U.S. Now A Black-Listed Country For Purpose Of Italy’s CFC Rules

Pursuant to the Tax Cuts and Jobs Act (“TCJA”) passed on Dec. 22, 2017, the U.S. will tax U.S. corporations with the following tax rates:

– 21 percent general corporate income tax rate,
– 13.125 effective tax rate on U.S. corporation’s foreign derived intangible income (“FDII”), for taxable years from 2018 through 2025;
– 10.5 percent effective tax rate on the U.S. corporation’s pro rata share of global intangible low taxed income (“GILTI”) of a controlled foreign corporation (“CFC”).

FDII is the portion of U.S. corporation’s net income (other than GILTI and certain other income) that exceeds a deemed rate of return of the U.S. corporation’s tangible depreciable business property and is attributable to foreign sales (i.e., property sold to a non-U.S. person for foreign use) and foreign services (i.e., services provided to any person outside of the U.S.). The U.S. corporation is entitled to a deduction equal to 37.5 percent of its FDII. The application of the 21 corporate tax rate on the 62.5 percent taxable portion of FDII results in an effective tax rate of 13.125 per cent (for taxable years after 2025, the deduction is reduced to 21.875 percent, equal to an effective tax rate of 16.406 percent).

GILTI is the portion of a CFC’s net income (not otherwise taxed currently to its U.S. shareholders) that exceeds a deemed rate of return of the CFC’s’s tangible depreciable business property. GILTI is included in the taxable income of U.S. corporate shareholders of the CFC and taxed at an effective tax rate of 10.5 percent. The U.S. corporation is entitled to a deduction equal to 50 percent of the amount of GILTI. The application of the corporate tax rate of 21 percent to the 50 percent taxable portion of GILTI results in an effective tax rate of 10.5 percent. The profits of the CFC that have been included into the taxable income of the U.S. corporation and taxed as GILTI can be paid as dividends without any additional U.S. tax.

A potential implication, in Italy, of the new corporate income tax rates applicable in the U.S. is the classification of United States corporations as “black listed” controlled foreign corporations subject to Italy’s anti deferral rules.

Until 2015, Italy operated its CFC rules by limiting their application to foreign corporations controlled by Italian shareholders and organized in one of the countries included in a specific list of tax favorable foreign jurisdictions, usually referred to as “black list”.

Starting with tax year 2016, the “black list” has been replaced by a general test based on a comparison between Italy’s and foreign countries’ corporate income tax rates.

The general test provides that a foreign country is considered a black-list jurisdiction, for purposes of Italy’s CFC rules, whenever its nominal corporate income tax rate is less than half of Italy’s corporate tax rates. For this purpose, reference is made to Italy’s 24 percent corporate tax (IRES) rate and 3.9 percent regional tax (IRAP) rate, which combine for a total rate of 27.9 percent.

A special test requires to take into account any special corporate tax regime applicable in a foreign country with respect to taxation of corporate profits. The term “special tax regime” is defined to include any favorable tax provision that results in a lower effective corporate income tax rate, due to exemptions or deductions that reduce the tax base for the application of the general corporate income tax rate. Exemptions or deductions with respect to profits deriving from foreign activities falls within the definition of “special tax regime”.

When a foreign country operates a corporate tax system that provides for a different tax treatment of different categories of income, such as, for example, a system in which foreign income is taxed more favorably than domestic income, an “all or nothing rule” applies pursuant to which, if more than 50 percent of the foreign corporation’s income is subject to an effective tax rate which is lower than the foreign country’s general corporate tax tax rate and less than half of Italy’s nominal corporate income tax rates, the foreign corporation is deemed to be organized in a black listed country and all of its income is treated as income of a controlled foreign corporation taxable to its Italian shareholders on a current basis. For the purpose of the all or nothing rule, a determination is required to be made on a company by company and tax year by tax year basis.

The U.S. general corporate tax rate of 21 percent does not fall below the “less than half of the Italian corporate income tax rates” standard for the general CFC test. However, the 13.125 percent effective tax rate on FDII clearly does (13.125 is less than half of the 27.9 combined Italian tax rates). As a result, when more than 50 percent of the taxable income of a U.S. corporation directly or indirectly controlled by Italian shareholders is FDII and is subject to an effective tax rate of 13.125 percent in the U.S., then all of that U.S. corporation’s income is treated as income of a CFC taxable currently to its Italian shareholders. The fact that the income derives form genuine business transactions carried out with unrelated parties does not matter.

Italian shareholders are entitled to prove that a U.S. corporation is engaged in an active trade or business, representing its principal business activity, within the United States, and exclude the application of the CFC rules. A tax ruling may (but need not) be filed and a positive response would be binding upon the tax administration.

Now that the corporate tax rate differential between Italy and the United Sates makes it advantageous, for Italian taxpayers, to conduct international business activities through their U.S. subsidiaries or affiliates, and allocate more profits to the U.S. where they would be taxed at lower rates, it is reasonable to expect increased enforcement of Italy’s CFC rules by the Italian tax administration.

Italian taxpayers should review their U.S. controlled companies and take the proper steps to make sure they do not run afoul of Italian CFC rules.

Have a question? Contact Marco Rossi.

Your comments are always welcome!

I am a U.S. and Italian tax counsel and focus on U.S. and Italian international tax and business law. My firm, Marco Q. Rossi & Associati (MQR&A), which I founded in 1998 and established as a U.S./Italy cross border practice in 2005, is a boutique law firm operating out of New York, Miami and Los Angeles and with local offices in Italy (Genoa and Milan) and the United States (Pittsburgh and Scottsdale).

I was born and educated in Italy where I graduated in law in 1990. I earned an international tax LL.M. degree from New York University School of Law and set up my New York office in 2005.

I assist international individuals and companies engaged in international investments or business transactions in the United States and the E.U. or doing business on a global basis, and foreign clients doing business or investing in or with Italy or the U.S. I also assist U.S. and Italian individuals relocating abroad on a permanent basis or for temporary working assignments, and foreign individuals working in the U.S. or Italy.

I travel between New York, Miami and Los Angeles, which serve as the international headquarters of the firm for our international and U.S. based clientele, and divide my time between the US and Italy working at our Italian offices that serve as our local base for Italian clients operating in the United States and U.S. clients engaged in Italian-E.U. legal and tax matters.

My major practice areas are international legal and tax planning for global firms; tax planning for foreign-owned U.S. and Italian businesses; transfer pricing and tax treaties planning; corporate and commercial transactions; holding company and fiduciary services for foreign investors and international groups, cross border mergers and acquisitions, immigration or expatriation planning for individuals relocating abroad or in Italy and the U.S., international tax reporting and compliance.

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1 comment on “U.S. Now A Black-Listed Country For Purpose Of Italy’s CFC Rules”

  • Thanks for this fascinating discussion. An excellent example of how U.S. tax policy can affect people who are NOT U.S. tax residents.

    Imagine how the Italian shareholders must be experiencing this:

    On December 21, 2017 they simply owned shares in a U.S. corporation.

    By December 23, 2017 they were in a situation where the income earned by the U.S. corporation was now attributed directly to the Italian shareholders.

    Moral of the story: In a global world, one cannot ignore how tax laws change/evolve in other countries.

    And the USA seems to think that only other countries are “tax havens”.

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