Calculation of the effective tax rate in case of prior foreign tax losses

Application of the article 47-bis, CIT code, to foreign dividends

Prepared by Lucia Pagliari, Gian Maria Minnella and Alessandro Scala

The purpose of this note is to briefly discuss the taxation of non-EU dividends, in light of the combined provisions of articles 89, paragraph 3 and 47-bis of the CIT code.

Specifically, the purpose is to provide an operative solution, related to the performance of the so-called effective tax rate test, in case of joint existence of: (i) tax losses carried forward by the foreign subsidiary and (ii) their effective use to reduce the taxable income.

This solution is to be found in the official clarifications provided in the past by the Italian Revenue Agency with respect to the CFC rules; the application of which, as from the 2010 tax period, provided for a comparison of the tax rates (foreign and virtual domestic).  Moreover, it is worthwhile specifying that the test in question is now much more significant in the case of distribution of dividends, rather than in cases of deferral of the profits themselves; in fact, the CFC rules, for the purposes of its application, also require the passing of the so-called passive income test, and being totally disapplied in the event of the existence of the only exemption relating to the performance of “(…) an actual economic activity, through the use of personnel, equipment, assets and premises“.

Having said that, it should be noted that article 89, paragraph 3 of the CIT code sets forth the procedures for the taxation of foreign dividends, and makes a reference to article 47-bis on the other hand, with respect to the criteria for the identification of countries with privileged taxation, and the criteria related to the attribution of a certain colour (i.e. black or white) to the distributed profits.

Specifically, article 47-bis has introduced a discipline applicable to (direct or indirect) controlling interests in companies other than those resident in the EU or the EEA, and an ad hoc discipline applicable to minority interests in companies other than those resident in the EU or the EEA.

The first of the two tests to be applied to non-resident subsidiaries (subject to our analysis), provides that the application of the rule operates where the effective foreign tax rate is less than 50% of the virtual domestic tax rate, and more specifically the virtual domestic IRES.

A highly critical aspect, concerning the calculation of effective taxation relates, as anticipated, to the management of the tax losses carried forward by the foreign subsidiary and formed in years prior to 2019, i.e., the year from which the effective tax rate test was introduced for non-resident subsidiaries. In fact, the stock of losses carried forward is intended to reduce or eliminate the foreign tax base (despite the fact that the taxation procedures may be almost similar to those existing in Italy), thus resulting in the failure to pass the test and consequently in the taxation at 50% or 100% of the dividends received by the foreign subsidiaries depending on whether or not the foreign subsidiary carries on an actual economic activity in the country where it is located through the use of personnel, equipment, assets and premises.

In this respect, the Italian Revenue Agency in the Circular Letter no. 51 of 2010, commenting on the CFC rules, clarify that tax losses accrued before the entry into force of the amendment to the rules contained in article 167 of the CIT code (which introduced paragraph 8-bis, and therefore the effective tax rate test) should not be considered in the calculation of the foreign tax rate, for obvious reasons of homogenisation.

On the other hand, tax losses realised since the introduction of the provision (i.e., from the tax year ending on 31 December 2010), were to be considered for the purposes of the test, and therefore tracked in the tax return (as if they were carry-forward losses accrued by the parent company, in order to homogenise the tests for subsequent years).

In such a case, making such conclusions valid also for the test under article 47-bis, would imply the full sterilisation of the tax losses accrued by the foreign subsidiaries for the tax periods until 31.12.2018.

This solution is also supported by the fact that the taxpayer, prior to the introduction of the rule in question, was not obliged to track the virtual domestic tax losses of the foreign subsidiary in the tax return in the FC section (when the rule concerning the effective tax rate test concerned only article 167 of the CIT code), for example because of the failure to pass the passive income test, rather than for the existence of the exemption (which, differently from the rule contained in article 89, paragraph 3, CIT code, provides for the total disapplication of the provision).

In conclusion, on the basis of the above arguments, it is sustainable that the calculation of the foreign effective taxation, starting from the tax year 2019 (i.e., from the year in which the legislation came into force), should be made gross of the tax losses accrued prior to the entry into force of the legislation; while the losses accrued from that year onwards should theoretically be tracked within the FC section of the tax return, and considered both as a reduction of the foreign tax rate and as a reduction of the domestic virtual tax rate.

Let’s Talk

For a deeper discussion, please contact:

Lucia Pagliari

PwC TLS Avvocati e Commercialisti


Gian Maria Minnella

PwC TLS Avvocati e Commercialisti

Senior Manager