The Italian tax authority and Italian tax courts have taken very aggressive positions on corporate taxation over the past 10 years, and this has significantly affected corporate tax planning. In fact, the Italian tax authority has mounted significant challenges to tax-planning structures under Italy's general anti-abuse rule (GAAR).
However, new rules were introduced in 2015 to more appropriately define the scope of the Italian GAAR. Thanks to these new rules and their interpretation by the Italian tax authority and Italian tax courts, the tax-planning landscape has improved.
The GAAR is an aspect to evaluate carefully (e.g., when structuring an acquisition or disinvestment), but more certainty now exists as to its application.
II LOCAL DEVELOPMENTS
i Entity selection and business operations
General overview of the Italian tax system
Italian corporations2 are subject to corporate income tax (CIT) and to regional taxes on production activities (IRAP).
CIT applies based on the 'worldwide taxation principle', whereby any income – including foreign-sourced income – is included in the relevant taxable base and taxed at the ordinary rate of 24 per cent (a 3.5 per cent surtax applies to banks and other financial intermediaries). IRAP is levied at the ordinary rate of 3.9 per cent.3
A special regime applies to Italian investment funds, whereby (in very general terms) the profits realised by the fund (1) are not subject to tax in the hands of the investment fund, and (2) are subject to tax in the hands of the investors at the moment of the distribution. This principle is subject to certain exceptions depending on the type of investment fund.
Tax transparency regime
Businesses structured as partnerships (between two or more partners) are taxed under Italy's tax transparency regime, according to which they are subject to IRAP but not CIT, and their income is subject to tax in the hands of the partners.4
If the partnership includes foreign partners, its income is subject to CIT (in the hands of the foreign partners that are entities, not individuals) at a rate of 24 per cent, and no withholding tax (WHT) is levied on the profit distributions. This form of business may be attractive to foreign investors who are not entitled to a WHT exemption on dividends.
An Italian corporation may be treated as a look-through entity for tax purposes only if it elects to be treated as such and – among other conditions – each shareholder holds over 10 per cent but no more than 50 per cent of both the profit and voting rights. In this case, profits are proportionally allocated to each shareholder and subject to tax in the shareholders' hands (at a 24 per cent rate), irrespective of the actual distribution. Losses are also proportionally allocated to each shareholder, but only within the limit of their individual stake in the company's net equity.
This tax transparency regime reduces the overall tax burden deriving from profits that flow to company shareholders through dividend payments. Indeed, in contrast to the ordinary regime, company profits in this case are taxed only once, in the hands of the shareholders, and subsequent dividend distributions (ordinarily taxed at a rate of 1.2 per cent) are not taxable.
Furthermore, an Italian shareholder that holds a non-controlling interest in an Italian loss-making company might find the tax transparency regime particularly attractive. Indeed, the minority shareholder – which is not entitled to the tax consolidation regime (owing to its lack of control)5 – would be allowed to offset its profits against the company's losses.
Non-resident shareholders may opt for this regime if they are eligible for the WHT exemption under the EU Parent-Subsidiary Directive (or under the applicable double tax treaty (DTT)), or they own the relevant shareholding through a permanent establishment in Italy.
Domestic dividends and capital gains
Under the participation exemption (PEX) regime, dividends distributed to resident companies by other resident companies are subject to CIT only on 5 per cent of their amount (the final CIT tax burden is generally 1.2 per cent). Dividends are not subject to IRAP in most cases.
Capital gains realised by an Italian company upon the disposal of assets are, in principle, ordinarily subject to CIT and IRAP.6
However, under the PEX regime, capital gains realised on the sale of a shareholding in an Italian company could benefit from a 95 per cent CIT exemption (with the final CIT tax burden again generally being 1.2 per cent) if: (1) the shareholding was owned for at least 12 consecutive months; (2) specific accounting requirements are met; and (3) the participating company carries out an actual trade or business.
Foreign dividends and capital gain
Foreign-sourced dividends can benefit from the PEX regime if they are not directly or indirectly distributed by a company that is resident in a jurisdiction with a 'privileged tax regime' (as defined below).
Similarly, capital gains realised upon the disposal of shareholdings in non-resident companies can benefit from the PEX regime if – in addition to the conditions described above for shareholdings in Italian-resident companies – the foreign company is not resident in a jurisdiction with a 'privileged tax regime'.
Conversely, dividends deriving from jurisdictions with a 'privileged tax regime', and capital gains realised on the disposal of shareholdings in foreign companies that are resident in those jurisdictions, are generally fully subject to tax unless specific conditions are met.
As from 1 January 2019, a foreign company is deemed to be resident in a privileged tax regime7 if it is subject to:
- a nominal income tax rate that is lower than 50 per cent of that which would be applicable in Italy – if the Italian recipient company does not control the foreign company; or
- an effective taxation that is lower than 50 per cent of that which would be applicable to the company if it were resident in Italy – if the Italian recipient company controls the foreign company.
Italian WHT on outbound payments
Outbound payments (e.g., dividends and interest) are generally subject to Italian WHT at the ordinary rate of 26 per cent, which can be reduced or exempted if the conditions under EU Directives (i.e., the Parent-Subsidiary or Interest and Royalties Directives), DTTs or certain domestic provisions are met.
Financing an Italian company
Italian legislators recently repealed a tax incentive aimed at promoting the equity capitalisation of Italian companies (the Allowance for Corporate Equity (ACE)). This regime provided a notional interest deduction on certain equity increases that occurred in Italian companies; the aim was to mitigate the different tax treatment of debt- and equity-financed companies.
As a result of this change in the law, no incentives are envisaged for equity capitalisation starting from 2019. Consequently, financing an Italian company through debt might constitute the most efficient choice from a tax perspective, provided that the conditions for the deduction of interest expense are met.
Italian corporations may deduct interest expense (for CIT purposes) for an amount not exceeding the sum of (1) interest income, and (2) 30 per cent of the EBITDA8 accrued in a given fiscal year.
Differently from corporations, Italian partnerships (other than partnerships limited by shares) are not subject to this interest deduction limitation; rather, they may deduct interest expense connected to their business activity on a pro rata basis according to the ratio of proceeds included in the taxable base (and other specific proceeds) and the overall amount of proceeds.
Consequently, it might be tax-efficient to structure a business as a partnership if it is a profitable business that incurs significant amounts of interest expense.
Acquisition of Italian real estates
A real estate investment fund (REIF) is a very attractive vehicle for investments in Italian real estate – especially for foreign investors. As the name suggests, a REIF is an investment fund that invests mainly in real estate assets under specific rules.
Profits realised by a REIF are fully exempt from CIT and IRAP; in addition, income realised upon distributions of proceeds or redemption of units in the REIF may be exempt from Italian taxation in the hands of foreign unitholders (with no application of any WHT in Italy) if the foreign unitholders qualify as pension funds or undertakings for collective investment (UCI) located in a white-listed country (i.e., one on the list of countries that allow an adequate exchange of information with Italy9), or other specific entities (e.g., central banks and certain international organisations).
The WHT exemption still applies if a foreign qualifying investor uses a wholly controlled foreign vehicle to invest in the REIF.
Other foreign investors are subject to a 26 per cent final WHT, which may be reduced under the relevant DTT, if applicable.10
Given the above scenario, investing in Italian real estate assets through a REIF may be very appealing – indeed, it can lead to a zero per cent tax burden in Italy, both on the realisation and the distribution of profits.
This is the case, for instance, of a foreign UCI established in a white-listed country that invests in Italian REIFs: income arising from the real estate investment would not be subject to tax in the hands of the REIF, and WHT would apply neither on the REIF's periodic distributions of proceeds nor on the redemption of units in the REIF.
Under certain domestic provisions or the applicable DTT, foreign investors may achieve zero per cent taxation in Italy if they exit their investment through sale of their units in an Italian REIF.
The treatment for investors with Italian tax residence is quite different and less efficient.
Are tax incentives available to Italian companies?
Several tax incentives have been introduced over the past few years, including:
- the patent box;
- an R&D tax credit;
- hyper-depreciation; and
- a reduced CIT rate applicable to corporations incurring certain investment and hiring costs.
These incentives – which can be used jointly – can significantly increase interest on the part of foreign investors and be leveraged for acquisitions of Italian companies.
The patent box regime is an optional regime that a company earning Italian-sourced business income may opt for if: (1) the company bears expenses for R&D activities carried out by itself or third parties; and (2) these R&D activities aim to develop, maintain or improve qualifying IP assets.
Under this regime, 50 per cent of income derived from the direct or indirect use of qualifying IP assets (net of certain expenses and by a specific ratio) is excluded from taxation for both CIT and IRAP purposes.
An additional tax incentive, under the form of a tax credit, is available for companies that incur certain qualifying R&D expenses by the end of 2020. This incentive provides for a tax credit corresponding to the portion of qualifying R&D expenses incurred in a given fiscal year that exceed the average amount of qualifying R&D expenses incurred by the same company in 2012–2014 (multiplied by 50 per cent or 25 per cent depending on the type of expenses incurred).
These incentives could be very attractive for multinational groups interested in setting up or implementing an R&D hub in Italy.
For instance, a multinational group may carry out R&D activities through an Italian entity and charge the expenses for these activities (plus a proper mark-up) to foreign entities in the group. In this case, the Italian entity would benefit from both the tax credit and ordinary tax deduction of R&D expenses; at the same time, the foreign entity would deduct the cost for the services received.
Similar effects could be achieved through the patent box if the Italian entity licenses a qualifying IP asset to foreign entities in the group. In this case, the Italian entity could deduct the R&D expenses incurred in relation to the IP asset under the ordinary rules, and – at the same time – benefit from the partial exclusion from taxation of the royalties received under the patent box regime.
These incentives could be even more appealing for R&D activities that fall within the scope of both incentives, given that the R&D tax credit and the patent box can be cumulated. In this case, the Italian company would benefit from: (1) the R&D tax credit; and (2) the partial exclusion from taxation of the income deriving from the use of qualifying IP assets (if the R&D activities give rise to qualifying IP assets).
Hyper-depreciation is another incentive that has turned out to be very interesting over the past few years. This consists of a higher tax depreciation of certain qualifying tangible and intangible assets, and is mainly aimed at driving innovation in Italian companies (technological and digital transformation, digitalisation of processes, robotics, etc.). Under this regime, the cost for the tax depreciation is increased by 50 per cent to 170 per cent depending on the amount of the investment (a 40 per cent increase applies to intangible assets). This incentive will generally remain in force for investments made by 31 December 2019.
In addition, a new tax incentive became available at the start of 2019 for certain investments in new fixed assets and costs incurred for newly hired personnel. In this case, a reduced 15 per cent CIT rate applies to a portion of income that corresponds to whichever of the following is lower: (1) the previous fiscal year's profits allocated to reserves other than non-distributable reserves; or (2) the sum of certain investments in new fixed assets and costs incurred for newly hired personnel.
New tax rules on carried interest
New rules have recently been enacted on the tax treatment of carried interest (i.e., the remuneration paid to managers and employees of investment companies and private equity firms in order to align their interests with those of other investors). In the past, no certainty existed as to how this form of remuneration was to be qualified – i.e., whether it was to be treated as a financial income (subject to a flat tax rate of 26 per cent) or as employment income (subject to a tax rate of up to 43 per cent, plus surcharges). This was especially uncertain in (frequently occurring) situations in which the carried interest was linked to good or bad leaver events.
The new rules now qualify carried interest as financial income if it derives from direct or indirect stakes in companies or UCIs, and if certain conditions are met: (1) the managers invest at least 1 per cent of the overall investment; (2) the carried interest accrues only once all the investors have realised a certain minimum 'hurdle rate'; and (3) the managers hold the shares or financial instruments are held by the managers for at least five years or until a change of control occurs.
These new rules are very important, as they provide certainty on the taxation of carried interest; this is a very interesting opportunity for top executives, and not only those in private equity.
For instance, the new rules may be especially attractive to non-resident managers of Italian companies who hold shares in the same Italian companies and receive carried interest upon their disposal. Indeed, in this case, the carried interest is not subject to taxation in Italy if the manager is a tax resident in a country that has a DTT with Italy, and the DDT envisages the exclusive taxation of capital gains in the seller's country of residence.
ii Common ownership: group structures and intercompany transactions
Ownership structure of related parties
The tax consolidation
Italian companies may elect to include one or more of their controlled resident subsidiaries in the domestic tax consolidation regime. The tax consolidation regime is also available for Italian 'sister' companies that are not controlled by an Italian company, but by the same foreign company.
Under the tax consolidation regime, income and losses of the companies included in the tax consolidation are cumulated in a consolidated taxable base for CIT purposes (but not for IRAP purposes).
In addition, a company included in the tax consolidation can transfer accrued interest expense – if it exceeds 30 per cent of the company's EBITDA – to consolidated taxable base to offset the consolidated taxable income. In this case, the consolidated taxable base can be offset up to the sum of interest income and 30 per cent of the EBITDA generated by other companies included in the tax consolidation, and which have not been used to offset each company's interest expense.
Tax consolidation is a particularly efficient option for Italian groups, as it allows them to offset the taxable income from certain group companies against tax losses from others.
It is also a very interesting option in those frequent situations in which the holding company incurs significant interest expense (which it is not entitled to deduct itself, as it lacks its own EBITDA): with the tax consolidation regime, the holding company may offset its interest expense by using the EBITDA of the controlled operating companies.
The controlled foreign companies regime
According to recently introduced amendments, the controlled foreign companies (CFCs) regime applies when an Italian-resident person directly or indirectly controls a non-resident entity that meets both the following conditions:
- it is subject to an effective taxation that is lower than 50 per cent of that which would be applicable to the company if it were resident in Italy; and
- more than one-third of its proceeds includes 'passive income' (e.g., dividends, interest or royalties) or derives from:
- financial leasing, insurance, banking or other financial activities; or
- intra-group sales or supply of low value-adding goods or services.
CFC rules might not apply if the Italian controlling company can prove that the foreign company carries out an actual business in the foreign jurisdiction.
In general terms, profits realised by the CFC are subject to tax in Italy in the hands of the Italian controlling entity, irrespective of the actual distribution of the profit.
Italian law recently broadened the notion of control for the purposes of CFC rules. Under the new rules, an Italian-resident person is deemed to control the foreign company if it directly or indirectly holds more than 50 per cent of the profit rights, regardless of whether it is in a position to exercise a significant influence over the foreign company.
In light of these new rules, the use of financial instruments with enhanced profit rights in foreign companies could affect the application of CFC rules – the use of these instruments should therefore be carefully planned.
The branch exemption regime
Income and losses of an Italian company's foreign permanent establishment are ordinarily included in the Italian company's taxable base, with an Italian tax credit being issued for taxes paid abroad.
However, if certain conditions are met, resident companies may opt to exempt the income and losses of their foreign permanent establishments. This regime applies to all existing and newly incorporated foreign permanent establishments and is irrevocable.
This regime does not apply to permanent establishments that meet the conditions required for a foreign company to be deemed a CFC.
iii Third-party transactions
Sales of shares or assets for cash: most efficient structures
Business transfers may be carried out in various ways, but mainly the following:
- transfer of the shareholding in the Italian company that owns the business (share deal);
- direct transfer of the business (asset deal); or
- contribution or demerger of the business into a newly incorporated company and subsequent sale of the shareholding in this company (indirect share deal).
These alternatives trigger very different tax treatment, and indeed the choice is very much driven by tax considerations.
In share deals, the capital gain is taxable in the hands of the seller (under the ordinary rules) unless the PEX applies (in which case, the effective tax burden is 1.2 per cent) and no proportional registration tax applies (but a financial transaction tax (FTT) may apply11). From the buyer's perspective, no tax step-up is recognised on the business's assets.
Indirect share deals lead to similar tax consequences (as the contribution of the business to a newly incorporated company is a tax-neutral transaction).
In asset deals, the capital gain realised on the transfer of the business is taxable in the hands of the seller (normally at 24 per cent), and a proportional registration tax applies (at 0.5 per cent, 3 per cent or 9 per cent, depending on the nature of the assets). From the buyer's perspective, a full tax step-up is recognised on the business's assets (including intangibles and goodwill).
In the past, the Italian tax authority regularly challenged transactions structured as 'indirect share deals' for indirect tax purposes, and it would requalify the transactions as direct sales of businesses, and claim that a proportional registration tax applied as if the transaction were an asset deal.
The Italian tax authority also challenged these transactions for income tax purposes when they were made through a demerger and subsequent sale.
However, things have changed owing to recent amendments to Italian registration tax law and the GAAR. Indeed, the Italian tax authority recently stated that indirect share deals should now be considered legitimate transactions (unless the transferred company is merged into the transferee, in which case the proportional registration tax might still apply).
This position gives an opportunity to benefit from very tax-efficient structures when selling part of an Italian business ('Reverse Morris Trust' types of deals) – especially if the seller is a foreign person. Two structures can be envisaged.
The first could be implemented if the foreign shareholder is an EU company that benefits from the Parent-Subsidiary Directive. In this case, the Italian company may contribute the business unit to a newly incorporated Italian company and then sell its shareholding in the newly incorporated Italian company. A rollover regime applies to the contribution, and the sale should benefit from the PEX, with an overall direct tax burden of 1.2 per cent.12 Under the Parent-Subsidiary Directive, the subsequent distributions to the foreign shareholder are not subject to WHT in Italy.
The second could be implemented if the foreign shareholder is resident in a country that has a DTT with Italy, and the DTT envisages the exclusive taxation of capital gains in the seller's country of residence. In this case, the business unit may be transferred to a newly incorporated Italian company through a demerger. This structure is even more efficient than the previous one, as no Italian taxation is imposed: the demerger of the business benefits from a tax neutrality regime, and the subsequent sale of the shareholding is excluded from Italian taxation under the applicable DTT.
Foreign investors and acquisitions through equity and debt
Italian legislators recently amended the list of white-listed countries, which now includes several countries historically considered tax havens (e.g., Bermuda, the Cayman Islands, Hong Kong and Switzerland).
This amendment has a material impact on, among other things, the application of Italian WHT on interest paid on certain type of bonds. Indeed, it is now possible for entities located in certain countries historically considered tax havens to finance the acquisition of an Italian business in a very tax-efficient manner.
Specifically, the interest on certain qualifying bonds13 is eligible for a WHT exemption (in lieu of the ordinary 26 per cent WHT on interest) if the interest is paid on certain qualifying bonds to, inter alia, persons resident in a white-list country, or certain 'institutional investors', whether or not they are subject to tax, resident in white-listed countries.
In this respect, the acquisition of an Italian business could be carried out through an Italian SPV financed by means of (1) an equity injection from an EU company that benefits from the Parent-Subsidiary Directive, and (2) a qualifying bond issued by the Italian SPV and subscribed by qualifying investors resident in a white-listed country. In this case, dividends distributed to the EU company benefit from the WHT exemption under the Parent-Subsidiary Directive, and interest paid on the bond (which the Italian company could deduct under ordinary rules) is not be subject to WHT in Italy.
III INTERNATIONAL DEVELOPMENTS AND LOCAL RESPONSES
i Taxation of the digital economy: introduction of the digital services tax
Italy is one of the first EU Member States to implement the Commission's proposal of 21 March 2018 for an EU Directive on the introduction of a digital services tax (DST).
Indeed, a DST was introduced in Italy with the 2019 budget law and it should enter into force by July 2019. The relevant regulatory framework is not yet exhaustive, as the implementing provisions are still to be enacted.
The DST will apply to resident and non-resident companies that, either individually or as part of a group, meet both of the following conditions:
- their total amount of worldwide revenues for the relevant fiscal year exceeds €750 million; and
- their total amount of revenues for digital services provided in Italy that fall within the scope of the DST exceeds €5.5 million.
The DST will be levied at a 3 per cent rate on gross revenues – net of VAT and other indirect taxes – generated from the following services:
- advertising placed on a digital interface that targets users of that interface;
- making available to users a multi-sided digital interface that allows users to find other users and to interact with them, and also with the aim of facilitating the direct supply of goods or services; and
- the transmission of data collected about users and generated from the use of a digital interface.
The DST will not apply to intra-group services.
ii Tax treaties
Notable typical or model provisions
One of the key provisions included in most of the DTTs in force with Italy envisages the exclusive taxation of capital gains in the seller's country of residence. Under this rule, capital gains realised by a foreign investor upon the disposal of an interest in an Italian company are not subject to taxation in Italy.
Only under certain DTTs (e.g., with Canada, China, France, Hong Kong and India) may capital gains be subject to taxation in Italy, and this is only if certain conditions are met (e.g., if the value of the company whose shares are transferred mainly consists of real estate assets located in Italy).
In addition, DTTs generally envisage WHT reductions on the payment of dividends, interest and royalties, provided that – among other conditions – the recipient qualifies as the 'beneficial owner'.
It is well-known that 'beneficial owner' status is a very hot topic, including in international cases. With specific regard to Italy, the Italian Supreme Court has recently embraced an interesting position: that the beneficial ownership requirement should be assessed by also taking into account the nature of the foreign recipient's business. Consequently, the fact that holding companies – which typically have a 'light' organisational structure – lack employees or office space should not in itself be a decisive factor when assessing the 'beneficial ownership' status of similar entities.
Recent changes to and outlook for treaty network
Italy signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (MLI) on 7 June 2017.
Italy will provide its definitive MLI position only upon deposit of its instrument of ratification – in the meantime, it has chosen to apply Article 9(4) of the MLI. If Italy definitively confirms this choice, capital gains will be taxable in Italy if they are realised by a non-resident person upon the disposal of shares or comparable interests that, at any time during the 365 days preceding the disposal, derived more than 50 per cent of their value directly or indirectly from real estate assets located in Italy.
Article 9(4) of the MLI will affect DTTs in force with Italy only if the relevant contracting state also chooses to apply this provision (and if the relevant DTT qualifies as a 'covered tax agreement'). If this occurs, this provision will have a significant impact on foreign investors that hold interests in Italian real estate companies.
IV OUTLOOK AND CONCLUSIONS
As mentioned above, a general trend in the Italian tax system is to reduce uncertainty as to the interpretation of the law and the application of the Italian GAAR. It is therefore easier now to determine what tax planning is allowed and what is challengeable.
Another trend in the Italian tax system is to introduce tax incentives on qualifying investments and assets, the goal of which is to make the Italian system more attractive for businesses. This trend is clear, but the landscape is not entirely stable; indeed, Italian legislators have amended tax incentives from time to time.
1 Andrea Silvestri and Stefano Brunello are partners at BonelliErede.
2 i.e., joint-stock companies (S.p.A.), limited liability companies (S.r.l.), partnerships limited by shares (S.a.p.A.) and other forms of limited liability companies.
3 Higher rates apply for certain types of activities. In addition, each Italian region may decrease or increase these rates by up to 0.92 per cent.
4 Specifically, the Italian tax transparency regime applies to general partnerships (S.n.c.) and limited partnerships (S.a.s.), but not to partnerships limited by shares (S.a.p.A).
5 See p. 6 for a brief description of the tax consolidation regime provided under Italian tax law.
6 Capital gains realised upon the disposal of going concerns – and in most cases, upon the disposal of shareholdings – are not subject to IRAP.
7 Jurisdictions belonging to EU countries or EEA countries that allow an adequate exchange of information with Italy cannot be deemed to have a 'privileged tax regime', regardless of their income tax rate.
8 The EBITDA is based on items resulting from the profit and loss account of the company and is calculated as the difference between (1) value of production and (2) costs of production, excluding depreciation, amortisation and financial leasing instalments. The EBITDA must be calculated based on the tax (instead of accounting) value of the items of the profit and loss account.
9 This list is currently set out in the Ministerial Decree of 4 September 1996.
10 According to Italian tax authorities' position, proceeds distributed by REIFs qualify, in principle, as 'interest' for DTT purposes.
11 Transfers of shares in a company structured as a joint stock company are subject to a financial transaction tax (FTT) in the hands of the transferee. FTT is levied on the consideration paid and the standard rate is 0.2 per cent, which is reduced to 0.1 per cent for transactions carried out on regulated markets or multilateral trading facilities. FTT is not applicable on the transfer of participations in a company structured as a limited liability company (società a responsabilità limitata – S.r.l.). Specific exemptions from FTT apply, such as in case of shares transferred between entities that are part of the same group.
12 If possible, it is advisable to contribute the business unit to a company structured as a limited liability company (S.r.l.) – not a joint-stock company (S.p.A.) – to avoid the application of the FTT, which only applies on the transfer of shares of S.p.A.
13 Bonds and similar securities fall within the scope of this rule if they are: (1) issued by banks or joint-stock companies whose shares are traded on a regulated market or a multilateral trading facility in the EU or in an EEA country included in the white list; (2) traded in the same markets or multilateral trading facilities; or (3) held by 'qualified investors', as defined under Article 100 of Legislative Decree No. 58/1998.