With the Budget Law for 2018 (Law n. 205 of December 27, 2017), Italy amended the definition of the term “permanent establishment” set forth in article 162 of the Italian Tax Code.
The term permanent establishment now covers situations in which a foreign enterprise does not have a physical nexus with Italy, but it has a regular and continuous economic presence in the country; engages in ancillary activities that are an essential component of its corse business, or operates through commissioners or other agents who do not enter into contracts in the name of the enterprise, but procure the conclusion of contracts that are eventually signed by the principal with no material modifications.
As a result of the amendments enacted with the Budget Law, the scope of the term permanent establishment as defined under domestic law is significantly expanded, creating more situations in which a foreign enterprise may be subject to tax in Italy.
The domestic law definition of the term permanent establishment does not overrule that of article 5 of Italy’s tax treaties. Under Italian constitution law, tax treaties are international law and prevail over domestic law. To the extent that a tax treaty contains a narrower definition of the term permanent establishment, the tax treaty definition applies.
The first change concerns the enactment of the economic nexus rule, pursuant to which a permanent establishment of a foreign enterprise in Italy exists whenever the foreign enterprise’s activities result in a “regular, continuous and significant economic presence within the territory of the country”. Physical presence is no longer required for the existence of a permanent establishment and the consequent taxation of a foreign enterprise in Italy. Simultaneously, the tax code provision that excluded the presence of a permanent establishment for the sole reason of the location in Italy of electronic equipment used for the collection and transmission of data relating to the sale of goods and services has been repealed.
The new provision on the economic nexus would seem to originate from and be consistent with the OECD final report on the tax challenges of the digital economy (Action 1), released under OECD’s Action Plan on Base Erosion and profit Shifting (BEPS) on October 15, 2015.
The second change concerns the enactment of an additional requirement to the negative list of activities which are excluded from the definition of permanent establishment. For the exclusions to apply, it is required that each of those activities be preparatory or auxiliary in nature. A preparatory activity precedes the enterprise’s core business activities, while an auxiliary activity supports, but is not an essential and significant part of, the activity of the enterprise as a whole.
The new provision is consistent with clarifications provided in the Commentary to Article 5 of the 2017 OECD Model Income Tax Convention, at paragraph 60(“2017 OECD Model Treaty”), and with option A of Article 13 of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base erosion and Profits Shifting, signed on June 7, 2017 (“Multilateral Tax Convention”)
The third change concerns the enactment of the anti fragmentation rule pursuant to which the preparatory or auxiliary exception does not apply whenever the combination or aggregation of auxiliary or preparatory activities, together with other activities performed by the same or a closely related enterprise, in the same space or fixed place of business, constitute a permanent establishment. For the purpose of the anti fragmentation rule, two enterprises are closely related if one directly or indirectly controls the other or the two are directly or indirectly controlled by the same enterprise.
The anti fragmentation rule seems to be consistent with article 13 of the Multilateral Convention and reflects the clarifications provided in the Commentary to Article 5 of the 2017 OECD Model Treaty, at paragraph 79.
The fourth change concerns the definition of "dependent agent" permanent establishment. A permanent establishment now includes a dependent agent who habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise, and these contracts are: a) in the name of the enterprise; or b) for the transfer of the ownership of, or for the granting of the right to use, property owned by that enterprise or that the enterprise has the right to use; or c) for the provision of services by that enterprise. The new provision covers commissionare arrangements, whereby the agent does not sign contracts in the name of the enterprise, but promote the conclusions of contracts that are entered into by the enterprise without material modifications.
The new rule reflects the provisions of article 12 of the Multilateral Tax Convention, and implements the Action 7 of BEPS.
Although the new definition of the term permanent establishment in the Italian Tax Code does not overrule article 5 of Italy's existing tax treaties, Italy will move towards a renegotiation of its tax treaties pursuant to the Multilateral Tax Convention, ultimately enforcing the same concept and achieving consistency between international tax law of treaties and domestic tax law.
In the meantime, the Italian tax administration may be tempted to interpret and apply the permanent establishment provisions in Italy's current tax treaties taking into account the new rules, pursuant to a general anti abuse principle, to expand the potential taxation of foreign enterprises in Italy.