Italy announces draft legislative framework for major tax reform

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April 14, 2023
2023-0712

The Italian Council of Ministers approved a set of general principles and criteria for a full reform of the Italian tax system (Draft Framework) that the Parliament will finalize by issuing a law that will enable the government to implement the reform in detail.
The Draft Framework is aimed at reducing the tax burden of corporations and individuals, increasing the degree of legal certainty, reducing litigation, improving the relationship between tax authorities and taxpayers, and outlining a system capable of attracting foreign capital.

Executive summary

On 16 March 2023 the Italian Council of Ministers approved a set of general principles and criteria for a full reform of the Italian tax system (Draft Framework). The Parliament will now build on the framework to make it final by issuing a law that will enable the government to implement the reform in detail (Enabling Law). From the effective date of the Enabling Law (expected before this summer), the government will have approximately 24 months to execute the reform through one or more Legislative Decrees.

The aims stated by the Draft Framework include reducing the tax burden of both corporations and individuals, increasing the degree of legal certainty, reducing litigation, improving the relationship between tax authorities and taxpayers, and outlining a system capable of attracting foreign capital by ensuring consistency with the Organisation for Economic Co-operation and Development (OECD) recommendations under the Base Erosion and Profit Shifting (BEPS) project, along with specific reference to Pillar Two measures.

Detailed discussion

Introduction of a dual Corporate Income Tax (IRES) system

The Draft Framework addresses the introduction of a dual corporate income tax system aimed at attracting investments in Italy and boosting the capitalization of Italian businesses.

Under this proposed measure, a reduced corporate income tax will apply to companies' profits if both of the following conditions are met within two years from the end of year in which they were generated:

A sum corresponding, in whole or in part, to such profits is used for qualifying investments and new hires
The profits are not distributed or used for purposes other than the exercise of the companies' business

While not expressly mentioned by the Draft Framework, it is expected that the reduced corporate income tax will apply at the same rate as the OECD BEPS Pillar Two minimum tax (i.e., 15%). The reform might also slightly reduce the standard corporate income tax rate, currently levied at 24%.

From a procedural perspective, contrary to what normally happens under today's tax incentives landscape, the beneficial tax treatment (i.e., the reduction of the tax rate) should precede (not follow) the execution of the investments. This means that, in the first place, companies' annual income should be subject to the new reduced tax (likely set at 15%), while the difference between the standard tax rate and the favorable rate should only apply when, and to the extent that, the relevant income (or a fraction thereof) is not used for the above-mentioned qualifying purposes through the two subsequent tax periods.

Reshaping the tax incentives system

The Draft Framework explicitly states that all Italian tax incentive regimes will be revised and simplified in accordance with the introduction of the above-mentioned dual income tax system, and by also taking into consideration the European Union (EU) Directive 2022/2523 on Pillar Two.

These developments reasonably suggest that the current tax credits- e.g., for research and development (R&D) or for qualifying high technology investments -and other types of current tax incentives could be "replaced" with the application of the mentioned reduced corporate income tax rate to the amount of income reinvested in the relevant qualifying activities (e.g., R&D activities, high technology investments etc.).

This creates an expectation for a general switch from a tax incentive system mainly based on tax credits and extra deductions, to a new system based on a reduce corporate income tax rate rewarding companies that will follow qualifying behaviors.

Rationalizing tax step-up regimes

The Italian tax system provides multiple regimes allowing taxpayers to elect tax step-ups in relation to events creating differences between accounting and tax values, such as the case of tax-free corporate reorganizations or first-time adoption of an accounting system (e.g., switch from Italian accounting principles to international accounting principles or vice versa). In this respect, the Draft Framework aims at rationalizing these regimes by providing common tax step-up rules while also avoiding the risk of tax arbitrages stemming from the election of one specific step-up election as opposed to another.

Reviewing interest expense limitation

The Italian corporate income tax system currently provides for a general net interest expense limitation capped at 30% of the tax adjusted earnings before interest, taxes, depreciation and amortization (EBITDA). This general principle, in place since 2008, has been further modified with the transposition of the provisions provided for by the EU Anti-Tax Avoidance Directive 2016/1164 (ATAD). However, when transposing the ATAD, Italy chose not to apply the de minimis threshold set out therein — a threshold of net interest expenses free from any limitation (i.e., fully allowed). In this respect, the Draft Framework intends to introduce such a de minimis threshold and possibly further amend the general interest deduction limitation rule in compliance with the ATAD.

Rationalizing tax loss regimes

The Draft Framework provides an overall rationalization of the rules concerning the use of corporate income tax losses and the surrendering of companies' losses in corporate reorganizations and tax consolidation processes.

This rationalization applies in compliance with the following principles:

Revision of the loss regime within a tax group to avoid complexities deriving from allocating excess losses upon interruption of the tax consolidation
Aligning the existing different regimes concerning limits and conditions for tax loss offsetting
Amending the rules for tax loss carryforwards in connection with corporate reorganizations, including revising the net equity quantitative limit for mergers and demergers, as well as revising the notion of change of the core business
Defining final losses in compliance with the principles expressed by the EU Court of Justice (EUCJ) to allow resident parent companies to deduct definitive losses of a nonresident subsidiary under specific circumstances

Contributions of going concerns and exchanges of participations

The Draft Framework calls for a revision and rationalization of the treatment of contributions of going concerns and exchanges of participations, without prejudice to the principle of tax neutrality.

New rules for tax nature of foreign entities

Under current Italian tax rules, nonresident companies are always seen as corporations (i.e., as tax opaque), irrespective of their local jurisdictions' qualification. The Draft Framework calls for this principle to be revised and for a provision to be introduced that takes into consideration the local tax characterization of the foreign entity.

Reinforcement of taxpayers' bill of rights and legal certainty

The Draft Framework aims at reviewing the taxpayers' bill of rights (Law n. 212/2000) by strengthening the obligation for the tax authorities to include motivations in tax audits, enhancing the principle of legitimate expectation and legal certainty and rationalizing tax ruling procedures.

Application fees for tax rulings will likely be introduced, but taxpayers' needs to obtain rulings should significantly reduce thanks to the tax administration's publication of general interpretative measures providing for several case studies, including examples concerning the application of the general anti-avoidance rule (GAAR).

The expected reform should also provide for significant rationalization and simplification of tax reporting obligations.

Revision and gradual reduction of Individual Income Tax (IRPEF)

The Draft Framework provides a series of principles aimed at an overall revision and gradual reduction of the personal income tax. The reform is ultimately aimed at introducing an incremental flat rate system that complies with the principle of progressive taxation to be achieved by reorganizing tax expenditures and revisiting the income brackets system.

Financial income

The Draft Framework would reorganize the rules for financial income by introducing a single category that includes both capital income and other income of a financial nature, determining financial income exclusively under a cash-principal basis and allowing for the possibility of offsetting income and losses, as well as related charges and costs, and carrying forward any excess losses to subsequent fiscal years.

Review of tax residence rules

The Draft Framework calls for a review of the tax residence rules for individuals and companies, aiming to align domestic provisions with international best practices and the double-tax treaties signed by Italy.

Gradual elimination of Regional Tax on Productive Activities (IRAP)

The Draft Framework provides for a gradual elimination of IRAP (generally levied at 3.9%), starting from partnerships and other entities without legal personality, with a view toward totally replacing the tax with a surcharge on IRES.

Cooperative compliance regime

The Draft Framework aims to increase the attractiveness of the cooperative compliance regime (introduced by Legislative Decree n. 128/2015 to enhance cooperation between taxpayers and tax authorities) by reducing the minimum entry threshold (currently set at one billion EURO (€1b) turnover/revenues) and simplifying the access requirements, with the possibility of certifying the required tax control framework.

Further reduction of both administrative and criminal penalties are likely to be granted under the umbrella of cooperative compliance.

For small taxpayers, the Draft Framework introduces an optional regime under which the fiscal burden will be negotiated, on a two-year basis, with the Tax Administration.

Tax controversy

The expected reform is aimed at making tax litigations quicker and more efficient by implementing digitalization processes and improving settlement procedures for controversies pending before the Supreme Court.

The tax penalty system (both administrative and criminal) is expected to be reorganized by improving the principle of proportionality and ensuring greater integration between the two sanctioning systems (administrative and criminal).

Finally, the Draft Framework significantly restyles enforced collection procedures, in addition to simplifying and speeding up tax refund procedures.

Value Added Tax (VAT)

The Draft Framework includes guidance aimed at revising the domestic VAT rules for a better alignment with the applicable EU law provisions and EUCJ judgements with reference, among others, to VAT exempt transactions, VAT recovery, VAT rates and the VAT grouping.

Other measures

Among other additional principles, the Draft Framework includes guidelines for the revision of the tax provisions concerning the management of the economic crisis and financial insolvency of companies, rationalization of the rules concerning non-operating companies, simplification of the provisions to compute the business income basis by reducing the differences between book and tax.

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

Studio Legale Tributario, International Tax and Transaction Services, Milan