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N. 10/06


In its order no. 21371 issued on October 4, 2006 the Italian Supreme Court asked the European Court of Justice (ECJ) to provide clarifications on the abuse of law doctrine, which the ECJ had elaborated in its landmark decision in Halifax PLC vs. Customs and Excise Commissioners [1].


In Halifax, the taxpayer engaged in a plan designed to avoid VAT on costs of construction of a number of call centers.

Halifax PLC is a financial institution that supplies mainly VAT-exempt financial services and therefore is limited in its ability to deduct VAT on goods or services purchased (input VAT credit is limited to the ratio of VAT taxable supplies to total supplies made to customers that, for the taxable year involved, was equal to for 5 per cent).

Halifax PLC was engaged in a real estate development to build call centers. As a result it would have incurred a lot of VAT, most of which would have been nondeductible.

To plan around this problem, Halifax PLC interposed some of its wholly owned subsidiaries between itself and its contractors. It entered into a series of transactions so that the supplies of construction services were made to some of its wholly owned subsidiaries, which would be able to deduct VAT on constructions costs in full. Had Halifax PLC itself directly engaged the independent contractors, it would be have been able to recover only 5 per cent of VAT charged on those constructions costs.

The ECJ ruled that the plan was abusive and could not stand. It said that EU law (i.e., the right to deduct input VAT) could not be extended to cover “abusive practices” or “transactions carried out not in the context of normal commercial operations, but solely for the purpose of wrongfully obtaining advantages provided for by Community Law”.

In further qualifying the anti abuse test, the ECJ also stated that it must be apparent from a number of objective factors that “the essential aim” of the transactions concerned is to obtain a tax advantage.

No abuse can be found to exist when the transaction has other motive than the mere attainment of a tax advantage (the taxpayer being free to structure the transaction in a way to pay the lowest tax possible).


The case concerns leases of vehicles subject to VAT in Italy.

The transaction was carried out through separate but related arrangements part of the same plan and aimed at reducing VAT.

Namely, the lessee entered into a contract of insurance for the loss of or damages to the leased vehicles and a contract of guarantee covering the lease payments owed to the lessor under the lease contracts, with an affiliate and member of the same group. The payments due under the two contracts were exempt from VAT.

The lease contract provided for lease payments the were artificially low since they do not take into account the costs for the services provided by the affiliate under the separate guarantee and insurance contracts and corresponded only to the costs for the use of the vehicles.

The Court would want to treat the separate arrangements as a single financial lease contract entered into directly between the lessor and the lessee and subject the total amount of the payments made under the separate contracts to VAT as a sole payment under the financial lease, on the basis of the theory that the principal purpose or one of the principal purposes of the separate arrangements was to avoid VAT pursuant to the ECJ holding in Halifax.


For the purpose of stepping together the various parts of the transaction and subject the entire amount of payments to VAT, the Court asked the ECJ to clarify whether test used in Halifax would allow such treatment in cases where the principal purpose or one of the principal purposes (but not the only purpose) of the transaction is tax avoidance.

The interpretative problem arises because the ECJ has referred to the anti abuse test in different terms in the context of its decision. It first referred to transactions entered into solely for the purpose of obtaining tax advantages. This test would seem to apply to transactions whose exclusive purpose is to avoid the tax. It also referred to transactions whose essential aim is to obtain tax advantages. This test would seem to potentially extend also to transactions one of the principal purposes or whose principal (but not exclusive) purpose is to avoid the tax.

Now, in the light of the different language of the anti abuse test used in Halifax, the Italian Supreme Court asked clarifications on the exact scope of the test, namely whether the anti avoidance test (phrased differently by the ECJ) is one and the same and applies also to transactions the principal purpose or one of the principal purposes of which is to avoid the tax, or it is more restrictive and applies only to transactions whose exclusive and only purpose is to avoid the tax (or, perhaps, two different tests should apply depending on the specific facts of a case).

The response of the ECJ will have a significant impact on Italian tax laws, considering that Italian Supreme Court has held that the EU anti abuse doctrine has direct application at domestic tax law level, also in the area of direct (income) taxes.


In two recent cases, the Italian Supreme Court has held that the abuse of law doctrine elaborated at the EU level in the area of VAT law is a doctrine of general applicability in all areas of Italian domestic tax laws, including income tax, to prevent tax avoidance, and referred to it in support to its decision to consider null and void and deny tax effects to transactions entered into for the sole purpose of avoiding income taxes.

Both cases concerned dividend-washing transactions.

In the first case (decided with ruling n. 20398 issued on October 21, 2005) an investment fund sold stock of an Italian company to another Italian company after a dividend had been declared, but before the dividend were distributed, at a price equal to the value of the stock plus the amount of dividend.

The purchaser collected the dividend and immediately thereafter (pursuant to a prearranged plan) it sold the stock back to the fund, realizing a loss.

According to the law in effect at the time of the facts the dividend, if paid to the fund, would have been subject to a gross-basis withholding tax (while any gain realized by the fund through the sale of the stock at a price that included the amount of the dividend was not taxable to the fund).

The dividend collected by the purchasing company was taxable income for the purchaser, but the tax was eliminated by the imputation credit granted to the purchaser for an amount equal to the tax paid by the distributing company on the profits out of which the dividend had been distributed.

Therefore, the sole result of the transaction was avoiding the dividend withholding tax on the fund and providing the purchaser with a loss that could offset other income.

The transaction did not provide the potential for any economic profits or losses for the parties.

Tax law in effect at the time of the facts did not contain any anti-avoidance provisions that could challenge this type of transaction[2].

The Supreme Court, reversing its prior decisions on this issue, ruled that the case had to be tested on the face of the abuse of law tax doctrine developed at the EU level as elaborated by the ECJ in its recent decision in Halifax, which constitutes an underlying tax doctrine displaying effects also at national law level.

According to the Court, the abuse of law doctrine compelled the Court to find legal remedies within domestic law to disregard transactions aimed only at avoid taxes. The Court found those remedies in the general provisions of Italian Civil Code that establish that a contractual agreement is null and void if it lacks valid consideration (that is, it does not have economic substance) and is used to circumvent binding provisions of law.

Pursuant to those provisions the Court held that the arrangement was abusive and should be disregarded, and it treated the purchaser as a mere agent of the fund for the purpose of collecting the dividend payment. The dividend income and capital loss realized by the purchaser of the stock were ignored and the dividend was subjected to withholding tax as if it had been actually paid to the fund.

The second case (decided with ruling no. 22932 of November 14, 2005) presents facts similar to those of the previous one, except that the owner of the stock was a foreign person. He granted a usufruct right on the stock to an Italian company in exchange for a payment equal to the amount of the dividend declared on the stock.

The Italian company collected the dividend and received a credit equal to the tax paid by the distributing company on the underlying profits that offset the tax on the dividend (under the old imputation system).

The foreign person was not subject to withholding tax on the dividend substitute payment received under the usufruct agreement (that was treated as purchase price of the stock).

Pursuant to the abuse of law doctrine and domestic civil law provisions that disregard transactions lacking valid consideration and carried out in fraud of law, the Court disregarded the transaction as abusive and held that the dividend was subject to withholding tax as if it had been paid directly to the foreign person.


Pursuant to the order of Italian Supreme Court, the ECJ will further clarify the exact scope of the anti abuse doctrine that it has elaborated and applied in the area of EU VAT.

This will have a direct impact on Italian tax laws, on the face of Italian Supreme Court’s case law according to which the anti abuse doctrine of EU law has a direct and general application at domestic tax law level, in all areas of taxes including income tax.

Should the ECJ respond that the test applies to transactions one of the principal purposes of which is to avoid the tax, the scope and impact of the anti abuse doctrine would be greatly enhanced, and it would significantly add to the arrays of anti tax avoidance provisions already available under Italian domestic tax law[3].
If this is the outcome, taxpayers engaged in tax planning with Italian taxes will be under additional pressure and will have to carefully study and enact their plans in order to stay away from the statutory anti avoidance provisions and the general anti abuse judicial doctrine originating from the ECJ and adopted by the Italian Supreme Court.

[1] Halifax plc. at al v. Commissioners of Customs and Excise (C-255/02), February 21, 2006.
[2] Article 37-bis of Presidential Decree no. 600 of September 29, 1973 (which most likely would have killed that transaction) has been enacted later.
[3] Article 37-bis of Presidential Decree no. 600 of September 29, 1973 contains anti avoidance provisions applicable to a series of enumerated transactions more susceptible to tax abuse; article 37(3) of Presidential Decree no. 600 of September 29, 1973 contains conduit rules; and article 1 of Tax Code contains a general substance over form principle. Beneficial ownership, anti conduit and look through rules also apply to prevent tax treaty and EU directives shopping and make sure that profits arising in tax havens are subject to tax.