Italy awaits CJEU ruling on dividend tax’s Parent–Subsidiary Directive compatibility

The Parent–Subsidiary Directive (the Directive) aims to eliminate double taxation on dividends within the EU. Specifically, Article 4 allows member states to choose between two systems to avoid double taxation: the exemption and the imputation systems. Furthermore, paragraph 3 of Article 4 allows member states to establish that costs related to shareholdings and capital losses resulting from profit distributions by a subsidiary are not deductible from the taxable income of the parent company. In such cases, if management expenses related to the shareholding are fixed at a flat rate, this amount cannot exceed 5% of the dividends distributed by the subsidiary.

On May 17 2017, the Court of Justice of the European Union (CJEU) addressed the compatibility of taxes levied on dividends distributed to parent companies by subsidiaries based in other EU member states. In its judgments in cases C-68/15 and C-365/16, the court declared the illegitimacy of any national legislation imposing taxes, in any form, on profits distributed to parent companies by non-resident subsidiaries exceeding the 5% threshold set forth by the Directive.

The CJEU adopted a substantive approach, determining that, for the purpose of excluding double taxation, the legal nature of the tax or the timing of the levy does not matter. This indicates that, to eliminate double taxation, it is essential to consider the overall effect of the tax on dividends, regardless of the form or timing of the imposition.

Within the Italian context, the Italian regional tax on productive activities (imposta regionale sulle attività produttive, or IRAP) represents a levy that, under certain circumstances, affects dividends beyond the limit permitted by the Directive. Article 89 of the Consolidated Law on Income Taxes (Testo Unico delle Imposte sui Redditi, or TUIR) provides that dividends received by resident companies are excluded from the taxable income for corporate income tax purposes to the extent of 95%, leading to an effective taxable portion of dividends of 5%, which is in line with the Directive’s provisions.

However, Article 6, paragraph 1, letter (a), of Legislative Decree No. 446/1997 requires banks and other financial entities to include 50% of any dividends received in the calculation of the taxable income (net production value) for IRAP purposes. This results in additional taxation on dividends in the hands of the aforementioned taxpayers, exceeding the 5% limit set forth by the Directive and thus violating the European provisions.

Lower courts have recognised the illegitimacy of this additional taxation. For instance, the Tax Court of Milan (Judgment No. 1429 of April 2 2024) noted that, despite the peculiar nature of IRAP, it still qualifies as a tax on corporate income, like corporate income tax (imposta sul reddito delle società, or IRES), and that the CJEU’s rulings are illuminating and binding in this regard.

Moreover, in Order No. 1467 of October 6 2023, the Tax Court of Lombardy, a second-tier court, submitted a preliminary ruling request to the CJEU, emphasising that the obligation to tax 50% of dividends for IRAP purposes may be incompatible with the prohibition on taxing profits by more than 5% of their amount.

The conclusions drawn regarding dividend payments covered by the Directive must also be extended to domestic dividends, irrespective of the percentage of participation and the holding period. This stems from two main reasons:

• The conforming interpretation of Article 89 of the TUIR, as a rule implementing the Directive; and

• The need to prevent reverse discrimination, which is contrary to constitutional and European principles.

Article 89 of the TUIR should be considered as limiting the taxation of all dividends, both domestic and foreign, to 5%, without any requirement related to the percentage or duration of shareholdings. This uniform treatment results from a legislative process that extended the same benefits afforded to dividends from other EU member states to domestic dividends by eliminating prior restrictive requirements.

As an implementation of EU law, Article 89 of the TUIR must be interpreted in accordance with the Directive and the CJEU's jurisprudence. This implies that even for domestic dividends, the 5% tax limit cannot be exceeded. A conforming interpretation prevents undermining the legislator's objective of ensuring uniform tax treatment for all inbound dividends.

If it were argued that the limitation on taxation only applies to dividend payments covered by the Directive, the application of IRAP to domestic dividends would result in reverse discrimination. This would mean that dividends distributed by resident subsidiaries would be taxed at a higher rate than those from foreign companies, in violation of articles 49 and 63 of the Treaty on the Functioning of the European Union and the principles of equality and tax capacity enshrined in articles 3 and 53 of the Italian Constitution.

The Italian Constitutional Court, in its ruling No. 12 of January 20 2022, acknowledged the relevance of such discrimination, emphasising the need to prevent less favourable tax treatment of domestic cases compared with EU ones. Subsequently, the Tax Court of Reggio Emilia (Judgment No. 53 of March 23 2022) affirmed that the Directive prohibits double taxation by national legislation concerning "European dividends". Furthermore, it stated that the Directive applies to IRAP as well as to IRES, with a clear prohibition against reverse discrimination.

Moreover, the Supreme Court of Cassation, in Order No. 19922 of July 19 2024, suspended a case to await a preliminary ruling from the CJEU, highlighting the significance of the issue regarding the application of IRAP to domestic dividends.

Levying IRAP on dividends distributed from subsidiaries to parent companies, both in an European and domestic context, results in a taxation exceeding the 5% limit established by the Directive and violates constitutional and European principles. Therefore, it is more likely than not that the CJEU will rule against such law with reference to dividend payments falling within the Directive’s scope. Moreover, a coherent interpretation of such principles should lead to a similar approach for domestic payments, avoiding reverse discrimination.

In conclusion, while the case is under the CJEU’s scrutiny, it is advisable that the relevant taxpayers (i.e., banks and financial institutions) file for a tax refund, ‘freezing’ their right to claim back the amount of IRAP unduly paid in the past four years.