
– obtain (or increase the amount of) a foreign tax credit or similar relief from international double taxation,
– obtain (or increase the amount of) a tax refund,
– defer the payment – or accelerating the refund – of a tax,
– eliminate or reduce a withholding tax.
The ministerial decree provides that the MBT is met whenever the economic value of a tax benefit represents more than 50 percent of the total tax and non-tax economic benefits of the transaction. The ministerial decree makes it clear that the tax benefit must be the principal benefit, and not just one of the benefit, of the arrangement.
The draft circular clarifies that the actual existence (and the measure of the value) of a tax benefit, is determined with reference to the the overall tax treatment of a transaction, by taking into consideration the income taxes due in Italy and in any other foreign jurisdictions in respect of that transaction. When the total amount of income taxes due is lower that the amount of taxes which would be due in the absence of that particular cross- border arrangement, the tax benefit test is met. Also, the draft circular clarifies that the tax benefit is an objective test, which does not requires any inquiry into the taxpayer’s subjective motives or intentions.
In order to determine whether the tax benefit is the principal benefit of the transaction, a fraction must be sued, at the numerator of which there is the amount of the reduction in income taxes which is achieved through the use of the cross-border arrangement, and, at the denominator, there is the sum of the amount of the tax reduction and all other economic or monetary non-tax benefits of the transition. Whenever the result of the fraction is more than 50 percent, the MBT is met. Th formula can be represented as follows:
Amount of Tax Benefit
_______________________________= more than 50%
Amount of Tax Benefit +
other non-tax economic benefits
The draft circular clarifies that the non-tax economic benefits of the transaction, which go into the formula, may consist in cost savings or revenue increase, but must be measurable objectively, on the basis of specific documentation that the taxpayer should be able to make available and rely upon.
In conclusion, the MBT is an objective test, requires that the tax benefit is determined by taking into consideration the overall tax treatment of the cross-border arrangement and the income taxes due in all jurisdictions involved, and is met whenever the tax benefit is the principal benefit of the transaction, namely, prevailing over the total of other non-tax economic benefit of the transaction.
The ministerial decree and draft circular confirm that the administration and enforcement of the MBT will require a potentially very complicated analysis of the tax treatment of a cross-border arrangement in different jurisdictions, difficult calculations of the income taxes due in relation to a cross-border arrangement compared to the income taxes that would be due in relation to a comparable transaction carried out pursuant to a different legal scheme, and challenging computations of the monetary value of non-tax benefits of the arrangement to include in the measurement formula.
Not surprisingly, taxpayers are going to face significant challenges when trying to assess whiter a cross-border arrangement is reportable under the MBT.