This note provides a very high-level and preliminary overview of selected tax considerations applicable to Italian private equity funds, focusing in particular on income taxation applicable to the income realized by such funds and their investors, including non-resident investors.
1. General Principles.
Private equity funds are generally formed in Italy as closed-end investment funds for investing directly or indirectly (through holding structures) into relevant target companies (the “Funds”).
Usually, a management company (SGR) is responsible for the establishment, the investment management decisions and the administration of the Funds. The activities of an SGR and the relationship between the Fund and its investors are regulated under Italian laws and governed by the Fund’s regulation, which is generally subject to the approval of the competent regulatory bodies.
From an Italian tax perspective, undertaking for collective investments (“UCIs”) established in Italy are in principle subject to corporate income tax (IRES). Therefore, Italian UCIs are not considered as tax-transparent entities.
However, Italian closed-end investment funds, other than a real estate fund and subject to regulatory surveillance, are IRES exempt and subject to withholding tax limited to certain specific type of passive income.
Moreover, UCIs are not subject to regional tax on productive activities (IRAP).
As a consequence, income of general type (e.g. dividends and capital gains from portfolio companies) is not subject to taxation upon the Funds.
2. The Entitlement of the Funds to tax treaties.
Income from foreign sources may be subject to withholding tax applied by a foreign jurisdiction. Italian withholding taxes (in the few situations where they apply), as well as taxes levied at source by a foreign jurisdiction, would not be creditable for Italian tax purposes in the hands of the Funds (as income tax-exempted entities).
However, on the basis of the wording of the Italian laws, and according to the interpretation of the Italian tax authorities (the “ITA”) with Circular Letter No. 11/E of 28 March 2012, investment funds are entitled to the application of tax treaties submitted by Italy, when applicable, and the SGR may request the ITA to issue the certificate of tax residence with regard to the Funds.
As a consequence, if certain conditions are met, the Funds may benefit from the favourable conventional provisions aiming at avoiding/reducing double taxation including, by way of example, the following circumstances:
- limiting the other contracting state to apply withholding taxes, as its ordinary tax rate, on outbound dividend and interest payments (reference is made to Articles 10 and 11 of the OECD Model);
- envisaging, where there is the case, the exclusive right to tax capital gains, arising from the disposal of shares on participations, in the contracting state of which the seller is a resident, i.e. Italy, for the investments made by the Fund in other contracting states (with reference to Article 13 of the OECD Model).
As stated by the ITA, foreign tax authorities may subordinate the entitlement of the Fund to tax treaty provisions, provided the same benefits are recognized with regard to the investment funds (subject to prudential supervision) that are resident in their jurisdiction.
3. Taxation of investors resident in Italy.
The tax treatment of income derived by the Funds’ investors depends on both the type of proceeds and the type of investors.
Any amount received that can be regarded as capital reimbursement is not subject to taxation. In this regard, the actual qualification of the sums distributed by the investment funds shall be verified on the basis of the information provided by the SGR itself upon the payments (Circular Letter No. 33/E of 15 July 2011).
Italian tax laws characterize as “financial income” (redditi di capitale) the income derived – in whatever form (i.e. not only in case of distributions of profits both in cash or kind) but also upon the sale or redemption of the relevant units or liquidation of the Fund – by the investors from their participation in the Funds. Such profits are equal to:
- the proceeds distributed to the investors; or
- the positive difference between the “effective” value of redemption, liquidation or sale of the units and the weighted average cost of subscription or purchase of the units.
As a general rule, the SGR (or other financial intermediaries in charge of such payments, or other financial entities in the case the units are admitted to a centralized administration system) applies a withholding tax (provisional or final, depending on the nature of the investor) at the rate of 26% (the “WHT”) to profits for the investor derived from their participation in the Funds.
3.1 Italian resident investors non carrying on a business activity.
In the hands of Italian resident investors that do not hold the units of the Funds within a business activity (e.g. individuals, non-commercial entities, etc.), profits derived from the investment in the Funds would be subject to WHT applied as final taxation.
Based on the guidance of the ITA (Ruling no. 101/E of 19 November 2014), the SGR (or the financial intermediary involved, if any) would not be required to apply the WHT to proceeds derived from the sale of the Funds’ units, unless it has been specifically appointed by the investor to carry out such a sale, and would be required to report such a transfer in its annual tax return as withholding agent.
In that specific case (or in any case where the SGR or any other Italian financial intermediary does not act as withholding tax agent with regard to income derived from the Funds’ units), the relevant investor would be required to include the income in the relevant tax return and to apply a final substitute tax at the rate of 26%.
WHT does not apply to proceeds paid to (or realized by) Italian resident investors holding the Funds’ units through a portfolio subject to the 26% substitute tax regime under the “discretionary portfolio regime” (regime del risparmio gestito).
Moreover, no WHT applies to Italian UCIs (including Italian real estate investment funds). No WHT also applies to pension funds that are subject to a substitute tax at a rate of 20% on the net income accrued in each tax period.
3.2 Italian resident investors carrying on a business activity.
WHT is applied in advance to:
- individual entrepreneurs, when the investment in the Funds’ units relates to the business activity;
- commercial partnerships;
- joint-stock companies, limited liability companies, partnerships limited by shares and similar entities;
- public and private legal entities (other than companies) and trusts, whose sole or main purpose is the exercise of business activities; and
- Italian permanent establishments of foreign investors.
Italian earned by the above-mentioned investors from the participation in the Funds qualifies as business income (reddito d’impresa) and contributes to the total ordinarily taxable income of the tax period in which they are realized by the investors. In particular, the relevant income would be subject to IRES (or for individuals, IRPEF) and IRAP, where applicable, at the ordinary rates.
In this case, the WHT applied in advance is credited against the income taxes (IRES or IRPEF) due in the tax period. WHT does not apply to insurance companies with regard to units included among the assets held to cover the mathematical reserves of life insurance classes.
4. Taxation of non-Italian resident investors.
As a matter of principle, income derived from investment in the Funds by investors not resident in Italy and not owning the units through an Italian permanent establishment qualifies as financial income and is subject to the WHT applied as a final taxation.
Based on the guidance of the ITA (Ruling No. 101/E of 19 November 2014), the SGR (or the financial intermediary involved, if any) would not be required to apply the WHT to proceeds derived from the sale of the Fund’s units, unless it has been specifically appointed by the investor to carry out such a sale (and would be required to report such a transfer in its annual withholding agent tax return). In that specific case, the relevant investor would be required to file an Italian annual tax return and to apply to such proceeds a final substitute tax at the rate of 26%.
Subject to certain conditions, no WHT applies to profits perceived by foreign investors (as listed under Article 6 of Legislative Decree No. 239/1996) resident in states or territories that allow an adequate exchange of information (reference is made to Ministerial Decree of 4 September 1996, as subsequently modified and integrated, the “White List”), accrued during the period in which the units are held. The evidence confirming the holding period must be provided by the investor to the SGR.
Moreover, no WHT applies to the following categories of investors:
- international entities or bodies established according to international agreements implemented in Italy;
- foreign institutional investors, although not subject to tax (e.g. partnerships or other tax-transparent entities), established in states or territories included in the White List;
- central banks or other entities that manage the official reserves of a country (such as sovereign wealth funds).
In order to obtain the exemption from the WHT, qualified non-Italian resident investors submit the following items to the SGR, further to the evidence of the units’ holding period:
- a certificate of tax residence issued by the competent authorities of the state of residence;
- a self-certificate by the beneficial owner of the profits, attesting the existence of the requirements to benefit from the exemption (i.e. residence in a state or territory included on the White List or qualification in one of the relevant categories qualifying for the exemption) ;
- a copy of a document (e.g. an abstract of an identification document or certificate issued by the local public register, chamber of commerce or similar authority) reporting identification details of the legal representative of the beneficial owner of the profits.
In addition, foreign institutional investors must submit to the SGR:
- documentation attesting that the entity is subject to prudential supervision in the state or territory of establishment; or
- a declaration by the legal representative stating that the entity is not subject to prudential supervision but has adequate competence and experience in financial transactions to be considered an institutional investor.
Trusts, partnerships and other institutional investors not subject to supervision and not subject to tax shall submit to the SGR, together with the declaration of competence and experience with transactions of financial instruments, a declaration by the legal representative of the entity or of the relevant manager/management company stating that the entity has not been set up for the purposes of allowing to “unduly” benefit from an exemption from Italian taxation (or from any other relieving provisions of Italian tax laws) persons that are resident in Italy or in a country not included on the White List .
All the documents listed above have to be provided to the SGR and transmitted by this latter to the custodian bank prior to the date of realization of profits. As a matter of practice, the SGR generally requests the documentation upon subscription to the Fund’s units.
In this regard, as clarified by the ITA (Circular Letter No. 20/E of 27 March 2003), the SGR does not have to verify the actual existence of the requirements for the exemption declared by the investor.
In any case, although investors not resident in Italy could not meet the conditions in order to benefit from the exemption from the WHT under domestic rules, in principle, the same WHT could still be reduced (although not eliminated) pursuant to a tax treaty, if any, in force between Italy and the state of residence of such an investor, subject to the substantial and procedural requirements set forth by the specific tax treaty.