Tax Update (Italy): Authorities set criteria for distinguishing between shareholders’ loans and capital contributions

On March 30, 2016, the  Italian Tax Authorities issued Circular Letter no. 6 (“Letter 6”), which clarifies issues related to the structure of certain acquisitions, in particular those involving investments by private equity funds. The clarifications are based on para. 1.64 sbq. of OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2010.

Letter 6 also indicates the criteria by which the Italian Tax Authorities might assess shareholders’ loans as equity contributions, thereby challenging the deduction of passive interests.  According to the Italian Tax Authorities, a shareholders’ loan might be qualified as an equity contribution in the following instances:

• subordination of the reimbursement of shareholders’ loans and relevant interests payments to the repayment of third-party loans;
• exclusion of the shareholders’ loans from the financial covenants; or
• similar contractual treatment of reimbursement of shareholders’ loans and interests payments to distribution of dividends and equity reserves.

In any event, the re-characterization of a shareholders’ loan as an equity contribution will be determined on a case by case basis, following evaluation of the factual background of the case under investigation. The Authorities will scrutinize, in particular, whether the circumstance materially differs from a transaction involving third parties. In that case, the Authorities point out that the relevant assessment will also affect the notional interest deduction mechanism and the applicability of withholding taxes on dividends (instead of on interests).

Letter 6 refers not only to investment structures which will be set up in the future, but also those already existing. Penalties for non-compliance, however, will only be applied to transactions effectuated after March 30, 2016.