On July 18 2023, the Italian Supreme Court issued an unprecedented decision (No. 21047/2023) holding that the relief from double taxation provided by international tax treaties (Treaties) is not only applicable to Italian corporate income tax (IRES) but also to the Italian regional tax on productive activities (IRAP) if it qualifies as a ‘covered tax’ under a specific Treaty.
The decision opens up some interesting scenarios.
The heart of the matter
IRAP, introduced by Legislative Decree No. 446/1997, is a local tax levied on the net value of production derived in each Italian region. In principle, the net value of production sourced abroad is excluded from the taxable base. However, the amount is not identified analytically but rather with a formulaic approach based on allocation drivers. In detail, the exclusion from the IRAP taxable base can be obtained:
If the taxpayer has in the foreign country a factory, a building site, an office, or another fixed base for at least three months in a fiscal year and such foreign settlement qualifies as a permanent establishment in the meaning of the applicable Treaty (Circular Letter No. 263/E/1998, Section 2.1); and
In proportion to the cost of personnel employed in such factory, building site, office, or fixed base (in the case of financial intermediaries, the apportionment is based on the share of deposits or premiums collected through the foreign establishment).
As a result, foreign-sourced items of the value of production, in spite of a theoretical exclusion, may indeed be included, wholly or partially, in the taxable base, engendering possible juridical double taxation issues.
If we stick to Italian tax rules, the relief from double taxation provided by Article 165 of the Italian income tax code (Presidential Decree 917/1986, or IITC) cannot be claimed to deduct foreign taxes against IRAP, since such remedy is specific to IRES. Hence, the question is: can the foreign tax credit set forth by the provisions of Treaties entered into by Italy conforming to Article 23 B of the OECD Model Convention be deducted from IRAP? Such a question, unsolved for many years, has found a possible answer in a case analysed by the Italian Supreme Court.
The decision of the Italian Supreme Court
The dispute arose from a refund claim filed by an Italian resident company that suffered double taxation on a capital gain realised from the sale of a building located in France. According to the taxpayer, the amount of the income taxes paid in France which cannot be credited against IRES, due to a limited capacity of the debt due for the period, should have been relieved with a deduction from IRAP by virtue of Article 24(2) of the Treaty between Italy and France.
The Italian Tax Agency (ITA) denied the refund, holding that:
Since Article 165 of the IITC applies only to IRES, there is no legal basis to recognise the creditability of French corporate income tax against IRAP; and
IRAP is not a covered tax in the meaning of Article 2 of the Treaty between Italy and France, thus the foreign tax credit provided therein cannot apply to IRAP (a similar position was adopted by the ITA for Italian local income tax, or ILOR, which was replaced by IRAP from 1998; see Ruling No. 12/1548/1982).
The Italian Supreme Court rebutted the arguments of the ITA, maintaining that:
By virtue of articles 10(1) and 117(1) of the Italian Constitution, the Treaties prevail over national rules; hence, the exclusion of IRAP from the field of application of the foreign tax credit laid down by Italian tax laws is not decisive;
The possibility to claim relief from double taxation for IRAP should therefore be assessed case by case based on the provisions of the Treaties; and
Article 44 of Legislative Decree No. 446/1997 equates IRAP to the repealed ILOR for the purposes of the application of the Treaties and ILOR is indeed mentioned in the Treaty with France among the covered taxes, as acknowledged by the French tax administration (see Circular Letter No. 33/E/2002).
In light of the above, it is therefore fully legitimate for the Italian taxpayer to claim the remedy for double taxation against IRAP.
What comes next?
The decision may open the possibility to claim a refund of IRAP paid in the past as a consequence of the impossibility of deducting the excess of foreign taxes not creditable against IRES. According to the principles maintained by the Italian Supreme Court, the assessment of the feasibility of a refund claim should be based on two fundamentals:
The qualification of IRAP as a covered tax in the meaning of the provision of the Treaties, which corresponds to Article 2 of the OECD Model; and
The existence of juridical double taxation concerning IRAP and a limited capacity of IRES to absorb the entire taxes paid abroad on the foreign-sourced income.
With regard to the first point, almost all the Treaties entered into or supplemented after the enactment of IRAP already mention such tax among the covered taxes. As for the other Treaties, it would be necessary to assess on a case-by-case basis if one of the taxes repealed by IRAP (such as ILOR) is in scope of the Treaty and if the foreign tax administration acknowledged that IRAP is substantially similar to an income tax (that is the case for Austria, Denmark, France, Germany, the Netherlands, Portugal, Spain, Thailand, the UK, and Vietnam).
As for the second condition, as pointed out in paragraph 2, the typical case of juridical double taxation happens when a taxpayer derives an item of income from abroad without a permanent establishment (for example, royalties paid by a non-resident to an Italian company without a permanent establishment in the source state), but also if there is a permanent establishment which lacks the apportionment factors (for example, a permanent establishment with no personnel expenses).
It would be more debatable if double taxation occurs in cases where the Italian taxpayer earns income through a permanent establishment. As mentioned above, in such scenario foreign-sourced income should be excluded from the IRAP taxable base; however, such exclusion derives from a formulaic approach which may lead to a portion of foreign income (analytically identified) to be included in the net production value taxable in Italy.
For the time being, a refund claim seems to be the only option. Indeed, the IRAP tax return form does not provide any possibility to offset foreign taxes. However, the picture might change in the near future since Law No. 111/2023 delegated to the government the task of replacing IRAP with an IRES surcharge.
