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Bridging opportunities: Italy after US Tax Reform. What does it mean for business?

  • Italy
  • Tax planning and consultancy - Briefings

05-09-2018

Italian companies have often been interesting targets for US multinationals, due to their profitability and reasonably low prices. In the first half of 2018 US companies have acquired Italian companies in deals worth over 3.7 billion euros. How does US tax reform impact this dynamic?

Doing business in Italy

Italian companies are subject to Corporate Income Tax (“IRES”), at the rate of 24% and to Regional Tax on Business Activities (“IRAP”), at the rate of 3.9%.

Italy offers attractive opportunities to US multinationals, looking to invest in Italy or acquire Italian companies, which are particular strong in technology, manufacturing, art, and engineering sectors.
The Double Taxation Agreement (“DTA”) between Italy and US reduces the withholding taxes (“WHTs”) on outbound payments from Italy to rates of 5%-15% (on dividends), 10% (on interest) and 5%-8% (on royalties).  Further, under the DTA capital gains arising from the disposal of shares are exempt from tax in Italy.

For companies that develop intellectual property, Italy provides a BEPS compliant patent box regime, which partially exempts income derived from qualifying intangible assets and reduce the effective tax rates to 12% and 1.95%, respectively. In addition, Italian companies and Italian permanent establishments of foreign companies investing in research and development activities, are eligible for an R&D credit. Moreover, Italy provides for additional benefits, such as the super and hyper depreciation regime on investments on tangible and intangible assets and a benefit for investments on the purchase of industrial equipment. For those Italian subsidiaries which act as European sub-holding companies, an optional Branch Exemption regime is available, which provides an exemption on branch income.

These factors, added to the large number of tax treaties concluded and the eligibility to EU legislation, have contributed to make Italy a fair place where in which to invest and/or establish a European sub-holding company.

Key elements of US Tax Reform

The Tax Cuts and Jobs Act (the “TCJA”), signed into law on December 22, 2017, is the most substantial overhaul of the US Internal Revenue Code since 1986. The TCJA is far-reaching and significantly changes how the US taxes domestic businesses and multinational businesses.

While the centrepiece of the TCJA is the reduction of the US corporate tax rate from 35% to 21%, the TCJA also adopted a number of significant changes to the way the US taxes multinational businesses that are relevant to US multinationals with operations or investments in Italy.

The US is transitioning to a quasi-territorial system of taxation and so the repatriation of future non-US earnings should be exempt from US tax for 10% owned non-US corporations. In tandem, a mandatory one-time transition tax/deemed repatriation tax was introduced on previously untaxed accumulated earnings of certain non-US corporations at rates of 15.5% to the extent of cash/liquid assets and 8% on the remainder of such earnings. Importantly, the US has adopted a new tax on global intangible low-taxed income (“GILTI”). GILTI is broadly defined and, subject to certain exclusions, generally includes the net earnings of a US shareholder’s controlled non-US subsidiaries. In effect, this provision introduces a current US tax on the earnings of controlled foreign companies of US corporations and acts as a worldwide minimum tax on such earnings. Such US shareholders receive a deduction equal to 50% (which decreases from 50% to 37.5% in 2026) of their GILTI and, subject to applicable limitations, are able to claim foreign tax credits (“FTCs”) for 80% of the taxes paid by non-US subsidiaries in respect of such earnings. For a corporate US shareholder that can fully utilise its FTCs, if the GILTI is subject to local tax at a blended rate of less than 13.125%, it will be subject to residual US tax.
As a corollary to GILTI and incentive to retain activities domestically, the US adopted a deduction for US corporations equal to 37.5% (which decreases from 37.5% to 21.875% in 2026) of the corporations’ foreign-derived intangible income (“FDII”).

FDII generally includes a portion of a US corporation’s income from sales of goods, services and intangibles to unrelated non-US parties. The impact is that FDII is generally subject to an effective US rate of tax of 13.125%. The legislative history indicates that GILTI and FDII are intended to make US corporations indifferent as to whether sales and licenses to non-US persons are made directly from the US or through non-US subsidiaries in lower tax jurisdictions.

The US also adopted several provisions intended to address perceived erosion of the US tax base. The US adopted a new limitation on the ability to deduct interest expense, generally limiting such deductions to 30% of adjusted taxable income.

The US also adopted a new base erosion and anti-abuse tax (“BEAT”). The BEAT is effectively a minimum tax for certain large taxpayers, which is computed disallowing the benefit of deductions for certain payments to related non-US parties, including for example, interest that is not otherwise disallowed under the new interest expense limitation and disallowing the benefit of FTCs, including with respect to GILTI. Thus, a taxpayer subject to the BEAT will owe residual US tax on GILTI regardless of the local taxes paid with respect to the earnings of its non-US subsidiaries.

Next steps?

The changes enacted by the TCJA are significant, therefore, multinationals should analyse the impact of these provisions on their existing structures.

For US multinationals with operations or investments in Italy, earnings from Italian operations should not be substantially affected by GILTI, because these will be subject to Italian taxation at a rate of tax in excess of 13.125% (even if reduced by the patent box regime).

Further, dividend distributions from Italian subsidiaries to US parent companies, which were historically subject to US tax, are now exempt from further US tax when distributed.

The effective rate of tax for FDII (13.125%, though 2026) is comparable to the Italian nominal tax rate (13.95%) granted under the Italian patent box regime. Consequently, it is unlikely that US multinationals will want to move operations from Italy to the US on this basis.  Further, when the deduction for FDII decreases in 2026, the effective rate of tax on FDII will increase to 16.4% and the gain on any transfer of intangibles will be subject to tax in Italy.

Companies may however want to revisit their capital structures to take account of the impact of the new restrictions on the ability to deduct interest in the US.

Notwithstanding TCJA makes the US a more attractive country (CIT rate is lower that the Italian one), Italy can be still considered an interesting jurisdiction, due to the fiscal benefits it provides, including the patent box regime, and super and hyper depreciation regimes described above which reduce the effective rate of tax very close to the 21% corporate rate introduced by the TCJA.

Moreover, it should be considered that any transfer of business or only IPs from Italy to the US will trigger taxable capital gains or the application of the so called exit tax in Italy.

Concluding comment

It is clear that the TCJA enacted substantial changes that are relevant to US multinationals with operations or investments in Italy.

On further examination, multinationals may find out that Italy is still an attractive jurisdiction for developing and enhancing IPs and may also work as place where setting up sub-holding companies for their operations in Europe.

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