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With Circular 17/E of May 23, 2017 Italy’s Tax Agency provided administrative guidance on the interpretation and application of the provisions on the elective preferential tax regime for Italian new-tax resident individuals.

New article 24-bis of Italy’s Unified Income Tax Code, enacted with Law n. 232 of December 2016, provides that foreign-resident individuals who establish their tax residency in Italy, after having been resident in a foreign country for at least nine of the previous ten tax years, may elect to pay a fixed-amount tax of euro 100,000 on all of their foreign source income, in lieu of the ordinary Italian personal income tax. Domestic source income would remain subject to the ordinary personal income tax, charged at graduated rates on income tax brackets.

The election can be filed within the second tax year after the year in which tax residency was established in Italy. For example, a foreign person which became an Italian tax resident individual in 2016, can make the election either with effect from the 2016 tax year, when filing her personal income tax return in 2017, or with effect from the tax year 2017, when filing her income tax return in 2018. The election may be withdrawn by the taxpayer solely within the second year after the year it was first filed. After that, the election is deemed automatically renewed year by year and expires automatically after 15 years.

The election can be extended to a taxpayer’s family members, who shall pay a fixed-amount tax of 25,000 euros in lieu of the regular personal income tax on their own foreign source income. The extension for family members can be filed at any time after the initial election has been filed, within the 15 year period of duration of the initial election.

Circular 17/E clarified that, for the elective regime to apply, no mandatory tax ruling is required. Taxpayers at their choice may still file a request for a tax ruling, prior to filing their election for the fixed-amount tax.

The election exempts taxpayers from the payment of Italy’s asset-based tax on foreign financial assets, charged any the rate of 0.2% of asset’s fair market value, and asset-based tax on foreign real estate, charged at the rate of 0.76% of property’s historical cost (adjusted tax basis) or fair market value.

Even more significantly, the election also exonerates taxpayers from the duty to report, on their Italian income tax return, the value of their financial and investments assets held outside of Italy during the tax year. Under Italy’s international tax reporting rules (the equivalent of the U.S. FATCA and FBAR rules), foreign assets are reported at their fair market value at the beginning or the end of tax year, or on the date of purchase or sale, which must be converted into euro at the average exchange rate of the month or purchase or sale. Also non financial assets such as real estate, cars, boats, jewelry, artworks, etc. must be reported. Especially in case of complex financial portfolios, the duty to report may be very wide in scope and administratively burdensome and costly for the taxpayer.

Finally, taxpayers who elect for the special tax regime are exempt from Italy’s estate and gift tax.

The two key tax concepts that determine the eligibility for the application of the elective regime are tax residency and source of income.

Tax residency for individual taxpayers is determined in accordance with any one of three alternative criteria, which must be met for more than half of any tax year, namely:

1. registration on the Italian register of resident individuals, held at the local municipality in the place where the taxpayer has established her own residence for general administrative and legal purposes,

2. place of habitual abode (residence),

3. main center of interests and affairs (domicile).

For a foreign person to become eligible for the elective tax regime, it is sufficient that she registers on the register of Italian resident individuals with a local home address in Italy, in the place where she owns or rents a house or maintains a fixed place of abode. When the registration is completed in the first half of a tax year, Italy’s tax residency retroacts to the first day of that year. When the registration is completed in the second half of a tax year, Italy’s tax residency takes effect on the first day of the following year.

The registration creates an irrefutable presumption of tax residency in Italy. However, as a condition for the registration, the law requires that a person actually maintain her principle, fixed place of living (i.e., place of habitual abode) at her registered address in Italy. During the registration process, or at any time after the registration process has been completed, local municipal police may verify that the condition for the registration is met, by way of multiple visits to the local home address, made at various intervals of time, to check whether a person actually regularly lives there. If the condition for the registration is not met, the local authorities may start a process for the mandatory cancellation of a person from the register of resident individuals, which may result in the retroactive loss of the elective tax regime.

Residence (place of habitual abode) requires that a persone regularly live in Italy (objective test) with the intention of living there for the indefinite future (subjective test).

Domicile (main place of interest) revolves around an individual’s personal, family, business and financial interests, and does not requires physical presence in Italy.

A foreign person who was not registered on the Italian register of resident individuals, in 2016 or 2017, may still take the position that she had her place of habitual abode or domicile in Italy, thereby being a tax resident of Italy in those years, and elect for the special tax regime. Since the residence and the domicile tests (as described above) depend on the facts and circumstances of each particular case, it may be appropriate to apply for a tax ruling, whenever the election is based on residence or domicile, in the absence of a formal registration on the register of resident individuals.

Article 165, paragraph 2 and article 23 of the Unified Income Tax Code sets forth the rules on the source of income for general income tax purposes. In general, income is foreign sources whenever it arises from activities performed or assets located outside of Italy, or the payor of the income is a non resident individual or entity, such as the case of interest, dividends or royalties. Capital gains are sourced based on the location of the asset (as opposed to the residence of the seller).

Circular 17/E clarifies that in case of income received through shell companies, revocable trusts, nominees, fiduciaries, intermediaries or other conduit arrangements, the source of the income is determined by looking at the source of the underlying income in the hands of the trust, nominee, fiduciary, intermediary or conduit. In all other cases, and, most notably, in case of income earned through a fiscally transparent entity, the source of income is determined by not looking through the entity or legal arrangement through which the income is earned. Italian income source rules provide that income from domestic partnerships is characterized as Italian source income, while income from foreign partnerships or other similar entities is characterized as foreign source income, regardless of the source of the income in the hands of the entity. As a result, whenever a foreign fiscally transparent entity is interposed, between the taxpayer and the income, that may have the effect of converting domestic source income into foreign source income subject to the special tax regime (and not subject to tax in Italy).

Circular 17/E provides valuable clarity on the application of the elective tax regime for the neo Italian tax residents, which appears to be very attractive. However, careful planning and handling of the election is required, both with respect to the tax residency requirement, as well as with respect to the source of income, marking the division between foreign source income, which is covered by the fixed-amount tax and excluded form the personal income tax, and domestic source income, which remains taxable under the general rules of Italy’s tax code.

With the Budget Law for fiscal year 2017, Italy enacted a new flat tax for Italian first-time residents. The flat tax amounts to euro 100,000 regardless of the amount of taxable income. Foreign source income is completely exempt from the regular personal income tax, while domestic source income is taxed under the general tax rules (graduated tax rates on income brackets generally applying to all resident taxpayers). First-time residents will also be exempt from the duty to report their non-Italian financial assets, and will not be subject to Italy’s estate and gift tax. Special rules for residence permits and visas will also apply to facilitate the establishment of Italian tax residency in connection with the application of the new tax. The new flat tax is aimed at attracting high net worth individuals to Italy.  This who have solely non Italian source income will pay euro 100,000 and will be cleared from any other tax filing and payment obligations.

Requirements.

Individuals who have not been resident in Italy for Italian tax purposes for at least nine of the previous ten years, at the time they establish their tax residency in Italy, will qualify for the flat tax. An individual is Italian treated as an Italian tax resident if she registers as an Italian resident individual at the local municipal office in the place where an individual has her home, or maintains in Italy her place of habitual abode or the main center of interests, for more than half of a tax year.

Scope of the flat tax.  

The flat tax is elective and applies in lieu of the ordinary income tax on foreign source income. Italian source income will always be subject to the regular income tax (charged at graduated rates by brackets of income). The flat tax applies for a maximum period of 15 years. Foreign source capital gains (that is, capital gains realized from the sale of stock or other ownership interests in foreign entities), are subject to the the ordinary income tax (at the marginal rate of 43% charged on 49.72% of the amount of the gain under Italy’s participation exemption rules), if realized within five years from the beginning of Italy’s tax residency. Taxpayers must elect to pay the flat tax in lieu of the ordinary income tax. Taxpayers can terminate their Italian tax residency at any time, even before the expiration of the fifteen year period of application of the flat tax.

Individuals who qualify and elect for the new flat tax will be exempt from the obligation to report their non Italian investment and real estate assets, which is usually carried out by filling out a special section of Italian personal income tax return.  They will also be exempt from Italy’s estate and gift tax on non-Italian assets.  

Possible constitutional challenges.

The new flat tax may be challenged under the provision of the Italian Constitution, which requires income that taxes are charged in proportion to an individual’s "contributive capacity", that is, in a way that they are commensurate to an individual’s income or wealth.

Comments.

Individual taxpayers having solely non-Italian source income from financial or real estate investments located and managed outside of Italy, or from closely held foreign companies, would benefit from a very generous tax regime that would limit their tax liability to the flat amount fo euro 100,000 regardless of the actual amount of income they actually earn. The exemption from the duty to disclose foreign financial and real estate assets and investments will also result in much reduced administrative burden in filing an Italian income tax return.  

Hight net worth U.S. citizens or resident alien individuals who have relinquished or plan to relinquish their U.S. citizenship or terminate their U.S. tax residency should consider Italy as a new "tax haven", allowing for a a low flat tax on their non Italian source income with no reporting or disclosure of their non Italian assets wherever located in the world.   

         

            

 

With ist ruling n. 27113/2016 issued on December 28, 2016, the Italian Supreme Court interpreted and applied the beneficial ownership provision of article 10 of the tax treaty between Italy and France, for the purpose of determining whether a French holding company, wholly owned by a U.S. corporation, was entitled to the imputed credit granted under that treaty in respect of dividends received from an Italian subsidiary.

The Italian Supreme Court held that the beneficial ownership provision of the Italy-France treaty requires that the recipient of the dividends has full dominion and control over the dividend, meaning, that it enjoys the right to receive and keep dividends, unconstrained by any legal or contractual obligation to pass the dividends on to its parent, and actually enjoys the economic benefit of the dividend, which it treats and reports as its own income on its accounting books and can dispose of without legal or contractual constraints. 

According to the Supreme Court, the fact that the French holding company did not have staff, offices and other significant sources of income, except for the dividends it received from time to time from its subsidiaries, and did not engage in any other activities except for holding the legal title to the shares of its subsidiaries, is consistent with a holding company’s typical functions and role, and does not negate the status of beneficial owner and eligibility to the tax treaty benefits.

The ruling is consistent with a previous decision of the Supreme Court, which we reported in the past on our blog, holding that beneficial owner is the person who has the legal control and economic enjoyment of the dividend (we refer to the Supreme Court’s ruling n. 10792  issued on May 25, 2016).

The interpretation of the term ‘beneficial owner’ as the person having the legal and economic dominion and control over the dividend, followed by the Supreme Court in ruling n. 27113/2016,  is also consistent with the clarification set forth at paragraph 12.4 of the 2014 Commentary to article 10 of the  OECD Model Income Tax Convention, according to which ‘beneficial owner’ is the person who has the full right to use and enjoy the dividend, unconstrained by a contractual or legal obligation to pass on the payment received to another person.

 The Supreme Court expressly rejected the notion that, in order to qualify as a beneficial owner of the dividend, the holding company is required to have a minimum level of organization, including employees and offices, and to engage in business activities generating operating receivables, aside from holding the legal title to the shares of its subsidiaries and receiving dividends therefrom.     

 

 

     

 

 

 

 

 

Continue Reading Italian Supreme Court Rules on Beneficial Ownership and Holding Companies

Under new anti money laundering legislation due to become effective in Italy in 2017, all foreign trusts with tax effects in Italy shall have to be filed and registered on the Italian Register of Enterprises. They include trusts with Italian settlor, Italian beneficiaries, Italian assets, Italian source income or treated as Italian resident trust under Italian tax law.

The tax effects of a trust in Italy and the consequent obligation to disclose it on the Italian Register of Enterprises is determined under Italian tax laws.  The way in which a trust, its income or its beneficiaries are treated under foreign tax law is not determinative for that purpose.   

Trustees of trusts subject to the new disclosure and filing rules shall have to collect, conserve and disclose adequate information about trust’s ultimate beneficial owners, which are meant to include the settlor, the trustee, the guardian, the beneficiaries, and any other person having any type of control or authority over the trust.

The scope of the new disclosure and reporting rules for trusts is very wide. All trusts with any apparent or potential point of contact with Italy should be revised to determine whether they fall within the application of the new rules.   

Continue Reading Italy Institutes New Register for Trusts

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 test. The 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. 
 
 
 

In its ruling n. 21614 of October 26, 2016 Italy’s Supreme Court considered the issue of the application of the gift tax upon the transfer of property to a trust. The issue arises under the provisions of Law n.  262 of October 3, 2006, which reinstated the gift tax. Article 2 of Law 262, at paragraph 45 and 49, while providing on the scope of the newly reinstated gift tax, refers to "legal arrangements having the effect of creating constraints or limitation on the use, enjoyment and disposition of property", for the final benefit of a person of for a specified purpose.

One interpretation of the statute is that the language of article 2 of Law 262 clarifies, but does not extend, the scope of the gift tax, which continues to apply solely to straight gifts, namely, transfers of property from a person, the grantor, to another person, the beneficiary, for no consideration, whereby the beneficiary obtains immediately legal title and economic ownership of the transferred property. According to that interpretation, no gift tax applies at the time of the transfer of a property to a trust, when the ultimate beneficiary of the property still does not acquire the direct legal ownership and full right of use, enjoyment and disposition of the transferred property. Instead, the gift tax will apply at the time of the ultimate and final distribution of the property, from the trust to the beneficiary.           

Another interpretation of the statute is that the language of article 2 of Law 262 actually intended to extent the scope of the gift tax, from straightforward gifts to any legal arrangement by means of which a person places some of his or her assets in a separate fund, not part of his or her estate, to be used and disposed of for the benefit of another person of for a specified purposed. Under that interpretation, the gift tax would apply on the transfer of property to a trust (while no gift tax would apply at the time of the actual distribution of the property from the trust to the beneficiary). 

The 5th department of the Court refused to construe the new statute as if it instituted a new tax; looked at the legislative history and intent, which was that of reinstating the "old" gift tax, and affirmed its previous rulings (issued under the previous law) according to which the gift tax applies solely to a direct transfer of property to the beneficiary, as a result of which the beneficiary is enriched and has a direct and full right to the use, enjoyment and disposition of the property. The Court held that  Law 262 just reinstated the old gift tax, rather than extending its scope or instituting a new tax, and that the reference to "legal arrangements creating limits or constraints to the use, enjoyment or disposition of property" is just aimed at preventing the possible avoidance of the gift tax in cases in which certain legal schemes may be used to deviate from a straightforward gift of property to the intended beneficiary while reaching the same result.    

The Supreme Court is split on this issue, and ruling n. 21614 of the 5th Department of the Court is in direct contrast with other recent rulings from the 5th (tax) department of the Supreme Court. Lower courts have constantly ruled against the application of the  gift tax, and the tax agency has filed appeals to the Supreme Court against those rulings, as a result of which more decisions from the Supreme Court are expected in the near future.   

If the interpretation of the 5th department ultimately prevails, it would have extensive and potentially disrupting effects on cross border estate and trust planning arrangements with connections to Italy.

For instance, Americans with assets located in Italy and held in U.S. trusts, would face the application of the Italian gift tax, at the time those assets are distributed to the beneficiaries of the trust, while no tax would apply in the U.S. at that time, whenever the original transfer of the assets to the trust was a full and final gift under U.S. tax law.

Similarly, for American who are domiciled in Italy at the time of their death, the distribution of their assets from their U.S. trusts to the beneficiaries of the trusts would be subject to the Italian gifts tax, regardless of the fact that those assets are located in the U.S. and held in U.S. trusts, while no tax would apply in the U.S. at that time, whenever the original transfer of the assets to the trusts was a full and final transfer under U.S. tax law.          

We will continue monitoring the situation and report on the developments on our blog while trust plans with pint of contact with Italy should be carefully revisited in the light of the continuing developments in this area of Italian tax law.  

 

 

 

 

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 ownership. A 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.

The Italian Supreme Court with its ruling n. 10792 of May 25, 2016 held that the 5 percent reduced dividend withholding tax provided for under article 10 of UK-Italy Tax Treaty does not apply, when the company that receives the dividends does not prove that it is the "beneficial owner" of the dividend as required under the relevant provision of the applicable tax treaty. For that purpose, according to the Court, the recipient of the dividends must prove that it has the legal and economic control of the dividend. As a result, in the absence of such proof, the Court held that the dividend was subject to the full 27 percent withholding tax rate provided for under Italy’s internal tax legislation. 

Under the facts of the case, an Italian company distributed dividends to a UK company, which was  ultimately owned or controlled by a US corporation. At the time of the distribution of the dividend, the Italian company applied the 27 percent withholding tax provided for under article 27 of Presidential Decree n. 600 of 1973. The UK company then filed a request of refund of the difference between the 27 percent dividend withholding tax applied by the payer of the dividend, and the 5 percent reduced dividend withholding tax provided for under article 10 of UK-Italy tax Treaty.

In support of its request of refund, the taxpayer submitted a certificate of tax residency issued by UK taxing authorities, and evidence that the UK company that received the dividends duly reported the dividends as its own income on its income tax returns filed in the UK.

The Tax Court ruled in favor of the taxpayer, and the Regional Tax Court affirmed the Tax Court’s ruling. According to the lower courts, "beneficial owner" means the person to whom the payment is attributed for tax purposes, and which reports the payment on its income tax return in its country of residence.

The Supreme Court disagreed, and held that "beneficial ownership" requires that the recipient of the income demonstrate that it has the economic and legal control of the dividend, namely that it receives the dividend for its own economic benefit, and without any legal obligation to pass it on to another person.

According to the Court, the beneficial ownership provision of tax treaties, as it evolved since it first appeared in the 1977 OECD Model Tax Convention, constitutes a general anti treaty shopping clause, which must be given a substantial meaning independent from and going beyond the tax residency requirement, based on an analysis of the facts and circumstances of each case showing that the recipient of the income derives a direct economic benefit from, and has the full dominion and control of, the income subject to withholding tax.

In contrast, the term "beneficial ownership" cannot be interpreted in a formalistic way, according to which beneficial owner is the person who receives the income and reflects it on its income tax return, because in that case it would just overlap with the tax residency requirement and would no longer serve its purpose of stopping treaty abuse.          

The decision is consistent with Italian Supreme Court’s case law and provides additional certainty in a complex area of international tax law.

The Italian Supreme Court, with its ruling n. 8196 of April 22, 2015 held that a NY corporation, wholly owned by an Italian company, and effectively managed and controlled by its Italian shareholders and directors in Italy, had to be treated as an Italian resident company for Italian tax purposes, and was subject to corporate income tax in Italy on all of its profits, inclusive those arising from sales to US customers in the United States. Unlike the United States, which classifies a corporation as domestic or foreign based on whether it is incorporated in the United States or abroad, Italy applies the "place of administration" test and treats a company as Italian resident whenever it is administered in Italy. The other two tests to determine corporate tax residency are the place of incorporation test and the principle place of business test. The Court concluded that the NY corporation was administered in Italy because the manager was domiciled in Italy, and the corporation’s accounting books, commercial contracts, and minutes of meetings of shareholders and directors were all located in Italy. In an additional blow to the taxpayer, the Court ruled that no foreign tax credit for the taxes paid by the NY corporation in the United States could be granted in Italy, because the corporation had failed to file its Italian income tax returns in Italy, whereby it should have reported its foreign income and taxes and computed and claimed the credit, which had then become time barred. Under Italy’s tax administrative rules,  in order to obtain a credit for foreign taxes paid on foreign source income, a taxpayer is required to file its tax return, reporting the foreign income and taxes paid and the amount claimed as a credit to offset the Italian taxes on the same income taxed abroad. The taxpayer raised the argument that the credit should have been granted, regardless of the fact that no income tax returns had been filed in Italy, pursuant to the foreign tax credit provisions of the US-Italy tax treaty, which would prevail over Italy’s internal tax legislation. The Court however rejected the argument, holding that the way in which the credit is substantiated and claimed through the timely filed true and accurate Italian corporate income tax return in Italy is an administrative matter duly regulated under domestic law, and  not affected by the treaty. The ruling shows that Italian companies with foreign subsidiaries must pay specific attention to Italy’s anti inversions rules reclassifying foreign companies as Italian resident companies subject to tax in Italy whenever they are effectively managed and control from Italy. That includes making sure that local managers (with real management responsibilities) are appointed and sit on the board of the company in the Unites States; board meetings are held and resolutions are properly recorded on the company’s books in the United States; commercial contracts are negotiated, executed and filed in the company’s records the United States, and accounting books and records are kept at the company’s offices in the United States. The risk of losing the credit and being subject to double taxation is high and requires a great deal of due diligence and care.                                          

The application of tax treaties to fiscally transparent entities is controversial. Two requirements for the application of the benefits of a tax treaty (that is, the elimination or reduction of the source country tax on payments made by a person resident in one Contracting State, to a person resident in the other Contracting Sate) are that the person receiving the payment is a "resident" of the other contracting state, and the "beneficial owner" of the payment.

Residence is usually defined in tax treaties (typically, under article 4, paragraph 1), as requiring that a person be "liable to tax" in the other Contracting States, by reason of his residence, domicile, place of management, place of incorporation or other criterion of a similar nature (article 4, paragraph 1).

According to the OECD, whenever an entity is treated as fiscally transparent in a State, the entity is not "liable to tax" in that State, within the meaning of article 4, paragraph 1, and so it cannot be a resident thereof for purposes of a treaty. In such case, the entity’s partners or owners should be entitled to the benefits of the treaty entered into by the State of which they are residents, with respect to their share of the income of the entity, to the extent that the entity’s income is allocated to them under the tax laws of their State of residence (see OECD Commentary to the Model Tax Convention, on Article 1, paragraph 5).

The current Tax Treaty between Italy and the United States adopts a slightly different approach and assigns tax residency to a an entity that is treated as fiscally transparent entity in the United States, for the purposes of the treaty, to the extent that the entity’s income is taxed in the U.S in the hands of its parents or beneficiaries. In fact, Article 4, paragraph 1, letter b) of the Convention, with reference to partnerships, estates and trusts, provides that “in the case of income derived or paid by a partnership, estate of trust, this term applies only to the extent that the income derived by such partnership, estate or trust is subject to tax in that State, either in its hands or in the hands of its partners or beneficiaries”. Article 1, paragraph 5, letter d) of the Protocol extends the same provision to fiscally transparent entities, by providing that “d) The provisions of subparagraph 1(b) of Article 4 (Resident) of the Convention shall apply to determine the residence of an entity that is treated as fiscally transparent under the laws of either Contracting State”.

Under the provisions referred to here above, a U.S. entity that is treated as fiscally transparent under US tax laws, receiving dividends from an Italian subsidiary, should be entitled to the 5% withholding tax on inter company dividends, provided that it satisfies the other requirement (minimum 25% ownership for a period of at least 12 months at the time of the payment of the dividends). For that purpose, the documentation provided to the Italian subsidiary must include tax certificates for both the entity and it shareholders or beneficiaries, providing that the shareholders or beneficiaries US residents and are taxed on the entity’s income in the United States.    

As for the second requirement, the term "beneficial owner" is generally not defined in tax treaties. However, the 2014 Update to the OECD Model Tax Convention issued by OECD the Committee on Fiscal Affairs on June 26, 2014 clarifies the meaning of beneficial owner as requiring that a person have "the right to use and enjoy" the income, "unconstrained by a contractual or legal obligation to pass on the payment received to another person". Sometimes, the term is interpreted as meaning that the beneficial owner is the person to whom the income is attributed for tax purposes under the tax laws of a Contracting State. 

The EU Directive 2003/49/EC of June 3, 2003 provides a definition of the term “beneficial owner” for the purposes of the withholding tax exemption of interest and royalties paid to a EU parent or affiliate corporation, according to which “A company of a Member State shall be treated as the “beneficial owner” of interest or royalties only if it receives those payments for its own benefit and not as an intermediary, such as an agent, trustee or authorized signatory, for some other person”. Circular 47/E of November 2, 2005, which at paragraph 2.3.2 clarifies that in order for a company to be considered the beneficial owner of the interest or royalties, “it is necessary that the company receives the payment as the ultimate beneficiary, not as an intermediary such as an agent, a fiduciary, or collector of the payment for another person, … and that the company receiving the interest or royalties derives a direct personal economic benefit from the income from the transaction”.

Clearly, the tax treatment of an entity in its country of organization is key to determine whether the entity, or its shareholders, partners or members, are entitled to the benefits of a treaty with respect to a parent made by a resident of the other Contracting State. The residence and beneficial owner requirements, whose meaning is not entirely free from doubt, and depends on the facts and circumstances of the particular case, call for extensive analysis of the tax classification and treatment of the entity and its owners, under the laws of their country or organization or asserted residence, as well as the organizational structure, role and functions of the entity receiving the payment. Under that scenario, the payer of the income bearing withholding agent obligations is usually under pressure, and must make sure that the documentation provided by the payee establishes with sufficient certainty the payee’s eligibility for treaty benefit.