Budget 2008 Includes Major Changes for Company Taxation

The 2008 Budget approved on 21 December 2007 contains many provisions that will affect

corporate taxpayers. The budget provisions generally entered into effect on 1 January 2008.

The corporate tax (IRES) is reduced from 33% to 27.5% and the regional tax on production

activities (IRAP) base rate reduced from 4.25% to 3.9%. Accordingly, the theoretical tax rate for corporate taxpayers is approximately 31.4%. The effective combined tax rate continues to be unpredictable in advance because, in most cases, the tax base for IRES and IRAP are significantly different.

The thin capitalization rules are abolished, as is the "pro rata" rule that limits the deduction of

interest expense connected to the acquisition of investments that benefit from the participation

exemption. Instead (and similar to the recent German changes), net interest expense (i.e. net of interest income) is deductible only up to an amount equal to 30% of EBITDA (i.e. earnings before interest, taxes, depreciation and amortization), with any excess nondeductible interest available for unlimited carryforward to offset 30% EBITDA of another year not fully absorbed by interest expense in the same period. From 2010, carryforward will be allowed for the portion of EBITDA not fully used to absorb net interest expense in the same year. In that case, exceeding capacity in a given year will increase EBITDA of subsequent years. Further, companies included in a fiscal unity will be permitted to offset the nondeductible excess amount against the 30% EBITDA not used by other entities in the consolidated group.

The new rules also allow a virtual tax consolidation of a foreign company for the sole purpose of the 30% EBITDA computation. For example, if there is a fiscal unity among Italian companies, one Italian member can increase the overall group's EBITDA capacity if it owns non-Italian subsidiaries that have not fully exhausted their non-Italian 30% of EBITDA capacity with their own net interest expense.

The consolidated entity regime is amended so that 5% of dividends remain taxable even if received from a consolidated entity. As a result, only 95% of dividends are exempt (rather than the 100% exemption applicable until 31 December 2007 on dividends from consolidated entities). This rule is retroactively effective for dividends declared as from 1 September 2007, other than profits generated in the previous fiscal year (generally 2006). Additionally, the option for the tax neutrality of transactions between consolidated entities is repealed. Therefore, asset transfers among members of a consolidated group are no longer optionally viewed as nontaxable intragroup transactions.

Other important changes include the following:

• Capital gains from the disposal of qualified investments held by an Italian company are

subject to a 95% exemption (previously, such gains were 84% exempt), resulting in a

reduction of the effective rate on such transactions from 5.28% to approximately 1.4%. An

84% exemption remains on gains to the extent a write-off of the investment was deducted

before 2004. The holding period for taking advantage of the participation exemption is

shortened to 12 months (18 months for disposals taking place until the fiscal year open at

31 December 2007).

• Capital gains from contributions of going concern operations no longer are a taxable event.

• For profits generated from 2008 onwards, the withholding tax rate on dividends paid to

entities resident in the EU (and to EEA residents if there is an adequate exchange of

information on tax matters) is 1.375%.

• The "black list" of countries (or entities triggering certain tax anti-abuse restrictions) is

converted into a "white list," and entities not included in the white list remain subject to the

previous restrictions provided for black list entities. The white list will be effective from the

fiscal year following the year the new list is officially published, but different transition rules

will apply.

• The ability to accelerate amortization and depreciation for tax purposes is substantially

abolished, as well as certain other expenses that previously could be deducted before being

accounted for in the statutory books.

• For purposes of deducting financial leasing fees, the required duration of leasing

arrangements is extended so that the arrangement will last for at least two-thirds of the

depreciation period (with a minimum of 11 years and a maximum of 18 years for

immovable property). Interest expense included in the leasing fees is subject to the 30%

EBITDA interest limitation.

• The previous limit of Euro 15 million of expenses that qualify for the 10% tax credit for R&D

activities is increased to Euro 50 million, and the 10% tax credit is increased to 40% with

respect to R&D arrangements with universities and public bodies.

• The method for computing the IRAP taxable base is simplified and should significantly

reduce the impact of deferred taxation in Italian statutory accounts.