In several judgements regarding withholding taxes on Italian investment income, it came as a surprise to many when Italian tax courts found that the dividend withholding tax (WHT) regime applicable to non-resident recipients may be seen to be discriminatory in certain cases and thus in violation of the principle of the free movement of capital as evidenced by CJEU case-law. This line of reasoning has recently been upheld by the Italian Supreme Court (Corte di Cassazione) in their judgement (No. 1967/2020 published on 29 January 2020) where it ruled that a Spanish pension fund should be entitled to a refund of the withholding tax on dividend payments from Italian resident companies.
The Supreme Court case relates to a refund claim filed by a Spanish management company, on behalf of 11 Spanish pension funds, for withholding tax on dividend distributions made during 2006 by Italian resident companies. A final tax rate of 15% was applied to the dividends, pursuant to Article 10 of the double tax treaty between Italy and Spain.
The dispute arose as the Spanish pension fund sought to be taxed on the same basis as Italian entities (which for the year in question were subject to a rate of 1.65%). The claimant argued that the 15% tax rate was unlawful and in breach of the principles of the free movement of capital provided by the Treaty on the Functioning of the European Union (TFEU).
Dividends paid by Italian resident companies to Italian pension funds are subject to the following tax treatment:
Only 5% of the domestic dividends received by corporate Italian resident entities (excluding pension funds) would be subject to corporate income tax. For the years in question, this leads to dividends received by Italian corporates from Italian resident companies, effectively being taxed at 1.65% (5%* 33% corporate income tax rate).
On the other hand, dividends paid by Italian resident companies to foreign entities (including pension funds) are subject to 26% withholding tax (Art. 27, paragraph 3, Presidential Decree No.600/1973).
As a consequence of an infringement procedure opened by the EU Commission against Italy, Art. 27, paragraph 3, Presidential Decree No. 600/1973 was introduced. Under this provision, non-Italian EU/EEA pension funds are subject to withholding tax at 11% (effective 29 July 2009) while non-Italian EU/EEA companies are subject to a reduced withholding tax of 1.20% effective from 2017 (1.65% from 2004 to 2007; 1.375% from 2008 to 2016), provided that certain requirements are met. These reduced WHT rates are aimed at aligning the taxation of dividends earned by non-residents and Italian residents.
The Supreme Court ruled that the Spanish management company, on behalf of the Spanish pension funds, was entitled to the more favourable 1.65% 1 withholding tax rate. The ruling was based on the principles stated by the CJEU in case C-540/07 (November 2009) in which it was confirmed that it is a violation of the principle of free movement of capital to subject foreign corporate entities to a withholding tax rate of 26%, while Italian resident corporate entities only suffer tax at an effective rate of 1.65% 1 on the same dividends, distributed by Italian resident companies.
The Supreme Court clarified that the reduced rate of 1.65% 1 would also apply to dividend payments prior to 1 January 2008 and would therefore be applicable to the dividends paid in 2006 as in the case before the court.
In order for foreign entities to benefit from the 1.65% 1 reduced withholding tax as provided for under domestic provisions, they should amongst other requirements, be liable to corporate income tax in their country of residence. In this regard, the Supreme Court clarified that this requirement will be met where the foreign entity is liable to tax in their state of residence, albeit not actually having a corporate tax burden due to particular objective exemptions (e.g. Spanish pension funds that are subject to tax at 0%).
The Supreme Court further clarified that the discriminatory treatment may also result from the application of the relevant double tax treaty. In other words, the fact that treaty relief is granted is not per se sufficient to prevent a discriminatory effect, to the extent that the relief cannot
completely eliminate the difference in the tax treatment.
The Italian Supreme Court ruling is particularly relevant to corporate type tax exempt EU/EEA pension funds as it clarifies that these can benefit from a reduced withholding tax rate of 1.65%, as opposed to the 11% rate specifically applicable to pension funds. Apart from this, the favourable clarification of the “liable to tax” requirement is positive news for corporate type investment funds which are exempt from tax in their country of residence, such as Luxembourg SICAVs or UK OEICs, to name a few.
It is WTax’s view that current case-law outlines valid grounds for a non-resident taxpayer (both in the EU and third countries) to bring an appeal to a denial from the Italian Tax Administration to rant the refund for the withholding tax applied on outbound dividend payments.
Foreign entities should continue to protect their rights for refunds by the timely filing of claims and furthermore, should consider the above grounds for possible appeals against either the silent or explicit denial of the refund.
Please contact WTax’s regional specialists, to find out more about how WTax can improve the performance of your Italian investments.