On 1 July 2009 the Italian Government enacted a Law Decree (hereinafter referred to as “Decree”) which embedded several dispositions, some of which have a tax nature and will likely have a significant impact on the operations of multinational companies.
The following note aims at providing a first brief explanation of the most important tax measures.
It should be preliminarily noted that as a Law Decree enacted by the Government, it is immediately effective. However, it must be subsequently approved by the Parliament and converted into ordinary Law within 60 days, and in this process of approval the Decree can undergo further changes.
The tax measures commented here below are the following:
Tax breaks granted to new investments (so-called “Tremonti-ter” rules)
Review and extension of the CFC (“Controlled Foreign Corporations”) rules
Tax Breaks Granted to New Investments (so-called “Tremonti-ter” Rules, Article 5 of the Decree)
As from 1 July 2009, up to 30 June 2010, 50 per cent of the amount invested in certain categories of machinery and equipments will be excluded from the taxable base for corporate income tax purposes.
The benefit consists of a flat deduction of 50 per cent of the amount of the investment, to be added to the ordinary deduction for the depreciation of the asset. In case there is no sufficient taxable income to offset such additional deduction, this results in a tax loss that can be carried forward according to the ordinary rules.
Taxpayers will be allowed to take advantage of such benefit for fiscal year 2010 although no guideline has yet been issued to clarify when taxpayers whose fiscal year does not coincide with the calendar year can benefit from this tax break. Another disposition provides for the recapture of the tax benefit in case the machinery or equipment that caused entitlement to the tax break is given away to a third party or is used for purposes other than those of the business activity, before the second fiscal year subsequent to the purchase.
Essentially, the disposition traces back to two precedents (dated 1994 and 2001 and know as “Tremonti” and “Tremonti-bis”) but with the following modifications:
Not all investments in fixed assets entitle the taxpayer to take benefit from the tax break, but only certain listed categories of machinery and equipment. For instance, real estate property and intangible assets are excluded from the tax break
There is no legal definition of “investment” but it is likely that some restrictions or conditions similar to those provided for under the previous tax breaks will be introduced (for example, restrictions concerning “new” assets)
While in the earlier precedent measures only the portion of new investments exceeding a certain threshold (i.e. the average amount of similar investments made in the previous five years) could benefit from the tax break, the “Tremonti-ter” rules stipulate that all investments made in the relevant period can now benefit from the tax break irrespective of how much has been invested in the past.
Review and Extension of the CFC (“Controlled Foreign Corporations”) Rules
These provisions aim at tackling international tax arbitrage opportunities and, as can be clearly inferred from the wording of the law, were enacted in order to bring Italian legislation in line with that of other EU Member States.
The new rules have a twofold aim as follows:
To review the current applicable rules regarding the safe harbour for the exclusion from the CFC regime of companies located in black-listed countries that carry on an effective trade or business activity
To extend the applicability of CFC rules also to companies that are not located in black-listed countries (subject to certain conditions)
These two different set of rules are separately analysed here below.
CFC Rules Change – the Exclusion from the CFC Regime of Companies that carry on an Effective Trade or Business Activity
Under Article 167, paragraph 5.a, of the Italian Income Tax Code, the Italian company controlling a CFC can be excluded from the CFC regime if it can demonstrate that the controlled company carries on an effective trade or business activity, as its main activity, in the jurisdiction where such company is established.
The Decree introduces a re-wording of said paragraph 5.a, which provides that, for the purposes of applying the safe harbour rule, the trade or business activity must be carried on as the main activity within the market where the company is established. Therefore, it is required that the activity has, as its main target, the local market (i.e. the market of the country where the company is located). Consequently, it is not enough, for purposes of exclusion from the CFC regime, to demonstrate the existence of significant structures and activities within the local territory if the bulk of the economic results derives from transactions entered into with parties located outside of the relevant market. This principle is further explained in the rules concerning banking, financial as insurance activities, for which it is provided that such an exclusion can be claimed as long as the major part of sources, investments and proceeds are originated in the state or jurisdiction of establishment.
This change was introduced in order to turn into law the position that the Italian tax authorities (“Agenzia delle Entrate”) had already expressed in recent administrative rulings (e.g. resolution n. 165 of 22 June 2009). The aforementioned position had been strongly criticized by tax practitioners as it implied a requirement (i.e. that the main activity takes place in the local market) which was not actually contemplated by the pre-existing wording of the law.
As a further change, the Decree has also introduced paragraph 5-bis of Article 167 in order to hinder the applicability of the exclusion from the CFC regime in situations where more than 50 per cent of the proceeds realised by the controlled company are made of passive income, i.e. are derived in connection with one of the following sources:
The management and holding of or investment in bonds, shareholding participations, credit instruments, or other financial activities
The transfer or licensing of intellectual property rights of industrial, literary or artistic nature
Rendering of services to related entities
In situations where these conditions are met, the exclusion from the CFC regime can only be achieved under the other safe harbour rule set forth by paragraph 5.b, according to which the Italian controlling company must demonstrate that holding the CFC does not cause a leakage of income to the (black-listed) state or territory of residence of the CFC.
The Extension of the Scope of CFC Rules also to Companies that are Not Located in Black-listed Countries
This is probably the change which will have the greatest impact. This will affect not only Italian-based multinationals, but also foreign-based groups having an Italian subsidiary at an intermediate level of the control chain.
A new paragraph 8-bis was introduced under Article 167 of the Italian Tax Code and it provides for an extension of the scope of the CFC rules to controlled companies that are not located in black-listed countries in situations where the two following conditions are met:
The controlled foreign company is subject to an effective taxation lower than half of the tax that it would pay, had the company been resident of Italy, and
The company derives over 50 per cent of its proceeds from the same passive income sources mentioned above, i.e.:
- The management and holding of or investment in bonds, shareholding participations, credit instruments, or other financial activities
- The transfer or licensing of intellectual property rights of industrial, literary or artistic nature
- Rendering of services to related entities.
If both the abovementioned conditions are met, the exclusion from the CFC regime can still be claimed insofar as the Italian controlling company files for a ruling request and demonstrates that the controlled foreign company was not established as part of an artificial structure aiming at obtaining tax advantages.
The extension also applies to companies located within the European Union
The effective tax burden test is extremely generic and its enforcement can come across several obstacles of a practical nature. It should be borne in mind that in evaluating the tax burden, mere timing differences between two different regimes should be taken into account and, accordingly, neutralised, thus making such analysis rather cumbersome
It looks like the only possible way to avoid the triggering of the CFC regime would be to demonstrate the non artificial nature of the relevant structure. This a principle developed by the European Court of Justice in the Cadbury Schweppes case (C-196/04, of 12 September 2006). However, it also must be taken into account that in the Cadbury Schweppes case the existence of a wholly artificial structure was to be ruled out to the extent that the taxpayer could demonstrate the existence of an effective economic activity in the state of establishment (by evaluating criteria such as physical presence of personnel, premises and equipment). It still has to be seen whether the position of the Italian tax authorities on this rule will come to the same conclusion set out above, requiring not just the existence of significant structures and activities within the local territory but also that the business activity must be carried on as the main activity within the market where the company is established. Certainly such latter requirement cannot be derived from the Cadbury Schweppes case.
For the purpose of calculating the taxable income of the CFC in the hands of the Italian controlling company the same rules valid for the ordinary CFC regime are applicable. This includes flow-through approach, income reassessment according to domestic criteria, separate taxation, tax credit for taxes paid abroad. Dividends paid by CFC companies still benefit (subject to ordinary requirements) from the 95 per cent exemption.
Enter into Force
Article 26 of the Decree provides, consistently with the general rule, that the Decree enters into force on the same day of its publication on the Official Gazette (i.e. 1 July 2009), and does not provide for any particular provision regarding the effectiveness of the new CFC provisions. Therefore, it can be argued that the provisions will be effective as from the first fiscal year starting after the date in which the Decree has come into force, according to the general principle established by Article 3 of the Taxpayers Statute.
Hardening of Penalties for Non-Disclosure of Foreign Assets (Article 12 of the Decree)
The declared purpose of this rule is to enforce the understandings recently achieved among OECD Member States on contrasting tax havens.
Under Italian legislation the states and jurisdictions considered as tax havens are listed under the Ministerial Decree of 4 May 1999 (black-list for the purposes of individuals’ presumption of residence under Article 2, paragraph 2-bis of the Italian Income Tax Code) and under the Ministerial Decree of 21 November 2004 (black-list for CFC purposes).
The change introduced by the Decree of 1 July 2009 provides that investments and activities held in the abovementioned states or jurisdictions in breach of the disclosure obligations are deemed to be income deriving from tax evasion (unless the taxpayers proves the contrary). In this case the ordinary applicable penalties for omitted or unfaithful tax return are doubled (e.g. in case of unfaithful tax return the applicable penalty would range from 200 to 400 percent of the evaded tax).
Also this provision should be effective as from fiscal year 2010.
It is also provided that the Italian tax authorities will set up a special audit unit targeted with tackling international tax evasion and avoidance by means of an improvement in the exchange of information and mutual cooperation.
No disposition concerning the repatriation of capital held abroad (“tax shelter”) has been enacted. It has been broadly speculated, though, that such disposition is to be included upon the conversion of the Decree into ordinary Law to be approved by the Parliament.
Alessio Persiani and Tatiana Penido were also principal authors of this article.