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Italy's 2007 Budget Law contains new tax provisions on trusts[1].

They are far from comprehensive but establish some important principles on classification and tax treatment of trusts in Italy.

As a default rule, trusts are classified as separate taxable entities (and treated like corporations).

However, trusts whose beneficiaries are named in the trust agreement are treated as fiscally transparent entities, that is, their income is attributed to the beneficiaries regardless of its distribution and taxed directly upon them.

Trusts formed in jurisdictions that do not allow exchange of information with Italy are treated as residents and subject to worldwide taxation in Italy if certain connections with Italy exist (any settlor or beneficiary is an Italian resident person), unless taxpayers provide evidence that they are resident (that is, effectively managed) outside of Italy.

Trusts are obliged to keep tax books to compute their taxable income (taxed upon the trust or passed through to and taxed upon the trust’s beneficiaries).

The new rules will affect the use of trusts for tax planning purposes, both in general and in specific contexts (like those conserning possible use of trust to avoid the applciation of thin capitalization or controlled foreign company rules).

Tax Classifications of Trusts

Tax Code article 73, which lists the entities that are classified as corporations for tax purposes, was amended and now includes trusts. Therefore, as a general rule, trusts are treated as separate taxable entities (like corporations), and are subject to corporate income tax.

Resident trusts are subject to corporate income tax on their worldwide taxable income. Non-resident trusts are subject to tax on Italian source passive income and on business income attributable to a permanent establishment in Italy through which they carry on a trade or business there.

However, if the trust’s beneficiaries are expressly named in the trust agreement, the trust is treated as fiscally transparent, that is, the trust’s income is not taxed upon the trust but it is attributed to the beneficiaries regardless of its distribution and taxed directly upon them.

The special rule on tax transparency of trusts applies also to nonresident trusts.

Tax Residency of Trusts

The new provisions do not contain any specific rule on the tax residency of trusts (except for the anti abuse rule that we will describe below).

Therefore, the general rules on tax residency of entities should apply, which establish tax residency in the place where an entity has maintained its legal seat, place of administration or principal business for most part of the taxable year (>183 days)[2].

A special anti-abuse rule provides that if a trust is formed in a low tax jurisdiction, not included in the list of countries that allow exchange of information with Italy (the white list), and at least one of its settlers or beneficiaries is resident in Italy, it is presumed to be resident in Italy and subject to worldwide taxation there.

The taxpayer can rebut the presumption by providing evidence that the trust is nonresident in Italy according to the general rules (meaning, that the trust’s place of effective management or place of business are outside Italy)[3].

The rule refers to the place where the trust is formed. The place of formation of the trust is the place where the trust agreement is executed. Since the choice of the place of execution of the trust agreement is completely under taxpayer’s control, the rule might be scarcely effective.

A trust is also considered to be resident in Italy when, after its formation, an Italian resident transfers to the trust full or limited ownership rights on real property. From the language of the statute, it is not entirely clear whether taxpayers can rebut this presumption by providing evidence of trust’s foreign tax residency under the general rules.

Tax Treatment of Trusts and their Beneficiaries

Fiscally Nontransparent Trusts

Although the new tax provisions on trusts do not contain specific rules in this respect, the tax treatment of fiscally nontransparent trusts should be relatively straightforward.

As noted above, fiscally nontransparent trusts are treated as corporations and taxed on their worldwide income, if they are resident in Italy, or on Italian source income or business income attributable to a permanent establishment in Italy, if they are nonresident.

Taxable income of a fiscally nontransparent trusts is computed according to the same rules that apply to corporations, including the participation exemption rules for dividends and capital gains.

Resident trusts qualify as resident in Italy for tax treaty purposes, but are not be eligible for the benefits of the EU tax directives since they are not organized in one of the legal forms indicated in the annexes to the directives.

Distributions from trust’s profits are taxable as dividends to the beneficiaries.

Fiscally Transparent Trusts

The new provisions contain a rule on taxation of fiscally transparent trusts, according to which the income of the trust is passed through to the trust’s beneficiaries and taxed upon them, regardless of distribution, in proportion to the beneficiaries’ shares of trust income as determined in the trust agreement or - in the absence of such a determination - by equal shares.

Beneficiaries’ share of trust income is characterized as income from capital. In a brief comment on the rules, the tax administration stated that the characterization as income from capital applies only for individual beneficiaries receiving the income from the trust outside the carrying out of a trade or business. The comment suggests that, for individuals beneficiaries engaged in a trade or business or corporate beneficiaries, the trust income should be re-characterized as business income.

The new provisions do not contain any rule on the source of the income derived from fiscally transparent trusts and the treatment of trust losses.

The most immediate comparison is with partnerships. The general rules on sources of income provide that a partner’s share of a domestic partnership income is Italian source income, regardless of the source of the income in the hands on the partnership (the source of partnership’s income does not go through). However, no similar rules apply to trusts. It should also be noted that Italian law does not contain any rule that attribute the Italian trade of business of a trust (or a partnership) to its beneficiaries for purpose of taxing the beneficiaries on Italian source business income.

Since the source of income in the hands of the trust does not pass through to the beneficiaries, and (unlike a partner’s share of partnership income) there is no rule that expressly re-characterizes the beneficiaries’ share of trust income as Italian source income, establishing the exact legal basis for the current taxation of nonresident beneficiaries of Italian fiscally transparent trusts may be problematic. Indeed, income from an Italian fiscally transparent trust may be treated as non-Italian source income and escape taxation in Italy. That income may also be treated as other income and be sheltered from tax under the other income article of tax treaties.

At the same time, taxing nonresident beneficiaries upon distribution of income from the trust would also seem not feasible because, in principle, the tax applies on a look through basis when the income is realized, and distributions from fiscally transparent entities are nontaxable to the entity’s members.

Treatment of Trust's Losses

The statute is silent on the tax treatment of trust's losses.

A comment issued by the tax administration on the treatment of fiscally transparent trusts makes a general reference to the rules on taxation of companies that elect to be treated as partnerships under Tax Code article 115 and 166 (Italian check-the-box rules). By analogy to those rules, trust losses should also pass through to the beneficiaries.

However, it is not clear whether the rules on checked-the-box companies (or partnerships) should apply by way of analogy to trusts all across the board, and further clarifications from the tax administration on this issue are badly needed.

If it is concluded the also losses pass through, since nonresident trusts are treated like resident trusts for fiscal transparency purposes (contrary to nonresident partnerships, which are always separate entities regardless of their tax treatment under foreign law), nonresident trusts would allow pass through of foreign losses to Italian beneficiaries who could use them in Italy to offset other Italian taxable income.

That would be a major exception to the general rule according to which nonresident entities are always treated as separate entities for Italian tax purposes, regardless of their tax classification under foreign law, as a result of which foreign losses can never be used in Italy unless taxpayers operate in branch form or are able to consolidate foreign subsidiaries under Italian worldwide consolidation rules.

Indeed, the rules may create for the first time a foreign entity that could be treated as fiscally transparent entity for Italian tax purposes. In that case, the use of nonresident fiscally transparent trusts would offer resident taxpayers interesting tax-planning opportunities for outbound investments.


[1] Article 1, paragraphs 74 to 76 of Law n. 296 of December 27, 2006.
[2] The legal seat, place of management and principal place of business tests apply for the purpose of determining the tax residency of both corporations and partnerships.
[3] A comment issued by the tax administration draws a parallel with the new anti inversion corporate residency rules, according to which a foreign entity (that is, an entity formed and having its legal seat in a foreign country) is presumed to be resident in Italy for tax purposes, and subject to Italian worldwide taxation, unless the taxpayer provides evidence that it is resident abroad under the place of management or place of business test, when the entity is controlled by Italian resident shareholders or the majority of its directors (or its sole director) are Italian residents.

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