Italian Supreme Court stumbles regarding the taxable base of interest payments
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Italian Supreme Court stumbles regarding the taxable base of interest payments

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Paolo Ludovici and Andrea Iannaccone of Gatti Pavesi Bianchi Ludovici argue that a decision by the Italian court violates the European freedoms in treating a non-resident taxpayer differently from resident entities without justification

In its judgment No. 26204/2023, the Italian Supreme Court of Cassation ruled on a complex case in which the Italian Revenue Agency had requalified under the anti-abuse rule the financial fees paid in favour of a non-resident company under an interest rate swap agreement as interest expenses, and, consequently, challenged the failure to apply withholding taxes on the interest payments.

The taxpayer opposed several grounds of appeal, including that, in any case, the withholding tax would have to be applied on an amount determined net of the relevant costs, as "the failure to recognise the costs incurred in the production of interest paid by a resident company to a non-resident company restricts the free movement of services and capital, granted by the Treaty on the Functioning of the European Union [TFEU]."

The court rejected the claim on the following grounds:

a. The positions of a resident and a non-resident company are not comparable because they realise income of a different tax nature. For resident business corporations, interest does not represent income from capital but business income, included in the relevant taxable base; for non-resident corporations, instead, interest is considered as income from capital, for the determination of which no deduction is allowed.

b. In any case, the different tax base cannot affect the fundamental freedoms, since the two items of income are differently qualified and identified. Indeed, the different treatment provided for by the tax legislation (i.e., the different tax mechanism), depending on whether the beneficiary companies are resident in Italy, addresses situations that are not comparable, by reason of the different nature of the interest income (see (a) above) and the different ‘position’ of the taxing state, which acts as the taxing body for resident entities, and as the source of the interest for non-resident companies.


Although the Italian Supreme Court has recently endorsed an EU-compliant approach in interpreting some debated rules (for example, the recent jurisprudence in favour of the application of the participation exemption to non-resident companies; decision No. 27267/2023 of September 25 2023), in this case the Supreme Court's position is openly illegitimate and mistaken in its premises and conclusions.

Firstly, the income always has the same nature – i.e., it is interest income – regardless of the category of income in which it falls for the recipient. Specifically, interest is considered as business income for resident taxpayers engaged in business activities and for non-resident taxpayers with a permanent establishment in Italy to which interest income is attributable. It is qualified as income from capital in the hands of non-resident taxpayers with no permanent establishment in Italy just for taxation purposes. The Italian tax law is structured on the assumption that a non-resident entity with no permanent establishment in Italy never carries out a business activity in Italy, which is true for the identification of the Italian category of income but not from an EU perspective. Indeed, the non-resident entity could carry out a business activity abroad, which is a condition that must be considered for understanding the comparability of the positions.

Secondly, the different taxation technique (withholding tax versus inclusion in the taxable business income) has nothing to do with fundamental freedoms but is simply derived from different collection requirements. If an income considered territorially relevant – such as interest income – is paid to a non-resident recipient, the application of withholding tax at source represents the final levy and ensures that the state of source collects the taxes due on the income. Conversely, if the payment is to a resident taxpayer, there is no risk of revenue loss since the latter is required to include any proceeds in its taxable income. The role of the state as the taxing entity is the same: for the sole purpose of collection of taxes. In the first case, it requires the intervention of the Italian resident payer of the income acting as a withholding agent and in the second one, it collects taxes directly from the taxpayer itself.

Key question on tax bases

The question is whether it is correct to use two tax bases in respect of two recipients of income, both carrying on business activities within the EU, for the sole reason that one is resident in the same state of the paying entity and the other is not (and does not operate through a permanent establishment). Obviously, the answer can only lead to non-compatibility with EU law.

National legislation violates EU law every time it discriminates or restricts European freedoms, as provided by the TFEU. Taxes levied by European states must not prevent or restrict the free movement of goods, persons (including the freedom of establishment), services, or capital among EU member states. Discrimination exists if a member state treats a cross-border transaction less favourably than it would the same domestic transaction. If the treatment seems discriminatory, the freedom that has been limited by the discrimination should be identified to evaluate whether a justification can be invoked.

Case law

The case under investigation is the following:

  • Article 26 of Presidential Decree No. 600/1973 provides that interest paid to non-resident recipients is subject to a 26% domestic withholding tax on the gross amount paid; but

  • For resident companies, the interest income qualifies as business income and, therefore, is not subject to domestic withholding tax.

This difference violates fundamental freedom. It is crystal clear that a non-resident taxpayer has a detrimental treatment to that accorded to resident entities, with no valid justification.

What is surprising in the case at hand is that the illegitimacy of the Italian tax law (and of the Supreme Court’s decision) is not questionable as it has been confirmed by several decisions of the European Court of Justice (ECJ).

The leading case is Gerritse (C-234/01), concerning the freedom to provide services in relation to a self-employed individual, where the ECJ ruled that the taxable amount of the professional income derived by the non-resident individual had to be determined in a similar manner as for resident individuals carrying out the same activity, as their positions were considered comparable, concluding that non-residents should also be allowed to deduct costs incurred to produce taxable income.

The main principle has been ruled in further decisions (among others, C-290/04, the Scorpio case; C-345/04, the Centro Equestre case; and the very recent C-461/21, the Cartrans case, on September 7 2023). The Brisal case (C-18/15) clearly states the incompatibility with Article 49 of the TFEU of a national legislation that “taxes non-resident financial institutions on the interest income received within the Member State concerned without giving them the opportunity to deduct business expenses directly related to the activity in question, whereas such an opportunity is given to resident financial institutions”.

For the sake of completeness, a domestic case (Decision No. 363 dated April 15 2019 issued by the Regional Tax Court of Abruzzo) ruled in favour of the ‘net taxation’ of Italian-source royalties accrued by a non-resident company without a permanent establishment in Italy; i.e., considering as taxable the royalties net of the direct costs of production. For this purpose, the tax court disapplied the Italian domestic tax law as it has been considered incompatible with the prevailing principles enshrined in the European treaties and with their interpretation provided by the ECJ.

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