- re-definition of the two categories of "capital income" and "miscellaneous income" on a logical-economic basis and simultaneous differentiation of criteria for the determination of their taxable base;
- re-definition of the concepts of "qualified" and "non-qualified" participations;
- taxation, by means of a substitute tax on two levels (12.5% and 27%), of all capital gains deriving from the sale of financial assets as well as of margins earned from derivatives;
- final withholding taxation solely for non-residents and non-entrepreneurs.
All revenues of certain existence are defined in the Decree as "capital income" irrespective of the fact that their amount is determined or not: thus, every item of income regarded as ordinary yield of an investment of capital, even though not determined in its amount at the moment of investment is included.
Here is a list of the main examples of capital income:
- interest paid in exchange for an investment of capital within a loan, a deposit or a current account;
- interest deriving from bonds or similar securities;
- revenues from irredeemable debentures or perpetual annual allowances;
- profits deriving from participations in companies or from associations in participation;
- profits deriving from participation in investment funds, profits deriving from REPOS or contango contracts.
- considerations for surety or other guarantees;
- revenues deriving from life insurance contracts and other interests deriving from an investment of capital;
Moreover, the concept of "capital income" also relates to the difference between the amounts (or the fair market value of goods) received and the amounts (or the fair market value of goods) invested. This is the case of zero coupon bonds.
As concerns income from the sale of investment fund units, it must be split as follows:
- interest or yields earned through the investments effected by the fund are defined as "capital income";
- the remaining part (i.e., gains from the sale of units due to fluctuations of the market's estimation of the fund) is defined as "miscellaneous income".
In addition, a new criterion for distinguishing "qualified" from "non-qualified" participations has been established both for the tax rate purposes and for the method of application of the substitute tax (see below).
In the presence of a listed participated company, a qualified participation - other than savings shares - represents more than 2% of the voting rights in the ordinary shareholders' meeting or 5% of the company's capital. In case of a non-listed company, such percentages will respectively undergo an increase up to 20% and 25%.
According to the Decree, "miscellaneous income" is a residual category with respect to capital income and it refers to all revenues which, at the moment of investment, are not certain, both in their amount and in their existence.
The following items are deemed to be "miscellaneous income":
- capital gains deriving from the sale of qualified or non-qualified company participations;
- capital gains realised through the sale of securities other than participations, foreign currencies and precious metals;
- income realised through derivatives or forward contracts;
- revenues deriving from the sale of contracts, credits or other relationships generating higher values.
Capital gains will result in the difference between the amount earned from the sale and the cost of the sold asset, increased of every cost related to its production, including inheritance and gift tax, but excluding interest payable. In general terms, also income accrued but not yet collected/earned must be considered for the determination of the gain.
If sold assets are inherited, the cost to be taken into account is the value declared for the inheritance tax purposes or, for tax exempt assets, the arm's length value; for assets achieved through donation, the cost is considered to be the donor's cost; as to shares obtained through a free capital increase, the cost is determined by splitting the historical cost on the whole number of shares; for foreign currencies, the cost to be considered is the value of the currency calculated at the exchange rate of the date of sale.
Income arising from the stipulation of derivatives consists of the algebraic sum of positive and negative differences obtained. Premiums paid or received for the exercise of options, provided that such options have not been disposed of or closed in advance, are included in the taxable income of the period during which the option was exercised or the right to exercise it expired.
Income from the sale of credits is represented by the difference between sums or considerations received and sums paid; from such sums and considerations, income, accrued but not collected, deriving from the sold relationship as well as those for the benefit of the original creditor must be deducted.
If gains derive from the sale of assets which were possessed for more than 12 months (starting from the date of purchase until the date of sale), their portion to be included in the taxable income is obtained by adopting the so-called "equaliser", i.e. an adjusting parameter aimed at making cash-based taxation equal to accrual-based taxation. The equaliser takes into account some factors, such as the period of ownership of the financial assets sold, the moment of payment of tax, rates of State bonds and quotations of listed shares.
Substitute taxation regimes
Three are the possible regimes governing the taxation of capital gains and of capital income, as determined above. They may vary depending on the kind of assets sold and on the choice of the taxpayer.
The Regime of the Tax Return
Unless the taxpayer does not elect an optional regime, the "regime of the tax return" is to be adopted ordinarily and applies, irrespective of the fact that other operations may be ruled by other taxation systems.
In some specific cases, the adoption of the "regime of the tax return" is compulsory; this is the case for gains from the sale of qualified participations, or other income derived from them, gains from the sale of foreign currencies (provided that the average deposit exceeded 100 million lire for at least seven days) and dividends distributed by foreign listed companies (unless the taxpayer does not opt for the "collectively managed investment regime").
The "regime of the tax return" consists of the determination and payment of the tax by means of the ordinary tax return.
Generally, income and gains are determined as the difference between purchase price (inclusive of costs related to the production of the gain, inheritance and gift tax, but excluding interest due) and realisation value (see above).
The "regime of the tax return" states the application of two substitute tax rates applicable to two different aggregates: the so-called "first aggregate" (i.e., capital gains, net of losses, realised with respect to qualified participations and options or similar instruments which enable to acquire qualified participations) is taxed at 27%, whereas the so-called "second aggregate" (all other cases) is taxed at 12.5%.
As the "regime of the tax return" follows a cash-based criterion, possible payment deferrals and instalments are taxed only in the period of actual realisation.
Furthermore, an anti-avoidance rule establishes that all sales of non-qualified participations carried out within 12 months, totally exceeding the threshold of qualification, are taxed at 27% (net of tax already paid).
Income, both referring to the first and second aggregate, is taxable net of related losses incurred, with the possibility of carrying forward negative surpluses in order to compensate future gains realised in the following tax periods, but not beyond the fourth one. However, a rigid separation exists between the two aggregates: the taxpayer may benefit from the capital loss compensation and carry-forward only with respect to gains belonging to the same aggregate.
Gains or losses realised by residents in Countries other than tax havens, having with Italy a Convention including an exchange of information clause or realised by international organisations recognised by Italy are not included in the substitute taxable base, except for the case where the gains derive from the sale of qualified participations.
The "regime of the tax return" appears to be less attractive than the optional ones, since it confers on the taxpayer the burden of calculating and paying taxes, while in the other two the intermediary has to comply with them. In substance, those who adopt such regime are supposed to keep proper documentation in order to demonstrate the actual carrying out of the declared operations. In addition, the apparent financial advantage of deferring taxation to the moment of actual realisation is annulled by the mechanism of the equaliser. A further disadvantage of such regime is the absence of anonymity for the taxpayer.
The Individually Managed Investment Regime
In the case of the "individually managed investment regime" an intermediary applies the 12.5% substitute tax rate to "miscellaneous income" earned by a taxpayer having a custody, deposit or administration relationship with it. As it clearly appears, this regime grants anonymity to the taxpayer.
The main items of income which may be subject to this regime are:
- capital gains deriving from the sale of non-qualified participations;
- capital gains deriving from the sale of securities, investment fund units, foreign currencies (provided that the average amount of currency deposited exceeds 100 million lire within seven days) and precious metals;
- positive differences obtained from derivatives.
As concerns gains deriving from the sale of participations and other securities, the exercise of the option must be communicated in writing at the opening of the custody, deposit or administration relationship or before the beginning of each tax period. With respect to already existing relationships, the option is presumed to be exercised.
As regards other items of income, the option may be exercised also after the conclusion of the first operation generating taxable income.
Once exercised, the option lasts for the whole tax period; it may be revoked before the expiration of each fiscal period, having effect from the following one.
If a capital loss derives from the sale, it may be offset by the first capital gain arising within the same relationship. In the event that no positive results are obtained, the loss may be carried forward up to the fourth subsequent year and compensated with the first capital gain arising.
If the option is revoked or the relationship with the intermediary is interrupted, the taxpayer maintains the loss as a credit which can be used with another relationship with another intermediary or in its tax return. After the fourth tax period the right to such credit expires.
The intermediary applies the substitute tax on every gain realised by the taxpayer. The realisation value is the amount received and the cost price must be deducted from it.
Transfers carried out for no consideration are not assimilated to transfers against payment and are not included in the taxable income.
Technically, a transfer occurs only when the assets disposed of are handed over to another person. However, according to some anti-avoidance provisions set forth by the law, also the handing over from the deposit on behalf of one person to a "collectively managed investment" relationship related to the same person is considered "transfer".
In such cases, before executing the transfer, the intermediary must obtain from the client the amount needed to pay the tax due and consigns him certification of the value of the transferred assets.
If the transfer is carried out to:
- another intermediary with which the same client has an administered deposit contract; or
- the same client withdrawing its assets; or
- the same client revoking the option;
the intermediary shall consign him a certification indicating the initial and the final value of the assets and the amount of the equaliser.
In the event that, in view of the amount sold in the whole year, the participations sold lose their character of non-qualified participations and become qualified, the option may no longer be exercised. If it has already been exercised, the intermediary acts as if the option had been revoked or the assets had been withdrawn.
The Collectively Managed Investment Regime
This regime can be applied to the cases in which an individual portfolio management contract exists between the taxpayer and an authorised intermediary. Also said regime grants anonymity to the taxpayer. With respect to other regimes, the main difference in taxation is that income is taxed on an accrual basis (12.5% substitute tax rate).
Income realised under the above contract is generally earned gross of any withholding tax. In effect, according to the Decree, income included in the "collectively managed investment regime" is in most cases exempt from income tax, withholding taxes and other substitute taxes and is taxed within the whole result deriving from the portfolio management.
The portfolio manager applies the substitute tax on the result accrued during the management at the end of each year. The result is the difference between the value of the managed estate at the end of each calendar year, gross of substitute tax and of the withdrawals and net of the contributions performed during the year, and the value of the estate at the beginning of the year plus income which is not subject to the substitute tax.
The "collectively managed investment regime" is chosen by option, which is tacit if management relationships between the taxpayer and authorised intermediaries already exist on July 1, 1998. The option has effect for every management contract. If the contract is concluded after July 1, 1998, the taxpayer must exercise an option by communicating it in writing when subscribing the contract. The option lasts for the whole relationship and ceases upon termination. However, it may be revoked by opting for another taxation regime.
The reform of the withholding tax system
Interest and other capital income are subject to withholding tax at the two standard rates of 12.5% and 27%.
The 12.5% rate applies to interest from Government bonds, private bonds having a duration of more than 18 months, finance bills and other financial instruments. The 27% rate applies to bonds lasting less than 18 months, bank accounts and deposits.
Said withholding tax is applied as an advance withholding tax if the receiver is an individual entrepreneur, a partnership, a corporation or a permanent establishment of a foreign corporation. The tax is not applied to companies residing in Countries (other than tax havens) which have concluded with Italy a treaty providing for an exchange of information.
As regards dividends, the following principles are set forth by the Decree:
- advance withholding taxes are no longer applicable for resident beneficiaries;
- a final 12.5% withholding applies to dividends deriving from non-qualified participations in Italian companies owned by resident individuals;
- a final 27% withholding tax applies to dividends paid to non-resident companies;
- an advance 12.5% withholding tax applies for individuals (a final withholding tax for funds) on dividends distributed by non-resident companies.
The main difference between the tax treatment of non-residents and that of residents does not concern tax rates, but it depends on the receiver's Country of residence.
In effect, rates applicable to non-residents are substantially the same as for residents (i.e., 12.5% for bonds and 27% for bank deposits and accounts).
As regards capital income not ruled by specific provisions, the reform establishes that the ordinary final withholding 12.5% tax rate is also applied for non-residents and for permanent establishments in Italy of non-resident companies, except for persons residing in Countries which are considered tax havens and are included in the so-called "black list", for which the final withholding tax rate is 27%.
However, if a bilateral Convention between Italy and the Country of residence of the receiver exists, more favourable provisions of said Convention shall apply, irrespective of the domestic rule.
Furthermore, an exemption from Italian withholding taxation is provided for as regards capital income realised by the following entities:
- residents in Countries with which Italy has a Convention against double taxation foreseeing a clause of exchange of information, except for tax havens;
- international bodies and organisations created in compliance with international agreements ratified by Italy.
The following items of capital income are covered by such exemption:
- interest and other revenues deriving from loans, bank deposits and accounts, excluding interest deriving from cash loans;
- irredeemable debentures and annual perpetual allowances;
- considerations for surety and guarantees;
- income from REPOs and contango contracts;
- income deriving from guaranteed security loans.
Domestic provisions may always be derogated by conventional rules with the consequence that also Countries excluded from the above-mentioned exemption may benefit from it by virtue of specific treaty rules.
As for dividends paid by resident companies to non-resident shareholders, the taxation regime has been changed. For dividends paid or resolved upon before June 30, 1998 a 32.4% withholding tax applied. Starting from July 1, 1998 said withholding is reduced to 27%, except for different provisions stated by the Parent-Subsidiary Directive or by bilateral Conventions.
With respect to dividends received by resident shareholders related to participations in non-resident companies, a distinction must be made, depending on the kind of legal entity.
In the case where the receiver is an individual, dividends deriving from participations which are not related to its business activity are subject to an advance withholding tax at a 12.5% rate. This entails a discrimination with respect to dividends only related to non-qualified participation distributed by resident companies on which an optional (otherwise the dividends may be included in the tax return) 12.5% final withholding tax is levied.
Moreover, the introduction of the "collectively managed investment regime" provides for an exemption from withholding taxes on dividends deriving from foreign participations negotiated on stock markets (excluding qualified participations) if they are included in this regime.
In case of receiving companies or other commercial entities, there is no withholding tax on inbound dividends as well as on domestic ones.
If the receiver is exempt from the Corporate Income Tax, a 27% final withholding tax is to be applied by intermediaries collecting the dividend on behalf of the beneficiary.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.