65ti0381 la candia occhetta panteghini by Ignazio La Candia

Volume 65, Number 5

by Ignazio La Candia, Luca Occhetta, and Paolo Panteghini Reprinted from Tax Notes Int’l, January 30, 2012, p. 381

Italy’s New Regime for Tax Loss Carryforwards

January 30, 2012

by Ignazio La Candia, Luca Occhetta, and Paolo Panteghini

Ignazio La Candia and Luca Occhetta are with Studio Pirola, Pennuto, Zei & Associati in Milan, and Paolo Panteghini is with the University of Brescia and with CESifo. The authors wish to thank Patrizia Di Rosa and Veruska Bramante for editing assistance.

ecent years have seen a series of actions by the Italian government concerning the rules on the treatment of tax losses. The most recent change was introduced by Decree Law No. 98 of July 6, 2011 (the July measure), containing a number of urgent provisions aimed at enhancing the country’s financial stability. The July measure was then ratified by Parliament, and the amended rules are now contained in Law No. 11 of July 15, 2011. As explained in the accompanying report, the new decree aims to provide much-needed support for companies during the current harsh economic conditions.1 The decree was published in Official Journal No. 155 of July 6, 2011, and entered into force on the same date.

ward to future accounting periods, while also abolishing the five-year limit for carrying the loss forward.

The tax authorities have provided important clarification on the rules at issue in Ministerial Circular No. 53/E of December 6, 2011; in particular, certain doubtful and controversial changes, such as the date of entry into force of the new rules, have been addressed in greater detail.

• any transaction aimed at refreshing losses approaching expiry is no longer necessary; and

Changes to Tax Loss Rules Article 23(9) of Decree No. 98/2011 introduces a restriction on the total tax loss that may be carried for-

The report on Decree Law No. 98/2011, explaining the reasons for the new rules, states: ‘‘The provisions are measures supporting the enterprises which, coming out of an unprecedented economic/financial crisis, have accumulated huge volumes of losses which may not be usable within five years.’’

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For practical purposes, the change meets the double need to exclude a time limit to the carryforward of losses and to introduce a limit to the amount of losses that can be used. Furthermore, as pointed out by the tax authorities in Ministerial Circular No. 53/2011, the new rules meet the following simplification requirements: • the new regime simplifies the evaluations on the possible recovery of losses, for the purposes of recording deferred taxes in the financial statements;

• the new regime ensures steady revenue to the state (given that as explained by the example contained in the annex to this article, the effect will be ‘‘definite’’ taxation of 20 percent of income produced).

Taxpayers Affected Article 73(1) of the Italian Income Tax Code states that the new rules apply to all persons subject to corporate income tax (IRES), that is, resident companies and corporations, public and private entities, and Italian resident trusts whose sole or principal object is conducting a commercial business. Nonresident companies or entities of any description, including trusts, with or without legal personality carrying on business in Italy through a permanent establishment are also affected.

JANUARY 30, 2012 • 381

Italy’s New Regime for Tax Loss Carryforwards

PRACTITIONERS’ CORNER

The New NOL Carryforward Rules Article 23(9) of the July measure amends the first two paragraphs of article 84 of the Income Tax Code, which regulates the carryforward of tax losses for persons subject to IRES. In particular, losses incurred in any one accounting period by an IRES payer may be carried forward and utilized to offset the profits of subsequent accounting periods without any time limitation. However, such losses can only be used to offset 80 percent of the taxable profits of each subsequent period until the losses have been fully utilized.3 (For an example of the availability of losses for carryforward, see the annex to this article.) The new rules do not affect the right for newly constituted businesses to carry forward 100 percent of tax losses realized in the first three tax periods after commencement of business in full (that is, to offset 100 percent of the taxable profits of subsequent fiscal years) without limitation provided that the losses derive from a wholly new business activity.4

New Detailed Provisions There are new detailed provisions regarding the carryforward of trading losses in which activities benefit from relief or exemption from tax.

Activities Qualifying for Tax Relief Article 83(1) of the Income Tax Code provides: ‘‘For activities which qualify for full or partial relief from income tax, any tax loss arising will be allowable to the same extent that profits are liable to tax.’’ Thus, losses resulting from activities that qualify for relief from income tax are not recognized for tax purposes and therefore cannot be carried forward to offset profits of subsequent fiscal years, to the extent that income is excluded from taxation.

The new regime does not apply to all IRPEF taxable persons under ordinary accounting regime and noncommercial entities carrying out business activities, which continue to be subject to article 8 of the Income Tax Code, providing for the five-year limit to the carryforward of the entire amount of tax losses. 3 Under article 84 of the Income Tax Code, before the amendment, the entire amount of the accumulated losses that could be covered by the taxable income of the subsequent years up to the fifth year could be carried forward. Paragraph 1 of article 84 provided that the loss for a fiscal year ‘‘can be deducted from income for the subsequent fiscal years not over the fifth, up to the amount that can be covered by the taxable income of each year.’’ 4 The new rules, as specified by the Research Institute of the National Board of Chartered Accountants and Accounting Experts in Circular No. 24/IR of September 14, 2011, will affect the criteria for planning the use of the losses by the enterprises.

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Also, regarding the activities qualifying for full or partial exemption from tax,5 the new rules provide that the tax losses of any accounting period can be carried forward only as far as they exceed profits excluded from the charge to tax in previous accounting periods.

Tax Treatment of Losses Group Taxation When an election for the Italian domestic group taxation has been made, losses of the group (or losses arising during the period in which a group tax election is in force) can be used to reduce the total taxable profits of the group according to the rules set out in the Income Tax Code. Accordingly, the parent company can use the losses incurred in any one accounting period to offset subsequent group losses up to 80 percent of the group’s total profit in any period without a time limitation.6 Tax losses incurred by a single company before the election for group taxation relief may only be used to offset the taxable profits of the company that originally incurred the loss and up to 80 percent per tax period limit.7 Companies Treated as Fiscally Transparent Entities The Income Tax Code provides that when an election for tax transparency (taxation at shareholder level rather than at company level) has been made by a corporate shareholder, any loss is attributable to the shareholder in proportion to the shares held and the share of equity of the subsidiary. Article 7 of an unnumbered Ministerial Decree, dated April 23, 2004, provides that any tax losses in excess of this limit may be utilized only by offsetting them against the subsidiary’s taxable income, in accordance with article 84 of the Income Tax Code. A shareholder taking a loss from a fiscally transparent subsidiary must include the loss in the computation of taxable profits.

5 For example, cooperative companies characterized by prevailing mutual aid, for which a portion of the operating profit is set aside as indivisible reserve, is not included in the taxable income. Following the amendments made to Decree Law No. 138 of August 13, 2011, converted with amendments into Law No. 148 of September 14, 2011, 10 percent of the operating profit destined for the compulsory indivisible reserve will be included in the taxable income of the cooperative company or consortium. 6 As specified by Ministerial Circular No. 53/2011, the new loss carryforward regime also affects the treatment of the tax losses shown in the consolidated income tax return; such losses must be carried forward by the controlling company and can be used to reduce up to 80 percent of the aggregate income produced by the group for the subsequent fiscal years. 7 Reference should be made to the clarification given by the revenue agency in Ministerial Circular No. 9/E of March 9, 2010, stating that one of the key criteria of the domestic group taxation regime is the limit to the use of the tax losses existing before the adoption of group taxation.

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The rules governing taxpayers subject to IRPEF (personal income tax) remain unchanged.2

PRACTITIONERS’ CORNER realized from 2006 to 2010. Finally, the losses for the fiscal years prior to 2006 (not subject to the new carryforward regime) can no longer be used because the five-year limit provided for by the previous regime has been exceeded.

‘Dummy’ Companies Some consideration needs to be given to the interaction between article 84 of the Income Tax Code and the regulations on nonoperating companies. These regulations are designed to suppress the use of companies for the holding of nonbusiness assets, by imposing a minimum tax charge based on a statutory yield on the value of fixed assets if actual profits do not reach specific limits. They also set extra limits on the carryforward of losses and tax credits. Some clarification on the matter has been provided by the National Board of Chartered Accountants and Accounting Experts in their Circular No. 24/IR of September 14, 2011. First, the required minimum profits that a nonoperating company must report cannot be decreased through the offset of carried forward losses. Second, a nonoperating company may carry forward losses provided that any future offset does not exceed 80 percent of the total taxable profits for the future year, in line with the terms of new article 84 of the Income Tax Code. However, the profit after offset of the loss carried forward cannot be lower than the minimum profit under the nonoperating company rules. An official pronouncement from the tax authorities is awaited to clarify the matter.

Importantly, Decree No. 138 of August 13, 2011, also imposed further measures for financial stabilization and development. This was ratified and became law on September 14, 2011 (No. 148), and introduced rules affecting relief for losses.

Commencement of the New Regime It appears that the new regime applies to losses realized in tax periods straddling July 6, 2011, the date of entry into force of Decree No. 98/2011. Losses incurred in prior accounting periods may still be carried forward in accordance with the former rules. The explanatory report states that ‘‘in the absence of a transitional regime, the losses accrued before the commencement of the amended legislation will be carried forward in accordance with the previous wording of article 84.’’ However, a different interpretation of the rules has been put forward by the National Board of Chartered Accountants and Accounting Experts in Circular No. 24/2011 and more significantly in Ministerial Circular No. 53/2011. The latter specifies not only that the new carryforward regime applies with effect as of the fiscal year 2011, but provides important clarification on the regime applicable to the losses accrued in the fiscal years prior to that in which the provisions of Decree No. 98/2011 have entered into force. The new regime is applicable to previous losses that can still be offset in fiscal year 2011. For those entities whose fiscal year coincides with the calendar year, such losses are those

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Impact of the Amendments

Under the provisions of this law, the definition of nonoperating company is extended. Under these rules, companies that may not fall within the strict definition of nonoperating company (because their profits exceed the limits specified in the legislation) will be considered nonoperating if they incur a loss in any three consecutive years or report losses for two consecutive periods and in a third period show taxable profits in an amount lower than the statutory thresholds. The latter provision applies from the accounting period including September 17, 2011 (the commencement date of Law No. 148/2011). Following the introduction of Decree Law No. 78 of May 31, 2010, the authorities are able to carry out additional checks8 on companies that report a trading loss in their tax return for more than one accounting period. The purpose of this provision is to prevent tax avoidance associated with the use of losses to lower future profits, unless the loss is a genuine sign of nonprofitability.9

Systemic supervision, however, does not apply in the case of a reported loss when the enterprise has resolved and fully paid in, in the same period, one or more capital increases at least in the amount of the tax losses. The explanatory report to Decree Law No. 78/2010 prepared by the Italian Senate states: The exclusion of the cases in which losses derive from compensation given to shareholders and directors is the consequence of the fact that for tax purposes the enterprise’s loss is counterbalanced by income of the beneficiaries who are subject to personal income tax. 9 See Ministerial Circular No. 13/E of April 9, 2009. The tax authorities through Circular No. 20/E of April 16, 2010, said: Special attention needs to be paid to the significant changes or discrepancies in the results for the year, or the realisation of tax losses which may be indicators of the implementation of aggressive tax planning schemes, particularly significant in the fiscal years characterised by a severe economic-financial crisis. See the Court of Cassation Judgment No. 24/436 of October 2, 2008, stating that it was deemed lawful to make an inductive analytical audit on the enterprise that for several consecutive years had filed returns showing tax losses. Court of Cassation Judgment No. 16/642 of July 29, 2011.

JANUARY 30, 2012 • 383

If, following the inclusion of the loss received from the fiscally transparent entity, the shareholder still has a tax profit, this profit can be offset by any losses of the shareholder carried forward under ordinary rules. Tax losses arising in an accounting period before the company being treated as tax transparent can only be carried forward against the profits of that company and cannot be transferred to shareholders.

PRACTITIONERS’ CORNER

Year N N+1

Income

Loss Carryforward

Available Loss

Taxable Income

Loss Carryforward

€18,000

€20,000

€16,000

€4,000

€2,000

Final Considerations The new rules on the carryforward of losses give rise to considerations and criticism. First, the new rules will inevitably affect the criteria for the planning of the use of losses by the enterprises; in the absence of rules prescribing the priority in use, it will be more costeffective to deduct the losses realized in the first three fiscal years (which can be fully carried forward) first and then those realized from the fourth year onward. Under the system previously in force, it was more costeffective to deduct first the losses realized from the fourth fiscal year onward, subject to a five-year limit, deferring the use of those losses incurred in the first three fiscal years, which could be carried forward without limits. Further, as noted above, there still remain doubts on the effective date of the changes. Therefore, we hope clarification in this respect will be given by the tax authorities as soon as possible for both practical reasons (see, for example, the calculation of the taxes for 2011, which could be affected by the new rules on the availability of losses for carryforward) and to ensure clearcut application of the system. Finally, the changes introduced regarding dummy companies (which report tax losses in their returns for several fiscal years) should not apply in all those situations in which the enterprise may produce losses such

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as in the start-up10 period; in this case, the presence of tax losses, including for several fiscal years, is the natural consequence of the start-up of a new business and does not represent non-cost-effective conduct by the taxpayer.

Annex. New Method We assume that company Alpha has previous losses of €18,000 for the year N and that in the year N+1 it produces income of €20,000, as shown in the table. The loss available for use in the year N+1 amounts to €16,000, that is, 80 percent of income produced (80% x 20,000 = 16,000). The taxable income thus amounts to €4,000 (20,000 - 16,000), while the remaining loss available for use in the year N+1 amounts to €2,000 (18,000 - 16,000). It follows that the financial effect of the new loss carryforward mechanism is the taxation in the year N+1 of 20 percent of income produced. ◆

Paragraph 2 of article 84 of the Income Tax Code provides that ‘‘the losses realised in the first three fiscal years from the date of incorporation can . . . be deducted from the aggregate income for the subsequent fiscal year without limitation provided that the losses derive from a wholly new business activity.’’

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Example — Company Alpha