Tax Alert (Italy) – Budget Law For 2018 Introduces Major Developments To Domestic Tax System

This is the third of a series of posts on the major developments introduced by Law No. 205 (enacting the Italian Budget Law for 2018),

Corporate taxation – Partial exemption of dividends distributed by CFCs.

According to current Italian rules, profits realized by non-resident subsidiaries are deemed to exist under the CFC legislation (article 167(4) of the ITA) if the relevant nominal rate in the foreign jurisdiction (other than EU and EEA countries) is lower than 50% of the combined IRES tax (rate 24%) and IRAP tax (rate 3,9%).

Additionally, specific regulations apply to “special tax regimes”. Under this definition are the situations in which the (standard) nominal tax rate in the foreign jurisdiction is higher than 50% of the foregoing limit, but, due to special exemptions and other mechanisms, the foreign nominal tax rate drops under the 50% threshold of the combined Italian tax rates.

Thus, article 167 of the ITA, provides for “safe harbour rules” allowing taxpayers not to apply the CFC legislation if they are able to demonstrate, by way of a Tax Ruling, that either (i) the non-resident subsidiary predominantly carries out, within the local market or relevant jurisdiction, an effective industrial or business activity; or (ii)from the participation in the CFC, the Italian shareholder does not achieve the result of shifting income to low-tax jurisdictions.

The first exception (also “business test”) requires the taxpayer to prove that the foreign entity has actual economic ties with the territory of establishment (plus its business substance in terms of employees,organization, equipment, etc). The second exception (also “anti-abusive test”), in accordance with the guidance of the Italian Revenue Agency, can be unlocked by demonstrating – inter alia – that the CFC derives more than 75% of its income from sources not located in the privileged jurisdiction or, alternatively, that its main activities are carried out in a territory that is not a privileged jurisdiction (thus, the CFC is fully taxed therein at ordinary tax rates, and is not benefiting of zero or reduced tax rates granted by its residence jurisdiction) or, finally, that the CFC’s effective tax rate overrides the 50% of the Italian effective tax rate to which the CFC would have been subject in Italy if resident therein.

Budget Law for 2018, amending article 89(3) of the ITA, has established that profits distributed are excluded from shareholder’s taxable income for 50% of their value, provided that the Italian shareholder is able to demonstrate the effective industrial or commercial activity carried out by the CFC in the local market of its residence jurisdiction. Moreover, an indirect tax credit of the underlying foreign corporate tax paid by the distributing company, is allowed on the remaining portion of profits.Entry into force of Law No. 205 of 27 December 2017: 1 January 2018.

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