On July 6 2022, the Italian Supreme Court recognised that imposing withholding tax on dividends paid by Italian resident companies to investment funds established in non-EU/EEA countries results in a discriminatory treatment of the latter with respect to investment funds established in Italy (Italian Supreme Court, decisions No. 21454, 21475, 21479, 21480, 21484, 21482/2022). The court found that the tax treatment represented an infringement of the EU principle of free movement of capital.
The cases decided by the Supreme Court concern the Italian tax rules applicable until July 1 2011, but the decisions also represent a turning point for the tax treatment of non-EU investment funds in subsequent years.
A similar principle has been stated by the Supreme Court with the decision issued on July 7 2022, about the Italian legal provisions providing for the application of a withholding tax on dividends paid by Italian resident companies to an EU investment fund (namely, German – decision No. 21598/2022).
Italian regulatory background
Before going into the details of the Supreme Court’s decisions, it is worth summarising the Italian tax treatment of dividends paid to investment funds.
Until July 1 2011, Italian funds for collective investment in transferable securities were subject to a 12.5% substitute tax on the operating results, but they were not subject to withholding tax on dividends received.
The above taxation system was repealed by Article 2, paragraphs 62 to 84, of Decree Law No. 225 of December 29 2010 (converted, with amendments, by Law No. 10 of February 26 2011), and a generalised system of exemption was introduced. With effect from July 1 2011, Italian investment funds were no longer subject to the 12.5% substitute tax, as well as to withholding tax on dividends.
Unlike Italian investment funds, non-Italian investment funds are subject to a withholding tax on dividends distributed by Italian companies – at the domestic rate or at the reduced rate provided for by the applicable double taxation treaty.
The withholding tax treatment applicable to non-Italian investment funds established in EU/EEA member states was investigated by the European Commission (EU PILOT 8105/15/TAXU) because the application of a withholding tax on dividends paid by Italian companies to non-Italian investment funds established in EU/EEA member states resulted in discrimination between the latter and funds established in Italy.
To remove the discriminatory treatment and prevent any infringement of the EU principles, the 2021 Budget Law (Law No. 178 of December 30 2021) amended the legal provisions and introduced a withholding tax exemption on dividends paid by Italian companies to investment funds not established in Italy that are compliant with Directive No. 2009/65/EC or not compliant with such directive but whose management company is subject to regulatory oversight in the country of establishment pursuant to Directive No. 2011/61/EU and whose state of residence is allowing a proper exchange of information (amended Article 27, paragraph 3 of Presidential Decree No. 600/1973).
However, the scope of the new legal provision only includes investment funds established in EU/EEA member states. Non-EU/EEA investment funds comparable to those established in EU/EEA member states do not fall within the scope of the withholding tax exemption. Also, the new legal provision applies to dividends paid starting from January 1 2021. These circumstances (limited scope of the legal provision and non-backdated effect) make the recent decisions of the Supreme Court even more interesting and useful.
US investment funds make a claim
The Supreme Court’s decisions originated from the requests for refund filed by US investment funds to claim back the withholding tax levied by Italian companies on dividends distributed from 2007 to 2010.
The US funds receiving the dividends were subject to withholding tax at the 15% rate set forth by the double taxation treaty between Italy and the US. In the same period, Italian investment funds were subject to a 12.5% tax on their operating results and were not subject to withholding tax on dividends.
Arguing that such different treatment resulted in discrimination against US funds in breach of the EU principle of free movement of capital set forth by Article 63 of the Treaty on the Functioning of the European Union (TFEU) – which also applies to non-EU member states – the US investment funds claimed back the higher withholding tax suffered (2.5%, as the difference between the 15% withholding tax applied under the double taxation treaty and the 12.5% domestic tax).
As the Italian Tax Authority did not reply to the refund requests, the requests were deemed to be rejected. The US investment funds then filed an appeal against the tacit rejection and asked the tax court to recognise the discriminatory treatment applied to them with respect to the taxation of dividends and to assess their right to a refund of the higher withholding tax.
The tax courts’ decisions
The tax courts of first and second instance denied the right of the US investment funds to be refunded the higher withholding tax, arguing that the Italian withholding tax treatment applicable to dividends paid to non-Italian investment funds did not result in an infringement of the EU principles.
The decision of the Italian tax courts of first and second instance was based on two (incorrect) arguments.
First, they argued that no unjustified discrimination occurred between Italian and non-Italian investment funds since the application of the 15% withholding tax set forth by the Italy–US double taxation treaty was agreed between the Italian and US governments irrespective of any different tax treatment granted to Italian investment funds.
Moreover, the different treatment applied to US investment funds could have been considered discriminatory only if it resulted in an actual disadvantage to them. According to the tax courts of first and second instance, this was not the case, as the US investment funds did not prove that the total taxation incurred by them in the United States – taking into account any tax relief granted by the United States as a tax credit – was higher than that to which they would have been subjected in Italy.
The Supreme Court’s ruling
The Supreme Court rejected both the above arguments.
The Supreme Court acknowledged that the application of a withholding tax on dividends paid by Italian companies to non-Italian investment funds leads to a discriminatory treatment in breach of the EU principle of free movement of capital set forth by Article 63 of the TFEU. Indeed, the existence of discrimination is the reason behind the changes made by the 2021 Budget Law with respect to dividends paid to EU/EEA investment funds.
The fact that in the case under analysis the claimants are US investment funds is not relevant – and it does not rule out the existence of prohibited discrimination – as the EU principle of free movement of capital also applies to non-EU member states.
Likewise, it is irrelevant that the level of taxation of dividends has been agreed by the Italian and US governments. As the double taxation treaty in force between Italy and the US was concluded after the Treaty of Rome establishing the European Economic Community (which was signed on March 25 1957 and entered into force on January 1 1958), its provisions must be interpreted in compliance with EU primary and secondary law.
Therefore, the application of a withholding tax on dividends paid to non-Italian investment funds has led to a restriction of the EU principle of free movement of capital that was not justified on the ground of public policy or public security and should therefore be prevented.
Impact of the Supreme Court’s decisions
Starting from July 1 2011, Italian investment funds are exempt from taxes and are not subject to withholding tax on dividends received.
The same discrimination found by the Supreme Court with respect to the regulatory framework in force until 2011 still exists (and even more so) in relation to the withholding tax treatment applicable after July 1 2011.
The acknowledgment by the Supreme Court of such discrimination is of the utmost importance to broaden the scope of the withholding tax exemption granted to EU/EEA investment funds by the 2021 Budget Law.
First, the Supreme Court clearly stated that non-EU/EEA investment funds will also be exempted from withholding tax on dividends, given that the application of a withholding tax is an infringement of EU principles. Also, the Supreme Court’s decisions of July 2022 support the possibility to apply retroactively the withholding tax exemption introduced by the 2021 Budget Law and to claim back any withholding tax levied on dividends paid to EU/EEA and non-EU/EEA investment funds before January 1 2021.