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Italy to tax non-residents on indirect sales of Italian real estate held through foreign entities

Under the current legislation, Italy taxes non-resident entities only on capital gains derived from a direct sale of Italian immovable property or from a direct sale of participations in Italian companies (including real estate companies).

The 2023 budget law currently being considered by the Italian parliament includes a provision for the taxation of indirect sales of Italian immovable property. Under the new provision, non-residents would be subject to Italian income tax on capital gains realised on the sale of participations in non-resident “real estate entities”. Participations listed on a regulated market are outside the scope of this rule.

The new provision - implementing Article 9 of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (MLI) - will certainly have an impact on some investment structures holding Italian immovable property.


Before 2003, under the “Capital Gains” Article of the OECD Model Convention, the primary taxing right over capital gains realised by a resident of a contracting state from real estate located in the other contracting state was allocated to the real estate jurisdiction, whereas the taxing rights on capital gains realised on shares issued by a company established in the other contracting state were allocated exclusively to the resident jurisdiction. Holding real estate through a company could therefore defer (indefinitely) the real estate jurisdiction’s taxation of gains on that real estate.

The 2003 OECD Model Convention - in line with the UN Model and the US Model which, at that time, already contained a similar provision - then included a new Article 13(4) to prevent such tax deferral where the real estate held through a company exceeded a certain portion of the company’s overall assets. The aim of Article 13(4) was to prevent treaty abuse, but the OECD’s Commentary does not say so explicitly (while the UN Commentary on Article 13(4) of the UN Model clearly focuses on this intention).

This rule has, however, allowed for abusive behaviors through transactions involving the contribution of non-real estate assets (such as cash injections) made shortly before the disposal of the shareholding in order to dilute the proportion of the value of the entity that is derived from immovable property.

Article 9(4) of the MLI addresses this issue by stating that “For the purposes of a Covered Tax Agreement, gains derived by a resident of a Contracting Jurisdiction from the alienation of shares or comparable interests, such as interests in a partnership or trust, may be taxed in the other Contracting Jurisdiction if, at any time during the 365 days preceding the alienation, these shares or comparable interests derived more than 50 per cent of their value directly or indirectly from immovable property (real property) situated in that other Contracting Jurisdiction” (emphasis added). Whilst aimed at preventing abuse, the provision works as a distributive rule, meaning that it does not seek to assess whether the taxpayers are pursuing abusive schemes for the avoidance of taxation on capital gains derived from the sale of immovable property in the source state.

Given that Article 9(4) does not reflect a minimum standard, a contracting jurisdiction can reserve the right for the entirety of the Article not to apply. Italy has opted to apply Article 9(4) to its covered tax agreements in the place, or in the absence, of any existing immovable property articles. Therefore, Article 9(4) will be included in bilateral tax treaties lacking an immovable property article, if the other contracting jurisdiction has also opted for the application of Article 9(4).

The transposition of the Article 9(4) of the MLI into the Italian legislation

In order to make Article 9(4) of the MLI effective, it is necessary to introduce a similar provision into the Italian domestic law as the imposition of tax is based on internal tax law and not on tax treaties. For this reason, the 2023 budget law will introduce the new paragraph 1-bis into Article 23 of the Italian Income Tax Code stating that “capital gains derived by non-residents from the sale of participations in non-resident companies and entities are taxable in Italy if, at any time during the 365 days preceding the alienation, these shareholdings derived more than 50 per cent of their value directly or indirectly from immovable property situated in Italy”.

If confirmed, the new provision will leave open numerous questions, for example:

  • The reference to “entities” indicates that the tax charge would apply to capital gains realised on the disposal of interests in non-resident funds as well as interests in partnerships and trusts which are explicitly mentioned in Article 9(4) as examples of interests comparable to shares that are intended to be caught.
  • It is not clear whether the new provision can be considered an autonomous sourcing rule or an anti-abuse rule. In the latter case, it would not be applicable where the taxpayer demonstrates that the transaction is justified by sound, non-negligible non-tax reasons.
  • The term “value” is not defined. Would it be tested by reference to the book value of the assets or their fair market value (FMW)? Neither the Commentary to the 2017 OECD Model Convention nor the Explanatory Statement to the MLI provide any guidance. However, the use of FMV might be preferred based on both the ordinary meaning of the term “value” and in the pursuit of an economically sound application of the test. In this regard, the Italian tax authorities clarified - for the purposes of the Italian participation exemption regime - that the value of the immovable property shall be determined based on its FMV.
  • It is not clear how the new provision would interact with the exemption from tax on capital gains if the sale of the immovable property occurs after 5 years from its acquisition.
  • No distinction is made between immovable property used directly in the company’s business activity and immovable property held for the purpose of realizing passive income. It may be arguable that taxing corporate investors on capital gains would be contrary to Articles 56 and 63 of the Treaty on the Functioning of the European Union as Italian resident companies may benefit from the participation exemption regime in comparable situations.
  • It seems that there will not be a step up in the tax value of the shares in the non-resident land-rich entity as a consequence of the sale.
  • The new provision does not take into account the position of paragraph 28.9 of the OECD Commentary on Article 13(4), i.e. the exclusion of the value of the immovable property sold (and already taxed in the source state) during the whole year preceding the sale of the shareholding.
  • Small portfolio investors are not carved out from the provision. For them it will be quite difficult to obtain information on the value of the underlying immovable property held.

Finally, the new provision, if implemented, can have detrimental effects on real estate investment funds (including those set up outside of Italy) deriving more than 50 per cent of their value from immovable property situated in Italy. Indeed, the exemption for capital gains realised by qualified non-resident investors will be replaced by the new paragraph 5-bis of Legislative Decree No. 461/1997 which – based on its wording – seems erroneously to include also capital gains realised by non-resident investors. Moreover, it seems that capital gains realized by foreign funds on the sale of non-qualified shareholdings in Italian real estate companies cannot longer benefit from the exemption. The new provision would probably cause a new restriction against foreign funds (contrary to Article 63 of the Treaty on the Functioning of the European Union).

The impact of the new legislation

The new legislation will have an immediate impact on investors resident in countries with double tax treaties that already include a property-rich clause (e.g. the USA).

When Italy ratifies the MLI, it will also impact investors resident in other countries, depending on the final choices with respect to Article 9(4) of the MLI. Based on the Italy’s preliminary “MLI position”, the affected countries would be: Armenia, Azerbaijan, Barbados, China, Finland, France, Germany, Hong Kong, India, Israel, Kenya, Mexico, New Zealand, Pakistan, Philippine, Romania, Russian Federation, Saudi Arabia, Slovenia, Sweden, Ukraine.

Some other countries – for example Austria, Luxembourg, or Switzerland which have signed a treaty with Italy - will not be affected by the new provision as they opted out entirely from this MLI provision by reserving the right for the whole of Article 9 not to apply.

It goes without saying that, from a practical point of view, it will be a challenge for Italy – as a source state – to monitor the disposal of the shares at all and defend its taxing rights.


bonellierede, italian tax, tax treaties, real estate