One of the directives recently issued by the Italian Parliament to the Government to reform Italian tax law requires “the definition of ‘definitive losses’ for the purposes of their compensation in accordance with the principles enshrined in the case law of the Court of Justice of the European Union (CJEU)”.

Reference is made to the consistent case law of the ECJ, which has been in force since Marks & Spencer Decision (C-446/03) finds that the refusal to offset losses incurred by a subsidiary established in an EU Member State and claimed by a parent company established in another Member State constitutes an unlawful restriction on freedom of establishment where the non-resident subsidiary has exhausted the possibilities available in its State of residence to take the losses into account (that is to say where the losses are ‘final’ tax losses).

On 30 April 2024, the Italian government laid the groundwork for the implementation of the final loss rules with the provisional approval of a draft legislative decree (in Italian, “Draft Decree”).

According to the draft regulation, in the case of a merger of a company established in a Member State of the EU or the European Economic Area that allows the exchange of information in tax matters with Italy with a company established in Italy, the tax loss carryforwards (TLCF) of the foreign company will be transferred by the company established in Italy if the following conditions are simultaneously met:

• A qualified control relationship exists between the merging companies, both in the tax periods in which the TLCFs were realized and when the merger becomes effective (the “control test”).

• The TLCF can no longer be used in the state in which it was created because the company has ceased operations and sold to a third party or has sold all of its assets. In addition, under local law, the TLCF cannot be used if control of the company is transferred to entities that are not members of the same group (the “No Opportunities Test”).

Similar to the model case law of the ECJ, the proposed rules give rise to considerable doubts as to their scope of application and make it more difficult to determine the final losses.

Despite the wide scope offered by the Delegation Act, the Implementing Regulation limits loss compensation to cross-border mergers and thus excludes:

• A comprehensive transfer of the tax residence of a foreign company; and

• The closure of a foreign permanent establishment for which the Italian headquarters has opted for the optional exemption regime as a method of avoiding double taxation (Article 168-ter of the Italian Income Tax Law).

The exclusion of cross-border relief in the case of the relocation of a non-resident company to the country is in line with the recent case law of the ECJ (Aures Holdings, C-405/18), which the Italian tax authorities appear to have already followed by recognising a cross-border tax exemption only in the case of an incoming transfer of a foreign entity that is already subject to tax in Italy under the rules on controlled foreign companies (see Circular No. 18/2021, Section 8.1, in Italian).

However, the exclusion of the exemption in the event of the closure of an exempted permanent establishment may not be compatible with the ECJ’s view. Bevola case (C-650/16) the Court ruled against the refusal to compensate for the final losses of a foreign permanent establishment under the Danish branch exemption system (which is similar to the Italian one). A change of course is therefore desirable.

According to the draft regulation, the “finality” of losses should be assessed on the basis of the “no potentials” test, which essentially requires proof that the offsetting of TLCF in the State of origin, even if theoretically possible from a legal point of view, is factually impossible. In this respect, the explanatory notes to the draft regulation refer to the case law of the ECJ (inter alia: Marks & Spencer, C-446/03; Memira HoldingC-607/17; and HolmenC-608/17), clarify that the no-opportunity test is met if:

• The non-resident subsidiary has ceased its business activities by selling or disposing of all of its income-generating assets and has exhausted the possibilities available in its country of residence to take account of the losses, including the possibility of transferring those losses to third parties (e.g. other members of a tax consolidation system); and

• It is not possible for the subsidiary or a third party acquiring the subsidiary to take into account losses in the country of residence of the non-resident subsidiary in future periods, taking into account possible tax advantages from tax losses.

In this context, the cross-border tax relief is intended to be limited to foreign subsidiaries whose only asset is the tax losses. It should be noted that the Italian tax legislation on mergers (currently in force) does not allow the carry-over of tax losses of companies that have ceased to operate. However, the draft regulation also aims to amend this legislation to allow the carry-over of losses if they were incurred when the merging companies were part of the same group.

A final but no less complex step requires the revaluation of foreign losses according to the Italian profit determination rules. This requirement, even if it is consistent with the case law of the ECJ (A OyC-123/11, paragraph 61) raises practical difficulties, in particular when the losses have been incurred over several years. However, a simplification should be allowed for TLCF incurred when the foreign company was subject to the controlled foreign company rules, since in this case a recalculation of the foreign TLCF under Italian tax law is already possible.

As the European Commission points out in its Communication on the tax treatment of losses in cross-border situations, “the absence (or limitation) of cross-border loss relief constitutes an obstacle to entry into other markets, which maintains the artificial segmentation of the internal market along national borders.” In this respect, the proposed legislation on final losses seeks to reconcile the need to avoid restrictions on freedom of establishment with the need for a fair allocation of taxing powers between Member States.

The Marks & Spencer The doctrine and the draft regulation are a complex, if not impossible, task that could make the cross-border acquisition of definitive losses impossible, all the more so given that it is impossible for taxpayers (except those complying with the Italian cooperative compliance regime) to obtain an advance ruling from the Italian tax authorities on this issue.

The rules could be short-lived if the new proposal for a directive on a consolidated tax base is adopted at European level. The initiative provides for cross-border loss relief as a general measure and not as a last resort when losses are “final”. This makes the rule in question only a transitional solution.