The Italian supreme court extends the participation exemption regime to EU companies

The Supreme Court's judgement

The Italian Supreme Court (Judgment No. 21261 of 19 July 2023) ruled that non-resident companies without a permanent establishment (PE) in Italy may apply the 95% participation exemption (PEX) regime to the capital gain realised on the sale of a participation held in an Italian resident company, provided that the requirements for the PEX regime are met. The capital gain would be subject to an effective tax rate of 1.2% (resulting from the application of the ordinary corporate income tax rate of 24% on a taxable income equal to 5% of the capital gain), instead of 26%.

The Supreme Court upheld the position of a French parent company holding a "substantial participation" in an Italian subsidiary, i.e., a participation entitling it to 25% or more of the subsidiary's profits. The capital gain realized upon the sale of the shares had been subject to Italian taxation; pursuant to Article 8(b) of the Protocol annexed to the Italy-France Double Taxation Treaty (DTT), Italy is not prevented from taxing such capital gain. However, the 95% pex regime was denied by the Italian tax authorities.

In order to benefit from the PEX regime: (i) the participation must have been held continuously for at least 12 months prior to the sale (holding period); (ii) the participation must be classified among financial fixed assets in the first balance sheet closed after the acquisition of the participation; (iii) the subsidiary must not be resident in a black-listed country; (iv) the subsidiary must have actually carried out a commercial activity (e.g., participations in real estate companies are not generally entitled to the participation exemption regime).

According to the Supreme Court, the non-application of the PEX regime to non-resident companies without an Italian PE would violate the fundamental freedoms provided for by the Treaty on the Functioning of the EU. Moreover, the Court emphasised that the discrimination against companies resident in France/EU would not be eliminated by the tax credit granted under the relevant DTT.

The practical effects of the Supreme Court’s decision

From a preliminary analysis concerning the capital gains provisions of the DTTs entered by Italy and the EU/EEA States, France appears to be the only EU/EEA country for which taxation in the source State of capital gains realised on participations in non-real estate companies is provided for.

Therefore, provided that the requirements of the PEX regime are fulfilled, French parent companies can reasonably rely on this Supreme Court’s judgement to directly apply this regime on the capital gains realised on the disposal of relevant participations in Italian companies or, following a more prudent approach, to pay the full taxes on the capital gain and then requesting a tax refund. Please note that the gain would still be subject to French taxation but there should be a tax credit for the Italian taxes paid.

The impact of the Supreme Court’s ruling may not be limited to Italy-France transactions only. Based on the experience concerning the tax regime of dividends distributed by Italian subsidiaries to EU-resident parent companies (following the CJEU ruling of 19 November 2009, C-540/07, Commission v. Italy), Italian tax law may react to the recent case law by adopting a provision expressly extending the direct applicability of the PEX regime to capital gains realised at least by EU-resident parent companies and to parent companies resident in European Economic Area (EEA) States without an Italian PE.

A similar issue arose in France and the tax regime was modified to allow other EU companies to benefit from the French participation exemption (long-term regime). The participation exemption can be availed of from the outset, provided that all justifications are duly disclosed.

Moreover, the most recent CJEU jurisprudence indicates that a rule designed in a manner such as PEX should be tested against the provisions on the free movement of capital (rather than those on freedom of establishment). Relying on this aspect and on the applicability of the free movement of capital to non-EU countries, it could be argued that the PEX regime should also be extended to non-EU parent companies that hold a participation in an Italian company and realise a taxable capital gain in Italy under the applicable tax rules.

From a first analysis, this would be the case for China, South Korea, and Israel, regardless of the activity carried out by the Italian company.