Possible Tax Exemption for EU Investment Funds Investing into Italy – Update from the Draft Tax Bill for 2021

Tax Regime of Italian Investment Funds

Under Italian tax law, investment funds established in Italy (both as UCITS and AIF) are deemed to be resident therein for income tax purposes, regardless of their legal form, and are liable to Italian corporate income tax (IRES), which is generally applied at a rate of 24% (i.e. Italian investment funds are opaque entities for Italian tax purposes).

Italian tax law establishes that proceeds realised by Italian investment funds are exempt from Italian income taxes (i.e. IRES and local operating profit tax (IRAP), which is ordinarily applied at a rate of 3.9%).

Consequently, proceeds realised by Italian investment funds arising from their investments shall be received gross of any Italian withholding tax or substitutive tax (with some minor exceptions – e.g. under certain conditions, interest from certain unlisted bonds), and shall not be subject to Italian income taxes.

Tax Regime of Foreign Investment Funds

Unlike Italian investment funds, foreign investment funds are generally subject to Italian taxes on the proceeds from investment into Italian companies. In particular, under the current Regime:

• 26% withholding tax is applicable on outbound dividends; and

• 26% substitutive tax is applicable on capital gains realised upon sale of “qualified participations” (i.e. a participation representing more than 20% (2% in case of listed company) of the voting rights or 25% (5% in case of listed company) of the capital) into Italian companies. Foreign investment funds are already generally exempt under Italian domestic tax law from taxation on capital gains realised upon sale of (i) “non-qualified participations” (i.e. a participation representing no more than 20% (2% in case of listed company) of the voting rights or 25% (5% in case of listed company) of the capital) into Italian companies and (ii) participations into Italian companies which are listed on regulated markets.

The aforementioned discrimination against foreign investment funds, representing a violation of the fundamental freedoms provided by EU law, had been brought to the attention of EU Commission which had already launched an investigative initiative with the competent Italian authorities (EU PILOT 8105/15/TAXU, which refers to a potential discrimination of EU investment funds only – and not of extra-EU funds – in respect to the Italian ones).

As a matter of practice, foreign investment funds used to invest into Italian companies through the interposition of foreign special purposes vehicles (SPV) in order to obtain, inter alia, treaty protection on capital gains and under certain conditions, exemption from withholding tax on outbound dividends under the EU Parent-Subsidiary Directive.

However, the interposition of such vehicles has been extensively subject to scrutiny by the Italian tax authorities under the “beneficial ownership” test and the anti-avoidance rules, mainly relying on the lack of sufficient “economic substance”.

Proposed Amendments Introduced by the Tax Bill for Financial Year 2021

According to the draft of Tax Bill for FY 2021, EU investment funds investing in Italy are to be exempt from taxation on dividends and capital gains realised therein.

In particular, the proposed amendments introduced by the Tax Bill for FY 2021 would allow for the full exemption on dividends payments as well as on capital gains to the following categories of foreign investment funds:

• UCITS funds;
• non-UCITS funds, established in EU/EEA “white list” countries of which management is subject to regulatory supervision under the AIFMD in its country of incorporation.

Based on the wording of the draft of Tax Bill for FY 2021 and of the accompanying explanatory note, the new provision should be effective with respect to distributions of profits and capital gains realised as of the entry into force of the same law (most likely January 1, 2021).

Certain Preliminary Comments on the Tax Update

The proposed amendments to the tax law would represent a landmark change to the tax regime of EU investment funds, allowing them to invest directly into Italian companies and benefit from the exemption regime already granted to Italian investment funds.

Notwithstanding the good news, some outstanding doubts remain:

• the wording of the law and of the accompanying explanatory note seem clearly aimed at excluding any interpretative function of new provision. Accordingly, the tax relief would be applicable only to future proceeds.However, one may argue that the new law should support refund procedures for taxation suffered in previous FYs. To also be considered would be the impact of the new provision on tax audits/litigations where Italian tax authorities challenged the tax treatment applicable to foreign SPV structures used by EU investment funds assessing an undue tax benefit under the Italian GAAR.

• the wording of the law refers to “dividends paid” and “capital gains realized” by EU investment funds. Based on a literal interpretation of the provision, the exemption would apply only if the first payee (in case of dividends) or direct recipient of the sums from the sale (in case of capital gains) qualifies as an EU investment funds. Accordingly, only direct investments would fall within the scope of the new tax exemption. Such interpretation would be consistent with recent guidelines of the Italian tax authorities commenting on other Italian domestic relief rules providing with similar wording (see Rulings 76 and 423 dated 2019). However, a restrictive approach would prevent the application of the new tax exemption provision to foreign SPV structures used by EU investment funds which can be set-up for other non-tax non-marginal reasons (e.g. ring-fencing, security package on financings), regardless of their “economic substance” for tax purposes;

• the new provision will grant the exemption from Italian taxation only to EU investment funds. Therefore, a potential restriction to the movement of capital under EU law for third countries still remain, entailing a discrimination for tax purposes for extra-EU investment funds (specifically those comparable to the EU ones);

As anticipated, this is just a draft of law. We need to wait for the final enactment of the Tax Bill for FY 2021 in order to have confirmation and, eventually, for administrative interpretations to deal with some outstanding matters.