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The preferential tax regime for the new resident workers, enacted by way of Article 16 of the Legislative Decree 147 of 9/14/2015, is now permanent and extended to non-EU citizens and independent consultants and service providers (while, originally, it was limited to EU citizens working in an employee capacity).

Given its wider scope and increasing relevance, for foreign enterprises which plan to move personnel to Italy, or foreign consultants who consider the opportunity to relocate to Italy, it is worth providing a review of the basic tax advantages of the preferential tax regime.

Eligible taxpayers include dependent workers and independent consultants and service providers, who are allowed a 50 percent deduction from the amount of taxable wages and salary or compensation for personal service performed in an independent capacity, with the personal income tax (IRPEF) applying on the remaining 50 percent portion of that income at graduated rates.

The special tax regime applies to the following categories of taxpayers:

A. dependent workers (employees) possessing a three or five year of five graduate degree, provided that:

1. in case of a foreign degree, a certificate is issued by the Italian consulate in the taxpayer’s home country, certifying that the degree is equivalent to an Italian graduate degree,

2. the taxpayer has carried out a studying or working activity outside of Italy for at least 24 months (or more) prior to his or her relocation to Italy,

3. the taxpayer is a EU citizen or citizen of a non-EU country with which Italy has an income tax convention or a tax information exchange agreement,

4. the taxpayer works as an employee or a independent consultant or service provider (for private or public organizations, and regardless of whether the work or activities are consistent with the taxpayer’s degree),

B. taxpayers who are employed in a managerial capacity of specialized skill capacity, provided that:

1. they have not been Italian tax residents in the last 5 years preceding their relocation to Italy,

2. they are employed with an Italian employer or a foreign enterprise’s permanent establishment located in Italy, or are employed on secondment or assignment to an Italian affiliate of a foreign company or enterprise,

3. they carry out their work primarily in Italy (the requirement is satisfied whenever the work is performed in Italy for more than 183 days of the year),

4. they perform managerial or specialized skill functions.

The managerial or specialized function requirement is deemed to be satisfied for taxpayers who are in possession of an 3+ year undergraduate degree in the area of management, liberal arts, scientific or high skilled professions, or technical jobs (such as software and IT developers, computer programmers, data base and computer systems programmers, program managers, etc.).

To qualify for the special tax regime, a taxpayer (1) must establish his or her tax residency in Italy during his or her employment there, and (2) must maintain his or her tax residency in Italy for at least two (2) years.

The maximum period for which the benefit applies is five (5) tax years, starting with the first year in which the taxpayer becomes an Italian tax resident.

The benefit consists in a 50 percent deduction of employment and personal services income. Assuming a total income of euro 100,000 in Italy the taxable income after the 50 percent deduction would be reduced to euro 50,000 and the Italian personal income tax (IRPEF) – without taking into account personal deductions or exemptions – would amount euro 15.320 (equal to an effective tax rate of 15.32 perfect).

Any other income, different from wages and compensation for services, continues to be taxed in full or according to the general rules.

Relocating to and establishing tax residency in Italy would still result in taxation in Italy on worldwide income, and carry with it the obligation to report foreign financial accounts and other reportable assets on the Italian income tax return. Consequently, specific pre-immigration tax planning would still be needed to make sure the employees are not subject to an overall adverse tax treatment and Italian taxation is properly coordinated with taxation still applicable in their home country.

The 50 percent income deduction appears to be very attractive and should facilitate foreign direct investments in Italy, in connection with which a foreign investor needs to move managerial or high-skilled personnel from its home country to Italy, and employe it at its Italian subsidiary or place of business.

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.

Pursuant to the Tax Cuts and Jobs Act (“TCJA”) passed on Dec. 22, 2017, the U.S. will tax U.S. corporations with the following tax rates:

– 21 percent general corporate income tax rate,
– 13.125 effective tax rate on U.S. corporation’s foreign derived intangible income (“FDII”), for taxable years from 2018 through 2025;
– 10.5 percent effective tax rate on the U.S. corporation’s pro rata share of global intangible low taxed income (“GILTI”) of a controlled foreign corporation (“CFC”).

FDII is the portion of U.S. corporation’s net income (other than GILTI and certain other income) that exceeds a deemed rate of return of the U.S. corporation’s tangible depreciable business property and is attributable to foreign sales (i.e., property sold to a non-U.S. person for foreign use) and foreign services (i.e., services provided to any person outside of the U.S.). The U.S. corporation is entitled to a deduction equal to 37.5 percent of its FDII. The application of the 21 corporate tax rate on the 62.5 percent taxable portion of FDII results in an effective tax rate of 13.125 per cent (for taxable years after 2025, the deduction is reduced to 21.875 percent, equal to an effective tax rate of 16.406 percent).

GILTI is the portion of a CFC’s net income (not otherwise taxed currently to its U.S. shareholders) that exceeds a deemed rate of return of the CFC’s’s tangible depreciable business property. GILTI is included in the taxable income of U.S. corporate shareholders of the CFC and taxed at an effective tax rate of 10.5 percent. The U.S. corporation is entitled to a deduction equal to 50 percent of the amount of GILTI. The application of the corporate tax rate of 21 percent to the 50 percent taxable portion of GILTI results in an effective tax rate of 10.5 percent. The profits of the CFC that have been included into the taxable income of the U.S. corporation and taxed as GILTI can be paid as dividends without any additional U.S. tax.

A potential implication, in Italy, of the new corporate income tax rates applicable in the U.S. is the classification of United States corporations as “black listed” controlled foreign corporations subject to Italy’s anti deferral rules.

Until 2015, Italy operated its CFC rules by limiting their application to foreign corporations controlled by Italian shareholders and organized in one of the countries included in a specific list of tax favorable foreign jurisdictions, usually referred to as “black list”.

Starting with tax year 2016, the “black list” has been replaced by a general test based on a comparison between Italy’s and foreign countries’ corporate income tax rates.

The general test provides that a foreign country is considered a black-list jurisdiction, for purposes of Italy’s CFC rules, whenever its nominal corporate income tax rate is less than half of Italy’s corporate tax rates. For this purpose, reference is made to Italy’s 24 percent corporate tax (IRES) rate and 3.9 percent regional tax (IRAP) rate, which combine for a total rate of 27.9 percent.

A special test requires to take into account any special corporate tax regime applicable in a foreign country with respect to taxation of corporate profits. The term “special tax regime” is defined to include any favorable tax provision that results in a lower effective corporate income tax rate, due to exemptions or deductions that reduce the tax base for the application of the general corporate income tax rate. Exemptions or deductions with respect to profits deriving from foreign activities falls within the definition of “special tax regime”.

When a foreign country operates a corporate tax system that provides for a different tax treatment of different categories of income, such as, for example, a system in which foreign income is taxed more favorably than domestic income, an “all or nothing rule” applies pursuant to which, if more than 50 percent of the foreign corporation’s income is subject to an effective tax rate which is lower than the foreign country’s general corporate tax tax rate and less than half of Italy’s nominal corporate income tax rates, the foreign corporation is deemed to be organized in a black listed country and all of its income is treated as income of a controlled foreign corporation taxable to its Italian shareholders on a current basis. For the purpose of the all or nothing rule, a determination is required to be made on a company by company and tax year by tax year basis.

The U.S. general corporate tax rate of 21 percent does not fall below the “less than half of the Italian corporate income tax rates” standard for the general CFC test. However, the 13.125 percent effective tax rate on FDII clearly does (13.125 is less than half of the 27.9 combined Italian tax rates). As a result, when more than 50 percent of the taxable income of a U.S. corporation directly or indirectly controlled by Italian shareholders is FDII and is subject to an effective tax rate of 13.125 percent in the U.S., then all of that U.S. corporation’s income is treated as income of a CFC taxable currently to its Italian shareholders. The fact that the income derives form genuine business transactions carried out with unrelated parties does not matter.

Italian shareholders are entitled to prove that a U.S. corporation is engaged in an active trade or business, representing its principal business activity, within the United States, and exclude the application of the CFC rules. A tax ruling may (but need not) be filed and a positive response would be binding upon the tax administration.

Now that the corporate tax rate differential between Italy and the United Sates makes it advantageous, for Italian taxpayers, to conduct international business activities through their U.S. subsidiaries or affiliates, and allocate more profits to the U.S. where they would be taxed at lower rates, it is reasonable to expect increased enforcement of Italy’s CFC rules by the Italian tax administration.

Italian taxpayers should review their U.S. controlled companies and take the proper steps to make sure they do not run afoul of Italian CFC rules.

With the Legislative Decree n. 90 of May 25, 2017, published on June 19, 2017 Italy finally adopted and transposed into its own legal system the EU Directive 2015/849, usually referred to as the “IV Anti Money Laundering Directive”.

One area that attracts particular attention concerns the new reporting rules applicable to trusts.

Article 21, paragraph 3 of Decree n. 90 provides that “trusts producing juridical effects relevant for tax purposes, in accordance with article 73 of the Presidential Decree n. 917 of January 22, 1986, shall be registered with a special section of the Register of Enterprises”.

Italy (which does not have domestic trust laws) recognizes and gives legal effect to trust set up and governed under foreign law, pursuant to the Hague Convention on Trust of July 1, 1985 implemented in Italy with law n. 364 of October 16, 1989.

Article 73 of Presidential Decree n. 917 (Italy’s Unified Income Tax Code) classify all trust as separata taxable entities for Italian income tax purposes. Trusts administered abroad are classified as foreign (non resident) trusts. Trusts administered in Italy are classified as domestic (resident) trusts. Foreign trusts are taxed solely on their Italian source income, while domestic trusts are taxed on their worldwide income, Trusts with identified income beneficiaries are taxed on a fiscally transparent basis (they compute their taxable income, which is then attributed to and taxed upon the income beneficiaries as designated in the trust agreement). Trusts without identified income beneficiaries are subject to Italy’s corporate income tax.

The scope of the new duty to register a trust into the Register of Enterprises, set forth in Decree n. 90, is extended to trusts which “produce relevant legal effects for tax purposes in Italy”. As a result, trusts subject to reporting include all domestic trust, foreign trusts with Italian assets or income, as well as foreign trusts with Italian settlor or beneficiaries.

Article 22, paragraph 5 of Decree n. 90 provides that fiduciaries and trustees of express trusts, which are recognized and enforceable in Italy pursuant to the 1964 Hague Convention on Trusts, shall collect and conserve sufficient and adequate and updated information on the beneficial ownership of the trust, meaning, information relating to the settlor, trustee or trustees, guardian, or any other person acting on behalf of the trustee, individual beneficiaries or class of beneficiaries, as well as any other person who exercises the control over the assets of the trust through direct or indirect ownership or other means. Trustee shall conserve that information for a minimum period of five years, and shall make it accessible to the authorities who are entitled to have access to that information for investigation purposes (typically, tax agencies in charge of tax inquiries and audits, and department of justice in charge with anti money laundering and criminal investigations). The information referred to at article 22 shall be filed electronically with the Register of Enterprises. Trustees are personally liable and subject to penalties for failure to comply with the duty to report.

Article 21, paragraph 5 of Decree n. 90 provides that the Ministry of Economy and Finance shall issue a regulation with specific provisions concerning:

a) the information to file with the register,
b) the procedure for filing and disclosure of the information to the governmental agencies which may require them, as part of tax or criminal investigations,
c) the procedure for the access to the register for review of filed information,
d) the procedure to determine the right to access the filed information,
e) the exchange of information on trusts between the Register and Tax Agency’s databases, concerning a trust’s tax code or VAT number, as well as any agreements setting up, amending or terminating a trust, or transferring assets into tor outside a trust, as they are relevant for the purpose of the application of income or transfer taxes relating to the trust.

The regulation, which has not been adopted yet, shall be very important to finalize and complete the law on new trust reporting rules. Sub paragraph e) of article 21.5 seems to suggest that also the relevant agreements concerning a trust may have to be file or disclosed. If that is the case, the reporting, which is due under the trustee’s personal responsibility, shall be quite challenging and require careful handling.

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For practitioner and professionals active in the international tax arena, it is interesting to know that the International Tax Institute, Inc. has launched its new web site (www.internationaltaxinstitute.org). 

Founded in 1961, the International Tax Institute, Inc. is a non-profit organization run by tax professionals to benefit the international tax community.  It provides continuing education led by top tax professionals as well as government policy-makers. 

Its core program is a series of monthly luncheon seminars, which are available to members and non-members. It provides New York State Continuing Legal Education Credits to lawyers, and New York State Continuing Professional Education Credits to accountants.

It is a membership organization comprised of the top global accounting and law firms, as well as boutique international firms.  Individual memberships are also available.  Non-members are welcome at all its programs.