Law Decree No 225 of 29 December 2010 (the Decree), converted to Law No 10 of 26 February 2011, has drastically changed the Italian tax regime of domestic and Luxembourgish collective investment vehicles (CIVs), other than real estate investment funds. Before the amendments the CIVs were taxable at a rate of 12.5% on the accrued annual result and the distributions to investors were, in principle, exempt. Now the accrued result of the CIVs is taxable only in the hands of the investors on a cash basis. The new tax regime of the CIVs is in line with the Italian tax regime applicable to almost all EU/European Economic Area (EEA) CIVs that are distributed in Italy.
The new regime applies to the following undertakings:
- Italian Undertakings in Collective Investment in Transferable Securities (ITA UCITS), provided for by Legislative Decree No 58 of 24 February 1998, also Consolidation Act on Finance (TUF), other than real estate investment funds:
- Italian closed-end common funds (fondi comuni di tipo chiuso);
- Italian open-end common funds (fondi comuni di tipo aperto); and
- Italian open-end investment companies (società di investimento a capitale variabile (SICAV)).
- Luxembourgish Undertakings in Collective Investment in Transferable Securities (LUX UCITS), already authorised for placement in Italy (fondi lussemburghesi storici).
OLD TAX REGIME AT THE UNDERTAKING LEVEL
The previous tax regime of the CIVs (applicable to LUX UCITS only with respect to quotes placed in Italy) can be summarised as follows:
The CIVs were not subject to the Personal Income Tax (IRPEF), the Corporate Income Tax (IRES) and the Regional Tax on Productive Activities (IRAP). However, they were subject to a substitute tax at the rate of 12.5% (or 27% in limited cases) on the annual increase of value of the CIV. The annual increase was determined as the difference between the net asset value at the end and the beginning of the relevant year, subject to certain adjustments. The adjustments were required to avoid taxation of drawdown and the deduction of distributions of capital and profit to the investors.
Even if the CIVs were, in principle, not subject to an Italian withholding tax on collected income, they suffered certain non-recoverable final withholding taxes, including tax on interest on bonds of non-listed companies and bank deposits if the deposited amount exceeded 5% of the averaged amount of the CIVs’ assets.
Due to the CIVs liability to the substitute tax, they were not considered transparent entities. However, it was uncertain whether, under a narrow and literal interpretation of the wording contained in the double tax treaties, the CIVs (other than SICAV, which are ‘treaties entitled’) could be considered:
- ‘person’s; and, even more uncertain,
- ‘liable to tax’, under the meaning of Article 3(1)(a) and Article 4(1) of the Organisation for Economic Co-operation and Development (OECD) Model Tax Convention.
However, it has to be mentioned that pursuant to the Tax Authorities with Circular Letter No 29/E of 20 March 2001 and Ruling No 167/E of 21 April 2008, pension funds are entitled to treaty benefits. Furthermore, the OECD report on ‘The Granting of Treaty Benefits with respect to the Income of Collective Investment Vehicles’, issued in 2009, made the application of tax treaties to CIVs possible and more straightforward. Notwithstanding the above, in several cases the Italian tax authorities were reluctant to issue the tax residence certificates required for the application of tax treaty benefits.
OLD TAX REGIME AT THE INVESTORS’ LEVEL
The CIVs’ profit – corresponding to the increase in value of the undertaking already subject to the substitute tax – paid to:
- Italian resident investors that did not hold the interest in the CIVs in the course of a trade or business (eg resident individuals) were excluded from taxation;
- Italian resident companies, individual entrepreneurs and permanent establishments of non-residents were subject to IRES or IRPEF, but they could credit an amount equal to the 15% of the distributed amount;
- residents in countries not white listed were not further taxable; and
- residents of white-listed countries (eg the UK and Ireland), institutional investors incorporated therein (eg pension and mutual funds), certain international organisations created under international treaties, central banks and organisations that manage the official reserves of Italy, were entitled to claim a refund of 15%. The refund achieved the goal of neutralising the taxation levied at the level of the CIVs.
Distributions exceeding the increased value of the CIVs, subject to the substitute tax, were, in principle, taxable as capital gains.
NEW REGIME AT THE UNDERTAKING LEVEL
CIVs are now included in the list of subjects that are liable to IRES, however explicitly, excluding their liability to income taxes, except for the substitutive tax of 27% on short-term bonds issued by banks and listed companies. They are still subject to withholding on interest on bonds of non-listed companies and from bank deposits if the deposited amount is higher than 5% of the average amount of the assets of the CIVs. Furthermore, CIVs are not subject to IRAP. CIVs are now almost exempt from any form of taxation.
NEW REGIME AT THE INVESTORS’ LEVEL
Article 26-quinquies of Presidential Decree No 600/1973 of 29 September 1973 has introduced a new withholding tax of 12.5%, which is applicable to the CIVs’ proceeds paid to the investors. Such withholding has replaced the previous system of taxation of the accrued annual result of the CIVs.
The income derived from the CIVs is classified domestically as income from capital (redditi di capitale). The negative result derived from the participation of such undertakings is classified among the other incomes (redditi diversi). Therefore, except for Italian companies, individual entrepreneurs and permanent establishment of non-resident, negative results cannot be offset against positive income realised in following years.
The taxable events that can trigger the 12.5% withholding tax are the distributions of income realised by the CIV, redemption of quotes or shares (units) of the CIV, liquidation of the CIV and disposal of the CIV’s units.
For distributions, the taxable base of the withholding of 12.5% is represented by the income distributed by the CIVs. The taxable base for the other taxable events is represented by the difference between:
- the value of the redemption, liquidation or disposal of the units; and
- the average weighted cost of subscription or purchase of the same units.
The value and the cost of the units are shown by periodical statements.
With regard to certain Italian undertakings, such as pension funds, funds of funds, and real estate funds, the withholding tax is not applicable.
The withholding tax is applied in the form of an advance payment – creditable against the IRES or IRPEF due – to Italian companies, individual entrepreneurs and permanent establishments of foreign investors. The withholding tax is final in all the other cases.
Residents of white-listed countries (eg the UK and Ireland), institutional investors incorporated therein (eg pension and mutual funds), certain international organisations created under international treaties, central banks and organisations that manage the official reserves of Italy, are exempt from the withholding tax.
The other non-residents may benefit from the more favourable regime provided for Italian double tax treaties.
DOUBLE TAX TREATIES
In the absence of any specific provision contained in the relevant double tax treaty, it is likely that the Italian Revenue Agency will adopt the same position held in Circular Letter No 11/E of 9 March 2011. On that occasion the Revenue Agency confirmed that the Italian real estate funds’ distribution is classified as interest, so Article 11 of the treaties, which conformed to the OECD Model, is the relevant applicable distributive rule (probably also with regard to CIVs’ distribution). By stating that Article 11 is applicable, the Revenue Agency seems to imply that real estate funds are also resident persons under the meaning of Articles 3(1)(a) and 4(1) of the OECD Model, since Article 11(5) requires that the payer is a ‘resident’ of the source state. On the basis of the existing analogies between the CIVs and the Italian real estate funds – both of the categories of UCITS are not liable to IRES, IRPEF and IRAP, but collect certain items of income that are taxed at the source – the clarification given in the Circular No 11/E might lead to the further conclusion that, being tax resident (persons), they should be entitled to treaties. It is worth mentioning that this could be argued, since it is undermined by the fact that the CIVs are no longer subject to the substitute tax of 12.5%. Therefore, they might not be considered to be ‘liable to tax’ under the meaning of Article 4(1) of the OECD Model.
TAX REGIME OF OTHER FOREIGN UCITS
For the sake of completeness it has to be noted that the Decree has extended the tax treatment of foreign UCITS complying with the EU UCITS Directive 2009/65/CE to foreign UCITS not complying with the EU Directive providing they are:
- incorporated in EU and EEA countries that allow an adequate exchange of information; and
- subject to control of a competent authority in their country.
This new tax regime provides for a withholding tax of 12.5% triggered by the same taxable events described before with regard to CIVs.
EFFECTIVE DATE AND TRANSITIONAL REGIME
The new tax regimes will become effective from the 1 July 2011. The management companies and SICAVs are therefore required to close the financial statements of the CIVs on 30 June 2011. The profit realised by the undertaking and paid to the investors from 1 July 2011 will be subject to the withholding tax of 12.5%. The risk of double taxation and double non-taxation deriving from the passage from the old to the new regime is avoided by a transitional regime. Positive results – accrued by the undertakings until 30 June 2011 – will not be taxed at the level of the investors once distributed, since they will represent profits already taxed at the level of the CIVs. Furthermore, the refund or the credit right – of the tax levied on the CIVs – granted during the old regime is still maintained during the transitional period under the same conditions. Negative results accrued by the undertakings until 30 June 2011 will be offset against the taxable base of the income realised and distributed from 1 July 2011.
The new regime has been designed to relaunch the CIV industry by aligning their tax treatment to that of their foreign direct competitors. Indeed, during positive market trends the CIVs were penalised in respect to foreign undertakings, since the performance indicators of the former were lower than those of the latter, due to the tax cost effect of the substitute tax affecting their accrued result. Aside from this, the new regime indirectly lowers the nominal withholding tax rate of 12.5% due to the tax deferral achievable by delaying the taxation through the cash basis system of taxation of the income.