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INTERNATIONAL TAX NEWSLETTER

Issue # 7 - July 5, 2005
ITALY

THE ITALIAN “CHECK-THE-BOX” RULES.

As part of the corporate tax reforms of 2003 that took effect in 2004, Italy has adopted new rules according to which taxpayers can elect that domestic companies classified as corporations and subject to Italian corporate income tax are treated as fiscally transparent entities. Taxpayers can elect fiscal transparency simply by filing a form on which the appropriate box has been checked to that effect. Therefore, the new rules may rightly be referred to as the Italian “check-the-box” rules. The rules provide for two different types of fiscal transparency, each subject to different requirements. The first type of fiscal transparency applies to domestic companies treated as corporations and owned exclusively by domestic companies treated as corporations or foreign entities of any kind, each owning directly not less than 10 per cent and no more than 50 per cent of the stock of the entity measured by voting power and profits share. This type of fiscal transparency is governed by Tax Code section 115 and in the Italian tax parlance is usually referred to as the “big transparency”. The second type of fiscal transparency applies to domestic limited liability companies owned exclusively by no more than ten (twenty in case of limited liability cooperative companies) resident or nonresident individuals and with revenue in the immediately preceeding taxable year not in excess of € 5,164,569.00 (about six million dollars). This type of fiscal transparency is governed by Tax Code sec. 116 and in the Italian tax parlance is usually referred to as the “little transparency”.

Once fiscal transparency is successfully elected the effects are the same in both cases: the domestic company for which tax transparency has been elected is no longer treated as a separate entity subject to corporate income tax, but the company’s income or loss flows through to the company’s owners, who are taxed on their distributive share of the company’s taxable income in their separate or individual capacity. At the domestic level, the election of fiscal transparency permits to avoid partial double taxation on corporate profits and to consolidate a subsidiary’s losses with parent’s profits (and vice versa). At the cross-border level, the election of fiscal transparency offers all tax planning opportunities connected with the use of foreign reverse hybrids. From the U.S. perspective in particular, the election should be particularly attractive for the U.S. multinationals that would be able to enhance their foreign tax credit through the use of a combination of hybrids and foreign reverse hybrids with respect to their Italian business operations. Indeed, the Italian tax on the income earned by the Italian transparent entity is imposed on the owner of the entity, which makes the owner the “technical taxpayer” for foreign tax credit purposes. If the entity is treated as a separate corporate entity for U.S. tax purposes (that is to say, it is a foreign reverse hybrid), this income would not be subject to U.S. tax until distributed to the owner. If the owner is a U.S. person, it will have foreign tax credits in respect of income that it has not yet included for U.S. tax purposes. U.S. taxpayers in excess limitation positions can use this foreign reverse hybrid strategy to reduce U.S. residual tax on other foreign source income.

With respect to the second type of fiscal transparency, an Italian limited liability company owned by individual investors can be used as a holding company to own portfolio investments in stock with a significant tax advantage. Indeed, by electing fiscal transparency dividends received with respect to the portfolio stock owned by the entity, which would be taxable on 40 per cent of their amount if earned directly by the individual investors, would be converted into dividends taxable on only 5 per cent of their amount as earned through the fiscally transparent company.

In both cases, when one or more entity’s owners are foreign entities or foreign individuals, the election can be made provided only that no withholding tax would be applicable on dividends payable from the entity to its foreign owners. In case of foreign entities, no withholding tax applies if the foreign entity is resident in a EU member-state or holds the stock of the Italian subsidiary through a permanent establishment in Italy. In case of foreign individual owners, no withholding tax applies if the foreign individuals hold the stock through a permanent establishment in Italy. This rule imposes additional tax planning to foreign taxpayers who intend to benefit from the election.

A detailed report on the Italian “check-the-box” rules is expected to be published on Tax Analysts soon.

ITALY ISSUED REGULATORY PROVISIONS FOR THE APPLICATION OF TONNAGE TAX.

The decree of the Ministry of Economy and Finance containing rules for the application of the tonnage tax was published on the Official Gazette n. 153 of July 4, 2005. The decree implements the general statutory provisions of Tax Code section 155 through 161 on the elective determination of a conventional taxable income for shipping companies. Tax Code section 155 provides that, subject to certain qualifications and requirements, shipping companies can elect to compute their taxable income deriving from operation of ships used in the international commerce on a conventional basis as provided for in the statute, basically in accordance with the ship’s net tonnage and age. If the election is made, the conventional income so computed instead of the actual net income derived from the operation of a ship is subject to tax at the corporate rate. The statute and the decree identify the companies and ships and the types of income or income producing activities eligible for the election, clarify the procedure required to make the election, and set forth the situations in which the election cannot be made or if already in place is mandatorily terminated. The essential concepts at the base of the Italian tonnage tax rules are briefly described here below. Each deserves specific attention to make sure the taxpayer’s business actually fits in the election’s requirements.

1. Eligible Companies.

They include domestic companies (joint stock companies, limited liability companies and limited partnerships with stock divided by shares resident in Italy and classified as corporations for Italian tax purposes) and foreign entities of any kind carrying on a business in Italy through a permanent establishment located therein.

2. Eligible Vessels.

Vessels eligible to elect the tonnage tax are those registered on the Italian International Register with a net tonnage of at least 100 metric tons. The rules adopt an all in/all out approach: the election must be made with respect to all eligible vessels operated within the same group (that includes all companies under common control within the meaning of Civil Code section 2359). Vessels let on bareboat charter party terms to third parties are non eligible for the election.

3. Qualified Income Covered by the Tonnage Tax.

The tonnage tax applies to income derived from the use of a ship in the international commerce for the purpose of carriage of goods and passengers, salvage services and tow services for purposes of transportation, transportation and installation of off-shore installations and assistance at sea. Income derived from other activities that are incidental to or connected with the above mentioned services, including operation of cinemas, restaurants and bars on board the ship; franchising arrangements related to commercial activities carried out on board the ship; cargo booking and passenger ticket services; loading, unloading and handling of goods or containers within the harbor area; containers rental; grouping and de-grouping of goods before and after the sea passage and land transportation immediately before and after sea passage. The ship must be used by the taxpayer in its capacity as registered owner or operator on bare boat charter party terms to that effect. The election of tonnage tax is not available to NVOCCs. Gains from the sale of a ship are included in the conventional tax basis of the tonnage tax for an amount equal to the excess of the sale price over the fair market value of the ship at the time of the election. The excess of the fair market value of the ship at the time of the election over the adjusted tax basis of the ship in the hands of the owing company at that time is taxed under the ordinary rules. Income derived from any other activities related to the operation of a ship or from letting a ship on bare boat charter party terms to a third party is taxed on a net basis according to the ordinary rules. Most notably, income from operation of casinos, gambling and betting activities on board a ship does not qualify for the tonnage tax.

4. Computation of the Conventional Income.

Income covered by the tonnage tax is computed on a conventional basis by multiplying a conventional amount by the ship’s metric tons and then the resulting amount by a factor related to the ship’s age. The conventional amounts are

- from 0 to 1,000 metric tons: € 0.0090 per metric ton;
- from 1,001 to 10,000 metric tons: € 0.0070 per metric ton;
- from 10,001 to 25,000 metric tons: € 0.0040 per metric ton;
- from 25,001: € 0.0020 per metric ton.

The ship’s age factors are

- from 0 to 5 years: 0.90;
- from 6 to 10 years: 0.95;
- from 11 to 25 years: 1.05;
- beyond 25 years: 1.10.

For ship age calculations purposes any periods of maintenance, repairs and temporary lay up are not included. Income obtained through the calculations set forth above is subject to tax at the corporate tax rate without any allowance for costs or deductions.

5. Exercise and Renewal of the Election.

The election must be exercised within the end of the taxable year and takes effect from the first day of the taxable year. If more ships are operated within the same group, all must be included in the election. For this purpose, each controlled company must notify its consent in writing to the parent company, which files the election with the tax administration with respect to all ships also on behalf of the controlled companies. The election is irrevocable for a period of ten years and if terminated earlier for any reason it cannot be exercised again before a full period of ten years from its original filing has elapsed. The election is renewed in the same way within the end of the first taxable year following the last taxable year in which the initial election was in place.

6. Impediment to the Election.

The election cannot be exercised, or it is terminated earlier if already in place, if more than 50 per cent of the ships operated by a company or a group is let on bare boat charter party terms to third parties for a period of time exceeding for each ship 50 percent of the days of actual navigation in a financial period. Calculation of the disqualified bare boat charter period is made on a vessel by vessel basis. Bare boat charter deals within the same group are not relevant.

A more detailed analysis of the Italian tonnage tax rules is expected to appear in Tax Analysts soon.

EUROPEAN UNION

ECJ REJECTED THE MOST FAVORED NATION TREATMENT

On July 5, 2005 the European Court of Justice ("ECJ") issued its much expected decision in the "D case", in which it rejected the application of the most favored nation treatment and held that differences between tax treaties are allowed within the EU. The "D case" is the first in which the ECJ ruled on the possibile application of the most favored nation treatment. The facts of the case concerned a taxpayer resident in Germany who was denied a tax-free allowance with respect to real estate he owned in the Netherlands. The taxpayer challenged this denial arguing that, in his capacity as resident of a EU member state, he was entitled to the same tax treatment granted by the Netherlands to residents of any other EU member states, under either its domestic tax rules or any tax treaties between the Netherlands and any other EU member states, whichever granted the most favored treatment, with no discrimination and pursuant to the equal treatment principle embedded in the EC treaty. In particular, the taxpayer argued that he was entitled to the same tax relief granted to Belgian residents under the bilateral tax treaty between the Netherlands and Belgium, which provides for a tax-free allowance in favor of Belgian residents with respect to real estate they own in the Netherlands. The Advocate General concluded in favor of the taxpayer, arguing that the denial of the tax benefit costituted an impermissible discrimination between residents of EU member states in violation of the EC Treaty. The ECJ reversed this position and held that the taxpayer, as resident of Germany, was not entitled to treaty benefits provided for in the tax treaty between the Netherlands and Belgium, which are reserved to persons who are resident of a contracting state, since the reciprocal and bargained-for rights and obligations of a tax treaty pertain only to those who are residents of a treaty contracting state and this is the very nature of a bilateral convention on double taxation. According to the ECJ, taxpayers resident in Germany (or any other EU member state) are not in the same position as taxpayers resident in Belgium for purposes of the Belgium-the Netherlands tax treaty, and a tax benefit provided under the treaty is an integral part thereof contributing to its overall balance and cannot be severed from the remainder of the treaty and extended to taxpayers resident in a non-treaty contracting state.

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