Italy's thin capitalization rule was abolished in 2008 and replaced with a regime under which interest and similar expenses that exceed interest income (ie, net interest expenses) may be deducted each year up to 30% of the company’s gross operating margin (essentially a type of EBITDA). The rule applies to all interest and similar expenses, not just to those on related party loans (as under the thin capitalization rules).
The concept of interest and similar expenses includes those which are derived from mortgage contracts, finance leasing agreements, bonds and all other financial relationships (ie, commissions payable on loans, interest payable deriving from notional cash pooling, commissions on factoring contracts of a financial nature, charges originating from derivatives contracts stipulated for the purpose of covering risks from fluctuations in the interest rate). Exceptions are provided, inter alia, for interest capitalised on tangible and intangible assets in compliance with the relevant statutory provisions, interest capitalised on stock, interest related to loans secured by mortgage and interest on trade debt.
Interest that is not deductible in a particular year may be carried forward indefinitely for offsetting against available 30% EBITDA in subsequent years. Also, where EBITDA exceeds the net interest in a given year, the balance may be carried forward to increase the deductible limit for subsequent years.
Special rules apply to tax consolidated groups; specifically, any excess net interest expense may be transferred to another group company and where the 30% EBITDA of one group company exceeds that company's net interest expense, the balance may be transferred to another group member and used to deduct that member's net payable interest. The same rule applies to a foreign company owned by a member of the tax consolidated group, provided certain requirements are met (i.e. the Italian company holds more than 50% of the voting rights or rights to participate in the profits of the non-resident company, both companies use the same tax year, and the financial statements of the non-resident company are audited).
Certain entities are not subject to the rule; banks, financial institutions, insurance companies and holding companies (other than those which hold a participating interest in industrial and commercial companies) are allowed to deduct up to 96% of their interest costs.
In the case of certain types of interest payable, provision is made for specific regimes that lay down the absolute non-deductibility or deductibility (within the 30% EBITDA cap) which is limited by additional restrictions:
- Interest payable in relation to real property that is not directly utilized in the performance of corporate activities (ie, real estate for residential purposes) is completely non-deductible.
- Interest payable deriving from bonds issued by non-listed companies is deductible, applying the 30% EBITDA rule, within the limits of the "official reference rate" approved by the European Central Bank increased by two-thirds; the amount in excess of that figure is completely non-deductible. The rule is not applicable if the bonds are not subscribed by the shareholders of the company, but by banks or financial institutions.
- Interest payable deriving from operations with non-resident companies belonging to the same group is deductible, applying the 30% EBITDA rule, but subject to the transfer pricing regulations.
- Interest payable deriving from operations with foreign companies resident in countries having privileged fiscal regimes (including those not belonging to the same group) are deductible, applying the 30% EBITDA rule, provided it can be demonstrated that: (i) the foreign company carries out a genuine commercial activity, or that (ii) the operation has been carried out for valid economic reasons.
Lastly, the ability to carry forward interest payable in excess of 30% of the EBITDA (which is generally deductible in subsequent financial years), is restricted if the company which has accrued such excess amounts undertakes certain merger or demerger operations. In such cases, the excessive interest may be carried forward provided certain tests (designed to determine whether the company in question is truly operative) are passed, with reference to the two financial years prior to that of the merger or demerger operation, and, subject to the limits of the net equity recorded in the last balance sheet.