Clarifications on the tax treatment of so-called “carried interests”
Circular Letter 16 October 2017, No. 25/E
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Circular Letter No. 25/E published by the Italian Revenue Agency on October 16, 2017 (the “Circular Letter”) provides clarifications in relation to the tax treatment of “carried interests”, as set forth by Art. 60 of Law Decree No. 50, April 24, 2017.
In brief, such provision generally states that income/proceeds deriving from direct or indirect participation with privileged economic rights (“aventi diritti patrimoniali rafforzati”) held in collective investment vehicles (“OICR”) or companies/entities by:
- their employees and/or directors;
- employees and/or directors of entities linked to such companies or collective investment vehicles by a control or management relationship (including asset management companies and advisory companies),
shall qualify as financial income generally taxable at 26% rate (not as employment or similar income) provided that the following three conditions are satisfied:
- the global undertaking to invest by the above-mentioned individuals implies an actual disbursement equal to at least 1% of the overall investment made by an OICR or net worth of a company/entity;
- the right to receive income from the “privileged” participations arises only after all the investors have received reimbursement of capital plus a minimum pre-determined remuneration (so-called “hurdle rate”);
- the “privileged” participations are held for at least 5 years.
The law also provides that the regime at stake only applies to:
- income/proceeds deriving from participations in OICR and companies/entities resident or established in the Italian territory and/or in States which ensure an adequate exchange of information with Italy(1); and
- income derived starting from April 24, 2017.
With reference to the above, the Circular Letter (i) comments on the above requirements established by the law for the qualification of “carried interests” as financial income and (ii) clarifies that satisfaction of such requirements must be interpreted as creating a sort of “safe harbor”.
Consequently if the above three requirements are not fully satisfied, income derived by employees and/or directors from “privileged” participations may still be allowed to access to the tax treatment of financial income if it is possible to prove that (i) employees/directors are acting as investors and, consistently, (ii) the ownership of the participations is not strictly linked to the employment/director relationship. In this respect, the Circular Letter provides some useful hints.
A case-by-case analysis is therefore necessary and the taxpayer is allowed to possibly file a ruling request with the Italian Tax Authority in order to confirm to be entitled to benefit from tax regime of financial income.
The Circular Letter also clarifies that:
- even if introduced mainly for the benefit of the “private equity” industry, the tax treatment provided for “carried interests” can be generally applied to any industry, being it only aimed at granting a favourable tax treatment anytime an investment is reserved to employees/directors with the purpose to align their interests with those of the “ordinary” shareholders/investors; and that
- any amendment to structures that are already in place, ordered to satisfy the requirements for employees/directors to benefit from the tax treatment of financial income, will be considered legitimate.
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1% of the overall investment
With reference to the first condition, the Circular Letter clarifies that:
- in relation to OICRs, the overall investment is to be determined without considering any leverage of the OICR, but taking into account the amount of the global commitment. As far as the timing is concerned, it is specified that the 1% threshold over the committed amount must be met at the time of closing of the subscription of the OICR quotas, provided that the committed amounts are then actually paid by the employees/directors; and that
- in relation to companies/entities, the overall investment is to be determined on the basis of the fair market value of the relevant net worth, to be quantified by means of specific appraisal. For the purposes of the computation of the 1% threshold, the overall investment made by employees/directors by means of either capital injections and/or purchases of the “privileged” participations shall be taken into consideration.
The Circular Letter clarifies that “privileged” participations purchased by employees/directors through loans which are then waived by the lender should not be counted in the 1% threshold (since the employees/directors do not suffer an actual disbursement and do not undertake any risk).
In addition, the amount of “ordinary” shares or quotas without “privileged” economic rights possibly subscribed/purchased by employees/directors shall also be taken into account in the computation of the 1% threshold.
Reimbursement of invested capital and payment of the hurdle rate.
With reference to the second condition, the Circular Letter clarifies that the postponement of the payment to the employees/directors relates only to the remuneration exceeding the “hurdle rate”.
With respect to the reimbursement of capital and the payment of proceeds up to the “hurdle rate”, employees/directors shall be instead treated equally to other “ordinary” shareholders/investors.
5-year minimum holding period.
With reference to the third condition, the Circular Letter clarifies that the computation of the 5-year minimum holding period starts from the subscription date of each “privileged” participation.
The Circular Letter also clarifies that any carried interest distributed prior to the completion of the minimum 5-year holding period can be subject the tax treatment of income from capital even if the minimum holding period is afterwards satisfied.
(1) The list of States which ensure an adequate exchange of information with Italy is provided for by Ministerial Decree 4th September 1996, as subsequently amended and supplemented.