September 11, 2023
Italian Supreme Court decision extends capital gains participation exemption to nonresident entities
With decision n. 21261 of 19 July 2023, the Italian Supreme Court stated that, based on European Union (EU) fundamental freedoms, nonresident companies without an Italian permanent establishment (PE) disposing of an Italian participation should not be treated worse than Italian companies in a comparable situation. Based on this principle (already affirmed by multiple lower court decisions in the past years),1 the Court concluded that a French company was entitled to benefit from the Italian 95% participation exemption (PEX) regime on capital gains realized from the sale of an Italian participation.2
Generally, based on the principles stated by the Court, if PEX prerequisites are met by a nonresident seller under a treaty that does not provide for capital gain protection, the seller should be able to benefit from a 1.2% nonresident capital gain tax rate, rather than being subject to the current 26% rate provided by the law.
The impact of the decision should be carefully evaluated. On the one hand, it is expected that the relevant PEX provision will be amended by extending the regime, by law, to nonresident EU companies, and potentially to non-EU companies. On the other hand, while awaiting a probable legislative change, taxpayers in a position comparable to that of the French company involved in the case could consider directly applying the principles expressed by the Court or following a more prudent approach by paying the ordinary capital gain tax and start a refund procedure on the difference in tax imposed at 26% versus 1.2%. This refund procedure might also be available to qualifying nonresident companies that paid the full Italian capital gain tax no more than 48 months before the filing a refund claim.
The Supreme Court sustained the position of the French parent company that had claimed a refund of the difference between the ordinary capital gain tax paid upon the disposal of an Italian substantial participation and the reduced rate applicable under the Italian PEX regime. Under the Italy-France tax treaty (Paragraph 8.b of the protocol), gains deriving from the disposal of a substantial participation (i.e., holding shares with the right to at least 25% of the subsidiary's profits) may be taxed by the residence jurisdiction, Italy in this case. However, after paying the Italian capital gain in full, the French company filed a refund claim based on EU nondiscrimination principles — specifically on Article 49 (Freedom of establishment) and 63 (Free movement of capital) of the Treaty of Functioning of the European Union (TFEU).
Since the French entity met all the requirements that an Italian company is required to meet under the PEX regime (i.e., by being in a comparable position), the Supreme Court agreed that not recognizing the beneficial regime for the seller would result in discriminatory treatment not compatible with the EU fundamental freedoms. The Court also stated that the discrimination against the French company was not eliminated by the tax credit that France is required grant to its resident taxpayer because the gain is (only) partially taxed in France and the treaty limits the credit to the amount of the applicable French tax. In reaching the conclusions, the Court also referred to key principles expressed by the European Union Court of Justice (EUCJ) regarding the incompatibility of EU member state provisions with EU fundamental freedoms. Specifically, the Court analogized EUCJ case C-540/07 of 19 November 2009 as very similar to the case at issue, regarding the disparity between the tax treatment of Italian residents and that provided to EU shareholders with regard to dividend income.
As Italy is a Civil Law country, principles stated by the tax courts are only binding with reference to the specific subject case and do not automatically apply to all taxpayers. However, given the importance of the decision and the reference to EUCJ cases on comparable matters, it is very likely that the Italian legislature will amend the PEX provision by considering the Supreme Court's point of view and the precedent of the mentioned EUCJ case C-540/07. This case resulted in the change of the Italian dividend tax rules by recognizing EU shareholders as entitled to the same beneficial tax treatment as Italian shareholders (95% exemption) on dividends paid by an Italian subsidiary. The Supreme Court decision not only mentions Freedom of Establishment but also the principle of Free Movement of Capital, which also applies to non-EU residents. Hence, the question on whether the possible future amendment of the PEX provision might result in the explicit extension of the beneficial capital gain taxation regime not only to EU companies but also to non-EU companies. For example, Italian tax treaties with Brazil, China, India, Israel and South Korea do not necessarily prevent the source state from applying capital gain taxation. Therefore, this court case could become relevant with respect to potential sales of Italian entities by parents residing in these jurisdictions.
Also, even short of a legislative amendment of the PEX provision, principles the Supreme Court expressed provide an important point of reference for interpreting the law (not only because the Court represents the third and final level of the judiciary but also because of its institutional mission of ensuring the correct observance and uniform interpretation of the law). It may seem reasonable for French companies that find themselves in circumstances comparable to those of the French plaintiff in the case under discussion to rely directly on the Court principle without the need to wait for a legislative change of the PEX provision (although it is not yet clear how nonresident entities may, in practice, self-assess and pay a 1.2% tax); alternatively, they may just pay the full capital gain tax and request a refund.
Different analysis and considerations should be made carefully for companies residing in other jurisdictions, especially if the other jurisdiction is not part of the EU because it is unclear whether any future change of the PEX rule would extend the regime to non-EU entities (the Italy-France treaty, together with the Italy-Cyprus one, is the only Italian treaty with EU jurisdictions providing for capital gain taxation rights in favor of the source country).
Also, as a general principle, it must be kept in mind that any foreign entity potentially claiming that the PEX regime applies, should avail of adequate economic presence in the respective country of residence. In fact, extending domestic treatment to foreign entities on the basis of the Freedom of Establishment or Free Movement of Capital would generally require that the entities are truly and concretely exercising such freedoms (e.g., with adequate assets, people and functions).
With Italy's ratification of the Organisation for Economic Co-operation and Development (OECD) Multilateral Instrument (MLI), a number of qualifying treaties will automatically incorporate the relevant Article 9 on capital gains ("land-rich clause") that would require gains that foreign entities derive upon transferring Italian companies to be taxed in Italy if they mainly derive from Italian real estate. However, the PEX regime would likely remain inapplicable in this situation because, even for Italian taxpayers, the regime is not available for participations held in real estate companies.
As a last note, companies that have already paid the Italian nonresident capital gain tax in full and find themselves in a qualifying position aligned with the principles stated by the Supreme Court decision, should consider the opportunity to seek a refund, provided that the tax payment did not occur more than 48 months before the start of the process.
For additional information with respect to this Alert, please contact the following:
Studio Legale Tributario, International Tax and Transaction Services, Milan
Studio Legale Tributario, International Tax and Transaction Services, Rome
Studio Legale Tributario, Bologna
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 Among others: Provincial Tax Commission of Milan n. 2683 of 7 March 2017, Regional Tax Commission of Lombardy n. 159 of 19 December 2017, Regional Tax Commission of Lombardy n. 725 of 22 February 2021, Regional Tax Commission of Abruzzo n. 279 of 3 May 2022.
2 In this context, an "Italian participation" refers to participation in an Italian company.