Italy clarifies withholding tax exemption on loan interest
The Italian tax administration published Resolution No. 125/E/2021 (Resolution 125), on February 12, 2021, confirming a previous interpretation in 2019 (Resolution No. 76/E/2019) and providing additional clarifications on the withholding at Italian source (WHT) exemption of interest paid by an Italian borrower in the context of a medium/long-term loan granted by its controlling mutual fund.
In particular, Resolution 125 confirms that the tax exemption also applies to direct loans granted by a non-regulated private equity fund to its Italian subsidiary insofar as the asset manager of the fund is a regulated entity in accordance with local regulatory legislation.
Ordinary tax treatment of loans granted to Italian borrowers
As a general rule, any interest or income derived from a loan granted by a foreign entity to an Italian company is subject to WHT at a tax rate of 26%.
The Italian borrower, as the beneficiary of the loan, is obliged to apply the WHT on the interest paid to the foreign lender, in accordance with article 26, paragraph 5-bis of the Presidential Decree of September 29, 1973, No. 600 ( WHT Exemption Provision). The domestic WHT rate may be reduced in accordance with the relevant provisions of the tax treaty, if applicable.
Qualifying Loan Facilities may qualify for WHT Interest Relief. This exemption applies to interest paid by an Italian company on loans:
- granted by credit institutions established in an EU Member State, entities identified in Article 2 (5) of Directive 2013/36/EU, insurance companies licensed in accordance with regulations issued by Member States of the EU or by “white lists” foreign institutional investors within the meaning of Article 6 (1) b) of Legislative Decree No. 239 of 1 April 1996, subject to supervision in the foreign countries in which they are established; and
- medium/long term (i.e. with a final maturity greater than 18 months) granted to Italian “commercial enterprises”, including holding companies and real estate companies, but excluding investment funds Italian collective.
In practice, since the introduction of the law, the main entities authorized to carry out this financing activity in favor of Italian companies (except in limited cases) were credit institutions based in the EU; from the point of view of Italian banking regulations, all the other entities mentioned above were not authorized, other than those authorized, to grant loans to Italian borrowers. The WHT interest exemption applies only on condition that the lender is authorized to carry out financial and banking activity vis-à-vis the public in accordance with the Italian Banking Law (TUB) approved by Legislative Decree No. 385 of September 1 1993.
The practical case submitted to the Italian tax authorities was similar to that referred to in Resolution No. 76/E/2019 of 12 August 2019, where a regulated asset manager of several UK funds was tax resident in Guernsey (UK) and supervised by the local authority, the Guernsey Financial Services Commission (GFSC).
The regulated asset manager has filed a tax ruling requesting clarification of the WHT treatment applicable to interest paid by an Italian borrower to its indirect controlling collective investment fund (lender) in connection with a medium/ term (greater than 18 months) granted to the Italian borrower.
The tax authorities responded by confirming that the tax exemption was applicable because all the conditions were met, and in particular that the lender was an “institutional investor” regulated by the GFSC.
With Resolution 125, the Italian tax authorities have analyzed the tax treatment of interest on a medium/long term loan granted under a similar regime, as described below:
- a regulated asset manager resident in the UK for tax purposes and subject to the supervision of the local regulator, the Financial Conduct Authority (FCA), manages (based on a management agreement with the general partner) several UK funds. The (UK) General Partner and the Funds are not regulated entities and the Funds control a standard UK two-tier holding structure, ie UK1 controlling UK2;
- UK2 then controls 100% of an Italian holding company (ITAHoldCo) which is the special purpose vehicle (SPV) investing in Italian target companies.
On this basis, the asset manager asked the Italian tax authorities if the fund could be considered as a foreign institutional investor and, therefore, if the interest received by ITAHoldCo, in the context of a medium/long term loan aimed at financing the acquisition of an Italian company, could be exempt from tax under the WHT exemption provision.
Although the fund was not authorized to engage in regulated activities under the UK Financial Services and Markets Act, nor public banking and financial activities under the TUB, the Italian tax authorities nevertheless considered the fund as a qualified lender under Article 26, paragraph 5-bis of Presidential Decree No. 600/1973.
In particular, resolution 125 confirmed the tax exemption of interest paid by ITAHoldCo, referring to Ministerial Order No. 53 of April 2, 2015 which stipulates that “the activity of granting loans is deemed to be – vis-a-vis the public”. if it is carried out vis-à-vis third parties in a professional manner and on a professional basis and that all activities carried out exclusively in favor of the group to which it belongs are not considered as transactions vis-à-vis the public.
On this basis, the loans being granted by the fund in favor of an Italian company indirectly controlled (ITAHoldCo), the fund itself does not carry out any financing activity vis-à-vis the public.
Therefore, the Italian tax authorities have confirmed that all of the following conditions under the WHT exemption provision have been met:
- the loan has a maturity greater than 18 months;
- the fund is incorporated in a country (UK) that exchanges tax information with the Italian tax authorities (the whitelist);
- the beneficiary of the loan is an Italian company (ITAHoldCo);
- the fund’s asset manager is subject to supervision by the local regulatory authority (FCA); and
- the fund is qualified as a foreign institutional investor that does not carry out business with the public.
All the conditions for the tax exemption having been met, the Italian tax authorities have concluded that the interest paid by ITAHoldCo to the fund can benefit from the exemption.
- Resolution 125 confirms new structuring opportunities for whitelisted collective investment funds to finance private equity investments in Italy, which may partly disintermediate the banking system in financing the acquisition of shares or assets (or operating businesses) of Italian target companies.
- The innovative part of resolution 125 is that, even if the fund and its general partner are not both “regulated entities”, nevertheless since the asset manager (in charge of managing the funds) is an entity subject to supervision of the local regulator (FCA), the funds are deemed to benefit from the tax exemption as a foreign institutional investor since the loan is granted in favor of its indirectly controlled Italian company.
- This principle applies to any fund and asset manager subject to the supervision of a local authority insofar as they are incorporated in a country appearing on the white list of countries that exchange tax information with the Italian tax authorities ( i.e. in addition to EU and OECD countries, Switzerland, Jersey, Guernsey, British Virgin Islands, Cayman Islands, Hong Kong, Singapore, etc.).
This column does not necessarily reflect the opinion of the Bureau of National Affairs, Inc. or its owners.
Francesco Bonichi is Tax Partner and Antonio Festa is Tax Associate at Caiazzo Donnini Pappalardo & Associati.