By Daniele Majorana, Special Counsel, Miccinesi Tax, Legal & Corporate, Milan
In principle of law no. 10/2021, issued May 25, the Italian revenue agency (Agenzia delle Entrate) clarified that the taxable base of the exit tax must be determined on the difference between the market value of the transferred going-concern, considered as a whole, and the tax value of the individual assets and liabilities composing it. Therefore, dormant capital gains in shareholdings included in the transferred going-concern would not benefit from the participation exemption regime even though they meet the requirements. Likewise, this rule applies if the shareholdings show a capital loss, which, therefore, will be fully deductible.
Regarding this issue, in 2004 and 2006, the revenue agency had already adopted two discordant solutions. In the first instance (Letter Circular num. 36/E del 2004), the agency included the transfer abroad of the company among those relevant to the participation exemption purpose. In the second instance (Letter Circular num. 6/E del 2006), the agency contradicted itself, stating that, in the case of sale of a company including shareholdings, the company could not enjoy the benefit of the Italian participation exemption regime.
In the current principle of law, the agency’s arguments are based on the literal interpretation of the domestic rule governing the transfer of a going-concern. In such a case, the Italian tax law provides the computation of capital gains should be “jointly determined” because the consideration to compare with the costs of the transferred assets is defined as a unit, since it refers to the transferred assets as a whole and not to its single components. Hence, the agency points out that in this case, it is not possible to segregate single assets, such as shareholdings, by adopting “an atomistic valuation of the elements of the company, even if prevalent.”
In light of the above, the participation exemption regime does not apply in the calculation of the exit tax – neither in case of a transfer of tax residence of holding companies exercising management and coordination of the subsidiaries (activity implying the presence of commercial activity), nor in case of a transfer of companies that, in addition to holding shares, carry out an additional activity.
Italian participation exemption regime
The Italian participation exemption regime provides for a 95 percent exemption of the relevant capital gain on shares.
To qualify for the exemption regime, the seller must hold the shares starting from the first day of the 12th month before the sale occurs (holding period). In addition, the shares must have been recorded as a fixed financial asset on the first balance sheet closed during the holding period. Finally, the subsidiary company must be a resident of a state or territory other than a tax haven or have received a tax ruling stating that the participation is not localized in a tax haven, and it must carry on commercial activity from the tax point of view.
Italian exit tax
The transfer of tax residence would allow capital gains accrued during the stay in high-tax countries to be channeled to countries with milder taxation. At the EU level, the need to avoid this profit shifting phenomenon led to the implementation of a closing rule (ATAD directive) aimed at taxing capital gains accrued on assets transferred to other states, even in the absence of a formal deed of assignment, according to their respective market value.
To ensure continuity of values and to avoid economic double taxation effects, the EU Directive has established mirrored criteria for the recognition of input values, stating that values taken for output taxation purposes must also be recognised as source values in the receiving state unless the latter considers that they are not in conformity with market values.
In complying with EU law, Italian legislation taxes the dormant capital gains of an Italian company transferring its tax residence abroad. Such capital gains are determined on a unitary basis, as the difference between the fair market value (determined by applying transfer pricing principles) of the unit and the corresponding tax value of all assets and liabilities transferred abroad. At the same time, assets and liabilities that remain connected to a permanent establishment in Italy are not subject to the exit tax.
The notion of going concern
A going concern is an organised group of business assets, endowed with its own organisational and functional autonomy and treated by law as a unitary complex of assets. The rules on the transfer of a business also apply to transfers of business branches.
Recently the Italian revenue agency (ruling n. 546 of 12 November 2020), in line with the orientation of the European Court of Justice and of the Italian Supreme Court, has included in the notion of going-concern all the tangible and intangible elements that together constitute a firm or a part of a firm capable of carrying out an autonomous economic activity. Therefore, the agency considers a business as a collection of tangible and intangible assets and legal-economic relations enabling it to conduct business activity.
Thus, for the Italian tax authority, the essential element for identifying the going concern is the organisation of the combination of assets and liabilities necessary for the performance of a given business activity.
Systematic considerations
The authoritative practice of the Italian Association of Stock Companies (Associazione fra le Società Italiane per Azioni, or Assonime) highlighted, in Letter Circular Num. 16 (25 May 2021) and num 24 (4 August 2021), that the revenue agency’s principle of law is inconsistent with the ratio of the participation exemption regime. The latter does not qualify simply as a tax relief granted on the sale of shareholdings, but rather it plays a pivotal role in the Italian tax system, coordinating the taxation of the company with that of the shareholder, to avoid duplication on the latter of the taxes already paid by the participated company.
According to this systematic interpretation, when a company’s assets are sold, the rule of unitary determination of the capital gain should be derogated, allowing the uniform application of the participation exemption regime, in order not to introduce distortions that would undermine the coherence of the tax system.
Moreover, at the EU level, it is self-evident that if a firm moves from Milan to Münich, instead of Rome, it is subject to an unjust taxation, because it would lose the participation exemption benefit on shareholdings
Based on the EU principles, taxes should never be an obstacle but instead should help create a common level playing field in the EU. Otherwise, those taxes could constitute an unjustified obstacle to the freedom of establishment in other EU countries.
Therefore, in accordance with EU law, in the case of a business transfer, the rule of unitary determination of the capital gain should give way to the need to ensure a uniform application of the participation exemption regime with the consequent exemption regime.
Distortions concerning permanent establishments under the branch exemption regime
Consider a resident company that owns some assets located in Italy and a foreign permanent establishment under the branch exemption regime. Assume that this company transfers its tax residence to another state. In such a case, the regime of unitary computation of the capital gains of the firm transferred abroad could also be extended to the assets of the permanent establishment under the branch exemption regime, which no longer fall within the scope of Italian taxation (in fact, in the event of liquidation they would not generate capital gains taxable in Italy).
The case of the static holding company
The revenue agency’s principle of law refers to shareholdings included in a going-concern and does not address, inter-alia, the issue of so-called “static holdings” whose sole purpose is to purchase and passively hold shares without being involved in their management. In this case, the organisational requirement to identify the business compendium is not met. Therefore, according to the case law of the European Court of Justice’s case-law and the Italian Supreme Court, the revenue agency stated that the mere holding of shares does not constitute a business activity. Hence, static holding companies can benefit from the participation exemption regime even if they transfer their residence abroad.
Compliance of the agency’s principle of law with the ATAD Directive
The interpretation provided by the agency in the principle of law does not seem to comply with the anti-tax-avoidance directive (ATAD), which does not make any reference to a going concern. Instead, ATAD directive refers to the tax value of each of the assets and liabilities of the transferred company.
The Italian revenue agency should have considered this directive when analyzing the rule and rendering its opinion. It is a well-known principle that national authorities and courts must interpret national law “in the light of the wording and the purpose of the directive” (CJEU Sentence of 10 April 1984 cause C-14/83, para. 26).
Conclusions
The non-critical enforcement of the principle of universality of capital gain relating to going-concerns gives rise to double taxation at the national level and to a clear violation of the principle of freedom of establishment at the EU level.
Because the Italian revenue agency did not (or could not) avoid such distorting consequences, there is a need to introduce an exception to the general principle, which may consider the particularity of participation exemption regime. If in this situation it is not possible for the agency to do so while interpreting the law according to its spirit, the point should be addressed at the legislative level.
In this case, it must be pointed out that the distortions introduced are so significant, and the principle of law under comment is so partisan that more than one doubt arises as to the efficiency of such responses by the agency.
It seems clear that the legal arrangement of the Italian ruling deserves to be fine-tuned.
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