Italy, as many other countries in the western world, is facing a deep economic and financial crisis, which has affected the loan market and the ability of businesses to obtain bank financing. With the aim to facilitate access by small and medium companies (SMEs) – which do not qualify as micro enterprises pursuant to the definition of the EU recommendation No. 361/2003, in general, companies with a turnover in excess of 2 million and more than 10 employees - and unlisted companies to the debt capital market as an alternative method of funding to the banking finance, a package of reforms has been put in place.

The reform process started with the law Decrees No. 83/2012 and law Decree No. 179/2012 (so called “Decreti Sviluppo” or “Development” Decree) and continued with the subsequent law Decree No. 145/2013 ( so called “Destinazione Italia” Decree) and law Decree No. 91/2014 (so called “Decreto Competitività” ) and it is considered to have had a strong impact on Italian economy, which is largely based on small and medium sized companies. Indeed the number of Italian SMEs with a turnover between 5 and 250 million (which are the companies that could be actually interested to access debt capital market) is estimated to be approximately thirty-five thousand.

Overall effect of the enacted legislation is a relaxation of the legal and tax restrictions on issuance of bonds and similar securities, so called minibonds, by unlisted companies, including SMEs. Minibonds  is  not  a technical term, but it has become the term of reference to identify such securities.

First step of the reform was the amendment of Article 2412 of the Italian Civil Code, which removed the quantitative limits generally established for bonds issues by non-listed companies (i.e. twice the share capital and reserves) if they:

  1. Are intended to listing in regulated markets or in multilateral trading facilities; or
  2. Entitle the holder to purchase or subscribe shares.

Second step of the reform consisted in amendments of the taxation applied to minibonds for both underwriters and issuers.

As to the underwriters, issuers are not required to apply 26% withholding tax on interest and other income from bonds, similar securities, and commercial paper traded on regulated markets  or  multilateral  trading systems of the EU Member States and EEA States issued, as it already happened for banks and joint-stock company with shares traded on the same markets.

The same applies to interest and other income from bonds, similar securities, and commercial paper held (i) by one or more qualified investors in accordance with Article 100 of Legislative Decree 24 February 1998 n. 58 ("TUF"), (ii)  undertakings for collective investment, established  in Italy or in  a Member State of the European Union, whose assets are invested in excess of 50% in such securities and the shares of which are held exclusively by qualified investors in accordance with Article 100 of TUF and (iii) companies for the securitization of receivables (provided by Law 30 April 1999, n. 130) issuing securities held by the above qualified investors and whose assets are invested in excess of 50% in such bonds, similar securities or commercial paper.

As to the issuers, the reform has introduced a relaxation of limitations on deductibility of interest for corporation tax purposes for (a) unlisted companies as long as securities are traded on a regulated market or multilateral trading facility, (b) unlisted companies which securities are not traded on a regulated market or multilateral trading facility as long as the same are held by certain qualified  investors.  Fees,  costs  and expenses for the issuing of traded minibonds are also deductible by the issuing company.

Lastly, for the purposes of indirect taxes, the legislator extended the – now optional - application of so called 0.25% substitute tax, an advantageous regime which is in place of the indirect taxes (registration tax, stamp duty and mortgage tax) normally applied to secured loans, to include minibonds.

In terms of timeframes, the issuance of minibonds requires an average of 3 to 4 months. The main steps of the issuance are:

  1. Preliminary feasibility analysis;
  2. Structuring of the issue with specific regard to the terms and conditions of the bonds (e.g. duration, amount, applicable interest rate, etc.);
  3. Search for potential investors.

Minibonds issued by SMEs may then be listed on the ExtraMOT Pro (Italian stock  exchange  market segment), which is a dedicated market exclusively intended for qualified investors.

For the bonds to be listed on the Extra MOT Pro segment, the issuer must fulfil a number of obligations and

satisfy certain conditions. In particular, it must:

  1. Have published the financial statements of the last two years, the last of which audited;
  2. Publish a prospectus (according to European regulations 809/2004) or, alternatively, an admission document stating inter alia (i) persons in charge; (ii) information on the issuer (e.g. issuer’s history, description of main activities, etc.); (iii) financial information on the issuer’s assets and liabilities, financial position and profits and losses; (iv) risk factors and (v) etc.

After the entry into force of the reform a number of dedicated closed-end investment funds reserved to professional investors as defined by article 100 of TUF, such as bank foundations, pension funds, social security funds, insurance companies, have been set up with the purpose of subscribing minibond. Such funds may combine a number of issues of different SMEs in a single portfolio, thus removing the dimensional problem and the risk of a single issue.

The reform has also introduced specific provisions relating to  the  possibility  to  issue  profit-participating bonds, containing a participation clause which allows to link the return of the bond to the profit of the issuer.

Such bonds must have a maturity of at least three years, contain a fixed income component in addition to the profit-related component. The variability of the return does not apply to the right to the principal reimbursement of the subscriber of the notes. In essence, the remuneration of such bonds is composed of a:

  1. Fixed part: fixed interest rate which must be greater or equal to the official reference rate, i.e. the rate which is applied by the ECB to the loans provided to banks; and a
  2. Variable part: certain percentage of the year profit of the issuer.

The variable part cannot be changed during the life of the bond and shall be paid within 30 days from the approval of the issuer’s annual financial statement.

It is important to note that, should the issuer of the bond carry out  shariah  compliant  business  and  the regulation of such bond contain the above mentioned participation clause it is maintained that also such bond would be shariah compliant. Indeed the asset would provide a return based on a risk sharing principle rather than on  interest, which in particular in the present negative  interest environment would  be a very minor component.

Profit-participating minibonds may be very attractive from a tax point of view. In fact participating bonds are, as a general rule, subject to Art. 109, paragraph 9 of the ITC which provides for the non-deductibility of the remuneration of the securities, with reference to the portion arising from the participation  into  the economic performance of the issuing company.

However derogating to Article 109, paragraph 9 ITC, the reform has provided that companies issuing minibonds may deduct from their taxable income also this variable component. In particular Article  32, paragraph 24 of the Decree provides that the latter is subject to specific reserve, it represents a cost and it is deducted from the income of the fiscal year of competence. In this regard Circular No.4/E dated 6 March 2013, (the "Circular") issued by the Italian Tax Authority, underlines that the new regulation represents a derogation also from Article 107, ITC, which prohibits the introduction of reserves different  from  those expressly provided by the ITC. The reason is that the new regulation recognizes that the variable part of the remuneration is a cost of the fiscal year when the income arises.

A major issue, that the Circular does not address, is however whether the variable portion of remuneration of the bonds - in addition to being fiscally relevant - may qualify or not as interest expense and, accordingly, be subject to limits of deduction set out by Article 96 of the ITC. This represents a delicate issue and it is hoped that a clarification by the Italian Tax Authority may be issued.

Notably the tax regime above mentioned is applicable to participating bonds - issued by unlisted companies - which fulfil the following conditions (i) have a maturity date not lower than 36 months (ii) include - in addition to the participatory clause - also a subordination clause (i.e. which postpones the repayment after repayment of all other unsubordinated creditors); (ii) the remuneration, in addition to the variable portion, includes a fixed part not lower than the official reference rate; (iii) there is a limitation to distribute the share capital in excess of the amounts of the dividends arising from the profits of the year; (iv) must be subscribed by qualified investors - as defined under Article 100, TUF - which do not hold more than 2 per cent of the capital/assets of the issuing company.

Therefore, the Italian minibonds market could be very attractive for investors looking at shariah compliant asset issued by Italian SMEs as an alternative form of investment to sovereign or large corporate bonds and dedicated funds could be developed.