Law Decree No. 124 (Oct. 26, 2019) enacted a new provision concerning the income tax treatment for Italian resident beneficiaries of distributions from trusts established in low-tax jurisdictions. While the Decree must be converted into law within 60 days to become final, the provisions are effective starting Oct. 26, 2019. The objective of the Decree is to address the controversial topic of distributions from foreign trusts, a field that has been plagued with uncertainty following the release by the Italian Tax Authority in 2010 of Circolare Lett. no. 61/E/2010.
In short, article 13 of the Decree provides that distributions of trust income to Italian resident beneficiaries from nontransparent trusts established in countries or territories with a preferential tax regime (“low tax jurisdictions”) are treated as “reddito da capitale” (income earned from capital assets), which is a taxable form of income for an Italian resident taxpayer.
Italian resident beneficiaries are taxed according to their graduated personal income tax rates on distributions of trust income (that is, income earned or realized by the trustees from the assets or operations of the trust). Conversely, distributions of trust capital aren’t taxable income for an Italian resident beneficiary.
Decree Lacks Clarity
The Decree doesn’t define the clause “income distributed to Italian residents by trusts established in countries or territories adopting a preferential tax regime.” In the absence of clarification from the Italian Tax Authority, classifying receipts as trust capital or trust income will likely be controversial. Moreover, the Decree doesn’t distinguish between fixed interest and discretionary trusts, so that even discretionary beneficiaries may be taxed on receipt of a trust distribution, even if they had no legal entitlement to trust income as all distributions are in the sole discretion of the trustee.
In defining the term “low tax jurisdiction,” article 13 of the Decree refers to art. 47-bis of the Italian Income Tax Act (D.P.R. no. 917/1986) (TUIR), which provides two alternative standards to identify countries with a privileged tax regime (these rules apply to countries other than EU/EEA Member States).
First, when an Italian resident has “control” of a foreign entity, a country is defined as a “low tax jurisdiction” if its effective tax rate is lower than half the rate applicable in Italy. This standard is unlikely to be applicable in the case of trusts. Second, when the requirement of control isn’t met, a country is defined as a “low tax jurisdiction” if its nominal income tax rate is less than half of the income tax rate applicable in Italy. For these purposes, the nominal income tax rate must be calculated by taking into account “special regimes” (preferential tax regimes that aren’t extended to all taxpayers, but may provide favorable tax treatment based on the status or geographic location of a specific taxpayer). Furthermore, exemptions, deductions and credits that affect a significant part of a taxpayer’s activities should also be considered in the assessment if the overall effect is to reduce the nominal income tax rate below the aforementioned limit.
Article 13 of the Decree also introduces a presumption according to which trust distributions are deemed distributions of trust income unless the Italian resident beneficiary can prove with sufficient evidence that the trustees actually distributed “capital.”
Finally, the Decree implicitly supports the position that distributions from the trustees of foreign nontransparent trusts that are EU/EEA resident or are resident in jurisdictions other than “low tax jurisdictions” shouldn’t be treated as taxable income to an Italian resident beneficiary.