A referendum was held on June 23, to decide whether the UK would leave or stay in the European Union. Leave won by 52% to 48%. Brexit is a reality. As a result, in the absence of precedent about the mechanism for leaving the EU (Article 50 of the Treaty on European Union), uncertainty is prevailing. What does the exit from the European Union mean for the UK (politically, socially and economically)? What is going to happen now that voters opted for Brexit? How long will it take to leave the European Union completely? What are the tax consequences to UK businesses abroad? What does Brexit mean for UK companies in Italy?
In the field of direct taxation, Brexit will affect UK entities with subsidiaries or permanent establishments in Italy, considering that several (and favourable) domestic rules are applicable only to EU Member States and EEA (European Economic Area) countries. In case of UK entities without a permanent establishment in Italy, business income such as dividends, interest or royalties paid from an Italian entity would be subject to a final withholding tax, possibly reduced by treaty provisions. In case of UK entities with a permanent establishment in Italy, business income paid by an Italian company would be subject to (corporate income) tax in Italy as if it would have been paid to a resident company. More in details:
- Dividends distribution would be subject to article 10 of the Double Tax Convention between Italy and the UK (hereinafter also DTC), which allows the source country to tax at a rate not exceeding 5% of the gross amount of the dividends (if the beneficial owner is a company who controls at least 10% of the paying company) or 15% in all other cases. In case of UK entities without a permanent establishment in Italy, entities would be subject to a final withholding tax at 26%. However, they could claim for a refund of an amount up to 11/26 of the withholding tax paid in Italy, giving evidence that that item of income has been subject to final taxation in the UK;
- Interest payments between companies resident in Italy and the UK would be subject to article 11 of the DTC, which provides for the right to tax in the source state, but not exceeding 10% of the gross amount of the interest paid (if the recipient is the beneficial owner of the interest). In case of UK entities without a permanent establishment in Italy, entities would be subject to a final withholding tax at 26%;
- Royalty payments between companies resident in Italy and the UK would be subject to article 12 of the DTC, which provides for a taxation in the source state limited to 8% of the gross amount of the royalty paid (if the recipient is the beneficial owner of the interest). In case of UK entities without a permanent establishment in Italy, entities would be subject to a final withholding tax at 30%. However, given that for some items of royalties the withholding tax would generally be levied on 75% of the gross amount, it would result in an effective taxation at 22,5%;
- Taxation of capital gains (arisen in Italy) depends on the kind of item of income, subject to a number of exceptions. If UK entities operate in Italy on behalf of a permanent establishment, all gains realized in the course of business activities are taxed in the hands of the permanent establishment (business income). If the gains realized in Italy are not attributed to a domestic permanent establishment, they are taxed separately (subject to a final withholding tax at 26%) depending on the kind of property sold (movable or immovable property, shares, bonds, financial instruments, etc);
- For other business income, the UK entities would be subject to corporate income tax in Italy as if the income would have been paid to a resident company. If UK entities are not carrying-out the business through a permanent establishment in Italy, they would be subject to final withholding tax on all sources of income derived from Italy.
A pillar of EU tax policy to be considered in our analysis are European Directives (secondary legislation in the framework of EU Law). They are not directly applicable on the domestic legislation but each Member State is required to achieve results and objectives stated by Directives (e.g. Parent-Subsidiary Directive, Interest and Royalties Directive, Merger Directive) and deciding how to implement the legislative tool. As a result of Brexit, it could lead to a quick erosion of their effects, as the application of Directives would no longer be required.
At the level of Double Tax Convention between Italy and the UK, Brexit would have no direct impact, given that it has not been signed on the basis of EU membership. Consequently, treaty benefits would continue to be granted to persons who are resident in Italy and/or in the UK, dealing with personal and corporate income taxes. Therefore, assuming that a company resident in the UK (and trading in Italy) is entitled to treaty benefits, conventional withholding tax rates may apply if lower than domestic rates.
Consequences of the British exit from the European Union are highly uncertain. One significant issue has to do with Britain’s future relationships with the European internal market and depends on their status after the negotiations. For instance, if the UK becomes a member of the European Economic Area, UK entities would benefit of a reduced withholding tax at 1,375% (5% of the ordinary income rate of 27,5%) to dividend distribution from Italian subsidiaries to their parents (very likely, from fiscal year 2017 the withholding tax will be further reduced to 1,2%, given a general reduction of income tax rate from 27,5% to 24%).
Generally speaking, the outcome of Brexit would be burdensome for UK businesses in Italy, given that tax advantages granted under EU Directives would cease to apply (i.e. zero withholding tax on dividends paid from a subsidiary to its parent company, elimination of double taxation on cross-border payments of interest and royalties between associated companies, relief or deferral of the tax on gains arising from some cross-border divisions, partial divisions, transfers of assets, exchanges of shares). Further, the application of bilateral tax treaty rates may result in a less favourable treatment due to higher withholding taxes at source, since the EU laws cover a much wider range of topics than bilateral treaty between Italy and the UK usually does.
Dott. Elio Palmitessa
RSM Palea Lauri Gerla