Tax credit also extended to foreign source dividends

With the recent judgment No. 25698/2022, the Supreme Court addressed the case of an Italian resident individual who receives income directly - i.e., without the intervention of an intermediary - from a non-qualified participation in a US partnership.

According to the Italian Tax Authorities the foreign source dividends received without the intervention of resident intermediaries should be subject to a substitute tax of 26% of the relative amount, gross of foreign taxes. The consequence of such position is that the resulting juridical double taxation is not mitigated by other domestic rules.

On the contrary, the Supreme Court admitted, in the case at stake, the possibility for the Italian resident individual to credit from the 26% substitute tax the taxes paid on the same income in the United States.

The landmark Supreme Court's decision grounds on a (correct) a contrariis reading of the provisions of the Italy-USA Treaty.

The Supreme Court, preliminarily qualifies the income as a dividend on the basis of the Circular Letter No. 9/2015 on credit for taxes paid abroad and then begins its analysis from Article 18 of the Italian Tax Code (ITC), which does not allow the tax credit for dividends of foreign source subject to substitute taxation.

However, Article 2(2) of the Italy-US Treaty includes in the scope of application of the Treaty Italian taxes " even if they are collected by withholding taxes at the source". In addition, Article 23(3) provides that " no deduction will be granted if the item of income is subjected in Italy to a final withholding tax by request of the recipient of the said income in accordance with Italian law".

The Italian Supreme Court held that it must follow from this provision that no deduction must be granted only when the application of withholding taxes (or, as in the case at stake, when an alternative but substantially equivalent mechanism, the application of substitute taxes) is optional and not mandatory. Therefore, when an Italian substitute tax is applied ex lege (as in the case examined by the Supreme Court), the foreign tax must be considered deductible.

It is worth mentioning that the “principle of law” set forth by the Supreme Court should be applicable to all cases of foreign source income received by individuals holding a non-qualified participation in a foreign partnership, to the extent that the relevant convention contains the same provision set forth by Article 23(3) above (inter alia, France, the United Kingdom, Germany, Luxembourg, etc.).

Furthermore, it should reasonably be concluded that the principles expressed by the Supreme Court apply also to the case of dividends received from qualified participations in tax non-resident corporations (given the common regime provided by L. 205/2017 on income generated from 2018 or on income that after 31 December 2022 will not benefit from the transitional regime).

In light of this decision, in situations where the “principle of law” becomes applicable, the possibility of claiming a refund of taxes paid should be carefully considered.