The Italian Tax Agency’s Ruling n. 309 of April 28, 2023 (Risposta-n.-309_2023-1.pdf) deals with the issue of taxation to Italian beneficiaries of income distributions from a U.S. trust.
Under Italy’s tax law, trusts with identified income beneficiaries are treated as fiscally transparent, and the beneficiaries are taxed on their share of the income of the trust when accrued and regardless of its distribution to the beneficiaries of the trust. “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 the trust 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.
Under the facts submitted by the taxpayer and discussed in the ruling, the trust was initially set up under the laws of the Bahamas and was governed by the laws of the State of New York since 2019 and at the time of the ruling request. Two individuals who are residents of and domiciled in the United States serve as trustees, with the power to amend the terms or change the governing law of the trust ) with the consent of the guardian), revoke, appoint and replace a trustee or trustees, increase the number of guardians, or appoint successor guardian when no one i serving in such capacity. At their sole and absolute discretion, the trustees can make distributions of principal or income of the trust to any member of a class of discretionary beneficiaries described in the trust. The trustees are not related or subservient to the trustees, with whom they have no ongoing professional relationships. The trustees approved the annual distributions made to trust beneficiaries in 2020 and 2021 by way of written resolutions included as part of the trust records. The trust owns a financial portfolio that is managed by a financial firm based in the U.S. appointed and serving as the trust’s investment advisor. For federal income tax purposes, the trust is treated as a separate taxpayer and is liable to tax on its income at a rate of up to 23.8% for dividends and capital gains and 37% on other (ordinary) income.
In its ruling, the Tax Administration agreed with the taxpayer and held that, based on the facts submitted by the taxpayer, the trust is classified as a fiscally nontransparent trust established in the United States, and the distributions of income from the trust the Italian beneficiaries were not taxable in Italy. It also ruled that future distributions will not be taxable, as long as the taxpayer can rely on sufficient evidence that the trust is taxed on its income at a nominal rate of at least 50% of the applicable Italian rate, as in effect at the time the income is earned or produced by the trust.
The ruling concerns a rather straightforward case and does not clarify certain more challenging issues that may arise in certain situations where the terms of the trust agreement provide for more flexible criteria or standards pursuant to which the trust beneficiaries may receive distributions from the trust or a foreign country’s taxation of the income of the trust may change depending on the classification of the trust or the tax treatment of the distributions in that country. However, the ruling is useful in offering an overview of the opportunities and potential traps involved in the tax planning through cross border trusts under Italy’s tax law.