The Italian Tax Agency recently issued Ruling n. 237 of March 2, 2023 (Risposta-n.-237_2023.pdf), which clarifies foreign trusts’ tax treatment concerning Italian tax resident beneficiaries.
Under the ruling, when the trustee of a foreign trust is required to make an annual distribution to beneficiaries based on a predetermined percentage of the fair market value of the trust, calculated at a fixed date, the trust must be considered fiscally transparent. In this case, beneficiaries are taxed in Italy on the income of the trust proportional to their interests in the trust, as specified in the trust agreement, on a fiscally transparent basis. This applies regardless of the actual distribution of income to the beneficiaries during the tax year.
The ruling considers a case in which a foreign national created a trust for her husband and three children. Her husband was entitled to a 25% share, and the three children were entitled to equal shares of the remaining 75% (or 100% if the husband predeceased her). Upon their death, their shares were held in separate trusts to benefit each child or their descendants. The trust was governed by US law and administered by an institutional trust organized in the US. The trustee was required to make an annual distribution of as much income or property of the trust that represents 4.5% of the total fair market value of the trust as of the last day of the third year preceding the year of the distribution.
The taxpayer who filed the ruling request took the position that (1) she was not required to file any inheritance income tax return with respect to her share of the assets of the trust she received in trust upon her father’s death, (2) she was not required to report the value of her trust on her Italian income tax return, and (3) the annual distribution she was entitled to should be reported as income from capital, for an amount equal to the value (in cash or other property) that is actually distributed by the trustee to the beneficiary during the year and is taxed by way of the substituted tax at the fixed rate of 26%.
The Tax Agency ruled that the assets that were distributed upon the death of the primary beneficiary to the secondary beneficiaries were not part of the decedent’s estate and were not subject to inheritance tax in Italy. The Tax Agency ruled that the petitioner is required to disclose the value of the trust and her interest in the trust in her Italian income tax return, considering that she is a mandatory beneficiary with the right to receive the distribution of at least 4.5% of the value of the trust annually.
On the issue of whether the annual distribution should be reported as income from capital, the Tax Agency ruled that the entire trust should be classified as fiscally transparent. This means that the taxpayer would be subject to tax in Italy on her share of the trust’s income, which is attributed and taxed to the taxpayer on a look-through basis, regardless of its distribution. The trust income is part of the taxpayer’s general taxable income and is taxed at progressive rates. The amount of distribution that the taxpayer receives each year from the trust is ignored for Italian income tax purposes.
It’s important to note that the ruling on the third issue is questionable and may be affected by how carefully the taxpayer presented her case. Under Italian tax law, a trust is partially fiscally transparent and partially fiscally opaque when the trust agreement does not provide that a beneficiary has the right to the distribution of the trust income as such, but instead provides that a certain percentage of the value of the trust must be distributed to the beneficiary. In that case, the trust is fiscally transparent regarding a portion of the trust income not exceeding the share of the trust.