The Inward Investment and International Taxation Review: Italy
Italy is a country with prominent historical roots, featuring a corporate tax system in line with base erosion and profit shifting (BEPS), Organisation for Economic Co-operation and Development (OECD) and European Union (EU) standards and practices, but with a complex law framework.
Despite the complexity of its tax system, over recent years Italy has been experiencing important developments in the relationship between the taxpayers and the Italian tax administration, on the path toward enhanced cooperation and transparency. Indeed, important preventive administrative measures have been introduced that aim to provide a higher degree of 'certainty' with respect to the correct interpretation and application of the tax provisions, also as regards new investments by non-residents. Moreover, notwithstanding the economic emergency caused by the outbreak of covid-19, Italy has preserved its tax incentives policy, which includes tax relief for Research & development (R&D) and intangible properties (IPs).
The above elements, together with the excellent Italian network of double taxation treaties make Italy an attractive platform jurisdiction.
Common forms of business organisation and their tax treatment
Italy offers a wide range of legal forms for setting up companies depending on organisational model, business objectives, level of capital to be committed, extent of the liability of the founders as well as tax and accounting implications.
Italy's corporate law primarily differentiates between companies and partnerships.
Among the most commonly used corporate forms are the joint-stock companies (SpA), limited liability companies (Srl) and partnerships limited by shares (SApA).
The SpA is typically used for carrying on medium-sized and large businesses because, inter alia, it requires a minimum share capital of €50,000 and its shares can be listed and traded on a regulated market under certain conditions.
The Srl requires a lower minimum capital (€10,000 or €1 for the simplified Srl) and is usually established for small to medium-sized businesses.
In the SApA, two different groups of shareholders coexist: limited shareholders, who are liable only up to the amount of their contribution; and unlimited shareholders, who are unlimitedly liable.
From a tax standpoint, corporate entities are autonomous taxable persons, unless they opt, under certain conditions, for a tax transparency regime for corporate income tax purposes.
In Italy, there are three main types of partnerships: the simple partnership (Ss), the general partnership (Snc) and the limited partnership (Sas).
Italian partnerships do not have legal personality, no minimum capital is required and the partners have unlimited liability (with the exception of the limited partners of an Sas).
From a tax perspective, partnerships are transparent and so their income is generally allocated for tax purposes to their partners.
In the private equity and real estate sectors, closed-end funds are frequently used. An Italian fund is a separate pool of assets managed and set up by a management company (SGR). Generally speaking, investment funds are (1) not taxed at the level of the investment vehicle (i.e., exempt from income taxes), while (2) a specific taxation is provided for at the level of the investors at the time of distribution. However, certain exceptions may apply, for instance, to investors in real estate investment funds.
Finally, Italy implemented the AIFM Directive (Directive 2011/61/EU) which allows to freely set up and manage alternative investment funds throughout the European Union using the 'EU marketing passport', without having a fixed place in the country of the establishment of the fund.
Direct taxation of businesses
i Tax on profits
Determination of taxable profit
Italian corporate income tax (IRES) applies to both resident and non-resident companies. Resident companies are taxed on their worldwide income but may elect to exempt income deriving from their foreign permanent establishments. Non-resident companies are subject to tax in Italy only with respect to their Italian-source income.
For resident companies, the taxable base is the aggregate worldwide income resulting from the profit and loss account adjusted according to the tax rules provided by the Italian Tax Code (ITC). However, exempt income and income subject to either a final withholding tax or a substitute tax do not concur to the taxable income.
Save for certain exceptions, profits are taxed on an accrual basis and business expenses are generally deductible in computing the taxable profits, to the extent that they are incurred for the production of income. Further tax adjustments are allowed for depreciations of tangible assets, amortisations of intangible assets and interest expenses.
Subject to specific anti-avoidance rules, resident companies may also benefit from an 'allowance for corporate equity' (ACE), introduced to promote capitalisation of Italian companies. ACE benefit entails a notional deduction from the corporate income tax basis, corresponding to the net increase in the 'new equity' injected into the relevant entity (meaning the equity increases generated after the fiscal year 2010), multiplied by a rate of 1.3 per cent for the fiscal year 2019 and thereafter.
If the turnover of a resident company (or of a permanent establishment of a non-resident company) owning fixed assets does not exceed a predetermined threshold (or it has recorded tax losses for five consecutive years), the company might be regarded as a shelf company and, in such a case, its taxable income is determined on a presumptive basis ('dummy companies').
Capital and income
Capital gains are generally included in the aggregate taxable income. However, in case of disposal of assets held for at least three years, the taxpayer may choose to spread them in equal instalments over that year and the following years, up to the fourth. Moreover, under the participation exemption regime and subject to the relevant conditions, 95 per cent of the gain realised by an Italian company on the disposal of shares is exempt from IRES.
Corporate taxpayers may carry forward tax losses to offset taxable income of subsequent years only up to 80 per cent of the taxable income of any given year, without any time limitation. Such an 80 per cent limitation does not apply to tax losses incurred in the first three years of business activity.
Specific anti-avoidance rules are provided to limit the carry-forward of tax losses in cases of (1) change of ownership or (2) extraordinary transactions (e.g., mergers and demergers). However, under certain conditions, the taxpayer may ask the Italian Tax Authority (ITA) to disapply such anti-avoidance measures by filing a ruling.
Tax losses cannot be carried back.
IRES is generally levied at the standard rate of 24 per cent, although a 3.5 per cent surtax is provided for certain entities operating in specific business sectors (including, for instance, financial intermediaries, except for asset management companies and brokerage companies).
Dummy companies are also subject to a 10.5 per cent surtax.
Italy has a self-assessment tax system: companies must electronically file their corporate income tax return within 11 months from the end of the relevant fiscal year. However, companies may file an amended corporate income tax return until the statute of limitations for the relevant fiscal year has expired.
Taxpayers have to pay corporate income taxes due through (1) two advance payments (usually based on a percentage of the tax paid for the previous tax year, save for the adoption of a forecast method) and (2) a final balance payment, to be ordinarily paid by the last day of the sixth month following the end of the relevant fiscal year.
ITA regularly issues official clarifications and rulings to provide the correct interpretation of tax uncertainties and new tax provisions. However, in case of doubt in the interpretation of a tax measure with respect to a specific case, a taxpayer may submit a preventive tax ruling to ITA to clarify its position.
Tax audits on corporate income tax are generally carried out by the Italian Revenue Agency and Italian Tax Police.
The taxpayer may appeal any tax-assessment before the competent tax courts. The tax litigation trial encompasses two degrees of judgment before a provincial tax court and a regional tax court, and a third degree before the Supreme Court, which rules only with respect to certain legal reasons. Different pre-litigation and settlement procedures are available, aimed at reaching an agreement with the tax authorities also by virtue of significant reductions in penalties.
Italian tax law provides for two different regimes of tax consolidation.
Domestic tax consolidation
Companies belonging to the same group can opt for the domestic tax consolidation regime, which allows the determination of a single IRES taxable base comprised of the taxable income and losses of each of the participating entities. Such consolidation regime does not operate for IRAP purposes.
To validly opt for the domestic tax consolidation regime, certain conditions (including a 'control' requirement) must be met.
The tax consolidation regime operates on an elective basis and, once opted, it cannot be revoked for three fiscal years.
Tax losses and interest expenses incurred before the exercise of the option for the group tax consolidation can only be used by the company that incurred those losses or interest expenses.
Italy also extended its domestic tax consolidation regime to groups of resident 'sister' companies that are all commonly controlled by a parent company with residence in a European Economic Area (EEA) country included in the white list and without any permanent establishment in Italy.
Worldwide tax consolidation
Under certain requirements, some resident companies may opt to apply a worldwide tax consolidation to their 'controlled' non-resident subsidiaries. The election for the worldwide tax consolidation regime follows an all-in/all-out principle: so, in case of election, all non-resident subsidiaries should be included in the worldwide tax consolidation. Once exercised, the regime is irrevocable for five years and is subject to three years' renewal, unless expressly revoked. Under such regime, the incomes of the non-resident subsidiaries, adjusted in accordance with the IRES provisions, are attributed to the parent company in proportion to its profits entitlement.
ii Other relevant taxes
Regional income tax (IRAP)
Companies are also generally liable for IRAP, which is levied on the net value of production derived in each Italian region. The taxable base determination criteria changes depending on the type of taxpayer and the activity carried out.
IRAP standard rate is 3.9 per cent, but regional authorities have the right to increase or decrease the IRAP rates within the limit of 0.92 per cent. Under some conditions, IRAP is partially deductible from the IRES tax base.
Value added tax (VAT)
Italian VAT is a consumption tax that applies to the supply of goods and services carried out in Italy by entrepreneurs, professionals, or artists and on importations of goods.
In Italy, the standard VAT rate is 22 per cent, but reduced rates of 4 or 10 per cent are applicable to certain supplies of goods and services. Moreover, certain supplies of goods and services are VAT-exempt.
On the basis of the 'territoriality' principle, only goods and services supplied within the territory of Italy are VAT relevant. As a general rule, (1) for goods, the place of supply is considered to be where the goods are located at the time of the supply, while (2) services are deemed to be supplied within Italy if they are provided to taxable persons established within Italy (B2B services) or if they are provided to final consumers (B2C services) by taxable persons established within Italy. Special rules apply to particular types of services (e.g., services related to real estate assets).
In general, the deduction of input VAT is allowed on goods and services purchased that are used for taxable transactions.
Under certain conditions, taxable persons established in Italy may opt for a VAT group regime, aimed at treating the electing entities as a single taxable person for VAT purposes. Under this regime, supplies of goods and services between members of the group are no longer relevant for VAT purposes.
The option for the VAT group regime is valid for three years and it is automatically renewed year by year until it is expressly revoked. The members of the VAT group are jointly and severally liable for VAT, penalties and interest deriving from assessment and control activities.
VAT financial consolidation
The VAT legislation also provides for a limited form of VAT consolidation that does not create a single taxable person, nor does it alter the requirements to charge VAT and issue VAT invoices for transactions carried out between the group members.
Subject to the relevant requirements, this measure allows the companies of the same group to consolidate their output and input VAT and pay the net result. Under this regime, the VAT periodical payments may be made by the controlling entity on a consolidated basis.
Registration tax, mortgage tax and cadastral tax
In Italy there is no capital duty, but the transfer or contribution of real property situated in Italy is subject to transfer taxes (i.e., registration, mortgage and cadastral taxes), VAT, or both, with the rate depending on the property transferred, the status of the transferor, and other factors.
In general, registration tax is due on deeds and agreements subject to mandatory registration in local public registers or voluntary filing in such registers. Depending on the nature and the form of the contract and on the assets that are the object of the contract, registration tax is levied as a fixed amount (€200) or as a percentage of the value of the goods and rights that are the object of the contract (ranging from 0.5 to 15 per cent). However, as a general rule, no proportional registration tax is due in the case of transactions subject to VAT.
In addition, depending on the nature of the transaction, mortgage and cadastral taxes are generally applied at a fixed amount or proportional rate (up to 4 per cent).
A stamp duty is generally levied yearly on certain documents, agreements and registers (for instance, bank cheques and statements of accounts, bills). The tax is normally a nominal lump sum, with some exceptional cases in which it is levied as a percentage of the nominal value stated in the document.
Tax residence and fiscal domicile
i Corporate residence
In Italy, a company is considered resident if its registered office (or legal seat), place of effective management or main business purpose, is in Italy for the greater part of the fiscal year.
A non-resident company is presumed to have its place of management in Italy if it controls a resident company (i.e., may exercise relevant influence) and either of the two following conditions are met: (1) the non-resident company is directly or indirectly controlled by a resident person; or (2) the non-resident company's board of directors is mainly composed of resident persons. Such a presumption can be rebutted by giving sufficient evidence to the contrary.
Furthermore, a non-resident company is presumed to be resident in Italy if (1) its assets are mainly composed of units of Italian closed-end real estate investment funds and (2) it is, directly or indirectly, controlled (subject to relevant influence) by a resident person. Also, in such a case, this presumption can be rebutted by providing evidence to the contrary.
ii Branch or permanent establishment
A foreign entity has a 'fixed permanent establishment' (PE) in Italy when it has (at its disposal) a fixed place of business in the national territory, through which the business activity is wholly or partly carried out. Moreover, a dependent agent permanent establishment (DAPE) of the foreign entity is deemed to exist when a person acts in Italy on behalf of the same, and in so doing, habitually concludes or is involved in the conclusion of contracts that are routinely approved by the foreign entity without material changes.
However certain activities carried out in Italy for the exclusive benefit of the foreign entity and falling under the 'negative-list' are not able to trigger the existence of a PE/DAPE, provided their 'preparatory or auxiliary' character with respect to the overall business activity.
Furthermore, Budget Law 2018 introduced a new definition of permanent establishment aimed at tackling hidden PEs of multinational enterprises carrying on their business mainly through digital means, without a physical connection with the Italian territory. However, considering the higher rank of double tax treaties (DTTs) over domestic provisions, the domestic definition is applicable (1) when there is no DTT stipulated between Italy and the country in which the foreign company is resident for tax purposes, or (2) when the domestic legislation is more favourable to the taxpayer compared to the applicable DTT.2
Generally speaking, a PE is subject to the same tax treatment as an Italian company for IRES purposes. With respect to the profit allocation to a permanent establishment, a separate entity approach in line with the Authorised OECD Approach (AOA) guidelines is generally adopted. In this respect, any double taxation is usually resolved through the credit method provided by either domestic or DTT provisions.
Profits derived from a foreign permanent establishment of an Italian company are taxed in the hands of the Italian head office, unless – under the relevant conditions – the company opts for the permanent establishment profits exemption regime. This option is irrevocable and is made based on the 'all-in/all-out' approach.
Tax incentives, special regimes and relief that may encourage inward investment
i Holding company regimes
In Italy, there is no specific holding company regime, although dividends and capital gains on the sale of a participation may benefit from a 95 per cent exemption for IRES purposes, resulting in an actual taxation of 1.2 per cent.
In more detail, dividends are exempt from IRES for 95 per cent of their amount regardless of any holding period or ownership percentage. On the contrary, dividends derived from a company resident in a low-tax jurisdiction (LTJ) are fully taxable, unless the following evidence is provided eventually by submitting a ruling to ITA:
- genuine establishment of the foreign company occurs, in which case an exemption from IRES of 50 per cent applies (together with a foreign tax credit, granted under certain circumstances and subject to certain limits); and
- no effect of obtaining low taxation of the income made by the foreign company is achieved, in which case a 95 per cent exemption from IRES applies.
The criteria to determine whether a foreign entity is deemed to be an LTJ entity are: (1) for controlled entities, an 'actual' taxation lower than 50 per cent of that applicable in Italy; and (2) for non-controlled entities, a nominal taxation lower than 50 per cent of that applicable in Italy.
Dividends are also considered to be 'derived' from an LTJ if they are distributed by a controlled non-LTJ that in turn has received dividends from the company located in a low-tax jurisdiction.
The participation exemption regime (PEX) on the sale of shares applies only if the following requirements are fulfilled:
- at the time of the sale, the share must have been uninterruptedly held at least from the beginning of the 12th month before the month it was sold;
- the participation must have been booked as a 'fixed financial asset' in the first financial statement closed after the acquisition;
- the subsidiary must be resident in a 'white listed' state or territory. Alternatively, it is necessary to give evidence through a specific ruling that the effect of the participation was not the localisation of income in LTJ; and
- the subsidiary must carry out a commercial activity. In this respect, specific rules apply with reference to certain shares of companies, which mainly consist of immovable assets.
Following the amendments introduced by the Italian law implementing the ATAD Directive:3
- the requirement referred to in point (c) must exist, at the time of the disposal, with no interruption since the beginning of the shareholding period. However, in case of the sale of shares held for more than five years and not belonging to the same group, it is sufficient that the condition is met continuously for the last five years preceding the date of disposal; and
- the requirement referred to in point (d) must be met at the time of the disposal, with no interruption, over the previous three years only.
Capital losses arising from the disposal of shareholdings meeting PEX conditions are not tax deductible for IRES purposes. Conversely, if the PEX requirements are not met, any capital gain (or capital loss), upon disposal of shares is ordinarily included in the seller's overall income and subject to income tax (without any partial exemption).
ii IP regimes
Persons earning business income and owning qualifying IPs may opt for the patent box regime. Non-resident persons are eligible for the patent box regime only if they are resident in a country that has a tax treaty in force with Italy and allows an effective exchange of information (provided that the qualifying IP is allocated to a permanent establishment in Italy).
The regime covers income derived from the exploitation of (1) patents; (2) trademarks; (3) processes, formulas, designs and models that can be legally protected; (4) copyrighted software; and (5) any other kind of know-how that can be legally protected. However, from 2017 trademarks are no longer eligible IPs, although a grandfathering rule has been provided for options already exercised. In this respect, the patent box regime for trademarks is available until 30 June 2021 and cannot be renewed.
The regime is available in case of self-exploitation of the eligible IP, but in this case the incentive must be alternatively determined: (1) through a ruling procedure; or, starting from 2019, (2) directly by the taxpayer in the tax return by preparing a preventive ad hoc documentation, providing, inter alia, the benefit calculation and the information required by the guidelines provided by the ITA (in this case, the patent box tax adjustment must be split in three yearly equal instalments).
The option for the patent box regime requires that the taxpayer owning the qualifying IP either (1) carries out R&D activities aimed at developing, maintaining or improving the qualifying IP itself or (2) outsources these activities to universities, research institutions (or equivalent entities) or unrelated companies.
Under the patent box regime, income deriving from (1) licensing of the IP to third parties and related parties (i.e., royalties), net of the direct and indirect costs related to the qualifying IP and (2) directly utilising the qualifying IP, is 50 per cent exempt from IRES and IRAP.
Subject to certain requirements (including a reinvestment commitment), the tax incentive at hand is available also in relation to the consideration received upon the sale of qualifying IP.
iii State aid
In the context of the covid-19 pandemic and to encourage share capital increases in small and medium-sized companies (with gross revenues between €5 million and €50 million in fiscal year 2019 and with a reduction of its revenues of at least 33 per cent in March and April 2020 with respect to the same months of 2019), a tax credit for the taxpayer making the capital contribution and a tax credit for the company receiving it have been provided.
These measures have to comply with the EU state aid rules and are therefore subject to the authorisation of the European Commission.
Tax credit for investments in new business assets
A tax credit is recognised upon the purchase of new eligible tangible assets until 31 December 2020 or 30 June 2021, provided that in the latter case the seller has already accepted the order by 31 December 2020 and, by the same date, advance payments equal to at least 20 per cent of the purchase price have already been made.
The amount of tax credit is generally equal to 6 per cent of the acquisition cost, up to the amount of €2 million. For certain new high-tech tangible assets, the tax credit is equal to (1) 40 per cent of the acquisition cost for investments up to €2.5 million and (2) 20 per cent of the acquisition cost for investments between €2.5 million and €10 million. For other certain (listed) intangible assets the tax credit is equal to 15 per cent of the acquisition cost up to €700,000.
According to the draft Budget Law 2021 (under discussion), the tax credit would be extended, with some amendments to investments made until 31 December 2022.
Research & development and innovation tax credit
For the fiscal year starting after 31 December 2019, a new R&D tax credit replacing the former one applied in previous fiscal years has been introduced.
The new tax credit is available, under certain requirements and certification obligations, for investments made in activities of (1) research and development, (2) technological innovation and (3) other innovative activities (e.g., design and aesthetic design).
More specifically, the following tax credits are available: (1) the R&D tax credit, which is equal to 12 per cent of the eligible expenses, up to €3 million; (2) the innovation technology tax credit, which is equal to 6–10 per cent of the eligible expenses, up to €1.5 million; (3) the design tax credit, which is equal to 6 per cent of the eligible expenses, up to €1.5 million.
According to the draft Budget Law 2021 (under discussion), the R&D tax credit could be extended until the fiscal year ongoing at 31 December 2022.
Withholding and taxation of non-local source income streams
i Withholding outward-bound payments (domestic law)
The following withholding taxes are applicable with respect to outbound payments stemming from resident companies.
Dividends ordinarily paid by Italian entities to non-Italian resident persons, without a permanent establishment in Italy, are generally subject to a final 26 per cent withholding tax with the following main exceptions:
- under certain circumstances (i.e., actual taxation of the dividend in the foreign country), a portion of the 26 per cent withholding tax may be claimed back (up to 11/26 of the amount); and
- dividend distributed to non-resident beneficiary entities shall be subject to a 1.2 per cent withholding tax if the beneficial owner is a company resident and subject to corporate income tax in another EEA country that allows an effective exchange of information with Italy.
Interest payments made by Italian resident companies to non-Italian resident persons are generally subject to a final 26 per cent withholding tax.
Royalty payments made by Italian resident companies to non-Italian resident companies are subject to a 30 per cent final withholding tax, generally levied on 75 per cent of the taxable amount, resulting in an effective rate of 22.5 per cent.
ii Domestic law exclusions or exemptions from withholding on outward-bound payments
To eliminate or mitigate the double taxation, the following exemptions or exclusions from withholding tax on outbound payments are provided.
According to domestic law implementing in Italy the Directive No. 2011/96/EU (Parent-Subsidiary Directive), an EU company is entitled – under some conditions -– to receive dividends paid by an Italian resident company without the application of any withholding tax. To benefit from such exemption regime, an EU parent company should:
- have one of the legal forms listed in the Annex to the Parent-Subsidiary Directive;
- be resident for tax purposes in an EU Member State;
- be subject, in its state of tax residence, to income tax equivalent to the Italian corporate income tax, without any possibility of benefiting from regimes of option or exemption that are not limited in time or place; and
- continuously hold – for at least 12 months – a direct shareholding in the subsidiary representing at least 10 per cent of the share capital of the subsidiary.
In addition, in line with EU Directive 2015/121, the domestic law provides for a specific anti-abuse rule (SAAR) expressly referring to the Italian general anti-abuse rule (GAAR).
According to the Italian law implementing the Directive 2003/49/EC (Interest and Royalties Directive), interests paid by an Italian resident company are exempted from any Italian withholding tax provided that the beneficial owner of the interests is a company of another EU Member State or a permanent establishment situated in another EU Member State of a company of an EU Member State.
The exemption applies on interest payments if:
- the entity making the payment and the beneficial owner of the payment are companies (or permanent establishments of companies) that fulfil the requirements set forth in Annexes A (legal form) and B (subject to tax) of the domestic law;
- the company that makes the payment and the company that benefits from the payment are 'associated' according to the Interest and Royalties Directive; and
- the above-mentioned interests must be held for an uninterrupted period of at least one year.
The request for the application of the exemption regime must be supported by (1) a certificate of the tax authorities of the beneficial owner's residence country and (2) an affidavit of the beneficial owner regarding the fulfilment of the legal form and subject-to-tax requirements.
A withholding tax exemption applies to interest payments and other income arising from medium or long-term loans (i.e., maturity longer than 18 months) granted to Italian companies by some qualified lenders.
No withholding tax is levied on interest paid to non-resident entities on bank accounts and deposits, as well as postal savings deposits. Moreover, under certain conditions, an exemption from withholding tax applies to interest on bonds and similar securities issued by the state, and by banks and listed companies, or issued by non-listed companies provided that the bonds are listed (upon their issuance) on an EU-regulated market or multilateral trading facilities.
Under the same rules and conditions described for interests, pursuant to the Italian law implementing the Interest and Royalties Directive, royalty payments made by an Italian resident company may be exempted from withholding tax.
iii Double tax treaties
The DTTs stipulated by Italy allow resident companies to also directly reduce the applicable withholding taxes, subject to certain procedural fulfilments.
DTTs entered into by Italy are generally formulated in accordance with the provisions set forth by the OECD Model Convention and, in most cases, provide for reduced dividend withholding tax, ranging between 5 and 15 per cent, while interest and royalties withholding tax rates are usually reduced to 10 per cent or less.
iv Taxation on receipt
Except for dividends coming from companies located in LTJ, under the dividend exemption regime, both Italian and foreign-sourced dividends are exempt from IRES for 95 per cent of their amount.
Subject to certain conditions and limitations, a foreign tax credit is normally available with regard to final withholding taxes applied abroad.
No imputation credit is ordinarily granted in respect of non-local underlying taxes paid at the level of subsidiary distributing profits.
Taxation of funding structures
Resident companies can be founded by means of a capital injection or of financing depending on the equity needs of the company and the will of the shareholders.
i Thin capitalisation
Italian tax legislation does not contemplate a specific rule limiting the amount of debt with regard to the equity contribution of the shareholder.
ii Deduction of finance costs
According to Article 96 ITC, interest and assimilated expenses (including interest capitalised on the cost of qualifying assets used to carry on a business) are fully deductible up to (1) the amount of interest income and assimilated revenues of the relevant fiscal year, and (2) the amount of interest income and assimilated revenues carried forward from previous fiscal years. In this respect, any excess of interest income is carried forward without any limitation.
Any surplus of interest expenses is deductible up to the limit of (1) 30 per cent of the company's earnings before interest, tax, depreciation and amortisation (EBITDA) and (2) the excess of 30 per cent of the company's EBITDA carried forward from previous fiscal years. In this respect, the exceeding EBITDA of a certain fiscal year may be carried forward for a maximum of five years.
In determining the above limitations, the accounting EBITDA of the company is adjusted according to Italian corporate income tax rules.
Non-deductible interest expenses (and assimilated expenses) can be deducted from the income of subsequent tax periods, if and to the extent that, during these tax periods, the amount of interest expenses and assimilated costs exceeding the interest income and assimilated revenues are less than 30 per cent of the available EBITDA.
Special rules are provided for entities within the tax consolidation regime.
The limitations on the carrying forward of tax losses in case of merger, or demerger, also apply to non-deductible interest expenses to be carried forward.
Financial intermediaries are not subject to this limitation, whereas insurance companies, parent companies of insurance groups, qualifying asset management companies and qualifying brokerage companies (SIM) can deduct interest expenses up to 96 per cent of their amount.
Moreover, under certain conditions, interest expenses on loans used to fund a long-term public infrastructure project are outside the scope of this limitation.
iii Restrictions on payments
In Italy, the resolution on the dividend payments is issued by the ordinary shareholders' meeting. Only profits actually earned and resulting from the duly approved financial statements can be distributed.
An amount equal to 5 per cent of the annual net profits of the company must be deducted from said profits to constitute a legal reserve, until it has reached one-fifth of the share capital; the legal reserve is not available for dividend payments.
The distribution of interim dividends is allowed only to companies whose financial statements are subject to mandatory audit, subject to certain fulfilments and limitations.
iv Return of capital
According to the Italian Civil Code, the repayment of equity capital must be resolved by an extraordinary shareholders' meeting and is subject to a specific procedure and relevant formalities.
From a tax perspective, the repayment of equity capital is in principle tax-neutral. However, a taxable income may arise if the amount distributed exceeds the tax value of the shareholding in the distributing company.
According to a special tax presumption, if both capital reserves and profit reserves are available, for tax purposes, profit reserves are deemed to be distributed first, regardless of the allocation made in the resolution adopted by the shareholders' meeting for civil law purposes.
Acquisition structures, restructuring and exit charges
In the majority of cases, the acquisition of Italian businesses is structured through the incorporation of an Italian special purpose vehicle (SPV). A purchaser using an Italian SPV to complete an acquisition needs to decide whether to fund such vehicle with debt, equity or a combination of the two financing methods. In this respect, a well-known scheme that allows such combination and that is especially adopted for the acquisition of a target company is the leveraged buyout (LBO) scheme.
Another commonly used structure to minimise the tax burden of the seller with particular regard to asset disposals is (1) the contribution of the business into a new company or into an existing one and (2) the subsequent sale of the shares received as a result of the contribution.
Indeed, while the contribution of a business in exchange for shares is, in principle, a tax neutral transaction for income tax purposes, from an indirect taxation standpoint it is only subject to a registration tax at the fixed amount of €200 and it is outside the scope of VAT.
Moreover, the capital gain arising from the subsequent sale of the shares received in exchange by the contributing company may benefit (subject to the relevant requirement) from the participation exemption regime, resulting in an effective taxation rate of 1.2 per cent.
Under Italian tax legislation, mergers and demergers are completely tax neutral for income tax purposes. Indeed, capital gains (or capital losses) arising as a consequence of a merger or demerger are not taxable (or tax deductible) in the hands of the merging or demerged company. Such tax neutrality generally also applies to the contributions of businesses in exchange for shares.
The Italian tax legislation also provides for the possibility to obtain tax recognition of the higher values of tangible and intangible assets recorded in the financial statements following a merger, a demerger or a business contribution, by paying a substitute tax according to different step-up regimes.
In cross-border mergers, tax-neutrality is generally achieved provided that the assets of the Italian-resident participating company are allocated to an Italian permanent establishment of the foreign combined entity.
Further, it is worth mentioning that, if certain requirements are met, a free tax step-up regime (up to €5 million) is provided for companies resulting from extraordinary transactions and business contributions taking place between 1 May 2019 and 31 December 2022.
Finally, according to a special regime, contributions of shares between Italian companies are tax-neutral to the extent that: (1) the shares received represent a controlling participation or will convert a previously owned non-controlling participation into a controlling participation; and (2) the book and the tax values of the participations received are equal to the book and the tax values of the participations contributed. Such tax neutrality regime has been recently extended also to contributions of shares representing a non-controlling participation where the following requirements are met: (1) the shares contributed represent a 'qualified participation'; and (2) the shares are transferred to existing or new companies wholly owned by the transferor.
As from 2019, a new exit tax regime was introduced. According to this new provision, the transfers of: (1) tax residence abroad; (2) assets on cross-border mergers and demergers; (3) assets from a resident company to a foreign exempt permanent establishment; and (4) assets from an Italian permanent establishment to the foreign headquarters or to other permanent establishments, are all generally deemed as taxable events.
As a result, any unrealised capital gains must be computed on the basis of the fair market value principle and taxed immediately. However, any one of such transfers is not considered a taxable event only to the extent that the assets related to the Italian business remain attributed to an Italian permanent establishment.
As an alternative to the immediate levy, Italian companies shifting their tax residence (or undergoing any of the above-mentioned cross-border reorganisations or transfers of assets) to other EU or EEA countries with which Italy has a full tax information exchange agreement in place may elect to spread the payment of the exit tax over five annual instalments.
Special rules govern the carry-forward of a taxable loss for offsetting the deemed capital gains arising at the time of the exit.
Anti-avoidance and other relevant legislation
i General anti-avoidance
Under the Italian GAAR, a transaction lacking economic substance carried out with the sole purpose of obtaining 'undue tax advantages' – despite the formal compliance with the tax rules – can be disregarded by the Italian tax authorities under the 'abuse of law' principle.
The Italian GAAR applies to all abusive practices, regardless of the area of tax law and the transactions involved. Indeed, such an anti-avoidance provision may be applicable with respect to both domestic provision and international rules affecting the Italian tax legislation.
In this respect, ITA clarified that such a GAAR can also be used to disregard the undue tax benefit deriving from the application of a DTT, and obtained by a taxpayer through non-genuine arrangements.
From a procedural standpoint, the onus of proof as to the abusive conduct of the taxpayer rests on the ITA, while the taxpayer must give evidence that the transaction is supported by an economic substance.
A taxpayer may consider requesting a preventive 'anti-abuse ruling' to obtain the ITA opinion on whether an investment scheme or transaction may be deemed as 'abusive' on the basis of the Italian GAAR.
ii Controlled foreign corporations
Under the Italian controlled foreign companies (CFC) regime, profits of a non-resident entity are attributed to an Italian resident where the latter directly or indirectly controls the non-resident entity and the non-resident is considered as a 'CFC entity'.
In this respect, an entity is considered a CFC entity if: (1) it is subject in its foreign jurisdiction to an effective taxation lower than 50 per cent of the effective taxation that would have been applied if it were resident in Italy, and (2) more than one-third of its income is passive or derived from 'low value added' intercompany transactions.
The income of a CFC entity is attributed to the Italian resident in proportion to its interest in the CFC, and the profits of the CFC are taxed in the hands of the Italian resident at its average tax rate (which cannot be lower than the ordinary IRES rate), regardless of whether the profits have been distributed or not. However, taxes definitively paid abroad may be credited against the Italian tax levied on the CFC income.
An Italian resident may prevent the application of the CFC regime by obtaining a ruling from ITA.
iii Transfer pricing
Article 110(7) ITC incorporates the arm's-length principle set forth by Article 9 of the OECD Model Tax Convention, providing that items of income arising from transactions with non-resident companies which directly or indirectly control the enterprise, are controlled by it or are controlled by the same company controlling the enterprise, are determined based on the conditions and prices that would have been agreed upon between independent parties operating on an arm's-length basis and in comparable circumstances.
The Ministerial Decree enacting the transfer pricing legislation, in setting out the general guidance for the proper application of the arm's-length principle, makes explicit reference to the OECD Guidelines and to BEPS Actions 8–10 as well. Moreover, the aforementioned Ministerial Decree has implemented in the Italian legislation the 'safe harbour' provided for the 'low value adding services' under Chapter VI of the OECD Guidelines 2017.
Transfer pricing documentation is not mandatory, but a taxpayer can obtain protection against penalties in the event of a transfer pricing adjustment by maintaining appropriate documentation and disclosing the existence of such documentation in the annual income tax return.
iv Tax clearances and rulings
There are currently various ruling procedures available to taxpayers; namely:
- interpretative ruling;
- regime admission ruling;
- anti-avoidance ruling;
- disapplication ruling; and
- new-investments tax ruling.
Under applicable rules, the competent ITA should issue its reply within 120 days from the date of receipt of the relevant request, except in the case of the interpretive ruling in relation to which a shorter deadline of 90 days is provided. In case of request of supplementary information by the competent ITA, the latter has 60 days from the receipt of the additional documentation and information to issue the reply.
The positive reply is binding for ITA with regard to the case submitted. In case the applicant taxpayer does not receive the tax ruling within the deadlines provided, the ITA is deemed to have agreed with the solution proposed by the applicant.
In addition to the above rulings, taxpayers can also establish a specific agreement procedure ('international tax ruling') between the taxpayer and ITA with reference to certain eligible matters including, inter alia, transfer pricing (APA), the application of tax treaties on dividends, interests, royalties and the assessment regarding the existence of a permanent establishment in Italy of a non-resident company.
Year in review
Further, because of the covid-19 pandemic, many supporting law decrees with related tax impacts have been enacted.
Outlook and conclusions
Since the outbreak of covid-19 in early 2020, the Italian government has issued many decrees with relevant tax impacts, especially in the short term.
However, we expect that – in line with OECD recommendations – Italy will continue to support investments, inter alia, through its tax policy to try boosting the Italian market and by promoting inbound investments.
In this respect, the draft Budget Law 2021 contains a special provision exempting from Italian withholding taxes the dividends received and the capital gains realised by EU investment funds. Such provision is intended to make the taxation of dividends and capital gains of EU investment funds equivalent to the tax treatment of Italian funds.
Such a measure, if confirmed, would certainly give greater legal certainty to EU funds investing in Italian portfolio companies and hopefully boost private equity foreign investments in the Italian market.