Italian Tax Reform: New Residence Definitions for Individuals and Corporations

1. Individual Tax Residency

Article 1 of the draft decree, which concerns international taxation, changes the wording of Article 2(2) of the Italian Income Tax Code (D.P.R. n. 917/1986, the “IITC”), reformulating it as follows: “For the purposes of income tax, persons who for the greater part of the tax period, also considering fractions of a day, have their domicile or residence in the territory of the State or who are present therein are considered residents. For the purposes of applying this provision, domicile shall mean the place where the person’s personal and family relations are primarily developed. Unless proven otherwise, persons registered for the greater part of the tax period in the registers of the resident population are also presumed to be resident”, whereas the current rules provide that “For the purposes of income tax, persons who for the greater part of the tax period are registered in the registers of the resident population or have in the territory of the State their domicile or residence pursuant to the Civil Code are considered residents.”

This provision modifies the connecting factors for the purposes of determining the tax residence of individuals, replacing the civil law criterion of domicile (principal seat of affairs and interests of a person) with a substantive and tax-specific definition of domicile understood as the place where the person’s personal and family relations are primarily developed. As a new connecting factor, tax residence is also defined as the place where the person is physically present for the greater part of the tax period. The other alternative criterion, namely the place where the person has their habitual abode (definition of residence pursuant to the Civil Code) remains unchanged. Pursuant to the new provision, therefore, an individual will be considered a tax resident in Italy who, for the greater part of the tax period and also considering fractions of a day, alternatively or cumulatively: (i) is physically present in the territory of the State; and/or (ii) has in it their habitual abode; and/or (iii) has in it their primary personal and family relations.

It is important to note that the former criterion of considering tax resident an individual who is registered as a member of the resident population remains as a relevant connecting criterion for tax residence, albeit only as a rebuttable presumption.

This new provision also introduces a new and innovative way to calculate the time spent in the territory of the State. According to the draft bill, in assessing whether a person is resident in Italy for the greater part of the tax period, relevance must also be attached to fractions of a day.

These changes, pursuant to the framework Law No. 111/2023 are intended to be adjustments to international practice and Double Tax Conventions(DTCs), and are aimed at providing greater legal certainty.

The connecting factor represented by mere physical presence in Italy, however, does not seem to be in line with the principles adopted in the OECD and international practice. As such, it appears that this connecting factor conflicts with the stated purpose of standardizing the residency criteria dictated by national regulations and international provisions.

In any event, the application of the criterion of physical presence should be of limited practical relevance. This is because in most cases, its application will lead to a residence conflict. According to the “tie breaker rules” contained in most treaties, the criteria to resolve such a conflict of residence are, in order: 1) permanent home; 2) the place where personal and economic relations are closer to the individual (centre of vital interests); 3) if the Contracting State in which that person has the centre of their vital interests cannot be determined, or if they do not have a permanent home available in any of the Contracting States, they are deemed to be a resident of the Contracting State in which they have an habitual abode; 4) nationality; 5) mutual agreement between the two Contracting States.

It would therefore appear that the criterion of “presence” in the territory of the State does not align with the ranking of criteria set out by the treaty tie breaker rule.

With respect to the new definition of “domicile”, there is some doubt as to whether the definition truly aligns to international practice and double taxation conventions. The draft provision makes reference to personal and family relations, while the conventional tie breaker rule refers to personal and economic relations also defined as the centre of vital interests. It would follow that economic relations which are considered in the current domestic law definition of domicile (principal seat of affairs) and in the conventional rule, would no longer be relevant for domestic law purposes if the language of the draft provision is confirmed as such in the law. The exclusive relevance of personal/family relations would overcome the historical dilemma of whether economic or personal relations should prevail for residency purposes under domestic law. This is a question that the Supreme Court recently answered, stating that when personal and economic relations do not coincide in the same place, precedence should be given to the latter (Cass. N. 16954, May 25, 2022).

In other cases, both the courts and tax administration seem to have given a reverse precedence. In this respect, the proposed new provision certainly has the merit of mitigating uncertainty. A definition limited to personal/family relations may, however, create a mismatch with the conventional rule which still makes reference also to economic relations. One possible interpretation is that the wording “personal and family relations” is intended to reinforce the exclusive relevance of the personal sphere. Under this approach, Italy should no longer claim an individual to be Italian resident based on their economic relations and would only refer to their personal relations for the purpose of applying domestic law. However, when applying the DTC, Italy would be required to respect economic relations as a relevant factor when applying the “tie breaker rule”, with the possible result that the individual would be considered a resident of the other contracting State based on their economic relations. Another possible interpretation is to consider the word “personal” as inclusive of the economic sphere. In this case, the new domestic definition would in essence coincide with the conventional definition. However, given the aim of aligning domestic rules with conventional rules, why use different language? Any such interpretation therefore appears less grounded.

Finally, the amendment which lessens the significance of mere registration as part of the resident population (a factor already of limited importance when a DTC exists) is to be welcomed.

2. Corporation Tax Residency

According to the current wording of Article 73, paragraph 3 of the Italian Income Tax Code (IITC), companies and entities that either have their registered office or seat of administration or main purpose of business in Italy for the greater part of the annual tax period shall be considered resident of Italy.

While the location of the registered office is an objective criterion, the criteria of the seat of administration and the main purpose of business lend themselves to qualitative assessments with an uncertain outcome and indeed over time have given rise to a number of disputes.

In particular, the criterion of the main purpose of business represents a peculiarity of the Italian tax system and has led to tax disputes especially for companies with a passive type of income or that merely own assets in the Italian territory, without also carrying out an effective management activity.

With the express aim of ensuring greater legal certainty Article 2 of the draft decree under review repeals the two latter connecting criteria (seat of administration and main purpose), replacing them with the place of effective management and the place of routine management. This repeal is intended to take into consideration international practice and the criteria to determine tax residence provided by the DTCs.

According to the new draft provision which amends article 73, paragraph 3, of the IITC, “for income tax purposes, companies and entities that have their registered office or place of effective management or place of routine management in the territory of the State for the greater part of the tax period are considered resident”.

The draft provision specifies that “place of effective management” (POEM) is defined as the place of the continuous and coordinated taking of strategic decisions concerning the company or entity as a whole, while “routine management” means the place of continuous and coordinated performance of day-to-day management acts concerning the company or entity as a whole.

No change is introduced with respect to the current criterion of the “registered office”.

The reference to POEM uses the same wording which we typically see in DTCs. This choice of wording aligns with the goal of ensuring the new provisions are concomitant with international and conventional standards stated by the framework Law No. 111/2023.However, some uncertainty still remains as cross-jurisdictionally it has historically been impossible to provide a comprehensive definition of the term POEM based on the language of the OECD Model Convention and on the Commentary, since it remains unclear when interpreting and applying the Conventions which level of management is relevant.

Meaning that academics and court systems have attached to POEM across a number of jurisdictions is indeed variable and heavily influenced by the corporate governance models in force. It is also, with the progressive expansion of remote working, more and more affected by the use of technology. Last but not least, the nature of the business of the company may suggest a case-by-case approach. For instance, companies having a routine functional profile may suggest that importance should be attached to day-to-day management.

The different views taken across jurisdictions on the meaning of POEM and the fact that case law is not conclusive on the matter were probably the catalyst for the OECD to introduce a new tie-breaker standard in the 2017 Model Convention (2017 MC) by deferring dual residence cases to the Competent Authority procedure (MAP). In this respect, the attempt of aligning the new law provision to international and conventional rules may be frustrated by the adoption of a standard (POEM), which the OECD MC is progressively abandoning or at the very least questioning.

While Italy made a reservation on the new tie-breaker rule (which defers dual residence cases to the MAP procedure), when it signed in 2017 the Multilateral Convention (MLI) to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (BEPS), on the other hand it did adopt such new standard in recently executed DTC (e.g. Jamaica, Colombia, Uruguay, Romania).

Italy may yet align to the new standard within the ratification of the MLI. In any event, for the time being, most of the DTC that Italy currently has in force refer to POEM as a tie-breaker rule. While in the majority of cases, consensus has been reached that prevalence should be given to the place where the board of directors meet to discuss the strategy of the company and take key decisions, and that a company can have only one POEM, there are cases (also under Italian case law) where, in interpreting the treaty concept of POEM, prevalence was given to the day-to-day management. This was especially true for companies whose activity is limited and/or simple, as those that provide routine services, for instance toll manufacturers.

The draft law currently under discussion provides a definition of POEM making clear reference to the place of the continuous and coordinated taking of strategic decisions concerning the company or entity as a whole. Accordingly, it appears reasonable to expect that in the future from an Italian perspective the same meaning should be given to the concept of POEM for both domestic law and treaty purposes: POEM would thus be considered the place where strategic decisions are taken in a continuous and coordinated fashion.

As a consequence, while the proposed domestic provision also attaches residence to the place of continuous and coordinated performance of day-to-day management acts, conflicts of residence to be addressed under a POEM treaty clause should be resolved by giving exclusive relevance to the place where the strategic decisions are taken, no matter where the day-to-day management is carried out.

The analysis for new DTCs (and for several additional jurisdictions, in the case that Italy aligns to such new standard within ratification of the MLI) is different, as these defer to the MAP the resolution of dual residence of companies and legal entities. In such cases, pursuant to the new standard of article 4§3 of the MC, for the purposes of the MAP, the competent authorities should have regard to the place of effective management, the place where the company is incorporated or otherwise constituted and “any other relevant factors”, which according to the OECD Commentary should include, among others, “where the senior day-to-day management of the person in carried on”. It should therefore be expected that day-to-day management will still play a role in the application of those DTC which do not exclusively rely on the POEM for the resolution of dual residence.