With its ruling n. 32255 issued on December 13, 2018 (“Ruling 32255”), the Italian Supreme Court, Fifth Department (Tax) held that a dividend paid by an Italian subsidiary to a parent company established in a EU Member State is not eligible for the dividend withholding tax exemption granted under the provisions of Directive 90/435/EC (the “EU Parent Subsidiary Directive”, transposed into Italian domestic tax law by way of article 27-bis of Italy’s Presidential Decree n. 600 of September 29, 1973), unless the dividend is actually subject to corporate income tax in the parent company’s home country.

Ruling n. 32255 is consistent with a previous decision of the Supreme Court (n. 25264 of October 25, 2017), which we commented on this blog.

By requiring that the dividend is actuality taxed in the parent company’s home country, Ruling 32255 adds a requirement for the application of the dividend withholding tax exemption (the “double taxation requirement”), which is not part of the literal language of the EU Parent Subsidiary Directive, and – especially if adopted by national tax courts in other jurisdictions – may have far reaching implications on taxation of EU cross-border dividends.

Summary of the Law

Under Italian domestic tax law (article 27 of presidential decree n. 600 of September 29, 1973), outbound dividends are subject to withholding tax at the rate of 27 percent. The withholding tax can be reduced pursuant to a tax treaty between Italy and the recipient the dividend (provided that all treaty’s requirements for the withholding tax relief are satisfied).

However, outbound dividends are exempt from the 27 percent withholding tax, under the EU Parent Subsidiary Directive, provided that certain requirements are met, namely, that the recipient of the dividend, at the time the dividend is declared, is an entity that:

(i) is organized in one of the forms specifically set forth in an Annex to the Directive (the “legal form requirement”),

(ii) is resident of a EU Member State, under the domestic tax laws of that State, and is not treated as a nonresident entity pursuant to a tax treaty between that State and any third (non-EU) country (the “tax residency requirement”),

(iii) is subject to corporate income tax, in its own jurisdiction, and does not benefit from a general tax exemption or tax exclusion regime which is not geographically or temporarily limited (the “subject to tax requirement”), and

(iv) has been owning, directly and for an interrupted period of at least one year, 10 percent (15 percent, prior to 1/1/2009, or 20 percent prior to 1/1/2007) or more of the stock of the company that distributes the dividends (the “stock ownership requirement”).

Under the provision of article 27, paragraph 3-ter of the Presidential Decree n. 600 of September 29, 1973, dividends paid to a company which does not qualify for the exemption under the EU Parent Subsidiary Directive, but:

(i) is organized in the form of a corporation or other equivalent legal form,

(ii) is resident in a EU Member State, and

(iii) is subject to corporate income tax in its State of residence,

are subject to a reduced withholding tax of 1.20 percent. The reduced withholding tax rate is aimed at equating the taxation of outbound dividends to that of domestic inter company dividends, whereby dividends are not subject to withholding and are partially exempt, under Italy’s participation exemption regime, resulting in an effective tax rate of 1.20% in the hands of the corporate shareholder (in compliance with the non discrimination principle and free movement of capital provision of the EC Treaty).

Facts of the Case

Under the facts of the case, an Italian corporation paid a dividend to its Luxemburg parent, charging a 27 percent withholding tax of euro 1,059,921.45 upon distribution. The Luxemburg company filed a claim for refund of the withholding tax with the Italian tax agency, pursuant to the EU Parent Subsidiary Directive’s withholding tax exemption. The Italian tax agency failed to respond within the statutory deadline (90 days). Under the applicable statute, the lack of timely response to the refund claim which is treated as a deemed rejection of the claim. As a result, the Luxembourg company filed a petition with the tax court, challenging the rejection of the refund claim. The tax court ruled in favor of the taxpayer. The tax agency appealed, and the regional (appellate) tax court ruled in favor of the tax agency, reversing the trial court judgement and validating the withholding tax. The Luxembourg company then filed a petition with the Supreme Court.

Analysis

In light of the reasoning of the Supreme Court’s judgement, it is apparent that the Luxemburg company satisfied all the statutory requirements for the withholding tax exemption under the EU Parent Subsidiary Directive. Specifically, it parers to be stipulated (or undisputed) that the Luxembourg company is a corporation resident in Luxembourg and subject to corporate income tax there.

However, the Supreme Court held that the dividend withholding tax exemption cannot apply, because the Luxembourg company benefitted from a dividend tax exemption under a participation exemption regime provided for under Luxemburg law. According to the Supreme Court, the fact that the Luxemburg company is a taxable entity and is subject to Luxemburg corporate income tax does alter that conclusion, because the exemption from tax on the dividends in Luxemburg is sufficient to avoid any double taxation of the dividends which would otherwise result from the application of the Italian withholding tax.

The Supreme Court argues that the ratio of the EU Directive’s dividend withholding tax exemption is that of preventing a double taxation of the dividends (first, by way of a withholding tax charged in the country of source, at the time of the distribution of the dividends, and then by way of the income tax charged in the shareholder’s country of residence upon receipt of the dividends). According to the Court, when there is no double taxation of the dividends as a result of the dividend exemption in the shareholder’s country of residence, the withholding exemption has no reason to apply, considering that the Directive’s withholding exemption cannot result in a double non taxation of the dividends.

The Supreme Court does not directly discuss the meaning of the term “subject to tax” used in the EU Parent Subsidiary Directive. That term, in the Directive, is used in reference to the recipient of the dividend, which must be a taxable entity liable to tax in its country of residence. Generally, two alternative interpretations of the term have been debated, one interpretation requiring that the entity itself be “liable to tax”, that is, be classified as a taxable entity and falling within the scope of a corporate income tax, in its own jurisdiction (regardless of the fact that it actually pays a tax, on the income it receives and for which it claims a tax relief), and another interpretation requiring that the entity be “subject to tax”, that is, it actually pay a tax, on the specific item of income it receives and for which the tax relief is claimed.

Rather, the Court seems to inject an additional, overarching requirement for the application of the Directive’s dividend withholding exemption, namely, that the dividend be subject to double taxation (in the country of source and in the country of residence), while exemption should not apply when it would result in a double non taxation of the dividend.

Previous Case Law

Ruling 32255 is directly in line with The Italian Supreme Court’s ruling n. 25264 of October 25, 2017, also from the Fifth Department (Tax), in which the Supreme Court held that the actual payment of the corporate income tax in the parent company’s home jurisdiction is required for the parent company to benefit from the dividend withholding tax relief under the EU Parent Subsidiary Directive, and that no exemption applies to a dividend paid by an Italian company to its Dutch parent which benefits from a participation exemption regime resulting in the exemption of the dividend from corporate income tax in the Netherlands.

Possible Developments and Open Questions

The Italian Supreme Court did not discuss the possible application of the reduced 1.20 percent withholding tax. Indeed, the dividend in question was distributed in 2003, prior to the enactment of the reduced withholding tax rate. As discussed in the summary of the law paragraph, above, also for the purpose of the application of the reduced withholding tax rate, it is required that the corporate recipient be subject to corporate income tax in its EU Member State of residence (indeed, the language of the statute, on that particular requirement is very similar to – and drawn from – the language of the Directive). The reduced withholding rate is aimed at equating the Italian taxation of an outbound dividend to the taxation of a domestic dividend, whereby the company which receives the dividend is exempt on 95 percent of the amount of the dividend, and is taxed on 5 percent of the amount of the dividend, at the corporate tax rate of 24 percent, resulting in an effective tax rate of 1.2 percent. It is not clear whether the Court would reach a similar conclusion, under similar facts, when the issue is that of the application of the reduced withholding tax.

Another legitimate question is whether the Court would reach the same conclusion, with respect to the application of the Directive’s full exemption, when the EU parent company is at least partially taxed on the dividend, under a partial exemption regime.

Furthermore, it is interesting to see whether the Italian Supreme Court’s novel interpretation of the EU Parent Subsidiary Directive, as requiring a double taxation of the dividend for the withholding exemption to apply, is followed by other courts, in other EU jurisdictions, leading to more far reaching challenges to the tax treatment of inter company dividends throughout the EU, and further challenging tax planning structures for EU inbound investments, based on the use of EU holding companies located in favorable taxing jurisdictions.

Finally, readers should note that Italian Supreme Court’s decisions are not binding precedents, and that the Court can rule differently on the same issue arising in separate cases. If contrasting decisions on the same issue emerge within the Court, a case can be referred to the full bench for a decision resolving the contracts and establishing a uniform interpretation of the law on that particular matter.

The Italian Supreme Court with its ruling n. 25264 of October 25, 2017 (Cassazione n. 25264 of 10-25-2017) held that actual payment of the corporate income tax in the parent company’s home jurisdiction is required for the parent company to benefit from the dividend withholding tax relief under the EU Parent Subsidiary Directive (the “EU Directive”) or Italy-The Netherlands Double Tax Treaty (the “Treaty)”.

FACTS

Under the facts of the case, an Italian company controlled by a Dutch company (organized as a “naamloze vennootschap” or N.V., which is a type of entity falling within the scope of Dutch corporate income tax) paid a dividend to its parent and applied the 5 percent reduced dividend withholding tax rate under the Italy-The Netherlands Double Tax Treaty.

The Dutch parent filed a request for refund of the 5 percent withholding tax, pursuant to the EU Parent Subsidiary Directive n. 2003/123/EC of December 22, 2003 amending Directive 90/435/EEC (EUR-Lex – 31990L0435 – EN).

The Italian tax agency assessed the full 27 percent dividend withholding tax under article 27 of Presidential Decree n. 600 of 9/30/1973, on the theory that the Dutch parent company failed to satisfy the requirements for the withholding tax relief, under the EU Directive as well as the Treaty, because (1) it had not been subject to tax in the Netherlands on the dividend it received from its Italian subsidiary, and (2) it did not submit any valid evidence that it was the beneficial owner of the dividend.

According to the Italian tax agency, “subject to tax” requires evidence of the actual accrual of the tax liability and payment for the corporate income tax, as opposed to just a potential tax liability associated with the legal form and general tax status of the entity in its home country.

The Supreme Court ruled in favor of the tax agency on the “subject to tax” issues, thereby denying the benefits of the Directive and the Treaty.

LAW

Under the EU Directive, profits distributed by a company of a EU member state to a company of another EU member state which owns at least 10 percent of the capital of the company distributing the profits, are exempt from withholding tax in the distributing company’s member state.

Pursuant to article 2 of the Directive, for the exemption to applies it is required that the recipient of the dividend is subject to corporate income tax in its home country (vennootschapsbelasting in the Netherlands).

Under article 10 of the Treaty (nethe-en), a Dutch company is entitled to a 5 percent reduced withholding tax rate on inter company dividends received from its Italian subsidiary, provided that it a resident of the Netherlands, which, in turn, requires that it is liable to tax there.

ISSUE AND RULING OF THE COURT

The case revolved around the contraction and exact meaning of the terms subject to tax, used in the Directive, and liable to tax used in the Treaty.

According to one interpretation, those terms require solely potential taxation, meaning that, based on its legal form and tax status, an entity is generally treated as a taxpaying entity falling within the scope of the corporate income tax, while the fact that it may not be actually subject or liable to a tax as a result of a participation exemption or similar tax regime applicable in its home country is not relevant.

According to another interpretation, those terms requires the actual rising of a lability for the corporate income tax in connection with the receipt of the dividends, and the actual payment of that tax.

The Supreme Court observed in its ruling that the Dutch company recipient of the dividends had furnished a tax residency certificate issued by the Dutch tax authorities, but failed to demonstrate that it actually met all the requirements for the withholding tax relief, such as the proof of the “actual payment of the corporate income tax, in connection with the distribution of the dividend”.

The ruling is not entirely consistent with the tax administration’s guidance on the issue, which we refer to below.

ADMINISTRATIVE GUIDANCE

Circular 26/E of May 21, 2009 provides clarifications on the “liable to tax” requirement that applies for the purposes of the reduced withholding tax on Italian dividends paid to EU companies.

The first clarification reads as follow: “With reference to the second requirement” (the subject to tax requirement) “it must be pointed out that the condition of passive subject of the local corporate income tax must be interpreted as a general liability to tax, which occurs in all those situations in which a company is potentially liable to a corporate income tax, even though in certain circumstances it may benefit from beneficial tax regimes that are compatible with EU legislation”. As a result, all companies or entities to which is assigned general liability for the corporate income tax should qualify for the reduction, including those entities that do not owe the tax by virtue of special tax exemption regimes linked to the type of income they earn (e.g. passive income) or the place where they operate. On the other hand, companies and entities that do not fall within the area of application of the corporate income tax, do not qualify for the reduction.”

Circular 26/E refers to Circular n. 47 of November 2, 2005, which provides clarifications on the liable to tax requirement that applies for the purposes of the exemption from withholding tax for interest and royalties paid to a EU affiliate under the EU interest and royalties directive. Circular 47/E (referred to in Circular 26/E), in the relevant part, reads as follows: “With respect to the last requirement [the liable to tax requirement], it must be interpreted as a general or potential liability to tax. Therefore, according to what is clarified above, the benefit [of the exemption from withholding tax on interest and royalties] must be considered applicable to all those companies that, despite being potentially subject to corporate income tax, in fact benefit from special tax regimes compatible with EU law”.

The tax administration with its Circular 32/E of July 8, 2011 confirmed the above interpretation of the term liable to tax, when providing guidance on the refund of past withholding taxes charged on dividends to EU companies in excess of the new 1.375% rate instated pursuant to the decision of the European Court of Justice that declared the 27% outbound dividend tax in violation of the non discrimination principle of the EU Treaty. In Circular 32/E the administration clarified that EU companies eligible for the refund include all entities that “are passive subject of the local corporate income tax. Such condition must be interpreted as a general subjectivity to the tax, and it is satisfied for all companies potentially liable for the tax, regardless of the fact that they may benefit from special favorable tax regimes compatible with EU law. As a result, the reduced rate can apply to all companies or entities to which a general liability for the corporate income tax is assigned, including those that do not pay the tax due to exemptions linked to the type of income they earn (e.g. exemption of passive income) of the place in which their activity is carried out. On the other end, foreign companies and entities that do not fall per se within the scope of the tax do not qualify.”

CONCLUSIONS

The Supreme Court’s ruling is not well explained or thoroughly elaborated. That may very well be a direct result of lack of clarify and comprehensive briefs or a defective discussion of the case on behalf of the taxpayer.

As a result, it may be prudent to wait before reading too much into it going beyond the specific case and the way in which it was litigated and argued in court.

Still, the rather harsh conclusion of the Court, holding that evidence of the actual payment of the corporate income tax in connection with the receipt of the dividends to benefit from the withholding tax relief under the EU Directive (or the Treaty), is troubling, and sufficient to raise the level of awareness on a very sensitive and not entirely settled issue of international tax law.

With its ruling n. 975 issued on January 18, 2018 Italy’s Supreme Court held that the transfer of an asset (real estate property) to an irrevocable trust falls outside the scope of Italy’s registration, cadastral and mortgage taxes (transfer taxes), charged at the aggregate rate of 10 percent, on the theory that it is a transitory step before the final transfer of the property to the beneficiaries of the trust actually occurs, at which time the transfer taxes should apply.

The ruling is consistent with a previous decision of the Supreme Court on the same issue, that is, ruling n. 21614 of October 26, 2016 (which we also commented upon on this blog).

The question is whether the ruling extends to the gift tax, which replaces the registration tax for gratuitous transfers taking place from October 25, 2006.

The ruling concerns facts occurred before the reenactment of Italy’s estate and gift tax. The issue in front of the Court was to determine whether the transfer of real property to a trust was subject to the registration, cadastral and mortgage taxes (usually referred to as transfer taxes or indirect taxes), which are charged at the rates of up to 7 percent, 2 percent and 1 percent of the value of the transferred property.

The property was transferred to an irrevocable trust that specifically identified the beneficiaries of the corpus of the trust, their shares of the principal of the trust and the time at which the trustee would be requested to distribute the trust’s assets to the trust’s beneficiaries.

The Court ruled that the transfer of the property fell outside the scope of the transfer taxes because it did not fit within any of the enumerated categories of legal arrangements to which the transfer taxes should apply, namely (1) transfers for consideration (“atti traslativi a titolo oneroso”), (2) other transfers concerning legal or contract performances with an economic value (“atti diversi aventi ad oggetto prestazioni a contenuto patrimoniale, or (3) acknowledgements (“atti di natura dichiarativa”).

According to the Court, the transfer of the property to the trustee with instructions to hold and administer it in trust in the interest of the trust’s beneficiaries, for a certain period of time and until the conditions are met to proceed with the final distribution of the property to the trust’s beneficiaries, is a transitory step that is part of a legal arrangement designed to procure the final and definitive transfer of the property to certain beneficiaries at a future time. With reference of such a legal arrangement, the Court held that the transfer taxes should apply solely at the time of the actual, final transfer of the property from the trustee to the beneficiaries of the trust.

According to one interpretation, the ruling supports the principle according to which the gift tax (which applies in lieu of the registration tax with respect to gratuitous transfers completed after the re-enactement of Italy’s estate and gift tax with effect from October 25, 2006) should apply only at the time of the final distribution of a trust’s property to the beneficiaries of the trust, when the beneficiaries eventually acquire the unconditional legal ownership rights to the property and receive the full enjoyment of the economic value of the gift, rather than at the time of the transfer of the property to the trust, when the property is temporarily held in trust and administered in the interest of the beneficiaries.

Article 2, paragraphs 47 and 49 of Legislative Decree n. 262 of 2006 (finally enacted into law by way of Act n. 286 of 2006), reinstated Italy’s estate and gift taxes, as originally instituted and governed under Legislation Decree n. 346 of 1990 effective from 1/1/1991 and temporary repealed in October 2001. For gratuitous transfers from a donor to a donee, the gift tax applies at the rate of 8 percent, in lieu of the registration tax. For real estate properties, the cadastral and mortgage tax, at the rate of 2 and 1 percent, are still due on top of the gift tax. For close family members (spouse, parent, children, grandparents, grandchildren), a lifetime exemption of up to one million euros for each beneficiary applies, and the gift tax is charged at the reduced rate of 4 percent.

The gift tax historically applied only to straightforward gifts, as defined in the Civil Code, that is, gratuitous transfers of a property or other valuable economic interests from a person – the donor – to another person – the donee, whereby the recipient of the gift, or donee, would have immediate legal rights to and enjoy the full economic benefit of the gift.

Under the original estate and gift tax statute, the application of the gift tax in the event of a transfer of property through a trust, was unclear. The transfer of a property to the trustee of a trust was not be subject to the gift tax, because the trustee, as the immediate recipient of the property, typically does not have full legal rights to and economic benefit from the property, which he administers in trust for the ultimate benefit of the beneficiaries of the trust, while the beneficiaries of the trust do not receive the property until it is distributed to them out of the trust pursuant to the terms of the trust agreement.

At the time of distribution of the property from the trustee to the beneficiaries of the trust, the gift tax would not apply because the trustee distributes the property to the beneficiaries pursuant to a legal arrangement that does not fall within the legal definition of gift that is subject to the gift tax.

The original estate and gift tax statute, resurrected in 2006, was amended with the addition of a specific reference to deeds or other legal arrangements resulting in the creation of a legal restriction to or constraint on the final disposition of property (“atti costitutivi di vincoli di destinazione”).

The main purpose of the amendment was to bring trusts within the scope of the reenacted gift tax.

The tax administration, in its administrative guidance on the application of indirect taxes to trusts (provided with Circular n. 48/E of August 6, 2007 and n. 3/E of January 22, 2008), took the position that the new category of “legal arrangements resulting in the creation of a legal restriction to or constraint on the final disposition of property” refers to and includes the transfer of a property into a trust, whereby the property is subject to the legal restrictions set forth in the trust agreement, with respect to its administration and disposition, before it can be distributed to there beneficiaries of the trust. As a result, according to the Italian tax administration’s position, the gift tax applies at the time of the transfer of the property into the trust. Later, when the property is distributed out of the trust to the trust’s beneficiaries, no second tax would apply.

The Supreme Court agreed with the tax administration in a number of decisions issued in respect of transactions taking place under the newly reenacted and amended estate and gift statute. Those decisions include ruling n. 3735 of February 24, 2015 (concerning a self settled trust subject to gift tax at the full rate of 8 percent); ruling n. 3737 of February 24, 2015; ruling n. 3886 of February 25, 2015 (also concerning a self settled trust taxed at the full rate of 8%); ruling n. 5322 of March 18, 2015 and ruling n. 4482 of March 7, 2016.

More recently the Supreme Court, when addressing cases concerning transactions completed before the reenactment of the amended estate and gift tax statues, held that in light of the temporary and transitory nature of the transfer of a property to a trust, whereby the property is placed and held in trust, and is not immediately transferred to the intended final recipient and beneficiary, outright, the registration tax at the rate of 8 percent should apply. Ruling n. 975 is the last one on the issue, following previous ruling n. 25478 of December 18, 2015 and ruling n. 21614 of October 26, 2016.

According to one interpretation, the rational of those rulings extends to the realm of the newly reenacted gift tax and con-validates the principle according to which the gift tax should apply at the time of the final transfer of the property out of the trust to its final beneficiary. According to this interpretation, the new language added to the revised gift tax statute does not create an additional stand alone category of transactions subject to gift tax but, rather, it has the sole function of making it clear that the gift tax actually applies also to gratuitous transfer of property made through a trust, as it applies to straightforward gifts.

Clearly, the narrow interpretation of the scope of the Italian gift tax with respect to transfer of properties through trusts, is inconsistent with the way in which the gift tax applies in the U.S. Under U.S. principles, generally the transfer of property into an irrevocable trust is a complete gift, which falls within the application of the federal gift tax. Simultaneously, under Italian law, according to the interpretation illustrated here above, a complete gift would occur solely at the time of the final distribution of the property out of the trust, to the trust’s beneficiaries.

As a consequence, Americans with properties held in irrevocable trusts might be inadvertently exposed to Italian gift tax, at the time the property is distributed to the beneficiaries of the trust. That would happen whenever the original settlor is resident in Italy, for Italian gift tax purpose (in which case, all of the properties held in trust, wherever located in the world, would potentially be subject to Italian gift tax, based on the tax residency or domicile of the settlor), or some or the properties held in trust are located in Italy (in which case those properties might be subject to Italian gift tax, based on the location of the property and regardless of the tax residency or domicile of the settlor).

In conclusion, trust planning for individuals who have establish or are planning to move their tax residency or domicile into Italy, or held Italian properties in trust, should be reviewed to address Italian estate and gift tax issues in a very uncertain area of law.

On February 23, 2017 the Italian Government approved the final draft of the legislative decree (the "Decree") that is going to implement the provisions of the Directive (EU) 2015/49 of May 20, 2015 (the so called "IV Anti Money Laundering Directive"). The decree was sent to the Parliament for its review and with the consent of the Parliament it will become law.

One of the key concepts of the new anti money laundering legislation is the definition of "beneficial owner", meaning, the natural person who must be properly identified by the persons or entities obliged to carry out the  customer due diligence and report a transaction or legal arrangement whenever required under the anti money laundering law.   

Whenever the customer is an entity, as opposed to a natural person, article 20, paragraph 1 of the Decree provides a general definition of beneficial owner, as follows:

The beneficial owner of customers different from natural persons is identified with the natural person or natural persons to whom, ultimately, the direct or indirect ownership or control of the entity is attributable.

The definition of beneficial owner of an entity revolves around two concepts: ownership, or control, of the entity. Also, the ownership or control can be direct or indirect.  

The first test to apply is the ownership test. 

Article 20, paragraph 2 provides on direct or indirect ownership as follows:

When the customer is company:

a) it is an indicia of direct ownership, the ownership of an interest exceeding 25% of the capital of the customer, owned by a natural person;
 
b) it is an indicia of indirect ownership, the ownership of an interest exceeding 25% of the capital of the customer, owned through controlled entities, fiduciaries or intermediaries.
 
Beneficial ownership through indirect ownership in another entity requires that the tested natural person directly owns an ownership interest in another entity, which in turn holds ad ownership interest in the customer, ultimately making that natural person the indirect owner of the customer under the "more than 25 percent" test. 
 
The percentage of ownership owned in the intermediate entity, by the tested natural person, which should be required to qualify that entity as a controlled entity for the purposes of ultimately determine the existence of an indirect ownership interest in the customer, is not determined, and no attribution rules are set forth in the legislative decree for the purpose of applying the indirect ownership rule.
 
It would seem reasonable to assume that a direct ownership of more than 25 percent of the capital of the intermediate entity, could be sufficient to qualify that entity as a controlled entity, for the purpose of the indirect ownership testThe controlled entity, in turn, should directly own a sufficient percentage of the capital of the customer, as required so that, once percentage of direct ownership in the capital of the intermediate entity, owned by the natural person, is multiplied by the percentage of direct ownership in the capital of the customer, owned by the intermediate entity, the result would meet the "more than 25 percent" test for the indicia of beneficial ownership required for anti money laundering purposes.
 
Under that approach, when a natural person owns 50 percent of the capital of a company, which owns 51 percent  of the capital of another company, there would indication of beneficial ownership, because the natural person would indirectly own 25.5 percent of the capital of the customer.
 
Instead, if a natural person owns 20 percent of the capital of a company, which owns 100 percent of the capital of another company, there would be no indicia of beneficial ownership, because the intermediate ownership would be less than 25 percent. The same should be true when a natural person ones 100% of the capital of a company, which owns 24 percent of the capital of the customer.
 
Conversely, if a natural person owns 25.1 percent of the capital of two companies, each one of which owns 50 percent of the capital of the customer, there would indicia of beneficial ownership.
 
The control test applies whenever the beneficial owner cannot be identified through the application of the ownership test.       
 
Article 20, paragraph 3 defines the control test (that applies whenever the ownership test is insufficient to identify the beneficial owner of the customer) as follows: 
 
In the event that the ownership structure of the customer does not allow to identify in an unequivocal manner the direct or indirect ownership of the customer, the beneficial owner coincides with the natural person or persons to whom, ultimately, the control of the customer is attributable due to:
 
a) the control of the majority of the votes that can be exercised in the general meeting of shareholders, 
 
b) the control of a sufficient number of votes to exercise a dominant influence in the general meeting of shareholders
 
c) the existence of particular contractual constraints which allow a person to exercise a dominant influence (on the customer).
 
The control requirement is defined as control of the majority of the votes exercisable in the general meeting of shareholders, or dominant influence over the general meeting of the shareholders through voting power of contractual arrangements.  
 
When neither the ownership nor the control test are sufficient to identify the beneficial owner, article 20, paragraph 5 provides that the beneficial owner is the person who holds powers over the administration and direction of the entity. 
 
Article 20, at paragraph 5 provides that in case of private associations and foundations or other entities governed by Presidential Decree n. 361 of February 10, 2000 the definition of beneficial owner includes all of the following:
 
– the founder, when living;
 
– the beneficiaries, when they are identified or can be easily identified;
 
– the individuals with powers or authority over the administration or direction of the entity.  
 
No specific provision applies to trusts, which are not entities governed by Presidential Decree n. 361 of 2000, but are typically created under foreign law and recognized and made effective in Italy pursuant to the Hague Convention of July 1 1985 on Trusts. 
 
 
 

The European Court of Justice (ECJ) with its decision in the case C-277/09 issued on December 22, 2010 (RBS Deutschland Holdings) blessed an international tax arbitrage transaction whose final result has been to obtain a credit for input VAT charged on purchase of vehicles while avoiding the application of output VAT on rental payments from leases of those vehicles.

Under the facts of the case, RBS Deutschland Holdings GmbH, a Germany company, purchased cars in the UK through its VAT registered unit in the UK and leased the cars to a UK company, directly and through one of its German subsidiaries. In the UK the lease contracts were characterized as financial transactions, which for VAT purposes are supply of services that are taxable in the country of supplier (in the case Germany). However in Germany the leases where characterized as sales of goods which are taxable in the country of purchaser (in the case the UK).

RBSD claimed a credit for the input VAT paid on the purchase of the cars even though no output VAT was paid on the leases of those cars . The UK tax authority denied the VAT input credit and asked the Court to determine whether the general anti abuse principle embedded in EU VAT law would prevent a taxpayer from qualifying for an input VAT credit in circumstances in which sales are structured in a way to avoid output VAT.

The ECJ held that a taxpayer is not prohibited from exploiting the differences in national tax systems in a cross border transaction leading to a more favorable tax result, provided that the transactions in which the taxpayer is engaged are not entirely artificial and are not entered into for the sole purpose of avoiding taxes.

The Court acknowledge that taxes are a factor that is taken into consideration to determine the final form of a transaction, but when they are not the only factor and the transaction otherwise serves a legitimate business purpose, the final tax result should be respected event when if is predicated on an inconsistent tax treatment of the transaction under two different legal systems.      

           

On February 25, 2010 the European Court of Justice issued its ruling in X Holding (C-337/08 X Holding Judgment.pdf). Under the facts of the case, a Dutch parent wanted to be allowed to combine with its Belgian subsidiary under the Dutch tax consolidation rules to use the latter losses, which it would have been allowed to use had the subsidiary been a branch. The Dutch fiscal unit system, which disregards intra group transactions, is consolidation. Under Dutch tax law, the Netherlands does not tax a foreign branch’s profits, but allows a deduction for foreign branch’s losses subject to recapture of branch’s profits in the following years for an amount equal to losses allowed in prior years. The Belgian subsidiary could still use its losses in Belgium, so it was clear that the losses would not be deductible under Marks & Spencer holding and the case rested on a cash flow argument that the parent should be allowed to use the losses sooner in the Netherlands. The Attorney General’s opinion concluded that the denial of consolidation of foreign subsidiaries is justified under the balanced allocation of taxing powers, coherence of tax system and need to protect member state’s tax base and the restriction to the freedom of establishment is proportional and justified. The European Court of Justice upheld the AG’s opinion and ruled in favor of the Dutch government. The Court rejected the taxpayer’s argument that taxpayer should be allowed the same treatment granted in case of a foreign branch, on the ground that a foreign branch and a foreign subsidiary are not in a comparable situation, the former being subject in principle to the tax jurisdiction of the member state of origin, while the latter being an independent legal and tax entity subject only to the tax jurisdiction of the member state of destination.      

On March 4, 2009 the EU Court of First Instance issued a judgment in Italy v. Commission (T-424/04), in which it ruled that Italy’s favorable tax treatment for special investment funds violates state aid rule of the EC Treaty.  

Article 12 of Law Decree 269 of 2003 (converted into Law n. 326 of November 24, 2003) provides that collective investments funds which invest primarily in shares of  small and mid-capitalized companies are subject to tax at the rate of 5 instead of 12.5 per cent. The reduced tax applies on the increase of the fund’s net asset value at the end of each tax year.

For the favorable tax treatment to apply, the following requirements must be met:

– the regulation of the fund must provide that at least two thirds of the fund’s assets are invested in shares of small and mid-cap companies regularly traded in EU securities market;

– the fair market value of the qualified shares owned by the fund must be equal to at least two thirds of the value of fund’s asset for more than one sixth of non consecutive days in each calendar year.

Small and mid-cap companies are defined as companies whose market value computed on the basis of the average share price on the last day of each quarter has not exceeded 800 million euro.

The European Commission on September 6, 2005 ruled that such favorable tax treatment violated the state aid provisions of article 87 of the EC Treaty and ordered the Italian government to collect the balance of the tax (7.5 percent) from the funds. The Italian government appealed the decision of the European Commission and the EU Court of First Instance rule in favor of the Commission and rejected the appeal.

The Italian government now can appeal the judgment to the Eurpean Court of Justice or accept the decision of the First Instance Court.

The small and mid-cap investment funds are not really common in the market; however, in the present situation the market capitalization of many companies has dropped as a result of the crisis, and such type of special investments funds could become more popular due to the favorable tax treatment now in question.        

A similar judgment was issued on the same issues on the same date in the case Associazione italiana del risparmio gestito and Fineco Asset Management v. Commission (T-445/05).

Foreign investors resident or organized in qualifying jurisdictions are entitled to a refund equal to the tax charged upon the fund. If a higher tax is eventually collected from the fund, they would be entitled to a higher refund from the fund.   

 

 

Continue Reading Favorable Tax Treatment for Special Investment Funds Denied, EU Trial Court Ruled

With judgment issued on December 22, 2008 in Les Vergers du Vieux Tauves (C-48/07) the European Court of Justice (ECJ) held that Directive 90/435/EEC of July 23, 1990 (the EU parent-subsidiary directive), which exempts dividends paid by a EU subsidiary to its EU parent from withholding tax, does not apply to dividends paid to the holder of a right of usufruct on the shares for which the dividends are paid.

In the case decided by the Court, a Belgian company held a usufruct in the shares of another Belgian company, while a different Belgian company held legal title to the shares.

The usufruct conferred to the holder the right to receive the dividends paid on the shares, but it did not confer full legal title on the shares or the status of shareholder.

Article 3, paragraph 1 of the EU parent-subsidiary directive requires that, for the benefits of the directive to apply (exemption from withholding), the dividend recipient have a minimum holding of 25 per cent of the capital of the dividen payer (reduced to 15 per cent for dividends distributed from 1.1.07 and to 10 per cent for dividends distributed from 1.1.09).

The usufruct does not represent a participation to the capital of the company, and does not confer the status and rights of shareholder. As a result, the parent-subsidiary directive does apply to dividends paid to the holder of the usufruct on the shares.  

     

 

 

 

Continue Reading EU Parent-Subsidiary Directive Does Not Apply to Dividends on Shares Held in Usufruct, ECJ Ruled

On December 19, 2008, the Attorney General (AG) at the European Court of Justice (ECJ) filed his opinion in Aberdeen Property Fininvest Alpha (C-303/07).

The case concern Finnish taxation of dividends paid by a Finnish company to a Luxembourg SICAV investment fund owning 100 percent of the stock of the Finnish company.

Under Finnish law, the dividends paid to the Luxembourg fund are subject to Finnish withholding tax. The Luxembourg fund does not qualify for the dividend withholding tax exemption granted under the EU parent subsidiary directive, because it is not organized according to one of the corporate forms enumerated in the directive and is not subject to corporate tax in Luxembourg. 

Dividends paid to a Finnish company or investment fund are exempt from withholding tax to eliminate double taxation of corporate profits.

The Attorney General in his opinion took the position that the Finnish withholding tax violates the EC treaty.

According to the AG, the EC treaty still applies to inter-company dividends that fall outside the scope of the parent-subsidiary directive. The treaty freedom of establishment and free movement of capital prohibit member states from taxing outbound dividends less favorably than domestic dividends. The position of a Luxembourg investment fund Sicav is comparable to that of domestic company or fund, even though the Luxembourg fund Sicav is not subject to tax in Luxembourg.

The opinion is not binding on the ECJ, even though the Court tends to rule according to AG opinions in most of the cases. If the ECJ accepts the AG opinion, the case would be a major step ahead towards the elimination of dividend withholding tax in the EU.

Continue Reading Withholding Tax on Outbound Dividends to a Luxemburg Investment SICAV Illegal, AG of the ECJ Says