Italian Government changes Tax Rules for 2008

Italian Government changes Corporate Tax Rules for 2008

The Italian government has approved amendments to certain aspects of the corporation tax regime. If definitively approved by the Parliament, the changes would be effective from 2008.

Corporate Tax Rate

The Government Commission report acknowledges that there is a general trend in Europe to lower the notional tax rate and broaden the taxable base, so that, without specific changes to the Italian rate structure, Italy will have the highest tax rate in the EU, with a nominal corporation tax of 33%, plus the local tax (IRAP) generally levied at a rate of 4.25%. The government has approved a reduction of the corporation tax rate to 27,5% and IRAP to 3,9%.

Thin Capitalization and Dual Income Tax System

The thin capitalization regime (debt-to-equity ratio 4:1) will be abolished and probably replaced with a revised version of the dual income tax system that was in effect until 2003.

The dual income tax would reverse the concept underlying the anti-base erosion approach: rather than discourage taxpayers from using debt push-down strategies (as is the case with the thin capitalization rules), the new measures would stimulate the capitalization of companies so they could take advantage of a lower average corporation tax rate (i.e. the more a company's equity is increased, the lower the average tax rate).

Introduction of a interest / EBITDA ratio of 30% which, if exceeded, would allow a partial deduction of interest expense (net of the interest income). However, under this method, companies will be allowed to carry forward not deducted interest (five years) or to deduct them under the fiscal unit regime.

The interest calculation will include interest on leasing contracts.

Participation Exemption

The tax treatment of investments that qualify for the participation exemption is more consistent and rational. The 84% exemption of capital gains will be aligned with the 95% exemption for dividends, thus re-establishing symmetry of the exemption between capital gains and dividends.

Fiscal Unity

Abolition of the full exemption on dividends from consolidated entities (replaced by the regular 95% exemption); Review of the exemption from the "pro rata patrimoniale". The pro rata patrimoniale is a measure that (in addition to the thin capitalization rules) limits the deduction of interest expense to finance an acquisition whose capital gains benefit from the participation exemption.

IRAP

Simplification of the rules governing the determination of taxable income for purposes of the IRAP (currently, a complex exercise that is considerably different from the determination of the corporate tax base) and allowing IRAP to be deducted from the corporate tax base (currently not allowed).

International Accounting Standards

The Italian tax regime currently is not consistent with respect to determining the taxable income of entities subject to IAS/IFRS accounting. There are many significant issues that must be clarified and the Government Commission makes various recommendations to rationalize and simplify the tax aspects of IAS-compliant entities.