IRES income determination
Specific rules have been released for entities adopting Italian Generally Accepted Accounting Principles (GAAP) rather than International Financial Reporting Standards (IFRS) for Italian statutory financial reporting purposes. These provisions are aimed to align the taxable basis determination rules with the statutory financial reporting (so-called principle of derivation of the corporate income taxable basis from the statutory financial statements).
Therefore, the taxable basis is influenced by the qualification criteria, time-based recognition, and classification in the financial statements provided by the related accounting standards.
The already issued provisions for International Accounting Standards (IAS)/IFRS entities also apply to Italian GAAP adopters, if compatible.
There are also measures aimed at coordinating different items of the tax code in the light of new evaluation and representation criteria introduced by the accounting reform.
IRAP income determination
For IRAP purposes, relevant income and expenses are those reported in the statutory financial statements. Positive and negative items resulting from transfer of business concern are out of the scope of the taxable basis.
Italian tax law allows the application of all the most commonly used inventory valuation methods: last in first out (LIFO), first in first out (FIFO), average cost. For IRES only, the reference prices used to calculate the written down value of the inventory items cannot be lower than their market prices during the final month of the tax period.
Companies operating in the oil and gas sector are required to adopt either average cost or FIFO for tax purposes.
Capital gains are taxable in the tax period in which they are realised, as follows:
- Fixed assets: The gain realised on the sale of fixed assets is taxable for both IRES and IRAP purposes. Additionally, for IRES purposes, tax on capital gains can be spread over a maximum of five years. This treatment is allowed if the company owned the fixed assets for not less than three years.
- Financial investments: A specific participation exemption regime (PEX) is applicable. Under this regime, capital gains realised by Italian companies on sales of shareholdings are 95% exempt from IRES.
PEX applies if all of the following conditions are met:
- The shareholding was held uninterruptedly for at least 12 months prior to the sale.
- The investment was classified under financial fixed assets in the financial statements relating to the first tax period of uninterrupted ownership.
- The subsidiary is actually carrying on a commercial activity (e.g. investments in companies mainly performing management of their own real estate are not entitled to PEX benefits).
- The majority of the subsidiary's income is not generated in a tax haven country or one with a privileged tax regime.
The third condition must be met both at the time of the sale of the investment and in the three preceding years. The fourth condition must be met since the beginning of the shareholder period, or, if the buyer is a third party, over the five-year period before the disposal. If these conditions are not met, the capital gain realised by the company is ordinarily taxed.
Capital losses arising from the sale or write-down of shareholdings meeting PEX conditions are basically not tax deductible. Likewise, the capital losses realised on sales of non-PEX investments are tax deductible. Specific exemptions are provided for those entities adopting IFRS for Italian statutory accounts reporting purposes.
Specific anti-dividend washing rules provide that where capital losses arise from the disposal of shareholdings that are not eligible for PEX, such losses are deductible only for the part exceeding the tax exempt amount of dividends (see Dividend income discussion below) received from the shares in question in the 36 months prior to the disposal.
Capital gains on financial investments generally are excluded from the IRAP taxable base.
Dividends received by Italian resident companies from Italian companies or from companies resident in countries other than tax havens (i.e. not included in the 'black list') are excluded from the IRES taxable base for 95% of their amount. Conversely, no exemption applies to dividends paid by entities that are resident in tax haven jurisdictions (unless those dividends derive from profits that were already taxed under the Italian controlled foreign company [CFC] rules). There are specific rules for entities adopting IFRS for Italian statutory financial reporting purposes. For such entities, dividends from investments in shares and other financial instruments held for trading are fully taxable.
To avoid the standard taxation on dividend originated by a foreign entity resident in tax havens, provided that certain conditions are met, Italian parent companies may elect a new substitute tax regime (9% to 6% tax rates) on the amounts of profits and retained reserves distributed. For calendar year entities, the substitute tax is due by 30 June 2023 (or 30 June 2024) and the relating option is required in the tax return. The payment of the substitute tax allows for an increase of the tax value of the participation when assessing the taxable base for the determination of capital gains.
Dividends generally are excluded from the IRAP taxable base.
Interest income is generally part of the taxable base.
Waiver of credits
A specific regime is applicable regarding the waiver of credits (e.g. financial and/or commercial) towards the company by its shareholder. In particular, the part that exceeds the tax value of the credit is considered taxable income. Furthermore, the shareholder is required to provide a statement to the company pointing out the tax value of the credit. Without such a statement, the company will have to tax the full amount of the waiver of the credit.
An Italian resident corporation is taxable on all income whether produced in Italy or abroad. Profits earned by subsidiaries that are resident or located in countries or territories other than tax havens are taxed only on distribution of the relevant profits. Double taxation is, in principle, avoided by means of foreign tax credits.
An optional branch exemption regime is available, which allows Italian companies to exempt from Italian taxation branch income and losses arising outside Italy, instead of the normal regime, which provides for taxation of worldwide income with foreign tax credit relief. This option affects all foreign PEs of the Italian company and is irrevocable. It must be exercised at the time the branch is incorporated and takes effect from that fiscal year.
Resident companies and PEs of non-resident companies can be qualified as non-operating entities if the average revenues recorded in the current fiscal year and in the prior two years are lower than the amount resulting by applying certain 'deemed return’ percentages to the average balance sheet value of specific assets in the current fiscal year and the two previous years.
The main assets to be taken into consideration are shares and shareholdings, financial receivables, owned or leased real estate, and owned or leased tangible and intangible assets. The value of any assets acquired or sold during the fiscal year must be adjusted according to the ownership period.
These conditions must be checked every year. Therefore, it is possible for an entity to be 'non-operative' in one year and operative in the following year.
The shell company is assessed as having a minimum taxable income for both IRES and IRAP purposes.
For IRES purposes, the taxable income of a non-operative entity is determined as the sum of such values emerging from the application of specific percentages to the book values of the above-mentioned assets.
The current IRES standard rate for entities qualified as shell companies is 34.5% (24% plus surtax of 10.5%).
Tax losses generated in a tax period when the company was deemed to be non-operating cannot be carried forward.
For IRAP purposes, non-deductible items have to be added back to the deemed minimum IRES income as outlined above.
These rules are not applicable in the first year of a company’s incorporation. Exemptions from these rules can be achieved:
- by means of an advance ruling from the Italian tax authorities aimed at assessing the specific circumstances that caused the company not to earn the minimum amount of income or
- by specific objective situations provided for by Italian law (e.g. company directly or indirectly held by listed companies).
Shell companies are also subject to limitations in their ability to recover VAT credits.