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INTERNATIONAL TAX NEWSLETTER

Issue # 8 - July 18, 2005
ITALY

LEGAL LIABILITY FOR THE TAX UNDER ITALIAN TAX CONSOLIDATION RULES.

TheGuardian Industries case in the U.S. and the opinion of the ECJ’s Advocate General in the Marks & Spencer case at the EU level have drawn new attention to tax consolidation regimes around the world. As part of the corporate and international tax reforms of 2003, Italy enacted its own worldwide and domestic tax consolidation rules that apply to taxable years beginning after January 1, 2004. We provided specific information about the Italian tax consolidation rules in the context of both the U.S. foreign tax credit rules (with specific reference to the Guardian Industries case, just decided at that time) and the rule on deduction of corporate group losses within the EU that may stem from Marks & Spencer in the Issue # 2 of our International Tax Newsletter, published on April 18, 2005 and available in our archive.

The purpose of these additional notes on the same subject is to focus once more on the issue of liability for the tax on the group’s taxable income under the Italian tax consolidation rules. In a brief comment appeared recently on Tax Notes International a commentator concluded that under the Italian tax consolidation rules the parent company and all members of the group are jointly and severally liable for the tax owed on the taxable income of the group. We do not think that this statement accurately reflects the actual status of the matter under Italian law. Indeed, the relevant statutory provisions of the Italian Tax Code appear to confirm that the parent company is solely liable for the tax on the consolidated income of the group, and if it fails to pay the tax the Italian tax administration may look to the other members of the group but only after it has unsuccessfully tried to enforce the payment against the parent. As a matter of Italian law, this configures a secondary liability upon the members of the group, while the primary liability rests exclusively upon the group's parent. The regulatory provisions on domestic tax consolidation issued on June 9, 2004 confirm that the tax obligations related to the income of the members of the groups are transferred to the parent company as a result of the election of tax consolidation. The administrative guidelines on domestic consolidation issued on December 20, 2004 illustrate different types of liabilities that may arise upon the members of the group and, with specific reference to the tax on group’s taxable income, they clarify that the obligation for the tax rests exclusively upon the parent company, while the other members of the group are secondary liable only if such obligation is not properly discharged by or unsuccessfully enforced upon the parent. This analysis is consistent with the general mechanism of Italian tax consolidation, whose effect is that the companies of the group do not compute separately the tax on their income viewed in isolation, but rather transfer their taxable income or losses as well as any tax credits, withholding taxes paid or advance tax payments to the parent company. Income and losses of all members of the group are then netted at the level of the parent, which is liable to compute and pay the final tax due on the net taxable income of the group and offset the tax with any credits, withholding tax or advance tax payments transferred from the members of the group.

Just few days ago the Italian government extended the deadline to elect tax consolidation for the current taxable year up to October 31, 2005. Therefore U.S. multinationals that are considering the opportunity to elect tax consolidation in Italy will have extra time to examine the above matter as well as any other relevant issues to that effect.

TAX TREATMENT OF FOREIGN-CURRENCY GAINS OR LOSSES.

With resolution n. 80/E issued on June 17, 2005 the Italian tax administration provided some clarifications with respect to the tax treatment of income or losses arising from exchange rate fluctuations with respect to assets (payables and receivables and debt instruments) carried in foreign currency.

For taxable years open as of December 31, 2004 the tax treatment of foreign-currency gains or losses differs depending on the nature of the asset as carried on taxpayer's financial books. With respect to long-term or fixed assets, the general rule is that any foreign-currency gain or loss equal to the difference between the value of the asset translated in domestic currency at the exchange rate in effect on the booking date and the value of the asset translated in domestic currency at the exchange rate in effect at the time of the payment, retirement or disposition of the asset is recognized for tax purposes at that time of payment, retirement or disposition of the asset. By way of an exception to the general rule, unrealized losses on debts or liabilities computed on the basis of the exchange rate in effect at the end of the taxable year can be recognized at that time provided that they are non-transitory, i.e. result from currency fluctuations that cannot be expected to be reversed in the short term. With respect to short-term payables and receivables and debt instruments held as inventory property, the value of the asset is translated into domestic currency at the end of each taxable year at the exchange rate in effect at that time and any resulting gain or loss equal to the difference between such value and the value of the asset translated in domestic currency at the exchange rate in effect on the booking date is recognized for tax purposes at the end of the taxable year, even though not realized.

For taxable years beginning after December 31, 2004 the rule for long-term assets described above applies to all types of assets with no limitations or distinctions. Therefore, in general foreign-currency gains or losses are recognized only when realized through the payment, disposition or retirement of the asset based on the exchange rate in effect at the time of payment, retirement or disposition. Foreign-currency gains or losses are treated as ordinary income or losses.