The recent 2021 Budget Law (the Budget Law) (Article 1, paragraphs 631-633) provides for the Italian tax exemption of Italian source dividends and qualified capital gains on Italian shares earned by European UCITS (Undertakings for the Collective Investment in Transferable Securities) and qualified AIFs (Alternative Investment Funds). A similar exemption was already in place for Italian UCITS. The tax exemption applies for the future although there are good arguments that the tax exemption should have a retroactive effect. Such tax development might also have additional positive effects for the private equity (PE) market.
New Tax Rules Aim to Avoid EU Discriminatory Tax Procedure
The previous tax regime provided that Italian dividends paid to Italian regulated UCITS and qualified AIFs (i.e., whose asset manager was subject to regulatory supervision), were exempt from income tax and withholding taxes. Conversely, dividends paid by Italian companies to foreign UCITS and mutual funds were subject to a 26% final withholding.
Similarly, capital gains deriving from qualifying shareholdings in Italian companies (defined by Article 67, paragraph 1 c) of the Italian Tax Code) were exempt if earned by Italian funds and subject to a 26% final substitute tax if realized by foreign funds.
These provisions were discriminatory and contrary to the Treaty on the Functioning of the European Union (TFEU) principle of free movement of capital within the EU, and necessarily impacted the investment decisions of potential investors, damaging non-Italian private equity funds holding a qualified stake in Italian companies.
New Tax Exemption Limited to European and EEA Funds
The Budget Law equalizes (from January 1, 2021) the tax treatment of dividends and capital gains earned by UCITS and qualified AIFs established in EU member states (or in states signing the Agreement on the European Economic Area (EEA) and which grant an adequate exchange of information), with the tax treatment of dividends and capital gains earned by Italian mutual funds. The tax exemption, already applicable to Italian funds, is therefore also extended to EU UCITS and qualified AIFs which, therefore, will no longer be subject to the Italian final 26% withholding tax.
In particular, the Budget Law amends Article 27 of Presidential Decree No. 600/1973 in order to extend the tax exemption on Italian dividends paid to mutual funds (UCITS compliant with Directive No. 2009/65/EC or AIFs whose manager is subject to regulatory supervision in the country of establishment pursuant to Directive No. 2011/61/EU) established in EU member states and in states signing the Agreement on the EEA and granting an adequate exchange of information. Similar provisions have been introduced on taxation of capital gains on Italian equities.
As clarified in the explanatory note to the Budget Law, the genesis of the law amendment is based on the circumstance that the European Commission had already started an investigation against Italy (EU PILOT 8105/15TAXU) concerning the discriminatory treatment of European funds with regard to Italian funds, as described above.
In order to avoid the incoming infringement procedure, the Italian government approved the necessary amendments in the Budget Law aimed at “overcoming such differences” of tax treatment with European funds. It is worth noting that the discriminatory treatment is still in place regarding regulated funds set up in third countries which have similar features to European regulated funds.
New Tax Rule Might (Indirectly) have Further Positive Impact on PE Market
As already mentioned, the risk of an infringement procedure in respect of the different tax regimes applicable to Italian funds compared to foreign funds which invest in Italian equities was based on the violation of the principle of free movement of capital that represents a fundamental principle of the TFEU and that may be invoked by any interested party including any UCITS incorporated in a third country investing into the EU.
In particular, the Court of Justice of the European Union (CJEU) has on several occasions deemed national tax provisions treating domestic UCITS differently from those established in other EU member states to be discriminatory, declaring the domestic legislation non-compliant with the fundamental freedoms laid down in the TFEU and, in particular, with the free movement of capital, as per Article 63 of the TFEU (Case C-480/16, Fidelity Funds).
The legal background of the new Italian tax rules and the CJEU case law might legitimately support the initiative of mutual funds incorporated in third countries outside of the EU and EEA to invoke the extension of the tax exemption also to Italian dividends and capital gains arising on their Italian equity investments.
As confirmed in several decisions of the CJEU, the principle of free movement of capital provided by the TFEU is in the interest of the EU single market, and EU member states should not discriminate between investments into the EU, regardless of their EU/extra-EU nature; so the principle may be invoked by any interested party, including mutual funds incorporated in third countries (without prejudice to the exceptions set forth by Article 64 of the TFEU with regard to capital flows from third countries).
In particular, in the case at stake, certain arguments which previously justified a more burdensome tax regime for non-EU entities, based on the lack of mutual tax cooperation agreements, cannot be supported, since the Italian tax authorities in many circumstances treat EU regulated funds, and funds subject to a local supervisory authority when incorporated in a “whitelist” country which exchanges information with the Italian tax authorities, in the same way.
A further relevant positive impact of these tax provisions on the PE market is represented by the new tax exemption on pending tax litigations and likely future tax assessments. Indeed, following tax circular n. 6/2016, Italian tax authorities challenged non-Italian PE funds which invested in Italian companies through a European holding company. These structures were deemed tax abusive if the European holding did not satisfy a functional and operational substance test. The interposition of a European holding consented to European and third-party mutual funds to mitigate and significantly reduce the amount of Italian taxes on dividends and capital gains deriving from Italian investments.
The new tax rules should avoid future tax challenges and likely contribute to define pending tax litigation with EU funds, such Italian income being per se exempt.
Tax Exemption Should Have Retroactive Effect
The relevant law amendment provides that the tax exemption applies only to dividends paid and capital gains realised following the effective date of the provision (January 1, 2021).
In this regard, there are well-grounded arguments on the illegitimacy of the timing of the effectiveness of these provisions, which only exempt future dividends and capital gains earned by EU qualified mutual funds. Tax literature recognizes similar cases in which Italian law has (illegitimately) provided only for future effectiveness in circumstances of clear non-compliance of Italian tax provisions with the TFEU and regulations.
We may recall the 2008 Budget Law which reduced, with future effect only, the level of taxation of dividends paid to companies established in EU member states (and in states signing the Agreement on the EEA), at the same level applicable to dividends distributed to Italian companies. As in the present case, the law amended aimed at removing the discriminatory tax treatment of dividends in accordance with the EU principles of non-discrimination, freedom of establishment and free movement of capital.
The CJEU concluded that the limitation to the retroactivity of the amending provision was contrary to EU law (case C-540/07 of November 19, 2009), thereby confirming that the tax claims of undue taxes paid before 2008 were legitimate. The conclusions of the CJEU have been also reflected in a tax authority circular (n. 32/E of July 8, 2011), that clarified the conditions to obtain tax refunds for EU companies which appropriately filed the tax claims.
It is worth noting that the main condition in order to have a chance to obtain tax refunds on taxes paid on dividends and capital gains is to interrupt the statutory limitation period claiming the tax refund within 48 months from the date of tax payments or withholdings.
The Budget Law introduced a provision long awaited by the PE market.
- EU and EEA UCITS and regulated AIFs are exempt from Italian taxation on capital gains and Italian source dividends paid under qualified Italian equity investments. The provision equates the tax treatment of Italian and EU/EEA regulated funds.
- The new provision applies only for the future and is not retroactive; however, the non-retroactivity is legally arguable in light of CJEU case law on tax discrimination.
- Asset managers of non-Italian funds—conservatively—should seek advice to ascertain the conditions to claim the tax refunds of Italian taxes paid on Italian source dividends and capital gains, in order to timely submit the related tax claims within the statutory limitation period.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Francesco Bonichi is Tax Partner at Caiazzo, Donnini, Pappalardo & Associati.
The author may be contacted at: email@example.com