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Just another Italian style drama?

Wednesday October 25, 2006

Mark King

Italians celebrated when the government abolished succession tax in 2001, but those same individuals are now up in arms at new Prime Minister Romano Prodi?s attempt to re-introduce the charge. For British expatriates living in Italy, there is a chance that re-introduction of the tax (known in the UK as inheritance tax, or IHT) could hit them as hard as it will hit nationals.

At the time of writing, the proposals need to be passed by the Italian Parliament if they are to come into force (and it remains to be seen how Parliament will react) but the potential return of IHT is not a surprise, having been part of the new government?s electoral manifesto.

However, there is plenty of criticism at the rules being introduced by government rather than by Parliament and at the sloppiness of the drafting, which has led to one British law firm describing the situation as ?another Italian-style drama?.

As it stands right now, movables (which in law refers to personal property not attached to land) can be passed on death free of tax, while immovables (property that cannot be moved) remains subject to stamp duty land tax at 3%. However, that 3% is only charged on the official ?cadastral? value of the property, which is usually only a fraction of its market value.

Moreover, there is no tax on lifetime gifts between close relatives, while gifts to more distant relatives (ie, beyond the fourth degree) and strangers is subject to what is known as registration tax at 7%. The main difference between registration tax and gift tax lies in the scope of the tax, as registration tax only applies to certain transactions, rather than across the board (as was the case pre-2001).

Consequently, under the current system it is possible to make gifts of cash, offshore accounts and shares in foreign companies free of tax, which in turn presents big tax and estate planning opportunities using trusts.

Moreover, although gifts of real estate fall within the scope of registration tax (so transfers to distant relatives and strangers are subject to tax at 7%), various tax authorities accept that the establishment of a ?lifetime trust? of Italian land is only subject to a nominal registration tax of ?168. This, and the fact that Italy finally recognises trusts formally, means Italians have taken a robust interest in the trust concept during the last five years.

However, all this will change if Prodi is successful. He wants to reintroduce succession tax and also extend the scope of registration tax to include lifetime gifts of many types of assets not previously covered by this levy. In the future, for example, lifetime gifts and transfers on death will be taxed at up to 4, 6 or 8% depending on the relationship between the beneficiary/recipient and the deceased/donor (subject to certain thresholds depending on the nature and value of the asset concerned).

In numerical terms, homes worth more than ?250,000 (170,000) will be subject to IHT of 3-4% under the proposals. This means a 150 square metre home in Rome worth ?587,000 would, under the new inheritance tax rules, be liable to tax of ?13,838. Previously, it would have incurred a tax charge of just ?336.

But the draft legislation is muddled in places, so that lawyers do not yet know if the new rules apply to gifts of cash. A literal reading of the law indicates that gifts of cash are now caught by the new rules but it is difficult to see how this will work in practice, as traditionally gifts of cash (known in Italy as ?brevi manu?) have been outside the scope of registration tax, because they are not effected or completed by way of a stampable document.

So what does all this have to do with expatriates or those who have property in Italy but now live in the UK?

Filippo Noseda, a lawyer in the private client department at Withers LLP, says: ?Italian real estate is clearly within the new rules. Accordingly, a Brit who, having lived until his death in the UK, dies owning property in Italy will be subject to Italian succession tax at 4, 6 or 8% depending on the degree of the relationship between the deceased and the donee. In addition, his estate will be subject to UK IHT by virtue of his domicile. However, in these situations the UK/Italian treaty of 1966 will apply so that it should be possible to avoid double taxation in most circumstances.? There may however some administrative complexities (who pays the tax: the executors or the beneficiaries? What are the implications for international probate, etc).

Moreover, what if a Brit who lives and is domiciled in the UK wants to make a lifetime gift of his Italian property? One of the effects of the new legislation will be to push people into making more lifetime gifts. From a UK perspective, an outright gift will either be ?spouse-exempt? or a ?potentially exempt transfer? (the gift is tax-free, provided the donor survives the gift by seven years). Either way, the gift will trigger an immediate registration tax liability in Italy up to 8%.

?An interesting question arises where the donor does not survive the full 7 year period,? Noseda explains. ?In this case, IHT will become payable up to 40% (subject to a reduction in the rate if the donor survives the gift by more than 3 years). But will there be a credit for any Italian gift tax? The answer is probably ?no?, so there is a potential for double taxation, which might not be relieved under the UK/Italian treaty of 1966 as it only applies to succession taxes.?

Turning to Brits who live in Italy, it is likely that they will be subject to Italian succession tax on their worldwide estate by virtue of their residence. If they retained their English domicile, they will also be subject UK IHT on their worldwide estate. In this case, the UK/Italian treaty of 1966 will apply and it should be possible to avoid double taxation in many circumstances. However, it?s worth bearing in mind that there might be some administrative and potentially costly complications to factor in. As for trusts, the Italian rules are so unclear that it is difficult to see how they will operate in practice at this stage.

Vincoli di destinazione

The new rules applicable to gifts also apply to so-called ?vincoli di destinazione? trusts ? an embryonic form of trust recently introduced in the Italian civil code (however, although Italy now legally recognises Trusts, the concept is still alien to the Italian legal tradition).

It is not clear whether the new rules on ?vincoli di destinazione? will extend to foreign law trusts, as the two institutions are not identical. Assuming that the new rules do apply to trusts (so that their creation will be subject to registration tax at 4, 6 or 8% depending on the degree of relationship ? come on, keep up!) it is not clear from the wording of the law whether the relevant relationship for the purpose of determining the rate of tax is that between the settlor and the beneficiary or the settlor and the trustee.

Clearly, there are many questions yet to be answered, but if you own property in Italy or substantial movable assets, you may well want to speak to a lawyer that specialises in tax issues as soon as possible. The decisions you make now could have a bearing on your financial situation years down the road.

The situation elsewhere around Europe

  • France: Succession tax is payable on inheritances from a spouse unless the couple?s marriage contract has it written that goods are held in common. Leaving assets to a non-relative will see assets incur a whopping tax rate of 60%.
  • Spain: With the highest rate in Europe (the top band of IHT is a mind-blowing 80%), Spain is not the best place to die rich. Moreover, there is no exemption from the tax between husband and wife. If a husband dies, then, the widow will be liable for Spanish succession tax on worldwide assets. However, if the widow has a ?life interest? in an asset she will be able to use it before passing it onto her children. This means she could stay in her home, for example, before leaving it to her kids.
  • Portugal: There is no IHT to pay on assets left to spouses, kids or even parents. Everything else is subject to stamp duty of 10%.
  • Cyprus: If you move to Cyprus with the intention of staying for good, you will not face any inheritance tax.


Withers LLP:

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