Italian IRAP and foreign tax credit under Double Tax Treaties

The case concerns an Italian real estate company that in 2011 sold a property in France and paid French taxes there on the resulting capital gain. However, since the tax paid in France was higher than that paid in Italy, the company applied for a tax refund with the Italian tax authorities, believing that it could deduct the excess tax not deducted also from IRAP.

The Italian tax authorities' refusal was challenged before the tax courts. However, the judges of both first and second instance rejected the taxpayer's claims, stating that the foreign tax credit regime governed by Article 165 TUIR could not apply to IRAP.

The Court of cassation, hearing the dispute, expressed a contrary opinion.

Due to their specialty, double tax treaties (DTT) acquire primary source status and prevail over domestic rules, which must comply with the constraints of international obligations. In the specific area of income tax, treaty rules prevail over domestic ones, by reason of their speciality and their rationale of avoiding double taxation. Thus, in order to assess the relevance of IRAP with reference to DTT benefits, reference must be made to the specific wording of the single applicable convention.

In particular, the list of taxes to which the DTT inspired by the OECD Model applies is generally contained in Article 2 paragraph 2. This list, however, is not exhaustive, and the subsequent paragraph 4 of the same Article 2 expressly provides for the application of the DTT also to any identical or substantially similar taxes that are imposed after the date of the signature of the DTT in addition to, or in place of, the existing taxes. It is further provided that the competent authorities of the contracting states shall notify each other of any significant changes that have been made in their taxation laws.

The DTT concluded on 5 October 1989 between Italy and France (IT-FR DTT), applicable to the present case, although containing a list of the Italian and French taxes to which its provisions apply, does not expressly contemplate IRAP. IRAP was in fact introduced in Italy by Legislative Decree No 446 of 15 December 1997, in force as of 1 January 1998, i.e. a date subsequent to the IT-FR DTT. The list of Italian taxes, however, includes the old Local Income Tax (ILOR), which was repealed by Article 36 of the said legislative decree.

Article 44 of the legislative act introducing IRAP equalizes, for the purposes of the application of DTT, this latter tax to ILOR.

However, according to the Court of cassation, this mere assimilation is not a sufficient condition for automatically subject IRAP to the same treaty treatment previously reserved to ILOR, since Italian domestic law cannot determine the qualification of IRAP for the purposes of the other contracting state (in this case France).

In accordance with the provisions of the OECD Model, paragraph 4 of Article 2 of the IT-FR DTT regulates a mechanism for adapting the convention to the tax law amendments of the contracting states, providing that the DTT also applies to any identical or substantially similar taxes that are imposed after the date of signature of the DTT in addition to, or in place of, the existing taxes. It also provides that the competent authorities of the contracting states shall notify each other of any significant changes that have been made in their respective tax laws.

In Circular letter No. 33/E of 18 April 2002, the Italian tax authorities stated that Italy, following the introduction of IRAP, notified the competent authorities of foreign States with which a DTT was already in force, of the introduction of the new tax, illustrating its similarity to ILOR and proposing, therefore, to the other contracting state the replacement of ILOR with IRAP for the purposes of the existing DTT. In the same circular letter, it is stated that France (along with other States) recognised IRAP as a tax to which the DTT applies.

The relevance of IRAP for DTT purposes therefore depends on the way the IT-FR DTT is adjusted according to its provisions and implemented in the specific case.

Due to the assimilation between IRAP and ILOR, unanimously and regularly stated by the Italian jurisprudence, the Court of cassation affirmed that the relevance of IRAP must be assessed according to the provisions of the single DTT. The IT-FR DTT, expressly applicable to ILOR, must also apply to IRAP, by virtue of the substantial assimilation of the two taxes, of the provisions contained in Article 44 of Legislative Decree 446/1997, of the subsequent communication provided to the competent French authority, and of the subsequent recognition by the latter.

The Court of cassation, thus upholding the company's appeal, recognized the applicability to IRAP of the DTT benefits and, therefore, the taxpayer's right to claim credit for the taxes paid in France.

This judgment represents an important precedent for Italian companies operating abroad, which could also apply for foreign tax credit for IRAP.

With specific reference to the relations between Italy and Switzerland, it must be noted that Article 2 of the DTT between these two countries dated 9 March 1976 (IT-CH DTT), like the IT-FR DTT, expressly includes ILOR among the taxes to which the convention applies. It similarly provides that its provisions shall also apply to any identical or substantially similar taxes that are imposed after the date of signature of the DTT in addition to, or in place of, the existing taxes. The competent authorities of the contracting states shall notify each other of any significant changes that have been made in their taxation laws.

As mentioned above, in the said circular letter No. 33/E of 2002, the Italian tax authority stated that it had notified the competent authorities of foreign countries with which a DTT was already in force of the introduction of the new IRAP. It is, therefore, reasonable to assume that the notification obligation provided for in Article 2 paragraph 4 of the IT-CH DTT was also correctly fulfilled with respect to the Swiss Federal Tax Administration (FTA).

However, Switzerland is not expressly listed in the circular letter among the states which, like France, had then notified the Italian authority of its recognition of IRAP as a substitute for ILOR, nor is there any such notification from the FTA.

Consequently, the requirement of communication from the foreign tax administration on the recognition of IRAP for conventional purposes, which the Court of cassation would impose in this judgment, would not be met for the purposes of the automatic inclusion of IRAP among the taxes to which the IT-CH DTT applies.

It should, however, be pointed out that according to the wording of paragraph 4 of Article 2 of the IT-CH DTT, in line with the OECD Model, a notification obligation is imposed upon the competent authority of the state making the legislative change, but the express subsequent recognition by the authority of the other state is not further required.

The Commentary to the OECD Model in Article 2 clarifies that the list of taxes is purely declaratory and that the convention is also to apply to all identical or substantially similar taxes that are imposed in a contracting state after the date of signature of the DTT in addition to, or in place of, the existing taxes in that state. Each state undertakes to notify the other of any significant changes made to its taxation laws by communicating to it, for example, details of new or substituted taxes. States are also encouraged to communicate other significant developments as well, such as new regulations or judicial decisions, as well as any significant changes in other laws that have an impact on their respective obligations under the DTT.

As mentioned above, Italy correctly fulfilled this notification obligation under the IT-CH DTT.

However, there is no consequent obligation upon the FTA, addressee of such a notification, to provide some feedback to the sender on its acknowledgement of the Italian regulatory change. Such a communication could at most represent a mere act of courtesy in the context of diplomatic relations between the countries. If the opposite were true, in fact, IRAP, even though replaced ILOR, would still not be recognized by all DTT Italy concluded with those other states that received a notification but that not expressly communicated their recognition. The list of these states was updated as of 2002 and this would end up making Article 2 of the DTT void.

In the case dealt with by the Court of cassation, the express inclusion of France among the states that have acknowledged the notification would support the arguments and claims of the appellant company but should not be regarded as a necessary requirement for including IRAP within the scope of the IT-FR DTT.

Despite the clear orientation expressed by the Court of cassation in this judgment on the requirements for including IRAP in DTT, there are no valid juridical reasons for possibly denying the inclusion of IRAP in the IT-CH DTT.