In the tug of war between the Italian Parliament and Supreme Court in respect of the indirect tax treatment of indirect business transfers (see my earlier post), the Constitutional Court has come down on Parliament’s side: the form of the transaction must be respected. So, at least for now, the dividing line between legislative and judiciary powers has been clarified.

Indirect business transfers

An indirect business transfer is a simple two-step transaction: instead of selling an unincorporated business (which would give rise to ad valorem indirect tax charges), the seller hives down the business into a Newco and then sells the Newco.

What then is the indirect tax treatment of this two-step transaction?

• The Supreme Court had decided that the indirect transfer must be treated in the same way as a straight sale. The taxable event was the transfer of the business, and the circumstance that it was made “indirectly” did not alter the indirect tax treatment.
• Parliament then adopted rules to clarify expressly that, in a multi-step transaction, the indirect tax treatment is determined by looking at each step individually, without regard to the overall transaction of which they form part.
• The Supreme Court, however, referred these new rules to the Constitutional Court, claiming that they were in breach of the Italian Constitution. In the view of the Supreme Court, substance should prevail over form and the different indirect tax treatment of a direct and an indirect business transfer (i.e. two transactions which are, in substance, the same) could not be justified.

Constitutional Court’s decision

In a decision which reinstates legal certainty in this troublesome area, the Constitutional Court rejected the Supreme Court’s view. It decided that the rules adopted by Parliament comply fully with the Italian Constitution (judgement no. 158 of 21 July 2020).

In its view, Parliament has a wide discretion in prescribing what the taxable events are. The decision to apply indirect taxes individually in respect of each step in a multi-step transaction without considering a possible connection with other steps or extraneous elements may be outdated. But it is unquestionably within Parliament’s power to decide that this is how the indirect tax rules should be applied.

What about the GAAR?

The tax treatment of indirect business transfers remains subject to the Italian GAAR. But the GAAR activates only when the tax saving achieved by the taxpayer conflicts with a general principle of tax law, or its rationale.

In our view, the Constitutional Court’s decision would make it difficult for the tax administration to resort to the GAAR in cases where an indirect tax saving is achieved by dividing the transaction into different steps. This is because the Constitutional Court acknowledged that, unless the law specifically states otherwise, the indirect tax treatment of a multi-step transaction is determined by looking at each step individually. This can therefore be viewed as a general principle of the Italian tax system.