Prepared by Carlo Romano, Daniele Conti and Rubina Fagioli
The dispute stems from an appeal before the Tax Court of First Instance of Milan (‘CTP’) of a tax notice notified by the Tax Collection Agent following the payment of taxes due on the basis of the 2005 income tax return with the UNICO 2006 form. The taxpayer, resident for tax purposes in Italy and holder of an unqualified shareholding in a partnership incorporated under US law, had declared the substitute tax on capital income from foreign sources but do not pay it, on the assumption that he could offset it against the credit for the taxes paid in the United States. The CTP of Milan upheld the taxpayer’s appeal, which was then confirmed by the Tax Court of Second Instance of Lombardy (‘CTR’).
The position of the Revenue Agency
The Italian Tax Authorities (‘ITA’), therefore, submitted an appeal before the Supreme Court with five grounds of appeal, with which, for the purposes of interest in the present case, it contested (i) the infringement of Articles 2 and 23 of the Convention against double taxation concluded between Italy and the United States (‘Convention’), of Articles 18 and 165 of the Italian Tax Code (‘ITC’) and of Article 27, paragraph 4, of Presidential Decree No. 600/73, considering that the CTR had erroneously admitted the possibility to benefit from the credit for foreign taxes established by the Convention even if it was a substitute tax for the ordinary income tax and, therefore, for not having applied Art. 18 of the ITC, which does not recognize such tax credit for income accrued abroad in cases – such as that at issue – of an unqualified shareholding (first ground of appeal), and (ii) from the burden of the proof point of view, the infringement of Article 165 of the ITC (the domestic rule on entitlement to the credit for foreign taxes), on the assumption that the CTR had wrongly ruled that the certificate of the tax withholding agent produced by the taxpayer was sufficient to demonstrate the final payment of taxes abroad (fourth ground of appeal).
The decision and the principle of law provided by the Supreme Court
The Supreme Court dismissed the ITA’s appeal and referred the case back to the CTR for a decision also on the costs of the proceedings. The Supreme Court clarified, first of all, that the domestic legal background is represented by Articles 18 and 165 of the ITC, according to which, in abstract, taxpayers are entitled to a tax credit (in the event of an option for ordinary income taxation), and by Article 4, paragraph 2, of Legislative Decree no. 239 of 1 April 1996, pursuant to which the tax credit is granted to taxable persons (non-entrepreneurs) who have opted for ordinary taxation, being subject to mandatory substitute taxation at the rate of 26%. This domestic provision contrasts with the international tax law principles, since Article 24 of the Convention allows the use of the tax credit provided that the taxpayer has not applied for the substitute tax. And precisely the judgement of the Supreme Court regards the difference between substitution taxation upon request or mandatory (a distinction to be found in the different wording of the various double taxation treaties). Considering the principle of priority of international tax law respect the national tax law not compatible with the former, the Court stated the principle of law according to which for foreign-source capital income directly received by a natural person holding an unqualified shareholding in a foreign-law partnership (such as the US partnership in the present case), should the taxation by means of a withholding tax (pursuant to Article 27, paragraph 4, of Presidential Decree no. 600/73) or by means of a substitute tax – the two of which coincide by reason of the identity of their function referred to in Article 18 of the ITC – applies not as a consequence of the request of the recipient of the income but compulsorily, since the taxpayer cannot claim ordinary taxation, the income tax paid abroad must be considered deductible. Therefore, the tax credit provided for in the Convention to eliminate double taxation is due.
The above principle derives from the interpretation of the expression ‘also at the request of the taxpayer’, found in various international agreements (including the text of the Italy-United States convention), is the expression of the intention of the Italian legislator, i.e. when the legislator intended to deny the tax credit in all cases (i.e. whether the income is subject to substitute tax or withholding tax at source – at the request of the taxpayer or compulsorily by law) it expressly provided for it. This is the case, by way of example, with the conventions and agreements concluded with Cyprus, Malta, Saudi Arabia, Singapore and Monaco.
Moreover, in relation to the ground of appeal concerning the burden of proof, the Supreme Court stated that, in order to benefit from the tax credit for income produced abroad, the taxpayer must prove the final payment of the tax paid abroad. Therefore, in addition to the tax return filed abroad (if such a requirement is requested), it is necessary to provide a certification issued by the foreign Tax Authority proving the payment or, alternatively, any certification issued by the person who paid the foreign source income, accompanied either by the receipt of the taxes paid abroad or by the indication and proof of the fact that, under foreign law (in this case, of the United States), the person is obliged to pay.
Takeaway / Conclusions
With decision no. 25698 of 1 September 2022, the Italian Supreme Court acknowledged the possibility for individuals who, outside their business, are partners of US partnerships to obtain a credit for the tax paid abroad even though the capital income received is mandatorily subject to substitute tax in Italy: this principle may extend to further cases, if a double taxation convention is in force with the foreign State which does not exclude the right to the tax credit itself, and this must therefore be verified on a case by case basis checking the texts of the conventions entered into with Italy. With respect to dividends already collected, taxpayers may file a refund request, pursuant to Article 38 of Presidential Decree no. 602/1973 within 48 months from the payment of the substitute tax, providing documentary evidence that the taxes have been paid, on a final basis, in the foreign State.
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