The Private Equity Review: Italy
I General overview
Italian fundraising figures have varied significantly in recent years. Commitments raised by independent fund managers amounted to €1.313 billion in 2016, reached a €6.239 billion peak in 2017, dropped to €3.415 billion in 2018, went further down to €1.566 billion in 2019 and then increased again to €2.072 billion in 2020.2 New commitments totalled €2.827 million in the first half of 2021, with a sharp increase of 194 per cent compared with the first half of 2020.3 Of the 2020 commitments, only 10 per cent was made by international investors, which fell to 5 per cent in the first half of 2021. If these figures are broken down by investor categories, important changes again emerge over time. Family offices and individual investors were the larger investors, accounting for an overall 27.9 per cent of the total commitments in 2020 (only 3.2 per cent in the first half of 2021). Insurance companies were the second largest investors with commitment amounting to 26.8 per cent in 2020 (reducing to 6.6 per cent in the first half of 2021). Pensions funds and other retirement schemes – which accounted for only 12.4 per cent of the market in 2020 – were the largest investors in the first half of 2021 with 34.7 per cent of the total commitments. There were 27 firms engaged in raising funds in 2020 (21 in the first half of 2021).
Private equity (PE) and venture capital funds raising money in 2020 and 2021 included Green Arrow Capital's 10th fund (energy and infrastructure – €140 million at first closing in 2020); Star IV Private Equity Fund (€140 million at final closing in 2020); Taste of Italy 2 (€330 million at final closing in 2020); Claris Biotech I (€30 million at first closing in 2020); FIEE II (€125 million at first closing in 2020); Primo Space (€58 million at first closing in 2020); Fondo Innovazione e Sviluppo (€370 million at first closing in 2020); FII Tech Growth (€123 million at first closing in 2020); Entangled Capital's first fund (€25 million at first closing in 2020); IGI Investimenti Sei (€170 million at final closing in 2020); Eureka! Fund I (€40 million at second closing in 2020); Sella Venture Partners' fund (€30 million at first closing in 2020); Sofinnova Telethon Fund (Luxembourg fund with a French AIFM investing exclusively in Italy – €108 million at final closing in 2020); Sinergia Venture Fund (€30 million at first closing in 2021); Neva First (€150 million at first closing in 2021); Charme IV (€500 million at first closing in 2021); Equiter Infrastructure II (€140 million at first closing in 2021); F2i's fifth fund (€900 million at first closing in 2021); Tages Helios II (€477 million at final closing in 2021); Clessidra Capital Partners 4 (€270 million at first closing in 2021); Itago IV (€61 million at first closing in 2020); and Anthilia Etf Economia Reale Italia (€20 million at first closing in 2021). With some exceptions reflecting the current market tendency towards larger commitments concentrated on fewer managers, fundraising periods are generally becoming longer. While public data is not available (and sponsors' statements about the launch of a fund sometimes do not consider the start date to be the time when fundraising efforts actually commenced), it is not uncommon for a fund to take more than a year to achieve the first closing. Fund terms proposed to investors may include a right of the manager to extend the maximum delay between first and final closing beyond the customary 12 months (generally up to an additional six months) subject to investor consent.
Apart from the perception of the country's political instability limiting the appetite of large international investors for local funds, other structural factors have traditionally influenced the Italian fundraising landscape, which has not caught up with the significant increase in global fundraising numbers in recent years. Allocations to private equity by Italian pension funds continue to represent a limited portion of their assets compared to pension funds in other Western countries. Also, pension funds are now more willing than in the past to diversify their PE commitments geographically, and this is reducing allocations to local funds. More generally, only some Italian managers have the size, track record and ability to raise funds in the international markets.
Notwithstanding the above, the private equity industry appears to have significant potential for further growth, given the size and dynamism of the Italian economy, the large number of small and medium-sized enterprises (SMEs) that need to optimise their funding sources (still dominated by the banking system) and capture opportunities for export growth, and the new generations of fund managers progressively changing the face of the industry. Tax incentives have been introduced in recent years to foster direct and indirect long-term investment in local SMEs by pension funds. While the effects of the covid-19 pandemic can be seen in the 2020 fundraising figures, the improved data for the first half of 2021 confirm a growing investor confidence in the ability of the local private equity industry to deliver interesting returns.
II Legal framework for fundraising
i Preferred jurisdictions and legal forms
Italian sponsors typically establish private equity funds as contractual structures governed by Italian law and managed by investment entities authorised and supervised by the Bank of Italy. Establishing funds under the law of another jurisdiction is infrequent for Italian sponsors. In some instances, funds were formed as English limited partnerships (before Brexit) considering their particular investor base or the management team's ability to implement an investment strategy covering multiple jurisdictions.
The transposition of the AIFMD into law did not significantly alter the regulatory framework that was applicable to private equity and other alternative funds beforehand. Collective portfolio management was already a regulated activity requiring prior authorisation, and the conditions to meet for the release of the authorisation were substantially similar to those applying under the AIFMD. This framework applied to both open-end harmonised funds under EU directives (UCITS) and other funds, including private equity funds (alternative investment funds (AIFs)). However, the definition of collective portfolio management was narrow before the implementation of the AIFMD as it only covered contractual funds and SICAVs, so non-UCITS funds could be established also as unregulated structures. Over time, this gave birth to a number of funds set up as corporate vehicles under ordinary company law.
Because the AIFMD applies to all AIF managers (AIFMs) irrespective of the legal nature of AIFs, this regulatory framework changed with the implementation of the AIFMD. AIFs may now be established in contractual or corporate form, both structures being regulated by law. Also, in implementing the AIFMD, Italy gold-plated its provisions regulating sub-threshold AIFMs by requiring all AIF managers to be authorised (with limited regulatory differences between full-scope and sub-threshold managers).4
The regulatory regime applicable to all AIFs requires the appointment of a depositary carrying out safekeeping and other functions in accordance with the AIFMD. Only Italian banks and investment firms (or local branches of EU banks and investment firms) can be authorised by the Bank of Italy to carry out depositary functions. An important distinction between AIFs is based on their permitted investors. If the governing rules of an AIF limit them to certain qualifying investors,5 the AIF (a reserved AIF) is subject to a more flexible regulatory regime. In particular: (1) commitments to a reserved AIF may be drawn down on an as-needed basis; (2) its constitutive documents are not subject to the prior approval of the Bank of Italy; and (3) the Bank of Italy provisions on limitation and diversification of risk concerning the generality of AIFs do not apply. The governing documents of a reserved AIF must contain provisions setting out, among other things, its investment restrictions, the maximum level of leverage the AIF can employ and the types and sources of permitted leverage.
In this environment, private equity funds6 are almost invariably set up as closed-end reserved AIFs of a contractual nature. While corporate structures (SICAFs) are also available as alternative legal vehicles, these structures are now subject to comparable regulatory requirements to contractual funds. Because their constitutive documents are more complex than those of contractual funds, corporate vehicles definitely lost appeal compared to the pre-AIFMD (unregulated) scenario. Funds covered by Regulation (EU) No. 345/2013 on European venture capital funds, as amended (the EuVECA Regulation) can be established in Italy as closed-end reserved AIFs taking contractual or corporate form subject to the above considerations.7 The managers of European venture capital (EuVECA) funds qualify as AIFMs. As such, they are subject to an authorisation requirement in the Italian regulatory system.8
Main legal and regulatory provisions
The following are the principal Italian laws and regulations applicable to reserved AIFs and their managers:
- Legislative Decree No. 58 of 24 February 1998, as amended, is the main piece of legislation regulating financial markets and intermediaries;
- Ministry of Economy and Finance Decree No. 30 of 5 March 2015 regulating the structure of AIFs and other general criteria to be met by them;
- Regulation of the Bank of Italy dated 19 January 2015, as amended, regulating the management of AIFs (including provisions governing the authorisation process and requirements applicable to managers, subsequent ongoing regulatory requirements, supervision and prudential requirements);
- Regulation of the Bank of Italy dated 5 December 2019, setting out the corporate governance and organisational requirements to be met by, among others, AIFMs;
- Regulation No. 20307 of 15 February 2018 of the Italian Securities and Exchange Commission (Consob), setting out rules of conduct applicable to certain intermediaries, including AIFMs, with a view to protecting investor interests; and
- Consob Regulation No. 11971 of 14 May 1999, as amended, regulating issuers of securities and including provisions concerning the marketing of fund interests.
A contractual fund is a pool of assets and liabilities created pursuant to a board decision of an authorised manager and segregated by operation of law from all other assets and liabilities of the manager (including those of other funds managed by it), the depositary and the investors. Under the legal segregation rules, the fund's assets are protected against possible claims and legal actions filed by the creditors of the manager, other funds managed by it, the depositary and the investors. The fund's creditors may only enforce their claims against the assets of the fund (i.e., not against those of the individual investors, or those of the manager, which is not liable for the fund's debts to third parties).
The governing rules of a fund and the subscription agreements signed by the investors (in a form prepared by the manager) are the fund's constitutive documents. The governing rules are approved by the manager when establishing the fund and are accepted by investors by signing their subscription agreements. By accepting the governing rules of a fund, an investor enters into a contractual relationship with the manager that is governed by Italian law. The governing rules of a reserved AIF do not require prior approval from the Bank of Italy; however, the rules must be delivered to the Bank after the AIF is established (reserved AIFs are regulated structures subject to the supervisory powers of the Bank of Italy). Managers can issue side letters to individual investors but any preferential treatment an investor obtains under a side letter or its subscription agreement must comply with fairness and disclosure principles provided for by the AIFMD. Also, side letters and subscription agreements may not contain terms conflicting with those of the fund's governing rules.
Contractual funds can be established and managed by Italian authorised managers (SGRs) or other full-scope EU AIFMs acting under AIFMD passport provisions.
SGRs are Italian companies authorised by the Bank of Italy to provide collective portfolio management services. An SGR qualifies as a sub-threshold manager if the volume of its total assets under management is below certain thresholds established by the AIFMD and it has not opted into the full scope of the AIFMD.9 Sub-threshold SGRs benefit from more relaxed regulatory requirements than full-scope SGRs concerning own funds, remuneration policy, control functions, valuation of assets, outsourcing of manager functions to third parties and some other matters. Unlike full-scope SGRs, sub-threshold managers cannot rely on the AIFMD passport provisions. A company wishing to obtain authorisation as an SGR to manage private equity funds must satisfy a number of conditions, including the following: (1) company limited by shares (legal form); (2) registered office and headquarters in Italy; (3) initial share capital of €500,000 (for full-scope SGRs) or €50,000 (for sub-threshold SGRs); (4) directors, general managers and statutory auditors meeting certain moral, independence, experience, skills, fairness and other requirements; (5) owners of qualifying holdings meeting certain moral, skills and fairness requirements; and (6) group structure not preventing a sound and prudent management and the effective exercise of supervisory functions by the Bank of Italy and Consob. If all applicable legal and regulatory requirements are complied with and the conditions for a sound and prudent management are met, the Bank of Italy will release the authorisation. An authorisation process may take five months or more to complete. Documents to be enclosed with the application include a description of the internal organisation and the main aspects of the proposed policies and procedures of the applicant as well as a regulatory business plan. SGRs are subject to ongoing regulatory requirements concerning the operation of their business, their own funds, reporting duties to the Bank of Italy and Consob, etc.
Italian funds managed by AIFMs of other EU jurisdictions acting under the AIFMD passport provisions represent a limited portion of the total market. However, the number of EU AIFMs establishing Italian funds is growing as a consequence of various factors including considerations related to the preferences of certain local institutional investors.
SICAFs were introduced in Italy as regulated entities with the implementation of the AIFMD. SICAFs can be formed as reserved AIFs and can be managed internally or by an external manager (an SGR or a full-scope EU AIFM). Unlike contractual funds, externally managed SICAFs cannot be formed unless their prospective founding shareholders obtain an authorisation from the Bank of Italy.10 Internally managed SICAFs have the double nature of AIFs and managers. An authorisation of the Bank of Italy is required for their formation. This authorisation covers only their internal management (internally managed SICAFs cannot manage other AIFs).
When the AIFMD was transposed into law, all then existing corporate vehicles carrying out private equity or venture capital investments and falling within the definition of AIF were faced with the alternatives of applying for an authorisation as SICAFs or being liquidated. Many of them opted to continue their investment business as SICAFs and applied for the authorisation. Only a few a limited number of SICAFs were formed thereafter (mostly in the real estate sector). Contractual funds are indeed simpler legal vehicles, and adopting the corporate form provides no particular tax or other advantage.
ii Key legal terms
Traditionally, the terms of Italian funds targeting only domestic investors are simpler than those seeking commitments from international investors, although the gap is slowly closing and standard fund terms in the private equity arena are becoming the norm also for purely domestic funds.
The Italian regulatory framework has some impact on the terms of private equity funds. Investors may not be granted the right to opt out of specific investments. Italian law indeed provides that investors should share pro rata (in accordance with the rights attached to their class of fund interests) in the income, gains and losses of all portfolio investments of a fund. This makes negotiation on investment restrictions less flexible than it would be with fund vehicles in other jurisdictions as all restrictions should be contained in the fund's governing rules (not in side letters). Annual and semi-annual valuations of portfolio investments and fund interests must be made in compliance with (conservative) criteria laid down by the Bank of Italy. However, common fund terms require managers to provide investors with quarterly reports including valuations made in accordance with the International Private Equity and Venture Capital Valuation (IPEV) Guidelines issued by the IPEV Board.
Distribution waterfalls almost invariably follow the European 'fund-as-a-whole' model with an 8 per cent hurdle rate and a 20 per cent carried interest (with a catch-up mechanism). The greater bargaining power acquired by investors in the past decade has resulted in tougher and more protracted negotiations putting certain traditional fund terms under pressure. Escrow and clawback provisions are more frequently negotiated to ensure effective protection against the risk of paying excess carry to the manager or members of its team. Given the small size of most local funds, average management fees continue to be 2 per cent of commitments during the investment period and 2 per cent of invested capital net of write-offs thereafter. However, rebates are frequently negotiated with investors making large commitments, particularly investors joining a fund at first closing. Extensions of a fund's investment period or term require the consent of a majority in interest of investors (less frequently of the advisory committee), and during such extensions investors normally expect to pay lower fees. The commitment a manager and its affiliates are typically requested to make to a fund is around 2 per cent of total commitments although individual arrangements may vary depending on a number of factors. No-fault remedies sought by investors often include, in addition to the removal of the manager, a right to trigger an early termination of the investment period or an early liquidation of the fund. However, these latter remedies tend to be pushed back by managers in exchange for other concessions. Key manager provisions attract much more attention than in the past. Triggers are generally becoming stricter and unresolved key manager events are often treated as cause for a removal of the manager (with limited exceptions depending on the nature of the event and with partially different economic implications). The definition of cause and the carve-outs in the exculpation and indemnification provisions have become other areas of more intense negotiation.
Side letters are commonly issued to address investor-specific needs or requests, including seats on the advisory committee, co-investment opportunities and particular information or assistance requirements. Most-favoured nation clauses are recurring provisions in side letters. As the governing rules of a fund prevail over conflicting terms contained in side letters, care should be taken in determining whether (or subject to what conditions) a particular matter can be dealt with through a side letter.
iii Key items for disclosure
Fund managers generally prepare a private placement memorandum (PPM) containing information in line with market practice for delivery to potential investors. A PPM typically includes information on the manager and its team, an overview of the relevant market, a description of the manager's investment strategy, deal flow, sourcing and investment process, the track record of the manager and senior team members, case studies from the manager's track record, a summary of key terms, a description of risk factors and a discussion of the main legal, regulatory and tax considerations affecting an investment in the fund. It is common practice for managers also to establish an electronic data room containing more detailed information on the manager and its investment transactions, legal documentation, updates and, frequently, responses to a standard due diligence questionnaire (DDQ) designed to streamline the due diligence process. PPMs and standard DDQs are very often prepared with the assistance of a placement agent.
Information contained in marketing documents must comply with the guidelines on marketing communications issued by ESMA under Regulation (EU) 2019/1156 (see Section III.iv). In addition, certain mandatory disclosures to potential investors are imposed by Italian and EU law. These include:
- pre-contractual information on the manager, its services, some of its policies, the nature of the fund interests and connected risks, all costs and associated charges to be borne by investors in connection with an investment in the fund and the classification of investors as professional or retail clients under the provisions implementing the Markets in Financial Instruments Directive (MiFID II);11
- an offering document concerning the fund containing the information set out in Article 23 of the AIFMD (the offering document); and
- if fund interests are offered to retail investors, a short-form document containing key information on the fund in the format prescribed by Regulations (EU) Nos. 1286/2014 and 2017/653 (key information document (KID)).12
Full-scope AIFMs must file the offering document under (b), above, with Consob and obtain a no-objection letter under the provisions implementing the AIFMD before fund interests can be marketed (see Section II.iv). If required, the KID is also to be submitted to Consob before marketing of fund interests (to retail investors) commences. The offering document and the KID must be kept separate from the PPM and other marketing documents.
For each managed fund, the manager must prepare and make available to investors the following documents in the format prescribed by applicable regulatory provisions:
- annual financial statements within six months of the end of any financial year (or of the shorter period in relation to which profits are distributed);
- semi-annual financial statements within two months of the end of any six-month calendar period; and
- a prospectus showing the value of the fund interests as at the end of any calendar semester.
Investments are valued in accordance with criteria set out by the Bank of Italy. The annual financial statements must be audited. Common fund terms generally impose shorter delivery terms for these documents and require managers to provide investors with quarterly reports prepared in accordance with the International Private Equity and Venture Capital Investor Reporting Guidelines issued by the IPEV Board, including a valuation of the portfolio at fair value.
Private equity funds are typically marketed by way of private placement, relying on the exemptions from prospectus requirements available under Italian law.13 Marketing is defined by law as any 'direct or indirect offering of units or shares of an AIF at the initiative or on behalf of its managing AIFM to investors domiciled or with a registered office in the Union'. No guidance as to what 'indirect' means in this definition is provided by regulatory authorities; however, it is sensible to assume that no 'offering' is made until the constitutive documents of a fund are in final form and a firm and binding commitment to the fund can be made by an investor. Reverse solicitation is not a legally defined term and no regulatory guidance on this concept is available. As a practical matter, a fund manager should not rely on reverse solicitation unless it has clear evidence that the initial contact with a potential investor in respect of a given fund was made at the initiative of the investor itself. Because offering fund interests in breach of the applicable regulatory provisions is a criminal offence, a manager should act cautiously when relying on reverse solicitation. These concepts must be now considered also in light of Regulation (EU) 2019/1156 and Directive 2019/1160 on cross-border distribution of funds, introducing the legal notion of 'pre-marketing' and including provisions affecting the ability of fund managers to rely on reverse solicitation (see Section III.iv).
A full-scope SGR must notify Consob of its intention to market a fund in Italy indicating whether the fund is also expected to be marketed to professional investors in other EU Member States under the AIFMD. The notification must enclose the governing documents of the fund, the offering document and other documentation as indicated in Annex III or IV of the AIFMD, as applicable. Marketing activities can commence after Consob, having verified that the documentation complies with the AIFMD and its implementing provisions, issues a no-objection letter. This process takes some 30 days to complete. Sub-threshold managers are not required to go through this process to market their funds in Italy but do not benefit from the AIFMD passport provisions. Managers of EuVECA funds may market their funds in all EU Member States to professional investors and retail investors that commit to investing a minimum of €100,000 under the provisions of the EuVECA Regulation, as amended.
When seeking commitments to a fund, the manager must provide potential investors with the prescribed pre-contractual information, the offering document and (if fund interests are also offered to retail investors) the KID (see Section II.iii). Before accepting subscription agreements, the manager must also comply with other requirements, including making appropriateness checks under the MiFID II provisions and carrying out customer due diligence procedures under anti-money laundering and counter-terrorist legislation. Special regulatory provisions apply when fund interests are offered to retail investors in Italy outside the principal or branch offices of the manager or of a licensed placement agent. These offerings must be carried out acting through licensed tied agents. Also, retail investors must be given the right to withdraw from their subscription agreements without paying any indemnity during a seven-day delay from the date of execution. Any breach of these provisions would make the agreements null and void.
Placement agents are frequently engaged by managers when marketing funds to non-Italian potential investors. Placement agents are instead rarely involved in a purely domestic fundraising.
Under the passport provisions implementing the AIFMD, full-scope EU AIFMs can market their EU AIFs to Italian professional investors and retail investors making a commitment to the fund of €500,000 or more.
When transposing the AIFMD into law Italy cancelled its national private placement regime, which was then permitting the marketing of non-Italian AIFs by non-Italian AIFMs to Italian investors subject to an authorisation of the Bank of Italy. As a result, AIFs managed by non-EU AIFMs and non-EU AIFs managed by EU AIFMs may not be currently marketed to Italian investors. This marketing will be permitted when the third-country passport provisions of the AIFMD take effect with the adoption of the relevant delegated acts by the EU Commission (or in the context of the AIFMD review).
v Fiduciary duties
Italian AIFMs (SGRs and internally managed SICAFs) are required by law to act diligently, correctly and in a transparent manner in the best interests of the AIFs they manage, their investors and the integrity of the market. They must also: (1) be organised in a manner that minimises the risk of conflicts of interest and, in the event of a conflict, to ensure the AIFs they manage receive fair treatment; (2) adopt appropriate measures to safeguard the rights of the investors in the AIFs they manage and have adequate resources and adopt appropriate procedures to ensure efficient performance of their services; (3) in the case of reserved AIFs, give preferential treatment to individual investors or categories of investors only in accordance with the AIFMD; and (4) exercise the voting rights attached to financial instruments held by the AIFs they manage in the investors' interest.
III Regulatory developments
The Bank of Italy is empowered to issue regulations determining the activities that may be carried out by Italian managers and establishing their legal duties and requirements within the framework of primary legislation applicable to them. Matters covered by Bank of Italy regulation include minimum capital, own funds, risk management, permitted holdings, corporate governance and organisational requirements (including control functions), outsourcing of key functions and services, remuneration and incentive systems and safekeeping of assets. Also, AIFs are subject to the regulatory powers of the Bank of Italy that cover matters such as investment diversification, limitation of risk, format of financial statements, valuation of assets and conditions to satisfy when valuation functions are delegated to an outsourcer. The Bank of Italy authorises Italian entities to carry out collective portfolio management services and keeps the roll where they are registered.
Consob is empowered to issue regulations concerning the duties of transparency and fair business conduct of fund managers in the provision of collective portfolio management services. No objection letters permitting Italian managers to market their AIFs under the provisions implementing the AIFMD are released by Consob. Other regulatory powers of Consob cover matters including inducements, conflicts of interest, personal transactions, complaints handling and knowledge and competence of personnel.
Within their respective remits, the Bank of Italy and Consob have regulatory oversight for Italian managers and AIFs.
Authorisation requirements applicable respectively to SGRs and internally managed SICAFs are dealt with in Section II.i in relation to contractual funds and SICAFs. The establishment of reserved AIFs of a contractual nature is not subject to authorisation, registration or any similar requirement; however, their governing rules must be delivered to the Bank of Italy as a reporting requirement. The authorisation requirement applicable to externally managed SICAFs is dealt with in Section II.i in relation to SICAFs.
Tax exemption at fund level
Italian tax rules consider all AIFs opaque (i.e., non-transparent) entities, regardless of their legal form (i.e., both contractual funds and SICAFs), and treat them as separate taxable persons for Italian purposes. To avoid double taxation, AIFs are fully exempt from income taxes in respect of profits and gains realised in respect of their investments. An exemption applies also in respect of other direct taxes, such as the regional tax on productive activities, although funds established in corporate form (i.e., SICAFs) remain subject to the regional tax on certain management and subscription fees.
No tax ruling is required for this tax regime to apply. Any AIF established in compliance with Italian laws, regardless of whether it is managed in Italy or elsewhere, is considered tax-exempt and is treated as resident in Italy for domestic purposes (as such, it could in theory also avail itself of tax treaties signed by Italy).
The Italian tax authorities have confirmed that, after the implementation in Italy of the AIFMD, AIFs should be subject only to the tax laws of the jurisdiction in which they are established and that, accordingly, the fact that a non-Italian AIF could be managed by an Italian SGR does not trigger per se the application of Italian tax rules on the AIF itself or on its investors.
Non-Italian AIFs are in principle subject to taxation in Italy only in respect of income and gains from Italian sources; accordingly, revenue streams arising from investments in Italy could in principle be subject to Italian income taxes. However, the 2021 Italian Budget Law has introduced a specific tax exemption in respect of Italian-sourced dividends and capital gains derived by AIFs set up under the laws of a EU Member State (or of a EEA country allowing for an adequate exchange of information with Italy) and managed by EU AIFMs subject to regulatory supervision pursuant to the AIFMD.14
Taxation of investors
While AIFs are exempt, income taxes in principle apply at the level of their investors. Italian tax rules characterise as 'income from capital' all profits and gains derived from the investment in AIFs. Such income is subject to a withholding tax, which is levied at the standard rate of 26 per cent (although lower rates or exemptions apply in respect of certain investors) in the following cases: distributions, sale or redemption of the fund units or shares, and liquidation of the fund. The taxable base includes all proceeds effectively distributed to the investors, as well as the balance between the value of the units or shares upon sale or redemption or liquidation of the fund and the subscription or purchase value of the same units or shares. The withholding tax is provisional or final, depending on the nature of the investor. In general, with some exceptions, it is a final levy for all resident investors not acting in a business capacity and for non-resident investors.
Full exemption from withholding tax is available for various categories of investors, including (1) certain eligible non-resident investors, (2) Italian private individuals investing – up to €1.5 million and with a minimum holding period of five years – in AIFs that comply with the rules on 'alternative individual saving plans' (Alternative PIRs) and (3) certain qualifying Italian pension funds investing – up to 10 per cent of their total assets and with a minimum holding period of five years – in AIFs that are either compliant with the Alternative PIR Rules or that invest primarily (i.e., more than 50 per cent) in equity instruments issued by business entities resident for tax purposes in Italy (or by EU/EEA business entities with a permanent establishment in Italy).15
In particular, the following eligible non-resident investors satisfying specific procedural requirements are entitled to a full exemption from the domestic withholding tax:
- certain international entities established in accordance with international treaties;
- central banks or similar entities;
- investors resident for tax purposes in a whitelisted country (i.e., a jurisdiction that is recognised by a special regulation as having in place with Italy an effective exchange of information for tax purposes); and
- institutional investors established in a whitelisted country (this definition includes entities whose activity consists of investing or managing investments, for their own benefit or on behalf of third parties, regardless of their legal status or tax treatment in the country of establishment).
As a result of the recent international trend of enhanced cooperation between tax authorities, the great majority of foreign jurisdictions have now been included in the Italian whitelist (originally approved by Ministerial Decree of 4 September 1996), which now comprises 134 countries. In practical terms, most foreign investors are nowadays allowed to rely on the exemption on proceeds of the Italian AIFs in which they invest.
As concerns the Alternative PIR Rules, which allow resident private individuals (including, in principle, members of the management team) and certain domestic pension funds to benefit from a full exemption from the Italian withholding tax, an AIF (whether set up in Italy or in another EU jurisdiction) is compliant if its investment policy provides, among other requirements, that at least 70 per cent of the fund commitments be invested – with a diversification limit of 20 per cent (or less) per each investment – in financial instruments (equity or debt) issued by, or loans to, or receivables in relation to Italian resident business entities (or EU/EEA business entities with a permanent establishment in Italy) that are not listed in an exchange market, or, if listed, that are neither included in the FTSE MIB nor in the FTSE Mid Cap indexes of the Italian Stock Exchange, Borsa Italiana (or in equivalent indexes of other regulated markets).
VAT and other indirect taxes
Fees charged for management of AIFs and certain related services are exempt from VAT, while fees due for custodian and controlling activities are subject to the standard VAT rate (currently 22 per cent).16
VAT rules in principle apply also to transactions carried out by a SICAF or by an SGR on behalf of contractual funds under management. The investment activities of private equity funds, however, generally fall within the scope of the VAT exemption for financial services (this also entails that input VAT paid in respect of certain services received is not recoverable).
Neither the set-up of AIFs, nor the subscription or sale of their units are subject to any proportional ad valorem registration taxes or similar duties.
An annual stamp duty, at the proportional 0.2 per cent rate, may apply to the net asset value of AIFs units or shares, as resulting from their financial statements. This is, in practice, a wealth tax, which applies to all financial investments of certain investors and which is levied by the financial intermediaries involved with holding such investments. For investors other than individuals, this stamp duty is in any case capped at €14,000 per year (although many investors are de facto fully exempt because they do not fall within the subjective scope of application of the stamp duty).
Until 2016, there were neither statutory rules nor revenue guidelines specifically dealing with the Italian taxation of carried interest schemes of private equity funds. Careful planning was therefore required to efficiently structure the carried interest for managers of Italian AIFs, having regard to general income tax rules and principles that provided only limited guidance to distinguish between employment-related income (taxable at marginal progressive income tax rates, up to 43 per cent plus surcharges) and investment income (subject to a flat rate of taxation at 26 per cent).
Typically, Italian fund structures set up in past years required an actual financial investment (in most cases ranging between 1 per cent and 3 per cent of the total commitments raised) to be made by the managers in special classes of units or shares of the AIFs that give right to special distributions representing the carried interest entitlement.
In general, the proceeds received by the managers from their investment in these special classes of units of the AIFs were (and still are, subject to certain conditions) characterised as investment income and taxed accordingly. However, the notion of employment-related income laid down by Italian tax rules is very broad, so that the distinction is not always clear-cut and there remains a grey area, where possible concerns could easily arise.
Also as a response to the requests of the private equity fund industry, in April 2017 the government approved a law decree containing special tax rules for the characterisation and taxation of carried interest, which were subsequently confirmed by the Italian parliament. According to the new provisions (which de facto operate as 'safe harbour rules', as clarified also by the Italian tax authorities) income from direct or indirect participation in companies, entities or investment funds (including AIFs) established in Italy, or in a jurisdiction allowing an adequate exchange of information, arising from shares or other similar financial instruments granting enhanced economic rights (i.e., the carried interest shares or units), will be deemed, by operation of law, as investment income subject to a flat rate of taxation at 26 per cent.
This safe harbour regime applies, as far as AIFs are concerned, provided that all the following conditions are met:
- the carried interest holders collectively invest in the AIF (directly or indirectly) an amount of at least 1 per cent of the total commitments (including also investments in ordinary shares or units);
- the carried interest distributions are subordinated (i.e., they become due only when all the other investors have received a return equal to the invested capital plus hurdle); and
- the special shares or units to which carried interest distributions are attached are held for at least five years.
If one or more of the above conditions cannot be met, the carried interest could still be considered as investment income, subject to a case-by-case analysis and to careful planning and scrutiny. In this respect, the Italian tax authorities have already issued interpretative guidelines (addressing cases where one or more conditions set by the new rules are not satisfied) and have confirmed that they are willing to analyse and provide their view on specific situations if a ruling application is submitted to them.
Special tax incentives available to managers (individuals) relocating to Italy
Managers of private equity funds who plan to relocate to Italy, either for personal reasons or in the context of the establishment of an Italian office of the firm for which they work, can benefit from various tax advantages, which have been extended and made much more appealing, starting from 2017.
The first set of rules that could be of interest for such managers (especially for those moving to Italy to perform a working activity within the country) are those for inpatriate workers. In a nutshell, these rules, as recently modified, starting from fiscal year 2019 for workers who have already moved their fiscal residence in Italy as at 30 April 2019, and who meet the conditions for benefiting from this regime, grant a 70 per cent exemption from personal income taxes, for up to five years (which could be extended for an additional five years if certain conditions are met)17 to qualifying new residents in respect of income that they earn from employment or from self-employment activities performed in Italy.18
Other very favourable tax incentives are provided by the new 'flat-tax regime', which allows individuals wishing to move their tax residence to Italy to pay an annual flat tax rate of €100,000 in respect of income and gains of any nature (with very limited exceptions) arising from foreign sources (i.e., produced outside Italy);19 in practical terms, only income and gains from Italian sources, if any, remain subject to ordinary income taxes.20 This regime is therefore very appealing to persons who do not have significant business interests in Italy, or whose working activity or source of income is predominantly based outside Italy; as a matter of fact, a few managers of non-Italian private equity firms have already moved their personal residence to Italy to take advantage of the flat-tax regime, which is available to any individual who has not been fiscally resident in Italy for at least nine of the previous 10 fiscal years. The option of this special regime can be taken year after year, for a maximum of 15 years. A ruling can be obtained by managers interested in assessing whether the flat-tax regime can be applied to them and the specific effects of the regime in respect of their personal situation (e.g., as concerns carried interest structures set up prior to their possible relocation to Italy).
iv Key changes to the regulatory regime
Recent key changes to the regulatory regime of Italian private equity and venture capital managers and funds are mostly driven by EU legislation and include provisions on sustainable finance and cross-border distribution of funds.
After the entry into force of Regulation (EU) 2019/2088 on sustainability-related disclosures in the financial services sector (the Disclosure Regulation) and Regulation (EU) 2020/852 on the establishment of a framework to facilitate sustainable investment (the Taxonomy Regulation), the main developments occurred in 2021 in the area of sustainable finance are as follows:
- despite a delay in the development of the Regulatory Technical Standards (RTS) laying down detailed provisions required for the full application of the Disclosure Regulation, the 10 March 2021 deadline for the initial disclosures imposed by such Regulation was confirmed;
- draft RTS to be issued under the Disclosure Regulation were published by the three European Supervisory Authorities in February and October 2021, and it was subsequently announced that the final RTS – yet to be approved by the EU Commission – will become applicable from 1 January 2023;
- the first Delegated Act under the Taxonomy Regulation, introducing technical screening criteria affecting the climate change mitigation and the climate change adaptation objectives of such Regulation, was approved by the EU Commission in June 2021 and became applicable on 1 January 2022; and
- Commission Delegated Regulation (EU) 2021/1255, requiring AIFMs to take account of sustainability considerations when complying with various provisions of the AIFMD (due diligence, risk management, conflicts of interest, etc.), was published in August 2021 and will become applicable on 1 August 2022.
The principal impacts of these sustainability-related developments on the Italian private equity and venture capital industry will be discussed below (see Section IV).
As part of the Capital Market Union action plan, Regulation (EU) 2019/1156 and Directive 2019/1160 introduced new rules relating to the cross-border marketing and distribution of funds within the EU (the CBDF Rules). While Regulation (EU) 2019/1156 became applicable in all EU jurisdictions on 2 August 2021, Directive 2019/1160 was transposed into Italian law by Legislative Decree 191/2021 which entered into force on 15 December 2021.21 The CBDF Rules introduced a new harmonised regime for 'pre-marketing' of funds within the EU, also with a view to ensuring that the conditions under which the AIFMD passport can be used for 'marketing' activities are applied consistently in all EU jurisdictions.22 The new notion of 'pre-marketing' focus on information being shared with potential professional investors to test their possible interest in a given AIF (whether already established or not).23 It does not include situations where the information presented to potential professional investors (1) is sufficient to allow them to commit to acquiring units or shares of a particular AIF, (2) amounts to subscription forms or similar documents whether in a draft or a final form, or (3) amounts to constitutional documents, a prospectus or offering documents of a not-yet-established AIF in a final form.24
Consob must be notified of pre-marketing activities within two weeks of their commencement by an Italian AIFM, with an indication of the EU Member States where such activities have been or will be carried out. Consob is required, in turn, to transmit a corresponding information to the competent authorities of the EU Member States concerned. An important legal consequence of pre-marketing is that reverse solicitation will not be permitted for a period of 18 months from the starting date of the relevant activities by an AIFM. Indeed, the CBDF Rules provide that any commitment to units or shares of an AIF made by a professional investor during this 18-month term will be considered to be the result of marketing (and will therefore be subject to the applicable marketing notification procedures under the AIFMD rules).
The CBDF Rules also provide that marketing communications addressed to investors are identifiable as such and describe the risks and rewards of purchasing units or shares of an AIF in an equally prominent manner, and that all information included therein is fair, clear and not misleading. In accordance with the CBDF Rules, ESMA issued guidelines implementing the above principles on marketing communications which became applicable from 2 February 2022.
The Italian private equity industry overcame the acute phase of the covid-19 pandemic without significant repercussions and, despite the persistence of an underlying weakness in the ability to raise foreign capital, is continuing its process of strengthening and diversifying its product offering, also supported by the growth in investment volumes of domestic institutional investors. Other elements characterising this favourable phase include the entry into the market of numerous first time funds, the growth in number of sectoral funds, with teams that have been able to replicate the first positive experiences by raising larger funds in a variety of sectors (in particular, food, fashion and energy, but also other sectors such as aerospace and defence), the continued strengthening of the venture capital and technology transfer strategies, with the creation of a more segmented offer by product type, the development of more flexible and efficient forms of collaboration between multi-product fund managers and operators specialised in individual investment areas, with regard to fund governance models (consistent with the Bank of Italy's supervisory guidelines), as well as medium-sized and large corporations promoting and sponsoring initiatives in the sector. As mentioned above, Italian institutional investors look more prone to increasing their exposure to private equity in this phase as they have equipped themselves, over time, with more articulated and robust investment structures.
In this context, two medium- to long-term trends deserve attention. In terms of sustainability policies, Italian asset managers have tended to be substantially reactive to market pressures for a long time, with only a few exceptions, and this has led them to adopt ESG policies in line with the demands of their investors, without however feeling the need to link value creation strategies and sustainability according to individual paths that would distinguish them on the market. This passive approach is starting to change also as a result of the attention that the industry is paying to the complex regulatory framework on sustainability that is being developed in the EU. An initial boost came from the disclosures that asset managers had to make in March 2021 under the Disclosure Regulation (see Section III.iv). One element managers were faced with was the choice between the 'comply' or 'explain' options imposed by Article 4 of the Disclosure Regulation (consideration of principal adverse impacts of investment decisions on sustainability factors). When making their first disclosures under this provision, the vast majority of managers opted for the conservative solution ('explain'), also in consideration of the absence of the final text of the RTS and of the existence of some interpretative doubts. In particular, many feared that the 'comply' option – once reflected in the offering documents of their funds – could in some way influence their characterisation, bringing them under the scope of Article 8 of the Disclosure Regulation (funds promoting environmental or social characteristics) and thus imposing additional administrative burdens (for the specific disclosures associated with such funds). Ironically, in the second half of 2021 and the beginning of 2022, there was a marked and in some ways unexpected change of perspective with respect to this type of fund. Many private equity funds are now being structured and promoted as being compliant with Article 8 of the Disclosure Regulation, not only by emerging teams or by managers of specialist funds, but also by established managers for their flagship funds. Although this phenomenon is partly induced by the allocations that several institutional investors have reserved for funds in this category, there is no doubt that it is accompanied by an increase in awareness on the part of managers and their greater ability to structure sustainability models than in the past. It is foreseeable that the search for a greater characterisation of funds with reference to sustainability standards is destined to deepen and consolidate in the years to come.
A second important trend (not limited to the Italian industry) relates to the growing interest of retail investors in private equity and, more generally, the world of illiquid investments. Tax incentives are also playing an important role in this context, in particular the exemption from Italian income tax (as well as from inheritance tax) granted to private individuals who invest in AIFs (including both direct funds and funds of funds) compliant with the Alternative PIR Rules (described above). In Italy, the instruments through which retail investors can gain exposure to private equity are affected by regulatory limits on access to reserved AIFs, which can currently only be accessed by professional investors, directors and employees of the AIFM and retail investors who make a commitment to the AIF of €500,000 or more (see footnote 5). Alternative solutions, such as EuVECA funds, non-reserved AIFs or ELTIFs, may also be considered for structuring private equity funds and offering them to retail investors without the €500,000 minimum subscription requirement, but each of these different vehicles has investment policy limitations or structural complexities or other drawbacks that undermine their potential for use and diffusion (at least with respect to retail investor categories that in other jurisdictions qualify as semi-professional). The minimum subscription threshold for retail investors in reserved AIFs is under review and is expected to be reduced to €100,000 in the first half of 2022. According to available anticipation, however, retail investors who wish to take advantage of the reduced threshold to subscribe for a reserved AIF will only be able to do so if they benefit from MiFID II advisory services provided by the AIFM itself, a bank or an investment company. These entities will then be required to conduct investment suitability assessments in accordance with MiFID II, taking into account the composition of the retail investor's financial portfolio as well as its return objectives and investment horizon.
1 Enzo Schiavello and Marco Graziani are partners at Legance – Avvocati Associati.
2 The figures in this chapter (other than those relating to individual funds) are published by AIFI, the Italian Private Equity, Venture Capital and Private Debt Association.
3 The figures for the second half of 2021 were not available at the time of writing.
4 Under the AIFMD, a light registration regime applies to sub-threshold AIFMs but national authorities may impose stricter rules.
5 These include (1) professional investors under the AIFMD, (2) entities and individuals making a commitment of €500,000 or more to the AIF, and (3) directors and employees of the AIFM. It should be noted that these categories of permitted investors in reserved AIFs may de facto be further restricted under the provisions on product governance implementing MiFID II (Directive 2014/65/EU as supplemented by Commission Delegated Directives (EU) 2017/565 and 2017/593). Indeed, in accordance with the ESMA Guidelines on MiFID II product governance requirements of 2 June 2017, fund managers must identify the target market and define the distribution strategy for each fund they plan to establish and market by using five cumulative criteria: (1) the type of client (according to the client categorisation as 'retail client', 'professional client' or 'eligible counterparty', as applicable); (2) the client's knowledge and experience; (3) the client's financial situation and ability to bear losses; (4) the risk tolerance and compatibility of the risk or reward profile of the fund with the target market; and (5) the client's objectives and needs.
6 Private equity funds may not be established as open-end vehicles under Italian regulatory provisions.
7 Regulation (EU) 2017/1991 amending Regulation (EU) No. 345/2013.
8 Sub-threshold managers of EuVECA funds must be registered in a special roll kept by the Bank of Italy. To obtain this registration, the managers must satisfy conditions mirroring those applicable to sub-threshold AIFMs requesting an authorisation.
9 €500 million if the assets are acquired without the use of leverage at fund level and the investors have no redemption rights exercisable during a period of five years following the date of initial investment in each AIF. €100 million in all other cases.
10 Indeed, these SICAFs can retain a number of functions that, in the event of a contractual fund, fall within the responsibilities of an authorised manager (including marketing of shares and valuation of assets).
11 See footnote 5.
12 Qualifying investors in reserved AIFs include retail investors committing €500,000 or more to the AIF.
13 These exemptions include offerings made to certain qualifying financial intermediaries established by Consob or to a number of potential investors (excluding the intermediaries) not exceeding 150 or to parties investing €100,000 or more.
14 For the purposes of the said exemption, Italian tax authorities have clarified that it is necessary that the AIF meets the aforementioned regulatory requirements, while there is no requirement regarding the legal form and tax status of the same AIF in the country in which it is established (and, therefore, it is not relevant that the AIF be tax transparent in the country in which the same has been set up).
15 A full exemption also applies, in principle, to all investors holding units of Italian (or EU or whitelisted EEA) eligible venture capital funds that invest at least 85 per cent in certain qualifying Italian SMEs (in one of the following phases: seed financing, start-up financing, early stage financing, expansion or scale-up financing), provided that a number of other statutory conditions are satisfied. Since traditionally these conditions have been difficult to be met, fund managers interested in establishing a tax incentivised fund currently prefer to structure the AIF in compliance with the Alternative PIR Rules.
16 Based on certain recent clarifications issued by Italian tax authorities, the exemption from VAT referred to management of AIFs and certain related services would apply only after the asset manager has received the regulatory authorisation to operate as such.
17 This extension is possible to the extent that the inpatriate worker: (1) has at least one child under the age of 18 or who is not economically independent; or (2) has acquired a residential property in Italy, after the relocation, or in the previous 12 months. During the additional five fiscal years, the exemption is limited to 50 per cent of the employment or self-employment income, but this can be increased to 90 per cent in certain cases (e.g., for inpatriate workers with three children under the age of 18 or with any that are not economically independent).
18 The eligible employee or self-employee who moves his or her fiscal residence to Italy may benefit from this special tax regime if he or she: (1) has not been resident in Italy in the two fiscal years prior to the transfer and undertakes to reside in Italy for at least two fiscal years; and (2) performs his or her professional activity mainly in Italy.
19 The benefits of the flat-tax regime may also be extended to other eligible family members by paying an additional €25,000 per year in respect of each additional relative.
20 Applicants for the flat-tax regime are also fully exempt from (1) Italian wealth taxes on real estate and financial investments held abroad, (2) Italian gift and inheritance taxes on the value of foreign assets and investments, and (3) reporting and filing obligations in relation to the Italian tax authorities in respect of such foreign assets.
21 Consob is required to issue regulations implementing certain provisions of Legislative Decree 191/2021 within 120 days after the date of its entry into force.
22 Indeed, the activities now embraced by the definition of 'pre-marketing' (as introduced by the CBDF Rules) were considered to amount to 'marketing' in some EU jurisdictions. Also, solicitation activities not amounting to 'marketing' were not harmonised at EU level beforehand.
23 'Pre-marketing' is defined as the 'provision of information or communication, direct or indirect, on investment strategies or investment ideas by an EU AIFM or on its behalf, to potential professional investors domiciled or with a registered office in the Union in order to test their interest in an AIF or a compartment which is not yet established, or which is established, but not yet notified for marketing in accordance with Article 31 or 32, in that Member State where the potential investors are domiciled or have their registered office, and which in each case does not amount to an offer or placement to the potential investor to invest in the units or shares of that AIF or compartment'.
24 Therefore, it can now be argued that all these situations are attracted by the notion of 'marketing' under the AIFMD.