One of the directives recently given by the Italian Parliament to the government to reform Italian tax laws demands “the definition of ‘final losses’ for the purpose of their setting off in compliance with the principles upheld by the case law of the Court of Justice of the European Union [CJEU]”.
The reference is made to the settled case law of the CJEU, which, starting from the Marks & Spencer decision (C-446/03), states that the denial of relief in respect of losses incurred by a subsidiary resident in a member state of the EU, claimed by the parent company resident in another member state, is an unlawful restriction of the freedom of establishment to the extent that the non-resident subsidiary has exhausted the possibilities available in its state of residence of having the losses taken into account (i.e., if the tax losses are ‘final’).
On April 30 2024, the Italian government laid down the first stone to implement the final losses rules through the preliminary approval of a draft legislative decree (the Draft Decree, in Italian).
The proposed legislation concerning final losses
According to the Draft Decree, if a company resident in a member state of the EU or of the European Economic Area, which allows the exchange of information in the tax sector with Italy, is merged into an Italian resident company, the tax losses carried forward (TLCF) by the foreign company shall be carried over by the Italian resident company if the following conditions are jointly met:
A qualified control relationship exists between the merging companies, both in the taxable period(s) when the TLCF have been realised and when the merger becomes effective (the ‘control test’); and
The TLCF can no longer be used in the state where they arose because the company has ceased business and disposed to third parties or divested all the assets and, by virtue of the local laws, the TLCF cannot be used if the control of the company is transferred to entities that are not members of the same group (the ‘no possibilities test’).
Similarly to the CJEU’s case law from which it draws inspiration, the proposed rules pose significant doubts as regards their scope of application and pose a difficult task in identifying the final losses.
Scope of the cross-border relief for tax losses
In spite of the ample scope shaped by the delegation law, the implementation decree confines the relief for tax losses to cross-border merger transactions, thus excluding:
An inbound transfer of tax residency of a foreign company; and
The closure of a foreign permanent establishment (PE) for which the Italian head office elected for the optional exemption regime as a method to eliminate double taxation (Article 168-ter of the Italian income tax code).
The exclusion of cross-border relief in the case of an inbound transfer of a non-resident company is aligned with the most recent CJEU case law (Aures Holdings, C-405/18), to which the Italian tax authorities seem to already conform, having recognised cross-border relief only upon an inbound transfer of a foreign entity already subject to tax in Italy by virtue of the controlled foreign companies rules (see Circular letter No. 18/2021, Section 8.1, in Italian).
However, the exclusion of the relief in the case of closure of an exempted PE might not be consistent with the CJEU’s view. In the Bevola case (C-650/16), the court ruled against the denial of the relief for final losses incurred by a foreign PE under the Danish branch exemption regime (which is similar to the Italian one). A change of route is hence desirable.
The difficult path to identify final losses
According to the Draft Decree, the ‘finality’ of losses should be assessed based on the no possibilities test, which basically requires a demonstration that the offsetting of TLCF in the origin state, even if theoretically feasible from a legal perspective, is factually impossible. In such respect, the explanatory notes to the Draft Decree, recalling CJEU case law (among others, Marks & Spencer, C-446/03; Memira Holding, C-607/17; and Holmen, C-608/17), clarify that the no possibilities test is passed if:
The non-resident subsidiary has ceased its business through the sale or disposal of all its income-producing assets and has exhausted the possibilities available in its state of residence of having the losses taken into account, including the possibility to transfer such losses to a third party (e.g., other members of a tax consolidation regime); and
There is no possibility for the losses to be taken into account in the non-resident subsidiary’s state of residence in future periods, either by the subsidiary or by a third party that acquires the subsidiary, factoring in the potential tax benefit deriving from tax losses.
In light of the above, the cross-border relief shall be limited to foreign subsidiaries that have the tax losses as their sole asset. It is worth noting that, based on the Italian tax legislation applicable to mergers (currently in force), the carrying over of tax losses generated by entities that have terminated their business is not allowed. However, the Draft Decree is also expected to amend such legislation, allowing the carrying over of losses whenever they have been generated when the merging entities were part of the same group.
A last but not least complex step requires the restatement of the foreign losses in accordance with the Italian income determination rules. Such requirement, even if consistent with the CJEU’s case law (A Oy, C-123/11, Section 61), poses practical difficulties, especially if the losses have been accrued in multiple years. A simplification should, however, be allowed for TLCF accrued when the foreign entity was subject to controlled foreign companies rules, since in that case a recalculation of foreign TLCF according to Italian tax laws is already available.
Concluding remarks on cross-border relief for tax losses
As pointed out by the European Commission in the communication Tax Treatment of Losses in Cross-Border Situations, “the lack (or limitation) of cross-border loss relief creates a barrier to entering other markets, which perpetuates the artificial segmentation of the internal market along national lines.” In this respect, the proposed legislation on final losses tries to reconcile the need to avoid restrictions on the freedom of establishment and the need for a fair allocation of taxing powers between member states.
However, the no possibilities test laid down by the Marks & Spencer doctrine and the Draft Decree is a complex, if not nearly impossible, task that could render impractical the cross-border acquisition of final losses. This is even more so due to the impossibility for taxpayers (apart from those adhering to the Italian cooperative compliance regime) to obtain on this topic an advance ruling by the Italian tax authorities.
The rules could have a short life in the event of approval of the new proposal for a directive on a consolidated tax base at European level. The initiative envisages cross-border loss relief as a general measure and not as a last resort when the losses are ‘final’, making the rule at stake just a provisional solution.
