Pushing the investment fund industry in Italy: the new investment management exemption regime

Francesco Capitta 
FRM Studio Legale Tributario, Milan 
f.capitta@frmtax.it

Armando Tardini     
FRM Studio Legale Tributario, Milan   
a.tardini@frmtax.it                                                       

Introduction

‘Providing certainty to the operators of the investment business industry active in Italy’: this is the rationale that led to the introduction (via Article 1, para 255 of Law No 197 of 29 December 2022 (‘2023 Budget Law’) into the Italian tax system of the so-called ‘investment management exemption’ (the ‘IME’).

After most likely taking into account similar regimes in other jurisdictions (such as in Hong Kong, Singapore, the UK and the US), Italy has introduced a safe harbour aimed at minimising ‘the risk arising from the possible configuration of a permanent establishment of the investment structures’ that ‘could have a strong deterrent effect on the decision to locate the “asset managers” (and thus their employees and/or collaborators)’ on Italian territory (explanatory memorandum to the 2023 Budget Law).

For these purposes, the Italian domestic rule carrying the definition of permanent establishment (PE) (Article 162 of the Italian Tax Code) has been amended, in order to introduce a legal presumption of independence for local asset managers involved in investments made by non-resident 'investment vehicles', with the aim of excluding the possibility that such agents may constitute an Italian agency PE of non-resident vehicles, if certain conditions are met. This safe harbour is primarily focused on the asset management functions carried out in Italy (hence, for simplicity, we will hereinafter generally refer to ‘managers’ or ‘investment managers’) even though the scope of the activities falling under the IME is broader.

Moreover, according to the IME, the offices of investment managers should not be considered as a fixed PE of non-resident investment vehicles.

It is worth specifying that, if the conditions to qualify for the safe harbour are not met, that does not mean that the existence of a PE is automatically triggered. As clarified in the explanatory memorandum to the 2023 Budget Law, in such a case, the existence of a PE can be assessed solely on the basis of the general standards in the Italian domestic rule.

The implementing regulations of the IME are due to be set forth in a ministerial decree to be issued by the end of March 2023. 

Having said that, below we consider some of the interpretative issues arising in relation to the application of the new rule, which will hopefully be addressed in the implementing decree.

The concept of 'non-resident investment vehicle'

As noted, the IME aims to avoid non-resident investment vehicles (directly or indirectly) holding investments in Italian assets being subject to the challenge of a hidden PE in Italy because of the management activities carried out therein.

As there is no statutory definition of non-resident investment vehicles, the question arises as to what is meant by ‘non-resident investment vehicles’ for the purposes of the new rule.

In this respect, it seems that the Italian legislator has introduced a quite broad ‘catch all’ concept of ‘investment vehicle’. According to the explanatory memorandum to the 2023 Budget Law, ‘investment vehicle’ is a ‘broad-ranging expression that also includes […] “non-resident institutional investors”, even not subject to tax, incorporated in [white list, ed.] countries’. In other words, investment vehicles can include ‘institutional investors’ (which are defined in the guidelines of the Italian tax authority as ‘entities which, irrespective of their legal status and the tax treatment to which their income is subject in the country in which they are incorporated, have as their main activity the making and management of investments for their own account or for the account of third parties’, see Circular letter No 23/E of 2002), as well as ‘other’ entities that do not fall within any statutory definitions.

As further clarified in the explanatory memorandum to the 2023 Budget Law, the legislative change does not imply that investment vehicles qualify as ‘enterprises’, since they may well qualify, on a case-by-case basis, as entities that do not carry out a commercial activity in relation to their investment activity; for instance, that is the case with undertakings qualifying as collective investment vehicles (CIVs) for regulatory purposes which, by operation of the law, cannot carry on business activities. It is therefore apparently confirmed that, given that regulated CIVs cannot qualify as enterprises, they should not be deemed to have a PE in Italy through which a business activity is carried out. Therefore, with respect to regulated CIVs, the new IME negative presumption should not be needed.

On the basis of the above, the following non-resident entities should fall within the scope of the IME: non-resident intermediate holding companies through which a regulated CIV holds its investments; and entities other than CIVs and holding companies that carry out investments in an ‘independent’ manner (see below).

Persons whose activity in Italy is protected under the IME

Notwithstanding that the explanatory memorandum to the 2023 Budget Law clarifies that the new regime is mainly aimed at safeguarding the activity carried out in Italy by investment managers, the scope of the exemption seems broader on the basis of the wording of the law.

Indeed, according to paragraph 7-ter of Article 162 ITC, the IME applies with respect to resident or non-resident entities, including those operating in Italy through a PE, which:

• operates in the name of and/or on behalf of the investment vehicle or its subsidiaries;

• has discretionary powers; and

• habitually enters into contracts of purchase and/or sale and/or negotiation, or contributes, also through preliminary or ancillary transactions, to the purchase and/or sale and/or negotiation of financial instruments (including derivatives and participations) and receivables.

In light of such a broad scope, the IME benefit should also include activities carried out in Italy by persons providing other types of services to non-resident investment vehicles, notably advisory services provided by the local deal team of private equity funds.

IME requirements

According to the new rules, a manager can be considered an independent agent of the non-resident investment vehicle (therefore not giving rise to an agency PE) if the following conditions are met:

• the investment vehicle and its controlled entities are located in a ‘white list’ jurisdiction (listed in the Ministerial Decree of 4 September 1996); and

• the investment vehicle meets certain independence criteria, whose definition and scope will be determined in the implementing decree (yet to be issued).

Lacking any further guidance, for the time being, the generic wording of the law does not clarify whether independence is intended to be verified towards the investors or the manager. If one considers the rationale of the IME rule, however, the answer should be straightforward. Indeed, as also pointed out by His Majesty's Revenue & Customs (HMRC) with reference to the UK’s ‘investment manager exemption rule’ (see para 35 to 44 of the HMRC Statement of Practice One published on 1 February 2001), independence should be considered vis-à-vis the investors; as a consequence, if a fund is held by a plurality of investors (as the units of the fund have been offered for subscription with a proper fund raising activity), the ‘independence’ requirement shall be deemed to be met in re ipsa.

On the other hand, it would be inconsistent with the rationale of the IME to assess the investment vehicle's independence from the manager, as such an approach would render the new IME de facto inapplicable, given that there would typically be a close relationship between the investment vehicle and the managers. Furthermore, the economic independence of the manager is already captured under another condition (see below): ‘the manager shall not be appointed in the board of directors (or in any other internal body or committee) of the non-resident investment vehicle or of the companies controlled by the latter’.

This is the most controversial pitfall of the new regime as it may jeopardise the application of the exemption. The issue stems from a well-known market practice, according to which managers always maintain direct supervision of the target companies in which the fund has invested and are usually present in the administrative bodies of the intermediate holding companies through which the fund holds the investment. Moreover, the rationale of this requirement is unclear: as mentioned, the manager's independence should be ultimately assessed with reference to the investors of the non-resident investment vehicle and not with respect to the vehicle itself and its subsidiaries. In this regard, it is worth noting that, with respect to the UK investment management exemption, neither the regulations nor HMRC’s guidelines make any reference to such a requirement: ‘the manager (together with other entities belonging to the same group) must not hold a participation in the economic results of the investment vehicle higher than 25%’.

In this respect, it is unclear whether enhanced economic rights (‘carried interest’) attached to shares are to be considered for the 25 per cent threshold. In our view, the answer should be negative on the ground that the amount of economic rights to which the carried interest holder is entitled varies depending on the vehicle’s results (ie, whether the carried interest is in the money or not) and, as such, it cannot be verified before the completion of the lifecycle of the investment fund. Also, in this respect the implementing decree will have to shed some light.

As a final note on this condition, one should consider that the 25 per cent condition is consistent with the purpose of assessing the manager's independence from the investors. In fact, it is legitimate to doubt the existence of such independence where the manager is a ‘significant’ investor:

‘the investment manager must properly prepare "transfer pricing" documentation in a way that qualifies for the purposes of the penalty protection regime under Italian Legislative Decree No. 471/1997’.

On this point, the rule does not squarely require that the remuneration of the manager is at ‘arm’s length’, but it merely asks that the manager prepares the transfer pricing (TP) documentation in compliance with the Italian penalty protection regime (according to which no penalties apply in the case of TP challenges if the taxpayer kept TP documentation in compliance with certain requirements). Therefore, if during a tax inspection the manager’s remuneration is challenged, this should not jeopardise the application of the IME, but it should simply give the tax inspector the ability to assess the higher taxable income of the manager. In this respect, ad hoc guidelines from the Italian Revenue Agency are required in order to set the criteria for duly identifying a manager’s ‘arm’s length’ remuneration.

If the conditions above are met and therefore the safe harbour applies, a further consequence is that the fixed place of business of the manager (through which the activity providing the benefit to the non-resident investment vehicle is carried out) is not regarded as premises at the disposal of the non-resident investment vehicle and, therefore, it cannot per se give rise to a fixed PE of the non-resident investment vehicle.

Final considerations

Broadly speaking, the introduction of the IME is a significant step to increase the attractiveness of Italy with respect to the fund industry, together with other significant tax reliefs offered to employees moving to Italy. Despite some of the issues mentioned above that will have to be addressed in the implementing decree, the IME provides certainty and solves a long-standing issue (the potential challenge of hidden PEs), which in the past led certain private equity houses to relocate their employees from Italy to other jurisdictions in order to avoid/minimise the PE risk. 

Consistently with the rationale of the IME, in our view, there is the need for a further step to support the investment fund industry, that is, the awaited elimination of a distortion vis-à-vis non-EU funds that are not entitled to the full exemption from dividends and capital gains arising from participation in Italian companies, which is available to Italian and EU funds. Such discrimination is contrary to the EU principle of the free movement of capital (which applies to non-EU taxpayers as well), as clarified by the Italian Supreme Court and the Court of Justice of the European Union and, as such, needs to be removed.