The Anti Tax Haven Provisions in the Italian Tax System
“The anti tax haven provisions in the Italian tax system and their compatibility with the non-discrimination clause under the OECD Model” – Combined Bachelor and Master of Science in International Law and Public Institutions Bocconi University (Milan) LLM candidate in International Economic Law at the CUHK
By Dini Sejko
Tax havens and harmful preferential tax regimes, collectively referred to harmful tax practices, affect the location of financial and other service activities, erode the tax bases of other countries, distort trade and investment patterns and undermine the fairness, neutrality and broad social acceptance of tax systems generally. Such harmful tax competition diminishes global welfare and undermines taxpayer confidence in the integrity of tax systems (OECD, Harmful tax competition. An Emerging Global Issue, Paris: OECD 1998) The Italian legislator has faced the problem of erosion of tax base with the provision on the non-deductible costs and the Italian CFC (controlled foreign companies) legislation. Even though the economic crises has increased the concern of the government on the topic and the controls by the fiscal administration have become more penetrating there are no recent modifications to the legislation (Law n.102 3.08.2009 modified the CFC discipline).
General aspects of the provision on non-deductible costs
Italy, since the fiscal year 1992 has an ad hoc discipline to limit the deductibility of costs of resident entities with subjects that reside in territories with preferential tax regimes. The provision (In 1991 the provision was article 76 of the TUIR and art. 11 (12) of Law 413/1991 added the paragraphs 7 bis and 7 ter. The provision has been modified many times – the legislative decree n. 344 12.12.2003 modified the structure of and the article enumeration of the law; the law-decree n.262 03.10.2006 introduced in paragraph 12bis; law n.296 modified paragraph 11; law n. 244 27.12.2007 modified paragraph 10 – and is now contained in art. 110 paragraph 10,11,12 and 12 bis of the TUIR.) aims to prevent the misuse of fiscal planning for the purpose of shifting the tax base from Italy to countries with a preferential tax regime (PTR) through artificial operations that lack a real business purpose with entities that are domiciled in the aforementioned territories outside the European Union. The provision on fiscal havens PTR territories was added to the article on transfer pricing and is actually complementary to it. Both are anti avoidance regulations but on one hand the transfer pricing legislation prevent the reduction of Italian tax base between companies of the same group applying the market value instead of the fictitious price declared by the companies, on the other hand the provision on non-deductible cost introduces a rebuttable presumption which assumes that the operation between the Italian entity and the entity located in the PTR territory is fictitious. The entity can apply for the deductions if it proves one of the exemption’s conditions established by art. 110 (11) as it will be analyzed latter.
Entities subject to this law
It was quite clear which was the subjects to which the provision applies before the modification introduced by law n. 244/2007. The ordinary meaning of the provision was clear since it was expressed that the “resident company” cannot deduct costs and other negative components of transactions occurred with enterprises domiciled in states or territories, not part of the European Union, with a preferential tax regime.
The new paragraph, as modified by law n. 244/2007, does not specify who is the resident subject that cannot deduct the costs of its transactions with entities domiciling in PTR (preferential tax regime) states and territories. But due to the collocation of article 110.10 ITC (Italian tax code) the entities to which this provision is applied are determined by art. 73 (Art. 73 defines the person that should pay the corporate income tax which is determined by article 56 TUIR.). This means that those entities that generate corporate income are subject to the application of article 110.10, whatever their legal form; it can be an individual or a corporate resident in Italy.
The application of article 110.10 to permanent establishments (PE) seems to be more problematic. One part of the Italian scholarship don’t accept the applicability of art. 110.10 to the PE because it is not possible to consider the PE as a resident entity in the Italian territory since it is absorbed by the residence of the parent company. This interpretation has not been endorsed and has been criticized because it would generate a sort of discrimination against the resident entities and would stimulate the use of some types of organizational forms in respect to others and will cause the exclusion of a high number of transactions. This will be against the ratio of the provision (Garbarino Carlo, Manuale di tassazione internazionale, Milano: IPSOA Gruppo Wolters Kluwer, 2008, p.1606) Those who support the application of this rule to PE have explained that the use of the word “residence” is due to a terminological imprecision; what has to be taken in consideration is the economic substance, residence should be linked at the entrepreneurial activity actually performed in the Italian territory, without taking in consideration the independence of the management body. It should be added that a PE determines its income and pays taxes applying the concept of enterprise.
Actually, the article 110.10 that will be applied after the “white list –scambio” will enter into force, does not requires entities to be resident in Italy but the only condition for this law to be applied is that the entity produces business income. This means that is clear that also PE are subject to this law.
The current art. 110.10 includes in the applicability of the law entities that “are resident or are localized” in states and territories identified in the list provided by a Ministerial Decree issued under art. 168bis. Law n.244/2007 has introduced two criteria: the entity can be either resident in the PTR territory or state or localized in such places. These criteria are the same used in artt. 167-168 for the CFC. The criterion of localization requires a weak connection but it is applied in order to prevent the use of companies without real business purpose which hardly can integrate the requirement of residence. The law applies also to professionals in accordance to art.110.12bis (Art.110 (12-aa). The provisions of paragraphs 10 and 11 shall also apply to services rendered by professionals domiciled in states or territories other than those identified in the list referred to in Ministerial Order issued under Article 168-bis. This provision does not apply to professionals who are domiciled in states of the European Union or European Economic Area including in the list referred to in that decree).
Individuation of PTR territories and states
The legislation applies to transactions between a resident person and a company or professional resident in a state or territory not included in the white list. Italy has opted for this approach. Until the issuance of the decree containing the list and for five years thereafter, all states and territories not already included in the current black list will be treated as included in the white list. Under article 110.10 of the TUIR, a country or territory has a PTR if it levies no income tax or levies an income tax on the income of the relevant companies at a rate which is lower than the one to be determined by the Ministry of Finance and the Ministry of Treasury or has no adequate exchange of information or other equivalent criteria.
The existence of a Tax convention between Italy and the country is not a sufficient criterion for admitting that there is an exchange of information between the fiscal authorities of the two countries. The Italian fiscal authorities has in some cases carved out the possibility to continue to apply the anti avoidance legislation also when a treaty exist with the PRT state like in the case of the Sultanate of Oman (Art. 24.6 Treaty between Italy and the Sultanate of Oman “ However, the provisions of the preceding paragraphs of this Article do not affect the application of the domestic provisions to prevent tax evasion and tax avoidance. This provision includes in any case the limitations on the deductibility of expenses and other negative items arising from transactions between companies and enterprises of a Contracting State in the other Contracting State”)
Ministerial Decree of 23 January 2002 provides a list of such countries and territories. The list is divided into three sections. The first section contains the countries and territories regarded as having a privileged tax regime under any circumstance (Andorra, Anguilla, Aruba, the Bahamas, Barbados, Barbuda, Belize, Bermuda, the British Virgin Islands, Brunei, the Cayman Islands, the Channel Islands, the Cook Islands, Djibouti, French Polynesia, Gibraltar, Grenada, Guatemala, Hong Kong, the Isle of Man, Kiribati, Lebanon, Liberia, Liechtenstein, Macau, Malaysia, the Maldives, the Marshall Islands, Montserrat, Nauru, the Netherlands Antilles, Nevis, New Caledonia, Niue, the Philippines, Oman, the Solomon Islands, St. Helena, St. Kitts, St. Lucia, St. Vincent and the Grenadines, the Seychelles, Tonga, the Turks and Caicos Islands, Tuvalu, the US Virgin Islands, Vanuatu and Samoa.) The second section contains the countries regarded as having a privileged tax regime, with the exception of certain specific activities (Bahrain, excluding companies that carry out exploration, extraction and refining in the oil industry; Monaco, excluding companies whose turnover derives for more than 25% from outside the principality; Singapore, excluding the Central Bank and other entities that manage the official reserves of the state; and the United Arab Emirates, excluding companies that carry out exploration, extraction and refining in the oil industry) The third one contains the countries and territories that are generally deemed not to have a privileged tax regime but that are, due to specific offshore legislation or other tax incentives, deemed to be tax havens with regard to specified low-tax activities(Angola, with respect to oil companies that benefit from the exemption from oil income tax, to companies which benefit from exemptions or reductions of tax in industries essential to the Angolan economy and to investments provided for by the Foreign Investment Code; Antigua, with respect to international business companies that carry out their activity abroad, such as those under the International Business Corporation Act No. 28 of 1982 and subsequent amendments and integrations, and to companies that manufacture authorized products such as those under Law 18 of 1975 and subsequent amendments and integrations; Costa Rica, with respect to companies deriving income from foreign sources and companies engaged in high-technology activities; Dominica, with respect to International companies carrying out their activity abroad; Ecuador, with respect to companies carrying out their activity in the free trade zones that benefit from the exemption from income taxes; Jamaica, with respect to companies manufacturing for foreign markets and enjoying the tax benefits of the Export Industry Encouragement Act and to companies located in the territories indicated in the Jamaica Export Free Zone Act; Kenya, with respect to companies established in the export processing zones; Mauritius, with respect to “certified” companies engaged in export services, industrial development, tourism management, industrial construction and clinics and that are subject to lower than ordinary corporate tax, to off-shore companies and to international companies; Panama, with respect to companies deriving income from foreign sources, as defined under Panama legislation, to companies located in the Colon Free Zone and to companies carrying out their activity in the export processing zone; Puerto Rico, with respect to companies engaged in banking activities and to companies under the Puerto Rico Tax Incentives Act of 1988 or the Puerto Rico Tourist Development Act of 1993; Switzerland, with respect to companies not subject to cantonal and municipal taxes, such as holding, auxiliary and domiciliary companies; and Uruguay, with respect to companies carrying out banking activities and to holding companies that carry out exclusively off-shore activities)
Safe harbor clause
Article 110.11 ITC provides two exemptions which applies alternatively: the first one requires the entities resident in the PTR territories or states to be involved in a real business activity, the second exemption requires the transaction to be real and to have a effective economic interest. The first exemption requires the taxpayer to collect very detailed information on their supplier (Resolution 16.03.2004 n 46/E ) which requires a deep collaboration of the supplier. For this reason the second exemption acquires greater importance. The Tax Court of Second Instance ( Marche) in a recent case has explained that effective economic interest exists when the Italian resident company realizes an operation that produces profit in the specific nature of the activity, it doesn’t have to be more convenient as a single operation(Tax Court of Second Instance Marche 22.06.2010 n. 5 ) The entities in order to benefit can ask for an advanced ruling of the tax authorities
General aspects and application
Italian CFC legislation is now contained in articles 167 and 168 TUIR and implementing legislation. It was first introduced in 2000 by article 1 of the law n. 342, then modified by the legislative decree n. 344 12.12.2003 that renumbered it and extended its applicability to the connected foreign companies. The applicability was extended also by law n.244/2007 which abolish the black list regime with the introduction of a new regime based on the white lists. Some other modifications were introduced by law n.102 03.08.2009.
The purpose of this law, as it was also remarked in Circular n. 207 16.11.2000, is to contrast the elusive practices realized through participations in entities located in PTR states or territories. The profits realized by a foreign entity are deemed to be the profits of an Italian resident person, whether an individual, a corporation or another entity subject to corporate income tax, if the resident person controls, directly or indirectly, or through trustee companies or interposed third persons, a foreign entity and the entity is not resident in a state or territory included in the list of states or territories allowing an adequate exchange of information (Resident in the white list countries).
Control is defined based on the definition of art 2359 of the Civil Code which expound three types of control:
- direct control when a company holds the majority of the votes in the shareholders’ meeting
- de facto control – when a company has sufficient votes to exert a decisive influence in the shareholders’ meeting
- contractual control – when the company is under the relevant influence of another company due to a special contractual relationship
This regulation applies to profit of foreign persons not resident in a tax haven realized through their PE located in a tax haven.
After the modification introduced the 1 July 2009, the scope of application of the CFC rules has been extended to controlled companies localized in states or territories different from those included in the black list (e.g. also EU companies), if the controlled foreign company is subject to an actual taxation that is more than 50% lower than the tax that would have been levied if it was resident in Italy and more than 50 % of the proceeds of the controlled foreign company consists of passive income or intra group activities. Both conditions should be fulfilled in order for the CFC regulation to be applied.
Attribution of profits
The profits of a foreign entity are attributed to an Italian person on the last day of the financial year of the foreign entity. The income is computed by applying the Italian provisions regulating the computation of business income and is taxed separately (i.e. CFC income cannot be offset by the Italian person’s losses) at the taxpayer’s average tax rate. This average rate cannot, however, be lower than 27%. Under article 15 of the ITC, final taxes paid abroad are creditable against the Italian taxes levied on the CFC income.
Dividends subsequently distributed by the foreign entity are taxable only up to the amount exceeding the income that has already been taxed in the hands of the Italian recipient under the CFC regime. Foreign taxes paid on the part of income which, under this provision, is excluded from the taxable base in Italy are creditable against Italian taxes up to the amount exceeding the taxes already credited under the CFC regime.
The amount of income of the foreign entity subject to tax in Italy under the CFC regime also increases the taxable basis of the participation held by the Italian person in the CFC; correspondingly, subsequent dividend distributions decrease the tax basis of the same participation.
Safe harbor clause
The cases in which this provisions do not apply are defined in article 167 of the TUIR. There are two types of exemption: one in paragraph 5 dedicated to the application of the CFC legislation in black list countries and the other one in paragraph 8-ter dedicated to the application of the CFC legislation in the non black list countries (Miele Luca, Rolle Giovanni and Russo Valeria, Società estere: regime delle CFC ed esterovestizione, Milano: IPSOA Gruppo Wolters Kluwer, 2011)
With respect to paragraph 5 the Italian controlling entity should prove that the non-resident entity carries out effective industrial or commercial activities, as its main activity ‘in the market of the state or territory of settlement, for the activities’ banking, financial and insurance latter condition is satisfied when most of the sources of jobs and revenue originate in the country or territory of settlement (Art167 5-bis. The provision in subparagraph a) of paragraph 5 shall not apply where the income of the com pany or the other non-resident entity coming for more than 50% from management, holding or investment in securities, investments, loans or other financial assets, the sale or the right to use intellectual property rights related to the industrial property, literary or artistic work, as well as the performance of services in respect of persons who directly or indirectly control the company or the non-resident entity, are controlled or supervised by the same company that controls the company or the non-resident entity, including financial services). In the second the Italian resident should prove that the localization abroad does not constitute an artificial scheme aimed at achieving undue tax advantages. In order to benefit from the exemptions the Italian resident must apply for a ruling of the Italian tax authorities. Despite the wording of paragraph 5, the circulation 51/E 2010 has affirmed that the taxpayer conserves the prerogative to demonstrate subsequently the existence of the exemptions (The Tax Authorities has that the advanced ruling does not oblige the company to respect it and emphasizes that the company still have the possibility to demonstrate the existence of the conditions for the non application of the CFC rule)
In the case of paragraph 8ter, in order to avoid that the CFC rule extend to subsidiaries located in countries or territories with ordinary taxation, even if it is under the conditions specified in subparagraphs. a) and b) of that paragraph 8-bis(Article 167 c.8bis The regulation referred to in paragraph 1 also applies in cases where the controlled entities pursuant to the same paragraph are located in states or territories other than those referred to therein, if all the following conditions occur: a) are subject to effective taxation lower more than 50% than they would have been subject if resident in Italy; b) have earned income for more than 50% from management, holding or investment in securities, investments, loans or other assets’ financial, the sale or the right to use intellectual property rights related to the industrial property, literary or artistic as well as the performance of services in respect of persons who directly or indirectly control the company or the non-resident entity, are controlled by or are controlled by the same company that controls the company or the non-resident entity, including financial services.), the Italian controlling company should prove that controlled entities are representative of actual settlements, which are not artificial constructions, such as not designed to achieve an unfair tax advantage.
PTR territories and states
The criteria for the determination of the PTR territories and states are defined in article 168 bis of the TUIR. This law introduced in 2007 explains the criteria for the individuation of the white list countries. Those countries that are not included in the white list are black list countries. The ministerial decree which individuate the white list countries has not been issued yet. These territories and states are individuated in the Ministerial Decree adopted the 21 November 2001.
The first section contains the countries and territories regarded as having a privileged tax regime under any circumstance (Andorra, Anguilla, Aruba, the Bahamas, Barbados, Barbuda, Belize, Bermuda, the British Virgin Islands, Brunei, the Cayman Islands, the Channel Islands, the Cook Islands, Djibouti, French Polynesia, Gibraltar, Grenada, Guatemala, Hong Kong, the Isle of Man, Kiribati, Lebanon, Liberia, Liechtenstein, Macau, Malaysia, the Maldives, the Marshall Islands, Montserrat, Nauru, the Netherlands Antilles, Nevis, New Caledonia, Niue, the Philippines, Oman, the Solomon Islands, St. Helena, St. Kitts, St. Lucia, St. Vincent and the Grenadines, the Seychelles, Singapore, Tonga, the Turks and Caicos Islands, Tuvalu, the US Virgin Islands, Vanuatu and Samoa). The second section contains the countries regarded as having a privileged tax regime, with the exception of certain specific activities (Bahrain, excluding companies that carry out exploration, extraction and refining in the oil industry, Monaco, excluding companies whose turnover derives for more than 25% from outside the principality, the United Arab Emirates, excluding companies that carry out exploration, extraction and refining in the oil industry). The third section contains the countries and territories that are generally deemed not to have a privileged tax regime but that are, due to specific offshore legislation or other tax incentives, deemed to be tax havens with regard to specified low-tax activities (Angola, with respect to oil companies that benefit from the exemption from oil income tax, to companies which benefit from exemptions or reductions of tax in industries essential to the Angolan economy and to investments provided for by the Foreign Investment Code; Antigua, with respect to international business companies that carry out their activity abroad, such as those under the International Business Corporation Act No. 28 of 1982 and subsequent amendments and integrations, and to companies that manufacture authorized products, such as those under Law 18 of 1975 and subsequent amendments and integrations; Costa Rica, with respect to companies deriving income from foreign sources and companies engaged in high-technology activities; Dominica, with respect to international companies carrying out their activity abroad; Ecuador, with respect to companies carrying out their activity in the free trade zones that benefit from the exemption from income taxes; Jamaica, with respect to companies manufacturing for foreign markets and enjoying the tax benefits of the Export Industry Encouragement Act and to companies located in the territories indicated in the Jamaica Export Free Zone Act; Kenya, with respect to companies established in the export processing zones; Luxembourg, with respect to the holding companies regulated by the local law of 31 July 1929; Mauritius, with respect to “certified” companies engaged in export services, industrial development, tourism management, industrial construction and clinics and that are subject to lower than ordinary corporate tax, to off-shore companies and to international companies; Panama, with respect to companies deriving income from foreign sources, as defined under Panama legislation, to companies located in the Colon Free Zone and to companies carrying out their activity in the export processing zone; Puerto Rico, with respect to companies engaged in banking activities and to companies under the Puerto Rico Tax Incentives Act of 1988 or the Puerto Rico Tourist Development Act of 1993; Switzerland, with respect to companies not subject to cantonal and municipal taxes, such as holding, auxiliary and domiciliary companies; Uruguay, with respect to companies carrying out banking activities and to holding companies that carry out exclusively off-shore activities). In the case of countries listed in the third section of the list, the regime also applies to businesses (regardless of their form) benefiting from a tax regime substantially similar to the listed ones by virtue of a special measure by, or agreement with, the local tax authorities. The boundaries of such extension are unclear and a clarification is expected by the tax authorities.
Until the issuance of the decree containing the list and for five years thereafter, all states and territories not already included in the current black list will be treated as included in the white list.
Non–discrimination clause in the OECD model
The non- discrimination principle is broadly recognized in many countries constitutions and in human rights treaties. In a taxation context discrimination has been defined as “ the equal treatment of different cases or the unequal treatment of comparable cases. In an international tax context discrimination most often takes the form of different treatment of taxpayers whose situations are comparable except in respect of a characteristic such as nationality.
The relationship between domestic anti-abuse rules and international treaties needs an analysis especially after the changes made to the OECD commentaries on the improper use of tax treaties published in 2003 which are driven by the new paragraph 7 of the commentary to article 1, which reads as follows: “The principal purpose of double taxation conventions is to promote, by eliminating international double taxation, exchanges of goods and services, and the movement of capital and persons. It is also a purpose of tax conventions to prevent tax avoidance and evasion.”
The OECD model DTA contains the non-discrimination principle that forbid the contracting parties to discriminate between its nationals and enterprises and those of the other state in applying the provisions of the DTA between the two states in article 24. In paragraph 1, 2, and 5 of this article prohibit that the citizens of a contracting state, non-residents and enterprises whose capital is owned or controlled, directly or indirectly from a resident of the other contracting state receive a less favorable treatment to the some subjects that are citizens of the state and are in the same circumstances. The aim of this provision is to ensure that the state that levies the tax does not support its own citizens or the national enterprises that are in the same circumstances
Compatibility of art. 110.10 TUIR
The non-deductible costs legislation raises problems of conflict with paragraph 4 of article 24. This provision is designed to end a particular form of discrimination resulting from the fact that in certain countries the deduction of interest, royalties and other disbursements allowed without restriction when the recipient is resident, is restricted or even prohibits when he is a non-resident. The same situation may also be found in the sphere of capital taxation, as regards debts contracted to a non-resident. It is however open to Contracting States to modify this provision in bilateral conventions to avoid its use for tax avoidance purposes.
The problems involve the compatibility and the relation between the Italian law and the treaty law. The provision that is contained in the treaty law is implemented in Italy through an ordinary law; so in this case the Italian law on non-deductible cost and a DTA have the same hierarchic level. The treaty provisions are special laws that modify the ordinary laws and as a consequence the treaty law cannot be derogated by a forthcoming ordinary law if it is not explicitly aimed and specified.
If a DTA between Italy and a Contracting state contain a non-discriminatory clause as the one in art. 24.4 of the OECD model, art. 110.10 TUIR does not apply. Its application can discriminate in the deduction of disbursements if the entity is resident in Italy or in the Contracting Country and will be in breach of the non-discrimination of the OECD model applied in the DTA. The Italian anti-avoidance legislation would be in conflict with the special law as specified by the Convention.
The DTA Italy has signed with the Philippines, Malta, Malaysia, Singapore and Switzerland contain a non-discriminatory clause. If other conditions, such as the exchange of information between the Tax Authorities of the two countries are fulfilled the anti-avoidance legislation does not apply. The notes to the D.M. 24.04.1992 affirm that when between Italy and a contracting state there is a DTA the Italian legislation disallowing the deduction of cost with black list countries does not operate.
In addition and confirming this tendency in many treaties the Italian authorities have opted for adding a reservation on the applicability of while negotiating or renegotiating a DTA on the topic of discrimination. The Italian authorities have done so in the treaty with the United Arab Emirates and the Sultanate of Oman. In both cases has been added a paragraph where is specified that the non -discrimination clause does not operate when the Italian legislation is aimed to prevent tax evasion and tax avoidance.
Compatibility of the CFC rule
The applicability of CFC legislation in the presence of tax treaties is an issue that, on the one hand, involves the anti-abuse purpose of tax conventions and, on the other hand, their business proﬁts provision (article 7 of the OECD type) and their rules on dividends (article 10(5) of the OECD type).
The changes made to the OECD commentary on article 1 on the improper use of tax treaties published in 2003 ﬁrmly afﬁrmed the compatibility of CFC legislation regimes with tax treaties. The speciﬁc provisions of the domestic law of a contracting state that aims to prevent tax abuse, as the CFC legislation does, do not conﬂict with tax conventions.
The same conclusion is reached in the OECD commentaries with respect to articles 7 and 10(5). This is because, under CFC legislation, taxes are levied on the shareholder(s), not involving any taxation at source. In particular, paragraph 10(1) of the commentary on article 7 reads “Paragraph does not limit the right of a Contracting State to tax its own residents under controlled foreign company provisions found in its domestic law even though such tax imposed on these residents may be computed by reference to the part of the proﬁts of an enterprise that is resident of the other Contracting State that is attributable to these residents’ participation in that enterprise. Tax so levied by a State on its own residents does not reduce the proﬁts of the enterprise of the other State and may not, therefore, be said to have been levied on such proﬁts.”
Again, in paragraph 37 of the commentary on the subsequent article 10(5), it is afﬁrmed that “It might be argued that where the taxpayer’s country of residence, pursuant to its controlled foreign company legislation or other rules with similar effect seeks to tax proﬁts which have not been distributed, it is acting contrary to the provisions of paragraph 5. However, it should be noted that the paragraph is conﬁned to taxation at source and, thus, has no bearing on the taxation at residence under such legislation or rules. In addition, the paragraph concerns only the taxation of the company and not that of the shareholder.”
That stated, the compatibility of the Italian CFC legislation requires a step-by-step approach based on three levels of inquiry. The ﬁrst question is whether the OECD commentaries are to be considered as a primary source of interpretation.
If the answer is yes, the analysis stops at this stage with the consequence that the Italian CFC legislation is applicable notwithstanding the presence of a tax treaty due to the general anti-abuse purpose of DTAs. If the answer is no, the second question is related to the anti-abuse purpose of tax treaties.
Agreeing with the general anti-abuse purpose present in the OECD commentaries implies compatibility of the Italian CFC legislation with tax treaties. If the interpreter does not agree with the general anti-abuse purpose and the treaty under analysis does not contain a speciﬁc anti-abuse measure allowing application of the Italian CFC legislation, the issue requires in-depth examination of the taxation method adopted by the Italian legislator. Such an examination will be based on the fact that articles 167 and 168 ITC provide that the CFC income is to be taxed in Italy.
In this context, the Italian tax authorities have stated that the domestic CFC legislation is always applicable regardless of whether the state where the CFC is resident has signed a DTC with Italy or otherwise. It was so until the decision n. 170 of the Tax Court of Bergamo.
The Italian jurisprudence on anti avoidance legislation and the relation with international treaties is controversial on non-deductible costs and very limited on the CFC rule. Actually there is only the decision n.170 of the 12.11.2009 of the Tax Court of First Instance of Bergamo.
With respect to the decisions on non-deduction of costs for purchases from non-resident company that is resident in a PTR territory it is interesting to analyze the position of Corte di Cassazione in two recent decisions, one issued the 23.02.2010 n.4272 and the other one issued the 29.12.2010 n.26298. In addition it is worthy of attention the decision issued by the Tax Court of First Instance of Milan the 20.12.2010 n.338.
The case n.4272 refers to a very complex litigation involving two series of acts a twinned series of judgments at the fist tow judicial levels. The first instance court partly admitted the deduction. On the other side the second instance court partly overturned the decision, accepting entirely the tax authorities position. Also the Corte di Cassazione decided in favour of the tax authorities and based its argumentation on the fact that the anti-avoidance provision acts at a moment logically prior to that in which the treaty and the costs were not linked to genuine transactions with the entity localized in Switzerland. The DTA between Italy and Switzerland was signed in 1976 so the non-discrimination clause added to OECD MC that was added in 1977 is not relevant for the facts of this case. The Court recognized the specificity of the treaty in this case but did not considered it for the solution of the case. It focused its attention on the analysis of the costs. According to this analysis the Court decides that the function of the Swiss company, which acts as a distributor, was not genuine in those transactions. Even though the Corte di Cassazione acknowledged the existence of an actual substance, the presence of a staff and the involvement in several contracts of the company in Switzerland the Court did not recognized its genuine economic function and stated that it was not necessary in the transactions between the Belgium manufacturer and the Italian company. In the Court’s view the Swiss company was a “società cartiera”. This means that it formally exists but in the courts jurisprudence the cost that raise from transactions with this type of companies are non-deductible costs.
Professor Pistone criticizes the Courts argumentation because tax authorities and judicial instances in this way interfere with the business decisions more that it is required to counter wholly artificial transactions. He also criticize the Italian judiciary because “endorsing aggressive reactions of the tax authorities to the business practice of multinational enterprises often ends up in creating a environment hostile to interpretation and a permanent hermeneutic instability, which generally are typical indicators of tax systems that are unable to effectively and proportionately counter abusive techniques.”
The decision n.26298 issued the 29.12.2010 by the Corte di Cassazione firmly states that the taxpayer should prove during the trial one of the conditions established by article 110(11). If the taxpayer is does not prove that the counterpart established in the PTR territory or state run an effective economic activity or is not able to demonstrate the effective economic interest of its operations article 110.10 prevails. For the tax authorities it is sufficient to indicate that the deduction are not allowed by the ITC and the taxpayer has to demonstrate that the safe harbor conditions. In this decision, even though it would have been appropriate for the reasoning to analyze the relation between the domestic anti-avoidance provision and the treaty between Italy and Malaysia, the Court did not examine it. The DTA between Italy and Malaysia contains a non-discriminatory clause on the OECD MC which should be applicable because of the principle of speciality: This means that the treaty even though is prior to the domestic anti-avoidance provision cannot be repealed. The presumption of non-deduction in article 110.10 ITC cannot operate because of the application of the treaty provision and the costs should be deducted as in the case of resident entities.
Contemporary with this decision it was released from the Tax Court of First Instance of Milano judgment n. 338 which may seem in contrast with the tow previous decisions. The court, also in this case, recognizes the importance of the conditions established by article 110.11 ITC. Moreover it affirms that when between Italy and a contracting State there is a DTA that has a non-discriminatory clause as the one in article 24.4 of the OECD MC the Italian domestic anti-avoidance provision does not operate. The judgment states that: “ With respect to the products purchased by from the suppliers located in South Korea the plaintiff evoke the convention on double taxation between the latter and Italy which recognizes the possibility for the buyer to deduct the costs for the purchase of goods; this provision prevails in respect to article 110.10 and there are not any exceptions, this is not challenged by the tax authorities. It is true that the M.D. 23.01.2002 states that in order to apply the provision of article 110.10 ITC it is required to refer to the entities that benefit the concession provided by the Tax Incentives Limitation Law, but as stated before the conventions against double taxation prevails on the domestic provisions, every time that the suppliers does not benefit from this concession.”
With regards to the CFC rule the only decision of the Italian jurisprudence is the one issued by the Tax Court of First Instance in Bergamo issued the 12.11.2009 to reply to a contest to a notice of assessment which was contesting the non inclusion of the income of a CFC located in Cyprus in the tax return of the Italian controlling company. The Italian company intentionally excluded these components of its income after a negative answer to the demand of advanced ruling to the tax authorities for the non-application of the CFC rule. The Italian company in the appeal asked the court to decide on the incompatibility of article 167 ITC with article 7 of the DTA with Cyprus which matches the OECD MC. The Tax Court decide that CFC rule should not be applied when there is a DTA between the PTR territory or state and Italy. The court based its decision on article 7 of the DTA (Art7 Profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits that are attributable to the permanent establishment…) and on article 5.6 (The fact that a company which is a resident of a Contracting State controls or is controlled by a company which is a resident of the other Contracting State, or which carries on business in that other State (whether through a permanent establishment or otherwise), shall not of itself constitute either company a permanent establishment of the other.) This decision differs from the commentary of the OECD model which has not been recalled in the reasoning. The Court applied the treaty passed on the prevalence of the speciality principle.
The decision of the Tax Court which uniforms to the position of the Conseil d’Etat does not give a satisfying motivation and is in conflict with the commentary as it was modified in 2003. At this point it is important to discuss the value of the commentaries and if the modification introduced in 2003 that accepts the use of the CFC rule is still applicable in the case of the DTA between Cyprus and Italy that was signed in 1974.
For a footnoted version of the article and the references contact the author: email@example.com.
- Previous Article Chris Devonshire-Ellis on China’s Latest Economic Figures
- Next Article Shenzhen Issues FAQs on Tax Exemption Policy for Small and Micro-Sized Enterprises