Multi-Tier Groups and Tax Transparency

Ordinary Taxation of Dividends between Companies

Where the net profits generated by a corporation are distributed to another company subject to IRES (Italian corporate income tax), Article 89(2) of the Italian Income Tax Code (TUIR) ordinarily applies, providing for the exclusion of 95% of dividends from taxable income (the so-called dividend exemption), resulting in an effective tax of 1.20% on the amount distributed.

This relief stems from the need to allow profits to be reinvested, given that, being received by a corporation, they remain within the business regime.

In corporate structures with several levels of ownership, this taxation may, as a general rule, be repeated on each subsequent distribution of the same profits as they move up the ownership chain to the ultimate parent company.

In this context, it may be advantageous to use the tax transparency regime governed by Article 115 of the TUIR (the so-called “large tax transparency”).

Where specific requirements are met, this provision allows corporations held by other corporations to attribute their taxable income directly to their shareholders, regardless of whether profits are actually distributed. However, the regime can be elected only where each corporate shareholder holds an interest in both voting rights and profits of not less than 10% and not more than 50%, subject to the further conditions laid down by law. The election requires the consent of all shareholders and is irrevocable for three financial years of the investee company. At the end of each three-year period, it is tacitly renewed for a further three years, unless revoked in the manner provided by law.

The Ordinary Regime in Multi-Tier Groups: the 1.20% Double Taxation

Consider now a group holding company that holds shareholdings in one or more operating companies and is itself owned in equal shares by three personal holding companies. Absent the transparency election, each corporate step bears its own tax.

Assume that the operating companies distribute dividends of 100 to the group holding company. Under Article 89 of the TUIR, those dividends contribute to the holding company’s taxable income to the extent of 5%, thus producing net profit of 98.80 (tax due of 1.20).

When the group holding company distributes its net profit to the personal holding companies, they receive not the original 100 but 98.80. Here too, the dividend contributes to income to the extent of 5%, bearing a further tax of approximately 1.19 (98.80 × 1.2%). The total tax cost of bringing the gross profit from the operating company up to the holding companies at the top of the group is therefore 2.39, with net profit received of 97.61. Naturally, where there are further corporate levels, the mechanism repeats, so that the total tax due increases for the same net profit of the operating companies.

The Tax Transparency Election

If, on the other hand, the group holding company has elected for tax transparency under Article 115 of the TUIR, the taxation mechanism changes as follows. Dividends distributed by the operating companies to the group holding company continue to contribute to taxable income to the extent of 5%, under Article 89 of the TUIR.

The difference from the ordinary regime lies in the fact that this income, rather than being subject to IRES directly in the hands of the group holding company, is attributed by transparency to the personal holding companies, which pay the related tax regardless of whether profits are actually distributed.

Tax transparency therefore does not eliminate the 1.20% effective tax on the dividends originally received by the group holding company (5% × 24%), but shifts its burden directly to the shareholder companies. Consequently, when the net profit is subsequently distributed by the group holding company to the top-level family holding companies, that distribution has no tax relevance, having already been attributed to the shareholders by transparency.

In this scenario, the overall burden therefore remains at 1.20%, instead of approximately 2.39% under the ordinary regime.

Treatment of Profits and Reserves Accrued before the Election

In any event, profits arising during the transparency period must be distinguished from reserves built up in earlier years. Under Article 115(5) of the TUIR and Article 8 of Ministerial Decree of 23 April 2004, profit reserves accrued before the election generally remain subject to the ordinary tax regime provided by Article 89 of the TUIR.

Unless the shareholders’ meeting expressly decides otherwise, profits and profit reserves accrued while the election was in force are deemed to be distributed first, even where the distribution takes place after exit from the regime, unless the dividend distribution minutes provide otherwise.

Is Tax Transparency Always Advantageous?

Although the regime may offer tax advantages, its convenience must be assessed on a case-by-case basis. In particular, the decision must take into account any tax losses, the three-year duration of the election, continued satisfaction of the requirements of Article 115 of the TUIR, and the possible advantages of alternative regimes, such as the Italian national tax consolidation. Lastly, it must in any event be borne in mind that the potential advantage described arises from the interplay between the general rules on large tax transparency and those on the taxation of dividends under Article 89 of the TUIR. For this reason, where the multi-tier structure is set up without valid economic reasons other than purely tax ones, the potential challenge of an abusive transaction under Article 10-bis of the Taxpayers’ Charter of Rights remains applicable. In this regard, it should also be noted that, at present, there is no administrative practice of the tax authorities specifically addressing the case. The conclusions presented should therefore be treated with due caution and verified in the specific case.