Italy: Sweet Equity Becomes Sweeter

April 28, 2017

On April 24, 2017, the Italian Government passed a new rule (Art. 60 of Law Decree No. 50/2017) addressing the tax regime applicable to sweet equity.

With a view to providing clarity on the tax treatment of carried-interest type incentives - so far not specifically regulated and merely addressed in ad hoc rulings that generated some uncertainties particularly in the private equity sector - the new rule establishes that income earned by employees and directors of companies or investment funds in connection with equity or equity-like financial instruments held by such beneficiaries is to be characterized as income from capital (dividends or capital gains, as the case may be), generally subject to a flat 26% tax, rather than as employment income, generally taxed at the much higher graduated personal income tax rates of up to 43%, plus applicable local add-on taxes and social security charges, if the following requirements are met:

  • Beneficiaries: those can be employees and directors (consultants appear to be excluded) of companies and investment funds (or their directly or indirectly-controlled related parties) that are tax resident of either Italy or white-listed countries;
  • Skin in the game: the beneficiaries must invest an aggregate amount corresponding to at least 1% of the company’s net equity value or of the capital called by the fund;
  • Sweet equity: the financial instruments shall provide for a payout subject to the relevant stakeholders or investors earning a return equal at a minimum to their invested capital plus the hurdle rate contemplated in the relevant company’s by-laws or fund’s regulations;
  • Minimum holding period: the beneficiaries must hold the financial instruments at least 5 years, unless an exit occurs.
The new rule applies on income received as of April 24, 2017. Nonetheless, despite Law Decree No. 50 being already effective, it will elapse if not confirmed and converted into law, possibly with amendments, by the Italian Parliament within 60 days.

While the introduction of this new rule is definitely a much-awaited and welcomed development as it provides certainty as to the tax regime applicable to sweet equity in Italy, a review of existing plans appears to become urgent to ascertain its impact thereon and possible material tax consequences for beneficiaries and employers.