The Italian tax system is undergoing reform that seems to be
aimed at creating a direct taxation regime closer to the more
efficient systems in other EU countries, thus increasing
Since January 1 2004, the Income Tax Consolidation Act has
been substantially modified. Local taxpayers used to hate
Italy's tax system. But has recent reform converted the country
into a tax bright spot for foreign investors?
The evolution of corporate taxation in a number of European
countries and the blacklisting of many tax havens has changed
the ways that international investors and companies can legally
minimize their tax liabilities.
Tax exemptions on dividends and capital gains elsewhere in
Europe have induced a large number of investors, including
Italian entrepreneurs, to set up holding companies in those
countries. Competition among tax systems has harmed the Italian
economy for a long time, given its delay in implementing tax
reforms to promote inward capital flows. But this is changing.
Italy has started to adopt the tax devices used in other legal
systems. In particular, it is introducing tax exemptions on
dividends and capital gains, which, besides being necessary for
tax harmonization among European systems, aim to increase
It is undeniable that Italy lags behind its European
counterparts on this issue. For example, Spanish tax reform in
2000, which altered the 1995 rules, grants a general exemption
on dividends paid by Spanish companies or the capital gains
pertaining to them. The juridical qualification of ETVE
(Entitades de Tenencia de Valores Extranjeros) is available to
all companies established in Spain whose articles of
association allow them to invest in foreign entities. The
Ministry of Finance's authorization is no longer required, and
has been replaced by a simple prior notification of an
activity. Other European countries, such as Austria, Belgium,
Denmark, Germany, Luxembourg, and the Netherlands, have also
adopted similar exemptions.
The Netherlands and Luxembourg in particular have long made
opportunities for tax planning strategies available to foreign
Of course, a direct comparison between different exemption
regimes is not always easy because they are based on different
requirements. In the Netherlands, for instance, there is no
shareholding requirement for holding companies that own a
minimum of 5% of the foreign company's capital. Moreover, the
company in which the holding company has shares must pay tax
equivalent to that which is imposed in the country where the
holding company is established, and the investment must be
justified by an actual financial or managerial activity.
Luxembourg's tax system provides that the exemption regime
on capital gains is available if the shares sold amount to at
least 10% of capital in the company concerned, which must be
taxed at a rate not less than 15%, in the case of non-European
countries. Moreover, Luxembourg's rules require the shares to
be directly and continuously held for the 12 months before
Italy's tax reform, and the rules concerning holding
companies for the purpose of participation exemption, will turn
Italy into a country worth considering in terms of
international tax planning strategies. The reform could divert
the flow of foreign capital aimed at non-resident companies
from other jurisdictions, where more favourable provisions were
already applicable, to Italy.
Regarding the criteria underlying income imputation systems,
the introduction of an exemption (though partial), as opposed
to a tax credit, will remove pre-existing disparities. The
measures in force before the introduction of the Italian
corporate tax reform (IRES) granted a tax credit to resident
shareholders, as well as to non-resident shareholders with a
permanent establishment, discriminating against non-resident
shareholders without a permanent establishment.
The changes introduced by the Italian tax reform are based
on legal rules that already apply in other European countries.
These were, in turn, inspired by the American system. Since the
nineties, most European systems have gradually moved away from
the imputation system, which granted a tax credit to
shareholders, towards the exemption method (also providing for
partial exemption). Even France, traditional bulwark of the
imputation system based on tax credits, proposes to abolish the
so-called avoir fiscal in 2005.
In Europe, provisions basing the taxation of foreign
entities on worldwide consolidated accounts were already
explicitly contemplated by Denmark and France. The system
outlined by the Italian law decree is based on the French
system, although the tax reform in France is not due to enter
into force until 2005.
The concept of flow-through taxation does not represent a
breakthrough in the Italian tax system, even if, until the
present reform, it had not yet found an explicit statutory
sanction. However, Spain is the most representative forerunner
in the introduction of this concept.
Flow-through taxation was introduced with several specific
purposes: the non-deductibility of capital losses following
participation exemption requires the introduction of
appropriate corrections to avoid penalizing incorporated joint
ventures and, more generally, agreements that require the
establishment of jointly owned companies by legal entities.
In such situations, possible losses of the newly
incorporated company would otherwise be non-deductible for
participants in the deal, save for the possible opportunity,
for one of them only, to profit from the consolidated accounts
So the option of a transparency regime, similar to that
applicable to partnerships, has been introduced to remove the
problems arising in these situations.
This option's most obvious attraction for a foreign investor
is the possibility of its partial application in the presence
of non-resident shareholders. The Italian legislator provides
for such a regime when foreign shareholders exist for whom a
withholding tax would ordinarily apply on dividends distributed
in a different country.
In this respect, the non-applicability of the withholding
tax on dividends is also subject to the requirements provided
for in the so-called mother-daughter directive.
Moreover, the removal of withholding taxes on dividends is
effective where the mother-daughter directive applies,
which is in turn subject to a set of requirements.
Finally, in order to profit from the transparency option,
both the foreign shareholder and the business concerned must be
The advantage gained from the application of flow-through
taxation is that the foreign shareholder's revenue is
classified as business revenue rather than capital revenue. The
real point of classifying these revenues as business revenues
is not to avoid the withholding tax on dividends distributed in
a different country, but to accrue a foreign tax credit against
the taxes paid in Italy.
But the IRES Italian tax reforms do not appear enough
per se to attract foreign investors, when compared to
the rules already in force in other European countries. A
peculiar aspect of the new Italian regimen that might provide
specific tax appeal for foreign investors is the taxation of
contractual joint ventures.
Although this set of rules has been modified to some extent
by the IRES reform, establishing the non-deductibility of
consideration in favour of partners contributing assets other
than labour, there remains a clear distinction among financial
instruments available to Italian companies, including holding
companies, between those to which the rules pertaining to
shares apply, and those to which the debenture rules apply
The non-deductibility is only provided for the sums owed to
the owners of the former, such sums being considered as
dividends, but not for sums payable to the owners of the
latter. So the favourable taxation regime applies to financing
agreements entered into by Italian holding companies with third
parties, including parties belonging to the same group.
Such financing agreements can be the object of a
contractual, as opposed to an incorporated, joint venture,
which in turn can take the form of, for example:
- a silent partnership in the US;
- a sleeping partnership in the UK.;
- a Stillgesellshaft in Germany;
- a cuenta in partecipaço in Portugal and
- a participaciòn a la galancia in Spain
and Latin America;
- an EEIG in all European countries;
- an associazione in partecipazione in Italy;
- a contratto partecipativo a patrimonio separato
in Italy and several other countries.
The creation of a new independent entity, as is the case
with incorporated joint ventures endowed with rights and
obligations, implies a new tax liability upon the joint venture
as distinct from the venturers.
The issue is more complex with regard to contractual joint
ventures, where the income wholly arises from one of the
parties involved and is distributed among the others. This
framework is significant in terms of taxation: the issue is
whether the portion of income allocated to the other parties is
deductible from the total income and therefore is taxable upon
the said party, or if it is to be considered allocation of
income after tax.
Whenever the latter applies, it must be established whether
the monies owed to the other parties are tax-free or if they
contribute to the venturer's taxable income, upon the granting
of a proportional tax credit. This follows from the joint
venture's classification as either a trade agreement or a
In both circumstances, the issue may be further complicated
when the parties involved in a contractual joint venture belong
to different legal systems.
For instance, assuming that a joint venture should be
considered a trade and not a partnership contract, the other
party's income would be deductible from the pre-tax income to
which a given party to the contract is entitled. On the other
hand, the deductible income might be exempt, in compliance with
the rules provided for by the legal system in force in the
other party's country. In this context, situations of
under-taxation would arise, leading to rather obvious tax
This is why, even though contractual joint ventures are
usually considered trade, as opposed to partnership,
agreements, many legal systems have enacted a series of
US-style anti-avoidance measures, providing in particular for
the non-deductibility of the sums which are attributable to the
other party as its profit from the joint venture. The Italian
IRES reform takes this direction.
Before the reform, as far as the deductibility of the other
party's income from the joint venturer's income is concerned,
the rules in Italy provided for by Article 62 of DPR 917/86
applied. This arrangement tended to allow tax avoidance through
The new IRES provisions establish, under paragraph 9 of
Article 109, the non-deductibility of the other venturer's
profits and, more generally, the non-deductibility of any
revenue arising from financial instruments and transactions
involving a right to share the revenues of a given
On the other hand, the tax-planning strategy discussed above
still applies to contractual joint ventures that imply the use
of financial instruments comparable to debentures, or to other
financial instruments that imply a consideration other than a
share of the profits.
These situations create international opportunities to
reduce tax, which can be exploited through strategies based on
the analysis of every category of income and on the execution
of carefully drafted transactions between independent parties
that happen to be based in appropriate countries.