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INTERNATIONAL TAX NEWSLETTER

Issue # 6 - June 20, 2005
ITALY

ITALIAN RULES ON CLASSIFICATION OF FINANCIAL INSTRUMENTS FOR TAX PURPOSES (AND CROSS BORDER TAX ARBITRAGE OPPORTUNITIES).

The Italian tax law reforms of 2003 introduced specific rules on (re)characterization of financial instruments as equity for tax purposes.

Tax Code section 44(2)(a) provides that securities or financial instruments whose remuneration consists entirely in a participation to the economic results of the issuer, of another company belonging to the same group, or of the transaction with respect to which the instrument has been issued, shall be classified as equity for income tax purposes.

Tax Code sec. 44(2)(b) provides that financial instruments issued by a foreign entity shall be treated as stock in the event that the remuneration paid with respect of such instruments, if paid by a domestic issuer, would have been totally nondeductible under Tax Code sec. 109(9). According to Tax Code sec. 109(9), any remuneration paid or accrued with respect to any securities or financial instruments, however denominated, is nondeductible to the extent that it directly or indirectly implies a participation to the economic results of the issuer, another company of the same group or the transaction with respect to which such security or instrument has been issued.

Tax Code sec. 44(2)(c) (that has been left unaltered), provides that financial instruments which contain an unconditioned obligation to repay an amount that is not less than that stated on the face of the instrument, with or without payment of a periodic remuneration, and which do not grant the holder any right to directly or indirectly participate to the management of the issuer or the deal with respect to which the instrument has been issued, or to exercise any control over the same, shall be treated as debt obligations for tax purposes.

In addition to the above, the corporate law reform approved in 2003 introduced in the civil code new types of debt instruments, including subordinated debt obligations (CC § 2411(1)), contingent interest debt obligations (CC § 2411(2)), contingent principal debt instruments (CC § 2411(3)), limited liability companies debt instruments (§ 2483) and participating financial instruments (CC §§ 2346; 2349 and 2477), which must also be tested under the tax rules on classification of financial instruments for tax purpose in order to determine their correct tax treatment.

This vast array of tax and non-tax rules serving different purposes and non entirely coordinated with each other require specific attention and careful planning from the taxpayers (and their tax advisors), in order to achieve the desired tax treatment for a specific transaction and exploit the tax arbitrage opportunities that exist in the cross-border context.

UNITED STATES

TAXATION OF FOREIGN BUSINESS TRAVELERS IN THE UNITED STATES

Foreign persons traveling to the US to perform employment services here, as well as their employers, should pay specific attention to the U.S. tax rules that provide for substantive or reporting tax obligations in connection with the services performed in the United States. A fundamental distinction must be drawn between business travelers protected by treaties and business travelers not protected by treaties.

Typically, income tax treaties concluded by the U.S. exempt from U.S. federal income tax income earned by persons who are resident of the other contracting state from employment performed in the U.S., provided that the employee is present in the US for less than 183 days in the relevant year, and the remuneration is paid by or on behalf of an employer who is not resident in the U.S. and is not borne by a PE or fixed base that the foreign employer has in the U.S. Usually, income that is exempt from federal income tax is also exempt from most state and local income taxes. However, to claim exemption from tax under a treaty, the employee must submit a withholding certificate to his employer using IRS Form 8233, which must contain various statements and other details. The employer, in turn, must examine the statement for correctness and submit is to the IRS.

For employees who do not fall under the protection of a tax treaty, in general compensation for services performed in the US is taxable, with the only exception that such income is exempt when the foreign employer is present in he U.S. for a period or periods not exceeding 90 days during the tax year; the compensation does not exceed US$ 3,000 (in the aggregate), and the compensation is paid for work performed in the U.S. for an employer not engaged in a U.S. trade or business. The exempted compensation is considered foreign source income; therefore, the foreign employee is not considered to be engaged in the conduct of a trade or business in the U.S. by reason of the work performed in the U.S. and accordingly he is not required to file an income tax return in the U.S.

When the treaty or statutory exception does nor apply and the compensation for services performed in the U.S. is taxable in the U.S., the employer is obligated to collect the tax through wage withholding, which applies in the same way as for domestic employees, but for the fact that the withholding only applies to compensation for services performed in the US. The employer must also withhold social securities taxes.

Since foreign business travelers and their employers are potentially subject to non insignificant substantive and reporting tax obligations in the U.S. in case of performance of services in the US, with extensive and potentially severe penalties in case of failure to comply with these obligations, they need to pay specific attention to these rules and get the proper advice to avoid potentially adverse tax consequences.