With Circular n. 33 of December 28, 2020, Italy’s Tax Agency provided administrative guidance on the special tax regime for new resident workers, professionals and entrepreneurs.
The special tax regime, amended and extended in 2019, provides a 70 percent exemption from tax for income earned by individuals who establish their tax residence in Italy.
Eligible taxpayers include Italian and foreign nationals who (1) were not Italian tax residents in the two preceding tax years, (2) moved their tax residence in Italy in the current tax year, (3) undertake to maintain their tax residence in Italy for at least two years, and (4) during the tax year, carry out the activities which give rise to the exempt income primarily in Italy. The exemption applies for a period of five years, and, when certain conditions are met, can be extended for additional five years for a total period of up to ten years.
Circular 33 clarifies that the the 70 percent taxable income exemption applies to taxpayers who moved their tax residence in Italy on or after April 30, 2019 and became tax residents for the year 2019. Initially, the 70 perched exemption was limited to those who moved to Italy on or after July 3, 2019 and would apply starting from the tax year 2020, while a lower 50 percent exemption would apply to new residents in 2019.
Circular 33 clarifies that the first requirement (non-Italian tax residency during the preceding two years) is met, for taxpayers who are treated as Italian tax residents under Italian internal law, but as residents of a foreign country under the provisions of any applicable income tax treaty. The rule applies to Italian nationals who failed to register abroad and remained registered as Italian resident individuals at the time of their transfer to a foreign country, as well as to foreign nationals who at any had time registered themselves in Italy or maintained a place of habitual abode there, but had at all time their permanent home or center of vital interests in a foreign treaty country and should be treated as residents of that country under article 4 of a treaty between Italy and that country.
Circular 33 does not clarify the requirement that the activities giving rise to income eligible for the exemption be carried out primarily in Italy during the tax year.
Some possible interpretations are that the taxpayer:
– spends more than half of the calendar days in Italy,
– spends more than half of her working days in Italy,
– performs the majority of the activities giving rise to the income eligible for the exemption in Italy, regardless of the number of days she spent in Italy during the year.
The 70 percent tax exemption applies to the following categories of income:
1) employment income,
2) other categories of income taxable as employment income,
3) income from independent professional services,
4) business income.
The exemption applies solely to Italian source income.
Circular 33 clarifies that only business income earned by the taxpayer directly (as a sole proprietor) is eligible for the exemption. Income earned though a partnership or other entity treated as fiscally transparent, and flowing through to the taxpayer under Italy’s partnership rules, does not qualify for the exemption. Indeed, under Italy’s partnership rules, foreign source business income earned through an Italian partnership is re-characterized as Italian source partnership income, based on the partnership’s place of organization.
On the other hand, all foreign entities – including U.S. partnerships, limited liability companies treated as partnerships and corporations treated as S-corporations – are classified as separate taxable entities, for Italian income proposes (regardless of their legal form and tax classification in their foreign country of organization). As a result, in the case of a U.S. national who is a member of an LLC taxed as partnership, or shareholder of an S-corporation, the income which flows through the entity and is taxed upon her under U.S. income tax law is not eligible for the exemption. When that income is distributed to the member or shareholder, it is classified as a dividend and taxed with the 26 percent dividend tax rate in Italy.
Eligible income may derive from business or professional activities already under way at the time of the transfer of taxpayer’s tax residence to Italy, or new business or professional activities commenced at any time thereafter (within the five or ten year eligibility period).
There is no requirement that the employment or professional activities giving rise to the eligible income be performed for an Italian-based employer or resident entity. As a result, income received by foreign nationals who have become Italian residents and continue working in Italy for their foreign employer is eligible for the exemption. In the event the foreign employer is treated as having a permanent establishment in Italy as a result of its employee being based and working in Italy, any income attributable to the employer’s Italian permanent establishment would be taxable to the foreign employer under the regular Italian income tax rules.
Royalties received for the license of self-developed intangibles, copyrights or image rights are treated as income taxable as employment income. If paid by an Italian based entity or individual, they would be Italian source income eligible for the exemption.
Circular 33 provides some important clarifications on the application of the exemption to income earned before but received after the transfer of taxpayer’s residency to Italy. When the income is paid with respect to past employment carried out outside of Italy, when the taxpayer was a nonresident individual, for Italian income tax purposes, that income is not eligible for the exemption. The rule applies to incentive compensation schemes such as stock options or bonuses, and to severance or lump-sum payments, accrued with respect to foreign employment, but paid to a new resident taxpayer during the eligibility period.
Conversely, a bonus, severance or lump-sum compensation accrued with respect to Italian employment or services carried out in Italy during the eligibility period, but received after the end of the eligibility period, when the taxpayer has already moved her residence out of Italy, are also not eligible for the exemption and are taxable as Italian source income of a nonresident under the regular Italian income tax rules.
The eligibility period is five years. It can be extended by five years (going from a total of five to a total of ten years) for taxpayers with one dependent minor child (either at the time of the transfer, or at any time thereafter within the initial five year period), or who purchased a house in Italy during the twelve month period preceding the transfer, or at any time during the eligibility period. For taxpayers with three or more dependent minor children, the amount of exemption is increased from 70 percent to 90 percent.
Failing to maintain Italian tax residency for the minimum two-year period results in the retroactive loss of the exemption.
In general, the special tax regime for new resident workers, professionals and entrepreneurs offers tremendous opportunities to foreign companies with existing or new business in Italy, which plan to move personnel from heir home office to their Italian subsidiaries, foreign nationals who plan to pursue employment opportunities with Italian companies, and foreign professionals and entrepreneurs who plan to move to Italy and continue or start new business or professionals activities while there.
With proper planning, an exemption of as much as 90 percent of eligible taxable income in effect for a period as long as ten years is available to new tax residents under the special regime.