European Union Tax Law

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.

As a result of the significant reduction of U.S. corporate income tax rates pursuant to the tax reform of the TCJA enacted on December 22, 2017, the Unites States now has a lower corporate tax rate than many of its trading partners, meaning that, in many instances, the profits of foreign owned or controlled-U.S. subsidiaries shall be taxed more favorably than the profits of their foreign parent companies or affiliates in their home jurisdictions. That creates an incentive for foreign companies to channel more profits through their U.S. subsidiaries, in order to benefit from lower U.S. income taxation compared to that applicable in the parent company’s home country.

Starting in 2018, the U.S. taxes the profits of its corporations at the generally applicable corporate tax rate of 21 percent, with a preferential effective tax rate of 13.125 percent applicable on certain income deriving from foreign sales of goods and services (“foreign derived intangible income”). Those rates compare to the Italian combined corporate tax rate of 27.9 percent.

Italian companies with U.S. and international sales may benefit from a significant tax reduction by increasing their workforce and activities in the U.S. and handling more of their U.S. and internationals sales through their U.S. subsidiaries. Once the U.S. subsidiary has been taxed on its profits in the United States, it can repatriate those profits to its Italian parent virtually tax free, thanks to a substantial reduction of the inter company withholding tax rate under the U.S.-Italy income tax treaty (5 percent) and an almost complete exemption of the dividends from Italian tax in the hands of the Italian parent, pursuant to Italy’s participation exemption rules.

Under the new scenario described above, renewed attention should be given to Italy’s corporate “anti-inversion” rules. Under Italian income tax code, a company incorporated or organized in a foreign country is treated as an Italian resident company, for Italian corporate income tax purposes, and is subject to tax in Italy on its worldwide income, if it maintains its place of administration or its principle place of business in Italy. Also, a company owned or controlled by Italian shareholders, and owning or controlling a foreign company, is presumed to be an Italian resident company, unless the taxpayer proves that it is effectively managed and controlled in its own country of organization.

A company’s place of administration is the place where the company’s day to day management activities are carried out. According to the general guidelines issued by the Italian tax administration on this matter (see Protocol n. 2010/39678 of 3/19/2010 and 2010/157346 of 12/20/2010), several factors are looked at to determine a company’s place of administration, including:

– the place where the company’s directors and officers meet and vote upon company’s affairs;
– the place where the company’s directors and officers actually and regularly carry out their administration and management functions and duties for the company;
– the place where the company’s day to day legal, administrative, accounting and tax management functions are performed.

Italy’s Supreme Court ruled that a company’s place of administration is the place of effective management of the company, namely, the place where the day to day administrative activities for the company take place, shareholders’ and directors’ meetings are held, and company’s business activities are carried out, putting the company is connection with customers, business partners and third parties (see Supreme Court’s ruling n. 2869 of 2/7/2013).

The company’s place of administration should be distinguished from the place where the supervision, coordination and direction of a company’s business is performed, typically, at the headquarter of the parent or holding company. The sole fact that a company’s is wholly owned or controlled by another company, does not, in an on itself, produce the automatic effect of locating the company’s place of management at the same place as its parent’s headquarter, and day to day managements activities should not be confused with key direction, supervision and coordination activities that fall within the parent or holding’s company’s duties and functions (see ruling n. 61 of 1/18/2008 of Regional Tax Commission of Tuscany, Section XV).

A company’s principal place of business is the place where the company’s main business activities are performed. For example, a manufacturing company has its place of business where it perform most of its manufacturing activities; a marketing or selling company has its principale place of business where its principal sales office conducting most of its sales is located, and a services company has its principally place of business in the place where it performs most of its services to its customers.

Italy’s tax administration has been enforcing the place of management or principal place of business rules in situations involving U.S. companies owned of controlled by Italian companies, despite the fact that those U.S. companies were subject to a 35 percent corporate tax rate on their profits taxable in the United States, and no apparent tax saving was involved. Typically, those U.S. companies never file any income tax return in Italy. As a result, Italy’s tax administration assesses failure to file penalties, equal to minimum 120 percent and maximum 240 percent of any Italian tax due, on top of the Italian corporate income tax on all of the profits of the U.S. company. Furthermore, since no foreign tax credit is allowed under the Italian tax code when no Italian income tax return has been filed, the claim for a credit for the U.S. taxes paid by the U.S. company on its U.S. taxable profits is denied, leading to complete double taxation.

It is reasonable to expect increased enforcement activity of the place of administration rule, from the Italian tax administration, now that the corporate rate differential between Italy and the United States create a clear incentive to concentrate more profits in the United States, achieving a potentially significant tax saving.

Many small and mid size U.S. subsidiaries owned or controlled by Italian companies share their Italian directors and officers with those of their parent company, have a very limited governance structure and actual administrative activities carried out in the U.S., and perform accounting and administrative functions for their U.S. companies from Italy. Those companies should establish a more robust corporate governance, which includes local directors or officers; set up and carry out local administrative, legal, accounting and tax functions through local professionals reporting to local management; have the proper set of contracts with their parent or holding company, governing any inter company supporting administrative or commercial services they receive from their parent or other affiliates in the same group, and maintain accurate records of all functions and activities pertaining to the company’s administration performed in the United States, to rely upon in a possible audit.

The EU Directive n. 2015/849 (the “IV Directive”) on anti money laundering sets forth new provisions requiring financial institutions and professional individuals to verify their customers or clients by identifying the ultimate “beneficial owner” of an entity, legal arrangement or financial transaction; obtaining and conserving information about their customers and the ultimate beneficial owners, as defined in the Directive, and reporting an extensive amount of information about trusts, foundations and other similar arrangements in a central register held by each Member State. EU Member States have time until June 26, 2017 to traspose the provisions of the Directive into their national laws.

Unlike EU Regulations that are enacted by the EU Council of Ministers, which have automatically the full force and effect of EU prevail over any non conforming national law regulating the same area, EU Directives proposed by the EU Commission are not self executing. EU Members States are left with some leeway to decide which provisions are to be adopted. EU Directives are usually adopted through a number of legislative procedures depending on the different subject matters. As a result, while the deadline to implement the Directive is still pending, and until a country enacts domestic legislation actually implementing the Directive, the Directive has no immediate effect and cannot be directly applied. 

In Italy, the Italian Parliament by way of Act n. 170 of August 12, 2016 granted legislative authority to the Italian Government to implement the provisions of the IV Directive. Now the Government is working at adopting one or more legislative decrees containing the specific provisions that will traspose the IV Directive into Italy’s national law. The legislative decrees to be issued pursuant to the grant of authority provided by the Parliament need not be approved by the Parliament. Rather, they become law as soon as they are adopted by the Government. 

In light of the above, we can safely say that Italy is well on track to implement the Directive within the June 26, 2017 deadline. If that should not be the case, at that point the Directive would become self executing and could still be applied, for those provisions that are sufficiently detailed and need not be specified or modified by way of national implementing legislation.     

Law n. 170 refers to the definition of beneficial owner that is set forth in the IV Directive. 

The definition of “beneficial owner” in the IV Directive, for corporate entities, is the following (article 3, paragraph 6, letter a)):

(6) ‘beneficial owner’ means any natural person(s) who ultimately owns or controls the customer and/or the natural person(s) on whose behalf a transaction or activity is being conducted and includes at least:

(a) in the case of corporate entities:

(i) the natural person(s) who ultimately owns or controls a legal entity through direct or indirect ownership of a sufficient percentage of the shares or voting rights or ownership interest in that entity, including through bearer shareholdings, or through control via other means, other than a company listed on a regulated market that is subject to disclosure requirements consistent with Union law or subject to equivalent international standards which ensure adequate transparency of ownership information. A shareholding of 25 % plus one share or an ownership interest of more than 25 % in the customer held by a natural person shall be an indication of direct ownershipA shareholding of 25 % plus one share or an ownership interest of more than 25 % in the customer held by a corporate entity, which is under the control of a natural person(s), or by multiple corporate entities, which are under the control of the same natural person(s), shall be an indication of indirect ownership. This applies without prejudice to the right of Member States to decide that a lower percentage may be an indication of ownership or control. Control through other means may be determined, inter alia, in accordance with the criteria in Article 22(1) to (5) of Directive 2013/34/EU of the European Parliament and of the Council (3);

(ii) if, after having exhausted all possible means and provided there are no grounds for suspicion, no person under point (i) is identified, or if there is any doubt that the person(s) identified are the beneficial owner(s), the natural person(s) who hold the position of senior managing official(s), the obliged entities shall keep records of the actions taken in order to identify the beneficial ownership under point (i) and this point.  

Under the definition set forth here above, the beneficial owner is the natural person who ultimately owns or control the tested corporate entity (defined as “customer” in the Directive). 

For the purpose of identifying the natural person who ultimately owns or controls the tested corporate entity, the Directive adopts the “more than 25% shareholding or ownership interest” test, as an indication or presumption of beneficial ownership, and uses both a direct and indirect ownership test. 

Under the direct ownership test, if a natural person directly owns more than 25% of a shareholding or ownership interest in the “tested” corporate entity, that person is presumed to be the beneficial owners of that entity. In case of direct ownership, the analysis stops at the natural person who owns the relevant shareholding interest in the tested corporate entity. Under the indirect ownership rule, a shareholding or ownership interest (of any size) in the “tested” corporate entity, owned by another legal entity (such as another corporate entity, trust, foundation, etc.), is attributed to the beneficial owner(s) of such other legal entity, to determine the ultimate beneficial owner of the “tested” corporate entity.

In case of trust or other similar legal arrangements, “beneficial owner” is defined as follows (article 3, paragraph 6, letter b)):

(6) ‘beneficial owner’ means any natural person(s) who ultimately owns or controls the customer and/or the natural person(s) on whose behalf a transaction or activity is being conducted and includes at least:

(b) in the case of trusts:

(i) the settlor;

(ii) the trustee(s);

(iii) the protector, if any;

(iv) the beneficiaries, or where the individuals benefiting from the legal arrangement or entity have yet to be determined, the class of persons in whose main interest the legal arrangement or entity is set up or operates;

(v) any other natural person exercising ultimate control over the trust by means of direct or indirect ownership or by other means.  

If interpreted literally, the definition of “beneficial owner” in case of trusts, foundations and other similar fiduciary arrangements is extremely broad, and would automatically require to verify and disclose each one of the settlor, trustees, beneficiaries or protectors of a trust, regardless of whether any one of them  actually owns an interest in the trust’s income or property or has any meaningful power with respect to the administration of the trust. Also, the literal definition of “beneficial owner” used in the IV Directive in case of trusts does not make any distinction between an interest in the income of the trust, as opposed to an interest in the corpus of the trust, and does not refer to any minimum ownership requirement such as the 25 percent ownership threshold that applies in case of corporate entities.  

An over broad interpretation of the term “beneficial owner” in case of trusts would put banks, financial institutions, professional individuals and their customers under extreme pressure, potentially dramatically extending the amount of information to collect and creating a friction between the need of a thorough verification of the customer for anti money laundering purposes, and the right to privacy for all individuals involved who do not own any ownership interest of power of administration with respect to the trust.

It would seem more reasonable to limit the definition of “beneficial owner” of a trust, to those individuals or entities, among the settlor, trustee(s) or beneficiaries, who actually have a meaningful interest in corpus of the trust or real powers with respect to the administration of the trust.   

Arguably, sub paragraphs 6(a) and 6(b) of article 3 should apply separately, depending on whether the “customer” to be tested is a corporate entity (in which case, the test of sub paragraph a) should apply) or a trust or other similar arrangement (in which case the test of sub paragraph b) should apply).

However, there is a potential argument for a concurrent application of the two sets of rules, whenever a shareholding or ownership interests in a corporate entity is held through a trust, foundation or other similar legal arrangement. In that case, under the “indirect ownership” rule requiring to find the natural person that ultimately owns the corporate entity, it may be reasonably be argued that the “beneficial owner” of the trust should be verified under the separate rules of sub paragraph b), and he or she would be deemed to indirectly and ultimately own the shareholding or ownership interest which the trust owns in the tested corporate entity.

Under a different interpretation, in the event that a shareholding or ownership interest in a corporate entity is owned through a trust, the analysis should stop at the person or persons who control the entity, under the rules of sub paragraph a), thereby limiting the know your customer verification to the person or persons who act as trustee or trustees for the trust.

In light of all the potential interpretative challenges, briefly mentioned above, it is important to see how the provisions of the IV Directive are going to be incorporated into the national legislation that will be enacted to transpose the Directive into Italy’s internal law. 

As for the scope of the disclosure mandated by the Directive, it is carried out at two levels. At one level, a bank, financial institution or professional individual that does business with an Italian entity or trust is required to conduct proper customer due diligence, which under article 13, paragraph 1, letter (b) of the Directive, including the following:

(b) identifying the beneficial owner and taking reasonable measures to verify that person’s identity so that the obliged entity is satisfied that it knows who the beneficial owner is, including, as regards legal persons, trusts, companies, foundations and similar legal arrangements, taking reasonable measures to understand the ownership and control structure of the customer;

At another level, under article 30, paragraph 1 of the Directive, the companies themselves are required to obtain and hold  adequate, accurate and current information on their beneficial ownership, including the details of the beneficial interests held.

Article 30, paragraph 2 requires that the information of the companies’ beneficial ownership and beneficial interests be held in a way that it is accessible in a timely manner to the tax and financial authorities. 

In addition to the above, article 30, paragraph 4 of the Directive provides that the information on the companies’ beneficial ownership and beneficial interests shall also be held in a central register accessible in all cases to the tax and financial authorities, banks and financial institutions and any other person or organization that can demonstrate a legitimate interest to 

Finally, under the Directive, a separate and independent disclosure regime may apply to trusts. Indeed, article 31, paragraph 1 provides that:

1.Member States shall require that trustees of any express trust governed under their law obtain and hold adequate, accurate and up-to-date information on beneficial ownership regarding the trust. That information shall include the identity of: (a) the settlor; (b) the trustee(s); (c) the protector (if any); (d) the beneficiaries or class of beneficiaries; and (e) any other natural person exercising effective control over the trust.    

Italy does not have any law governing trusts (except that it applies its owns tax rules for the taxation of trusts both for income and gist and estate tax purposes). Trusts are usually established under foreign law, and recognized and enforced in Italy, if necessary, under the Hague Convention on Trusts which has been ratified in Italy by way of Law n. 364 of 1989. Law n. 171 refers is to “trusts governed under law n. 364 of October 16, 1089”, which includes any trust established under foreign law, which is recognized and enforced in Italy pursuant to the Trust Convention.

Furthermore, article 31, paragraph 4 of the Directive provides that

4.Member States shall require that the information referred to in paragraph 1 is held in a central register when the trust generates tax consequences. The central register shall ensure timely and unrestricted access by competent authorities and FIUs, without alerting the parties to the trust concerned. It may also allow timely access by obliged entities, within the framework of customer due diligence in accordance with Chapter II. Member States shall notify to the Commission the characteristics of those national mechanisms.

The separate disclosure for trusts seems to be triggered whenever a trust is recognized and made effective in Italy pursuant Law n. 389 and the Hague Convention, and when the trust generates tax consequences in Italy.

Finally, it should be noted that on July 5, 2016, the European Commission adopted a proposal to amend the IV Directive on anti money laundering, which would reduce the shareholding test from 25% to 10%. 

Until the IV Directive is actually transposed into Italian law,  the provisions of legislative decree n. 231 of November 21, 2007 still apply.  

Legislative Decree n. 231 treats as “beneficial owner” the natural person or persons who ultimately own or control an entity, by directly or indirectly owing or controlling an adequate shareholding, voting or ownership interest in the entity, with the understanding that a (direct or indirect) shareholding or ownership interest of more than 25% of the entity is sufficient to satisfy the definition of beneficial owner. 

In case of trusts, beneficial owner is any identified beneficiary of the trust, who owns a qualified interest in more than 25% of the trust’s assets. 

The disclosure under Legislative Decree n. 231 is much more limited and restricted, given the narrower definition of beneficial owner that applies when a corporate entity is owned indirectly through a trust. Unlike the IV Directive, which mentions each of the trust’s settler, trustees and beneficiaries as beneficial owners of the trust, and as owning indirectly indirectly any shareholding or ownership interest that the trust holds in the tested entry, the legislative decree n. 231 refers solely to the trust’s identified beneficiaries owning an interest in at least 25% of the trust’s assets. 

In the course of our practice, we have been involved in situations in which banks and other financial  institutions or professional firms adopt a stricter and more balanced approach, by referring to the 25 percent ownership test and, for trusts, by limiting their investigations to beneficiaries holding an interest on more than 25 percent of trust’s assets and trustees holding effective power of administration of the trust. In other situations, however, we noted that other banks may want to anticipate the application for the new provisions of the IV Directive, even before its entry into force, and conduct a 360 degree investigation on trusts, requesting information about all of the trust’s settlor, trustees and beneficiaries (both actual and contingent) of wither income or corpus of the trust, regardless of the existence of an actual interest in, or power of administration with respect to, the assets of the trust.
In those cases, we have experienced that clients are willing to discuss the matter with their banks to make sure that their legitimate privacy rights are respected, and that anti money laundering, know your client verifications do not go beyond their legitimate, reasonable needs and become unmanageable or drain excessive resources.
In anticipation of the implementation of the IV Directive, clients should make the effort to review their structures, and put together a standard package that should be used with all of the banks, financial intermediaries and professional firms with whom they do business, and who will require information pursuant to anti money laundering legislation, to achieve efficiency and stay in compliance in such a challenging area clearly destined to draw more scrutiny and attention.

Every time a trust has connections with Italy and is given legal effects or enforced there, the trustee will need to collect, keep and disclose (if required) information on beneficial ownership of the trust and, potentially, report such information in a special Trust section of the Italian Business Register. The new trust disclosure rules derive from the Italian bill  transposing into national law the EU Fourth Anti-Money Laundering Directive (2015/849).

The Directive requires trustees of any express trust governed under the law of a Member State to obtain and hold information on the beneficial ownership of the trust, inclusive of the identity of the settlor, the trustee, the protector (if any), the beneficiaries, and any other natural person holding any authority or exercising effective control over the trust. When the trust generates legal or tax consequences in the legal system of a Member State, such information has to be reported in a central register of that Member State.

The Italian bill implementing the Directive imposes such duties on “trustees of express trusts governed in accordance with Law dated October 16, 1989 n. 364″.   With law n. 364 Italy ratified the Hague Convention of July 1, 1985 on the Law applicable to Trusts and their Recognition. The reference to trust governed by law n. 364 has the effect to attract all foreign trusts recognized and enforced in Italy to the new disclosure rules.

Italy does not have a body of national statutory provisions on trusts, but the enforcement of the 1985 Hague Convention with the Law n. 364 of 1989 permits to recognize and give legal effects in Italy to trust created under and governed by foreign law.

As a result, every time a foreign trust is to be legally used in Italy, and is designed to produce legal and tax effects there, it can be considered a trust “governed in accordance with Law n. 364 of 1989”, thereby triggering the know your customer and disclosure obligations set forth in the Directive. Therefore, it will be automatically subject to the new disclosure obligations, including the registration in a special Trust section of the general Business Register. Foreign trustees of a foreign trust that has a connection with Italy, are potentially subject to those rules, and need to pay close attention to the their new reporting obligations under the new rules.

Situations that fall within the scope of the disclosure rules include common cases in which a foreign trust has Italian resident beneficiaries, or owns movable or immovable assets located in Italy. In those cases, the beneficiaries in order to claim the distribution of income or assets from the trust need to put in place the procedure to have the trust recognized and enforced in Italy. The same happens when a foreign beneficiary claims the distribution of the trust’s Italian assets pursuant to the trust.

Even when the settlor of a foreign trust is an Italian individual, the new rules would apply. Indeed, the settlor may need to rely on the trust to separate herself from the assets transferred to the trust, and claim that the trust assets and income belong to somebody else who should bear the responsibility of tax filing, payment and reporting relating to the trust. To the effect, the trust would have legal and tax consequences in Italy, which would put it within the scope of the new disclosure rules.

The Directive set forth a deadline for its implementation into EU member’ States’ law, currently expiring on June 26, 2017. The Italian bill once enacted into law will need legislative decrees with enforcement provisions to be adopted by the Government pursuant to the legislative authority granted therein.

 

Italy’s Tax Code determines the tax residency of a company on the basis of one of three alternative tests: place of legal seat, place of management and principal place of business. As a result, an Italian or foreign company that is effectively managed from Italy is treated as an Italian company for Italian tax purposes and it is subject to tax in Italy on its worldwide income.

In order to prevent abusive practices consisting in putting an Italian company owned or controlled by Italian shareholders under the umbrella of a foreign holding company established in a tax favorable jurisdiction, Italy enacted special anti abuse provisions according to which a foreign company owning or controlling an Italian company is presumed to have its tax residency in Italy if one of two alternative tests are met: Italian shareholders control the foreign company, or the majority of the company’s board members are Italian nationals. Taxpayers can rebut the presumption by providing clear and convincing evidence that the foreign company is effectively managed outside of Italy.

 

           

Continue Reading European Commission Blesses Italy’s Anti-Inversion Rules

On December 7, 2010 the Council of Finance Ministers of the European Union (ECOFIN) adopted a new draft legislation that provides for reinforced and more extended exchange of tax information among EU Member States to contrast international tax evasion. The new bill shall be formally presented in a future ECOFIN meeting and enacted into law as EU directive by the EU Parliament. At that point the EU Member States shall have to incorporate the new directive into their own internal legal systems so that the directive shall be generally enforceable throughout the EU.

The new directive shall eliminate the banking secret and shall prevent a Member State from denying the access to information in response to a detailed request coming from another Member State. From 2015, the exchange of information shall be automatic in at least five of the eight areas that are covered by the directive namely employment income, bonuses, dividends, capital gains, royalties, life insurances pensions and real estate.   

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 July 14, 2010 Marco Rossi presented a lecture on the European Union and EU tax law to candidates/students of Master of Science in Taxation at Fairfield University. We provided an overview of the European Union and its institutions, discussed the sources of EU law and the main developments in the area of EU statutory tax law (including the EU tax directives and tax arbitration convention), and illustrated the main concepts of the jurisprudence of the European Court of Justice in the area of direct taxation, including a brief analysis some landmark cases recently decided by the Court. We attach a copy of the presentation materials for your direct reference (EU Law-Fairfield University Lecture.pdf.) (An Italian Perspective On Recent ECJ Direct Tax Decisions (TNI 2_6_08).pdf)