Italy - Taxation of cross-border mergers and acquisitions

Italy has no special tax regulations for mergers and acquisitions (M&A), which are principally governed by Presidential Decree no. 917/1986 (the Italian Consolidated Income Tax Code (ITC)).

As a general rule, resident companies are subject to corporate income tax (imposta sul reddito delle società (IRES)) and regional tax on productive activities (imposta regionale sulle attività produttive (IRAP)).The basic IRES rate is 24 percent (down from 27.5 percent in fiscal year 2016).The basic IRAP rate is 3.9 percent, although IRAP rates vary according to the region where the company operates. Higher rates apply to banks, financial

This report describes the main tax issues to be considered when structuring a cross-border acquisition and is based on the tax rules applicable up to January 2021.

Accounting and legal issues are outside the scope of this report, but some of the key points to be considered when planning a transaction are summarized.

The following summary of Italian tax issues includes the amendments introduced by Law no. 178/2020 (‘2021 Budget Law’).

The most significant measures, inter alia, introduced by the 2021 Budget Law include:

• exemption from taxation on dividends and capital gains on qualifying stakes granted to certain foreign Undertakings for Collective Investment
• step-up of business assets
• step-up of the tax basis of certain shareholdings held in unlisted resident entities
• tax incentives for business combination.

How these tax changes affect M&A deals is summarized in the following sections.

Generally, an acquisition may be structured as an asset deal or a share deal. The tax implications of these two structures are different.

Purchase of assets

In an asset purchase, a person buys a business^[1] from another person for consideration.

Even if an appraisal of the business is not mandatory, it is often useful to have one in order to prove that the selling price is at arm’s length and show how the purchase price is allocated (for instance, a clear purchase price allocation is significant for registration tax purposes, see infra).

The buyer may step-up the tax basis of the assets to the price paid for them and then amortize and depreciate these assets based on their new tax basis.

From the seller’s perspective, the sale of a business may give rise to a taxable capital gain or a deductible loss, which is the positive or negative difference, respectively, between the sale price and the tax basis of the business. The capital gain (or loss) is included in (or deducted from) the seller’s overall IRES base in the year in which it is realized. The ordinary IRES rate (24 percent) applies. If the seller has held the business for at least 3 years, it may elect to spread the capital gain in equal instalments over a period of up to 5 years. The capital gain or capital loss deriving from the sale of a business unit is not included in the IRAP base.

The buyer of a business is jointly and severally liable with the seller for any tax liabilities connected with the business and originating from any breaches of tax rules:

• committed in the year of acquisition or in the 2 previous years, or
• imposed and formally contested in the same period even though relating to violations committed in preceding years.

The buyer’s maximum liability is equal to the value of the business acquired. In order to limit the buyer’s liability, both parties may apply for a certificate from the Italian tax authorities, attesting any tax debts existing on the acquisition date. The buyer’s exposure can then be limited to the liabilities shown on the certificate. The buyer is not responsible for any tax liability of the seller if the Italian tax authorities do not issue the certificate within 40 days of the application or if no liabilities are indicated on the certificate.

Purchase price

There are no particular tax rules for allocating the purchase price to the individual assets and liabilities forming the business, so the purchase price should be allocated based on the fair market value of the assets and liabilities transferred. The buyer and the seller agree upon the overall consideration to be paid for the business. If they wish, they can then apportion the total consideration among the assets in order to identify, insofar as commercially justifiable, the price paid for any individual assets belonging to the business, including goodwill.

Goodwill

The portion of the consideration paid to acquire the goodwill of the business is recognized for tax purposes.

Goodwill may be amortized for IRES and IRAP purposes over 18 years; consequently, the deductible amortization allowance may not exceed one-eighteenth of its value per year.

Depreciation and amortization

Deductible amortization allowances may not exceed 50 percent of the cost per year in the case of copyrights, patents, methods, formulae, and industrial, commercial or scientific know-how. In the case of trademarks, the annual amortization allowance may not exceed one-eighteenth of the cost.

Tangible assets may be depreciated from the tax year in which they are put into use, using the straight-line method.

Tax depreciation charges cannot be higher than the charges resulting from the application of the tax depreciation rates published in a Ministry of Finance decree. In the first tax year of use, these charges are halved.

These rules do not apply to assets worth less than 516.46 euros (EUR), because they can be fully depreciated in the tax year of acquisition.

Tax attributes

Tax losses and other possible tax attributes are not transferred in an asset deal as they remain with the seller.

On certain conditions, Value Added Tax (VAT) credits may be transferred to the buyer along with the business.

Value Added Tax

Business acquisitions are not subject to VAT. However, the sale of single assets by a VAT payer is generally subject to VAT at the ordinary rate of 22 percent.

Registration taxes

According to the Registration Tax Code (RTC), the transfer of a business is subject to registration tax, generally paid by the buyer (although the parties may agree otherwise). However, both parties are jointly and severally liable for the payment of the registration tax.

The tax rate depends on the type of asset transferred:

• accounts receivable: 0.5 percent
• buildings: 9 percent
• land: 9 percent (15 percent for agricultural land)
• movable and intangible assets, including goodwill, patents and trademarks: 3 percent.

If the assets are subject to different registration tax rates, the liabilities of the business must be allocated to the different assets in proportion to their respective values. If the purchase price is not apportioned to the various assets, the registration tax is levied at the highest rate of those applicable to the assets (generally, the rates for buildings or land). Thus, it is recommended that the purchase price should be clearly allocated to each asset so that there is separate taxation based on the different tax rates.

The RTC provides that the tax basis of a business is its fair market value (not its purchase price, which may be different). The fair market value is subject to assessment by the registration tax office. Therefore, it is often advisable to obtain an appraisal from an independent expert in advance of the transaction.

Step transactions: new tax rules

When an asset deal is structured through the contribution of a business into a new company in exchange for shares in the new company, followed by the sale of those shares, only EUR200 registration tax is due on each transaction.

However, over the last few years, the Italian tax authorities have often treated such two-step transactions as a straightforward sale of business, subject to registration tax of 0.5 percent, 3 percent or 9 percent, depending on the type of assets. The tax authorities argue that a certain rule in the RTC (‘art. 20’) allows deeds to be defined by the economic purpose they achieve and by their interaction with other deeds executed immediately before or after.

The Law no. 205/2017 (‘2018 Budget Law’) introduced a ‘new art. 20’, whose wording expressly stated that registration tax must be applied exclusively referring to the deed submitted for registration and without considering extratextual elements other than the deed itself and, thus, expressly excluding the mentioned interpretation provided by the Italian tax authorities. Nevertheless, with reference to existing litigations and past step transactions, the Italian Tax Courts continued applying the previous version of the art. 20 as interpreted by the Italian tax authorities.

For this reason, the Law no. 145/2018 (‘2019 Budget Law’) confirmed that the tax authorities are denied the ability to recast as a sale of assets the contribution of a going concern in the transferee company followed by the sale of
100 percent of the shares and, in particular, stated that the ‘new art. 20’ also applies to existing litigations and past step transactions.

The Italian Supreme Court, however, judging on a case, submitted to the Italian Constitutional Court a question on the compatibility of the ‘new art. 20’ with the Italian Constitution. The Italian Constitutional Court dismissed such question with the decision no. 158 of 21 July 2020, stating once again that, under art. 20, registration tax must be applied exclusively referring to the deed submitted for registration and without considering extratextual elements other than the deed itself.

Purchase of shares

No special issues arise for the buyer, except for the classification of the shares in the balance sheet (as inventory or fixed financial assets), which may affect the tax treatment of their subsequent sale.

In principle, the target company retains the tax attributes it had before the share acquisition; however, in certain cases, some of them may be jeopardized.

Tax indemnities and warranties

In a share deal, the buyer takes over the target company together with all its liabilities, including contingent liabilities. Therefore, the deal normally requires more extensive indemnities and warranties than an asset deal.

Tax losses and certain other tax attributes

A company cannot carry forward its available tax losses, interest expense and allowance for corporate equity (ACE) if it undergoes a change of control and its main business activity also changes. This regime, aimed at tackling the abusive trading of tax attributes, does not apply if the following two conditions are together met:

• The company employed a minimum of 10 employees throughout the 2 years preceding the year of the ownership change.
• The company’s profit and loss account for the tax year preceding the year of the ownership change shows revenues (and other proceeds from the main activity) and labor costs (and related social security contributions) that are higher than 40 percent of the average in the 2 preceding years.

If the above conditions are not met, the taxpayer may apply for a tax ruling to stop the rule’s application.

Indirect taxes

Transactions involving shares, quotas, bonds and other securities are VAT-exempt.

Notarial deeds and private deeds with notarized signatures are subject to a fixed registration tax of EUR200 when they concern the trading of shares.

No stamp duty is applicable.

A financial transaction tax (FTT) is levied on transfers of shares (not quotas) issued by Italian companies. The FTT is due by the final buyer. The standard FTT rates are:

• 0.20 percent for over-the-counter transactions
• 0.10 percent for transactions executed on regulated markets.

Sales of shares between companies of the same group are normally not taxable for FTT purposes.

Share-for-share deal

Art. 177 (2) of the ITC establishes how to calculate capital gains when shares are contributed. For example, Company A contributes shares in Company C to Company B and Company B thereby acquires or increases (pursuant to an obligation imposed by law or articles of association) a controlling interest in Company C. In return for the contribution, Company A receives shares in Company B. To determine Company A’s gain, reference must be made to the increase in Company B’s equity as a result of the contribution. Company A’s capital gain is the difference between:

• the equity increase of Company B, and
• the tax basis of the shares in Company A’s accounts.

Such rollover relief previously available for controlling stakes has now been extended to the contribution of minority stakes.

In case the receiving company does not acquire a controlling interest in the transferred company, the mentioned rollover relief can be applied where both of the following conditions are satisfied.

• The contributed shares represent a qualifying participation (i.e. more than 2 percent of the voting rights or 5 percent of the capital, in the case of participations in listed companies; more than 20 percent of the voting rights or 25 percent of the capital, in the case of other participations); and
• the minority shares are contributed to a company wholly owned by the transferor.

In order to benefit from the Italian participation exemption regime on future sales, the minority shareholdings contributed, inter alia, must be held by the transferee company uninterruptedly from the first day of the 60th month (60 months) preceding the month of the sale (instead of the ordinary holding period of 12 months).

Step-up of assets tax basis

Share deal

In case the price paid for the acquisition of a controlling shareholding is higher than the net equity of the acquired company, in the consolidated financial accounts, the acquiring company may allocate the positive difference between the acquisition price and the net equity of the acquired company as higher value of trademarks, goodwill or other intangible assets.

As a result of the purchase price allocation in the consolidated financial statements, the accounting values of such assets (trademarks, goodwill and other intangible assets) are increased, but such increased value is ordinarily not relevant for tax purposes.

According to a special step-up regime, the acquiring company could subject, in whole or in part, to a 16 percent substitute tax, the higher value of the controlling shareholdings acquired, recorded in the consolidated financial statements following the acquisition as goodwill, trademarks or other intangible assets. Starting from the second fiscal year following the one during which the substitute tax is paid, the tax amortization of the higher values recorded in the consolidated financial statements is made for an amount not exceeding one-fifth, regardless of the allocation to the (P&L) Profit and Loss statement. The 2018 Budget Law has extended this rule to the acquisition of shares in non-Italian companies, for 2017 and later fiscal years.

Merger

It is possible to step-up the tax basis of the target’s underlying assets by merging the acquisition vehicle and target company after closing. In this case, the step-up of the tax basis of the underlying assets is possible if the following substitute taxes are paid:

• 12 percent on the first EUR5 million of the higher amount
• 14 percent on the next part, up to EUR10 million
• 16 percent on the part exceeding EUR10 million.

Tax value of the shares to be sold

The 2021 Budget Law allows resident individuals and non-resident entities (having no permanent establishment in Italy) to step-up the tax basis of their shares in unlisted resident entities if all the following conditions are met:

• the shares are owned as at 1 January 2021
• an appraisal is finalized by an expert by 30 June 2021
• an 11 percent substitute tax on the value of the shares is due, payable in a maximum of three yearly instalments; the first one should be paid by 30 June 2021.

Step-up of business assets

According to the art. 110 of the law decree no. 104 of 14 August 2020 (‘August Decree’) as amended by the 2021 Budget Law, resident companies, not IAS-adopter (International Accounting Standards), can step-up tangible and intangible assets, excluding those whose production or trade is the core business activity, as well as controlling shareholdings in subsidiary or associate companies that are booked among fixed assets in the financial statements ongoing at 31 December 2019.

The step-up may be performed only for accounting purposes. Furthermore, a step-up also for tax purposes could be made through the payment of a 3 percent substitute tax to income taxes and to IRAP on the new value of the stepped-up assets.

The higher values of assets are recognized for depreciation tax purposes starting from the beginning of the financial year (FY) following the year  that the performed step-up referred to (i.e. step-up in FY2020, step-up for depreciation tax purposes starting from FY2021).

The recognition of the stepped-up tax values for capital gains purposes starts in the fourth FY following that in which the revaluation occurred (i.e. in case of step-up in FY2020, starting from FY2024).

Moreover, through the payment of a 10 percent substitute tax, the positive revaluation reserve can be totally or partially released for tax purposes (otherwise, the revaluation reserve qualifies as a ‘tax constraint reserve’, which is taxable for the company when distributed to the shareholders).

The mentioned substitute taxes should be paid in no more than three equal yearly instalments (i.e. the first one is due by the deadline for the settlement payment of income taxes referred to the FY in which the revaluation was made (i.e. by 30 June 2021). The second and third instalments are due within the terms respectively provided for the settlement payment of income taxes referred to the following FYs (i.e. by 30 June 2022 and by 30 June 2023).

In case the asset object of the tax step-up is sold, attributed to the shareholders or transferred before the first day of the fourth financial year following the one in which the revaluation is carried out, for the determination of the taxable gain it is required to make reference to the value of the asset before the step-up itself (re-capture clause).

Finally, both Italian GAAP-adopter and IAS-adopter companies could opt for a realignment of the tax basis of tangible and intangible assets (including goodwill), excluding those whose production or trade is the core business activity, as well as controlling shareholdings in subsidiary or associate companies that are booked among fixed assets in the financial statements ongoing at 31 December 2019, with their accounting value, if higher, by paying the same 3 percent substitute tax. In such case, being just a step-up of the tax value without a corresponding increase of the accounting value of the assets, there is no effect in terms of recapitalization nor revaluation balance to be imputed to an equity reserve; nevertheless, a special regime of tax suspension is imposed on existing equity reserves for an amount corresponding to the step-up, which can be released through the payment of the mentioned 10 percent substitute tax.

Tax incentives for business combination

Pursuant to the 2021 Budget Law, in case of mergers, demergers or contributions of going concerns resolved during 2021 (hereinafter ‘Business Combination’), the merging, the beneficiary or the receiving entity are allowed to convert into a tax credit a portion of the deferred tax assets (DTAs) relating to tax losses and excess ACE accrued up to the FY preceding the one in which the Business Combination occurs, even if such DTAs are not accounted for in the relevant financial statements.

The maximum amount of DTAs that may be converted into tax credit is equal to 2 percent:

a) of the sum of the accounting value of assets of the entities involved in the merger or demerger, without considering the entity having the highest value of assets; or

 b) in case of contribution of a going concern, of the accounting value of the contributed assets.

The mentioned DTAs conversion is effective for one quarter, on the date on which the Business Combination is legally effective and for the remaining three quarters on the first day of the following FY.

The said regime could be applied only to the extent the entities involved in the Business Combination:

• have been operating for at least 2 years, and
• on the date on which the Business Combination is effective and in the previous 2 years, have not been part of the same corporate group nor, in any case, are linked to each other by a shareholding higher than 20 percent or controlled, even indirectly, by the same person.

Furthermore, the DTAs conversion could also be applied in case the controlling shareholding in the entity has been acquired between 1 January 2021 and 31 December 2021 by virtue of a transaction different from a Business Combination and a Business Combination between such entities is executed within one year starting from the date on which the said control has been acquired.

The tax credit resulting from the DTAs conversion can be offset, without any limitation, with other taxes and social security contributions or transferred to third parties or claimed for refund.

In order to access this tax benefit, a fee equal to 25 percent of the total amount of the converted DTAs should be paid.

Such fee is deductible for both IRES and IRAP purposes and should be paid in two instalments of which the first one, equal to 40 percent, is due within 30 days starting from the date of legal effectiveness of the Business Combination, whereas the second one, equal to 60 percent, is due within 30 days starting from the beginning of the following FY.

A foreign company that intends to acquire a business or shares in a company located in Italy may do so:

• directly from abroad
• through a vehicle incorporated in a third jurisdiction
• through an existing permanent establishment in Italy
• through an Italian resident subsidiary, newly incorporated or already existing.

Local holding company

The most common forms of company in Italy are limited liability companies (Srl) and joint-stock companies (SpA).

If the asset is acquired through an Italian subsidiary (newly incorporated or already existing), repatriation of profits is subject to the domestic withholding tax (WHT) on dividends, unless the requirements for the EU Parent-Subsidiary Directive exemption are met or a lower (or nil) treaty rate applies. If a tax treaty applies, any subsequent disposal of the shares in the Italian subsidiary is not generally taxed in Italy. The requirements for the application of the EU Directives and tax treaty are aggressively scrutinized by the Italian tax authorities.

Typically, an Italian holding company is used where the buyer wishes to offset the interest expenses against the target’s taxable profits through a tax consolidation or merger, in accordance with the earnings-stripping rules.

Foreign parent company

Tax treatment of capital gains

A foreign buyer may choose to make the acquisition itself, perhaps to shelter its own taxable profits with the financing costs.

Under the tax rules in force up to and including 2018, if a non-resident company realizes a capital gain on the sale of a qualifying (i.e. more than 2 percent of the voting rights or 5 percent of the capital, in the case of participations in listed companies; more than 20 percent of the voting rights or 25 percent of the capital, in the case of other participations) equity interest in an Italian resident company and does not have a permanent establishment in Italy, IRES is payable as follows.

• For gains realized on or before 31 December 2017, 49.72 percent is taxable at a 24 percent rate of corporate income tax (CIT), with an effective tax rate (ETR) of 11.93 percent.
• For gains realized on or after 1 January 2018, 58.14 percent is taxable at the CIT rate of 24 percent, with an ETR of 13.95 percent.

The 2018 Budget Law has replaced the above system of taxation, from 1 January 2019 onwards, with a flat 26 percent substitute tax, aligned with the capital gains tax on non-qualifying shares.

On the disposal of a non-qualifying equity interest in an Italian resident company, gains realized by a non-resident seller (with no permanent establishment in Italy) are exempt in Italy if the shares are listed on a regulated market (or on a multilateral trading facility, which has been equated to a ‘regulated market’ for income tax purpose by the Italian tax authorities in the circular letter no. 32 of 23 December 2020, par. 2) or the seller is resident in a state that allows an adequate exchange of information with Italy. In other cases, these capital gains may be taxed at 26 percent, unless they are exempt under a tax treaty.

Tax treatment of dividends

Dividends paid to non-resident shareholders are generally subject to a final WHT of 26 percent.

A reduced 1.2 percent WHT is levied if the beneficial owner is a company resident and subject to tax in a European Economic Area (EEA) member state that allows an adequate exchange of information with Italy.

Dividends paid to qualifying EU parent companies are not subject to WHT. To qualify, the parent company must:

• be resident for tax purposes in an EU member state
• have one of the eligible legal forms
• be subject to tax, and
• hold at least 10 percent of the capital of the subsidiary for at least 1 year without interruption.

Under an agreement between the EU and Switzerland, dividends paid to Swiss parent companies may be exempt from WHT under conditions similar to those in the Parent-Subsidiary Directive (PSD).

It is to be noted that the application of the PSD has constantly been challenged by the Italian tax administration, even in perfectly legitimate cases.

Indeed, the Italian Supreme Court, in the decisions no. 25490/2019 and no. 32255/2018, stated that, in order to benefit from the withholding exemption under the PSD, a dividend must be effectively taxed in the EU member state of tax residency of the parent company.

These positions contrast with the very basic principles underpinning PSD and, thus, additional scrutiny should therefore be expected on the application of PSD.

Conversely, the Italian Supreme Court, in its decision no. 2313 of 31 January 2020, stated that PSD is aimed at eliminating not only juridical double taxation (same income taxed twice in the hands of the same taxpayer), but also economic double taxation (same income taxed twice in the hands of two different taxpayers — i.e. as business income at the level of the subsidiary and as dividend at the level of the parent company) and also stated that PSD should grant a tax neutrality in the taxation of dividend with reference to the EU parent company (i.e. the fiscal treatment should be the same as the one applicable in the case of dividend distributions between all Italian resident companies). In light of the above statements, the WHT exemption under PSD is also applicable to a UK parent company benefiting from an indirect tax credit on the dividends received from the Italian subsidiary, as UK company should be considered ‘subject to tax’ in the UK for the purpose of PSD.

Recently, the Italian Supreme Court, in the decision no. 14756 of 10 July 2020, provided for relevant indications in order to identify the status of ‘beneficial owner’ for the purposes of the PSD and EU Interest and Royalties directive (2003/49/EC) deciding on a case concerning interest payments made by an Italian subsidiary to its controlling shareholder, a Luxembourg sub-holding, carrying on financial and treasury functions.

Referring to its past case law concerning PSD, the Italian Supreme Court has stated (in par. 1.11 of the decision) that the assessment of ‘beneficial owner’ status should be based on the analysis of the autonomy of the recipient company (Luxembourg sub-holding) both in taking the strategic and management decisions related to the shareholding held and in retaining, investing or transferring to a third company the income received. Furthermore, the Italian Supreme Court also clarified that the circumstance that the Luxembourg sub-holding is a pure holding company does not exclude the application of the benefits of the PSD.

Exemption from taxation on dividends and capital gains on qualifying stakes granted to certain foreign Undertakings for Collective Investment

With reference to certain foreign Undertakings for Collective Investment (UCIs), the 2021 Budget Law:

• has introduced an exemption from WHT on dividends received with reference to any shareholding held in Italian tax resident companies; and
• has stated that capital gains on qualifying stakes are non-taxable in Italy.

These provisions apply to:

• foreign UCIs established in compliance with the Directive 2009/65/EC (i.e. ‘UCITS Directive’); or
• foreign UCIs established in an EU Member State or EEA Member State, allowing for an adequate exchange of information for tax purposes, and whose manager is subject to regulatory supervision in the country where it is established according to the Directive 2011/61/EU (i.e. ‘AIFM Directive’).

These new provisions are effective with reference to distributions of profits and capital gains realized as of 1 January 2021.

Local branch

The target company (assets or shares) can also be acquired through a permanent establishment of a foreign company. Under Italian law, a foreign company may establish a branch (permanent establishment) in Italy. However, branches cannot be considered as autonomous legal entities. From a corporate tax perspective, branches of non-resident companies are normally treated as resident corporations and taxed on their local profit.

Italy’s definition of permanent establishment largely follows the definition in the Organisation for Economic Co-operation and Development’s (OECD) model tax treaty.

A buyer using an Italian acquisition vehicle needs to consider whether to use debt and/or equity.

Debt

The principal advantage of debt is the potential deductibility of interest, as dividend payments cannot be deducted for tax purposes. Another potential advantage is the deductibility of expenses, such as guarantee fees, when computing income for tax purposes.

In a leveraged buyout (LBO) involving a merger or tax consolidation with the target, companies may offset interest against income of the target, within the limits described below (see ‘Deductibility of interest’).

The Italian tax authority used to challenge some LBO transactions aggressively, mainly when the acquisition was made by a foreign entity.

On 30 March 2016, the tax authority clarified the tax treatment of LBOs via Circular 6 as follows.

• An LBO is not generally a tax-abusive transaction, so related interest expenses are deductible under the ordinary rules.
• The tax authority will focus on the substance and activity of foreign inbound-investment platforms or holdings.
• Abusive transactions are still subject to review by the tax authority, based on the general anti-avoidance rules.

Deductibility of interest

As of 1 January 2019, interest expenses — including those accrued as at 31 December 2018 — are deductible each tax year up to the amount of the (i) interest income of the tax year and (ii) interest income carried forward of the previous years.

The excess of such interest expenses is deductible up to 30 percent of (i) first, the EBITDA based on the tax P&L (‘Tax EBITDA’) of the tax year and (ii) for the residual part, from the Tax EBITDA of the previous tax years, starting from the less recent year.

Excess of Tax EBITDA from 1 January 2019 can be carried forward for a period of 5 years.

Differently, the EBITDA carried forward and computed under the old rules (i.e. as at 31 December 2018) could be used, without time limits, but only to deduct interest expenses accrued on financial arrangements concluded before 17 June 2016 to the extent such arrangements were not subsequently amended in their amount or terms.

Where a company is part of a domestic tax consolidation arrangement, any non-deductible interest expenses (i.e. the portion exceeding 30 percent of tax EBITDA) may be used to offset the taxable income of another company within the tax group, if that company’s own tax EBITDA or interest income (of the tax year or carried forward, but not generated before the beginning of the tax consolidation) has not been fully offset against its own interest expenses.

The above limits do not apply to the deductibility of interest expenses incurred by:

• certain financial institutions and holding companies of certain financial groups
• insurance companies and holding companies of insurance groups
• certain consortia and Special Purpose Vehicles (SPVs) involved in public works.

Insurance companies, holding companies of insurance groups and qualifying asset management companies can deduct only 96 percent of interest.

Withholding tax on interest

A WHT of 26 percent is applied to interest payments made to non-resident companies, unless a reduced treaty rate or an exemption is available.

No WHT is due on interest payments made by Italian companies to Italian banks.

A WHT exemption on interest payments may apply if the following conditions are met.

• The regulatory provisions on reserved lending activities vis-à-vis the public pursuant to the legislative decree no. 385/1993 (Italian Banking Law) are respected (the Italian tax authorities, in the resolution no. 76 of 12 August 2019, have clarified that an I/C loan is out of the scope of such regulatory provisions — not qualifying as a lending activity “vis-à-vis the public” — and, thus, this requirement does not need to be satisfied by the I/C lender).
• The loan is a medium- or long-term loan (i.e. more than 18 months).
• The borrower is an enterprise.
• The lender is a bank established in the EU, an entity listed in article 2 (5) (4−23) of the EU Capital Requirements Directive (2013/36/EU), an EU insurance company or a foreign institutional investor subject to regulatory supervision in the country where it is established.

The EU Interest and Royalties Directive exemption may also apply if the following conditions are met.

• The company making the payment and the company receiving the payment are associated, as per the wording of the Directive (25 percent shareholding).
• The equity interests have been held for an uninterrupted period of at least 1 year.
• The companies making and receiving the payments have certain legal forms.
• The interest income is subject to tax.

WHT generally does not apply to corporate bonds listed on a regulated market or multilateral trading facility in a country that allows an adequate exchange of information.

Equity

A buyer may use equity to fund an acquisition. Contributions in cash do not give rise to taxable income for the recipient company.

Cash and contributions in kind to the capital of resident companies are subject to a fixed registration tax of EUR200. Registration, mortgage and cadastral taxes are due on contributions of real estate.

Under domestic law, there is a 26 percent WHT rate on dividends paid by Italian companies to foreign companies.

The ordinary WHT rate was reduced to 1.2 percent (1.375 percent before 2017) if the recipient of the dividend is a company resident within the EU or EEA.

If the EU Parent-Subsidiary Directive requirements are met (e.g. the EU parent company holds at least 10 percent of the shares for more than 1 year, is subject to tax and has economic substance, not qualifying as an artificial arrangement mainly aimed at obtaining the WHT exemption pursuant to PSD), there is no WHT on dividend payments.

Deductibility of the notional cost of equity

Since 2011, Italian companies have been able to benefit from an additional deduction from their tax base: the allowance for corporate equity (ACE). The allowance is equal to the aggregate qualifying equity increase since fiscal year 2010, multiplied by a notional rate of return. The equity increases include those resulting from certain cash contributions, waivers of certain financial receivables owed by an Italian company to its shareholders and undistributed profits set aside to freely disposable reserves.

The equity increases must be net of decreases resulting from distributions or assignments to shareholders and certain decreases that have to be made for anti-avoidance purposes.

The allowance is deducted from the company’s net taxable income and, if it exceeds the company’s net taxable income, the surplus can be carried forward indefinitely.

The ACE rates, set at 4.5 percent for 2015 and 4.75 percent for 2016, were reduced to 1.6 percent for 2017, 1.5 percent for 2018 and 1.3 percent for 2019 and later years.

Dividends not deductible for Italian tax purposes

Dividends paid by Italian companies to their shareholders may not be deducted from the IRES base.

Although equity offers less flexibility if the parent subsequently wishes to recover the funds it has injected, the use of equity may be more appropriate than debt in certain circumstances, such as the following.

• The target is loss-making, and it may not be possible to obtain immediate tax relief for interest payments.
• An appropriate mix of debt and equity is required in order to have efficient interest deductions under earnings-stripping rules.
• There are non-tax reasons for preferring equity, e.g. a higher level of equity may be preferable for commercial reasons.

Mergers, demergers and contributions of business units are usually tax-neutral transactions that do not trigger corporate income tax for companies or their shareholders.

Concerns of the seller

The tax position of the seller can have a significant influence on any transaction. If the seller of shares is an Italian company and if the shares held in an Italian company are booked as inventory in the financial statements of the year in which the shares were bought, any gain from the disposal of the shares must be included in full in the taxable income of the seller and taxed at the ordinary 24 percent IRES rate, as it is treated as revenue and not as a capital gain.

If the shares held in an Italian company are booked as fixed financial assets in the financial statements of the year in which the shares were bought, any capital gain realized by the seller is 95 percent tax-exempt (participation exemption) if the shares:

• have been held continuously for at least 12 months before the transfer
• are in subsidiaries that engage in an actual business activity.

The latter requirement must be satisfied from the first day of the third fiscal year preceding the year in which the shares are sold. Real estate companies are excluded from this regime if more than 50 percent of their aggregate asset value is represented by real estate other than assets built or purchased by the same company for resale or used in the business activity.

Conversely, capital losses on the disposal of shares that qualify for the participation exemption are not deductible by a corporate seller.

According to the Italian tax authorities, even if all the pre-conditions for the participation exemption are met, the regime does not apply to shares transferred in the context of a business transfer because the assets and liabilities included in that business must be considered as a ‘whole’ and cannot be unbundled (Circular 6/E of 13 February 2006).

Company law and accounting

M&A deals usually include transactions such as mergers, demergers and contributions in kind.

According to the Italian Civil Code, a merger involves the absorption of one or more companies by another company, resulting in the termination (without liquidation) of the absorbed companies and the transfer of their assets and liabilities to the absorbing company.

There are two types of mergers in Italy.

• All the companies are absorbed and their assets and liabilities are contributed to a newly incorporated company (fusione propria). The shareholders of the absorbed companies receive shares in the new company in exchange for their shares in the absorbed companies.
• An existing company absorbs one or more companies (fusione per incorporazione). The shareholders of the absorbed companies receive new shares from the absorbing company.

In the demerger of a company, all or some of its businesses are contributed to one or more other companies. The beneficiary companies may be newly incorporated or they may already exist.

The shareholders of the demerged company receive new shares issued by the companies to which the assets and liabilities are contributed.

In a contribution in kind (e.g. contribution of business units or shareholdings), a company transfers assets to another company and receives shares issued by the recipient in return.

As a rule, a sworn appraisal by a court-appointed expert is a prerequisite for contributions of business units (for limited liability companies, the contributing company can appoint the expert). The appraisal should describe the contributed assets and liabilities, the value assigned to each item and the criteria used for the appraisal. A notary public must execute the contribution deed.

Under Italian generally accepted accounting principles (GAAP), mergers and demergers are normally recorded at book value without any step-up (unless in the presence of a merger/demerger deficit, which could be allocated as higher value of assets or as goodwill).

When preparing their financial statements, Italian companies should generally use Italian GAAP, as set out in the Italian Civil Code and interpreted by the Italian Accounting Organization (OIC). Italian companies may in most cases also adopt International Financial Reporting Standards (IFRS) to prepare their accounts. These accounting standards provide for a step-up of the book values of the assets involved in a business combination, where certain conditions are met.

Finally, a common issue in transaction structuring is financial assistance. Broadly speaking, it is illegal for a company (or one of its subsidiaries) to give financial assistance, directly or indirectly, for the acquisition of that company’s shares.

Therefore, it is necessary to evaluate the rules carefully when structuring the financing of the deal and its security package.

Group relief/consolidation

As a general rule, Italian groups can opt for a domestic tax consolidation regime if the Italian companies are controlled by an Italian company.

However, a non-resident company can be head of the tax group if both the following conditions are met.

• The company is resident in a tax-treaty country.
• It carries on a business activity in Italy through a permanent establishment.

The main advantage of tax consolidation is that 100 percent of the tax losses incurred by one or more companies of the tax group can be immediately offset against the taxable income of other group companies. Any consolidated tax losses can be used to offset up to 80 percent of consolidated taxable income in subsequent years. However, losses incurred before the start of the consolidation regime cannot be offset against the taxable income of other group companies. These tax losses carried forward can only be offset against the taxable income of the company that incurred them.

Another advantage of tax consolidation is that the portion of interest expenses exceeding 30 percent of EBITDA (see ‘Deductibility of interest’ above) and generated after a company’s inclusion in the tax group can be used to offset the taxable income of another group company, if certain conditions are met.

To join a tax group, a subsidiary must have been directly or indirectly controlled by the parent company since the beginning of the financial year in which the option for tax consolidation is exercised (control requirement). As group membership is optional, it is possible that not all the Italian subsidiaries potentially qualifying for tax consolidation will join the group.

The domestic tax consolidation regime is irrevocable for a period of 3 years, and there are specific rules on its termination. For example, it is terminated if the control requirement is no longer met or there are certain merger/demerger transactions during the 3-year period.

Each consolidated company is liable for any tax liabilities, penalties and interest assessed by the tax authorities on its income. However, the controlling company is liable not only for its own tax liabilities but also — jointly and severally — for the tax liabilities, penalties and interest of each of the consolidated companies.

A non-resident company that (i) has a certain legal form, (ii) has no permanent establishment in Italy and (iii) is resident in an EU or EEA member state with which Italy has a tax information exchange agreement may also appoint an Italian resident company (or a permanent establishment of a controlled company resident in an EU or EEA member state) to opt for the domestic tax consolidation regime together with each resident company or permanent establishment that has the same non-resident parent company.

Transfer pricing

Transactions between resident companies and non-resident companies must be valued at fair market value if doing so increases the taxable base of an Italian company and if the non-resident:

• is controlled (directly or indirectly) by the resident
• controls (directly or indirectly) the resident, or
• is controlled (directly or indirectly) by the same person that controls the resident.

The fair market value is basically the arm’s length price under the criterion used in the OECD transfer pricing guidelines.

In other words, the price of each intercompany transaction, if it implies an increase in the tax base, should be equal to the consideration that would have been paid for goods and services of the same or similar type, in free market conditions, at the same stage in the distribution chain, and at the same time and place as the goods and services in question (or, if no such criterion is available, at the nearest time and place).

Since 2010, a group can prepare documentation supporting its transfer pricing (this is not mandatory). If such documentation is prepared and complies with the standards set by the Italian tax authorities, then a penalty-protection system applies and the group would not be subject to penalties if a tax assessment results in a transfer pricing adjustment.

The Italian tax authorities released a provision on 23 November 2020, amending the regulation on transfer pricing documentation, relevant for penalty-protection, starting from fiscal year 2020.

In particular, as of fiscal year 2020, with the aim of benefiting from the mentioned penalty-protection, all companies (including Italian permanent establishments) should prepare both the local file and the masterfile and such provision of 23 November 2020 indicates their necessary content.

According to par. 5.2.1 of the provision, the relevant documentation to obtain the penalty protection should be provided to the Italian tax authorities within 20 days from the date of request (previously 10 days).

If the documentation does not comply with the Italian tax authority’s guidelines or is deemed incomplete, administrative penalties ranging from 90 to 180 percent of the maximum tax assessed would be imposed for any transfer pricing adjustment.

As of 2016, multinational enterprises that meet specific requirements are required to file a country-by-country (CbyC) report, which must include their by-country revenues, gross profit, paid and accrued taxes, and additional indicators of actual economic activities.

The CbyC report must be filed within 12 months of the group’s year-end.

Foreign investments of a local company

The controlled foreign company (CFC) rule provides that the profits realized by a non-resident company are considered as profits of an Italian resident person if:

• the resident person directly or indirectly controls the non-resident company
• the company is resident in a jurisdiction that is deemed to have a low-tax regime.

As of 2016, foreign tax jurisdictions can qualify as low-tax regimes if their nominal level of taxation (tax rate) is lower than 50 percent of the combined IRES rate and IRAP standard 3.9 percent rate.

However, the CFC rule did not apply to controlled companies established in an EU member state or in an EEA state that allows for an effective exchange of information with Italy (i.e. Norway and Iceland).

To avoid the CFC rule, an Italian resident taxpayer must prove that:

• the CFC truly trades on the market of the country or territory in which it is located (the ‘business test’), or
• at least 75 percent of the CFC’s income is subject to tax in a country whose nominal level of taxation is equal to or higher than 50 percent of the corporate tax rate in Italy (the ‘subject-to-tax test’).

The CFC rule also applied to controlled companies resident or established in an EU member state, Norway or Iceland when both of the following conditions were met.

• Certain income, such as interest, dividends, royalties or revenues from intercompany services, exceeds 50 percent of their total income.
• The effective tax rate is lower than 50 percent of the rate that would apply if the company were resident in Italy.

CFC income is taxed at the level of the Italian resident corporate shareholder at the standard CIT rate of 24 percent.

The Law no. 205/2017 (‘2018 Budget Law’) has amended the tax treatment of dividends paid, directly or indirectly, by a CFC that passes the business test. The new law provides that 50 percent of such dividends are excluded from the taxable income of the Italian resident corporate shareholder (before this amendment, 100 percent of dividends were taxable).

Under certain conditions, the Italian resident shareholder may benefit from a foreign tax credit for income taxes paid by the CFC.

The legislative decree no. 142/2018 (‘ATAD Decree’) has amended the current CFC rules effective from 2019 by, essentially:

• extending the notion of ‘control’ to a share in profits higher than 50 percent;
• establishing that a controlled company is a CFC if
• its effective (no longer nominal) tax rate is lower than 50 percent of the tax rate that would apply if it were resident in Italy, and
• more than one-third of its income is passive income (there is no longer a distinction between EU/EEA and non-EU/EEA CFCs)
• establishing one safe-harbor rule (and no longer three), i.e. for non-resident entities that carry out a substantive economic activity, supported by staff, equipment, assets and premises.

Anti-hybrid rules

The ATAD Decree introduced certain anti-hybrid provisions effective from 2020, except for those on ‘reverse hybrids mismatch’, which will be effective from 2022.

Anti-hybrid rules only apply to cross-border instruments and to hybrid mismatches arising within the same group or in the context of a ‘structured arrangement’ between third parties.

Along the lines of the EU directive the following situations are addressed:

• hybrid mismatches leading to a double deduction (DD)
• hybrid mismatches leading to a deduction without inclusion (DNI).

In case of DD hybrid mismatches, the investor’s country may deny deduction first (primary rule) and only where it does not, the payer’s country will deny deduction (secondary rule).

In case of DNI hybrids, the payer’s country may deny deduction first (primary rule) and only when it does not, the beneficiary’s country will tax the item of income (secondary rule).

Collective Investment Vehicles (CIVs) set up in Italy, other than real estate investment funds, which are subject to regulatory supervision (‘vigilanza prudenziale’) are excluded from the scope of the rules concerning reverse hybrids.

Where the mismatch is caused by a special tax regime granted by a jurisdiction to an entity or to a financial instrument, anti-hybrid rules do not apply.

The Italian tax authorities, before issuing any notice of assessment related to a hybrid mismatch, must ask the taxpayer for clarifications.

Anti-avoidance rules

A transaction may constitute abuse of law if it has no economic substance and is essentially aimed at obtaining undue tax savings. Even if it is formally compliant with Italian tax law, a transaction will be abusive if it is at odds with the purposes of the provisions and/or the principles of the Italian tax system.

A transaction has no economic substance if it involves facts, acts and agreements (even interconnected ones) that have no significant effects other than tax savings or, in general, tax advantages. Transactions cannot be defined as abusive if they are justified by sound business reasons; these reasons include shake-ups or management decisions to improve the structure or operations of a business.

The taxpayer is allowed to submit an application for a tax ruling on whether a transaction constitutes unfair tax behavior.

Dormant company rule

A company is deemed to be dormant if, in a fiscal year, its revenues are lower than the sum of the following items:

• 2 percent of the average tax basis of the company’s financial assets in the fiscal year and the previous 2 years
• 6 percent of the average tax basis of the company’s real estate assets in the fiscal year and the previous 2 years
• 15 percent of the average tax basis of the company’s remaining assets in the fiscal year and the previous 2 years.

If the vitality test is not passed, the company’s minimum taxable income is deemed to be the sum of certain specific items. A dormant company may carry forward its tax losses but it can only offset them against the portion of its income that exceeds the minimum taxable income.

If a company is considered as dormant, a higher IRES rate of 34.5 percent is applied to a notional income computed on the basis of the assets recorded in the company’s balance sheet. In a tax group, the notional income cannot be offset against losses of other group companies.

A calculation similar to the vitality test is used for IRAP purposes. Other limits also apply for VAT purposes.

An entity is also considered as dormant in a fiscal year if it has had tax losses in 5 consecutive previous years (or, during the same timeframe, has had tax losses for 4 previous years and in 1 did not pass the vitality test).

Certain exemptions may apply.

Companies are allowed to apply for a tax ruling and to give evidence of the circumstances that have prevented them from passing the vitality test.

Carried interest

In 2017, measures were introduced to define the Italian taxation of carried interest, which is a form of remuneration granted to managers and employees who hold shares, quotas or financial instruments with ‘strengthened’ economic rights.

Carried interest is granted to managers and employees of investment companies and private equity firms in order to align their interests with those of other investors.

The new tax rule treats carried interest as capital income rather than employment income if the following requirements are met.

• All the individuals who have a carried interest must have invested, in aggregate, at least
  1 percent of the total amount invested by the company.
• Income from the securities carrying special profit rights must accrue only after all the other investors have obtained a minimum pre-defined return on their capital investment.
• The securities must be held by the individuals for a minimum of 5 years, or less if another firm takes over the companies in which the individual’s employer has invested or the funds in which the employer has invested are transferred to a new fund manager (change of control).

The Italian tax authorities have clarified, in the circular letter no. 25 of 16 October 2017 and in several other published rulings, that in case not all the above-mentioned requirements are satisfied, the qualification of carried interest as capital income cannot be automatically excluded. In this scenario, the Italian tax authorities will conduct a case-by-case analysis with the aim of understanding whether to qualify carried interest as employment income (i.e. remuneration of an employment activity) or capital income (i.e. for instance, in presence of the ordinary risks of a genuine financial investment).

Advantages of an asset purchase

• Step-up in the tax basis of the assets allows higher depreciation/amortization (including goodwill).
• Previous tax liabilities of the seller are only partially transferred to the buyer; in certain cases, they may be fully eliminated.
• Possible to acquire only part of a business.
• Possible for the seller to shelter the capital gain against any tax loss carry forwards of its own.

Disadvantages of an asset purchase

• Possibly unattractive to the seller, especially if a share sale would be partially exempt.
• May result in higher registration tax.
• Higher corporate income tax on capital gains.
• Benefit of any residual losses incurred by the target company remains with the seller.

Advantages of a share purchase

• Likely to be more attractive to the seller from a tax perspective (because the disposal may be partially exempt).
• Buyer may benefit from the tax losses of the target company.
• May have lower registration tax.

Disadvantages of a share purchase

• Buyer becomes liable for any claims or previous liabilities of the entity.
• No free step-up in the tax basis of the purchased assets.

Stefano Cervo
Partner, Deal Advisory, M&A Tax
Studio Associato Via
Vittor Pisani 27, Milano, 20124
Italy

T: +39 02 6764.4811
E: scervo@kpmg.it

This country document does not include COVID-19 tax measures and government reliefs announced by the Italian government. Please refer below to the KPMG link for referring jurisdictional tax measures and government reliefs in response to COVID-19.

Click here — COVID-19 tax measures and government reliefs

This country document is updated as of 31 January 2021.