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Italy introduces permanent establishment investment management exemption
February 2023
In brief
Italy’s 2023 Budget Bill introduced, in the Italian Income Tax Act (IITA), an Investment Management Exemption (IME) which is effective as of January 1, 2023. The IME is a ‘safe harbor’ that allows eligible foreign investment vehicles (including private equity and hedge funds) and controlled entities to avoid being deemed a permanent establishment (PE) in Italy due to local activities carried out by their investment managers.
The IME includes:
- a ‘safe harbor’ aimed at encouraging the establishment of investment managers in Italy and under certain conditions, the elimination of PE issues for the foreign investment vehicles and controlled entities, and
- a connection to the presence of such investment managers in Italy (whether they are traders, deal teams, local partners, etc.), and removes the triggering of a ‘nexus’ for the investment income of the investment structure (and therefore of the investors).
The Italian Ministry of Economy and Finance will implement the IME through a decree.
Action item: Foreign investment vehicles should consider how the IME could impact their operations. They should analyze their position for Italian tax purposes and consider the potential benefits of the new safe harbor. In addition, they should consider the potential Italian tax benefits for individuals under the so-called ‘impatriate’ regime.
New para. 7ter of Article 162 of the IITA provides the conditions under which independence (nonapplication of PE rules) is deemed to exist when investment managers (both Italian or non-Italian tax residents, including those operating in Italy thorough a PE - habitually (even if exercising discretionary powers):
- enter into contracts for purchasing, selling, or negotiating financial assets, derivatives, and receivables on behalf of the foreign investment vehicles (or their direct/indirect controlled companies), or
- actively contribute, including with preliminary and ancillary activities, to the executions of transactions under the previous point.
Observation: The rule introduced in the IITA does not define “investment vehicle.” The Explanatory Report states that the notion of investment vehicle should have a broad meaning, including foreign institutional investors, even if they are not subject to tax. Circular n. 23/E, 1 March 2002, of the Italian Tax Administration clarifies that the notion of Institutional Investors includes entities that, regardless of their legal form and/or tax treatment in the country where they are incorporated, have the purpose of making and managing investments on their behalf or on behalf of third parties. This definition includes insurance entities, investment funds, investment companies with variable capital (‘SICAVs’), and pension funds that are subject to supervision in the country where they are incorporated. Institutional investors also include entities and organizations which are not subject to tax or supervision, but that have a specific competence and experience in operations with financial instruments, explicitly declared in writing by the entity’s legal representative.
Section 2
For purposes of the IME, investment managers are deemed independent if all the following requirements are met:
- The foreign investment vehicle (and its subsidiaries) are resident or located in a country listed on Italy’s ‘white list’ (i.e., the jurisdiction and Italy have an actual exchange of information agreement).
- The relationship between the foreign investment vehicle (and controlled entities) and the investment manager meets the following requirements (to be further detailed by a Ministry of Economy and Finance Decree):
- The investment manager that carries out its activity in Italy, in the name of or on behalf of the foreign investment vehicle,
- does not hold any directorship/managing power on controlling bodies of the investment vehicle (and of its direct or indirect subsidiaries), and
- is not entitled to more than 25% of the foreign investment vehicle’s profits (also considering profit entitlements held by other entities of the group).
- The Italian tax-resident investment manager or the PE in Italy of the nonresident entity should support its remuneration by proper transfer pricing documentation. The Italian Tax Authorities should provide guidelines on application of the arm’s-length principle.
In addition, the Budget Bill introduces para. 9bis of Article 162 of ITC regarding the PE fixed place of business exemption for foreign investment vehicles (and their controlled entities). In particular, the Italian entities carrying out activity in Italy through Italian-based personnel do not constitute an Italian PE fixed place of business of the foreign investment vehicle merely because the activity exercised by the Italian enterprise is for the actual benefit of the foreign investment vehicle.
Observation: The IME provision may be difficult to apply in practice since investment managers having directorship/managing power on controlling bodies of the investment vehicle (and - most importantly - of its direct or indirect portfolios as it normally happens particularly in the context of private equity typical governance structures) are not considered independent. Further clarification of this clause is expected in the Ministerial Decree.
Observation: The transfer pricing documentation requirement is deemed to be met when there is appropriate documentation in place even if, as a result of a tax audit, the Italian Tax Administration adjusts the transfer prices applied to intercompany transactions. The purpose of this clause seems intended to ensure transparency of the relationship between the investment manager and associated enterprises and, more generally, on the activities performed in Italy.
Observation: Transactions carried out in Italy with respect to real estate properties or other asset classes (other than financial instruments and credits) does not seem to be within the IME’s scope. If that view is confirmed,certain non-Italian real estate and/or infrastructure funds may not be in a position to take advantage of these new rules. Taxpayers should await guidance in this area.
The takeaway
As outlined in the Explanatory Report, the Italian Legislator, by introducing the IME, intends to reduce the risk that investment managers operating in Italy might trigger a PE for the investment vehicle or its controlled entities. Thus it is hoped that investment vehicles would not be discouraged from locating their managers in Italy.
Under this approach, investment managers not only would be shielded from the PE risk to the investment structure, but also might benefit from the so-called ‘impatriate’ regime. As a result some individuals might consider transferring their tax residence to Italy with the goal of benefiting from a significant income tax incentive, and hence from a higher net wage from the same payout by the employer.
While some issues remain with respect to the IME’s scope and applicability, implementing provisions will be established by a Ministerial Decree (Article 162, para. 7quinquies). Investment managers seeking tax certainty in advance could apply for the advance ruling procedure to request the appropriate interpretation as to how the regime applies to their specific fact pattern.
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