Italian LBOs: New Regulations Clarify Material Tax Issues
March 31, 2016
Consistently with the current Government’s policy aimed at ensuring a more stable tax environment for domestic and foreign investors, on March 30, 2016, the Italian tax administration issued much awaited regulations (Circular of March 30, 2016, No. 6/E) addressing a number of tax items material to Italian LBOs and MLBOs with a view to eliminating uncertainties and doubts generated by audit trends that, over the years, hit LBO and MLBO structures in different respects.
Acquisition Debt Interest Expense Allowance
The regulations clearly state that, as a general rule, interest expense accrued on acquisition debt is deductible subject to the interest expense allowance limitations ordinarily applicable, whether within a tax consolidation arrangement or following a merger of the target and the bidding company, therefore superseding several challenges that the tax administration had been articulating in recent years on grounds of anti-avoidance or lack of a close connection of the interest expense with target’s business.
The tax administration makes it also clear that transfer pricing rules stand firm in determining the interest amount legitimately deductible.
NOL and Non-Deductible Interest Expense Carry-Forward
Having ruled that LBOs and MLBOs are not abusive per se, the tax administration also noted that NOL and non-deductible interest expense carry-forward limitations that could be ordinarily triggered in such structures, may be lifted with a positive tax ruling, an option so far rarely resorted to because of the concern that the nature of such structures could be tainted by the tax administration.
Management Fees and Other Fees
The regulations include indication as to the corporate income tax and VAT regime applicable to management and other fees, providing that, if a fee is remunerating services rendered for the benefit of a portfolio company, such a fee is generally deductible insofar as congruous.
IBLOR and Other Financing Arrangements
The regulations also address the withholding tax treatment of IBLOR and other financing structures confirming the position that the tax administration maintained in recent audits.
While transparent IBLOR structures are considered to be eligible for withholding tax favorable treatment, opaque IBLOR structures are generally deemed not to. The tax administration also confirmed that, given the uncertainty of the applicable rules, penalties will be waived on all assessed transactions set up before these regulations’ issuance. Non-availability of withholding tax favorable regimes is maintained in connection with other financing arrangements as well.
However, the regulations cross-reference to a recently-enacted exemption available for certain interest payments made to EU banks, EU insurance companies and white-listed regulated institutional investors, clarifying that any IBLOR or other financing structures’ challenges should take such exemption into account if the interest payments’ ultimate beneficial owners fall within the scope of this new rule.
Shareholders’ Loans
Depending on their terms and conditions, shareholders’ loans could be re-characterized as an equity interest, if and when such a loan features the typical economics of an equity interest (e.g., interest payment and principal repayment is postponed to interest payment and principal repayment made to third-party lenders and/or are subject to the restrictions typically applicable to dividend payments and/or net equity distributions). This would trigger the re-characterization of interest expense as dividend payments and would result in such payments not being deductible and subject to dividend withholding tax regimes.
Outbound Dividends and Capital Gains Realized on Exit
The regulations spell out certain features and criteria that need to be met in order for a foreign holding company to benefit from reduced taxation or exemptions on dividend payments received or capital gains realized upon exit, confirming that an adequate level of substance is required at the level such company, which should not be acting as a mere conduit.
Acquisition Debt Interest Expense Allowance
The regulations clearly state that, as a general rule, interest expense accrued on acquisition debt is deductible subject to the interest expense allowance limitations ordinarily applicable, whether within a tax consolidation arrangement or following a merger of the target and the bidding company, therefore superseding several challenges that the tax administration had been articulating in recent years on grounds of anti-avoidance or lack of a close connection of the interest expense with target’s business.
The tax administration makes it also clear that transfer pricing rules stand firm in determining the interest amount legitimately deductible.
NOL and Non-Deductible Interest Expense Carry-Forward
Having ruled that LBOs and MLBOs are not abusive per se, the tax administration also noted that NOL and non-deductible interest expense carry-forward limitations that could be ordinarily triggered in such structures, may be lifted with a positive tax ruling, an option so far rarely resorted to because of the concern that the nature of such structures could be tainted by the tax administration.
Management Fees and Other Fees
The regulations include indication as to the corporate income tax and VAT regime applicable to management and other fees, providing that, if a fee is remunerating services rendered for the benefit of a portfolio company, such a fee is generally deductible insofar as congruous.
IBLOR and Other Financing Arrangements
The regulations also address the withholding tax treatment of IBLOR and other financing structures confirming the position that the tax administration maintained in recent audits.
While transparent IBLOR structures are considered to be eligible for withholding tax favorable treatment, opaque IBLOR structures are generally deemed not to. The tax administration also confirmed that, given the uncertainty of the applicable rules, penalties will be waived on all assessed transactions set up before these regulations’ issuance. Non-availability of withholding tax favorable regimes is maintained in connection with other financing arrangements as well.
However, the regulations cross-reference to a recently-enacted exemption available for certain interest payments made to EU banks, EU insurance companies and white-listed regulated institutional investors, clarifying that any IBLOR or other financing structures’ challenges should take such exemption into account if the interest payments’ ultimate beneficial owners fall within the scope of this new rule.
Shareholders’ Loans
Depending on their terms and conditions, shareholders’ loans could be re-characterized as an equity interest, if and when such a loan features the typical economics of an equity interest (e.g., interest payment and principal repayment is postponed to interest payment and principal repayment made to third-party lenders and/or are subject to the restrictions typically applicable to dividend payments and/or net equity distributions). This would trigger the re-characterization of interest expense as dividend payments and would result in such payments not being deductible and subject to dividend withholding tax regimes.
Outbound Dividends and Capital Gains Realized on Exit
The regulations spell out certain features and criteria that need to be met in order for a foreign holding company to benefit from reduced taxation or exemptions on dividend payments received or capital gains realized upon exit, confirming that an adequate level of substance is required at the level such company, which should not be acting as a mere conduit.