Executive summary

On 19 November 2024, the Italian Parliament issued a favorable opinion with proposed recommendations to a Draft Legislative Decree submitted by the Government on 11 October (Draft Decree).

The Draft Decree streamlines and amends several existing tax step-up regimes that, according to the current rules, require the payment of substitute taxes ranging from 12% to 16% in exchange for aligning certain tax values to their respective (higher) accounting values. Among other things, the proposed rules replace the old rates with an 18% tax (in lieu of the corporate income tax) and a 3% tax (in lieu of the local tax).

The Draft Decree also simplifies the carryforward of tax losses for reorganizations occurring between entities that are part of the same corporate group, while also amending the requirements for the preservation of losses in the context of change-of-control and merger/demerger transactions.

The proposed rules extend the scope of certain domestic and cross-border tax-free reorganizations, including exchanges of shares and contribution of assets.

The Draft Decree, which may become final and effective by the end of the year, provides for certain provisions to apply retroactively as of 1 January 2024.

Detailed discussion

In accordance with the principles laid down by Articles 1, 5, 6 and 9 of Law 9 August 2023, n. 111 (2023 Tax Reform Framework Law),¹ the Draft Decree reforms aspects of both the corporate income tax (CIT or "Imposta sui redditi delle societa," i.e., IRES) and the regional tax on productive activities (Local Tax or "Imposta regionale sulle attivita' produttive," i.e., IRAP).

The most significant changes included in the Draft Decree are described below.

Tax step-up regimes

Mismatches from changes in accounting principles

Article 11 of the Draft Decree introduces a unified and simplified regime to electively align mismatches between tax and accounting values deriving from multiple cases, including the first adoption of international accounting standards, as well as shifts and variations in the application of accounting principles. This new rule replaces a variety of elective regimes scattered across the Italian tax law system.

The new regime may be applied to absorb the overall mismatch net balance (i.e., the algebraic sum of all positive and negative differences existing as of the beginning of the year) or on an item-by-item basis (i.e., by homogeneous categories of mismatches).

In the first case, the overall net balance is subject to CIT and Local Tax at standard rates (currently 24% and 3.9%, respectively) plus any applicable surcharges, if positive. A negative net balance would, otherwise, be tax deductible in 10 years (i.e., the year of the election and the following nine). In the second case, each mismatch category net balance is subject to substitute taxes of 18% (in lieu of CIT) and 3% (in lieu of Local Tax) plus any applicable surcharges, with any negative net balances not being deductible.

The Draft Decree provides that the new provision should apply retroactively as of the fiscal year (FY) following the one in course on 31 December 2023 (i.e., for calendar-year companies, as of 1 January 2024).

Mismatches from tax-free reorganizations

Under current provisions, taxpayers may alternatively elect two types of regimes to step up the tax basis of assets in the context of tax-free reorganizations. The ordinary regime allows tangible and intangible assets' step-up, subject to the payment of a CIT and Local Tax substitute tax of 12%/14%/16% applying per bracket (i.e., respectively up to €5m, between €5m and €10m, over €10m), possibly subject to a recapture mechanism if the assets are sold before a certain term. Alternatively, a special tax step-up is available for goodwill, trademarks and other intangibles, subject to a CIT and Local Tax substitute tax of 16% allowing, for instance, the tax amortization of goodwill over a five-year period, as opposed to the standard 18-year period.

Article 12 of the Draft Decree repeals the special regime and amends the ordinary one by aligning the substitute tax to the same rates introduced for the above-mentioned "Mismatches from changes in accounting principles," i.e., 18% and 3% plus any applicable surcharges. Although the Draft Decree eliminates the recapture mechanism, the Parliament suggests reintroducing a three-year recapture period to prevent tax-arbitrage practices.

The new provision should apply retroactively to corporate reorganizations implemented as of 1 January 2024, while, under certain circumstances, those implemented in the previous FY may still be subject to the old rule.

Carryforward of tax losses in change-of-control transactions

Article 15(1)(a) of the Draft Decree amends the rules on the carryforward of tax net operating losses (NOLs) and other tax attributes in the case of change-of-control transactions.

Under current rules, the carryforward of a company's NOLs and other tax attributes is denied in the event of a change of control if the Italian subsidiary's core business activity carried out in the years when the tax losses were generated is changed in the year of the change of ownership or during the two following or two preceding years (i.e., a five-year window). In any case, an exception applies if the following two-pronged test (Economic Vitality Test) is met: (i) the number of employee was never fewer than 10 units in the two-year period before the change of ownership and (ii) the amount of revenue and labor costs in the profit and loss (P&L) for the FY before the transaction exceeds 40% of the average amount of said revenue and costs in the P&L of the two prior years.

Apart from some limited exceptions, the following proposed changes are generally intended to apply to transactions taking place during the FY in course at the date of entry into force of the Draft Decree.

1. Introduction of the intra-group exception
   The Draft Decree introduces an exception for intra-group transfers, meaning that if the change-of-control transaction takes place between entities of the same corporate group, the above-mentioned limitation should not apply. Based on the Parliament's recommendations, it is expected that the new provision will be subject to implementing measures including a specific anti-avoidance clause. This intra-group transfer exception should affect changes of control occurring as of FY 2024 but only with reference to tax attributes generated as of FY 2024 (thus any 2024 or even post-2024 intra-group change of control will still require specific tests to be run with reference to any pre-2024 tax attributes).
2. Amendment to the Economic Vitality Test
   The Draft Decree amends the above-mentioned Economic Vitality Test exception by repealing the required minimum number of 10 employees in the two-year period before the change of ownership. Hence, the new test should only be based on the minimum gross revenues and labor costs requirement. The amended version of the test is now aligned with the Economic Vitality Test to be met for the carrying forward of NOLs and other tax attributes in the case of mergers and demergers (see below).
3. Introduction of the Net Equity Test
   In addition to the (modified) Economic Vitality Test, the Draft Decree provides that the company also needs to meet a quantitative limit for the carryforward of NOLs and other tax attributes. This new limit is represented by the higher of the economic value of the company's net equity (as determined by a qualifying sworn appraisal) and the net book equity (Net Equity Test). While the Draft Decree requires the net book equity to be net of any equity contributions made in the last 24 months, the Parliament's recommendation is to disregard any past contributions (i.e., not limited to the previous 24-months).
4. Review of the "change of core business" notion
   The Draft Decree clarifies that "change in the core business activity" means a company's change in the economic sector or product segment of operations. Furthermore, it states that a change in the activity may also occur when the company acquires a new business.
5. Date of reference
   The Draft Decree also clarifies that the change-of-control limitation applies to NOLs and other tax attributes resulting at the end of the last FY closed before the date of transfer of the participations, and the value of the (economic or accounting) net equity to be used as a quantitative limit should be the one resulting at the same date. However, if the transfer of the participation occurs after six months from the end of the previous FY, one should consider the NOLs and other tax attributes, as well as the net equity, resulting at the end of the FY of the transfer.

Carryforward of tax losses in mergers and demergers

Article 15(1)(b) of the Draft Decree amends the rules on the carryforward of NOLs and other tax attributes in the case of mergers and demergers. Under current rules, existing NOLs and other tax attributes of a company participating in a merger or a demerger can survive at the level of the company resulting from the reorganization provided that: (i) the Economic Vitality Test is met (i.e., the profit and loss accounts of the company that generated the losses should show for the fiscal year prior to the merger/demerger resolution gross revenues and labor costs deriving from the business activity higher than 40% the average of the two previous fiscal years) and within the Net Equity Test (i.e., NOLs and other tax attributes may survive up to the amount of the accounting net equity of the company that generated the relevant tax attributes resulting from the last financial statements or, if lower, from the interim financial statements drawn up for merger/demerger purposes.

1. Introduction of the intra-group exception
   The Draft Decree introduces an exemption for intra-group mergers/demergers. The new provision states that the limits represented by the Economic Vitality Test and the Net Equity Test do not apply in relation to: (i) NOLs and other tax attributes generated in FYs during which the involved entities belonged to the same (non-tax) group (Intragroup Losses), and (ii) NOLs and other tax attributes generated by a company prior to joining the group (but those derived till 31 December 2023) that have already passed the Economic Vitality Test and the Net Equity Test at the moment of entrance into the group, either by way of a change of control or a merger/demerger transaction (Homologated Losses). In the case of change-of-control transactions, the Parliament recommends the new provision be subject to implementing measures including a specific anti-avoidance clause.
2. Amendment to the Economic Vitality Test
   The Draft Decree provides that the Economic Vitality Test is conducted by comparing (i) the gross revenues and labor costs booked in the financial statement for the FY preceding the one in which the merger takes effect (no longer the one in which the merger transaction is resolved), with 40% of the average of these values resulting from the financial statements of the two preceding FYs, and (ii) the gross revenues and labor costs booked in the interim financial statement for the period between the beginning of the FY and the effective date of the merger, prorated per year, with 40% of the average of these values resulting from the financial statements of the two preceding FYs.
3. Amendment to the Net Equity Test
   The Draft Decree also introduces, with reference to mergers and demergers, the same concept of "economic net equity" introduced for the change-of-control transactions. The new provision states that the Net Equity Test is to be referred to the higher of (i) the economic value of the net equity as determined (on the merger/demerger effective date) by a qualifying sworn appraisal or (ii) the accounting book net equity (net of any contributions made in the last 24 months preceding the reference date of the financial statement or the relevant balance sheet).
4. Repeal of write-downs limitation
   The Draft Decree repeals the current provision that precludes the carryforward of losses and other tax attributes up to the amount of previously deducted write-downs related to the shares in the companies participating in the merger/demerger.
5. Change to the regime for the interim period
   The Draft Decree clarifies that, for backdated mergers/demergers, the NOLs and tax attributes generated during the interim period are subject to the two tests only with reference to those that would have been autonomously generated by the disappearing entity and not by the surviving one.

Final tax losses

The Draft Decree introduces the possibility for the tax losses of a company residing in the European Union (EU) or the European Economic Area (EEA) that merges into an Italian-resident related company to be used by the Italian company under the following conditions:

1. The foreign entity has completely ceased its business activity through the elimination of all its assets.
2. The tax losses cannot be used in any way in the foreign jurisdiction.

The Parliament proposes to cancel this provision, as apparently it does not meet the criteria addressed by the relevant case law of the EU Court of Justice.

New downstream demerger

The Draft Decree introduces a new type of demerger (Downstream Demerger) already regulated by the Italian Civil Code (Article 2506.1) in which a company (Transferor) transfers parts of its assets to an entity (Recipient) in exchange for shares in the Recipient (differently than in the ordinary demerger where the shares of the Recipient are assigned to the shareholder of the Transferor). The Downstream Demerger is treated as a tax-free reorganization and subject to a specific tax regime that generally leverages on the tax provisions that apply to the (ordinary) demergers. As recommended by the Parliament, the tax treatment of the new Downstream Demerger is expected to be harmonized with that of other tax-free reorganizations.

This change is intended to apply to transactions taking place during the FY in course at the date of entry into force of the Draft Decree.

Business and shareholdings transfers in exchange for shares

The Draft Decree revisits the tax regime of business and shareholdings transfers as follows:

1. The characterization of business "hive-downs" in exchange for participations in the transferee as tax neutral remains unchanged (Article 176 of the Italian tax code), however any preexisting goodwill at the level of the transferor (i.e., previously booked by the transferor as a consequence of previously occurred transactions), associated to the transferred business, should now be deemed to be transferred to the transferee (together with the rest of the assets) also for tax purposes.
2. Under current rules, the transfer in exchange for shares of substantial shareholdings between resident companies (Article 175.1 of the Italian tax code) may be regulated by the parties, even preventing the arising of a capital gain (Discretionary Capital Gain Regime), given that the realizing value for the transferor is equal to the higher of (i) the accounting value assigned by the latter to the shareholdings received from the transferee or (ii) the accounting value assigned by the transferee to the shareholdings received from the transferor. The Draft Decree makes any capital loss derived from any such transfer tax deductible in the hands of the transferor up to the difference between the tax cost and the fair market value of the transferred shareholdings, unless the participation exemption regime applies (Loss-making Transfer).
3. Under current rules, the transfer of shareholdings (other than those described under letter (b) above) that enables the transferee to acquire control over the entity whose shareholdings are transferred (Control Takeover Transfer), is also eligible for a Discretionary Capital Gain Regime (Article 177 of the Italian tax code). Indeed, the transferor is due to realize a taxable gain only if the net equity increase, as accounted for by the transferee, is higher than the historical tax cost at the level of the transferor. Among other things, the Draft Decree extends the possibility to apply the Discretionary Capital Gain Regime as follows: (i) the regime applies if the transferee increases (and not only acquires) its share of control, (ii) the regime also applies if the entity whose shareholding is transferred is a foreign tax-resident entity and (iii) any capital losses realized by the transferor become tax deductible under the same conditions described under letter (b) above.

The Parliament also recommends amending the current provision concerning the special Discretionary Capital Gain Regime for exchange of shares between EU-resident entities by extending this treatment to cases where the company whose shareholding is transferred and the transferee are resident in the same EU Member State (other than Italy).

The above changes should apply to transactions taking place after the date of entry into force of the Draft Decree.