«There is no liberty if the judiciary power be not separated from the legislative and executive» (C.L. de Montesquieu, The Spirit of Laws, Book XI, 6 Of the Constitution of England, 1748).

For centuries, the principles of the separation of powers and judicial independence have been considered central tenets of all liberal democracies. And rightly so. But the context has changed considerably and, today, the judiciary plays a more significant role than that of the mere “bouche de la loi” described by Montesquieu. Furthermore, when the dividing line between legislative and judiciary powers is blurred there is a risk of confusion, as this Italian live story tells.

In our tax system, a company willing to sell a business can do so directly or indirectly. An indirect transfer is made in a simple two-step transaction: a hive down of the business into a Newco followed by the sale of Newco to the purchaser. This can be done without any substantial tax burden and the law expressly states that it does not constitute tax avoidance, at least for corporate tax purposes. Thousands of M&A transactions have been completed in Italy using this “indirect” transfer of a business route.

The tax administration, however, was not happy. Precluded from attacking these transactions for corporate tax purposes, they challenged them on the grounds of transfer taxes: choosing an indirect transfer enabled also the saving of registration tax. They relied on Art. 20 of the Registration Tax Law, a rather obscure provision which – with minor modifications – has been in existence since 1862 (yes, 1862!).

The Supreme Court supported the tax authorities’ view and concluded that Art. 20 requires that the tax is applied on the basis of the substance of a transaction, considered in its entirety, and not its legal form. An indirect transfer of a business is, in substance, identical to a direct transfer and must be taxed identically.

Markets were shocked: if all transactions are taxed based on their substance, how many other market standard transactions could be attacked?

Parliament decided to reinstate legal certainty and, in the Budget Law for 2018, changed the wording of Art. 20 to clarify that the registration tax applies only on the basis of the legal effects that can be deduced from the deed submitted for registration. Hence, indirect transfers could not be challenged.

The Supreme Court was not happy and in its first judgment on an indirect transfer after the enactment of the new law, took the questionable view that the new law was effective only as of 1 January 2018. For transactions prior to that date, therefore, its interpretation remained valid.

In the Budget Law for 2019, Parliament ruled again and clarified that the new text of Art. 20 was meant to apply retroactively.

Matter closed? Not quite.

In a recent decision (no. 23549 of 23 September 2019), the Supreme Court referred to the Constitutional Court the task of verifying if the new text of Art. 20 complies with the Constitution.

The separation of powers and the independence of the judiciary are essential legal principles, often embodied in constitutional rules to protect them from illiberal turns of legislation and similar disasters. However, legal certainty is essential, especially in tax matters.

The decision of the Italian Supreme Court, published only one week after the OECD Tax Certainty Day, deserves additional consideration.