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February 23, 2022

Italy issues final guidance on hybrid mismatches

Executive summary

The Italian Tax Authorities issued Circular Letter n. 2/2022 on hybrid mismatch rules (the Circular) in January 2022. The Circular provides interpretations and examples on the provisions governed by Decree 142/2018 which implemented the European Union (EU) Anti-Tax Avoidance Directive (ATAD) in domestic law. The Circular follows a public consultation period (from October 2021 to 19 November 2021) during which stakeholders could provide comments on a previously circulated draft. Among some few differences with the document published for consultation, the Circular states that anti-hybrid rules may not apply to tax consequences of hybrid mismatch events that occurred (for calendar year companies) prior to 31 December 2018 as compared to 31 December 2016 as set forth by the previous draft.

This Alert summarizes the key topics addressed by the Circular.

Detailed discussion

Relevance of the Organisation for Economic Co-operation and Development (OECD) Base Erosion and Profit Shifting (BEPS) Action 2 reports

Principles and examples included in the OECD (2015), Neutralising the effects of hybrid mismatch arrangements, Action 2 -2015 Final Report, and in the OECD (2017), Neutralising the Effects of Branch Mismatch Arrangements, Action 2: Inclusive Framework on BEPS, are explicitly identified as sources of interpretation of the Italian anti-hybrid rules of Decree 142/2018 (Italian ATAD Decree).

Qualifying taxes for “deduction” and “inclusion” purposes

The Circular clarifies that the Italian ATAD Decree applies to the Italian corporate income tax (IRES) and the Italian individual income tax (IRPEF) but it does not apply to the regional tax on production activities (IRAP). With reference to foreign jurisdictions, the Italian anti-hybrid rules take into consideration any tax covered by a bilateral tax treaty in place with the relevant country. However, if the applicable treaty also includes local taxes (i.e., regional, cantonal etc.), the anti-hybrid rules will only consider taxes imposed at the highest governmental level (e.g., at the federal level). Absent a bilateral tax treaty, reference is made to taxes with the same or equivalent nature of the Italian taxes applied at the highest governmental level.

Effective date of the Italian ATAD Decree

The Italian anti-hybrid rules apply as of the financial year starting after the one ongoing on 31 December 2019 (i.e., as of 2020 for calendar year companies). Rules applying to (Italian) reverse hybrids apply as of the financial year starting after the one ongoing on 31 December 2021 (i.e., as of 2022 for calendar year companies).

Tax attributes with a hybrid origin

Generally, the Italian anti-hybrid rules should not apply to tax consequences of events occurred prior to the above-mentioned date, e.g., to tax loss carryforwards, amortizations/depreciations and excess interest deductions derived from hybrid structures in place prior to the entry into force of the Italian anti-hybrid rules, except for some tax attributes specified in the Circular (see Cut-off date of 31 December 2018 section below).

Cut-off date of 31 December 2018

As an important exception to the above-mentioned effective date, the Circular states that amortization and depreciation fall under the anti-hybrid rules even if the relevant tangible or intangible assets were acquired, giving rise to a hybrid mismatch, in prior financial years but not earlier than the end of the fiscal year ongoing at the date of 28 December 2018 (i.e., the date of publication of the Italian ATAD Decree). Therefore, for calendar year companies, amortization, depreciation, and write-offs related to tangible and intangible goods acquired starting 1 January 2019 may give rise to “deductions” under the Italian ATAD Decree. As mentioned, the draft circular referred to events that occurred not earlier than 31 December 2016.

Linking rules

Italy should not apply anti-hybrid mismatch reactions to the extent that the other involved jurisdiction has implemented anti-hybrid rules matching ATAD minimum standards as implemented by the Italian provisions. In such cases, Italy will activate an exchange of information procedure with the foreign tax authorities to assess any potential violation by the nonresident taxpayer. Absent an exchange of information agreement with a given jurisdiction, Italy will otherwise apply its anti-hybrid rule reaction.

Voluntary adjustments

In the absence of anti-hybrid rules adopted by the relevant foreign jurisdiction (or of ATAD equivalent minimum standards as implemented by the Italian provisions), a voluntary adjustment (e.g., renouncement of a deduction) made by the nonresident company would not prevent Italy from taking action.

Winding down of structures giving rise to hybrid mismatches

As a general principle, tax deductions that are consequences of arrangements replacing hybrid structures should not be seen as abusive. The Circular provides the example of a hybrid instrument replaced with another instrument giving rise to a negative item of income (e.g., interest expense) where, absent such change, such item of income would have been disallowed under anti-hybrid rules.

Qualifying deductions

The Circular clarifies that a qualifying “deduction” under the Italian ATAD Decree (both for double deduction and deduction/non-inclusion scenarios) is represented by a “negative item of income” which is defined as a cost to which a financial flow is associated. In this regard, it is irrelevant whether the financial flow occurs in the year when the relevant cost is sustained as opposed to previous or subsequent years.

Amortization, depreciation and write-off deductions

Amortization, depreciation and write-off deductions are treated as qualifying deductions falling under the Italian ATAD Decree since they are the consequences of a “financial flow,” irrespective of whether such financial event has already taken place in prior years.

Cost of goods sold (COGS)

COGS is explicitly mentioned as a negative item of income that may give rise to a deduction falling under the anti-hybrid rules.

Italian companies disregarded under United States (US) tax law

The Circular provides clarification on a series of cases concerning Italian resident companies treated as tax transparent by the foreign shareholder. Such clarification applies, therefore, to Italian S.r.l. companies that have elected to be treated as a disregarded entity for US tax purposes (S.r.l. checked-open), including the case where the Italian company pays a consideration to the US parent or where the latter remunerates the former for a service (based on a cost-plus mechanism on third party costs). Generally, if the Italian deduction of the third-party costs is offset only with a dual inclusion income, Italy should not be expected to disallow such a local deduction. In the case of remuneration paid from the US parent to the Italian disregarded entity, the consequential effect of a “non-deduction/inclusion” should not necessarily result in a hybrid mismatch provided that the “non-deduction/inclusion” stems from the same hybrid mismatch triggering the dual deduction. Similar principles apply in the case of an Italian permanent establishment.

Controlled foreign corporations (CFCs)

The circular clarifies that, subject to a case-by-case analysis, CFC rules may qualify as an “inclusion” for the purposes of the Italian ATAD Decree as long as they trigger full taxation of the relevant foreign income (i.e., the income must be included at full basis and subject to tax at full tax rate).


“Inclusion” may not necessarily require that a transaction have the same legal nature in the country of the payor and in the country of the recipient, provided that the relevant proceeds are included as ordinary income. The example considers an arrangement seen as financial leasing in the jurisdiction of the lessee (deduction of an interest expense) and as an operating lease in the jurisdiction of the lessor (inclusion of a lease fee).

Notional interest deduction (NID) arrangements

The Italian NID and analogous foreign rules should not qualify as a hybrid instrument since the relevant deduction lacks a correlated financial flow (payment) and lacks any financial or economic cause by rather being a pure tax incentive measure.

Foreign reverse hybrids

Interest expenses paid by an Italian entity to a foreign fund organized as a reverse hybrid should be disallowed despite the multitude of the vehicle’s investors for the fact that the unitary management (single controlling mind) of investors' interests makes them qualify as related parties.

However, payments to a foreign reverse hybrid are not necessarily disallowed if the foreign reverse hybrid’s bylaws provide for: (i) mandatory; (ii) mechanical; and (iii) at least annual distributions to investors (i.e., inclusion).

The “damage approach”

In accordance with article 6, paragraph 2, letter b) of the Italian ATAD Decree, the Circular points out that a hybrid mismatch, arising from a “dual deduction” or “deduction/not inclusion” scenario, has to be counteracted only in the fiscal year (and to the extent) that it can be deemed to be “actually harmful.” This generally occurs when in the payee’s jurisdiction, the negative item of income exceeds any positive item of income that may give rise to “double inclusion” (so-called “excess of deduction”) and the mentioned excess is offset against income that is not deemed to be at “double inclusion.”

Imported hybrid-mismatches

Article 8, paragraph 3, of the Italian ATAD Decree disallows the deduction of a negative item of income (expense) sustained by an Italian company to the extent that it is funding, directly or indirectly, deductible charges in another jurisdiction that generate a hybrid mismatch through a transaction or series of transactions between associated enterprises or parties to a structured agreement. In order to assess the nexus between the expense incurred by the Italian company and the potential funding of the imported hybrid mismatch, the Circular makes reference to the three methodologies (“structured”, “direct”, “indirect”) referred to in the mentioned OECD (2015), Neutralising the effects of hybrid mismatch arrangements, Action 2 -2015 Final Report, paragraphs 246 and 247.

In any case, the expense would be allowed if any of the other jurisdictions involved in the transaction or series of transactions has implemented an imported hybrid-mismatches rule equivalent to the one set forth by the Italian ATAD Decree.

Procedural aspects related to tax assessments

In the case of tax challenges addressing hybrid mismatch arrangements, the burden of proof for demonstrating that the conduct of the taxpayer has resulted in an actual hybrid mismatch is on the tax authorities. The latter should first request that the taxpayer provide clarifications regarding the transaction (or the series of transactions) carried out. Any relevant counterarguments have to be provided by the taxpayer within 60 days. Any subsequent notice of assessment by the authorities must include an adequate explanation concerning the actual hybrid mismatch resulting from the taxpayer’s behavior. If the authorities fail to fulfill these procedural conditions, the notice of assessment will have no effect.

Anti-avoidance rules and criminal tax exposure

The Circular also specifies that the Italian anti-hybrid rules cannot be classified as “anti-avoidance rules” and therefore they cannot be disapplied through the filing of a tax ruling. In addition, it is clarified that, to the extent that the relevant conditions provided by Law Decree no. 74 of 10 March 2000 are met, violations of anti-hybrid rules may trigger tax criminal consequences.


For additional information with respect to this Alert, please contact the following:

Studio Legale Tributario, International Tax and Transaction Services, Milan

Studio Legale Tributario, Transfer Pricing, Milan

Studio Legale Tributario, International Tax and Transaction Services, Rome

Ernst & Young LLP (United Kingdom), Italian Tax Desk, London

Ernst & Young LLP (United States), Italian Tax Desk, New York