US Italy Income Tax Treaty

US Italy Tax Treaty

US Italy Tax Treaty: The United States has entered into several tax treaties with different countries across the globe — including Italy. There are many US taxpayers who are originally from Italy and/or still maintain offshore accounts, assets & investments, and/or generate income from Italy. The United States and Italy have several tax agreements in place, including a FATCA Agreement and a Totalization Agreement. The purpose of the tax treaty is so Taxpayers can determine what their tax liability is for certain sources of taxable income. While the treaty is not the final word in how items of income will be taxed, it does help residents better understand how either the IRS and/or Italy will tax certain sources of income – and whether or not the saving clause will further impact the outcome. Let’s review the basics of the US & Italy Income Tax Treaty – and how the income tax treaty between US and Italy works.

Italy and US Taxation Basics

In general, the default position is that a Taxpayer who is a US person such as a US Citizen, Legal Permanent Resident, or Foreign National who meets Substantial Presence Test is taxed on their worldwide income. This would also include income that is being generated in Italy and maybe tax-free or exempt under the tax rules of Italy — unless an exception, exclusion, or limitation applies (such as with pension).

Saving Clause in the Italy Income Tax Treaty

As we work through the United States-Italy Tax Treaty, one important thing to keep in mind is the saving clause. The saving clause is inserted in tax treaties in order to limit the application of the treaty to certain residents/citizens. With the saving clause, each country retains the right to tax certain citizens and residents as they would otherwise tax under general tax principles in their respective countries — absent the tax treaty taking effect.

What does the Saving Clause Say?

• • • Notwithstanding any provision of this Convention except paragraph 3 of this Article, a Contracting State may tax: (a) its residents (as determined under Article 4 (Resident); and (b) its citizens by reason of citizenship as if there were no convention between the Government of the United States of America and the Government of the Italian Republic for the avoidance of double taxation with respect to taxes on income and the prevention of fraud or fiscal evasion.

Limitations on the Saving Clause

• • • 4. The provisions of paragraph 2 shall not affect:

      • (a) the benefits conferred by a Contracting State under

        • paragraph 2 of Article 9 (Associated Enterprises)

        • paragraphs 5 and 6 of Article 18 (Pensions, Etc.), and

        • under Articles 23 (Relief from Double Taxation), 24 (Non-Discrimination), and 25 (Mutual Agreement Procedure); and

      • (b) the benefits conferred by a Contracting State under

        • Articles 19 (Government Service), 20 (Professors and Teachers),

        • 21 (Students and Trainees), and 27 (Diplomatic Agents and Consular Officials), upon individuals who are neither citizens of, nor have immigrant status in, that State.

What Does This Mean?

The Saving Clause is inserted into a tax treaty in order to allow each country to reserve the right to tax citizens and residents the way that they would otherwise tax them had the treaty not been in effect. Despite the insertion of the saving clause into a tax treaty, there are exceptions to the saving clause as well —

Permanent Establishment in the Italy Income Tax Treaty with the US

• • • For the purposes of this Convention, the term “permanent establishment” means a fixed place of business in which the business of the enterprise is wholly or partly carried on. 

    • The term “permanent establishment” shall include especially: (a) a place of management; (b) a branch; (c) an office; (d) a factory; (e) a workshop; (f) a mine, quarry, or other place of extraction of natural resources; and (g) a building site or construction or assembly project which exists for more than twelve months;

What Does This Mean?

If a resident of one country has a Permanent Establishment (PE) in the other country, then that other country has the right to tax income generated from the Permanent Establishment within its borders. But, if there is no permanent establishment in place, then the mere fact that a non-permanent establishment generates income in the other country does not allow that other country to tax the income.

Income From Real Property

• • • Income derived by a resident of a Contracting State from immovable property, including income from agriculture or forestry, situated in the other Contracting State may be taxed in that other State. 

    • The term “immovable property” (“real property”) shall have the meaning which it has under the law of the Contracting State in which the property in question is situated. The term shall in any case include property accessory to immovable property, livestock and equipment used in agriculture and forestry, and rights to which the provisions of general law respecting landed property apply. Usufruct of immovable property and rights to variable or fixed payments as consideration for the working of, or the right to work, mineral deposits, sources, and other natural resources shall also be considered immovable property; ships, boats, and aircraft shall not be regarded as immovable property. 

    • The provisions of paragraph 1 shall apply to income derived from the direct use, letting, or use in any other form of immovable property.

    • The provisions of paragraphs 1 and 3 shall also apply to the income from immovable property of an enterprise and to income from immovable property used for the performance of independent personal services.

What Does This Mean?

This article provides that if income is earned by residents of one country, as a result of real property that is located in the other country — then it may be taxed in that other country. And, since it does not use the word shall, it presumes that either country may be able to tax the income. Still, foreign tax credits from a US perspective should avoid a US person from having to pay tax to both the United States and Italy on the same income (although the foreign tax credit is not always a dollar-for-dollar credit).

Dividends

• • • Dividends paid by a company which is a resident of a Contracting State to a resident of the other Contracting State may be taxed in that other State.

    • However, such dividends may also be taxed in the Contracting State of which the company paying the dividends is a resident and according to the laws of that State, but if the beneficial owner of the dividends is a resident of the other Contracting State, the tax so charged shall not exceed:

      • (a) 5 percent of the gross amount of the dividends if the beneficial owner is a company which has owned at least 25 percent of the voting stock of the company paying the dividends for a 12 month period ending on the date the dividend is declared; and

      • (b) 15 percent of the gross amount of the dividends in all other cases. This paragraph shall not affect the taxation of the company in respect of the profits out of which the dividends are paid.

      • The term “dividends” as used in this Article means income from shares, “jouissance” shares or “jouissance” rights, mining shares, founder’s shares, or other rights, not being debt-claims, participating in profits, as well as income which is subjected to the same taxation treatment as income from shares by the laws of the State of which the company making the distribution is a resident.

What Does This Mean?

When dividends are paid by a company of one country to a resident of that other country, then that other country has the opportunity to tax the income. Noting, that the first country (aka country of source) still gets the opportunity to tax the income — but may only tax the dividend income up to a certain tax rate not to exceed 15%.

Interest

• • • Interest arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State.

    • However, such interest may also be taxed in the Contracting State in which it arises and according to the laws of that State, but if the beneficial owner of the interest is a resident of the other Contracting State, the tax so charged shall not exceed 10 percent of the gross amount of the interest.

What Does This Mean?

It means that while either state may tax the interest income generated from either state for residents of either state — there are limitations to the amount of tax and the type of interest that may be taxed.

Capital Gains

• • • Gains derived by a resident of a Contracting State from the alienation of immovable property situated in the other Contracting State may be taxed in that other State.

    • Gains from the alienation of movable property forming part of the business property of a permanent establishment which an enterprise of a Contracting State has in the other Contracting State or of movable property pertaining to a fixed base available to a resident of a Contracting State in the other Contracting State for the purpose of performing independent personal services, including such gains from the alienation of such permanent establishment (alone or with the whole enterprise) or of such fixed base, may be taxed in that other State.

    • Gains derived by an enterprise of a Contracting State from the alienation of ships or aircraft operated by such enterprise in international traffic or of movable property pertaining to the operation of such ships or aircraft shall be taxable only in that State. 

    • Gains from the alienation of any property other than that referred to in paragraphs 1, 2, and 3 shall be taxable only in the Contracting State of which the alienator is a resident.

What Does This Mean?

The capital gains rules provide that when gains are earned by a resident of one country as a result of alienating real property located in the other country — then the other country has the opportunity to tax the income. It is important to evaluate the definition of the term immovable property situated in the other Contracting State to determine whether that particular type of asset qualifies.

Artistes and Athletes

• • • Income derived by a resident of a Contracting State as an entertainer, such as a theatre, motion picture, radio, or television artiste, or a musician, or as an athlete, from his personal activities as such exercised in the other Contracting State, which income would be exempt from tax in that other Contracting State under the provisions of Articles 14 (Independent Personal Services) and 15 (Dependent Personal Services), may be taxed in that other State, if:

      • (a) the amount of the gross receipts derived by such entertainer or athlete, including expenses reimbursed to him or borne on his behalf, from such activities exceeds twenty thousand United States dollars ($20,000) or its equivalent in Italian currency for the fiscal year concerned; or

      • (b) such entertainer or athlete is present in that other State for a period or periods aggregating more than 90 days in the fiscal year concerned.

What Does This Mean?

This section provides that, subject to other sections, an artist or entertainer who is a resident of one country and provides entertainment services in the other country may be tax in the other country — although any income that is less than $20,000 in total is exempt; there are exceptions, exclusions and limitations.

Pensions in the Italy Income Tax Treaty with the US

• • • Subject to the provisions of paragraph 2 of Article 19 (Government Service), pensions and other similar remuneration beneficially derived by a resident of a Contracting State in consideration of past employment shall be taxable only in that State.

    • Payments made by a Contracting State under provisions of the social security or similar legislation of that State to a resident of the other Contracting State shall be taxable only in the other State.

    • Notwithstanding the provisions of paragraph 1, if a resident of a Contracting State becomes a resident of the other Contracting State, lump-sum payments or severance payments (indemnities) received after such change of residence that are paid with respect to employment exercised in the first-mentioned State while a resident thereof, shall be taxable only in that first-mentioned State. For purposes of this paragraph, the term “severance payments (indemnities)” includes any payment made in consequence of the termination of any office or employment of a person.

    • Annuities beneficially derived by a resident of a Contracting State shall be taxable only in that State. The term “annuities” as used in this paragraph means a stated sum paid periodically at stated times during life or during a specified number of years, under an obligation to make the payments in return for adequate and full consideration in money or money’s worth (other than services rendered).

What Does This Mean?

Pensions are always an integral part of any tax treaty. Paragraph 18 provides that pension earned by resident of one country is only taxable in that country if that is where the pension was earned in that country. But, when referring to Social Security payments and other public pensions, it is taxed by source, which means the country that is making the payment gets the opportunity to tax the income. A portion of the pension application is exempted from the Saving Clause.

Government Service

• • • (a) Remuneration, other than a pension, paid by a Contracting State or a political or administrative subdivision or local authority thereof to an individual in respect of services rendered to that State or subdivision or authority shall be taxable only in that State.

    • (b) However, such remuneration shall be taxable only in the other Contracting State if the services are rendered in that State and the individual is a resident of that State who:

      • (i) is a national of that State and is not a national of the other State; or

      • (ii) did not become a resident of that State solely for the purpose of rendering the services; provided that the provisions of clause (ii) shall not apply to the spouse or dependent children of an individual who is receiving remuneration to which the provisions of subparagraph (a) apply and who does not come within the terms of clause (i) or (ii).

    • Subject to the provisions of paragraph 2 of Article 18 (Pensions, Etc.):

      • (a) Any pension paid by, or out of funds created by, a Contracting State or a political or administrative subdivision or local authority thereof to an individual in respect of services rendered to that State or subdivision or local authority shall be taxable only in that State.

      • (b) However, such pension shall be taxable only in the other Contracting State if the individual is a resident and a national of that State.

What Does This Mean?

When it comes to government service, it is important to note that if a person earns remuneration — including pensions as a result of working for the government — then those public funds are generally only taxable in that country, although exceptions such as which country the Taxpayer resided in at the time of earning the remuneration may impact the application of treaty,

Relief from Double Taxation in the Italy Income Tax Treaty with the US

• • • 1. In accordance with the provisions and subject to the limitations of the law of the Contracting States (as it may be amended from time to time without changing the general principle hereof), a Contracting State shall allow to a resident of that State and, in the case of the United States to a citizen of the United States, as a credit against the income tax of that State: a) the income tax paid to the other Contracting State by or on behalf of such resident or citizen; and b) in the case of a company owning at least 10 percent of the voting stock of a company which is a resident of the other Contracting State and from which the first-mentioned company receives dividends, the income tax paid to the other State by or on behalf of the distributing company with respect to the profits out of which the dividends are paid. For purposes of this paragraph, the taxes referred to in paragraphs 3 and 4 of Article 2 (Taxes Covered) shall be treated as income taxes, including any profits tax imposed on distributions but only to the extent such tax is imposed on earnings and profits as calculated under the tax accounting rules of the Contracting State of the beneficial owner of such distribution.

    • 2. Where in accordance with the provisions of the Convention income derived by a resident of Italy is exempt from tax in that State, Italy may nevertheless, in calculating the amount of tax on the remaining income of such resident, take into account the exempted income.

What Does This Mean?

This is more of a general provision that provides that the purpose of the tax treaty is to avoid certain double taxation — and that subject to certain restrictions in the different articles, double taxation will prevent a person from being taxed twice on the same income.

Mutual Agreement Procedure

• • • Where a person considers that the actions of one or both of the Contracting States result or will result for him in taxation not in accordance with the provisions of this Convention, he may, irrespective of the remedies provided by the domestic law of those States, present his case to the competent authority of the Contracting State of which he is a resident or, if his case comes under paragraph 1 of Article 24 (NonDiscrimination), to that of the Contracting State of which he is a national. The case must be presented within three years from the first notification of the action resulting in taxation not in accordance with the provisions of the Convention.

    • The competent authority shall endeavor, if the objection appears to it to be justified and if it is not itself able to arrive at a satisfactory solution, to resolve the case by mutual agreement with the competent authority of the other Contracting State, with a view to the avoidance of taxation which is not in accordance with the Convention. Any agreement reached shall be implemented notwithstanding any time limits in the domestic law of the Contracting States.

What Does This Mean?

The mutual agreement procedure provision is designed to further enforce the fact that the purpose of the tax treaty is to promote cooperation and to facilitate any exchange of information necessary for each country to obtain the goals and objectives of being in a double taxation agreement with the other country.

Offshore Reporting (FBAR & FATCA) & United States/Italy Tax Treaty

When a US person has various Accounts, Assets or Investments in Italy, they have to reported to the United States each year on various different forms depending on the value of and category of the assets/accounts.

Here are some common forms which may need to be filed:

5 International Tax Forms You May Have Missed

The following is a summary of five (5) common international tax forms.

FBAR (FinCEN 114)

The FBAR is used to report “Foreign Financial Accounts.” This includes investments funds, and certain foreign life insurance policies.

The threshold requirements are relatively simple. On any day of the year, if you aggregated (totaled) the maximum balances of all of your foreign accounts, does the total amount exceed $10,000 (USD)?

If it does, then you most likely have to file the form. The most important thing to remember is you do not need to have more than $10,000 in each account; rather, it is an annual aggregate total of the maximum balances of all the accounts.

Form 8938

This form is used to report “Specified Foreign Financial Assets.”

There are four main thresholds for individuals is as follows:

• Single or Filing Separate (in the U.S.): $50,000/$75,000

• Married with a Joint Returns (In the U.S): $100,000/$150,000

• Single or Filing Separate (Outside the U.S.): $200,000/$300,000

• Married with a Joint Returns (Outside the U.S.): $400,000/$600,000

Form 3520

Form 3520 is filed when a person receives a Gift, Inheritance or Trust Distribution from a foreign person, business or trust. There are three (3) main different thresholds:

• Gift from a Foreign Person: More than $100,000.

• Gift from a Foreign Business: More than $16,076.

• Foreign Trust: Various threshold requirements involving foreign Trusts

Form 5471

Form 5471 is filed in any year that you have ownership interest in a foreign corporation, and meet one of the threshold requirements for filling (Categories 1-5). These are general thresholds:

• Category 1: U.S. shareholders of specified foreign corporations (SFCs) subject to the provisions of section 965.

• Category 2: Officer or Director of a foreign corporation, with a U.S. Shareholder of at least 10% ownership.

• Category 3: A person acquires stock (or additional stock) that bumps them up to 10% Shareholder.

• Category 4: Control of a foreign corporation for at least 30 days during the accounting period.

• Category 5: 10% ownership of a Controlled Foreign Corporation (CFC).

Form 8621

Form 8621 requires a complex analysis, beyond the scope of this article. It is required by any person with a PFIC (Passive Foreign Investment Company).

The analysis gets infinitely more complicated if a person has excess distributions. The failure to file the return may result in the statute of limitations remaining open indefinitely.

*There are some exceptions, exclusions, and limitations to filing.

Receiving a Gift or Inheritance from Italy

If you are a U.S. Person and receive a gift from a Foreign Person, Foreign Business or Foreign Trust, you may have to file a Form 3520. The failure to file these forms may lead to IRS Fines and Penalties (see below).

Which Banks in Italy Report U.S. Account Holders?

As of now, there are nearly 2000 Foreign Financial Institutions, within Italy that report US account holder information to the IRS. The FFI list can be found here:

What is important to note, is that the list is not limited to just bank accounts. Rather, when it comes to FATCA or FBAR reporting, it may involve a much broader spectrum of assets and accounts, including:

• Bank Accounts

• Investment Accounts

• Retirement Accounts

• Direct Stock Ownership

• ETF and Mutual Fund Accounts

• Pension Accounts

• Life Insurance or Life Assurance Policies

Totalization Agreement for US & Italy

The purpose of a Totalization Agreement is to help individuals avoid double taxation on Social Security (aka U.S. individuals living abroad and who might be subject to both US and foreign Social Security tax [especially self-employed individuals] from having to pay Social Security taxes to both countries).

As provided by the Agreement:

• • • An agreement effective September 1, 1993, between the United States and Italy improves Social Security protection for people who work or have worked in both countries. It helps many people who, without the agreement, would not be eligible for monthly retirement, disability or survivors benefits under the Social Security system of one or both countries. It also helps people who would otherwise have to pay Social Security taxes to both countries on the same earnings.

    • The agreement covers Social Security taxes (including the U.S. Medicare portion) and Social Security retirement, disability and survivors insurance benefits. It does not cover benefits under the U.S. Medicare program or the Supplemental Security Income program.

    • This document covers highlights of the agreement and explains how it may help you while you work and when you apply for benefits.

The United States has entered into 26 Totalization Agreements, including Italy.

The Italy Income Tax Treaty with the US is Complex

In conclusion, The US and Italy tax treaty is a great source of information to help better understand how certain income may be taxed by either country depending on the source of income, the type of income and the residence of the taxpayer. The tax outcome may be changed depending on whether or not the savings clause impacts how tax rules will be applied for certain types of income.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure.

Contact our firm for assistance.