Italy approves framework for major tax reform, including BEPS Pillar Two principles

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25 August 2023

The Italian Parliament has approved a law that includes a set of general principles and criteria enabling the Government to implement a full reform of the Italian tax system (Enabling Law).
The Enabling Law 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, aligning domestic rules to international tax principles (including OECD BEPS Pillar Two provisions), and ultimately outlining a system capable of attracting foreign capital.

Executive summary

In law n. 111 dated 9 August 2023 (published in the Official Gazette, General Series, n. 189 of 14 August 2023), the Italian Parliament approved a set of general principles and criteria enabling the Government to implement a full reform of the Italian tax system (Enabling Law). The Enabling Law will enter into force on 29 August 2023. From the date of entry into force, the Government will have approximately 24 months to execute the reform through one or more Legislative Decrees.

The aims stated by the Enabling Law 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 the implementation of Pillar Two measures with effect 1 January 2024.

Detailed discussion

Implementation of BEPS Pillar Two provisions

The Enabling Law (Article 3.1.e) provides for the transposition of the European Union (EU) Council Directive n. 2022/2523 of 14 December 2022 on global minimum taxation based on the common approach shared at international level according to the relevant OECD technical guidance. Specifically, the Enabling law calls for the introduction of a qualifying domestic minimum top-up tax (QDMTT), as well as for a coordination of the current domestic controlled foreign companies (CFC) provisions with the upcoming global minimum tax.

Reduced corporate income tax rate

The Enabling Law addresses (in Article 6.1.a) 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 company profits is used for qualifying investments, new hires or stable employee profit-sharing schemes.
The profits are not distributed or used for purposes other than the exercise of the companies' business.

While the Enabling Law does not say how low the new reduced rate will be, some hope that it will be aligned with the 15% rate under BEPS Pillar Two provisions. In this respect, it is worth noting that a similar dual corporate income tax principle (15% reduced rate in case of setting aside of profits to non-distributable reserves and used for qualifying investments) had been introduced by the 2019 Budget Law but never entered into force, due to amending and repealing measures.¹

From a procedural perspective, contrary to what normally happens under today's tax incentives landscape, the beneficial tax treatment (i.e., the reduced 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, while the difference between the standard tax rate (currently levied at 24% standard, exception made for banks and other financial entities) and the favorable rate should be recaptured 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.

For companies that might not be able to benefit from a lower tax rate (e.g., those reporting accounting profits but in a tax-loss position), Article 6.1.b calls for alternative tax benefits such as extra amortization and depreciation measures for qualifying investments, as well as for extra deductions associated with new hires.

Reshaping the tax incentives system

The Draft Framework (Article 9.1.g) explicitly states that all Italian tax incentive regimes will be revised and simplified in accordance with the above-mentioned dual income tax system, and also by taking into consideration EU Directive 2022/2523 on Pillar Two.

These developments may 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 might be gradually "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 mainly based on a reduced corporate income tax rate (or alternatives incentives) 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 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 (Article 6.1.c) aims to rationalize these regimes by providing common tax step-up rules while also avoiding the risk of tax arbitrage 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 in the ATAD — a threshold of net interest expenses free from any limitation (i.e., fully allowed). The Enabling Law (Article 6.1.d) 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 Enabling Law (Article 6.1.e) calls for 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:

Revising 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 Enabling Law (Article 6.1.f) 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 how they are characterized in their local jurisdictions. The Enabling Law (Article 6.1.h) calls for revising this principle 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 Enabling Law (Article 4) 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' need 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 Enabling Law (Article 5.1.a) 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 Enabling Law (Article 5.1.d) calls for a rationalization of the rules concerning 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 Enabling Law (Article 3.c) 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. This includes a coordination of tax residence criteria with permanent establishment rules when it comes to individuals moving to Italy to work remotely.

Gradual elimination of Regional Tax on Productive Activities (IRAP)

The Enabling Law (Article 8) 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 computed similarly to IRES but excluding tax-loss carryforwards.

Cooperative compliance regime and potential elimination of penalties

The Enabling Law (Article 17.1.g) 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.

Administrative and criminal penalties will be reduced under the umbrella of cooperative compliance with a potential full elimination if the relevant tax risks have been duly communicated in advance to the competent authorities under a tax control framework certified by a qualified professional, except for cases of tax fraud and the like (Article 17.1.g.1.9.1).

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

Tax controversy, collection and refund procedures

The expected reform (Article 19) is aimed at making tax litigation less time consuming 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 Enabling Law significantly restyles enforced collection procedures, in addition to simplifying and speeding up tax refund procedures.

Value Added Tax (VAT)

The Enabling Law (Article 7) includes guidance aimed at revising the domestic VAT rules for a better alignment with the applicable EU law provisions and EUCJ judgments with reference, among others, to VAT exempt transactions, VAT recovery, VAT rates and the VAT grouping. (A Global Tax Alert detailing the VAT provisions in the Enabling Law is forthcoming.)

Other measures

The Enabling Law also includes guidelines for revising tax provisions concerning the management of companies' economic crises and financial insolvency, rationalization of the rules concerning nonoperating companies, simplification of provisions to compute 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