With its Resolution n. 83 of 2-14-2022, the Italian Tax Agency ruled on interaction between the Italian special tax regime for high net worth individuals (so called “flat tax” or “lump sum tax” regime) and taxation of Italian source employment income under Italy’s general income tax.
The case involved certain international employees of an Italian financial institution who moved to Italy and elected to be taxed under the flat tax regime, while continuing working for the Italian employer and performing their functions partly in Italy and partly abroad.
Italy operates a special tax regime for individual taxpayers (Italian or foreign nationals) who establish their tax residency in Italy while they have not been Italian tax residents in at least nine of the previous ten years. In that event, upon taxpayers’ election, Italy charges a fixed tax amount of 100,000 euro on taxpayers’ foreign source income, in lieu of its general income tax. Italian source income is taxed under the general income tax regime. Taxpayers are free to repatriate their foreign source income and may cary on an employment or engage in a business, trade or profession while electing for the flat tax. In that case, Italian source business, employment or professional income is taxed separately under Italys’ general income tax regime (by brackets at graduated rates) while foreign source income falls within the scope of the flat tax and is not subject to a separate regular income tax. The election for the special tax regime is done with the filing of the Italian income tax regime for the first tax year in which taxpayers are eligible, or the immediately following year.
Ruling n. 83 addresses two issues: the criteria for the computation of the foreign source and Italian source portions of taxpayers’ employment income and employer’s withholding tax obligations. On the first issue, the Italian Tax Agency confirms that the computation must be done by making reference to the number of working days during which the employee performed his or her functions abroad, over the total number of working days of the year, with fractions of days spent in Italy counting as full Italian working days for the purpose of the computation. The Tax Agency also clarified that the burden of proof falls upon taxpayers, who must be prepared to provide adequate documentation to prove the exact number of working days spent abroad, in the absence of which all days would count against the Italian source portion of the income.
On the second issue, the Italian Tax Agency ruled that the employer must operate the full amount of income withholding taxes as if the special tax regime does not apply, until the employees have elected for the special tax regime and provided evidence of the election (i.e., copy of their income tax return in which the election has been made), together with a requested to be filed the employer. Any excess withholding taxes will be be refunded upon taxpayer’s request.
One of the most prominent features of Italy’s flat tax regime is its flexibility. International executives or entrepreneurs can move to Italy, shelter their foreign source income – generally, income from financial investment and capital gains – from the Italian regular income tax, continue with their business ventures or employment, and minimize their Italian regular income tax by making sure that most of the income arising from their businesses or employment is sourced outside Italy, thereby falling within the scope of the flat tax.
Ruling n. 83 provides some sensible answer to some of the issues which arises in a scenario like the one described above, and confirms that Italian income sourcing rules pay a crucial role in determining the final tax treatment and benefits that taxpayers achieve out of the flat tax.