NEWSLETTER N. 1 - 2019

Please find below the news introduced by the Italian legislative decree 142 as of 29 November 2018 (published in the Official Gazette of the Republic of Italy no. 300 as of 28 December 2018) to implement EU directive 2016/1164 (Anti-Tax Avoidance Directive), as effective from the tax period following 31 December 2018.

Such news include a package of measures aimed to tackle tax avoidance practices related to:

• interest deduction (section 96 of the Italian Tax Code - TUIR);
• the exit tax on assets transferred abroad and the value determination of incoming assets (section 166 and section 166-bis of the Italian Tax Code - TUIR);
• the rules on controlled foreign companies (CFC) (section 167 of the Italian Tax Code - TUIR);
• the definition of financial intermediaries (section 162-bis of the Italian Tax Code - TUIR);
• hybrid mismatches.

First of all, a new definition of interest is provided. More specifically, interest payments and interest income include:

• interest qualifying as such under the accounting principles and confirmed as such under current tax provisions;
• deriving from a transaction or a financial relationship or a relationship with a significant financing component.

The limitations under section 96 of the Italian Tax Code (TUIR) are extended also to:

• interest payments included in the cost of assets under section 110 (1b) of the Italian Tax Code (TUIR),
• interest payments for mortgage-backed loans on properties rented out ^[1].

Under certain conditions, however, the limitations under section 96 of the Italian Tax Code (TUIR) do not apply to interest payments relating to loans used to finance long-term public infrastructure projects under the Italian legislative decree 50/2016, chapter V.

Moreover, it is confirmed that the limitations under section 96 of the Italian Tax Code (TUIR) do not apply neither to financial intermediaries (as defined under the new section 162-bis of the Italian Tax Code) nor to interest paid by insurance companies and parent companies of insurance groups, which are deductible at 96 percent of their amount.

Interest payments and similar financial charges (hereinafter referred to shortly as "interest payments") are deductible in each tax period up to the amount of interest income and similar financial income (hereinafter referred to shortly as "interest income").

If interest income exceeds the interest payments, any interest income in excess may now be carried forward to subsequent tax periods. Hence, as of subsequent tax periods, interest payments shall be deductible up to the amount of interest income not only of the current tax year but also of previous tax years.

In addition, interest payments exceeding interest income may be deducted up to the limit of 30 percent of EBIT generated from ordinary business activities in the tax period. Any contingent interest payments in excess - compared to interest income and the 30 percent limit of the current tax period - are deductible up to the limit of 30 percent of EBIT carried forward in the five previous tax periods, starting from the most recent one (previously, however, there was no time limit for EBIT to be carried forward).

EBIT is confirmed to equal the difference between income and expenses from ordinary business activities (items A and B under section 2425 of the Italian civil code, except for item no. 10 letters a) and b), and lease payments for capital goods). Nonetheless, it is now supposed to equal the EBIT amount calculated to determine business income.^[2]  Furthermore, extraordinary components from business transfers are no longer excluded from EBIT.

Finally, interest payments that exceed interest income and 30 percent of EBIT, regardless of whether they belong to the current year or are carried forward, may be deducted in subsequent tax periods up to an amount equal to the difference between: ^[3]

1. interest income of the tax period and 30 percent of EBIT,
2. interest payments of the tax period.

In the event of group taxation, interest payments in excess that cannot be deducted by the consolidated company may be deductible from group income, if and limited to the extent in which the other consolidated companies report

1. EBIT in excess and/or
2. interest income in excess,

in the same period, or even related to previous financial years, and provided that such amounts were generated under the domestic or worldwide group taxation regimes.

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Finally, please note that the EBIT (<<book value>>) of the tax period as of 31 December 2018 may be used in order to deduct interest payments incurred for loans concluded before 17 June 2016 only, provided that the term or the amount borrowed have not been modified after such date. More specifically, such interest is deductible for an amount equal to the sum resulting from:

30 percent of EBIT generated as of the third tax period after 31 December 2017 and, provided that it has not been used for interest payment deduction under section 96 of the Italian Tax Code (TUIR) previously in force at the end of the tax period as of 31 December 2018.

the amount deductible under the revised section 96 of the Italian Tax Code (TUIR).

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[1] Please be advised that the Italian Budget Law 2019 is effective as of 1 January 2019 (Law no. 145 as of 30 December 2018 published in the Official Gazette of the Republic of Italy no. 302 as of 31 December 2018) set forth as follows: <<Due to the failure to adopt the revised provisions on direct and indirect taxation of real estate companies, the provisions …>> under section 1 (36) of the Italian law 244/2007 <<.. apply and remain in force unchanged>>. Hence, interest payments for mortgage-backed loans on real estate properties rented out continue to be excluded from the provisions under section 96 of the Italian Tax Code (TUIR).

[2] In order to calculate EBIT:

The new provision sets out in detail the individual scope of application of the so-called exit tax.

The exit tax applies whenever taxpayers carrying on a trade business in Italy - be they resident in Italy for tax purposes or permanent establishments in Italy of non-residents - transfer (i) their fiscal residence (ii) the permanent establishment (iii) the assets abroad.

In such cases the capital gain generated from the difference between:

1. the market value,
2. and the fiscally recognized cost,

of the assets and liabilities or the assets transferred abroad is subjected to taxation.

Losses incurred in previous years may be deducted from the capital gain determined in such way, in compliance with the criteria set forth under the new section 166-bis.

Under certain circumstances the taxes calculated on the capital gain, net of losses, may be paid in five annual instalments.

The new provision sets out in detail the prerequisites required to determine the fiscal value of:

1. assets and liabilities, and
2. assets,

transferred to Italy and referred to taxpayers resident abroad for tax purposes or foreign-based permanent establishments of taxpayers resident in Italy.

The incoming tax value equals:

1. the market value of assets and liabilities and assets of taxpayers resident for tax purposes in Italy or in an EU country or in a country ensuring an appropriate information exchange;
2. the market value set forth further to an advance ruling under section 31-ter of the Italian DPR 600/1973 for taxpayers resident for tax purposes in a country that does not ensure an appropriate information exchange;
3. the lowest value amongst the cost of purchase, the book value and the market value at arm's length as regards assets, and the highest value amongst them as regards liabilities for taxpayers resident in a country which does not ensure an appropriate information exchange, and in the absence of an agreement.

In order for the CFC provisions to be applicable, non-resident companies/businesses/entities are deemed controlled, if the Italian taxpayer:

1. holds direct or indirect control under section 2359 of the Italian Civil Code;
2. owns - directly or indirectly - more than 50 percent of the profits distributed.

Furthermore,

1. foreign-based permanent establishments of non-resident controlled taxpayers;
2. foreign-based permanent establishments of resident taxpayers that opted for the branch exemption scheme;

are deemed controlled taxpayers.

The new provisions no longer distinguish between black list and white list countries. The CFC provisions apply if the non-resident controlled taxpayers jointly meet the following prerequisites:

1. they are subject to actual taxation of less than half of the taxes applicable in Italy (simplification criteria for comparison are still to be defined by decree);
2. more than 1/3 of their income qualifies as:

• interest or other income generated by financial assets;
• royalties or other income generated from intellectual property;
• dividends and capital gain;
• income from financial leasing;
• income from insurance, banking and other financial activities;
• income from infra-group sales of goods or services with no or little <<added economic value>>.

CFC provisions do not apply if the Italian taxpayer proves that the foreign controlled taxpayer carries on a substantive economic activity supported by staff, equipment, assets and premises. To this end an application may be filed with the Italian Revenue Agency.

The newly introduced section 47-bis of the Italian Tax Code (TUIR) provides a definition of businesses and entities resident or situated in countries or territories with a privileged tax regime for the purpose of dividend and capital gain taxation.

More specifically, the tax regimes of countries other than EU or EAA countries with which there is an agreement on the exchange of information in place are deemed privileged if:

1. an Italian taxpayer holds control - as defined under the CFC provisions - of a foreign taxpayer subject to actual taxation of less than half of the taxes applicable in Italy;
2. in the absence of control, if the par value of taxation is lower by 50 percent of that applicable in Italy.

However, the Italian taxpayer is allowed to prove - even by filing a request for advance ruling - that:

1. the foreign taxpayer carries on a substantive economic activity supported by staff, equipment, assets and premises;
2. equity investments do not cause income to be transferred to countries or territories with a privileged tax regime.

In the absence of an advance ruling or of a negative answer to such advance ruling, for capital gain purposes, the condition under b) must be met uninterruptedly from the first period of possession; however, in the event of relationships held for more than 5 tax periods and capital gains earned with counter-parties that do not belong to the same group, it is enough that such condition is met uninterruptedly for 5 tax periods before the capital gains are realized.

The newly introduced section 162-bis of the Italian Tax Code (TUIR) provides a definition of:

• financial intermediaries,
• financial holding companies;
• non-financial holding companies and similar companies.

The provisions apply as of the tax period 31 December 2018.

The changes will have an impact also on IRAP (regional tax on productive activities).

Finally, the Anti-Tax Avoidance Decree (ATAD) introduces a package of measures on hybrid mismatches with the aim to tackle phenomena of double deduction or <<deduction without income inclusion>> (deduction of a negative income component in one country without any taxation in the other country) due to a different characterization of financial instruments, payments, entities and permanent establishments in various countries.

Such mismatches are those registered at international level. Any domestic mismatches continue to be tackled through general anti abuse rules.

The provision providing for expenses on commercial papers, bonds and similar securities pursuant to the Italian legislative decree 239/1996 to be deductible in the business year in which they are incurred, regardless of how and when they are recorded in the balance sheet, has been repealed.