Italian tax law sets out a special provision under which – under certain conditions – outbound interest payments may be exempt from domestic 26% withholding tax (or the reduced withholding tax rate established under the applicable double tax treaty). The exemption should put Italian enterprises in a better position to raise credit from foreign lenders, but its interpretation has been posing many difficulties. The Italian Revenue Agency now provides crucial clarifications that contribute to solve some open issues and offer a clearer legal framework for the application of the Italian WTH exemption on outbound interest payments.
The Italian Revenue Agency (Agenzia delle entrate), with Resolution no. 76/E of 12 August 2019 addresses the application of the Italian tax law provision (article 26, paragraph 5-bis, Presidential Decree no. 600/1973) according to which – under certain conditions – outbound interest payments may benefit from an exemption from Italian withholding tax.
Italy ordinarily applies a 26% withholding tax on interest payments corresponded to non-resident recipients. The WHT rate may be reduced under the applicable bilateral double tax treaty in force between Italy and the State where the beneficial owner of the interest is tax-resident.
The Resolution stems from the response offered by the Italian Revenue Agency to a request for a preliminary tax ruling (istanza d’interpello) filed by a taxpayer, wherein the following case was addressed.
– An asset management company having its registered offices in Guernsey (the “Manager“) managed investment funds set up in the form of English limited partnerships (the “Funds“).
– The Manager operated under the authorization and surveillance of the Guernsey Financial Services Commission (GFSC).
– The Funds indirectly held the entire shareholding of an Italian holding company (“ITA HoldCo“).
– The Funds granted an interest-bearing medium-long term loan (duration longer than 18 months) to ITA HoldCo.
Italian tax law (article 26, paragraph 5-bis, Presidential Decree no. 600/1973) sets out a special provision under which outbound interest payments may be exempt from domestic 26% WHT (or the reduced WHT rate established under the applicable double tax treaty).
For the WHT exemption to apply the following conditions shall be met:
1. interest should be paid out of medium-long term loan, i.e. a loan the duration of which exceeds 18 months;
2. the lender should qualify as an EU financial institution, an EU insurance company, or as a “foreign institutional investor” set up in a State that ensures the exchange of tax information at an adequate (i.e. OECD-compliant) level and subject to administrative surveillance in its State of establishment.
3. the borrower should qualify as an “enterprise”.
4. the lender should comply, in its State of establishment, to local rules comparable to the rules that, in Italy, reserve the lending activity to duly authorised entities.
The provision is relatively recent. It has been introduced in order to facilitate access to credit for Italian businesses and, more particularly, to boost the loan market.
By preventing the application of WHT on outbound interest payments, the provision implements the EU freedom of movement of capitals. Moreover, by taking into account that the burden of Italian WHT is often contractually shifted to the Italian borrower through gross-up clauses in the loan agreements, the exemption puts Italian enterprises in a better position to raise credit from foreign lenders (as affirmed by the Italian Revenue Agency in Resolutions no. 84/E/2016 and no. 76/E/2019).
The interpretation of the provision has been posing many difficulties.
After its entry into force in June 2014, some amendments were introduced right in November 2014 and January 2015. In February 2016, condition under no. (4.) above was set out, raising significant concerns among financial operators and practitioners for its interpretative unclearness.
The Resolution offers important clarification on a set of issues and provides valuable help in fixing the contours of the WHT exemption interpretation.
Requirement no. (1.)
The Italian Revenue Agency made clear that reference should be given to the original duration of the loan as per the loan agreement. A loan the original duration of which is less than 18 months could not qualify as a medium-long term loan, even if its duration is subsequently extended to more than 18 months.
Moreover, in case the loan agreement grants to the lender an unlimited right of withdrawal, the loan does not qualify as a medium-long term loan (as affirmed by the Italian Supreme Court, judgement no. 7561/2018).
Requirement no. (2.)
Non-Italian funds could qualify as “foreign institutional investors” provided that, either the funds or their manager is subject to administrative surveillance in the State of establishment. Importantly, the requirement should be checked on the lender, and not on the ultimate beneficial owner of the interest payment. This clarification seems as highly interesting, especially considering that previous guidelines rendered by the Italian Revenue Agency with reference to MLBO transactions seemed to suggest a different outcome.
Requirement no. (3.)
For the purposes of the WHT exemption, a pure holding company could meet the definition of enterprise. Again, this appears as a valuable clarification since in the past the Italian Tax Administration sometimes took a strict approach in denying the qualification of enterprises to pure holding companies (i.e. companies that merely hold participations in subsidiaries without performing any commercial or productive activity). Italian non-profit entities and Italian UCITS do not qualify as enterprises for the purpose of the WHT exemption.
Requirement no. (4.)
The Italian Revenue Agency affirmed that requirement no. (4.) – according to which the foreign lender should comply, in its State of establishment, to local rules comparable to the rules that, in Italy, reserve the lending activity to duly authorised entities only – should apply to the extent the lender performs lending activity vis-à-vis the public. According to Italian banking regulations (Article 2, Ministerial Decree no. 53/2015), the definition of “lending activity vis-à-vis the public” does not cover any activity rendered to group companies.
If follows that in the case at stake, where the lender (the Funds) indirectly owned the borrower (ITA HoldCo), requirement no. (4.) would not apply.
The Resolution concludes that the loan granted by the Funds to ITA HoldCo could benefit from WHT exemption, since:
– the loan qualified as a medium-long term loan;
– the Manager of the Funds was subject to the surveillance of the GFSC and Guernsey ensures the exchange of tax information at an adequate level;
– the borrower qualified as an enterprise;
– the lending activity was rendered to a group company, thus it did not qualify as lending activity vis-à-vis the public.
The Resolution provides crucial clarifications that contribute to solve some open issues and offer a clearer legal framework for the application of the Italian WTH exemption on outbound interest payments.