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Italy: Rules on Controlled Foreign Corporations and Tax Havens Tightened

(Sept. 28, 2009) Law Decree No. 78, published in Italy's official gazette on July 1, 2009, covers a basket of new measures to deal with the global financial crisis, including a tightening of rules on tax havens and controlled foreign corporations (CFCs). The Law Decree entered in force on July 1, 2009, and was converted into Law No. 102/2009, of August 3, 2009, after its publication in the GAZZETTA UFFICIALE (OFFICIAL GAZETTE, No. 179 of Aug. 4, 2009, Supplemento Ordinario No. 140). (Conversione in legge, con modificazioni, del decreto-legge 1º luglio 2009, n. 78, recante provvedimenti anticrisi, nonchè proroga di termini e della partecipazione italiana a missioni internazionali, Italian Parliament website, (last visited Sept. 21, 2009).) The Italian Parliament first approved anti-tax haven and CFC legislation on November 9, 2000, in Law 342 of 2000, implemented by Decree No. 429 of November 21, 2001, published in the OFFICIAL GAZETTE, No. 288, of December 12, 2001. The Law was clarified in a number of Ministry of Finance circulars issued in 2001. (CARLO ROMANO, ADVANCE TAX RULINGS AND PRINCIPLES OF LAW: TOWARDS A EUROPEAN TAX RULINGS SYSTEM 66-68 (IBFD Publications, 2002).)

Among the notable features of the new Law Decree No. 78 is a provision on CFCs that affects the definition of a CFC and restricts “safe harbor” rules. Article 13 extends the country's CFC regime to subsidiaries in jurisdictions other than “black list” jurisdictions by amending the relevant provisions of the Tax Code. The black list is a list of jurisdictions that have low taxes and are deemed tax havens. The government's aim in altering the definition of a CFC by broadening the application of the CFC rules is reportedly “to reduce Italy's underground economy” at home and, internationally, “to work with other countries in applying OECD guidelines to reduce cross-border tax avoidance.” (Ulrika Lomas, Applicability of Italian CFC Rules Extended, TAX-NEWS.COM, July 6, 2009, available at
.) The new rules will also bring Italian legislation into conformity with that of other European Union Member States and, the government hopes, combat tax arbitrage in particular by penalizing “companies who have created structures to avoid paying taxes,” Gérard Prinsen, international tax partner, Ernst & Young in Italy, was quoted as saying. (David Stevenson, Italy Broadens CFC Rules, INTERNATIONAL TAX REVIEW,
(last visited Sept. 21, 2009).)

Under the previous definition of a CFC, “profits realized by a foreign entity are deemed to be profits of an Italian resident person if: 1) the resident person controls, directly or indirectly (even through trustee companies or interposed third persons), a foreign enterprise, company or any other entity;” and 2) the foreign subsidiary is a tax resident in a black-list jurisdiction. [Note: a 2008 measure replaced the black list approach with a white list approach, but the official decree on the new list has not yet been issued, and so the black list remains in effect.]. (Giuseppe Cristallo, Italian Government Approves Stimulus Package And New Rules On Tax Havens (CFC), INTERNATIONAL TAX ALERT [Ernst & Young], July 2009, available at,_International_tax_alert,_July_2009/$FILE/I

A new provision, article 167, 5 bis, is added to the Income Tax Code by the new Law Decree, in connection with condition (2) above, extending application of the CFC regime to foreign subsidiaries that are tax resident in non-blacklisted jurisdictions if two conditions are both met:

· The taxation levied in the foreign state or territory is lower than 50% of the effective Italian corporate taxation which the entity would be subject to if it were an Italian resident; and

· An “active income test” … is not passed with respect to at least 50% of the foreign entity's proceeds (i.e., if the income is from passive sources such as interest and dividends). (Id.; Stevenson, supra.)

Avoidance of the application of the CFC regime, therefore, would require that the applicable tax rate for the foreign subsidiary be at least half of Italy's 27.5% tax rate “levied on a taxable base determined under rules equivalent to those applied in Italy.” (Id.) The Law Decree mitigates this restriction, however, by allowing Italian entities to apply to the Ministry of Finance for an advance ruling, to demonstrate that they did not establish the CFC as an “artificial structure” in order to obtain improper tax benefits. (Id.) The term “artificial structure” refers to the decision of the European Court of Justice in the Cadbury Schweppes case “and reflects the intent of the Italian government to comply with EU tax principles. This concept is likely to give rise to a significant debate as to its meaning in the context of both European and Italian tax law,” in the opinion of Italian tax experts with the firm Deloitte Touche Tomatsu. (Carlo Hassan, Paolo Ippoliti, Olderigo Fantacci, & Stefano Schiavello, CFC Rules Amended, ITALY TAX ALERT [Deloitte Touche Tomatsu], July 17, 2009, available at
; Press Release No. 72/06, Court of Justice of the European Communities, Judgment of the Court of Justice in Case C-196/04: Cadbury Schweppes plc & Cadbury Schweppes Overseas Ltd v Commissioners of Inland Revenue (Sept. 12, 2006), available at

As for safe harbor rules, under article 167, paragraph 5 (a), of the Income Tax Code, formerly an Italian parent company could avoid the application of the CFC regime if it could prove that the foreign subsidiary or entity's main, actual activity in the jurisdiction in which it was located was industrial or commercial (the “business test exemption”). Under the amended Law, the parent company must prove that such activity is conducted in the market of the foreign jurisdiction, which means that the subsidiary must “have a predominant link with the local market to justify that its incorporation in that territory is justifiable on local business grounds.” (Id.; see also Paolo Giacometti, Italian CFC Regime – A New Interpretation of the Business Test Exemption, INTERNATIONAL TAX REVIEW (July/Aug. 2009),

Thus, it has been pointed out, if most of the entity's economic results come from transactions with parties located outside that market, it will not be sufficient, in order to avoid application of the CFC rules, “to demonstrate the existence of significant structures and activities within the local territory
… .” (Mario Martinelli et al., New Italian Tax Measures Impact Operations of Multinational Companies, MCDERMOTT NEWSLETTERS [McDermott, Will & Emery], July 2, 2009, available at
.) In the case of parent banks, insurance companies, and financial institutions, the Law specifies that they will be deemed compliant with this new rule if the majority of their deposits, assets, or revenues are derived from the foreign state or territory in which their foreign subsidiaries are located. A new, general restriction on access to the safe harbor rule provides that no parent company may claim the exemption if the foreign subsidiary does not pass an “active income test,” that is, if more than 50% of the foreign subsidiary's proceeds derive from investments or holdings of financial assets; the sale or lease of patent rights or copyrights; or services done with related parties. (Cristallo, supra.)

The Law Decree does not provide for the specific effective date of entry into force of the CFC provisions. Some legal analysts contend that they will be in force as of the fiscal year after the date on which the Decree came into force, i.e., “from 2010 for taxpayers whose fiscal year coincides with the calendar year,” based on the general principle set forth in article 3 of Italy's Taxpayers Statute (Law No. 212 of July 27, 2000). (Mario Martinelli et al., Italian Decree Brings in New Tax Breaks and Tax Amnesty, MCDERMOTT NEWSLETTERS, Aug. 6, 2009, available at
; see also Francesca Staffieri, Italy Tax Updater – 10 August 2009, Norton Rose LLP website, Aug. 2009, available at