A landmark decision of the Italian Supreme Court might finally lead to a better tax environment for foreign investment funds

Wednesday 5 October 2022

Paolo Ludovici
Gatti Pavesi Bianchi Ludovici, Milan

Andrea Gallizioli
Gatti Pavesi Bianchi Ludovici, Milan


The Italian tax legislation has long been hostile (to a certain extent) to foreign investment funds. Italian funds have indeed constantly benefitted from more favourable tax rules, resulting in various discriminatory treatments toward foreign funds. In addition, the Italian Revenue Agency has always highly scrutinised the use of any foreign corporate structure that, among its effects, could have allowed the overcoming of such discrimination. In this context, a recent decision of the Italian Supreme Court might be a pivotal turning point that could finally make Italy a better place to invest for foreign funds, including non-European Union ones.

The legal background until 31 December 2020

Under Italian legislation, dividends paid by Italian companies to undertakings for the collective investment in transferable securities (UCITSs) established in Italy have never been subject to any withholding tax and, based on the regimes ratione temporis applicable:

  • until 30 June 2011, Italian UCITSs were subject to a 12.5 per cent substitute tax (five per cent in case of certain funds) levied on the year result and as determined from the financial statements of the fund, while no taxation applied to the profits then distributed to the investors; and
  • since 1 July 2011, Italian UCITSs have been exempt from any taxation in Italy while profits distributed to the investors have been subject to a 26 per cent substitutive taxation, with quite significant exceptions (for instance, in the case of investors resident in whitelisted countries that benefit from an exemption).

By contrast, dividends paid by Italian companies to UCITSs established outside of Italy had been subject to withholding tax at the rate equal to 27 per cent until 31 December 2011, 20 per cent until 30 June 2014, and 26 per cent afterward (unless a double tax treaty providing for reduced taxation was applicable to the relevant foreign fund).

The higher taxation suffered by foreign funds has not been limited to dividends but has also referred to other items of income sourced in Italy. This is the case, for instance, of capital gains deriving from the disposal of Italian ‘qualified’ shareholdings which are exempt if realised by Italian funds while subject to a 26 per cent substitutive tax when realised by non-Italian funds (unless treaty benefits apply).

The legislation after 1 January 2021: the new measure for EU funds

Since 1 January 2021, an exemption regime has been set forth for Italian-source dividends and capital gains realised by the following non-Italian funds:

  1. EU UCITS compliant with Directive 2009/65/EC of 13 July 2009 (‘UCITS Directive’); and
  2. EU UCITS which do not comply with the above-mentioned Directive but:

whose manager is subject to forms of supervision in the foreign country in which it is established, pursuant to Directive 2011/61/EU of 8 June 2011 (‘AIF Directive’); and

which are established in the EU Member States and in the EEA States that allow an adequate exchange of information.

The explanatory report for the new law clarifies that the measure ‘is aimed at adapting national legislation to the requests of the European Commission for funds established in other Member States of the European Union or in the EEA area’. The new measure, however, does not solve all the instances of discrimination since it does not apply to:

  • dividends and capital gains realised until 31.12.2020 by EU funds; and
  • dividends and capital gains realised by non-EU funds.

Judgment No 21454/2022 of the Italian Supreme Court

Judgment No 21454, issued by the Italian Supreme Court on 6 July 2022, refers to a United States Mutual Fund, resident in California (‘US Fund’), which made several investments into Italian resident listed companies between 2007 and 2010.

Over the years, the Italian companies paid dividends to the US Fund and applied a 15 per cent withholding tax in accordance with Article 10 of the Treaty against Double Taxation concluded between Italy and the US (‘Ita-US Treaty’).

The US Fund filed claims to the Italian Revenue Agency (‘Agency’) for a refund of the withholding tax that exceeded the 12.5 per cent tax (ie, 2.5 per cent) applicable to the Italian funds on the same items of income. The US Fund indeed considered the 15 per cent withholding tax discriminatory under the principle of free movement of capital established by Article 63 of the European Treaty (‘EU Treaty’).

The Agency denied the refund request and the US Fund appealed such decision, giving rise to litigation, which before both the first-degree tax court and the second-degree tax court resulted in the judges confirming the correctness of the position taken by the Agency.

The landmark decision

The judgment of the Italian Supreme Court overturned the verdict of the tax courts on the following grounds:

  1. the circumstance that the appellant is an US investment fund, and is therefore not a resident of a Member State of the European Union, does not preclude Article 63 of the EU Treaty to apply, since ‘all restrictions on the movement of capital between member states, as well as between member states and third countries, shall be prohibited’;
  2. the principles under Article 63 of the EU Treaty are relevant regardless that the conflict with such principles is the effect of the provisions of a double tax treaty or of the domestic legislation. Indeed, the same Court in the past had already stated that ‘it is necessary to consider the role of Community law, which comes into play as a third dimension in the geometry of the legal system and plays its influence also in the interpretation and application of international treaties concluded by member countries of the European Community, among themselves and with third countries’;
  3. the discrepancy between the maximum rate of 15 per cent (applicable, by operation of the ITA-US Treaty on the gross amount of dividends paid by resident companies to the US Fund) and the rate of 12.5 per cent (applicable at that time by way of substitute tax on the accrued year profits as resulting from the financial statements of the fund) represents a discriminatory difference in tax treatment;
  4. the features of the US Fund in the case at stake are comparable to those of Italian UCITSs and do not justify a different tax treatment;
  5. finally, the different tax treatment is not supported by any valid justification:

    (i) no specific reasons of ‘coherence within the national tax system’ have been argued by the Agency (the Court clarified that such argument could justify a discriminatory tax treatment only when there is a direct link between the granting of a tax advantage to a resident taxpayer at an early stage of application of a given tax and the tax burden imposed on the same taxpayer at a later stage); and

    (ii) no overriding reasons in the public interest (such as the need to prevent conduct capable of jeopardising the right of Italy to exercise its powers of taxation in relation to activities conducted in its territory) can be reasonably found. In this respect, the Court noted that the ITA-US Treaty guarantees an effective exchange of information with Italy so to allow the Italian authorities to make any necessary investigations towards the US Fund if needed.

The principles of the judgment applied to non-EU funds

The judgment concerns the old regime applicable to dividends paid to UCITSs until 30 June 2011 and refers to the specific case of a mutual fund investing in listed stocks, mainly as a minority investor.

However, the conclusions reached by the Court should apply vis-à-vis the current tax regime and more in general to a larger number of situations. Non-EU funds should in particular be granted the same exemption also in case:

  1. they are established as alternative investment funds (AIFs) as UCITSs;
  2. they invest in majority shareholdings. While the investment into majority shareholdings falls in many cases within the scope of the freedom of establishment (not granted to non-EU persons) rather to the free movement of capital, in the case of the Italian legislation this is not the case since the exemption if granted to Italian and EU regardless of the size of the shareholding they own in the company paying the dividends (see for instance the judgment of 20 September 2018, Case C-685/16, EV v Finanzamt Lippstadt); and
  3. they realise capital gains that, as dividends, are exempt when realised by Italian and EU funds and subject to a 26 per cent substitutive tax when realised by non-EU funds.

Finally, the decision of the Court should also lead to the treatment of proceeds made by Italian private investors, who are subject to a 26 per cent flat tax on proceeds from Italian and European funds and progressive taxation, up to a maximum 45 per cent tax rate, on proceeds on non-EU funds, both being considered illegitimate. Indeed, the principles under Article 63 of the EU Treaty prohibit tax discrimination on inbound investments, as well as on outbound investments.

The principles of the judgment applied to EU funds

EU funds already benefit from an exemption regime, but this regime does not apply to dividends and capital gains realised before 1 January 2021 by EU funds. The judgment of the Supreme Court – so firm in making EU law prevail – should also lead to any taxation of dividends and capital gains received from EU funds before 1 January 2021 being considered unlawful.

This conclusion is also supported by another very recent decision of the same Italian Supreme Court. In Judgment No 21159 of 4 July 2022, the Court stated that the tax regime on dividends distributed to EU companies before 1 January 2008 was discriminatory and in breach of the EU Treaty, regardless of the fact that a new tax rule had intervened to eliminate the discrimination but with effect only from the entry into force of the same rule.

Final remarks

What might happen next remains difficult to predict. On one hand, the decision of the Court should encourage many taxpayers to consider refund claims against situations where they have suffered discriminatory taxation. On the other, it is legitimate to hope that the principles of the Court could be directly ‘applied’ by the same Agency, both in the context of tax assessments and in the context of pending tax litigation. This would finally improve the Italian tax environment for foreign investment funds.