On 13 April 2007, Legislative Decree No. 49, dated 6 February 2007, (Legislative Decree) implementing the EC Directive 2003/123 (Directive) which amends the EC Parent-Subsidiary Directive (90/435/EEC), was published in the Official Gazette No. 86.
The Legislative Decree amends Art. 27-bis of Presidential Decree No. 600 of 29 September 1973 (Presidential Decree). It will enter into force within 15 days from its publication in the Official Gazette (i.e. 28 of April). However, the shareholding threshold, which is reduced to 15%, is applicable on all dividends distributed as of 1 January 2007
he Legislative Decree reduces to 20% (previously, 25%) the shareholding threshold with regard to dividends paid from 1 January 2005 until 31 December 2006, EU companies are allowed to claim the refund for the withholding tax levied on dividends received during that period. A claim for a refund must be submitted to the Italian tax authorities pursuant to Art. 27-bis(2) of the Presidential Decree. In this respect, the EU parent company must provide the Italian tax authorities with:
| - | a declaration issued by the tax authorities of the shareholder's state of residence certifying that the parent company meets the requirements of the EC Parent-Subsidiary Directive; and |
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| - | a self-declaration stating that the participation has been held for at least 1 uninterrupted year. |
A refund is also available for any withholding tax levied on dividends paid during 2007 provided the dividends paid related to a shareholding not lower than 15%.
Art. 27-bis (1-bis) of the Presidential Decree, as amended, explicitly states that the exemption from the withholding tax applies also on interest paid to the EU parent company and re-qualified as a dividend pursuant to Italian thin capitalization rules, provided that the EU parent company falls within the scope of the Parent-Subsidiary Directive.
EC Directive 2003/123: details
On 12 December 2006, the government approved a Legislative Decree implementing the Parent-Subsidiary Directive 2003/123/EC). Even though the Legislative Decree has been approved, it has not yet been published in the Official Gazette and is, therefore, not yet effective. Details of the Legislative Decree are summarized below.
The status of parent company is attributed if a company of a Member State, which is not deemed to be resident outside the Member State pursuant to a double tax treaty, has a minimum holding of 20% in the capital of a company of another Member State. Previously, the minimum holding was 25% and the reference to the presumption of residence outside the EU was not included.
Pursuant to Art. 2 of the Legislative Decree, the 20% holding threshold is applicable from 1 January 2005, whilst the threshold is further reduced to 15% for dividends distributed from 1 January 2007 and to 10% for dividends distributed from 1 January 2009.
The Legislative Decree amends Art. 27-bis of Presidential Decree No. 600/73 (which implemented the Parent-Subsidiary Directive) in order to make the relevant law consistent with the thin capitalization rules introduced in the domestic legislation in 2004. In particular, interest that, pursuant to the thin capitalization rules, is re-qualified as a dividend falls within the scope of the Parent-Subsidiary Directive (i.e. is exempt from withholding tax). Para. 4 of Art. 27-bis, which includes the possibility to apply the withholding tax when dividends are paid to a parent company resident in a country that had concluded a double tax treaty that provides the reimbursement of such withholding (i.e. France and UK), will be repealed.
With regard to the amendments to Art. 1(1) of the Directive 90/435, introduced by the Directive 2003/123, according to which:
| - | "profits received by permanent establishments situated in that State of companies of other Member States which come from their subsidiaries of a Member State other than that where the permanent establishment is situated"; and |
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| - | "distributions of profits by companies of that State to permanent establishments situated in another Member State of companies of the same Member State of which they are subsidiaries" |
Fall within the scope of the Parent-Subsidiary Directive, the Italian tax authorities state that these provisions are already included in the domestic legislation. Therefore, no amendments have been provided in this respect.
Finally, it should be noted that, even though the reduced holding participation should be directly applicable, the Legislative Decree will only enter into force when published in the Official Gazette. To date, it is not clear if and when it will be published.
Merger, division and transfer of going concern
On 21 March 2007, the Ministry of Finance issued a Ministerial Circular No. 16 (the Circular) clarifying the special regime introduced by the Finance Bill 2007 with respect to mergers, divisions and transfers of going concern carried out during the fiscal year 2007 and 2008. In particular, the Circular specifies (i) the subjective requisites, (ii) the timing, (iii) the deductible goodwill, (iv) the objective requisites, and (v) the definition of group for this purpose.
Subjective requisites
The Finance Bill for 2007 stated that the company resulting from the extraordinary transaction must be a joint-stock company - società per azioni (S.p.A.) or a partnership limited by shares - società in accomandita per azioni (S.a.p.a.) or a limited liability company - società a responsibilità limitata (S.r.l.). The Circular clarifies that such requirement must be met only by the resulting company. Therefore, a non-resident company can be part of an extraordinary transaction as merging, dividing and contributing company.
Timing
In order to verify whether or not the transaction has been carried out in the relevant fiscal years (2007 and 2008) reference shall be made to the date in which the merger, division or transfer of going concern has juridical effect (i.e. in case of merger or division the date on which the merger or the division deed is registered with the Companies' Registrar - Arts. 2504-bis and 2506-quarter of Civil Code).
Deductible goodwill
The maximum amount of goodwill deductible (i.e. EUR 5 million) must be allocated to instrumental tangible and intangible assets. The Circular states that the goodwill allocated on the inventory and/or on participations is not tax deductible. Where the goodwill is higher than EUR 5 million, the taxpayer must identify the revalued deductible assets. The value of the assets in excess of EUR 5 million will be taken into consideration for capital gain purposes at the time of their disposal. In this respect, it should be noted that the revalued assets can be transferred and/or sold only after 4 years from the relevant date on which the extraordinary transaction took place; otherwise, the tax benefit may be lost.
Objective requisites
All companies involved in the extraordinary transaction must be "operational" (e.g. carry out a real business activity) since at least two years. Even though a direct reference to the "non-operating" company legislation is not made, the tax authorities may utilize those parameters to verify whether the companies carry out a business activity.
Definition of group
The companies involved in the extraordinary transaction cannot belong to the same group. The Circular clarifies that companies are deemed to be part of the same group when:
| - | a company has the majority of voting shares in the controlled company; | |
| - | a company, without the majority of voting shares, nevertheless has enough voting shares to have a dominant influence in the shareholders meeting of another company; | |
| - | a company owns one or more share(s) in another company; and | |
| - | companies involved in the transaction are indirectly controlled by the same shareholder |
All the above requirements must be met in the 2 years preceding the extraordinary transaction.
Further, any company that wants to benefit of the privileged tax regime must submit an advance ruling to the tax authorities
Cross-border merger: disregarding of anti-avoidance rules for carry forward of losses.
On 30 March 2007, the Italian tax authorities issued Ruling No. 66 regarding cross-border mergers and the possibility to carry forward the losses of the acquiring company. In particular, the Ruling deals with the interpretation of the Italian domestic anti-avoidance provision and Council Directive 90/434/EEC of 23 July 1990 on the common system of taxation applicable to mergers, divisions, transfers of assets and exchanges of shares concerning companies of different Member States (the Directive).
(a) Facts. A Dutch company (Alfa) owns a branch in Italy (the Italian branch). Through the latter, Alfa wholly owns another Italian company (Delta).
In 2002, Delta entered into a services agreement with Alfa. In 2003, the same companies signed an agreement having as its object the rental of a going concern. This agreement expired in 2004.
In 2004, the cross-border merger took place. Delta was merged into Alfa by means of a merger resolution. At the time the merger was effective:
| - | Alfa wholly owned Delta through the Italian branch; and | |
| - | the merger involved another group company with its registered office in the Netherlands (Eta), which was wholly owned by Alfa through the Italian branch |
Both Delta and Eta were merged into Alfa.
As in 2004, the Italian branch had accrued fiscal losses generated in 2002 (pre-merger losses), which could be carried forward. After the merger, the difference between the assets and liabilities of the Italian branch was negative. Pursuant to Italian legislation, therefore, the losses could no longer be carried forward.
The taxpayer claimed that Art. 181 of the Italian Income Tax Code (the ITC), which limits the carry forward of the losses in case of a cross-border merger if a number of requirements are not met, did not apply in this case.
(b) Legal background. Arts. 181 and 172(7) of the ITC limit the carry-forward of pre-merger losses in the case of a cross-border merger. In particular, Art. 181 of the ITC provides that in the case of a cross-border merger, fiscal losses may be carried forward by the non-resident entity (i.e. the Italian branch) subject to the same conditions and limitations imposed on domestic mergers (Art. 172(7) of the ITC). Further, the losses that can be carried forward are proportional – and in any event not higher – to the difference between the assets and liabilities attributed to the Italian branch.
Art. 172(7) of the ITC provides that "losses of companies involved in a merger, including losses of the receiving company, may be used to reduce the income of the receiving company only if the profit and loss account of the company whose losses are to be carried forward shows, in the fiscal year prior to the merger resolution, gross income and labour costs and related social security contributions of at least 40% of the average of the 2 previous fiscal years. Moreover, the deduction is limited to the portion of losses not in excess of the relevant net asset value resulting from the last balance sheet or, if less, from the financial statements provided for by Art. 2501-quater of the Civil Code, excluding any contribution or payment made during the 24 months prior to the date of those statements. If the shares or quotas of the company the tax losses of which are to be carried forward were owned by the receiving company or by another company participating in the merger, the deductible losses are reduced by any write-down of the shares or quotas made prior to the merger".
The tax authorities further recalled the content of the fifth "whereas" of the Directive where it is stated that "... mergers, divisions or transfers of assets, normally result either in the transformation of the transferring company into a permanent establishment of the company receiving the assets or in the assets becoming connected with a permanent establishment of the latter company". Indeed, the cross-border merger may result in two different scenarios:
| - | the acquiring company does not have a permanent establishment in the other Member State and, therefore, the target company's assets and liabilities are attributed to a new permanent establishment; or | |
| - | the foreign acquiring company already has a permanent establishment in the other Member State. In such a case, the assets and liabilities of the target company may be attributed to the existing permanent establishment and, therefore, assets and liabilities of the acquiring and target companies are co-mingled for tax purposes. |
The case at hand falls within the scope of the second scenario since the Dutch incorporating company owns the Italian branch.
(c) Tax authorities' opinion. In principle, the tax authorities pointed out that Art. 181 of the ITC is applicable at the time the assets of the target company are attributed to a new permanent establishment or to an existing permanent establishment, as in the case at issue.
Further, Art. 181 of the ITC cannot be interpreted as an ad hoc anti-avoidance provision. In this respect, the tax authorities highlighted that Art. 181 of the ITC entails two limitations:
| - | losses can be carried forward up to an amount equal to the net equity of the target company, which can effectively be attributed to the Italian permanent establishment; and | |
| - | it extends the limitations imposed on domestic mergers to cross-border mergers (referring to Art. 172(7) of the ITC). |
Point (1) essentially limits the availability of losses when the assets and liabilities of the target company are only partially attributed to the permanent establishment. Even though this limitation is not explicitly contained in the Directive it is in line with the scope of the Directive since in the fourth "whereas" it states that "... the common tax system ought to avoid the imposition of tax in connection with mergers ... while at the same time safeguarding the financial interests of the State of the transferring or acquired company". Therefore, interpretational issues should not arise when all the assets and liabilities of the target company are attributed to the Italian permanent establishment.
In light of the above, the tax authorities stated that Art. 181 of the ITC is not an anti-avoidance provision and, therefore, it cannot be disregarded.
With regard to point (2) above, it is worth noting that Art. 6 of the Directive provides that benefits and limits applicable to domestic mergers will be applicable to cross-border mergers as well. The domestic legislation (Art. 172(7)of the ITC), however, recalled by Art. 181 of the ITC is applicable only if, as a result of the cross-border merger, the assets and liabilities of pre-existing entities are mixed (as it is the case at hand, since the permanent establishment already exists within the Italian territory).
To this extent, Art. 172(7) of the ITC can be seen as an anti-avoidance provision aimed at merger transactions having as their main scope the "inter-subjective compensation" of the losses. Therefore, it can be [disallowed] through an advance ruling pursuant (Art. 37bis(8) of Presidential Decree No. 600/73).
Finally, for the sake of clarity, the tax authorities pointed out that in order to calculate the amount of losses that can be carried over by the Italian branch, the net equity that is taken into consideration is that of the Italian branch (losses were all born therein) and not, as was claimed by the taxpayer, the sum of the net equity of the target company and of the Italian branch.
CFC regulation can be disregarded if effective tax burden of group is congruous with Italian tax burden
On 28 March 2007, the Italian tax authorities issued a ruling according to which the controlled foreign corporation (CFC) rules can be disregarded if the effective tax burden of a group as a whole is congruous with the level of taxation that should have been achieved by applying the CFC rules even though the controlled company is located in a black listed country.
(a) Facts. An Italian company wholly owns a US company, which holds 100% of the shares of a company tax resident in Cyprus. Therefore, the Italian shareholder indirectly controls the Cypriot company. It is worth noting that Cyprus is included in the list of tax havens for CFC purposes (Ministerial Decree 21 November 2001, as amended on 27 December 2002, effective 14 January 2003). Further:
| - | the Italian company became an indirect shareholder of the Cypriot company as a consequence of the purchase of the shares of the US company; | |
| - | the Cypriot company is subject to the ordinary corporate income tax rate (i.e. 10%); |
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| - | the Cypriot company is subject to the ordinary corporate income tax rate (i.e. 10%); | |
| - | the controlled Cypriot company is primarily a holding company, which also coordinates the services carried out by its foreign affiliated companies and by its permanent establishments; and | |
| - | the employees of the Cypriot company are not permanently resident in Cyprus and are, mainly, seconded to its permanent establishments. |
The taxpayer requested that the CFC rules not be applied on the basis that the participation in the Cypriot entity does not achieve the localization of income in a tax haven country.
(b) Legal background. Italian CFC legislation contained in Art. 167 of the Income Tax Code (ITC) provides that the profits of a foreign entity, which is resident in a black listed country, are attributed to the Italian shareholder and taxed therein. In particular, CFC income is computed by applying the Italian provisions regulating the computation of business income and is taxed separately at the Italian taxpayer's average tax rate. This average rate cannot, however, be lower than 27%.
The application of the CFC rules, however, can be avoided if the resident person proves, through an advance ruling, that:
| - | the foreign entity predominantly carries on an actual industrial or commercial activity in the state or territory in which it is located (Art. 167(5)a)); or | |
| - | the participation in the foreign entity does not achieve the localization of income in tax haven countries or territories (Art. 167(5)b)). |
Further, Art. 5(3) of Ministerial Decree No. 429/2001 (the Decree), which implemented the rulings for CFC purposes, states that a positive advance ruling can be issued if at least 75% of the total income of a company resident in a tax heaven is born in another country that is not a black listed country.
(c) Tax authorities' opinion. In primis, the tax authorities stated that, as the Cypriot company does not carry out an industrial or a commercial activity, the exception provided in Art. 167(5)a) of the ITC is not available. Therefore, it should be verified whether the conditions provided under Art. 167(5)b) of the ITC are met.
Moreover, the tax authorities pointed out that the condition provided for by Art. 5(3) of the Decree cannot be relied on in this situation, as it is clear that the income of the foreign company was born in Cyprus. It was stated that such condition is an exemplification and should not be seen as exhaustive. Accordingly, a case-by-case analysis must be carried out.
In other words, the tax authorities implied that, if income derived from foreign entities is subject to an effective tax burden equivalent to the one applicable in Italy pursuant to the CFC rules, the holding of shares in a company resident in a black listed country does not entail an avoidance circumstance per se. In this respect, it should be noted that, as highlighted in the explanatory note issued with the law that implemented Art. 167 of the ITC, the ratio of the CFC rule is that, at least once, foreign income is taxed at a congruous level.
In the case at hand, as the income born in Cyprus is taxed,
| - | first, in the hands of the Cypriot company at a corporate income tax rate of 10%, and | |
| - | then, at the ordinary federal corporate income tax rates applicable to dividends in the hands of the US company, |
The tax authorities pointed out that the higher the income distributed by the Cypriot company to the US company the higher the effective tax burden of the group as a whole (e.g. 10% in Cyprus plus 35% in the US, gross of the tax already paid in Cyprus).
In light of the above, the tax authorities ruled that CFC rules can be avoided in the case at stake (based on the exception included in Art. 167(5)b)) on the condition that:
| - | the Italian shareholder provides each year documents proving the tax burden of the Cypriot company therein; and | |
| - | the Cyprus company distributes each year an amount of income that triggers a tax(Cyprus and in the US) equal to at least 27% of the gross income realized by the Cypriot company (i.e. the tax burden is equivalent to the minimum required in case of application of the CFC rules). |
Furthermore, the positive ruling is based on the following considerations:
| - | if the income of the Cypriot company is taxed under the Italian CFC rules, double taxation would result due to the high taxation levied in the US; |
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| - | the Cypriot company existed before the acquisition by the Italian holding company of the US company, which is the direct shareholder of the former; and |
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| - | the Italian company undertook to deliver to the tax authorities the fiscal data of the Cypriot company and to have the latter distribute a certain amount of income each year. |
Finally, the tax authorities made it clear that the above requirements must be met each year and, in particular, the requirement that the Italian company provide the tax authorities with the documents proving the annual income accrual and distributions by the Cypriot company.