In its judgment no. 21261 issued on 19 July, the Italian Supreme Court stated that non-resident companies without an Italian permanent establishment (PE) are entitled to apply the Italian 95% participation exemption (PEX) regime on the capital gain realized upon sale of a participation held in an Italian resident company, provided that the requirements for the PEX regime are met. In such a case, the capital gain would be subject to a 1.2% effective tax (resulting from the application of the 24% CIT ordinary rate on a taxable income equal to 5% of the capital gain).
In the Supreme Court’s view, not applying the PEX regime to non-resident companies without an Italian PE would infringe the fundamental freedoms laid under the Treaty on Functioning of the EU. Based on this reasoning, the Supreme Court upheld the position of a French parent company holding a ‘substantial participation’ in an Italian subsidiary, i.e. a participation attributing the right to 25% or more of the profits of the subsidiary. Pursuant to Art. 8, let. b) of the Protocol attached to the Italy-France Double Tax Convention (DTC), Italy is not prevented from taxing such capital gain.
The Supreme Court confirmed that the French parent company met all the requirements under Italian tax law for the application of the PEX regime. The Supreme Court pointed out that the discrimination against French resident companies was not eliminated by the tax credit granted pursuant to the Italy-France DTC considering that: (i) the DTC provides for a limited (and not full) tax credit, i.e. not exceeding the amount of French tax attributable to the relevant income and (ii) the capital gain is partially exempt from tax in France, thus limiting the attribution of a tax credit to the parent company.
Current Scenario and Next Steps
Provided that the requirements of the PEX regime are met, French parent companies can reasonably leverage on the judgment to directly apply such regime on capital gains realized upon the sale of substantial participations in Italian companies2. While the risk of an audit of Italian Tax Authorities cannot be completely ruled out (the 1.2% tax due upon application of the PEX would result from filing an Italian tax return and the current template does not provide for such tax for non-resident taxpayers), the arguments supporting the position are solidly grounded and further strengthened by the well-established case law of the Court of Justice of the European Union (CJEU) on discrimination and restrictions. A more prudent approach could be followed whereby the tax is paid and then a refund is requested.
We expect that the legislature will react to the judgment soon, adopting a provision that expressly extends the applicability of the PEX regime to capital gains realized by non-resident companies without an Italian PE. Considering the past experience in respect of dividends distributed by Italian subsidiaries to EU resident parent companies3, it is reasonable to assume that the legislature will extend the PEX regime to EU resident parent companies and to parent companies resident in States of the European Economic Area (EEA) that have an adequate exchange of tax information with Italy4.
While the Supreme Court’s judgment makes a generic reference to EU fundamental freedoms, the most recent CJEU jurisprudence indicates that a rule designed in a way such as the PEX should be tested against the provisions on the free movement of capital (rather than those on the freedom of establishment)5. Leveraging on this and on the applicability of the free movement of capital to non-EU countries, it could be argued that the PEX regime should also be extended to non-EU parent companies holding a participation in an Italian company and realizing a capital gain taxable in Italy based on the applicable DTC rules. Based on a first analysis, this would be the case with respect to China, South Korea and Israel, irrespective of the activity carried out by the Italian company. It would also be the case for United States companies with participations in an Italian company “whose assets consist wholly or principally of real property situated in Italy” (Art. 12, let. b) of the Protocol attached to the Italy-US DTC; this would therefore trigger taxation in Italy of the capital gain pursuant to Art. 13, para. 1 Italy-US DTC) and using such real property for its business activity, either as trading goods or fixed assets (thus not qualifying as a real estate company for the purpose of the PEX regime). While the extension of the principles stated by the judgment to such cases is affirmed neither directly nor implicitly by the Supreme Court, please note that it can be argued insofar as the applicable DTC includes a clause providing for an adequate exchange of information with Italy.
1 More specifically, to qualify for the PEX regime: (i) the participation must have been held uninterruptedly for at least 12 months prior to the sale (holding period); (ii) the participation must be classified under the financial fixed assets in the first financial statements closed after the acquisition of the participation; (iii) the subsidiary must not be resident in a black list country; (iv) the subsidiary must have actually carried out a commercial activity (i.e. participation in real estate companies are not entitled to the participation exemption regime). 2 Capital gains on non-substantial participations are already not taxable in Italy. 3 Further to the CJEU judgment of 19 November 2009, C-540/07, Commission v. Italy.
4 Based on past experience of the dividends, they should reasonably be identified in Iceland and Norway. Based on a first analysis of the provisions on capital gains laid under the DTCs entered into by Italy and the EU/EEA States, France seems to be the sole EU/EEA country for which the taxation in the source state of capital gains realized on participations in non-real-estate companies is provided.
5 On the applicability of the freedom of establishment vs. free movement of capital see the principles laid under the CJEU judgment of 24 November 2016, C-464/14, SECIL.