Introduction

The recent decision by the Lombardy Tax Court in case no. 567/1/2024 has brought to light critical aspects of the application of foreign tax credits under international tax treaties. This ruling, which follows the Italian Supreme Court's precedent in case no. 25698/2022, addresses the entitlement of taxpayers to claim credits for taxes paid abroad, even when such income is subject to withholding or substitute tax. This article explores the intricacies of the case, the legal principles involved, and the broader implications for both taxpayers and tax authorities.

Case Background

The case originated from a taxpayer's appeal against a payment notice for substitute tax on foreign capital income. The taxpayer had declared the tax but did not pay it, opting instead to offset it 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.

Supreme Court's Principle of Law

The Supreme Court, in its ruling, established a crucial principle: the foreign tax credit is applicable even if the foreign income does not contribute to the taxable income but is subject to mandatory withholding or substitute tax. This principle is grounded in the majority of double taxation treaties, including the one between Italy and the United States. The Supreme Court overturned the lower court's decision and remanded the case to the Lombardy Tax Court for further examination of the evidentiary aspects.

Lombardy Tax Court's Decision

Upon reassumption, the Lombardy Tax Court reaffirmed the Supreme Court's principle, emphasizing the conflict between domestic law (Article 165 of the Italian Income Tax Code) and international treaty provisions. According to domestic law, the foreign tax credit is granted if the foreign income contributes to the overall taxable income and is not subject to withholding or substitute tax. However, Article 23 of the relevant treaty mandates the credit's recognition if the withholding tax is applied mandatorily, not at the beneficiary's request.

Supremacy of International Law

The court underscored the supremacy of international law over domestic provisions, asserting that the foreign tax credit must be granted in cases where the withholding tax is mandatory. This interpretation aligns with other judicial decisions, such as those from the Siena Tax Court (case no. 68/2024), the Verona Tax Court (case no. 321/2024), and the Milan Tax Court (case no. 3184/2024).

Proof of Definitive Tax Payment

Another significant aspect of the ruling is the court's stance on proving the finality of foreign tax payments. Article 165 requires that the foreign tax payment be definitive. The court clarified that this requirement could be satisfied through a statement from the withholding agent, detailing the amount and type of tax imposed, even in the absence of certification from the foreign tax authority.

Implications for Taxpayers and Tax Authorities

This decision has far-reaching implications for taxpayers with foreign income. It reinforces the taxpayer's right to claim foreign tax credits under international treaties, even when the income is subject to withholding or substitute tax. It also simplifies the process of proving the finality of foreign tax payments, reducing the administrative burden on taxpayers.

For tax authorities, this ruling necessitates a careful review of existing practices and policies to ensure compliance with international treaty obligations.
It also highlights the importance of clear communication and documentation between taxpayers and withholding agents.

Conclusion

The Lombardy Tax Court's decision in case no. 567/1/2024 marks a significant development in the application of foreign tax credits. By affirming the supremacy of international treaties over domestic law and clarifying the evidentiary requirements for proving the finality of foreign tax payments, the court has provided valuable guidance for taxpayers and tax authorities alike. This ruling underscores the importance of understanding and adhering to international tax principles in an increasingly globalized economy.

Critical Aspects and Potential Issues

1. Interpretation of International Treaties: Ensuring consistent interpretation and application of international tax treaties across different jurisdictions.

2. Evidentiary Requirements: Balancing the need for sufficient proof of tax payments with the administrative burden on taxpayers.

3. Coordination Between Tax Authorities: Enhancing cooperation and communication between domestic and foreign tax authorities to streamline the process for taxpayers.

Common Pitfalls and Errors

1. Misunderstanding Treaty Provisions: Taxpayers and tax authorities may misinterpret the specific provisions of international tax treaties, leading to incorrect application of tax credits.

2. Inadequate Documentation: Failing to provide sufficient documentation to prove the finality of foreign tax payments can result in denied credits.

3. Overlooking Mandatory Withholding: Not recognizing the mandatory nature of withholding taxes can lead to disputes and litigation.

By addressing these critical aspects and avoiding common pitfalls, taxpayers and tax authorities can navigate the complexities of international tax law more effectively.