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Issue 2017-01

No gift tax on the transfer of property to a trust, Italy's Supreme Court ruled

 

In its ruling n. 21614 of October 26, 2016 the Italian Supreme Court considered the issue of the application of the Italian gift tax on the transfer of property to a trust.

 

The issue arises under the provisions of Law n. 262 of October 3, 2006, which reinstated the gift tax. Article 2, at paragraphs 47 and 49, while providing on the scope of the newly reinstated gift tax refers to “legal arrangements having the effect of creating constraints or limitation on the use, enjoyment and disposition of property”.

 

One interpretation of the statute is that the language of article 2 of Law 262 clarifies, but does not extent, the scope of the gift tax, which continues to apply solely to a straight gift, namely, the transfer of property from a person, the grantor, to another person, the beneficiary, for no consideration, whereby the beneficiary obtains the immediate legal title as well as the beneficial enjoyment, use and economic value of the transferred property (made with the intent to enrich the recipient of the property). According to that interpretation, no gift tax applies at the time of the transfer of a property to a trust, when the ultimate beneficiary still does not acquire the directly legal ownership and full right of use, enjoyment and disposition of the transferred property. Instead, the gift tax will apply at the time of the ultimate and final distribution of the property, from the trust to the beneficiary.     

 

Another interpretation of the statute is that the language of article 2 of Law 262 actually intended to extend the scope of the gift tax, from a straightforward gift to any legal arrangement by means of which a person places some of his or her assets in a separate fund, not part of his or her estate, to be used and disposed of for the benefit of another person or for a specified purpose. Under that interpretation, the gift tax would apply on the transfer of property to a trust, while no gift tax would apply at the time of the actual, final distribution of the property from the trust to the beneficiary.  

 

The 5th Department of the Court refused to construe the new statute as if it instituted a new tax, separately from and in addition to the old gift tax. It affirmed its previous rulings, according to which the gift tax applies solely to a direct transfer of property to the beneficiary, as a result of which the beneficiary is enriched and has a direct and full right to the use, enjoyment and disposition of the property. It also held that Law 262 just reinstated the old gift tax, without instituting any new tax, and that the reference new to “legal arrangements instituting limits or constraints to the use, enjoyment or disposition of a property” is just aimed at preventing the possible avoidance of the gift tax in cases in which certain legal schemes may be used that deviate from a straightforward gift of the property to the intended beneficiary while reaching the same result (that is, enriching the beneficiary with unlimited use, enjoyment and disposition of the property).

 

According to the Court, Law 262 by referring to the Gift Tax Act simply reinstated the gift tax, which requires the actual transfer of and receipt of the full beneficial ownership and value of the property, with resulting enrichment of the beneficiary. In case of transfer of properties to trusts, the beneficiary is not immediately enriched, and does not receive the full value of the property unless and until the property is transferred from the trust to the beneficiary (at which time the gift tax would apply). The Court pointed out certain inconsistencies that would arise if the opposite interpretation were adopted, including the need to put the liability for the tax upon the trustee, which is in contrast with the provisions of the Gift Tax Act placing the liability for the tax upon the beneficiary and recipient of the gift.  

 

The Supreme Court is split on this issue and ruling 21614 of the 5th department is in direct contrast with other rulings from the 6th (tax) department of the Supreme Court on the same issue. Lower courts have constantly ruled against the application of the gift tax, and the Italian tax agency has filed appeals against those rulings, as a result of which more decisions are expected from the Supreme Court in the near future.     

 

If the interpretation of the 5th department prevails, it would have extremely important and potentially disrupting effects on cross border estate and trust planning arrangements with connections to Italy.

 

For instance, Americans with assets located in Italy and held in U.S. trusts would face the application of the Italian gift tax, at the time those assets are distributed to the beneficiaries of the trust, while no U.S. tax would apply whenever the original transfer of the assets to the trust was a full and final gift under U.S. tax law.

 

Similarly, for Americans who were domiciled in Italy at the time of their death, the distribution of their assets from their U.S. trusts to the beneficiaries would be subject to the Italian gift tax, regardless of the fact that the assets are located abroad and are held in U.S. trusts, while no U.S. tax would apply, while no U.S. taxes would apply at that time, whenever the original transfer of the assets into the trusts was a full and final gift under U.S. tax law.  

      

Below we review the statute, the position of Italy’s tax administration, the most recent rulings issued by the Supreme Court and the position of lower courts.

 

1) Law 262 of 2006 Reinstating The Gift Tax.

Law Decree 262 of October 3, 2006 reinstated the gift and estate taxes introduced and governed by Legislative Decree No. 346 of 1990 and repealed in 2001.

 

In reinstating the estate and gift tax, Law 262 (at article 2, paragraphs 47 to 49) refers to the following transaction:

  • Gifts,
  • Transfers or property at death,
  • Transfers of property for no consideration, and
  • Other instruments or deeds having the effect of separating or segregating certain assets from all other assets of the grantor and subject them to restriction on use, enjoyment and disposition.

 

For the purpose of determining the tax base and tax rates, Law 262 refers to the Gift Tax Act. The tax base for the gift and estate tax includes the net market value of all transferred assets, with only the exception of state and municipal bonds, which are excluded (but only for estate tax purposes). Different rates and exemptions apply, depending on the family relationships between the parties, as follows:

  • 4 percent for spouses and lineal relatives, with an exemption of €1 million for each beneficiary;
  • 6 percent for siblings, with an exemption of €100,000 for each beneficiary;
  • 6 percent, with no exemption, for other family members within the fourth level; and
  • 8 percent, with no exemption, in all other cases.

 

The gift tax applies for gifts granted from October 3, 2006. The estate tax applies to transfers at death occurred from November 28, 2006.

 

One interpretation of Law 262 reinstating the gift is that, by referring specifically to instruments segregating certain assets and subjecting them to restrictions on use, enjoyment or disposition, it intended to extend the scope of the gift tax, with the result that the newly reinstated gift tax would apply both to actual gifts or donations (namely, transfers of property to a beneficiary made with the intent to enrich the transferee, and with the transferee having immediate and full control, enjoyment and disposition of the property), as well as to any other transfers of assets for no consideration and, in particular, to any arrangement or transaction that separate the transferred assets from all of the other assets of the grantor and subject them to restrains as to their use or disposition (article 2, paragraph 47). Under this interpretation of Law 262, the transfer of property to a trust would fall under the last category and would be within the scope of the new estate and gift tax. Two related issues would be what rate and with what exemptions the tax should apply, and whether the subsequent transfer of the same assets from the trust to the beneficiaries should be taxed again.

 

Some commentators argued that the scope of the original gift tax was not expanded and no tax should apply on transfers of assets to trusts, because the transfer is only temporary and the trust is used as a vehicle for a transfer of the assets to the final beneficiaries, so that only one tax should apply, at the time of the actual and final transfer of the assets from the trust to the beneficiaries.

 

Another opinion distinguished between fixed nondiscretionary trusts with named beneficiaries and other types of discretionary trusts with beneficiaries not identified in the trust agreement. In the former case, the gift tax should apply as if the transfer were made to the beneficiaries directly (that is, at the time of the transfer of assets to the trust, and at the rate and with the exemptions that apply to the named beneficiaries). In the second case, two taxes might actually apply.

 

2) Italian Tax Agency’s Interpretation and Administrative Guidance.

Initially, the tax administration asserted that the gift tax would apply first on a transfer of assets to a trust, and then on the subsequent transfer of trust assets to the beneficiaries. For the transfer to a trust, the tax would apply at the full rate (8 percent) and with no exemptions. For the transfer to the beneficiaries, the tax would apply with the rates and exemptions based on the relationship between the beneficiary and the settlor. According to this interpretation, the use of trusts for individual tax planning would be at risk and potentially subject to adverse consequences.

 

Circular 48/E issued on August 8, 2007 provided important clarifications that partially rectify the initial determination of the tax administration. According to the tax administration, Law 262 of 2006, in reinstating the gift tax, actually extended the scope of the tax and made it applicable to legal arrangements that segregate the assets and subject them to restrictions on their use or disposition. Such arrangements include trusts, foundations and other similar legal structures, whereby one party transfers the legal title to certain assets to another party (fiduciary) and put them under fiduciary administration for the benefit of other parties (beneficial owners). The tax applies with the exemptions and rates provided for in the statute, when the beneficiaries of the assets of the trust are identified in the trust agreement. This can be at the time of formation of the trust, for nondiscretionary irrevocable trusts with named beneficiaries, or at a later time when the trustee designates the beneficiaries under her powers as granted in the trust agreement. Exemption and rates are determined in accordance with the status of the beneficiaries and their relation with the grantor. For charitable trusts or trusts with no clearly identifiable single beneficiaries, the gift tax applies at the time of transfer of he assets to the trust, at full rate and with no exemption. No second tax applies at the time of the distribution of the assets from the trust to the final beneficiaries.
    

By way of Circular n. 3/E issued on January 22, 2008, the tax administration confirmed its interpretation of Law 262 and provided further guidance on the application of the reinstated gift tax. Circular 3/E confirms that the gift tax applies at the time of the transfer of the assets to the trust, and no second tax applies at the time of the transfer of the assets from the trust to the beneficiaries, on the theory of the extension of the scope of the tax and its application to arrangements having the effect to segregate the assets and put them under restrictions as to their use, enjoyment and destination. It also clarifies that whenever the provisions of the trust do not identify the final beneficiaries of the assets of the trust with sufficient certainty, the exemptions and reduced tax rates cannot apply, and the tax is charged at the full rate of 8% with no exemptions. The party liable for the tax is the trustee acting on behalf of the trust.

 

3) Supreme Court’s Case Law.

The Supreme Court is split on the application of the gift tax to the transfer of properties to a trust.

 

The 6th Department of the Court, which is also the Tax Division of the Court, has issued four decisions, by which it held that the tax applies to the transfer of property to a trust, following the tax administration’s interpretation of Law 262 of 2006. We refer to the rulings below:

  • n. 3735 of 2/24/2015,
  • n. 3737 of 2/24/2015,
  • n. 3886 of 2/25/2015,
  • n. 4482 of 3/07/2016.

 

In its rulings, the 6th Department/Tax Division of Supreme Court held that Law 262, at article 2, paragraph 47, instituted a completely new tax, which applies to legal arrangements or transactions having the effect of segregating assets and subjecting them to constraints or limitations about their use, enjoyment or disposition.

 

For the application of the new tax, Law 262 refers to the Gift Tax Act (Presidential Decree n. 346 of 2000). However, the tax is a new tax that applies to a transaction that is different from the “gift” or “donation” subject to the gift tax once repealed and then reinstated gift tax.  

 

According to the Court, the transfer of a property to a trust is a transaction that has the effect of segregating assets and subjecting them to constraints or limitations about their use, enjoyment or disposition, and as such, it is subject to the new tax under the new statute. Indeed, by setting up a trust and transferring a property to the trust, the grantor transfers the legal title to the property upon the trustee, and limits the use, enjoyment and disposition of the property, under the terms and provisions of the trust.

 

The 5th Department of the Supreme Court has issued four decisions (the most notable of which only few days ago), by which it held that no tax applies to the transfer of property to a trust. We refer to the following rulings:

  • n. 25478 of 12/18/2015,
  • n. 25479 of 12/18/2015;
  • n. 25480 of 12/18/2015;
  • n. 21614 of 10/26/2016.

 

In its rulings n. 25478 and n. 25479, the Supreme Court considered the issue of the application of the gift tax to the transfer of property to a trust, under the Gift Tax Act and prior to the reinstatement of the gift tax pursuant to Law n. 262. The Court held that the gift tax did not apply, prior to or in the absence of a definite and final transfer of the property to and enrichment of the beneficiary who enjoys the full power to use, benefit and dispose of the property.

 

In its latest ruling, n. 21614 of 10/26/2016, the Supreme Court considered the same issue under the new provisions of Law 262, Article 2 paragraphs 47-49 reinstating the gift tax and extending it to arrangements that segregate and create legal constraints on the use, enjoyment and disposition of property. The 6th Department refused to construe the new statute as if it instituted a new tax, separately from and in addition to the old gift tax. It affirmed its previous rulings, according to which the gift tax applies solely to a direct transfer of property to the beneficiary, as a result of which the beneficiary is enriched and has a direct and full right to the use, enjoyment and disposition of the property. It also held the Law 262 just reinstated the old gift tax, without instituting any new tax, and that the reference new to “legal arrangements instituting limits to the use, enjoyment or disposition of a property” is just aimed at preventing the possible avoidance of the gift tax in cases in which certain legal schemes may be used that deviate from a straightforward gift of the property to the intended beneficiary, while reaching the same result (enriching the beneficiary with unlimited use, enjoyment and disposition of the property). According to the Court, Law 262 by referring to the Gift Tax Act simply reinstated the gift tax, which requires the actual transfer of and receipt of the full value of the property, with resulting enrichment of the beneficiary, for the gift tax to apply. In case of transfer of properties to trusts, that occurs only when the property is transferred from the trust to the beneficiary, and the gift tax should apply solely at that time. The Court pointed out certain inconsistencies that would arise if the opposite interpretation were adopted, including the need to put the liability for the tax upon the trustee, which is in contrast with the provisions of the Gift Tax Act placing the liability for the tax upon the beneficiary and recipient of the gift.

 

4) Lower Courts’ Case Law.

Lower tax courts throughout the country (both trial courts and appellate courts) have unanimously ruled that no gift tax applies at the time of the transfer of property to the trust and no new tax has ever been instituted by law 262 that should apply in lieu of the gift tax under those circumstances. The reasons in support of those rulings mirror those elaborated by the Supreme Court in its latest ruling n. 21614. We have examined more than thirty decisions, issued in the last ten years, which consistently ruled in favor of the non-application of the tax.

 

It is reasonable to expect additional decisions from the Supreme Court, in the incoming months, as it decides cases decided by appellate courts in favor of taxpayers, which have been appealed by the tax administration.

 

Considering the status of the case law, both from the Supreme Court (that is split on the issue) and from the lower courts (that are unanimously in favor of the non-application of the tax), there appears to be substantial authority and reasonable basis for taking the position that no tax applies to the transfer of the Property to the Trusts.

 

It should be noted that the Italian tax code provides a complete relief from penalties, for failure to pay a tax due, in the event that a split of authorities exist on a particular tax issue, or objective conditions exist as to the correct interpretation and application of the law that may justify the taxpayer’s decision not to pay the tax.