Introduction
As is commonly known, residence is a crucial element in tax law. It is used by legal systems as a linking criterion to justify their taxation on the income of a specific individual.
On the one hand, people who are considered as residents of a country are usually taxed on their global income, irrespectively of where it is produced (i.e. worldwide taxation principle); non-residents, on the other hand, are taxed only on the income produced in that country (i.e. source taxation principle).
How is the residence of a trust determined for Italian corporate income tax purposes?
According to Italian corporate income tax law, a taxpayer’s residence is determined by looking at three alternative criteria on Italian territory for most of the tax period, i.e. the registered office, the seat of administration or the main object (Article 73(3) TUIR [Consolidated Income Tax Act]).
In principle, the above-mentioned criteria could be used to determine the residence of a trust as well. However, since Italian civil law does not recognize the legal personality of trusts, the registered office criterion cannot be applied. The main object criterion also leads to application difficulties, because it is strictly connected to the specific type of trust under investigation ([1]).
Generally, the residence of a trust is determined with reference to the seat of administration, understood as the place where the preeminent directive and administrative activity is carried out and where the most important decisions for the activity in question are made (places where meetings are convened and where offices are used to lead the entity’s activity or its representative bodies).
From this definition, it follows that this criterion must be interpreted in the light of the particular institution in question. There may in fact be two different situations. A special organized structure may be set up to administer the trust, with residence consequently attributed to the place where this structure is located([2]). In all other cases, the place where the trustee exercises its decision-making powers in relation to the trust’s assets will be the decisive element in identifying tax residence.
In practice, the residence of a trust is often identified as the place of residence of the trustee, assuming that this is the same as the place of administration of the trust.
In addition to these general rules, since 2019 the Italian tax legislator has introduced two relative presumptions for the residence of a trust in Italy([3]), in order to avoid tax evasion and/or avoidance. More specifically, according to the new wording of Article 73(3) TUIR, a trust must be considered as an Italian tax resident when it has been constituted in a country with which Italy does not have an adequate exchange of information and where (i) at the time of its constitution at least one of the settlors and at least one of the beneficiaries is fiscally resident in Italy; (ii) after its constitution, an individual who is an Italian tax resident transfers Italian assets into the trust fund.
How should the attribution by a foreign trust to an Italian resident beneficiary be considered for Italian income tax purposes?
After a legislative amendment in 2019, the tax treatment of an attribution by a foreign trust to an Italian resident beneficiary depends on whether the said beneficiary is qualified as “vested”. More specifically, a vested beneficiary is an individual who has a certain and actual right to the attribution of the income produced by the foreign trust, thus creating a vested position for the beneficiary (e.g. a non-discretionary trust).
As a consequence, and in application of the transparency principle, in the case of a foreign trust with a vested Italian beneficiary, the income produced by the trust would be attributable to the Italian beneficiary and therefore taxable in Italy as capital income.
In principle, in the case of a foreign trust with a non-vested Italian beneficiary (e.g. a discretionary trust), the solution adopted above does not apply. In this case, in fact, it would not be possible to apply the “transparency” regime and to “attribute” the foreign income to the beneficiary, since such income would be likely to be taxable within the trust itself according to the applicable foreign regulations.
However, the above-mentioned 2019 legislative amendment, with a clear anti-abuse purpose, has provided for Italian taxation of both cases in the (sole) hypothesis of trusts resident in low-tax jurisdictions.
When does a country qualify as a low-tax jurisdiction?
In order to determine the type of tax treatment, it is therefore fundamental to identify when a country can be classified as a low-tax jurisdiction with regard to the criteria indicated in Article 47-bis TUIR.
First of all, this most likely excludes the European Union member states and the countries in the European Economic Area (EEA) with which Italy has stipulated an agreement that ensures an adequate exchange of information.
Secondly, for a country to be classified as a low-tax jurisdiction, the actual foreign taxation must be 50% lower than the taxation to which the controlled entity would have been subject if resident in Italy or, alternatively, where the nominal level of taxation is 50% lower than the level applicable in Italy, taking into account any special regimes that may apply in this latter case.
With reference to trusts, it would seem correct to state that, given the objective impossibility of applying the first criterion, only the residual remaining criterion of the nominal level of taxation is useful. To this end, the Italian corporate income tax rate should be compared to the tax rate to which the trust is subject in the foreign country of residence.
How is the taxable capital income determined?
Generally speaking, taxation can only apply to those allocations that constitute the “new wealth” produced by the trust fund, i.e. the income produced by the trust; any asset allocation, i.e. distributions of capital (or of the value representing capital) to beneficiaries subject to segregation by the settlor is irrelevant.
In other words, the income attributed to an Italian tax resident by a foreign trust, irrespectively of where it is resident, must be included in the capital income category.
While this distinction is clear and unavoidable on a theoretical level, it is not so on an applicative level, especially in cases where the initial trust fund has not only increased, but has also changed in quality. In such cases, it may not be easy to provide proof of the asset or income nature of the attribution to the beneficiary.
However, a relative presumption has been introduced which states that if it is not possible to distinguish between income and estate at the moment of the attribution, the total amount transferred will be considered as income.
In order to overcome this presumption, the trustee must use appropriate accounting methods to distinguish between the portion referring to the initial segregation transfer, net of any asset attributions made in favour of the beneficiaries, and the portion referring to the income realized from year to year, also net of any attributions made in favour of the beneficiaries.
Author: Insignum International Office, Milan
[1] The Italian tax administration has applied the said criterion in some cases where the trust fund consisted exclusively of real estate and, as a consequence, the trust’s residence could be identified as the place where the majority of such real estate was located.
[2] This is mostly the case where a professional trustee is appointed.
[3] Since they are relative presumptions, the taxpayer will always be allowed to provide proof to the contrary.
