One of the issues in the area of finance that most frequently comes to the attention of Italian tax practitioners relates to the tax treatment of non- Italian investment funds—in particular, Non-Harmonised Funds (NHFs) that are not in conformity with EU Directive 85/611.
For an Italy-resident individual, most of the relevant income is included in his or her ordinarily taxable income and is subject to the ordinary progressive tax rates that go up to 43 per cent for income in excess of €75,000, plus local taxes. More precisely, income subject to the progressive taxation is equal to the proceeds distributed by the NHF and the sums received by the individual upon sale or redemption of the quotas, corresponding to the increase in the net asset value of the funds in the period of ownership. Other income in excess of this is taxed at the 12.5 per cent rate and any loss can be offset against income of a similar nature. On the other hand, the same resident individual would be subject to a significantly lower flat taxation of 12.5 per cent with respect to most other incomes, including those relating to certain foreign but harmonised investment funds.
Because of their different qualification for tax purposes, other financial instruments (carrying a yield which mirrors in whole or in part that of an underlying NHF) have access to the 12.5 per cent flat rate of tax ordinarily provided under Italian legislation. This therefore allows a significantly more advantageous tax treatment in the hands of an Italian individual investor than in relation to a direct investment in an NHF. Such instruments should be carefully reviewed on a case-by-case basis before their implementation in order to assess (i) any possible tax inefficiencies that may affect the structure and therefore eliminate or significantly reduce the relevant tax potential, and (ii) the risk of possible challenges by the Italian Tax Authorities based on the current anti-avoidance provisions or certain anti-abuse doctrines. The Italian Tax Authorities are devoting increasing attention to the area of finance, especially in a cross-border context.
The most common structures are Italian fund of fund investments in quotas of NHF, unit linked/index linked insurance policies and structured bonds (see table).
Possible Breach of the EU Treaty and Potential Remedies
The treatment of NHFs, when compared to other investments of a similar nature, may be reasonably viewed to be in contrast with the EU principles of the freedom of establishment and the free movement of capital. In fact, the regime makes the tax treatment of returns on investments contingent upon the fact that they relate to an NHF or other type of fund eligible for the 12.5 per cent flat taxation. As a result, an Italian individual is heavily influenced by this tax factor in his or her choice of investment and is “forced” to prefer other types of investments or channel the purchase of NHF quotas through more efficient structures. The taxation rules for NHFs seem not to have any rationale other than that of dissuading investors from purchasing the NHF, thus giving rise to a significant distortion of the market and/or competitive advantages for some operators.
All these considerations offer a reasonable ground for claiming a breach of the EU Treaty by the Italian tax rules on NHF, at least in the case of EU-based NHFs. Suitable routes for pursuing this claim are either (i) a formal submission of the case to the European Commission asking to open an infringement procedure against Italy, or (ii) the filing of a tax refund request, followed, in the case of a denial, by litigation (and, if the Italian Judge so wishes, by the submission of the case to the European Court of Justice). Professional investors and private bankers, typically involved in the management of investment portfolios on behalf of individuals, should seriously consider such a course of action.
Although there is no formal evidence of any specific intervention in this area, it is to be hoped that the current discrimination of NHFs could be removed by the legislator as part of the announced reform of the Financial Income, effective as of 1 January 2008. The reforms would mainly be targeted at rationalising the rules of taxation and increasing the relevant flat rate from 12.5 per cent to 19 or 20 per cent.