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November 23, 2021

Italy issues draft guidance on hybrid mismatches

Executive summary

The Italian Tax Authorities launched a public consultation in October 2021 on a draft circular regarding the hybrid mismatch rules (Draft Circular). The Draft 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 consultation period ended on 19 November 2021 and a final circular is now expected to be issued.

This Alert summarizes the key topics addressed by the Draft Circular.

Detailed discussion

Relevance of the Organisation for Economic Co-operation and Development (OECD) Base Erosion 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, have explicitly been 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 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 applied 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 reverse hybrids apply as of the financial year starting after the one ongoing on 31 December 2021.

Tax attributes with a hybrid origin

Generally, the Italian anti-hybrid rules should not apply to tax consequences of events occurring 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 Draft Circular.

Cut-off date of 31 December 2016

As an important exception to the above-mentioned effective date, the Draft 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 31 December 2016. Such date explicitly follows what is suggested by the OECD 2015 and OECD 2017 reports on Action 2, respectively at par. 263 and par. 112, despite being less technically grounded here, where the main rules start applying in 2020.

Linking rules

Italy should not apply anti-hybrid mismatches 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.

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 applying the secondary reaction.

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 Draft 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.

Amortization and depreciation

Amortization and depreciation deductions are treated as qualifying “payments” giving rise to deductions falling under the Italian ATAD Decree since they are the consequences of a financial flow (payment), irrespective of whether such financial event has already taken place in prior years or takes place in the year of the deduction or subsequent financial 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 company disregarded under US tax law

The Draft Circular provides clarification on a series of cases applicable to Italian S.r.l. companies that have elected to be treated as a disregarded entity for United States (US) tax purposes (S.r.l. checked-open), including the case where the Italian company pays 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 dual inclusion income, Italy should not be expected to disallow such a local deduction. In the case of a 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.

Controlled foreign corporations (CFC)

CFC rules may result in full taxation (i.e., full basis inclusion at the full tax rate) of income qualifying as “inclusion” under the Italian ATAD Decree.


“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 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 Draft 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.”

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 counter-arguments 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 fulfil these procedural conditions, the notice of assessment will have no effect.


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

  • Emiliano Zanotti |
  • Maria Elena Passaretti |

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