Global Tax Alert | 11 September 2017
Italy issues implementing instructions for branch exemption regime
On 28 August 2017, the Italian Tax Authorities (ITA) issued the final version of the Branch Exemption (the BEX) implementing instructions1 (the Instructions).
The BEX had been introduced by Legislative Decree no. 147/2015 (Internationalization Decree)2 and allows Italian taxpayers to opt for the exemption of the profits and losses pertaining to their foreign permanent establishments (PEs). Such mechanism represents an alternative to the application of the Foreign Tax Credit (FTC) method, thus making the selection of the vehicle (i.e., branch or subsidiary) used to carry out cross-border business activities immaterial.
Topics that the Instructions specifically address include: (i) election for the regime and its related termination; (ii) recapture of tax losses previously accrued by the PE; (iii) treatment of the internal dealings between the PE and its head office; and (iv) application of the Italian transfer pricing rules and CFC provisions.
The BEX rules grant the possibility to opt for the exemption of profits and losses derived from foreign PEs of Italian taxpayers carrying out cross-border activities. The option is irrevocable, and applies to all existing and newly constituted foreign PEs of the Italian head office (all in-all out).
Exercise of the option
The BEX is elective and irrevocable and subject to a specific option to be exercised in the corresponding tax return.
From an operational standpoint, and unless specific exclusions apply, all profits and losses flowing from the foreign PEs covered by the option, would generally be exempt in Italy.
As a general rule, the election may be made upon the creation of a new PE. For branches in place at the date of entry into force of the Internationalization Decree (7 October 2015), the election can be made by the end of the second tax year (i.e., 2017 for taxpayers having the fiscal year (FY) ending on 31 December). The rule also applies in the event that new branches were established during the mentioned two-year period.
Termination of the BEX election
The Instructions clarify that the BEX election might be terminated in case of: (i) a business reorganization, such as a merger, or division, etc. under certain circumstances; or (ii) liquidation, dissolution or disposal of all the foreign branches. In the case that a branch is newly established, a new election is required.
Specific rules have been established in relation to the recapture of net operating losses (NOL) incurred before the election of the BEX regime.
The rules are aimed at recapturing the NOLs related to the PE, which have been offset by the Italian head office in the five FYs preceding the BEX election. Under the rules in question, all profits derived from the branch will be relevant for tax purposes at the level of the head office until full absorption of the NOLs.
If the resident enterprise has more PEs, the recapture mechanism follows a per country limitation approach. In the case that multiple entities were deployed in the same foreign jurisdiction, the Instruction sets forth that the latter shall be treated as a unique PE for BEX purposes.
The Instructions clarify that the allocation of profit and losses shall be conducted in accordance with the provisions of the Authorized OECD Approach (AOA). The PE shall therefore be considered as a separate entity, carrying out the same or similar activities of an independent entity, taking into account the functions performed, risk assumed and assets used (FAR analysis). The PE’s endowment fund shall be determined using the mentioned criteria.
Transfer pricing (TP) rules also apply to the internal dealings between the PE and its head office or other PEs. In order to benefit from the penalty protection regime, the resident entity shall file adequate TP documentation.
BEX and CFC rules
If one or more branches are subject to the application of the controlled foreign company (CFC) provisions without the possibility to benefit from any of the exemptions set forth by law, the Instructions prescribe that the PE income shall be determined in accordance with the CFC criteria. If multiple CFC branches are located in the same jurisdiction, they shall be seen autonomously for CFC purposes. In contrast, if CFC and non-CFC PEs co-exist, the latter shall be considered as a unique branch(es).
CFC branch profits shall be fully taxed at the level of Italian head office when distributed to its shareholders. FTC applies on the overseas taxes paid by the CFC branch in order to avoid double taxation.
Mismatches between tax systems – especially on the recognition of a PE - may result in double taxation or double non-taxation. The ITA will publish on the website clarifications and examples considered as tax avoidance.
Anti-avoidance provisions and ruling procedure
Italian general anti-avoidance rules could be applied in order to assess operations aimed at unduly benefitting from the BEX regulations. The Instructions also prescribe the possibility to file a Ruling request before the ITA to evaluate, for example, the existence of a foreign PE and the non-application of the anti-avoidance provisions.
1. The ITA initially published a provisional version of the Instructions, which was issued for public comment and observations by the relevant stakeholders.
2. See EY Global Tax Alert, Italy issues major changes to internationalization rules, dated 28 September 2015.
For additional information with respect to this Alert, please contact the following:
Studio Legale Tributario in association with Ernst & Young, International Tax Services, Milan
- Domenico Borzumato
+39 02 851 4503
- Marco Magenta
+39 02 851 4529
Studio Legale Tributario in association with Ernst & Young, International Tax Services, Rome
- Emiliano Zanotti
+39 06 855 67383
Ernst & Young LLP, Italian Tax Desk, New York
- Simone De Giovanni
+1 212 773 2351
- Federica-Luisa Testa
+1 212 773 7348
- Giulia Rizzo
+1 212 360 9086
EYG no. 05119-171Gbl