On December 27 2023, the Italian government published a legislative decree that revises several international tax rules as part of a major tax reform (Legislative Decree No. 209/2023 (in Italian), or the Decree).
An important measure addresses the criteria that identify the tax residence of legal entities, which are revised to “assure a higher degree of legal certainty, taking into account international practices and the linking rules which define the tax residence laid down by the Conventions for the avoidance of double taxation” (see the explanatory report to the Decree drafted by the Italian government).
Based on the Italian government explanations, the new framework serves the purpose of solving some issues of the previous linking rules.
Italy’s previous linking rules
The previous criteria were introduced in 1973 and had not been significantly amended since then. According to the former linking rules, a legal entity was resident in Italy for tax purposes if, for most of the taxable period (more than 183 days), one of the following conditions was met:
Its registered office (or legal seat) was in Italy;
Its place of management was in Italy (sede dell’amministrazione, or Place of Management); or
The main object of its business was in Italy (oggetto principale, or Main Business Object).
However, a lack of legal certainty over the interpretation of the notions of Place of Management and Main Business Object fuelled a vast amount of litigation between taxpayers and the Italian tax administration.
For the Place of Management, in the absence of a legal definition, a typical issue was related to the type and level of decisions needed to locate it in Italy. One of the crucial points was whether the management and coordination activities exercised by the parent company in respect of its subsidiaries could locate the Place of Management in the state where the parent company was tax resident (see the decisions of the Italian Supreme Court Nos. 1753/2023, 33234/2018, and 43809/2015).
Regarding the Main Business Object location (i.e., the place where the legal entity carries out the essential activity to realise its business purpose), a common controversial topic was whether this place should coincide with the location of the main company’s assets, especially in the case of real estate, participations in Italian companies, or intangible assets licensed to Italian companies (see the decisions of the Italian Supreme Court Nos. 6995/2014, 1811/2014, 7080/2012, and 13579/2007).
Such issues were not solved by the international tax treaties entered into by Italy, which entrust the resolution of conflicts regarding residence to the concept of ‘place of effective management’ (POEM). Indeed, according to the observations of Italy on the commentary to Article 4 of the OECD Model Tax Convention on Income and on Capital (versions from 2000 to 2017), the assessment of the POEM also requires an evaluation of the “place where the main and substantial activity of the entity is carried on” and not only the place where the key and strategic decisions are taken.
The new framework and its possible impact
The new framework designed by the Decree is grounded on the following alternative linking rules:
The legal seat (the same formal criteria provided by the former rules);
The “main ordinary management”, which is the location where the “day-by-day management activities concerning the whole legal entity are taken in a stable and co-ordinated manner”; and
The “place of effective management” (sede di direzione effettiva), which is defined as the place where the “main and most strategic decisions concerning the whole legal entity are taken in a stable and coordinated manner”.
The new substantial criteria are a good starting point to unravel the interpretative issues that arose in the previous framework.
As for the repeal of the Main Business Object and the replacement with criteria based on the place where the strategic or day-by-day administration of the company is carried on, that should allow a dropping of the convention under which the location of the main assets of a company defines its tax residence. From now on, it should be clear that the performance of an activity cannot be confused with the place where the assets used for such activity are located.
The introduction of the ‘place of effective management’ criteria – which echoes many conventions entered into by Italy on the basis of the OECD models prior to the 2017 version – should help to clarify the type and level of decisions that may lead to the residence of a legal entity being classified as Italy. In particular, the reference to “effective management” in a “stable and coordinated manner” should preclude that the exercise by an Italian controlling (or sole) shareholder of its typical prerogatives vis-à-vis non-Italian subsidiaries is a sufficient element to link the subsidiaries' POEM in Italy.
That conclusion is confirmed by the explanatory report to the Decree drafted by the Italian government, which specifies that “decisions taken by the shareholders, other than those with management content [emphasis added], are not relevant, nor are supervisory activities and any monitoring of the management by the shareholders”. Therefore, in the new framework, the location of the POEM in the state of the parent entity should be legitimate only if the subsidiary is de facto managed by the parent entity while the directors of the subsidiary endorse decisions taken elsewhere and are stripped of any management power.
The new rules have not amended the presumption of Italian tax residence of non-resident companies that control a resident company and are, in turn, controlled, directly or indirectly, by a resident person (natural or not). In such a case, the existence of a qualified control assumes the value of presumption of residence in Italy of the foreign legal entity, unless the taxpayer proves the contrary.
Final remarks on Italy’s changes to the linking rules
The new linking rules were welcomed by the operators, since they allow the issues that have been controversial for a long time to be overcome.
However, the reform has overlooked one of the directives provided for in the delegation law; namely, the “coordination of the linking rules with the provision of work services in agile mode” (Article 3(1)(c), Law No. 111/2023).
Given the emphasis of the new linking rules on decision-making processes and the wide spread of the remote- and smart-working phenomenon, it will be crucial to scrutinise where the people in charge for the decision are located in the evaluation of the tax residence (or the existence of a permanent establishment). This is particularly so in light of international and domestic tax practices, which seem still reluctant to downplay the role of physical presence in the assessment of linking rules.
Indeed, on the one hand, Section 24.1 of the Commentary to Article 4 suggests that relevant factors to assess tax residence could be “where the meetings of the person’s board of directors or equivalent body are usually held, where the chief executive officer and other senior executives usually carry on their activities, where the senior day-to-day management of the person is carried on, where the person’s headquarters are located”.
On the other hand, Part III, Section 2.2 of Italian Circular Letter No. 17/2017 grants a ‘safe harbour’ only to foreign entities managed from Italy by directors who benefit from the Italian res-non-dom regime.
