New From January 2024 | Participation Exemption for European Corporations on Disposal of Shareholdings - McDermott Will & Emery

New From January 2024 | Participation Exemption for European Corporations on Disposal of Shareholdings


The Italian government recently approved a draft 2024 budget law which provides for the extension of the domestic participation exemption regime on disposal of shareholdings (PEX) to those non-resident corporations that: (i) are resident in the European Union (EU) or resident in the European Economic Area (EEA) and allowing an adequate exchange of information, (ii) do not have a permanent establishment (PE) in Italy and (iii) are subject to corporate income tax in their State of residence (in practical terms, all EU Member States plus Iceland, Norway and Liechtenstein).

In Depth

New Tax Rules on Gains Deriving from “Qualifying” Shareholdings

Article 68 of the Italian Income Tax Code (IITC), governing the taxable base of capital gains qualifying as “other income”, will be amended to reduce to 5% the taxable base of capital gains deriving from the disposal of “qualifying shareholdings”1 if all the subjective and objective requirements for the PEX regime are met (article 87, IITC)2.

According to the new rule, qualifying capital gains made by non-resident companies would be subject to a 1.3% effective tax burden, resulting from the application of the 26% substitute tax on a taxable income equal to 5% of the capital gain, substantially reducing the tax burden, as compared to the current 26% tax rate (substitute tax).

Non-qualifying shareholdings are not affected as they are already tax-exempt for EU/EEA corporations under existing Italian law. The new law also states that if the capital losses exceed the capital gains, the excess is deducted up to 5% of their amount from the taxable capital gains arising in the following four financial years.

The Supreme Court’s “French Cases” Behind the Reform

The new provision is intended to align national law to the Supreme Court’s judgments no. 21261 issued on July 19, 2023 and no. 27267 issued on September 25, 2023, which ruled that non-resident companies without an Italian PE are entitled to apply the same national regime enjoyed by Italian-resident corporations on the capital gain made upon sale of a participation (provided that the objective and subjective requirements for the PEX regime are met), thus resulting in the 1.2% tax burden applicable to resident companies (i.e., 24% corporate income tax (CIT) on a taxable income equal to 5% of the capital gain).

The motivation for the change in national law comes from the aforementioned Supreme Court position that not applying the PEX regime to non-resident companies without an Italian PE would infringe the fundamental freedoms established under the Treaty on Functioning of the European Union (TFEU). 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 entitling to 25% or more of the profits of the subsidiary under the Protocol to the treaty). In this case, pursuant to Art. 8, let. b) of the Protocol attached to the Italy-France Double Tax Convention (DTC), Italy is not prevented from taxing any such capital gain under the treaty, with the result that the French corporation would have been fully taxed on the gain, whereas its Italian-resident equivalent corporation would have enjoyed a 1.2% effective tax rate.

The Impact of the New Provision

This legislative amendment is welcome in that it is intended to align national law to EU fundamental freedoms, taking also into account past experience in respect to dividends distributed by Italian subsidiaries to EU and white-listed EEA resident parent companies, which are subject to a 1.2% withholding tax, the same tax burden which applies to an Italian-resident corporation)3.

However, while the tax burden was perfectly aligned with the change in the regime of dividends, the new measure on capital gains leaves (probably inadvertently) a small difference in the regime applicable to resident companies. Qualifying capital gains will be taxable at a 1.3% effective rate to non-resident corporations versus a 1.2% effective rate applicable to resident corporations. This small gap derives from the change in law introduced by Law 27 December 2017 no. 205 which subjected qualified capital gains to the 26% substitute tax. Before this change, capital gains made by non-resident companies were subject to the 24% CIT. A full alignment to the regime of resident corporations would have required not only the exemption of 95% of the tax base but also the adoption of the same tax rate (24%).

On the basis of the DTCs currently in force with EU and EEA members, the amendment of article 68 IITC would mainly affect French and Liechtenstein companies4: France is affected because the provision of the Protocol attached to the Italy-France DTC, as mentioned, allows Italy to tax substantial capital gains made by French companies. Liechtenstein is affected because there is currently no DTC in force (the July 12, 2023 DTC is not yet enacted). However, Liechtenstein has entered a Tax Information Exchange Agreement (TIEA) with Italy (ratified on November 3, 2016) which brings Liechtenstein within the scope of the new provision.

The new provision might also have a marginal impact on those EU and EEA members which have a DTC with Italy allowing the source country to tax capital gains on shares of “real estate companies”. This is currently the case for Finland, Romania, Estonia, Latvia and Lithuania, and will be the case for Liechtenstein when the new DTC is enacted. The number of affected jurisdictions is expected to increase when Italy ratifies the Multilateral Convention (MLI) to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (BEPS). In fact, Italy, by approving article 9§4 of the MLI, elected to adopt the provision of art. 13§4 of the post-BEPS OECD Model Convention5, which would grant an automatic extension to those jurisdictions which adopted the same MLI option. According to treaty provisions in line with article 13§4, Italy will be entitled to tax gains on participations in Italian or non-resident companies whose value derives more than 50% from real estate property situated in Italy, irrespective of the “passive” or “active” function of such immovable property. The national provisions also allow to tax such gains. However, absent the new provision which amends article 68 IITC, a non-resident company would be taxed at 26% on a gain on the alienation of a qualifying shareholding in a resident company whose value derives more than 50% from real estate property situated in Italy, even if such immovable property has an “active” function (i.e., it is immovable property used directly in the operation of the enterprise, or for the production or exchange of which the business activity is actually directed), while a similar gain realized by a resident company would qualify for the 95% PEX regime. Now, the new provision would extend the 95% PEX to such gains made by non-resident companies for which the DTC allows Italy to tax6.

Are Italian Provisions in Breach of EU Law?

Apart from the aforementioned slight difference in the effective tax rate (1.3% vs. 1.2%) other aspects seem likely to frustrate the new rule’s objective of bringing national legislation in line with EU fundamental freedoms.

It should be noted that the Supreme Court’s position which triggered the legal change makes reference to the well-established case law of the Court of Justice of the European Union (CJEU) on discrimination and restrictions. However, while the Supreme Court’s judgment no. 21261 makes a generic reference to EU fundamental freedoms, the most recent CJEU jurisprudence indicates that any rule designed in the way in which the PEX has been designed should be tested against the provisions of the free movement of capital, rather than those on the freedom of establishment, which applies also to non-EU Countries7. It should be noted that this principle seems to be further supported by the afore mentioned September 25, 2023 judgement no. 27267, which also makes reference to the free movement of capital, albeit in a not entirely clear manner.

The new draft rule, however, is not inclusive of the non-EU/EEA corporations resident in States allowing an adequate exchange of information (as enumerated in Decree 4 September 1996), thus leaving the national legislative framework still in potential breach of EU fundamental freedoms (i.e., free movement of capital). Indeed, based on the Supreme Court’s decision, it could be argued that the PEX regime should also be extended to “white-listed” non-EU parent companies holding a qualifying participation in an Italian company and making a capital gain taxable in Italy based either on the applicable DTC rules, or on the absence of a DTC with Italy.

Should the PEX regime be extended to non-EU/EEA corporations it would therefore impact on gains made by corporations:

  1. Resident in a state having a DTC which allows Italy to tax any such gains irrespective of the activity carried out by the Italian company. This would be the case for instance for China, South Korea, Brazil and Israel
  2. Resident in a state having a DTC which allows Italy to tax gains on disposals of shareholdings in real estate companies. In respect of these jurisdictions the extension of PEX may impact shareholdings in “active” real estate companies as defined above. This would be the case for several jurisdictions such as, for example, the United States, Saudi Arabia, Hong Kong, Colombia, Jamaica, Panama and Uruguay
  3. Resident in a state not having a DTC with Italy, but that has entered into a TIEA with Italy. In any such case, the PEX regime would extend to an even larger number of jurisdictions such as, for example, Andorra, Bermuda, the Cayman Islands, Guernsey, Gibraltar, the Isle of Man, Jersey and Monaco.

Entry into Force

With regard to the effective date of the draft bill, it is expected that capital gains would be affected by the new provision if realized on or after January 1, 2024. For previous financial years a refund claim to be filed with Italian Tax Authorities should be considered. This would likely result in a tax controversy, similar to what happened in the Supreme Court French cases, mentioned above.


  1. “Qualifying shareholdings” are defined as those granting more than 20% of voting rights or more than 25% of the share capital, reduced to 2% and 5% respectively in the case of listed companies.
  2. 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 ( the “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 be carrying out an actual commercial activity (i.e. participation in passive real estate companies are not entitled to the participation exemption regime).
  3. Pursuant to the CJEU judgment of November 19, 2009, C-540/07, Commission v. Italy.
  4. Cyprus, given the unusual and oblique wording of art. 13 of the DTC, may also be impacted when the alienation of the participation in an Italian company takes place in Italy.
  5. Gains derived by a resident of a Contracting State from the alienation of shares or comparable interests, such as interests in a partnership or trust, may be taxed in the other Contracting State if, at any time during the 365 days preceding the alienation, these shares or comparable interests derived more than 50 per cent of their value directly or indirectly from immovable property, as defined in Article 6, situated in that other State.”
  6. Note, no such discrepancy would occur in respect of gains made on the disposal of non-resident “active” real estate companies: according to art. 1§98 of Law 29.12.2022 no. 197 for the purpose of qualifying non-resident real estate companies for which gains made by non-resident persons are taxable in Italy,  “immovable property to the production or exchange of which the business activity is actually directed as well as that used directly in the operation of the enterprise is not considered”.