November 27, 2023
Italy | Overview of recent tax developments including BEPS Pillar Two provisions
Several significant Italian tax measures are being discussed in the context of a comprehensive reform1 to be implemented over the next couple of years (e.g., Pillar Two provisions, new Controlled Foreign Corporation rules, onshoring incentive and repeal of the Notional Interest Deduction), as well as through the approval process of the 2024 Budget Law (e.g., extension of participation exemption to European Union companies).
The main draft measures of interest to multinationals with Italian operations are highlighted below:
Introduction of BEPS Pillar Two provisions
After the public consultation process ended on 1 October 2023, the Organisation for Economic Co-operation and Development (OECD) BEPS Pillar Two provisions have been now transposed in the draft Legislative Decree on international tax matters, as part of the announced comprehensive tax reform (International Tax Decree).
In general, the Italian Pillar Two provisions published in the draft International Tax Decree do not differ significantly from the text circulated for public consultation.2
The version for consultation consists of 52 articles and the new text includes an additional provision, resulting in a total of 53 (i.e., from Article 8 to Article 60 of the International Tax Decree). The new article (Article 59) addresses preventing controversies in interpreting the new rules that could produce instances of double taxation by referring to the Mutual Agreement Procedure (MAP) clause included in bilateral tax treaties and providing for the application of a similar procedure to cases where no MAP clause or no treaty is in place.
In brief, the Italian Pillar Two regulations are divided into nine chapters. After addressing introductory elements, including a definition of the scope of the rules (Chapter 1), they introduce the global minimum top-up taxation rules by providing for the three relevant interlocking measures: the Income Inclusion Rule (IIR), translated in Italian as "imposta minima integrativa"; the Undertaxed Payments Rule (UTPR), translated in Italian as "imposta minima suppletiva"; and the Qualifying Domestic Top-Up Tax (QDMTT), translated in Italian as "imposta minima nazionale" (Chapter 2). Other sections introduce rules on the calculation of the effective tax rate at jurisdictional level (Chapters 3, 4 and 5) and on certain group reorganizations (Chapter 6). Other provisions aim to ensure proper coordination between certain domestic tax regimes and the new rules (Chapter 7), introduce provisions on tax compliance (including the Global Information Return) and tax assessment (Chapter 8), and provide some transitioning rules (Chapter 9).
The last article (Article 60) provides for the entry into force of the new rules with reference to financial years (FY) starting on or after 31 December 2023, except for the UTPR provisions that are due to apply to FYs starting on or after 31 December 2024.
Coordination of CFC rules with Pillar Two provisions
Under current rules, the income of CFCs is attributed to the Italian parent under a flow-through taxation principle if the foreign subsidiary meets two negative conditions: (i) it is subject to an effective tax rate (ETR) lower than 50% of the Italian ETR that would have applied if the entity resided in Italy, and (ii) more than one-third of its revenues qualify as passive income. The ETR test comparison requires a complex computation to redetermine the CFC's taxable income according to the Italian tax rules and — if both conditions are met (i.e., low ETR and more than 1/3 passive income) — such income is taxed to the Italian parent at 24% corporate income tax (CIT). An exception applies for CFCs having an adequate level of local economic substance, in which case the CFC's income is not imputed to the Italian parent.
The International Tax Decree simplifies the mentioned ETR test by providing for a 15% ETR based on the accounting results of the CFC. This simplification is driven by the need to align the required minimum level of CFC's taxation with the minimum global tax under Pillar Two provisions. The minimum 15% ETR test is based on the accounting results of the CFC as a ratio between the foreign tax burden and the foreign accounting earnings before taxes. The foreign tax burden includes current taxes, deferred taxes, and the fraction of the local QDMTT (if any) attributable to the CFC. For the CFC to utilize this simplified ETR test, the CFC's financials must be certified by locally authorized professional auditors, with the findings of the CFC's audit being used for the purpose of the certified stand-alone or consolidating accounts of the parent. For CFCs that are not subject to audit, the ordinary ETR test (as provided under the current provision) remains applicable.
As an alternative to the mentioned 15% minimum ETR test (which, if failed, would require a complex redetermination of the CFC's income and taxation at 24% CIT), Italian companies may elect a further simplified regime requiring a mandatory minimum payment on a three-year period basis. If elected, this regime provides for a substitute tax at 15% applied on the local adjusted accounting profits (i.e., grossed up by current and deferred taxes, as well as by assets' write-offs and provisions). The election made by the Italian parent company involves all CFCs with more than one-third passive income and remains mandatory for a three-FY lock-in period (automatically renewable unless explicitly revoked) irrespective of the minimum 15% ETR test. As a pre-condition to elect this simplified CFC taxation regime, the CFC's financials must be certified by locally authorized professional auditors.
The new rules should become effective 1 January 2024.
Onshoring income exemption
The current draft of the International Tax Decree introduces a temporary 50% exemption from CIT (currently levied at 24%) and Local Tax (Imposta Regionale sulle Attivita' Produttive, IRAP, currently levied at standard 3.9%) of the income deriving through going concerns moved from a foreign jurisdiction, other than EU or EEA member states, to Italy. The exemption is limited to the income deriving from the onshoring of going concerns that, at least during the previous 24 months, were not located in Italy. From a timing perspective, the exemption applies for the FY of the migration and the following five FYs.
The mentioned income exemption is subject to recapture (with interest but without penalties) if the business going concern is then migrated, even partially, from Italy to any other foreign jurisdictions (including EU and EEA countries) in the five years following the expiration of the regime or 10 years for large enterprises, as defined by the EU recommendation n. 361 of 6 May 2003 (i.e., with at least 250 employees plus a turnover of at least €50m or, alternatively, total assets of at least €43m value).
While subject to the EU Commission's approval under the relevant EU State-aid principles, the proposed rule is expected to enter into force as of 1 January 2024.
Extension of capital gain exemption regime to EU and EEA companies
A draft version of the 2024 Budget Law includes an amendment to the domestic 95% Participation Exemption (PEX) provision by extending the regime, with reference to capital gain deriving from substantial participations,3 to nonresident companies without an Italian permanent establishment (PE), residing in the EU or in certain EEA jurisdictions with an exchange of information clause in place with Italy.4
The proposed change follows the decisions of the Italian Supreme Court (n. 21261 of 19 July 2023 and n. 27267 of 25 September 2023) stating that, based on EU fundamental freedoms, EU and EEA companies (without an Italian PE) disposing of Italian participations should not be treated worse than Italian companies in a comparable situation.5
Under the new rule, if the same PEX prerequisites required for Italian companies are met byEU and qualifying EEA companies, the latter would be subject to the 26% foreign capital gain tax computed only on 5% of the relevant gain (i.e., 95% exemption), thus to 1.3% effective taxation. Also, according to the draft provision, EU and qualifying EEA residents should be allowed to offset 5% of the gain with any capital loss incurred from the disposal of participations qualifying for the PEX regime. The draft provision provides that any excess capital loss can be carried forward for five fiscal years.
The new provision should be limited to companies residing in EU and qualifying EEA jurisdictions that, while having an adequate level of economic substance in the country of residence, cannot benefit from a bilateral treaty with full capital gain tax protection. For example, French companies deriving gains from the disposal of Italian subsidiaries are not protected by the Italy-France treaty capital gain provision under which gains from substantial participations are taxable in Italy.6
The new rule is expected to become effective as of 1 January 2024.
Review of tax residence rules for corporations
Under current rules, companies are considered tax-resident in Italy if they alternatively meet one of the following requirements for the most part of the FY: (i) have a registered office in Italy, (ii) have an administrative office in Italy, or (iii) have a principal activity in the territory of the Italian state.
According to the proposed amendments, the first requirement, (i.e., (i) the registered office) is confirmed, while the second and third requirements are replaced respectively by (ii) the place of effective management and (iii) the place of day-by-day management.
The above amendment aims at providing a higher degree of legal certainty by also aligning the Italian provision to international practice and double-tax-treaty principles about tax residency. The "registered office" is a formal prerequisite that remains unchanged by assuring continuity with the current law. In contrast, the place of "effective management" and the place of "day-by-day management" are innovative substantial criteria that refer, respectively, to the place where strategic decisions are made and where the management activity is carried out in practice.
The new rule should become effective 1 January 2024.
Repeal of NID benefit
As part of the announced comprehensive tax reform, the draft Legislative Decree on other income tax matters (Income Tax Decree) provides for the repeal of the NID, currently set at 1.3% of the qualifying net equity.
However, the new rule provides that companies may carry out any residual NID excess without time limitation.
The new rule should become effective 1 January 2024.
Earlier filing deadlines for tax returns
As another part of the announced tax reform, the draft Legislative Decree on tax compliance simplification (Tax Compliance Decree) provides that CIT and IRAP returns should be filed by 30 September (rather than by 30 November) of the year following the reported FY for companies with a calendar year, and by the end of the ninth month (rather than by the end of the eleventh month) following the end of the reported FY for companies with a non-calendar year.
The change in law should be applicable from fiscal year 2024.
Extra deduction for new hires
The Income Tax Decree provides that companies that through 2023 have carried out business activities in Italy may deduct for CIT purposes 120% of the labor costs in relation to new hires (up to 130% for specific categories of employees).
The extra deduction is granted under two concurrent conditions: if (i) the number of employees hired on a permanent basis in 2024 is greater than the average of the same category of employees in 2023 (employment decreases in controlled companies should be factored into the computation), and (ii) the number of all the employees (including temporary employees) at the end of the 2024 is greater than the 2023 average.
The eligible cost for the increased tax deduction (20% or 30% depending on the case) is the lower of the cost for the new hires or the increase in the labor costs based on the profit and loss statement.
The new rule should become effective 1 January 2024.
For additional information with respect to this Alert, please contact the following:
Studio Legale Tributario, Milan
Studio Legale Tributario, Rome
Studio Legale Tributario, Bologna
Studio Legale Tributario, Florence
Studio Legale Tributario, Torino
Studio Legale Tributario, Treviso
Studio Legale Tributario, Verona
Ernst & Young LLP (United Kingdom), Italian Tax Desk, London
Ernst & Young LLP (United States), Italian Tax Desk, New York
Published by NTD's Tax Technical Knowledge Services group; Carolyn Wright, legal editor
1 See EY Alert, Italy approves framework for major tax reform, including BEPS Pillar Two principles, dated 25 August 2023.
2 See EY Alert, Italy launches BEPS 2.0 Pillar Two draft law for public consultation, dated 13 September 2023.
3 A "substantial participation" in a company listed on a stock exchange requires more than 2% of the voting rights at ordinary shareholders' meetings or 5% of the company's capital. For an unlisted company, these percentages are increased to 20% and 25%, respectively.
4 EEA countries with an exchange of information clause with Italy are Island and Norway. Liechtenstein, the third EEA country, has recently signed a treaty with Italy (including an exchange of information clause) which however has not yet been ratified.
5 See EY Global Tax Alert, Italian Supreme Court decision extends capital gains participation exemption to nonresident entities, dated 11 September 2023.
6 Under the Italy-France treaty, a substantial participation is represented by shareholdings giving right to at least 25% of the subsidiary's profits. It should be noted that, generally, capital gains from the disposal of Italian non-substantial participations are already excluded from Italian taxation under domestic rules (i.e., for taxpayers residing in jurisdictions with an exchange of information clause with Italy).