The OECD Committee on Fiscal Affairs has released as a discussion draft a Report on “The Granting of Treaty Benefits with respect to the Income of Collective Investment Vehicles”(PDF) which contains proposed changes to the Commentary on the OECD Model Tax Convention dealing with the question of the extent to which either collective investment vehicles (CIVs) or their investors are entitled to treaty benefits on income received by the CIVs. The Report is a modified version of the Report “Granting of Treaty Benefits with respect to the Income of Collective Investment Vehicles” (PDF) of the Informal Consultative Group on the Taxation of Collective Investment Vehicles and Procedures for Tax Relief for Cross-Border Investors (“ICG”) which was released on 12 January 2009. In that original Report, the ICG addressed the legal and policy issues specific to CIVs and formulated a comprehensive set of recommendations addressing the issues presented by CIVs in the cross-border context.
The Italian parliament on March 3, 2009 enacted law n. 20 which authorizes the ratification of the new U.S.-Italy tax treaty signed in 1999.
Law n. 20 of March 3, 2009 was published on the Official Gazette on March 18, 2009 and is now into force. The U.S. had ratified the treaty on December 28, 1999.
The new treaty will enter into force at the time of the exchange of the instruments of ratification. It will apply and take effect for taxable periods beginning on or after January 1, 2010 and for withholding taxes on payments made or accrued on or after the first day of the second month following the date of entry into force. A grandfathering provision allows a taxpayer to elect for the application of the old treaty for a period of 12 months following the entry into force of the new treaty, should the old treaty result in a better treatment.
The new treaty reduces the withholding tax rates on dividends, interest and royalties; authorizes the collection of a dividend equivalent tax on the repatriated profits of a branch, includes a provision limiting the benefits of the treaty to certain qualified residents of the other contracting state, addresses the creditability in the U.S. of the Italian regional tax on production activities, and provides that the competent authorities of the two contracting states may agree to refer a case to special arbitration procedure if they fail to reach an agreement within two years of the date on which the case was referred to one of them.
The current U.S.-Italy tax treaty entered into force on December 30, 1985. On August 25, 1999 Italy and the U.S. signed a new treaty and protocol (the "1999 Treaty"). On November 5, 1999 the U.S. Senate consented to the ratification of the 1999 Treaty, subject to a reservation and understanding.
The reservation required the elimination of following language which appears as the final paragraph of the withholding tax provisions of articles 10 (Dividends), 11 (Interest), 12 (Royalties) and 22 (Other Income):
"The provisions of this Article shall not apply if it was the main purpose or one of the main purposes of any person concerned with the creation of assignment of the" (respectively, shares or other rights; debt claim, rights, and rights) "in respect of which the" (respectively, dividend, interest, royalties and income) "is" (are) "paid is to take advantage of this Article by means of that creation or assignment".
That language established the so-called main purpose tests aimed at tackling possible abuses of the treaty or treaty shopping arrangements.
The understanding concerned the exchange of information provision of Article 26, which, according to the U.S. Senate, should grant to the competent authorities of the two contracting states the authority to obtain or provide information held by financial institutions, nominees, or persons acting in an agent or fiduciary capacity, or respecting interests in a person.
President Clinton signed the U.S. instrument of ratification on December 28, 1999, subject to the above mentioned reservation and understanding. The reservation required approval from the Italian government, which held the ratification process in stand by.
The 2006-2007 Exchange of Diplomatic Notes
By way of diplomatic note n. 291 of April 10, 2006, the Embassy of the United States of America reiterated the above-mentioned conditions to the ratification of the 1999 Treaty.
The Italian Minister of Foreign Affairs issued a note on February 27, 2007 by means of which it formally agreed with the reservation requiring the deletion of the main purpose tests and the understanding on exchange of information.
That step eventually paved the way to the final ratification of the new treaty.
The Italian Law Authorizing the Ratification of the Treaty
Eventually, the Italian Parliament enacted law n. 20 of March 3, 2009 which authorizes the Italian Minister of Foreign Affairs to exchange the instrument of ratification of the new treaty.
Effective Dates and Grandfathering Provision
The 1999 Treaty enters into force on the date on which the instruments of ratification are exchanged.
In general, the 1999 Treaty shall apply to taxable years beginning on or after the the first day of the year in which it entered into force. Therefore, if the instruments of ratification are exchanged in 2009, the Treaty shall take effect for taxable years beginning on or after January 1, 2010.
In the case of withholding taxes at source, the 1999 Treaty shall apply to payments made or accrued on or after the first day of the second month following its entry into force. Therefore, if instruments of ratification are exchanged on March 24, 2009 the Treaty shall apply to withholding taxes due on or after May 1, 2009.
A grandfathering provision allows a taxpayer, for a period of 12 months following the entry into force of the 1999 Treaty, to elect for the application of the 1985 Treaty should it provide a more favorable tax treatment.
Highlights of the New Treaty
Under the 1999 Treaty, the withholding rates on dividends are 5 percent for inter-company dividends (that is, dividends paid to a person owning at least 25 percent of voting shares of the payer for at least 12 months as of the time of the declaration of the dividends) and 15 percent for portfolio dividends. Dividends paid by a US RIC are subject to 15 percent withholding. Dividends paid by a US REIT may be subject to 15 percent withholding only if specific requirements are met.
The withholding rate on interest is reduced to 10 percent.
Royalties for patents and software are subject to a 5 percent withholding and all other royalties are subject to 8 percent withholding rate.
The 1999 Treaty authorizes the application of a branch profits tax. Italy does not have a branch profits tax. However, all Italian companies operating in the U.S. through a branch shall be subject to the U.S. branch profits tax.
Article 23 of the 1999 Treaty (Elimination of Double Taxation) contains specific provisions for the computation of the amount of the foreign tax credit in the U.S. for Italian regional tax on production activities (IRAP) paid to Italy.
Article 2, paragraphs 1-5 of the Protocol to the 1999 Treaty contains the new limitation of benefits provisions of the treaty.
A Memorandum of Understanding signed with respect to article 25 of the 1999 Treaty (Mutual Agreement Procedure) provides that the competent authorities may agree to invoke arbitration in a specific case, if they fail to reach and agreement within two years of the date on which a case was submitted to one of them. The Memorandum of Understanding sets forth the main aspects of the arbitration procedure and refers to the EU Convention on Arbitration Proceeding in transfer pricing matters and the US tax treaty with Germany.
The 1999 Treaty also contains specific provisions on application of treaty benefits to income derived or paid by partnerships or other fiscally transparent entities.
The Italian Supreme Court issued an important decision concerning the application of tax treaty benefits to partnerships.
The judgment (n. 4600 of 2009) will be deposited soon and we will publish it with additional comments as soon as it is available.
Under the facts of the case, a US Limited partnership received the payment of a dividend from an Italian company. A Japanese fund, member of the US limited partnership, claimed the reduction of the Italian withholding tax on the dividend pursuant to the Italy-Japan tax treaty. The Italian dividend withholding tax rate is 27 percent. The Italy-Japan treaty reduces it to 10 percent for inter-company dividends (paid to shareholders owning at least 25 percent of voting shares of the payer) and to 15 percent for portfolio dividends.
Italy’s tax administration rejected the treaty claim on the ground that the Japanese fund is not the legal recipient of the dividend. The treaty grants the benefits if "the recipient" of the dividend is a company that qualifies to treaty benefits.
In the case at hand, the US LP, which was the recipient of the dividend, was transparent and did not qualify for treaty benefits under the US-Italy treaty, while the Japanese fund was the final economic owner but not the legal recipient of the dividend.
The Court accepted the position of the tax administration and observed that other Italian treaties, granting treaty benefits to a treaty partner who is the beneficial owner of the dividend, would command a different result.