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02 May 2008
Corporate Tax Rate
Depreciation of Assets and Leasing Expenses
Difference between Accounting and Tax Bases
From Blacklist to Whitelist
Outbound Withholding Tax on EU Dividends
Revaluation of Participations and Lands for Building and Agricultural Activity
Transformation or Liquidation of Dormant Companies
Neutral Regime for Contributions
Regional Income Tax
International Accounting Standards
On December 21 2007 the Senate approved Finance Bill 2008 as Law 244/2007, which was published in the Official Gazette on December 28 2007 and came into force on January 1 2008. It includes significant changes to the tax system, particularly with respect to corporate income tax and regional income tax. The measures have been set out in a government report.
The report acknowledges a general tendency in Europe towards lowering corporate tax rates and broadening the taxable base. Therefore, the report envisages a reduction in corporate income tax rates from 33% to 27.5% for the financial year beginning on January 1 2008 and a reduction in regional income tax rates from 4.25% to 3.9% in the same period.
The government plans to compensate for these cuts with an increase in taxation on dividends and capital gains.
The exemption on capital gains realized by Italian corporations and branches of foreign companies in Italy (except passive companies and foreign blacklisted entities) on the disposal of shares or quotas of subsidiaries’ investments has been increased from 84% to 95%. Accordingly, the rate on the disposal of shares or quotas for Italian corporations and branches has been reduced from 5.25% (ie, 33% on 16%) to 1.375% (ie, 27.5% on 5%).
Moreover, a recapture rule has been introduced whereby the 84% capital gains tax exemption remains in force for gains realized from January 1 2008 to the extent that the investment has been written off by the taxpayer. As write-offs of investments were allowed under tax law provisions that applied generally until December 31 2004, the recapture proposed under the bill appears to have a retroactive effect.
The bill introduces significant changes to interest deductions.
Thin capitalization rules, aimed at limiting the deduction of financial expenses connected with credit and loan facilities granted or secured by a qualifying shareholder or a related party, have been repealed with effect from January 1 2008. Also repealed from this date are the equity pro rata rules which were aimed at limiting the deduction of interest if, at the end of a fiscal year, the book value of shares qualifying for the participation exemption regime exceeded the net equity of the company holding the shares.
These rules have been replaced by a new general restriction based on an earnings before depreciation, interest, taxes and amortization test. The new rule provides that interest expenses, net of interest income, are deductible up to a value equal to 30% of the taxable amount of earnings before depreciation, interest, taxes and amortization (EBITDAX); this amount is calculated as the difference between gross revenues and production costs before depreciation and amortization of assets. Interest expenses in excess of this amount may be carried forward to future fiscal years.
The EBITDAX quota (in excess of interest expenses) realized from the third fiscal year following that commencing after December 31 2007 can be used to increase the EBITDAX amount for the following fiscal years.
The bill seems to suggest that EBITDAX is calculated on the basis of a company's financial statements, gross of applicable tax adjustments. This may give rise to incorrect double taxation. If the relevant company is part of a consolidated taxpaying entity, interest expenses in excess of one taxpayer's EBITDAX amount (subject to the 30% test) may be freely allocated to the taxable income of the consolidated taxpaying unit, provided that other companies in the consolidation have an excess EBITDAX quota. This rule also applies to excess amounts carried forward. To this extent, branches of foreign companies and foreign companies that may choose national or worldwide tax consolidation can be considered part of the pool of taxpayers to which interest expenses on EBITDAX can be allocated.
Banks, insurance companies and financial companies, except for holding companies, are excluded from the new regime. Domestic partnerships also fall outside the scope of the limitation.
Under the rules which applied before the bill came into force, straight-line depreciation of tangible assets was deductible to a value up to twice the maximum amount established by decree by the Ministry of Economics and Finance in the three years following the acquisition (in the case of new assets) or in the first year (in the case of used assets) - this is termed 'accelerated depreciation'.
The new legislation has abolished this regime and depreciation will be allowed on a straight-line basis.
Except for specific assets (ie, cars and other motor vehicles), the reduction to half of the depreciation rate, applicable in the first year of acquisition, does not apply for the fiscal year beginning after December 31 2007.
The leasing expenses deduction has been further restricted: rental payments are deductible on condition that the leasing contract lasts for at least two-thirds of the depreciation term established by the ministry's decree. For real property, if the 'two-thirds rule' gives rise to a leasing contract term shorter than 11 years or longer than 18 years, the deduction is allowed if the leasing contract term is not shorter than 11 years or at least 18 years.
Interest expenses implicitly accounted for in the leasing contract are subject to the interest expenses limitation.
Under the rules applicable before the bill entered into force, companies which were part of a tax consolidation were free to: (i) transfer assets which did not give rise to profits (ie, which were not inventory assets of the transferring company) among other companies that had opted for tax consolidation (ie, domestic group relief); and (ii) enjoy 100% tax exemption when distributing dividends within such companies.
The bill repealed both rules. Dividends distributed among consolidated companies are subject to 5% taxation - that is, an effective rate of 5% of 27.5% (ie, 1.375%).
This substantially reduces the advantages of opting for tax consolidation, the benefits of which are further limited by the fact that the equity pro rata exemption under the previous rules has been repealed.
Companies opting for tax consolidation will be able to realign the tax basis of shares previously written down for tax purposes under the pre-2006 tax regime by paying a 6% realignment tax
The bill withdraws the right - introduced under the previous tax reform regime from January 1 2004 - to deduct certain costs even if they were not accounted for in the income statement. The costs in question related to:
The tax deduction in excess of the accounting deduction was allowed only for specific items and on condition that a corresponding amount of equity reserves (net of deferred taxes on the deducted amounts) was taxable upon distribution, unless an amount of equity reserves equal to the tax deduction in excess remained available after distribution.
The strengthening of the derivative principle means that tax deduction in excess is no longer available and the tax authorities are entitled to disregard the accounting choices made by taxpayers where these are inconsistent with the positions that the taxpayers have taken in previous fiscal years. However, taxpayers are entitled to submit evidence to demonstrate sound business reasons for such choices.
A grandfathering rule has been introduced to: (i) allow equity reserves to be freely distributable upon payment of a 1% substitute tax; and (ii) allow for the realignment of the assets on which a tax deduction in excess of an accounting deduction was made in previous years by payment of a substitute tax at 12% for up to €5 million of step-up, 14% for between €5 million and €10 million, and 16% for over €10 million.
A taxpayer may also make a partial realignment, but the assets on which the step-up is requested must be in the same category.
Under rules applicable before the bill entered in force, Italian tax law included a comprehensive set of anti-abuse rules on offshore and tax haven companies. These rules, aimed at avoiding the allocation of income to foreign subsidiaries located in certain low-tax jurisdictions, included provisions that:
The blacklist will be replaced by two whitelists.
The first list will be based on exchange of information rules and will apply to all tax provisions aimed at recognizing the effectiveness of the underlying transaction with a blacklisted entity (ie, costs incurred in relation to blacklisted entities).
The second list, which will be based on both exchange of information rules and taxation levels, will apply to all tax provisions aimed at avoiding double taxation (eg, participation exemption and capital gains provisions). Accordingly, the limitation of an advantage provided to foreign entities (eg, the withholding tax exemption on securitization or real estate investment fund proceeds) will be conditional on the foreign country of residence being whitelisted. However, this provision will not become effective until the fiscal year following that in which ministerial decree is issued to introduce and outline the two whitelists.
Under rules applicable before the bill entered in force, dividends paid by an Italian company to corporate shareholders that were resident in an EU or EEA country were subject to 27% withholding tax on 100% of the distributed amount.
In light of the harmonization of dividend taxation in the European Union and the fact that taxation of outbound dividends at a rate higher than that applied to domestic dividends contravenes both the EC Treaty and the EEA Agreement,(1) the 27% withholding tax rate has been reduced to 1.375% (ie, 27.5% on 5% of the distributed amount).
This reduction applies regardless of any reduction of the withholding tax under a double taxation treaty and/or the parent-subsidiary withholding tax exemption. Only EU and EEA companies on one of the two whitelists may qualify.
The bill has reintroduced an elective regime providing for the revaluation of the tax basis of participations (ie, shares, quotas and rights) in unlisted companies and land held as of January 1 2008.
Revaluation is available only if the owners are resident individuals, non-commercial partnerships or non-resident persons (for a participation not held through a participation exemption). However, in the last case the non-resident owner will not be entitled to rely on the provisions of a tax treaty (eg, through the use of a 1929 Luxembourg holding company) or a treaty which provides that share gains may also be taxed in the source country.
The revaluation is executed according to the value appreciating to the company as at January 1 2008, pursuant to an appraisal drawn up by June 30 2008.
The revaluation is recognized upon payment of substitute tax on the appreciated value of the appraisal. The tax rate is 4% for land or for a qualified participation and 2% for a non-qualified participation.(2) The substitute tax can be paid in a one-off payment by June 30 2008 or in three annual instalments of the same amount - interest at 3% a year will be due on the second and third instalments.
The bill has reintroduced a fiscal incentive for taxpayers wishing to (i) dissolve a dormant company or a company in its first year of activity, or (ii) transform such a company into a simple partnership.
They may do so on condition that:
Favourable tax treatment consists of the reduction of corporate income tax and elimination of shareholder-level tax. Income, recognized upon liquidation or transformation of the arm's-length value of the assets, is subject to a substitute tax in lieu of corporate income tax and regional income tax at 10%.
A substitute tax of 5% applies the event of the distribution of the revaluation surplus.
Under Law 244/2007 contributions to a going concern in exchange for shares will be tax-neutral, as the relevant optional regime has been repealed and an elective regime for step-up in the value of the assets contributed has been introduced. The rates are:
Substitute tax can be paid in three annual instalments at 30% in 2008, 40% in 2009 and 30% in 2010. Interest will be due on the second and third instalments at 2.5% a year.
The same election and tax rates are available if the taxpayer is involved in a merger (whether downstream or upstream), a spin-off or a demerger. However, the step-up is available only on condition that the assets are either tangible or are recorded as fixed assets.
The bill introduces significant changes to regional income tax. Apart from a rate reduction from 4.25% to 3.9%, the main difference is that the taxable basis for regional income tax will not be determined according to consolidated corporate income tax rules. Rather, it will be calculated as the difference between general income and production costs. (Under the income statement scheme set out in EU Directive 78/660/EEC, this is equivalent to items under A minus items under B.) The calculation excludes:
Taxpayers may not deduct (i) expenses related to personnel costs or similar costs not accounted for under B9,(3) or (ii) interest on expenses implicitly included in leasing payments, losses on receivables and communal estate tax.
Contributions paid to the taxpayer under the provisions of a law (except where related to non-deductible costs) are taxable, as are capital gains and losses on disposal of real properties where the latter are not considered depreciable assets or inventory.
The amortization of goodwill and trademarks is deductible regardless of how they are recorded in the income statement. This provision is aimed at allowing a deduction for companies which adopt international financial reporting standards and then subject goodwill and trademarks to the impairment test, rather than to amortization. Companies adopting such standards are required to determine the appropriate regional income tax basis using the income and production cost items which correspond to those specified in the law.
The abolition of the tax deduction in excess of the accounting deduction also affects the basis for regional income tax: the differences in the tax bases of the assets which were subject to a tax deduction in excess of the accounting deduction under the previous regime will be released for regional income tax purposes by subjecting them to tax for six fiscal years from 2008.
It is as yet unclear whether the 1% substitute tax on equity reserves also applies for regional income tax purposes and whether the application of the step-up at 12%, 14% or 16% operates as an alternative to taxation for six fiscal years.
The bill introduces changes reflecting the coordination between corporation tax rules and the international accounting standards (IAS) introduced by EU Regulation 1606/2002.
Before the bill was introduced, two basic principles applied under Decree-Law 38/2005.
First, the derivative principle provided that the taxable base of a company was determined according to net income, plus or minus the elements that were required to be included in the balance sheet under IAS or IFRS.
Second, the neutrality principle provided that equal treatment be accorded to companies adopting IAS or IFRS and companies adopting Italian generally accepted accounting principles.
Law 224/2007 modifies the neutrality principle and strengthens the derivative principle. In principle, assessments of a company's tax basis for consolidated corporate tax and regional income tax must take into account the costs and profits directly assigned to the profit and loss account with the exception of goodwill and trademark amortization, which remains deductible over 18 years even if not accounted for in the statutory income statement;
A different fiscal rule applies for other accounting items as follows:
(2) For unlisted companies, a non-qualified participation is a participation with no more than 20% of the voting rights in the ordinary shareholders’ meeting or no more than 25% of the issued capital.
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