Dividends received by Italian financial intermediaries (including banks) from their subsidiaries are subject to Italy’s regional tax on productive activities (IRAP). In Banca Mediolanum SpA, the CJEU ruled that, where dividends from subsidiaries in other Member States are concerned, this IRAP charge violates the Parent Subsidiary Directive (PSD). The judgment is particularly interesting because it considers what types of tax (other than corporate income taxes (CIT)) falls within the scope of the PSD. Furthermore, the fact that IRAP can no longer be charged on EU-source dividends opens the door to arguments that the charge should not apply to dividends paid by Italian or third country subsidiaries either. 

What was the case about?

Banca Mediolanum SpA (Banca) held shares in companies resident (and subject to CIT) in Ireland, Luxembourg and Spain. It received dividends from these companies and the dividends were paid free from withholding tax in reliance on the PSD. 

• Banca included 5% of the dividends in its taxable income for Italian CIT (IRES) purposes.
• Because it qualified as a financial intermediary, Banca also included 50% of the dividends in its taxable income for IRAP purposes. This was taxed at the rate of 5.57% according to Article 4(1)(a) of the legislative decree no. 446/1997 (IRAP Decree).

Banca claimed a refund of the IRAP charge, arguing that it was incompatible with Article 4 of the PSD which limits Member States’ rights to tax parent companies on dividends received from EU subsidiaries (the 5% IRES inclusion was not at issue given that it is permitted under Article 4(3)). The Italian tax authorities refused the claim, Banca appealed and the question whether the IRAP charge is compatible with Article 4 of the PSD was referred to the CJEU. 

What did the Advocate General say?

The Advocate General (AG) considered that the limitation in Article 4 of the PSD applies to CIT and comparable taxes. If IRAP falls within that category (which would ultimately be a question for the referring court), the charge would be incompatible with Article 4; if not, it could stand. 

The AG noted that the PSD aims to eliminate double taxation of profits distributed by a subsidiary to its parent, suggesting that it targets the imposition of similar taxes on what are essentially the same profits at the level of the subsidiary and the parent. This would mean that the limitation in Article 4 focuses on CIT and comparable taxes levied in substitution for, or as a supplement to, them. The AG, therefore, concluded that the main issue is whether the tax at issue can be regarded as a CIT or comparable tax. 

Whilst this is ultimately a question for the national referring court, the AG suggested that IRAP is a hybrid tax that combines a type of wealth tax, a type of tax on assets and a type of activity tax, and that such a hybrid tax would be of a different legal nature from CIT and probably not comparable to it. Consequently, the taxation of dividends under IRAP would not be covered by the prohibition laid down in Article 4 of the PSD.

Did the CJEU follow the AG?

No, the CJEU did not adopt the AG’s test based on the similarity between the relevant tax and CIT. Where the Member State has chosen an exemption system (rather than a system allowing credit for tax paid at the subsidiary level), Article 4 prohibits taxing the parent company on dividends received from an EU subsidiary (subject to the 5% inclusion authorized by Article 4(3)). This prohibition applies irrespective of the nature of the tax.

The CJEU’s conclusion was based on the following arguments:

• Article 4(1)(a) of the PSD must be interpreted as meaning that the exemption system it provides for concerns any tax which includes in its basis of assessment the dividends a parent company receives from its subsidiaries resident in other Member States.
• That IRAP is not listed in Part B of Annex I to the PSD does not mean that it is excluded from the scope of Article 4. The list is used for identifying the types of company within the scope of the PSD; it should not be read as limiting the types of tax to which Article 4 can apply. 
• Considering the PSD’s aim of avoiding double taxation of distributed profits “in economic terms”, the exemption provided in Article 4 must apply with respect to any tax that, in the parent’s Member State, includes in its basis of assessment even a part of dividends received from a subsidiary in another Member State, irrespective of the nature of the tax at issue. 

The CJEU rejected the Italian Government’s argument that an IRAP exemption for dividends from subsidiaries in other Member States may, in essence, give rise to “reverse discrimination” as dividends from Italian subsidiaries would continue to be subject to the charge. This, the Italian Government argued, would breach the principle of equal treatment. The CJEU, however, noted that the principle of equal treatment (as enshrined in EU law) cannot be relied on in a purely domestic situation. In such a situation, the referring court would have to determine if there is any discrimination that is prohibited by national law and, if so, how that discrimination should be addressed.

What are the implications?

Italian financial intermediaries who paid IRAP on dividends received from EU subsidiaries should consider filing a claim for a refund of that tax. The CJEU has clearly stated that Article 6(1)(a) of the IRAP Decree is incompatible with the prohibition against double taxation in Article 4 of the PSD. 

IRAP charges on dividends from domestic subsidiaries could possibly be challenged. Banca Mediolanum SpA may have an impact on a purely domestic situation. The higher tax burden applicable to purely domestic situations under Italian law compared to that applicable to similar EU situations under the PSD may conflict with Article 3 (Principle of equality) and Article 53 (Principle of ability to pay) of the Italian Constitution. 

Dividends from non-EU subsidiaries may also need to be exempted. This could be argued for on the same constitutional principles referred to in relation to purely domestic situations. Moreover, if domestic dividends are exempted from IRAP, a further argument could be made based on Article 63 of the Treaty on the Functioning of the European Union according to which "all restrictions on the movement of capital between Member States, and between Member States and third countries, are prohibited."