A series of recent decisions by the Italian Supreme Court has strengthened the position of individual taxpayers seeking a foreign tax credit on dividends that are subject to mandatory substitute taxation in Italy.
The issue arises when foreign-source dividends are taxed in the source state and are then also subject to Italy’s 26% final withholding tax or substitute tax. Under Article 165 of the Italian income tax code (IITC), a foreign tax credit is granted only where the foreign-source income is included in the taxpayer’s aggregate taxable income. Because dividends subject to final withholding or substitute taxation are, by definition, taxed separately and do not enter that aggregate taxable income, Italian domestic rules generally prevent taxpayers from claiming a foreign tax credit in these circumstances. The Supreme Court has nevertheless held that relief may still be available under Italy’s double tax treaties (DTTs), independently of the domestic limitation.
This approach, first established in 2022 and subsequently reaffirmed, may carry significant implications for individual investors with foreign portfolios, including the possibility of claiming refunds for prior years.
Italian taxation of foreign dividends
Italian resident individuals are generally subject to tax on their worldwide income. Foreign dividends received outside the course of a business activity are subject to a 26% final tax.
Where the dividends are collected through a resident intermediary, that intermediary generally applies the relevant final withholding tax under Article 27 of Presidential Decree No. 600/1973. Where, instead, the dividends are received directly from abroad without the involvement of a resident intermediary, the taxpayer must self-assess a 26% substitute tax under Article 18(1) of the IITC.
For foreign dividends falling within these rules, the regime described above is mandatory. Taxpayers cannot elect instead to include the dividends in their ordinary individual income tax base, which would otherwise allow them to claim the domestic foreign tax credit under Article 165 of the IITC.
This mandatory regime may result in juridical double taxation: the source state may levy withholding tax on the dividend, while Italy taxes the same income at 26%, without the domestic foreign tax credit rules providing any relief. It should be noted, however, that – pursuant to Article 27(4-bis) of Presidential Decree No. 600/1973 as consistently interpreted by the Italian tax administration – where foreign dividends are collected through a resident intermediary, the 26% Italian tax applied by the financial intermediary that intervenes in the relevant payment is due on a “net frontier” basis, that is, on the gross foreign dividend reduced by the foreign withholding tax already suffered abroad, rather than on the full gross amount. This mechanism mitigates, without eliminating, the double taxation effect described above.
It does not, however, eliminate double taxation altogether: because the Italian tax is still computed on an amount already reduced by the foreign tax, part of that foreign tax is implicitly taken into account through a smaller Italian tax base, rather than through a full tax credit mechanism. The economic relief obtained in this way is generally more limited than the relief that would result from a foreign tax credit granted under the applicable DTT.
The treaty issue
Italian DTTs generally require Italy to grant a credit for tax paid in the other contracting state on income that may be taxed in both states, within the limits set by the relevant treaty.
However, several Italian treaties include a specific exclusion from this credit mechanism where the income is subject to final or substitute taxation in Italy at the taxpayer’s request.
For example, Article 23(3) of the Italy–US DTT provides that no credit is granted when the relevant income is subject in Italy to final withholding taxation “by request of the recipient of the said income in accordance with Italian law”.
The key question is therefore whether this exclusion also applies where final or substitute taxation is mandatory, rather than the result of an election by the taxpayer.
The Supreme Court’s approach
The Supreme Court first addressed this issue in judgment No. 25698 of September 1 2022. The court held that an exclusion expressly referring to taxation applied at the taxpayer’s request cannot be extended to cases in which Italian law mandatorily subjects the income to final or substitute taxation.
Accordingly, where the taxpayer has no option to subject the foreign dividends to ordinary taxation, the treaty exclusion does not apply, and the foreign tax credit may, in principle, be claimed under the applicable DTT.
The Supreme Court reaffirmed this interpretation in judgment No. 10204 of April 16 2024, examining in greater detail the relationship between the domestic foreign tax credit rules and Italy’s treaty obligations.
Under Italian domestic law, income subject to substitute taxation does not form part of the taxpayer’s aggregate taxable income and, consistent with Article 165 of the IITC discussed above, therefore falls outside the domestic foreign tax credit mechanism. However, the Supreme Court held that this domestic limitation cannot define the scope of an autonomous entitlement arising under a DTT. Italian legislation itself recognises the primacy of applicable treaty provisions, through Article 75 of Presidential Decree No. 600/1973 and Article 169 of the IITC.
The court also rejected the argument that treaty relief necessarily requires the foreign income to be included in the taxpayer’s ordinary aggregate taxable income. In the court’s view, it is sufficient that the income is included in the tax base of an Italian tax falling within the scope of the relevant DTT, which may include substitute taxation.
The wording of the treaty exclusion was central to the court’s reasoning. In particular, the court noted that some Italian DTTs use broader language, excluding the foreign tax credit where substitute taxation applies “even upon request of the taxpayer”.
According to the Supreme Court, the existence of this broader wording in other treaties confirms that Italy is able to exclude the credit irrespective of whether substitute taxation is mandatory or elective, when that is the intended result. An exclusion referring only to taxation applied at the taxpayer’s request cannot, therefore, be read in the same way.
An uneven approach by the Italian tax authorities
Despite these Supreme Court decisions, the administrative treatment of refund claims remains uneven.
In practice, some local offices of the Italian Revenue Agency have granted refunds based on the principles established by the Supreme Court, while others continue to reject comparable claims. In the latter cases, the Revenue Agency has argued that the Supreme Court decisions were issued in specific disputes and are not, at the administrative level, sufficient to override the domestic statutory framework, which does not expressly provide for foreign taxes to be credited against the substitute tax applicable to foreign dividends.
This position highlights the continuing tension between the domestic rules and the treaty interpretation adopted by the Supreme Court, whose reasoning rests precisely on the principle that the absence of relief under domestic law does not prevent taxpayers from relying on an autonomous entitlement under an applicable DTT.
As a result, taxpayers in comparable situations may currently face different outcomes depending on the approach taken by the competent local tax office, with some refund claims ultimately requiring litigation.
Implications for taxpayers
The Supreme Court’s approach may be relevant to a broad range of Italian resident individuals holding foreign investment portfolios.
In particular, taxpayers may wish to review prior years in which foreign dividends were subject both to source-state taxation and to the 26% Italian final or substitute tax, without any corresponding foreign tax credit.
Where the relevant DTT contains an exclusion limited to cases in which substitute or final taxation applies at the taxpayer’s request, the Supreme Court decisions provide a basis for claiming treaty relief where the Italian taxation was instead mandatory.
The amount potentially recoverable must be determined under the relevant DTT. In principle, the credit is limited to the foreign tax eligible for relief under the treaty and to the Italian tax attributable to the same income. Foreign withholding tax exceeding the maximum rate permitted by the DTT would generally need to be recovered in the source state, rather than through the Italian foreign tax credit.
Refund claims may be submitted under Article 38 of Presidential Decree No. 602/1973, generally within 48 months of the relevant tax payment.
From a practical perspective, taxpayers considering a refund claim should be able to document the following:
The amount and date of the foreign dividends received;
The foreign tax effectively withheld in the source state;
The withholding rate permitted under the applicable DTT;
The Italian final withholding or substitute tax paid on the same dividends; and
The link between each foreign dividend, the corresponding foreign tax, and the Italian tax against which the treaty credit is claimed.
The distinction between mandatory and elective taxation remains critical: the Supreme Court’s interpretation rests on the fact that the taxpayer had no option to subject the relevant income to ordinary taxation instead of the final or substitute regime.
The same issue may arise regardless of whether the investments are held directly through a foreign custodian or through an Italian intermediary or fiduciary company. Although the mechanics of Italian taxation differ in each case, the relevant treaty question remains substantially the same wherever application of the final tax regime is compulsory.
A developing area of Italian treaty law
The Supreme Court’s case law addresses an important mismatch between Italian domestic legislation and Italy’s treaty obligations.
Domestic rules generally prevent a foreign tax credit from being claimed against the final or substitute taxation of foreign dividends, since such income falls outside the aggregate taxable income to which Article 165 of the IITC applies. The Supreme Court has nevertheless clarified that this domestic limitation cannot override a DTT that independently grants relief and excludes it only where the taxpayer elects for final taxation.
The practical importance of this principle extends beyond the cases already decided. It potentially opens the way for refund claims concerning foreign dividends received in prior years, while also requiring close analysis of the wording of each applicable DTT.
At the same time, the divergent approach currently adopted by local offices of the Italian Revenue Agency means that the availability of treaty relief may still need to be established through litigation.
Further Supreme Court decisions could help consolidate this emerging interpretation and encourage more consistent administrative practice. In the meantime, taxpayers with foreign investment portfolios should consider reviewing prior years in which the same dividends were taxed both in the source state and in Italy, while the applicable refund period remains open.
