According to local experts, reports that the Italian government was suspending withholding tax on coupon payments to foreign holders of BTPs were inaccurate. It seems reporters confused proposed reforms to the treatment of withholding taxes on equity dividends (which have yet to be agreed by the government, let alone take effect) with a change to the procedure for reclamation of withholding tax on both equity dividends and BTP coupons. In reality, holders of Italian government debt have enjoyed so-called “tax neutrality” since 1996. Neutrality means that foreign investors in Italian government bonds pay only the rate of tax to which they are liable in their country of residence via a complex but fully automated procedure operated between the custodian banks and the Italian Ministry of Finance. In other words, foreign investors in BTPs or any other |Italian government bond have been eligible to collect coupons gross of withholding tax (under the terms of relevant double tax treaties between their place of residence and Italy) for over five years. This tax neutrality obviously excludes Italian residents and foreign buyers resident in places – such as all offshore financial centres – which have no double taxation tax agreements with Italy: they have continued to receive coupons net of withholding tax. But neutrality has certainly encompassed the whole of the mainstream cross-border government bond trading and investing industry around the world for over five years.
So what has changed? Nothing in terms of Italian withholding tax itself. All that has changed is the procedural formalities by which foreign investors declare themselves eligible to receive income gross of withholding tax. From 1 January 2002 foreign investors in both equities and bonds will no longer have to present form 116/IMP – in which they are obliged to declare their identity, place of residence and status under the relevant double taxation treaty – to the Italian tax authorities. Instead, they can self-declare that they are eligible for re-payment of tax withheld under the relevant double taxation treaty without having to fill in any form at all. The change will be a popular one, because 116/IMP obliged foreign investors to secure confirmation from their domestic tax authorities that everything they declared in 116/IMP was true. 116/IMP also had to be renewed annually, whereas self-declarations will be valid in perpetuity, or at least until there is a change of identity or residence. Even better, anybody who has filed a 116/IMP for this year is automatically accepted as having self-declared. “It is quite a change,” says Achille d’Antoni, securities country manager, Italy, Citibank Worldwide Securities Services (WWSS). “This will ease up considerably the paperwork which foreign companies and individuals holding Italian securities have to present to the Italian tax authorities, free them of the need to queue up at their own fiscal authority to get the necessary confirmation, and relieve them of the obligation to renew their eligibility every year.”
However, initial reports were right to be positive about the impact of self-declaration on the government bond markets, because it is there that the benefits will largely accrue. In the equity markets, by contrast, more fundamental problems remain untouched. Theoretically, foreign holders of Italian equities can reclaim tax withheld at rates set by the relevant double taxation treaty between the government of their country of residence and its Italian counterpart. Foreign investors resident in Britain and France enjoy a particularly favourable rate: they can reclaim tax credit withheld on dividends at a rate of 9/16ths of the gross dividend minus 15 per cent, or nearly half (47.8 per cent) of the total value of the dividend. So the tax is well worth reclaiming. The only problem is that it takes years to accomplish. “To recover withholding tax on equity dividends paid by Italian companies is a cumbersome and time-consuming process,” explains d’Antoni. “It has been, and remains, manual and labour-intensive.” There are three reasons for this. First, applications for re-payment of the tax credit have to be lodged not with a centralised tax bureaucracy but with the regional tax office nearest the headquarters of the company paying the dividend. Secondly, many of these local offices lack either the manpower or the computers (or both) to process applications efficiently. Thirdly, the treasury at Rome is notoriously lackadaisical about remitting the cash to re-pay withholding tax even when an application is successful. Though the timescales for tax reclaims vary widely between the different regional tax offices, it can take foreign investors anywhere between two and five years to reclaim tax withheld on equity dividends paid by Italian companies.
Last year, the Italian Ministry of Finance agreed to tackle the problem. It has launched an initiative which aims to centralise, automate and accelerate the processing and payments of withholding tax reclaims on equity dividends during the course of 2002. The new coalition government of Silvio Berlusconi, led in this instance by Minister of the Economy Tremonti, has agreed to pursue it. He says a new system can be put in place as early as January, which will allow time for it to be tested before the 2002 dividend season starts in March. It is part of a wider programme of reform launched by Tremonti designed to transform the taxation of both domestic and foreign traders and investors in Italian securities.
“The reason why the Italian authorities are now looking at reforming the taxation of equities is simple,” says d’Antoni. “They made changes to the tax treatment of bonds much earlier because they had such a large public deficit to finance, and needed to make BTPs as attractive as possible to foreign investors. As interest rates have fallen in the wake of the adoption of the euro, their focus has shifted to equities. They reckon the stock market could be an enormous fiscal opportunity for the government.
If more issuers and investors can be attracted to the market, the collection of both direct and indirect taxes will go up, in the shape of capital gains tax on domestic investors and companies which go public, and via withholding taxes on dividends.” But the details of the reform are as yet unclear and it will in any event take years to drive any fiscal changes through the Italian legislative machine. Tremonti himself does not expect his proposed modifications to the tax system to be implemented before 2003. But one tax privilege which the rumour mill has brought to the surface already as a prime candidate for abolition is the special rate at which French and British investors reclaim tax withheld on equity dividends. “It is only a rumour at present, and the government has not yet made up its mind exactly what it wants to do,” says d’Antoni. “But clearly if it happened it would be a major discouragement to French and British investment in Italian equities.” Doubtless Citibank WWSS will be lobbying furiously behind the scenes for the idea to be canned.