The Italian tax authority published Resolution No. 125/E/2021 (Resolution 125), on February 12, 2021, confirming a previous interpretation in 2019 (Resolution No. 76/E/2019) and providing further clarification on the Italian withholding tax (WHT) exemption on interest paid by an Italian borrower under a medium/long-term loan granted by its controlling collective investment fund.
In particular, Resolution 125 confirms that the tax exemption also applies also to direct lending granted by a non-regulated private equity fund to its Italian subsidiary to the extent that the asset manager of the fund is a regulated entity pursuant to the local regulatory legislation.
Ordinary Tax Treatment of Loans Granted to Italian Borrowers
As a general rule, any interest or income derived from a loan granted by a foreign entity to an Italian company is subject to WHT at a 26% tax rate.
The Italian borrower, as a beneficiary of the loan, is required to apply the WHT on interest paid to the foreign lender, according to Article 26, paragraph 5-bis of the Presidential Decree of September 29, 1973, No. 600 (WHT Exemption Provision). The domestic WHT rate may be reduced pursuant to the relevant tax treaty provisions, if applicable.
Qualifying loan facilities may benefit from an interest WHT exemption. Such exemption applies to interest paid by an Italian company under loans:
- granted by credit institutions established in a member state of the EU, entities identified in Article 2 (5) of Directive 2013/36/EU, insurance companies authorized in accordance with regulations issued by member states of the EU or by “white-listed” foreign institutional investors as per Article 6 (1) b) of legislative decree No. 239 of April 1, 1996, subject to supervision in the foreign countries in which they are established; and
- with a medium/long-term maturity (i.e. with a final maturity exceeding 18 months) granted to Italian “commercial enterprises” including holding companies and real estate companies but excluding Italian collective investment funds.
In practice, since the introduction of the law, the main entities entitled to carry out this funding activity in favor of Italian companies (apart from in limited cases) were the EU-based credit institutions; from an Italian banking regulatory perspective, all other entities mentioned above were not allowed, other than those authorized, to grant loans to Italian borrowers. The interest WHT exemption applies only provided that the lender is authorized to carry out financial and banking activity with regard to the public pursuant to the Italian Banking Act (TUB) approved by Legislative Decree No. 385 of September 1, 1993.
The practical case submitted to the Italian tax authorities was similar to the one addressed by Resolution No. 76/E/2019 of August 12, 2019, where a regulated asset manager of several U.K. funds was tax resident in Guernsey (U.K.) and supervised by the local authority, the Guernsey Financial Services Commission (GFSC).
The regulated asset manager filed a tax ruling requesting clarification on the WHT treatment applicable on interest paid by an Italian borrower to its indirect controlling collective investment funds (lender) in relation to a medium/long-term loan (exceeding 18 months) granted to the Italian borrower.
The tax authorities replied confirming that the tax exemption was applicable because all the conditions were satisfied, and in particular that the lender was an “institutional investor” regulated by the GFSC.
With Resolution 125, the Italian tax authorities analyzed the interest tax treatment of a medium/long-term loan granted under a similar scheme, as described below:
- a regulated asset manager tax resident in the U.K and subject to the supervision of the local regulator, the Financial Conduct Authority (FCA), manages (on the basis of a management agreement with the general partner) several U.K. funds. Both the (U.K.) general partner and the funds are not regulated entities and the funds control a standard two-tier U.K. holding structure, i.e. UK1 which controls UK2;
- UK2 then controls 100% of an Italian holding company (ITAHoldCo) which is the special purpose vehicle (SPV) investing in Italian target companies.
On this basis, the asset manager asked the Italian tax authorities whether the fund could be considered as a foreign institutional investor and, accordingly, if the interest received by ITAHoldCo, under a medium/long-term loan aimed at funding the acquisition of an Italian company, could be tax exempt pursuant to the WHT Exemption Provision.
Although the fund was not authorized to carry out activities regulated under the U.K. Financial Services and Markets Act, nor financial and banking activities relating to the public pursuant to the TUB, nevertheless the Italian tax authorities considered the fund a qualified lender pursuant to Article 26, paragraph 5-bis of Presidential Decree No. 600/1973.
In particular, Resolution 125 confirmed the tax exemption on interest paid by ITAHoldCo, referring to Ministerial Decree No. 53 of April 2, 2015 which states that “the activity of granting loans shall be deemed to be carried on vis-à-vis the public if it is carried on vis-à-vis third parties in a professional manner and on a professional basis and that all activities performed exclusively in favor of the belonging group are not considered to be transactions vis-à-vis the public.”
On this basis, the loans being granted by the fund in favor of an indirectly controlled Italian company (ITAHoldCo), the fund itself does not carry out a financing activity vis-à-vis the public.
Therefore, the Italian tax authorities confirmed that all the following conditions provided by the WHT Exemption Provision were satisfied:
- the loan has a maturity exceeding 18 months;
- the fund is incorporated in a country (U.K.) which exchanges tax information with the Italian tax authorities (the White List);
- the beneficiary of the loan is an Italian company (ITAHoldCo);
- the fund’s asset manager is subject to the supervision of the local regulatory authority (FCA); and
- the fund is qualified as a foreign institutional investor that does not carry out activity vis-à-vis the public.
With all the conditions for the tax exemption satisfied, the Italian tax authorities concluded that interest paid by ITAHoldCo to the fund may benefit from the exemption.
- Resolution 125 confirms new structuring opportunities for White List collective investment funds to finance private equity investments into Italy which may in part disintermediate the banking system in financing the acquisition of shares or assets (or going concerns) of Italian target companies.
- The innovative part of Resolution 125 is that, even if the fund and its general partner are both not “regulated entities,” nevertheless since the asset manager (in charge of the funds management) is an entity subject to the supervision of the local regulator (FCA), the funds are deemed to qualify for the tax exemption as a foreign institutional investor since the loan is granted in favor of its indirectly controlled Italian company.
- This principle applies to any fund and asset manager subject to the supervision of a local authority to the extent that they are incorporated in a country included in the White List of countries that exchange tax information with the Italian tax authorities (i.e. in addition to EU and OECD countries, Switzerland, Jersey, Guernsey, British Virgin Islands, Cayman Islands, Hong Kong, Singapore, etc.).
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Francesco Bonichi is Tax Partner and Antonio Festa is Tax Associate at Caiazzo Donnini Pappalardo & Associati.