In order to implement the EU Directive No. 2016/1164 (so-called ‘ATAD Directive’), with Legislative Decree No. 142/2018, the law reformed the normative framework on Controlled Foreign Companies (or CFCs).
With the introduced changes, the Tax Authority has provided important clarifications in Circular no. 18/E and in the implementing provision, both dated December 27, 2021, as well as most recently in Circular no. 29/E, dated July 28, 2022. Let’s look at some of these clarifications together, briefly going over how the new regime will work.
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- The CFC regime in brief. As a preliminary reminder, it should be noted that the CFC regulations apply, pursuant to paragraph 1 of Article 167 of Presidential Decree No. 917/1976 (TUIR, the Consolidated Act on Taxation), if the controlled foreign company, regardless of its residency (EU/extra-EU), simultaneously:
- is subject to effective taxation of less than half of that to which it would have been subject if resident in Italy (so-called Effective Tax Rate – ETR test, by which the “effective foreign tax rate” is compared with the “virtual domestic tax rate”);
- has income that, for more than one-third of its total value, qualifies as passive income (so-called passive income test).
In such cases, the income generated by the controlled foreign company is imputed by transparency to the resident controlling entity, in accordance with the provisions of paragraph 6 of Article 167 TUIR. Such provisions apply unless the latter is able to prove that the controlled entity carries out in its country of residence (or establishment) “an effective economic activity, through the use of personnel, equipment, assets and premises” (so-called “exemption“).
The calculation of the ETR
The “effective foreign tax rate” is equal to the ratio of foreign taxes to the pre-tax profit shown in the financial statements of the foreign subsidiary. The implementing provision states that foreign taxes are to be considered:
- income taxes actually payable by the controlled entity in the foreign country of location, excluding the use of any tax credits for income generated in different countries;
- taxes levied on income of the same foreign entity in other jurisdictions, paid outright and not eligible for refund [1].
Regardless of whether they are recognized in the financial statements, the Agency clarified that taxes relating to a given fiscal year paid after the close of the fiscal year are also relevant, even if they are paid after the close of the financial statements but before the Italian parent entity files its income tax return.,.
For the calculation of the “virtual domestic tax rate,” only the IRES (corporate income tax) is relevant, without taking into account any surtaxes, gross of any tax credits for income produced in a state other than the subsidiary’s state of location. On the contrary, the IRAP (regional tax) is irrelevant.
Effects of favorable regimes
It is clarified that if the foreign subsidiary is eligible for favorable regimes, but does not actually benefit from them by its own choice, the higher taxes paid are relevant for ETR purposes. Also, foreign taxes paid voluntarily, even if aimed at passing the ETR test, are not relevant.
Exit from the CFC regime
Contrary to the previous regulations, in Circular No. 29/2022, the Tax Authority provided that if a CFC has been taxed for transparency in one or more fiscal years, the disapplication of the CFC regime is allowed in the fiscal year in which the requirements (i.e., the conditions of the ETR test or passive income test) are not met, without the exemption of actual economic activity being proven.
Transfer of the CFC to Italy
Finally, the Tax Authority also provides clarification regarding the valuation for tax purposes of the assets of companies previously subject to the CFC regime but then transferred to Italy. In fact, it is clarified that if the foreign company was subject to the CFC regime in a tax period prior to the one immediately preceding its transfer to Italy (in which it did not fall under the CFC regime because of the exemption or because it passed the tests), the so-called “entry tax” regime, as per art. 166-bis of the TUIR (which provides for a repatriation of assets at market values), would not be applicable.
Conversely, as better clarified in the answer to interpellation No. 408/2022, if the exit from the regime takes place in the last tax period of foreign residence, it is possible to access the market value criteria of Art. 166-bis.
Conclusions
The cases analyzed are not exhaustive of those proposed by the Tax Authority. Undoubtedly, the clarifications on the new features introduced are of great interest to multinational groups and represent considerable support for the audits to be carried out within them. Further cases of application of these regulations will be the subject of our other posts.
