According to the recent Supreme Court ruling, No. 25698, filed on September 1, 2022, individuals who are tax residents in Italy and receive dividends from companies resident in most states with which a double taxation treaty is in force could benefit from the credit for taxes paid abroad.
If it were to be consolidated, this significant jurisprudential arrest would revolutionize the taxation system of foreign-source dividends as interpreted by the Internal Revenue Service to date.
The orientation of the Internal Revenue Service
According to the current guidance of the Internal Revenue Service (ex pluribus, principle of law no. 15/2019), individuals who receive dividends from a foreign source, after having been subject to withholding tax in the foreign country, are subject again to taxation in Italy at a rate of 26% (with withholding tax in the case of collection through an intermediary or substitute tax in the absence of an intermediary). It is applied on the so-called “net frontier,” where the dividends are collected through a resident intermediary or on the amount before withholding tax in the case of a dividend received without the intervention of an intermediary. In any case, without the possibility of deducting from the Italian tax, the withholding suffered abroad, thus resulting in substantial double taxation, only partially mitigated in the case of application of the Italian tax on the so-called “net frontier.”
The Supreme Court’s pronouncement
According to the Court of Cassation (which ruled on dividends distributed by a U.S.-resident company), this arrangement is contrary to most of the double taxation treaties entered into by Italy (the older ones, e.g., France, Germany, Great Britain, Belgium, Luxembourg Netherlands, Switzerland, U.S.A.). These conventions, after providing that Italy must deduct from income taxes the tax paid abroad, stipulate that no deduction is granted if the income element is subject to taxation in Italy using withholding tax (this also applies in the case of substitute tax) “at the request of the beneficiary” of the income under Italian law, an option, however, that has not been recognized by domestic law since 2004. Reading to the contrary suggests, according to the Court, that where the subjecting of foreign income by withholding or substitute tax takes place, as it does today, not “at the request of the recipient,” but mandatorily, the withholding tax applied abroad must be considered deductible.
Otherwise, in more recent conventions where the phrase has been modified by adding “also” before “at the request of the beneficiary” (e.g., Saudi Arabia, Cyprus, Korea, Philippines, Singapore, Hong Kong), or in conventions where the phrase “at the request of the beneficiary” has been replaced by “at the request or otherwise of the beneficiary” (e.g., Chile, Jamaica, Colombia), the tax credit would not be usable.
According to the Court, the very change inserted in the text of the most recent conventions would reveal that when Italy wished to exclude the use of the tax credit in all cases (thus including when withholding tax or substitute tax is mandatory), it expressly provided for it.
The principle enunciated by the Court is to be welcomed as, if implemented by the Internal Revenue Service, it would make it possible to overcome the double taxation resulting from the current interpretative practice.
The tax burden
See the overall tax burden in the different scenarios:
What can the taxpayer who intends to benefit from the foreign tax credit do?
At the moment, it is unlikely that such an appreciable jurisprudential arrest will be implemented shortly by the Internal Revenue Service (which, we recall, took almost 15 years before making its own with the very recent Circular no. 34 the jurisprudential orientation on the applicability of the inheritance and gift tax to the trust at the time of the devolution of assets to the beneficiaries). For the taxpayer who intends to benefit from the credit for foreign taxes, the path of the refund application and subsequent challenge of the probable silence-denial of the Internal Revenue Agency could be envisaged.
