The proposed reform of the taxation of portfolio dividends is a seemingly marginal adjustment to the Italian tax system, but akin to Lorenz’s “butterfly effect” will have far-reaching consequences. On 22 October 2025, the Italian Government approved the draft 2026 Budget Law, currently under parliamentary scrutiny, which includes significant amendments to the taxation of dividends deriving from portfolio shareholdings, rendering them fully taxable.

Such reform undermines a foundational element of the Italian corporate tax system, namely the mitigation of economic double taxation of corporate profits. It may also compel the legislator to adopt further corrective measures to prevent arbitrage between capital gains and dividends and to avoid instances of (reverse) discrimination between domestic and cross-border dividends.

The existing tax framework for dividends and capital gains

Under the current regime, both domestic and foreign dividends benefit from a substantial exemption, subject only to limitations concerning distributions from preferential tax jurisdictions, and irrespective of the percentage of participation held. This dividend exemption is complemented by a corresponding exemption for capital gains realised upon the disposal of shareholdings (the so-called participation exemption regime).

The underlying rationale of the Italian participation exemption rests on the assumption that capital gains largely represent the crystallisation of profits, either already earned or expected to be earned, by the subsidiary whose shares are sold.

The Government’s legislative proposal

The draft amendment restricts the dividend exemption to a holding of a minimum 10% participation, considering both direct and indirect ownership and adjusting appropriately for dilution along multi-tiered structures. Dividends stemming from portfolio investments would, consequently, become fully taxable.

Importantly, the proposed reform does not amend the participation exemption regime applicable to capital gains, thereby introducing a structural asymmetry that raises questions of coherence and consistency within the tax system.

Potential infringement of the principle of non-(reverse) discrimination

Even abstracting from broader tax policy considerations, system-coherence and anti-arbitrage principles suggest that the legislator may ultimately seek to align the participation exemption regime with the amended dividend regime, introducing a similar 10% threshold for capital gains.

Moreover, additional measures appear necessary to prevent forms of reverse discrimination affecting dividends from portfolio shareholdings. The draft reform leaves unaltered the existing withholding tax framework for outbound dividends, which remains as follows:

1. full exemption where the requirements of the EU Parent–Subsidiary Directive or Article 9 of the EU–Switzerland Agreement are satisfied;
2. a 1.2% withholding tax where the dividend recipient is resident in an EU/EEA Member State but the Directive does not apply;
3. a 26% withholding tax, or the reduced treaty rate, in all other cases.

As a consequence, from 1 January 2026 dividends on portfolio shareholdings paid to an EU/EEA parent company not covered by the Directive would be taxed at 1.2%, whereas the same dividends paid to an Italian resident shareholder would be subject to final withholding tax at 26% rate. Such disparity creates an instance of reverse discrimination, whereby domestic taxpayers are treated less favourably than cross-border taxpayers.

Although EU law does not prohibit reverse discrimination as such, its prevention may be conventionally and constitutionally required.

From the perspective of the European Convention on Human Rights, the recent judgment of the ECtHR (No. 45446/21, De Galbert Defforey et autres v. France, 22 May 2025) suggests that reverse discrimination in the field of dividend taxation may infringe both Article 14 ECHR (non-discrimination) and Article 1 of Protocol No. 1 (protection of property).

From a constitutional perspective, the proposed regime may contravene (i) the principles of equality and reasonableness (Art. 3), (ii) the principle of ability to pay (Art. 53), and (iii) Art. 117, which requires Italian legislation to conform to the constraints arising from EU law and international obligations, including Article 14 ECHR.

Possible legislative solutions

To neutralise risks associated with reverse discrimination, the legislator could extend the new domestic tax treatment of portfolio dividends to outbound dividends, aligning the withholding tax rate with the current IRES rate (24%).

Such alignment would also eliminate direct discrimination affecting dividends paid to companies resident in third countries, which—under the current regime—are taxed at a higher rate (26%) compared to domestic or intra-EU/EEA dividends (1.2%).

Nevertheless, a residual disparity would persist with respect to non-portfolio dividends paid to companies resident in third countries that ensure an adequate exchange of information, as such dividends would remain subject to a 26% withholding tax. Eliminating this discrimination would require reducing the withholding tax on such dividends to the level applicable to EU/EEA recipients (1.2%).

Conclusions

The proposed reform of the taxation of portfolio dividends is limited in scope yet capable of generating a spectrum of discriminatory outcomes that may jeopardise its effectiveness from the start.

The reform exemplifies how seemingly marginal adjustments to the tax system may trigger far-reaching systemic consequences and serves as a cautionary example of the unintended and potentially disruptive implications of reforms primarily driven by fiscal considerations.