CFC regulation in Italy – what do I need to know?

I. Introduction

Italy is one of the most interesting countries to live in. Many people have the desire to move to this country, but there are some pitfalls to be aware of. In this case, we are talking about controlled foreign companies (CFC). 

A CFC in simple words is a company registered in another country, which is controlled by residents of a certain country (for the purposes of this article – residents of Italy). The CFC rules imply that, in certain cases, controllers must pay tax on the income of such a foreign company.  

In some countries these rules apply only to legal entities, and in some countries they apply to individuals and legal entities. So what are the rules in Italy?

The CFC rules in Italy are regulated by the Decreto del Presidente Della Repubblica 22 dicembre 1986, n. 917 “Approvazione del testo unico delle imposte sui redditi” (the “Law”).   According to Article 167(1) of the Law, the CFC rules apply to both legal entities and individuals who control non-resident entities.

II. How is a company defined as a CFC under Italian law? 

According to Article 167(2) of the Law, non-resident controlled entities include companies and organisations that are not resident in the territory of the Italian State and:

• they are controlled directly or indirectly by a resident;
• more than 50 per cent of their profits are owned directly or indirectly through one or more subsidiaries. 

Based on the above, if an Italian resident individual is a founder of a foreign company, such individual is defined as a controller of a non-resident company (CFC). The question immediately arises whether CFC income will be taxable in Italy, and if so, what are the rules?

III. CFC test

The CFC rules apply if entities controlled by a non-resident simultaneously fulfil the following two conditions:

1. they are subject to an effective taxation that is less than half of that to which they would be subjected if they were resident in Italy.
2. more than one third of the income realised by them falls into one or more of the following categories:

• interest or any other income derived from financial assets;
• royalties or any other income derived from intellectual property; 
• dividends and income from the sale of equity interests;
• income from financial leasing;
• income from insurance, banking and other financial activities;
• income from transactions involving the purchase or sale of goods with little or no value added by parties that directly or indirectly control, are controlled by, or are controlled by, a controlled non-resident entity or are controlled by the same party that controls the non-resident entity;
• income from the provision of services with little or no economic value added, performed for the benefit of entities that directly or indirectly control, or are controlled by, or are controlled by the same entity that controls, a non-resident controlled company; for the purposes of identifying services with little or no economic value added, the instructions of the Minister of Economy and Finance shall be taken into account.

Regarding the first criterion (effective tax rate – less than half of that in Italy), it is worth noting that the Italian corporate tax rate (IRES) is 24%, i.e. for the first rule for determining a CFC company not to be met, it is sufficient for the CFC company’s income tax to be at least 12.1%. 

Consider the second criterion – more than one-third of the income realised by the CFC falls within a certain statutory category. Based on the list above, we can say that in order for the CFC rules to apply (if the first criterion is met), more than one third of the income must be derived from inactive activities (interest, royalties, dividends, or income from transactions with affiliated companies). 

So, based on the above, in order for the CFC rules to apply, two conditions must be met:

• CFC taxation in the country of incorporation is less than 12 per cent;
• more than ⅓ of income is derived from inactive activities (interest, royalties, dividends, or income from transactions with affiliated companies). 

It is also worth noting that although the two conditions above are met, the CFC rules do not apply if an individual can prove that the CFC carries out effective economic activities through the use of personnel, equipment, assets and premises. For the purposes of this paragraph, the taxpayer may apply to the Revenue Agency.

IV. Taxation of CFC income under Italian law

Subject to the conditions mentioned above, income derived by a controlled CFC is attributable to the controllers in proportion to the share owned directly or indirectly by them.

It is also worth noting that the income of a CFC is subject to a separate taxation (i.e. the personal expenses of the controller cannot reduce the tax base of the CFC, or shift the income of the CFC to a different tax rate), at the average rate imputed to such person, but in any case not lower than the Italian corporate tax rate.

The income taxes finally paid abroad by a non-resident person (i.e. CFC) abroad are allowed to be deducted from the CFC tax that is payable, in the manner and within the limits established by the Law”.

Based on the above, the taxable income of a CFC is calculated on the basis of Italian corporate tax rules and is separate from other income of an Italian person and is therefore taxed separately without the possibility of utilising tax losses that are not attributable to the CFC.

In simple words, the income of a CFC is subject to taxation in Italy at a rate of 24%, from which taxes paid by the CFC in its country of incorporation can be deducted (e.g. if the corporate tax rate in the company’s country of incorporation is 10%, an additional 14% CFC tax must be “paid”).

V. Conclusion 

First of all, before raising the issue of the rate of tax to be paid in connection with a CFC it is necessary to determine whether the controlled company fulfils two conditions:

• CFC taxation in the country of incorporation is less than 12 per cent;
• more than ⅓ of the income is derived from inactive activities (interest, royalties, dividends, or income from transactions with affiliated companies). 

In addition, even if it meets these conditions, it must be determined whether the CFC is carrying on an effective economic activity. How this is determined is worthy of a separate article. 

If a CFC fulfils the two conditions for the application of CFC taxation, the controller must pay tax in the amount of corporate income tax (24%), from which taxes paid on income by the company in its country of incorporation can be deducted. 

You can find out how to be exempted from CFC taxation in Italy in our article at the link, and how to do it correctly – qualified lawyers will help you!