Italy cuts taxes on carry to win Brexit business

Amedeo Goria
15 May 2017

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The Italian government has reduced its taxation on carried interest to adapt to its European peers and lure international fund managers to the country. Amedeo Goria analyses the flaws and virtues of the long-awaited reform

Italy's recent budget adjustment decree cleared up the uncertainty over the regulation of carried interest, specifying that from now on carry will be taxed as capital gains, with a 26% flat rate, rather than income. The so-called manovrina aligns Italy to the benchmarks of the European market and represent a consistent tax reduction for fund managers.

The regulation followed longstanding negotiations between the Italian private equity association AIFI on one hand and Italy's ministry of economy and ministry of economic development on the other, and "bridges the gap between Italy and the higher performing European markets", explains Anna Gervasoni, CEO at AIFI. "The legislator drew inspiration from the German and French models, not just because of the performances of these markets but also because of the similarity of their legal and fiscal systems to the Italian code.

"The decree follows up the recent annual budget decree, which stated that pension funds allocating up to 5% of their assets into alternatives will not pay capital gains taxation on their proceeds," says Gervasoni. However, boosting local private equity activity is not the sole target of the government. Amid the ongoing debate around taxation of carry across Europe and the US, Italy aims to play a central role in post-Brexit Europe and increase its appeal to UK-based investment funds.

The legislator drew inspiration from the German and French models, not just because of the performances of these markets but also because of the similarity of their legal and fiscal systems to the Italian code" – Anna Gervasoni, AIFI

"The government aims to attract international deal-makers to acquire assets in the country and manage these assets locally," explains Vania Petrella, Rome-based partner at law firm Cleary Gottlieb. "In fact, this reform is to be seen in continuity with other tax measures including 50% tax breaks on labour income of managers moving to Italy and the 2017 regime for newly-resident high-net-worth individuals of all nationalities who have lived abroad for at least nine years – mimicking the UK resident non-domiciled rules but without its remittance complexities."

Against this backdrop, the recent manovrina laid itself open to a few objections from market players with particular regards to its application, unquote" understands. Nonetheless, the reform currently consists of only six pages and Italy's financial authority is expected to clarify the details as soon as the decree finalises its parliamentary course.

Flaws and virtues
In fact, the reform foresees that proceeds from participations in companies or investment funds will be taxed more favorably as capital gains or dividends rather than income tax if three conditions are met. The first condition is that returns must come from an investment that represented at least 1% of the entire investment made by the fund. "However, it is not defined yet if the percentage concerns either the commitments to the fund, the newco's capital shares or the targeted company," says Petrella.

Secondly, the norm states that proceeds from shares, stakes or other financial instruments must be paid after investors have cashed in all their invested capital and the hurdle rate has been met. "Currently, the norm does not clarify which taxation regime applies in case of an asset sold prior to the fulfilling of the hurdle rate," says Petrella. Finally, the third condition requires fund managers to maintain their investment in the fund for at least five years. Although it includes the options of tag- and drag-along, the Italian authorities will need to clarify the fiscal scenario occurring when this condition remains unmet.

Beside the operational technicalities that need to be solved, the norm taps into an increasingly competitive backdrop, in which European countries roll out their red carpet to attract wealthy managers and their overflowing pots. This was the case for the introduction of Reserved Alternative Investment Fund (RAIF) vehicles in Luxembourg and, more recently, the Finnish reform of carried interest in March 2017.

The recent decision of the Swedish Administrative Court of Appeal on taxation of carried interest showcases how differently the European countries react on such highly-disputed matters. Whether Brexit will turn the tide depends on how countries cope and co-operate to seize the challenge.