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The Italian government has extended the country's controlled foreign company (CFC) rules in a bid to combat tax evasion.

The decree law that was enacted on July 1 has immediate effect. However it must be subsequently approved by the Parliament and converted into ordinary law within 60 days, in which time it can be amended or abolished.

The CFC rules previously applied only to subsidiaries in tax havens. They are now applicable to jurisdictions which have a tax rate 50% less than Italy's effective tax rate of 31.4%. They also apply if 50% of the income is passive, for instance royalties and dividends.

The government hopes to combat abuse of law, specifically tax arbitrage with these changes.

"The aim is to penalise companies who have created structures to avoid paying taxes," said Gérard Prinsen, international tax partner at Ernst & Young in Italy.

The decree law has been enacted to bring Italian legislation in line with that of other EU member states and the declared purpose of this rule is to enforce the understandings recently achieved among OECD member states on contrasting tax havens. The extended CFC rules now apply to EU member states, specifically those with low rates of taxation such as Hungary and Ireland.

"Taxpayers will need to prove that there is a substantive business purpose behind their transactions with subsidiaries and will need to get a ruling from the tax authorities, This may prove hard to do," said Maricla Pennesi, a partner at DLA Piper in Italy.

"Tax authorities are very strict and sometimes business reasons aren't accepted by them," said Pennesi.

"If the tax authorities discover you have money in tax havens the assumption is that it is undeclared income; there is an inversion of the burden of proof," said Prinsen.

For non-black listed countries, countries that the OECD deems to be cooperative in tax matters, the burden of proof is different. "A taxpayer has to prove it is not using an artificial structure which may prove difficult," said Prinsen. This principle was developed by the European Court of Justice in the Cadbury Schweppes case which highlighted the need to prove genuine economic activity if a parent company has a subsidiary in country with a lower rate of taxation.

The change to CFC rules is not the only government measure seeking to increase tax revenues. Italy is also enacting a tax amnesty, aimed at bringing money back into the country. "The government desperately needs money. Next month's tax amnesty allows Italian taxpayers to repatriate foreign income and only be taxed 4% as opposed to 40% with a 100% penalty. This is a carrot and stick approach," said Prinsen. The aim is to encourage taxpayers to bring money back from jurisdictions such as Switzerland and Liechtenstein.

Published on our website on July 14, 2009