Taxpayers are entitled to a foreign tax credit for taxes paid abroad, even if the foreign income is subject to withholding or substitute tax, as per most double taxation treaties.
This principle was affirmed by the Lombardy Tax Court in ruling 567/1/2024, following the precedent set by the Supreme Court in decision 25698/2022.
The case involved a taxpayer who offset foreign tax credits against U.S. income, leading to a favorable ruling in lower courts but an appeal by the tax office to the Supreme Court.
The Supreme Court clarified that the credit applies regardless of whether the foreign income contributes to the taxable income, provided the withholding is mandatory.
The Lombardy Tax Court reaffirmed this, emphasizing the supremacy of international treaties over domestic law.
The finality of foreign tax payments can be demonstrated by a statement from the withholding agent, even without certification from the foreign tax authority.
In a significant ruling, the Lombardy Tax Court has affirmed that taxpayers are entitled to a foreign tax credit for taxes paid abroad, even if the foreign income is subject to mandatory withholding or substitute tax.
This decision, encapsulated in ruling 567/1/2024, aligns with the principle established by the Supreme Court in decision 25698/2022.
The case in question arose from a taxpayer's challenge to a payment notice for substitute tax on foreign capital income directly received by the taxpayer.
The taxpayer had declared the tax but did not pay it, believing it could be offset with a foreign tax credit for income earned in the United States.
The taxpayer won favorable judgments in both the first and second instances, but the tax office appealed to the Supreme Court.
The Supreme Court, in its decision, articulated that the foreign tax credit is applicable under most double taxation treaties, such as the one with the United States, even if the foreign income does not contribute to the taxable income but is subject to mandatory withholding or substitute tax.
The Supreme Court overturned the lower court's decision and remanded the case to the Lombardy Tax Court for further evaluation of the evidentiary aspects.
In the reassessment, the Lombardy Tax Court reiterated the principle set by the Supreme Court, resolving the conflict between domestic law (Article 165 of the TUIR) and international treaties.
Article 165 of the TUIR grants a credit for taxes paid on transnational income to mitigate double taxation, but it stipulates that the credit is available only if the foreign income contributes to the total taxable income and is not subject to withholding or substitute tax.
Conversely, Article 23 of the relevant treaty mandates that the credit must be granted if the withholding tax is applied mandatorily, not at the request of the beneficiary.
This underscores the supremacy of international treaties over domestic law.
This conclusion is consistent with other rulings, such as those from the Siena Tax Court (68/2024), the Verona Tax Court (321/2024), and the Milan Tax Court (3184/2024), which have similarly interpreted the treaties to deny the credit only if the withholding is applied at the taxpayer's discretion.
Furthermore, the court established that the finality of foreign tax payments, a requirement under Article 165, can be proven by a statement from the withholding agent indicating the amount and type of tax imposed.
This is valid even in the absence of certification from the foreign tax authority.
Critical Aspects and Potential Issues
1. Interpretation of Treaties: The interpretation of double taxation treaties can vary, leading to potential inconsistencies in the application of foreign tax credits.2. Evidentiary Requirements: Proving the finality of foreign tax payments can be challenging, especially if the foreign tax authority does not provide certification.
3. Conflict Between Domestic and International Law: The precedence of international treaties over domestic law can create legal ambiguities and conflicts.
Common Pitfalls and Errors
1. Misunderstanding Treaty Provisions: Taxpayers and practitioners may misinterpret the provisions of double taxation treaties, leading to incorrect claims for foreign tax credits.2. Inadequate Documentation: Failing to provide sufficient evidence of foreign tax payments can result in the denial of the credit.
3. Assuming Discretionary Withholding: Incorrectly assuming that withholding tax applied at the taxpayer's request qualifies for the credit.
Suggestions and Useful Tips
1. Thoroughly Review Treaties: Ensure a comprehensive understanding of the relevant double taxation treaties and their provisions regarding foreign tax credits.
2. Maintain Detailed Records: Keep meticulous records of foreign tax payments and obtain statements from withholding agents to substantiate claims.
3. Seek Professional Advice: Consult with tax professionals to navigate the complexities of international tax law and avoid common pitfalls.
In conclusion, the Lombardy Tax Court's ruling reinforces the taxpayer's right to a foreign tax credit for taxes paid abroad, even when the income is subject to mandatory withholding or substitute tax.
This decision highlights the importance of understanding the interplay between domestic law and international treaties and the need for thorough documentation to support foreign tax credit claims.