Italy’s Supreme Court resolves withholding tax dispute over interest paid to holding company

September 10, 2020 Europe, European Court of Justice, Featured News
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By Francesca Amaddeo, Researcher, Tax Law Competence Centre (SUPSI), Manno, Switzerland

The Italian Supreme Court, in a decision released 10 July, has addressed whether a sub-holding company was beneficial owner of interest payments for withholding tax purposes, applying the European Court of Justice’s holdings in the well-known Danish cases.

In 2019, the international taxation framework witnessed a revolution in approaching the application of both the EU parent-subsidiary directive and the interest and royalties directive when the European Court of Justice clarified the concept of beneficial owner and its relationship with the abuse of tax law.

Almost one year after that decision, EU nations continue to implement the ruling within their domestic systems.

Italy seems to have welcomed the approach.

Italy’s withholding tax exemption for interest payments

The Italian Supreme Court case, in n. 14756, deals with a suspicious company structure. Under the tax administration lens, at issue were amounts paid by an Italian company to a Luxemburg sub-holding company, its controlling shareholder. The Luxembourg holding company was the “financial core” of the group; it had only financial and treasury functions and managed investments and financial flows.                                                                         

The payments arose from a loan granted within a leveraged buy-out transaction, aiming to acquire target companies in Italy and Sweden.

In Italy, the interest and royalties directive has been implemented through the introduction of the Presidential Decree 29 September 1973, n. 600.

The taxpayer invoked the withholding tax exemption according to article 26-quater of the above Decree. This provision states that non-resident companies shall be exempt from tax on interest payments if they are the beneficial owner and they do not act only as intermediaries.

The Italian tax agency claimed that the Luxembourg holding company could not benefit from the exemption since it was solely a conduit company. The Luxembourg company was not the beneficial owner of the interest payments, tax officials said.

Indeed, the Luxembourg sub-holding company had the indicia of a conduit company. Not only did it exclusively carry on holding functions, but the loan between the Italian company and the Luxembourg subsidiary mirrored one granted to the Luxembourg company by its controlling shareholder. Moreover, the Luxembourg holding company transferred to the controlling shareholder the interest that received from the Italian company almost immediately, deriving a minimum markup (0.125%). 

The Italian lower courts decided in favor of the taxpayer, determining that the Luxembourg subsidiary was the beneficial owner. This follows the legitimacy of invoking the interest exemption under article 26-quater.

Italy’s tax administration appealed against the decision before the Supreme Court.

The beneficial owner definition and Danish cases

In reaching its conclusions, the Italian Supreme Court identified elements of beneficial ownership, following the approach of the European Court of in the so-called Danish cases, N Luxembourg 1, X Denmark A/S, C Danmark I, and Z Denmark ApS vs. the Danish Ministry of Taxation (joined cases C-115/16, C-118/16, C-119/16, and C-299/16).

Supreme Court was aware of the narrow line drawn at the EU level and of the never-ending debate about this complex issue.

They noted that the concept of beneficial owner was introduced within the international tax framework in the 1977 OECD model tax convention at articles 10 and 11 on dividends and interest. The goal was to fight abusive behaviors of taxpayers which benefit unduly from tax advantages.

The commentary to the OECD model tax treaty has evolved. The most recent version provides that the beneficial owner is deemed to be the “real owner” of the income if not forced to convey the income to somebody else.

The Supreme Court recalled the relevance of the commentary, which, even though not binding, represents a strong recommendation.

Given these premises and mindful of the so-called Danish causes, the judges said that the direct recipient of interest is not the “beneficial owner” if that recipient’s right to use and enjoy the interest is constrained by a contractual or legal obligation to pass the income received to another person.

Thus, conduit companies and intermediaries are not covered.

Luxembourg holding company

In the case at hand, the Luxembourg company, as a holding company, was identified by the tax agency as a conduit company, established to allow an artificial scheme.

It is worth noting that the nature of a “pure holding” or “sub-holding” company does not preclude the possibility of being a beneficial owner. It follows that the interest and royalties directive shall also apply to either type of company.

The Supreme Court concluded that the case must be considered based on all the facts.  It is not possible to rely on ordinary features of a company, such as, for example, the number of employees or if the company has a proper management structure.

Suitable parameters shall be the autonomy of the recipient company in taking the strategic and management decision related to the underlying assets or in retaining, investing, or transferring to a third company the same income.

Moreover, the Danish cases state that proof of an abusive practice requires, firstly, a combination of objective circumstances. Despite formal observance of the conditions laid down by the EU rules, the purpose of those rules must not have been achieved.

Second, a subjective element is required, namely, the intent to obtain an advantage from the EU rules by artificially creating the conditions laid down for obtaining it. As stated by the European Court of Justice:

The artificiality of an arrangement is capable of being borne out by the fact that the relevant group of companies is structured in such a way that the company which receives the interest paid by the debtor company must itself pass that interest on to a third company which does not fulfill the conditions for the application of Directive 2003/49, with the consequence that it makes only an insignificant taxable profit when it acts as a conduit company to enable the flow of funds from the debtor company to the entity which is the beneficial owner of the sums paid.

Italy Supreme Court conclusions and remarks

Given the above, the Italian Supreme Court upheld the Court of Appeal reasoning concluding that the Luxembourg sub-holding company was the beneficial owner of the interest.

Although the Luxembourg company mainly carried out financial activities, is not necessarily deemed a conduit company and can be beneficial owner. Besides, it had no legal or contractual obligation to pass on the income received to a third party, the Court noted.

Considering the whole context, the Court concluded that the net profits derived by the Luxembourg entity were adequate and, overall, that the loan granted to the Italian company was only one of a series of loans existing with other group companies.

This decision follows others given by Italian lower courts. It is possible to say that this case directly affects the Italian domestic tax system, as stated by the European Court of Justice in the Danish cases regarding interest.

Francesca Amaddeo

Francesca Amaddeo

Lecturer-researcher at Tax Law Competence Centre, Department of Business Economics, Health and Social Care, University of Applied Science and Arts of Southern Switzerland (SUPSI)
Dr. Francesca Amaddeo, PhD in European law and national legal systems, is an Italian lawyer that works as Lecturer-researcher at the Tax Law Competence Centre, Department of Business Economics, Health and Social Care, University of Applied Science and Arts of Southern Switzerland (SUPSI).

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