The Emilia-Romagna Court of Tax Justice, in ruling No. 929 of October 2, 2023, affirmed that when the Tax Authority challenges the application of a reduced WHT provided for by double taxation treaties, due to the lack of the status of beneficial owner on the recipient, it is the Tax Authority itself that must prove the lack of this requirement. The ruling bravely stands in opposition to a Supreme Court’s guideline, but in accordance with other decisions of lower courts that have valorized the new allocation of the evidentiary burden pursuant to Art. 7, c. 5-bis, Legislative Decree 546/92.
The case originates from a deed of assessment notified to an Italian company that had paid royalties to a Swiss-based subsidiary in 2013. The Italian company had applied, instead of withholding at the ordinary rate of 30 percent, the reduced 5 percent withholding tax provided for in the Double Taxation Convention between Italy and Switzerland.
This convention, similar to the OECD model, provides in Article 12 for the application of a reduced withholding tax when the recipient of the royalties is: a) resident in the other contracting state (so-called Treaty entitlement); and b) the beneficial owner of the income (so-called Beneficial ownership).
The Tax Authority challenged the Beneficial ownership requirement, believing that the Swiss company was a conduit entity, which transferred the income back to another company, resident in the United States, which controlled it 100 percent.
The Italian company impugned the deed of assessment, obtaining a favorable verdict in the first instance because the judge, as a result of an evaluation of the financial statements of the recipient, had found no retrocession of royalties in favor of the U.S. parent company. The Tax Authority appealed this decision before the Emilia-Romagna Court of Tax Justice.
The Tax Authority challenged the Italian company's failure to prove that the Swiss recipient was the beneficial owner of the income. Specifically, the Tax Office believed that the beneficial owner was the U.S. parent company because it was the formal owner of the trademark that, through an affiliation contract, was granted for use to the Swiss company. The latter, which owned not the trademark but the right of use, managed the brand for the European market by entering into franchise agreements with other affiliates, including the Italian company.
The latter replied, however, that it was the Tax Office's burden to prove beneficial ownership.
The judges, in the ruling, stated that it was irrelevant that the recipient of the royalties was not the owner of the trademark but of the right of use. This conclusion is in accordance with the OECD Model Double Taxation Convention in Article 12, c. 2, where it states: "The term 'royalties' as used in this Article means payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph films, any patent, trade mark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience."
In addition, based on the financial statements, the court certified that the Swiss recipient should have been considered an operating company and not a conduit entity.
With regard to the burden of proof, the Court agreed with the taxpayer, "that the proof that the percipient of the royalties is not the beneficial owner is the duty of the tax administration. In fact, there is no discussion of a facilitating rule. (...). So, it was the burden of the tax administration to provide suitable evidence to support the contention that the recipient of the royalties was [the American company] and that [the Swiss company] was a mere conduit. Such evidence - as noted above - was lacking."
The ruling in comment is particularly appreciated, as it departs from that Supreme Court guideline (see Cass. civ., sec. V, Feb. 28, 2023, no. 6005) that wants the taxpayer to prove who the beneficial owner is, based on the principle of closeness of proof. Another recent ruling (Reggio Emilia, Court of Tax Justice No. 192/2023) stated that this principle is no longer sustainable in light of the "strong warning that has come from the Lawmaker, in terms of the proper application of the burden of proof" thanks to the new Art. 7, c. 5-bis, Legislative Decree 546/92.