The recent Judgment of the Italian Supreme Court marks an important development regarding exemption from withholding tax on interest relating to medium-to-long term loans as per Article 26, paragraph 5-bis of DPR 600/73.
The dispute that the Court of Cassation dealt with concerns a loan granted by a company resident in Luxembourg ("the parent company" - an entity not included in the list of subjects entitled to exemption under Article 26, paragraph 5-bis of DPR 600/73) to its Italian subsidiary (without applying withholding tax according to the exemption regime provided by the Interest and Royalties Directive), in the context of which the parent company obtained the funds necessary to finance the Italian operational company from the sole shareholder, an investment fund also based in Luxembourg. The latter, adopting a look-through approach, was the beneficial owner of the interest and fell among the subjects entitled to exemption from withholding tax on interest as an institutional investor under supervision.
The courts of legitimacy, expressly in contrast with the practice of the Italian Tax Authorities, have laid down the principle of law whereby the subjective requirements for benefiting from the exemption in question are not to be verified in the direct recipient but rather in the beneficial owner (in this case, unquestionably, the Luxembourg fund).
The Supreme Court thus stated that, although Article 26, paragraph 5 of DPR 600/73 mentions interest "paid" to one’s counterpart (suggesting a direct relationship between lender and borrower), paragraph 5-bis derogates by requiring verification of the subjective conditions directly in the beneficial owner of the income flow (based on a look-through approach).
The underlying argument is that the tax benefit should be tied to the concept of the "beneficial owner" and not merely the formal receipt of the interest. This principle emerges both from the Commentary to Article 11 of the OECD Model and from Article 1 of the Italian Income tax Code, which links taxation to the actual "possession" of income. Secondly, the principle developed by the Supreme Court would be consistent with the purpose of Article 26, paragraph 5-bis, which aims to facilitate access to credit for Italian companies by removing tax burdens on interest paid to qualified foreign lenders.
Following the approach of the Italian Tax Authorities, there would be a risk of undermining the purpose of the rule and incentivizing potentially artificial structures, where a foreign entity formally meeting the exemption requirements is interposed as the direct recipient, merely acting as a "conduit company" through the transfer of the income flow to a third party which, if it had received the interest directly, would not have been able to benefit from the exemption.
Therefore, although it is necessary to clarify that “one swallow does not make a summer”, the decision marks an important step forward for capital market operators, recognizing the application of the exemption regime to those foreign intermediaries who can access the Italian credit market only through sub-participation structures.
