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Italy searching for new rules defining the tax residence of individuals

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Paolo Ludovici and Andrea Gallizioli of Gatti Pavesi Bianchi Ludovici comment on the ‘Delegation Law’ recently passed by the Italian Parliament, which provides for a broad revision of the tax residence of natural persons.

On August 4 2023, the Italian Parliament approved a law (the Delegation Law) delegating to the government the task of adopting one or more decrees enacting a massive reform of the Italian tax system. The government has 24 months to draft, adopt, and publish all the relevant decrees for the implementation of the Delegation Law, in compliance with the guidelines and principles contained therein.

Of particular importance among the changes is a provision that requires the government to “provide for the revision of the discipline of the tax residence of natural persons, companies and entities other than companies as a criterion for linking personal taxation, in order to bring it in line with the best international practices and the conventions signed by Italy to avoid double taxation, as well as to coordinate it with the discipline of permanent establishment and the special regimes in force for persons transferring their residence to Italy, also examining the possibility of adapting it to the provision of work services in agile mode”.

At present, with regard to the residence of natural persons, the national tax law provides that natural persons are considered to be residents in Italy for tax purposes if, for the greater part of the year (i.e., more than 183 days), they meet one of the following criteria:

  • They are entered in the register of Italian residents; or

  • They have their habitual residence in Italy; or

  • They have established their main centre of business, family, and social interests in Italy (a ‘centre of vital interests’).

A person is resident or non-resident for the whole year, as Italy does not have a ‘split year’ mechanism.

The Delegation Law does not provide further guidance, leaving ample scope for government action, but Gatti Pavesi Bianchi Ludovici believes that the new discipline should address four critical areas:

  • The identification of new criteria for defining tax residence;

  • The introduction of a split-year mechanism;

  • The provision of specific references to agile working; and

  • Coordination with double tax treaties and the concept of a ‘resident person’.

New criteria to define tax residence

The first priority would undoubtedly involve the elimination of the formal criterion that deems a person as a tax resident in Italy solely on the basis of their registration in the population register.

This criterion lacks logical coherence, as it results in the classification of individuals as tax residents who may not have spent a single day in Italy. Furthermore, this criterion carries the risk of incentivising behaviour that runs counter to the spirit of the regulations, especially in cases where individuals relocate to Italy solely to exploit favourable tax conditions without establishing any substantial ties to the territory.

The criteria of the ‘habitual abode’ and the ‘centre of vital interests’, as also referenced in the tie-break rules found in most treaties, require a comprehensive re-evaluation. These criteria heavily rely on subjective and inevitably discretionary assessments. Moreover, within the contemporary context of heightened mobility and the flexibility of familial and social relationships, determining an individual's habitual residence or centre of vital interests risks engendering situations of considerable uncertainty and potential disputes between tax authorities and taxpayers.

The Delegation Law calls upon the government to seek inspiration from international best practices, and in this regard, the statutory residence test implemented by the UK in 2013 could serve as a notable example. It has indeed demonstrated its ability to mitigate uncertainties in the determination of tax residency, reducing discretionary elements in the evaluation process.

The introduction of a split-year mechanism

The absence of a split-year mechanism is a source of significant cases of double exemption and double domestic taxation. However, these double taxation situations are not resolved by the double tax treaties, except in a few cases (such as the treaties with Switzerland and Germany) where specific split-year provisions are introduced.

The risk of double taxation is also illustrated by a recent decision of the Italian Supreme Court, which refused to apply the split year to a football player who transferred his residence from Italy to France in the second half of the year and has been considered tax resident by both France – which, based on domestic law, considered the person tax resident since the day of relocation – and Italy, which considered the person resident till the end of the fiscal year (Case 25690/2023).

Specific references to remote working

Remote working is an established reality that is increasingly used by companies as a talent acquisition tool. The tax implications, which determine the tax residence of individuals as well as the taxation of salaries, the application of social security contributions, and even the taxation of corporate income (including the possible establishment of a permanent establishment) are of considerable importance.

Recently, the Italian Revenue Agency issued a circular that attempted to provide guidance, although it repeatedly emphasised the lack of specific rules. The approved version of the Delegation Law explicitly refers to agile work. Therefore, the need for a specific regulation in this regard is imperative.

In addition, considering (but not limited to) what happened during the COVID pandemic, the adoption of a provision mitigating the effects of certain circumstances that might occur due to force majeure would be beneficial.

Coordination with treaties and interpretation of the concept of a resident person

In recent years, Italy has taken significant initiatives to attract high-net-worth individuals, a trend that has been observed in other countries in Europe and beyond.

The election for these schemes, particularly where they include exclusion or flat-rate rules for income earned outside the individual's country of residence, raises questions about the applicability of double tax treaties. To qualify for the benefits of a treaty, an individual must be recognised as a ‘resident’ of a treaty country. However, this term does not include a person who is solely liable to tax in such a contracting state in respect of income derived from sources within that state or property situated within that state.

The Italian Revenue Agency has clarified on numerous occasions that beneficiaries of the Italian flat-tax regime are entitled to treaty protection. However, in a controversial ruling, the agency denied treaty access to UK-domiciled individuals subject to the ‘res non-dom’ status.

In light of these developments, it is appropriate for the legislature to provide a fair and consistent regime in this context.

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