Marco Guerra, LLM University of Milan; LLM Student, King’s College London
Alin Fouladvand, MSc Risk and Finance, London School of Economics
On July 17, 2012, the Finance Bill 2012, amending the Corporation Tax Act 2010, introduced the Tax Transparent Fund (hereinafter, the “TTF”), a new authorised collective investment scheme structure. The aim of the TTF is to attract overseas investment into the United Kingdom and positively reinforce the UK’s reputation as a world-class financial centre. Up to now, several investors have preferred to invest through Common Contractual Funds in Ireland, Funds Common de Placement in Luxemburg or Fundsen Voor Gemene Rekening in Netherlands or, outside of Europe, through exempted limited companies in Cayman Islands.
The attraction of a TTF lies in its tax treatment. TTFs are transparent as far as they will not be subject to corporation tax, income tax or capital gains tax, thus investors will be treated for UK tax purposes as receiving income directly from the underlying assets of the fund as it arises. This means that foreign investors with beneficial treaty entitlements will receive the same withholding tax rates as if they had directly invested into the market. Briefly, for investors who are non-UK residents this means that taxes will not be withheld from income accumulated in or distributed from the fund except where income arises from real property situated in the UK.
The introduction of this new investment vehicle could be an occasion to analyse the differences existing in the tax treatment of cross-border incomes received by Italian and UK transparent funds and their compatibility with the European law principles.
As known, agreements set to rule the treatment of cross-border incomes also exist within the Member States of the European Union. These bilateral double tax treaties coexist alongside EU law. The relationship between tax treaties and EU law can be briefly summed in the following two features:
(i) as the Court of Justice of the European Union (hereinafter, the “CJEU”) stated in the Gilly case, Member States are at liberty to develop and enforce their own rules in the sphere of direct taxation;
(ii) where there is a conflict between EU law and the provisions of a double tax treaty, the EU law will prevail.
Member States are free to decide who has the right to tax, but not how to tax if this results in discrimination against the foreign taxpayer if that taxpayer is a resident of a fellow EU Member State.
In this article we want to focus on the potential incompatibility existing in the field of the taxation of cross-border dividends. In fact, when analysing domestic provisions and the double tax treaty between United Kingdom and Italy, it seems that the newly introduced TTFs could be subject to a more burdensome treatment as regards Italian funds operating in similar conditions.
Treatment of investment funds under UK – Italy Treaty
Until 2012 the Italian investment funds were not considered liable to tax, as the UK funds still are. According to the Decree-Law 24 January 2012 No. 1, Italian undertakings for collective investment (hereinafter, “UCITS”) are to be considered liable to the corporate tax (IRES), even if, in general, exempt from tax. This means that UCITS established in Italy, which receive income from foreign States with which a convention against double taxation is in force, are recognised by the Italian Tax Administration (Agenzia delle Entrate) as subjects who may benefit from the treatment (as nil or reduced withholdings) provided by such conventions. Accordingly, the financial offices will be required to issue, at request, certificates of tax residence for the application of international conventions for the avoidance of double taxation with respect to funds established in Italy.
Article 10 (2) of the United Kingdom – Italy agreement for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income (hereinafter, the “Treaty”) provides for the treatment of cross-border dividends. When Italian investment funds that hold participations in a British company receive dividends, the withholding tax charged by the State of the source (United Kingdom) “shall not exceed: […] 5% of the gross amount of the dividends”. On the other hand, when a UK TTF receives dividends from an Italian company in which it has participation, the reduced withholding tax provided by the Treaty is not applicable. In fact, according to Article 1, the Treaty “shall apply to persons who are residents of one or both of the Contracting States”. Article 3 (1) (d) states that “the term “person” […] does not include partnerships which are not treated as bodies corporate for tax purposes in either Contracting State”.
Thus, since TTFs are not recognised as persons for tax purpose, the internal rules governing individual items of income are applicable and, in particular, with regard to dividends, Articles 27, paragraphs 3 of the Presidential Decree 600/1973. This provision establishes provides for a withholding tax of 20% on the amount of the dividends paid to foreign entities. This conclusion was expressly adopted by the Italian tax authority (Agenzia delle Entrate) in the Ruling No. 17 of 27 January 2006. The case involved dividends paid by a company resident in Italy to a common contractual fund (CCF) established in Ireland, but not liable to tax there. The tax authority ruled that no treaty applied at all, as the Irish fund did not have the status of “person” as defined above.
Furthermore, in its judgment No. 4600 of 26 February 2009, the Italian Supreme Court held that dividends paid by an Italian company to a U.S. transparent “limited partnership”, owned by a Japanese pension fund, cannot benefit from any treaties (i.e. Italy – U.S. Treaty and Italy – Japan Treaty). The Italian judges argued that the correct application of the tax treaty required a payment between two resident entities of the two contracting states, which was not the case because the recipient of the payment was a U.S. partnership.
Actually, the above-mentioned Ruling and the subsequent Ruling No. 167 of 21 April 2008, stated that it would be possible for the partners of a transparent entity to benefit from the treatment of a treaty when the latter is set as a “flow-through vehicle” and the partners are qualified as “beneficial owners”. This would require that the statute of the fund contemplates the obligation of an annually distribution of profits to investors and that they are liable to tax in the State where they reside.
Compatibility of the different treatments under the European law
It is not in the interest of the present work to analyse the concepts of “flow-through entity” or “beneficial owner” and their importance in the issues of international tax planning under discussion. The subject-matter of the article aims to focus on European fundamental freedoms and, in particular the free movement of capital and the freedom of establishment.
The first of the two fundamental freedoms is set out in the Article 63 of the Treaty on the Functioning of the European Union (hereinafter, TFEU). This provision apply to all measures that impose a more stringent tax regime on or in respect of cross-border movements of capital. The freedom of establishment is enshrined in Articles 49 and 54 of the TFEU. It is a right to establish a business in a Member State that could not be discriminated on the ground of the residence. Hence, EU companies formed in accordance with the law of a Member State have the right to establish themselves in any other Member State under the same conditions provided for nationals of the host Member State.
The first most important decision where the CJEU expressed its position was the Aberdeen case (C-303/07, dated 18 June 2009). It concerned a Finnish resident real estate company, held 100% by an open-ended investment company established and governed by the law of Luxembourg (SICAV). The Finnish subsidiary had asked the Finnish tax authority whether dividends distributed to the Luxembourg Company could be exempted from Finnish withholding tax. In fact, such dividends distributed to a resident Finnish investment fund would have been exempt. The CJEU found that the differences between a SICAV and a Finnish company were “not sufficient to create an objective distinction with respect to exemption from withholding tax on dividend received” (para 55). It was clear that the difference tax treatment to the detriment of non-residents funds discouraged (i) non-residents funds from investing in companies established in Finland and (ii) investors resident in Finland from acquiring shares in SICAV. The CJEU stated that such discriminatory treatment was contrary to the freedom of establishment and free movement of capital.
These principles were also mentioned in the decision that the CJEU delivered in the Santander case (joined cases C-338/11 a C-347/11). On 10 May 2012, the CJEU stated that the French legislation that imposes a withholding tax on French-sourced dividends when received by UCITS resident in another Member State, infringes the free movement of capital provided for by Articles 63 and 65 TFEU. This is the first time that the Court deals with the issue of taxation of outbound dividends in a case where the recipients are transparent foreign entities. According to the decision, non-resident UCITS are considered to be comparable to those resident, whatever their legal tax-status, the mechanism of allocation of income chosen by their state of residence and the characteristics of the partners are. The different treatment discouraged non-residents funds from making investments in a Member State and discouraged resident investors from acquiring shares in non-resident UCITS.
It was observed that “although member states have retained their competence to enter into treaties […] this competence must be exercised in a manner consistent with European law”. There is no doubt that the Treaty had been signed at a time when the funds were not considered to be resident in accordance with the laws of both contracting States. It is equally true that the Treaty currently presents, or better, it does not solve a clear discrimination: it is more convenient for an Italian fund to invest in a UK company rather than for a UK fund to invest in an Italian company. Moreover, the objection raised in the Aberdeen case according to which the status of “transparent” entity should have prevented the comparability between entities and non-residents was rejected by the CJEU. What matters is that two comparable situations are subject to two different tax charges.
As it has been briefly explained, studying the position of the Italian tax authority, subsequently endorsed by the Italian Supreme Court, a proper corporate structure and a careful tax planning focused on the concept of “beneficial ownership” could avoid that discrimination. It must be stressed, however, that the compatibility of the rules and treaties with European law is not a tax consultant’s task, but it is the legislator’s mission.
In line with my considerations expressed in the conclusion of another article, national legislator should make the domestic legislation directly compatible with the European principles. Rights of the EU taxpayers (individual or corporate) should be guaranteed by the legislator and not by the advisors.
 Case C-336/96 Mr and Mrs Robert Gilly v. Directeur des Services Fiscaux du Bas-Rhin  ECR I-02793
 Inter alia, CJEU, Case C-279/93, Finanzamt Köln-Altstadt v. Roland Schumacker : “Although, as Community law stands at present, direct taxation does not as such fall within the purview of the Community, the powers retained by the Member States must nevertheless be exercised consistently with Community law”.
 A. Miller, L. Oats, Principles of international taxation, 2014, p. 131. See also, T. O’Shea, Double tax conventions and compliance with EU law, in The EC Tax Journal, 11, 2010.
 Agenzia delle Entrate, Circular 28 March 2012, No. 11
 In this work it is assumed that “the beneficial owner [of the dividends] is a company which controls, directly or indirectly, at least 10% of the voting power in the company paying the dividends” (see Art. 10 (2) of the Treaty).
 J. Wheeler, The missing Keystone of income tax treaties, 2012, p. 109.
 M. Lang, P. Pistone, J. Schuch, C. Staringer, Beneficial ownership: recent trends, 2013, p. 211.
 This position is similar to that adopted by OECD in its commentary: “Where a State disregards a partnership for tax purpose […] since the income of the partnership ‘flows through’ to the partners [they] are the person who are liable to tax […] and are thus the appropriate persons to claim the benefits of the convention” (Commentary on Article 4, par. 8.8).
 In the cases C-315/02 Lenz v Finanzlandesdirektion fur Tirol  and C-319/02 Manninen  the CJEU held that a tax system that taxed dividends from local shares more favourably than dividends from shares in non-resident companies was within Article 63.
 See, inter alia, Tom O’Shea, Freedom of establishment tax jurisprudence: Avoir Fiscal re-visited, in EC Tax Review, 2008-6. With reference to the order of priority of the fundamental freedoms see Michael Lang, Pasquale Pistone, Josef Schuch, Claus Staringer, Introduction to European Tax Law: direct taxation, 2013, p. 53; Mattias Dahlberg, Direct taxation in relation to the freedom of establishment and the free movement of capital, 2005.
 T. O’Shea, ECJ finds Finnish withholding tax rules unacceptable in Luxembourg SICAV case, in Tax Notes International, July 27, 2009, p. 305.
 See also, joined cases C-338/11 to C-347/11, Santander Asset Management SGIIC .
 While the domestic distribution would have been exempt from tax.
 M. Marzano, “Compatibilità” comunitaria e dividendi distribuiti a organismi di investimento collettivo del risparmio non residenti, in Rassegna Tributaria, 3 / 2013, p. 714.
 C. HJI Panayi, European union corporate tax law, 2013, p. 261.
 J. Schwarz, Schwarz on Tax Treaties, 2013, par. 11-100.
 Objection raised by the Italian government!
 See tha above mentioned judgment No. 4600 of 26 February 2009.
 See http://www.kslr.org.uk/blogs/commercial/2014/05/17/tax-transparent-funds-when-transparent-means-fair/