With its ruling n. 251, issued on March 16, 2023 (n. 251 of March 16, 2023), the Italian tax agency addressed the issue of the tax classification of a Family Trust and a Testamentary Trust that were funded and started operating following the death of the settlor.

Background

Under Italy’s tax law, trusts are classified in one of three ways, with different tax consequences for the trust, the settlor, and the beneficiaries: fiscally interposed, fiscally transparent, or opaque trusts. The classification is based on the terms of the trust’s governing documents and the specific facts of the case (i.e., by looking at the way in which the settler, trustee, and beneficiaries operate and interact in reality, with respect to the trust, its property, and its income).

A fiscally interposed trust is ignored as an estate separate from that of the settlor or the beneficiaries, and the settler or a beneficiary is treated as the owner of the property and income of the trust.

A fiscally transparent trust is respected as an estate separate from that of the settlor or the beneficiaries, but a beneficiary is taxed on the trust’s income on a fiscally transparent basis, namely when the trust earns the income. No second tax applies when the income is distributed from the trust to the beneficiary. The tax is charged at progressive rates (the highest being 43%). The beneficiary may have a foreign tax credit if he or she is liable for an income tax on the trust’s income in a foreign jurisdiction.

A fiscally opaque trust is respected as an estate separate from that of the settlor or the beneficiaries, and no tax applies to a beneficiary on the trust’s income when earned by the trust. The beneficiary is not taxed upon the receipt of the distribution of the trust’s income, either, provided that the trust meets the minimum tax test, requiring that a tax equal to at least 50% of the tax that would be due in Italy, had the trust been an Italian tax resident trust, is assessed on the income of the trust in the jurisdiction where the trust is organized.

A revocable trust is typically classified as a fiscally interposed trust.

A simple trust is typically fiscally transparent.

A complex trust is typically fiscally opaque.

Depending on the classification of the trust, different obligations arise on the settlor or the beneficiaries with respect to the reporting of their beneficial interests in the trust’s property.

A trust with identified income beneficiaries is treated as fiscally transparent, and the beneficiaries are taxed on their share of the income of the trust when earned, regardless of its distribution to the trust beneficiaries.

“Identified” income beneficiaries are defined as specific persons or a class of persons who, under the terms of the trust agreement, have the right to receive distributions of income from the trust. Trusts with mandatory distribution schemes in the trust agreement are classified as fiscally transparent. Irrespective of the terms of the trust agreement, a trust may be classified as fiscally transparent if there is a pattern of regular distributions that, as a practical matter, is equivalent to a mandatory distribution scheme.

Fiscally non-transparent trusts are treated as separate taxable entities, with the consequence that, in the case of Italian resident trusts, the trust’s income is taxable to the trust (at a rate of 24 percent) and can be distributed to trust beneficiaries with no additional income tax on the distributions.

Income distributions from foreign, fiscally-non transparent trusts are not taxed to Italian tax resident trust beneficiaries. However, under a special anti-abuse rule enacted in 2021, income distributions from foreign trusts established in a low-tax jurisdiction are taxable to the Italian beneficiaries of the trust on the assumption that the trust income has not been subject to a minimum level of taxation in the jurisdiction where the trust is established. The income distribution is part of the annual general taxable income, and the Italian income tax is assessed at progressive rates. The minimum tax test is met whenever a foreign trust is subject to a nominal level of taxation in the jurisdiction where it is established that is equal to at least 50 percent of the Italian corresponding income tax rate (12 percent, based on the Italian nominal tax rate of 24 percent for taxation of trusts).

The nominal rate test applies at the level of the trust, and the nominal rate is determined by referencing the type of income “predominantly” earned by the trust. Any generally applicable exemptions, exclusions, or deductions not specifically linked to a trust’s particular class, type, or status are disregarded. The country of which the trust is a tax resident is deemed to be the “jurisdiction where the trust is established”. In the absence of a proper accounting of the principal and income of the trust, under Italy’s tax accounting principle, the full amount of the distribution is deemed to be income taxable to the beneficiaries upon receipt.

Facts of the Ruling

The settlor, an Australian national, was the trustee and beneficiary of a Family Trust while he lived in Australia. He later moved to Italy, where he passed away. The Family Trust owned rental real estate and other financial investments primarily located and managed in Australia.

When he was alive, the settlor treated the Family Trust as fiscally interposed and reported the trust’s property and income on his Italian personal income tax return. The settlor was also one of the trusts’ beneficiaries and the owner and manager of an Australian company that acted as the trustee of the trusts.

At the the settlor’s death, the settlor’s children were appointed as executors of his will and, as successor trustees, took over the function of trustees of the Famly Trust. In addition, a Testamentary Trust was created, in which part of the Family Trust’s property and the remainder of the decedent’s estate were transferred upon the settlor’s death. The settlor’s children were the primary beneficiaries of the two trusts.

One of the children filed a ruling request with the Tax Agency, asking for clarification on the trusts’ tax classification and the taxation of the trusts’ income.

In the ruling application, the applicant noted that he had waived his position as executor despite his appointment as successor trustee. He never carried out any function relating to the administration of the trusts and management of the trusts’ property, had no direct claims to the property or income of the trusts, and had never received any distribution of property or income from either trust.

Tax Classification of the Trusts

The Tax Agency ruled that both trusts were fiscally interposed with respect to the beneficiaries, who had retained the function of trustees after the settlor’s death. In that regard, the fact that the applicant had waived his appointment as executor of the will and had not performed any function with respect to the administration of the trusts was considered irrelevant.

Taxation of Trust Income

The Tax Agency ruled that the real estate income was taxable directly upon the beneficiaries of the trust and had to be computed with reference to the gross rents without any deduction. The Italian beneficiaries would be entitled to deduct a foreign tax credit for a portion of the income taxes paid in the foreign country on that income, in proportion to the amount of income they have declared in Italy. Similarly, the financial income deriving from the trusts’ financial investments was also taxable directly upon the applicant as a beneficiary of the trusts.

Tax Reporting

Finally, according to the Tax Agency, the applicant’s tax reporting obligation had to be carried out by referring to the trusts’ undelrying property.

Comments

This ruling deals with a common scenario in which various trusts are created and funded following the death of the settlor of an initial trust. Those trusts are usually referred to as family trusts, marital trusts, or testamentary trusts, depending on the way in which the assets part of the original trust’s estate and the settlor’s personal estate are divided upon the settlor’s death.

The terms of the documents that govern the various trusts are crucial to determining their tax classification, the tax treatment of the trusts’ beneficiaries, and the beneficiaries’ reporting obligations with respect to their interests in the trusts and trusts’ underlying property. A review of the beneficiaries’ roles, functions, and powers with respect to the administration of the rusts, including the possible role of investment trustee or power to appoint, revoke, or replace a trustee, investment trustee, trust advisor, or other persons or entities involved in the administration of the trusts, and the beneficiaries’ rights to the property or income of the trusts, are all factors to be considered as part of the analysis. The following step requires an analysis of the way in which the trusts are administered in reality.

While the facts of the ruling and the Tax Agency’s conclusions are relatively straightforward, the ruling still provides a valuable indication of the kind of inquiry the Tax Agency would conduct if involved in reviewing a similar situation to determine a taxpayer’s tax liability and tax reporting obligations in Italy.