Italy introduces the branch exemption regime
By Stefano Loconte and Emanuele Tozzi
With effect from 1 January 2016 (for calendar year taxpayers) Italian enterprises with a foreign permanent establishment can opt for the branch exemption regime (Art. 14, Legislative Decree no. 147/2015). Under this optional regime the income attributable to the foreign branch will be treated as tax exempt income in Italy. Of course, in case of a tax loss, it will not be deductible from the taxable income of the head office.
If the taxpayer exercises the branch option, therefore, the exemption method replaces the ordinary credit method used by Italian domestic law and Italian double tax treaties to relieve double taxation on foreign permanent establishments income.
The new regime applies to all foreign branches of the enterprise which exercised the option. Each enterprise (including each enterprise of the same group), however, may choose to join the branch exemption regime or to use the ordinary credit method. The option must be exercised at the time the branch is established or, if the branch already exists, within the second tax period from the effective date of the law introducing the new regime. The option is irrevocable.
It must be noted that, in case of option, the Italian CFC regime applies also to foreign branches, which could also effect the tax treatment of the dividend distributions to the head office’ shareholders.
The option does not trigger the realization of any taxable capital gains or capital losses, however the law provides for a tax loss recapture mechanism. The tax return of the year when the option is exercised must report the taxable income or taxable loss attributable to each branch in the preceding five years. If the sum of the taxable incomes and losses of the five preceding years is a net taxable loss, any income produced by the branch in the following years will be subject to tax up to the amount of the net taxable loss produced during the preceding five years (and deducted from the taxable income of the head office).
A similar tax loss recapture mechanism applies to the transfer of a branch to another enterprise of the same group applying the branch exemption.
The tax return of the head office will have to report the income attributable to the permanent establishment calculated according to the OECD principles and the Authorized OECD Approach (AOA).
Revenue authorities will issue periodically in their website examples of behaviors they consider in avoidance of the branch exemption rules.
Finally, it has been specified that the ruling procedure can be used to assess the existence of a permanent establishment abroad according to domestic law and double tax treaties in force.
This new regime aims at making Italian enterprises more competitive, and attracting group headquarters to Italy. It will be especially appreciated by companies which want to benefit from a lower tax rate imposed by the permanent establishment country, and when it is not possible to plan to reduce withholding taxes on income flows between parent and subsidiaries.
Together with other incentives, such as the patent box regime, the tax credit for research and development and the notional interest deduction, the branch exemption regime offers tax planning opportunities which deserve, at least, to be carefully considered.
Published: February 2016 l Photo: elephotos - Fotolia.com