Prepared by Alessia Angela Zanatto and Sandra Compiano
With the Reply to the Ruling request no. 83 of March 28, 2024, the Italian Tax Authorities provided some clarifications regarding the VAT treatment of Litigation Finance or Third Party Litigation Funding operations, recognising that they can be qualified as service provisions of a financial nature, exempt from VAT, under Article 10, first paragraph, no. 1), of the Presidential Decree no. 633/1972.
In short, the typical scheme of TLPF activity can be summarised as follows:
- a “disputed credit” is a monetary credit that requires legal activity to be realised and of which one of the parties to the dispute is the holder (i.e., credit right holder“); it can be a credit subject to a dispute still in the pre-litigation phase or a dispute before the competent judicial bodies, or a credit on which a judgment has already been rendered but that still needs legal support to be realised (e.g., for the execution phase);
- a “third-party investor” (i.e., litigation fund or funder) provides the holder of the disputed credit right with financial resources, without obligation of refund, obtaining all or part of the credit/compensation as consideration. The third-party investor – in the case subject of the document in question – is a SICAF that manages a reserved Italian AIF and that purchases pro soluto ex art. 1260 of the Civil Code and for valuable consideration all or part of the disputed credit. In particular, the investor pays a fee to the holder of the disputed credit right, composed of a fixed component and a possible variable component linked to the outcome of the litigation, in addition to the reimbursement of the litigation costs. In case of defeat of the holder of the disputed credit right, the investor loses his entire investment.
The SICAF’s question aims at ascertaining whether such operations undertaken by the “third investor” can be classified as “financial transactions through negotiation, also on a pro soluto basis, of credits“, pursuant to Article 3, paragraph 2, no. 3), of the Presidential Decree no. 633/1972, that is VAT exempt as “transactions, including negotiation, related to … credits … excluding debt recovery“, pursuant to Article 10, paragraph 1, no. 1), of the Presidential Decree no. 633/1972.
Litigation Finance or Third-Party Litigation Funding and the proposed directive to regulate the sector
The Litigation Finance is an activity already widespread in Australia, USA, Canada, United Kingdom, or Netherlands in which private investors (i.e., “litigation financiers” or “litigation funders“) – who are not part of a dispute, nor lawyer or insurers of one of the parties involved – invest in judicial and extrajudicial proceedings and judicial support and other types of expenses, in exchange for a share of any compensation.
The TPLF, on the other hand, represents a novelty for the Italian and European Union legal system.
At the European Union level, the European Parliament, with the Resolution of September 13, 2022, invited the European Commission to draft a EU directive to uniformly regulate this sector, at least in its minimum terms (i.e. level planning field). Attached to the Resolution is a proposal for an EU directive in which:
- the litigation funder (i.e., ”litigation financier”) is defined as “…any commercial enterprise that enters into a financing agreement… in relation to a proceeding, even though it is not a party to such proceeding, nor a lawyer or…a provider of regulated insurance services to a party in such proceeding and that has the primary objective of receiving a profit on the capital invested through the financing of such proceedings or of gaining a competitive advantage in a specific market”;
- the agreement for third-party financing” (i.e., third party funding agreement) is consequently defined as the contract “…in which a litigation financier commits to finance in whole or in part the costs of the proceeding in exchange for a share of the monetary amount awarded as compensation to the petitioner or of an increase based on success in the lawsuit (n.d.r. success fee), in order to reimburse the litigation financier for its financing and, if applicable, cover its remuneration for the service provided, in whole or in part based on the outcome of the proceeding. This definition includes all agreements in which a fee of this kind is agreed, regardless of whether it is offered as an independent service or is achieved through the purchase or assignment of the credit”.
From a technical point of view, according to the reply to the concerned ruling, the TPLF is a financial activity as it consists of “financing litigation” by third parties.
The financial cause can be found in the creditor’s intent to obtain financing from the SICAF that would allow him to bear the costs of the legal and/or judicial dispute, to manage this dispute under the direction of the SICAF, as well as the liquidation of the credit. This is supported by the fact that the SICAF is a subject monitored by the Bank of Italy, which implies that investments comply with legal, statutory, and regulatory provisions.
The Italian Tax Authorities believe that the services provided by the SICAF have a financial nature which should be considered VAT exempt if they are territorially relevant in Italy. The taxable base, in the case where the SICAF buys a credit, is determined by applying the clarifications provided by the Revenue Agency with Resolution No. 79/E/2021 (i.e., the economic value represented by the difference between expected cash flows from portfolio management and the purchase price paid by the lender, assignee of the credit – see the previous newsletter of 17 February 2022).
In the ruling under discussion, the Italian Tax Authorities have further specified that, being an exempt transaction, neither the issuance of the invoice is mandatory – except in the case where the customer requests it no later than the time of the transaction – under the terms of Article 22, first paragraph, no. 6), of the Presidential Decree no. 633/1972 – nor the certification of the fees – under the terms of Article 2, paragraph 1, letter h), of the Presidential Decree no. 696/1996.
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