Newsletter Private Equity - 5/2010 EN

Preface
This new edition of our Newsletter begins with a brief overview of directors’ duties of distressed companies as well as the cautions and preliminary activities in equity or debt restructuring transactions, particularly focusing on portfolio companies’ positions and directors nominated by financial sponsors.
Below is an interesting article that addresses typical instruments by which Funds operate in the context of restructuring transactions in light of the latest international and Italian market practice.
Then follows a brief summary of the latest amendments introduced in the Italian Bankruptcy Law aimed at encouraging restructuring of distressed companies (restructuring agreements, new financial means and bankruptcy crimes).

The paper which follows contains some considerations relating to the Circular No. 51/E dated as of 6 October 2010, by which the Tax Authority has provided for some preliminary clarifications concerning the new provisions set out by the legislative decree No. 78/2009 relating to Controlled Foreign Companies (Article 167 of Italian Consolidated Income Tax Act).
Such edition ends with a note on the status of the new European Directive ruling the management of alternative management funds (AIFM).
As always we hope that our Newsletter might be of interest to you and offer some food for thought. We of course are available to take up with you in greater detail on any of the topics we have discussed thus far or explore any themes of interest to you in future newsletters.

Franco Agopyan (Editor) (franco.agopyan@chiomenti.net)

torna su

Director’s Duty During A Corporate Restructuring
As a result of the crisis that has recently hit the economy, various companies have had to resort to the restructuring of their indebtedness, also drawing upon various instruments made available subsequent to the recent reform to the bankruptcy law. During a restructuring, prior to taking any such measures, directors will have to carry out a series of actions whose main principles are set forth below.
Brief points of discussion regarding director liability
The obligations that the law places on directors can be generally divided into two main categories: (i) the specific obligations required under specific statutory rules (including, for example, the obligation to convene a shareholder meeting in order to cover losses and to verify and file with the registry of companies the occurrence of a mandatory liquidation event) or through the by-laws, and (ii) obligations related to the general duty of care and duty of loyalty.
Director’s liabilities to the company
Directors owe two fundamental duties to the company: (i) to perform with the degree of care required in relation to the nature of their mandate, in an informed manner and according to their expertise, and (ii) to pursue the company’s interest without conflict of interests. The duty of care is an abstract performance standard and must be evaluated on a case-by-case basis.
Director liability toward creditors of the company
The directors are liable to the company’s creditors where they have not abided by their duty to preserve the company’s assets, and, as a result of such failure, the company has insufficient assets to satisfy its creditors. In the event of a bankruptcy, the cause of action is brought forth by the bankruptcy administrator.
Additional sources of director liability
In addition, directors are potentially liable to individual shareholders or to third parties if they are directly damaged by the directors’ action.
State of crisis and directors’ duties; Actions taken in anticipation of the restructuring
There are no provisions in the Civil Code that impose specific or more stringent duties of care on directors in the event that the company is in a state of insolvency or crisis (except where the financial problems result in effecting the integrity of the share capital, reducing it by more than a third or below the legal minimum). However, it is undeniable that the state of financial tension or the potential insolvency of the company require that the directors act with due caution in undertaking any managerial act, also in light of a possible restructuring of the company.
Generally, it is useful that, prior to undertaking negotiations with creditors, directors place into effect certain preliminary measures that include, among other things, identifying:
•whether the company may be subject to bankruptcy, workout agreement with creditors or extraordinary administration proceedings;
•the reasons for the insolvency or the crisis;
•the current and prospective financial conditions of the company;
•the appropriate measures upon which to base any restructuring.
It is necessary that any directors’ evaluation regarding initiatives to adopt (eventually for the restructuring of the company’s assets and for the choice of the best means to adopt for such restructuring) is taken only upon the completion of an in-depth analysis of the company’s status, including its prospects, which should ideally be carried out with the assistance of outside consultants, including, among other things:
•the accuracy and reliability of the company’s accounts;
•the financial indebtedness and related contracts (paying particular regard to any termination provisions that are expressly based upon a state of insolvency;
•controls regarding the company’s net assets;
•verifications of intercompany transactions;
•verification of the availability of shareholders to inject new capital.
Until the establishing of a restructuring plan, it is generally advisable for the directors to abstain from carrying out extraordinary transactions. In addition, in this phase, where the state of financial distress become translated into a lack of liquidity the result of which means that not all of the creditors can be satisfied, the company must adopt particular safeguards for the payments to be carried out to creditors to avoid disparate repayment under the principle of “par condicio creditorum”. To accomplish this, it is in principle best not to make any payment or distribution to shareholders (including payments for services or under shareholder loans, to related parties, or, possibly, to creditor.
In such a phase, moreover, it tends on principle not to be advisable to incur new debt to the extent that such new debt could deepen insolvency.
It is in all instances generally advisable that the above-mentioned transactions are put into effect only upon the execution of a restructuring plan whose reasonableness is verifiable pursuant to Article 67, Paragraph 3 letter d) of the Bankruptcy Law, or in execution of a restructuring plan under Article 182 bis of the Bankruptcy Law or of a workout agreement with creditors.
Directors nominated by the Fund
With reference to the specific position of a director nominated by the funds, we point out that her duties are not different from those of any other director of a limited company. We wish also to withdraw your attention to Article 2391 of the Italian Civil Code, ruling the case of a director of a company limited by shares who is personally interested, either on her own account or on behalf of third parties (such as the Fund which designated such director), in a transaction involving the company, and Article 2475 ter of the Italian Civil Code, ruling the case of a director of a limited liability company having an interest conflicting with that of the company.
In particular, Article 2391 of the Italian Civil Code, provides that:
(i)if a director has a personal interest in a transaction (also if not necessarily conflicting but simply competing with the interest of the company), she must disclose it to the board of directors, and if she is also a managing director, she must abstain from carrying out the transaction deferring any relevant decision to the board of directors;
(ii)if the company is managed by a sole director, she must disclose the interest to the general shareholders’ meeting;
(iii)the board of directors’ resolution must properly explain the transaction’s reasons and convenience for the company.
It is important to point out that if the director fails to disclose her interest and/or the board of director resolution is not properly motivated than, (i) directors and statutory auditors will be entitled to challenge the board of directors’ resolution approved with the determining vote of the interested director; and (ii) the interested director will be liable for any damage caused to the company.
With reference to limited liability companies, the Italian Civil Code dictates a different provision: in case of a conflict of interest and not a simple interest (whether convergent or neutral), Article 2475 ter of the Italian Civil Code provides that directors and statutory auditors or external auditors (if any) may challenge the board of directors’ resolution approved with the determining vote of the interested director, whether such resolution causes a damage to the stockholders equity.
Whether there is a real position of interest’s conflict and the transaction performed in such context has involved a disposal of corporate assets aimed at providing to herself or third parties an unlawful benefit, the interested director may incur in criminal liability.
With particular reference to the position of the director elected by a Fund, who may be a stockholder or employee of the Fund’s management company, where the interests of the Fund is in conflict, or in case of a company limited by shares, where there is however an interest of the Fund, it is desirable, more so in the context of a debt restructuring transaction, that:
(i)director must always operate in the best interest of the company;
(ii)any board of directors’ resolution is properly motivated by highlighting the benefits in favour of the company arising from the transaction object of the resolution;
(iii)in case of companies limited by shares:
(a)director must promptly disclose her interest, providing all the relevant information about the existence of an interest, detailing the nature, reason, terms and conditions, and consequence;
(b)if the interested director is a managing director, the decision must be deferred to the collegiality of the board of the directors;
(iv)in case of limited liabilities companies: the decision regarding the transaction must be referred to the quotaholders’ meeting, in accordance with Article 2479 of the Italian Civil Code.
If the board of directors will be composed by directors elected by different funds, which have co-invested in the company, and they are holders of interests of such funds, in conflict with each other, the same rules shall apply to each of the directors.
Finally it should be noted that the practice has developed instruments to protect the position of directors who have been elected by funds, rectius of those directors who have been elected by a third party in respect to the companies that manage and they are holders of interest potentially conflicting with those of the company. It is practice that, together with the acceptance of the office, the director:
(i)enters into a so-called “D&O”,policy an insurance policy to hedge against the risk of claims for civil liability arising from the performance of the director’s duties;
(ii)Fund issues a so-called “indemnity letter”, pursuant to which the Fund undertakes to indemnify and hold harmless the director against any third party claim in relation to the performance of her duties.

Franco Agopyan (franco.agopyan@chiomenti.net)
Giulia Battaglia (giulia.battaglia@chiomenti.net)

torna su

Market practice for PEFs in the light of the financial turmoil
Oversight
The financial crisis we are assisting since August 2007 represents a challenge for private equity funds, non-institutional investors and banks to depart from conventional practice and seek new business solutions. The primary market is still suffering a lack of liquidity; banks were left with a huge amount of assets in their balance sheets, and were not able to transfer those assets in the secondary market.
Hedge funds and securitization vehicles were unable to purchase debt, as the structured product market had dried up. As a consequence, investors are seeking for more profitable investments, as the restructuring deals are. This market has boomed in the last two years and will be booming at least for the next years as the defaults are increasing because of the financial crisis and the global recession, despite the governments and the regulators are trying to define recovery measures. So, since the private equity funds have management expertise, good track record, relevant financial acknowledges and are not burdened by capital adequacy rules, their role shall become even more crucial in the recovery of the market, investing where they might expect good IRR.
With the following, we purport to explain the most suitable restructuring tools for the funds, the light of the best international market practice, having regard to the Italian practice too.
The tools
When a distressed company needs restructuring, there is no established process, because every restructuring is different. Among the tools used to restructure a distressed company, as waivers, standstill agreements, equity cures, covenants re-sets, some of them have recently become very popular.
1)Debt-buy-back
Debt-buy-back is carried out with a significant discount to par value in the secondary trading market, or it is purchased directly from original underwriting banks at a price below or close to par. Despite the concerns when the first debt-buy-back has occurred in the 2008, the London Market Association, legal practitioners and bankers favourably considered this practice to the extent that, when drafting the relevant documentation, it is carefully considered: a) the governing law permits buy-back, b) the applicable tax law provisions; and c) what are the insolvency implication with that. So, the PEFs were happy to repurchase junior debt tranches with an interesting yield and whose price is cheaper than the senior debt price. Lenders might be concerned to allow sponsors to purchase debt, because it means to allow it to be vested by the rights, duties and interests of both the equity investor and the debt investors. Also, lenders will feel more comfortable if they are granted of an option to sell their loan if certain trigger events occur, if a maximum cap on the amount loan purchasable is fixed, or it is limited or prohibited the exercise of the voting rights above a certain threshold of the debt.
In Italy debt-buy-back is not widely popular, as funds generally prefer different restructuring tools. Nevertheless, it is useful to mention the Regulation of the Bank of Italy as of 14 April 2005, Title V, Chapter IV, par. 6.2.1, following the EC Directive 2007/16/CE, stating that investment funds can purchase loans, directly or indirectly, up to the 60% of the value of their assets.
2)Liquidity driven restructurings
Liquidity driven restructuring is another important rescue tool provided to distressed companies which need further funds to restore a liquidity shortfall to support the liquid assets, when approaching debt maturity. As a new market practice, funds inject super-senior debt, while historically they were used to inject junior debt, as convertible debt, senior subordinated debt or private mezzanine securities. Super-senior debt ranks prior than any other form of debts, but lenders are happy with that, because the business receives a capital injection, but they do not increase their exposure, while funds are satisfied with a secured investment. On the other hand, liquidity injection is suitable only if the debt/equity ratio is not high, because the overall indebtedness is increased.
3)Debt-for-equity-swap
Debt for-equity-swap is a tool to facilitate the restructuring of the balance sheet of a company when the value breaks down, and the company is overleveraged. This option will occur when the debt is held among a restricted number of creditors with similar administrative rights.
Converting creditors need to be ensured of a number of issues in order to proceed with the subscription of the swap, such as: a) the company is not burdened by repayment obligations which might affect its performance; b) the converted equity may be configured as non-voting redeemable preference shares, as indicated according to article 2346 and following of the Italian Civil Code; d) conversion rights permit the holder to become a holder of ordinary shares to benefit in case they increase in value, while the holder of preference shares will seek to include redemption rights in the shares; e) warrants could be issued to enable different classes of creditors to subscribe to shares of different pricings or with different maturities.
Under the Italian legislation, debt-for-equity swap can be affected under article 160 (Concordato preventivo – scheme of arrangement) or article 182-bis (Accordi di ristrutturazione – restructuring agreement) of the Bankruptcy Law no. 267/1942.
However, as the market conditions are changed because of the crisis, private equity funds are looking for “loan to own” businesses, practice which spread out from the U.S. to Europe.
The acquisition of Countrywide by a pool of funds, as Oaktree or Apollo Management, on 9 May 2007, represents one of the first loans to own business. The value of the deal was £1,054 billions, financed by senior debt, revolving facilities, bonds, notes, stub equity and PIK option. Notwithstanding the real estate market collapsed, with negative effects on the cash flow of Countryside, the documentation allowed the lenders not to call the default. For this reason, funds were able to define a loan to own strategy, according to which the debt, either in the form of cash or bond/notes, has been converted in stakes, and the funds put in place a “buy and hold” strategy, allowing the company to carry out its business for an eventual disposal of their participation for a higher value.
Perspectives
The Italian legislator aimed to make more secure and attractive investments in the internal market for Italian and foreign funds. For this purpose, Bankruptcy Law was amended and art. 67 and 182 bis integrated, so that reconstruction and restructuring plans were introduced in the legislation, following the example of the US (Chapter 11 of the US Bankruptcy Code). Recently, the Italian legislator has enacted Law no. 122/2010, which provided for further amendments of the Bankruptcy Law, introducing article 182 quarter, pursuant to which any loan/facility granted to a distress company by banks or financial institutions, in compliance with a scheme of arrangement or a restructuring plan provided for articles 160 and 182bis, if validated, shall rank prior to the other credits.
Finally, the current market practice is due to the effects of the financial crisis that arose during the summer of 2007, and which seem to be logically decreasing, but are not yet ended. The above description of the tools means to be a picture of the current restructuring market practice as it was during 2010, which will evolve as the market itself evolves. Nevertheless, we can assume that, as the financial turmoil will continue, private equity funds may consider to carry out alternative strategies. Practitioners will structure loan-to-own deals, as well as covenant re-sets strategies, where the company has an effective business and financial plan, and the default, with respect to specific financial covenants, is temporary. On the other hand, liquidity injection will be carried out only if the company is not affected by a huge indebtedness. In the meantime, within the threshold set out by the Bank of Italy and if the secondary market will remain nervous, debt-buy-back deals could start to appear also on the Italian market.

Carola Antonini (carola.antonini@chiomenti.net)
Angelo Alfonso Speranza (angeloalfonso.speranza@chiomenti.net)

torna su

Recent amendments to the Bankruptcy Law in favour of composition and restructuring arrangements
Law Decree No. 78 of 31st May 2010, converted into law and amended by Law No. 122 of 30 July 2010 (the “Law Decree”), has introduced the following significant amendments to the Royal Decree No. 267 of 1942 (hereinafter referred to as the “Bankruptcy Law”) aimed to favor composition and restructuring arrangements and instruments provided for by the Bankruptcy Law.
(i)New provisions in relation to restructuring agreement
These new provisions provide that the prohibition on commencing or continuing interim or foreclosure proceedings against the debtors’ estate for creditors whose claims arise under a title preceding the filing of the restructuring agreement (for which a sixty day period starting on the date of filing of the restructuring agreement with the competent companies’ register was already provided for) may be requested during the negotiations of the restructuring agreement with creditors, filing with the competent court:
(a)the documentation to be provided for the filing of the petition of a pre-insolvency workout agreement with creditors (concordato preventivo);
(b)a restructuring agreement proposal together with a statement by the debtor certifying that at least the 60% of the creditors are negotiating such restructuring agreement proposal; and
(c)a statement by a professional, meeting the requirements provided for by article 67, paragraph 3, letter d) of the Bankruptcy Law, declaring that conditions are in place to assure the regular payment of those creditors either not participating in the negotiation of the restructuring agreement or who have declared their intention not to enter into the restructuring agreement.
The court, once it has determined that the requisite conditions exist for the entering into of a restructuring agreement with 60% of the creditors that will also allow regular payment of the creditors not party to said agreement, shall issue a ruling providing for the injunction against commencing or continuing interim or foreclosure proceedings against the debtors’ estate, providing the debtor with a deadline of sixty days from the issuance of the court’s ruling for the filing of the agreed upon restructuring agreement and the expert’s report regarding its feasibility.
The amendments introduced by the Law Decree in article 182-bis allows the entrepreneur to benefit from the prohibition of interim and foreclosure proceedings before the execution of the restructuring agreement. Such benefit may be particularly useful where the relationship with financial or commercial counterparties is particularly strained due to the financial distress of the company
(ii)New provisions in relation to new money granted in the context of debts restructuring transactions, even if granted by shareholders
Pursuant to the new provisions, claims arising under loans that have been granted by banks or financial intermediaries with respect to either the implementation of a court-ratified pre-insolvency workout agreement with creditors (concordato preventivo) or a court-ratified restructuring agreement pursuant to article 182-bis of the Bankruptcy Law are deemed super-senior (prededucibili) under article 111 of the Bankruptcy Law. Super seniority also applies to claims arising under loans provided by banks and authorized financial intermediaries in anticipation of a filed application for pre-insolvency workout agreement with creditors (concordato preventivo) or the application for the ratification of a restructuring agreement pursuant to article 182-bis, but only if: (i) the loans fall within either the plan underlying the pre-insolvency workout agreement (concordato preventivo) or the restructuring agreement and (ii) the court subsequently ratifies the pre-insolvency workout agreement or the restructuring agreement.
It is further provided that, like loans advanced by banks and authorised financial intermediaries, super-seniority is granted in claims for repayment of 80% of the nominal value of those shareholder loans that have been granted to the company in implementation of a court-ratified pre-insolvency workout agreement (concordato preventivo) with creditors or a court-ratified restructuring agreements pursuant to article 182-bis of the Bankruptcy Law.
The priority granted to such shareholder loans -i.e. the right to be paid in priority to the other creditors- expressly marks a deviation from articles 2467 and 2497-quinquies of the Italian civil code. Said provisions provide for the statutory subordination of loans granted to limited liability companies by its shareholders (according to certain authors such provisions applies also to companies limited by shares) or by either entities that exercise direction and coordination activities or entities subject to direction and coordination activity of the same person, if such loan was made available when the company was not in a financially balanced position or when an equity injection would have been more reasonable.
In order for such loans to benefit from superseniority, said loans shall be expressly contemplated by the plan underlying the pre-insolvency workout agreement (concordato preventivo) with creditors or the restructuring agreements.
Differently from the loans granted by banks and financial intermediaries, shareholders’ loans benefit from the superseniority only if granted in implementation of a court-ratified pre-insolvency workout agreement (concordato preventivo) with creditors or a court-ratified restructuring agreement. Such superseniority is not granted to shareholders’ loans made available in anticipation of a filed application for pre-insolvency workout agreement (concordato preventivo) with creditors or the application for the ratification of a restructuring agreement.
These new provisions are clearly aimed to incentivize the granting of new loans (also by shareholders) in the context of pre-insolvency workout agreements (concordato preventivo) with creditors.
(iii)New provisions in relation to certain bankruptcy crimes (bancarotta)
The Law Decree has introduced new article 217-bis of the Bankruptcy Law, according to which the provisions regarding preferential bankruptcy (bancarotta preferenziale) (article 216, third paragraph of the Bankruptcy Law) and simple bankruptcy (bancarotta semplice) (article 217 of the Bankruptcy Law) does not apply to payments and transactions carried out to implement a pre-insolvency workout agreement (concordato preventivo) with creditors, a restructuring agreement or a restructuring plan pursuant article 67, third paragraph, letter d) of the Bankruptcy Law.
These new provisions – which mitigate the risk of criminal liability in the context of restructuring transactions – constitute a strong incentive in favour of composition and restructuring arrangements and instruments provided for by the Bankruptcy Law.

Carmelo Raimondo (carmelo.raimondo@chiomenti.net)
Antonio Tavella (antonio.tavella@chiomenti.net)

torna su

Tax Authority guidelines on the application of the Controlled Foreign Companies rules (Art. 167 “ITC”). The Ministerial Circular No. 51/E, 6 October 2010
Introduction
Article 13 of Law Decree No. 78/2009 introduced several amendments to article 167 of the Italian Tax Code (“ITC”) setting out the so called Controlled Foreign Companies regime.
First of all, in order to avoid the application of the CFC rules through the business test exemption (art. 167 par. 5 lett. a), it is necessary to demonstrate that the foreign company mainly carries out an actual commercial activity within the market of the State where it is established.
Secondly, a new paragraph (5-bis), relating to foreign companies having more than 50% of their profits deriving from passive income, came into force. With reference to these companies, the business test exemption has now been tightened.
Finally, the Decree also extended the CFC definition to subsidiaries not included in the Italian black-list if the following two conditions are met: (i) the effective taxation of the controlled foreign company is 50% lower than the Italian taxation on the same income, and (ii) the foreign company derives more than 50% of its proceeds from “passive income” or intra-group activities.
The aforementioned provision does not apply where the Italian taxpayer is able to prove to the Tax Authority that the CFC’s establishment is not a mere artificial arrangement aimed at achieving an undue fiscal advantage.
Regarding the regime at stake, some considerations provided by the Circular Letter No. 51/E are discussed below.
1.Changes to the first exemption
1.1Paragraph 5
According to the first exemption laid down under article 167 of the Italian Tax Code, the income derived by the CFC entity is not taxed by transparency in the hands of the resident controlling entity if: ”the foreign company mainly carries out an actual commercial activity within the market of the State in which it is established. Banks and insurance companies satisfy this requirement if the majority of their resources and investments are derived from the local market”.
Pursuant to the new CFC rules, Italian taxpayers intending to invoke the first exception are now required to prove that the business activity carried out by the CFC is connected with the local market and an adequate organisational structure is located therein. These two conditions must be met jointly. In the light of the new provisions, there shall be demonstrated that the entity “has the intention to participate, in a permanent and continuous way, to the economic life of the foreign country”.
The foreign company shall essentially carry out an activity towards local customers or suppliers - the so-called CFC area of influence, it has been clarified, though, that this area is not necessarily comprised within the boundaries of the state or territory where the CFC is located but, on the contrary, it is extended to the contiguous geographic area connected to the CFC state by means of economic, political, geographic or strategic links.
Special rules are provided for companies that carry out banking, financial or insurance activities. With reference to these subjects, the business test is considered fulfilled when the majority of “sources, investments or profits” originates in the State or territory where such activities are established. For example, for an insurance company there shall be considered as relevant the place of residence of the insured clients or the place where the risks are located. If these conditions are not met, the Italian Tax authority can evaluate further elements in order to determine the existence of a linkage of the company at stake to the foreign market.
1.2The new paragraph 5-bis
According to the new provisions set forth by paragraph 5-bis, the first exemption may not be claimed where more than 50% of the profits realised by the foreign company are constituted of passive income, i.e., they are derived in connection with one the following sources: (i) the management and holding of securities, shares, credit instruments or other financial activities; (ii) the transfer or licensing of intellectual property rights of industrial, literary or artistic nature; or (iii) the rendering of services (including financial services) to related entities.
1.2.1Entity without business
As mentioned earlier, the new rules provide that the first exemption may not be claimed in case of a CFC with more than 50% passive income. This provision targets the so-called “shell companies” or passive investment companies.
In accordance with EU law principles, the Circular letter clarifies that Italian parent company may supersede this presumption by filing an advance tax ruling under the first exception and by additionally proving the absence of any tax avoidance purpose. The Italian Tax authority may take into account the circumstance that the passive investment strategy constitutes the core business of the company at stake.
1.2.1The 50% threshold
It has been clarified that, in order to apply the par. 5-bis, the test concerning the quantitative limits shall be conducted on a year-by-year basis. All the gross profit earned by the CFC shall be considered.
2.The second exemption
The provision set forth by article 167 par. 5 lett.b) was not modified by the Law Decree No. 79/2008.
Notwithstanding this, the Circular letter No. 51/E provides some clarifications in respect of pre-existing aspects of the CFC regime.
In particular, the Italian parent company may lift the application of the CFC rules by proving that the participation in the CFC does not result in the allocation of income to a black-list country. Regulations implementing the CFC rules (Ministerial Decree No. 429 dated 21 November 2001) state that the second exemption requirement is specifically met when it is proved that at least 75% of the CFC income is derived in a non-black-list country which does not allow an effective exchange of information.
This scenario may happen, for example, in case of:
•The CFC earns its income through a permanent establishment located in a white-list country and therein subject to an ordinary level of taxation;
•The CFC income derives from the ownership of assets in white-list jurisdictions;
•The CFC has its tax residence in a white-list country and is ordinarily taxed therein;
The guidelines provided by the Italian Tax authority clarifies that the scenarios mentioned in the implementing regulations are mere examples and that, in general, the second exemption test may also be met by considering the overall tax burden of the group whom the CFC pertains to. Specifically, one should be able to prove that the global effective tax rate on the CFC income is adequate where compared to the Italian effective tax rate.
In addition, the taxpayer shall also demonstrate, by providing adequate documentation, that the profits earned at the CFC level are systematically distributed.
3.Extension of the CFC regime to companies located in white-list countries
Law Decree No. 78/2009 extended the CFC rules set forth by article 167 to foreign subsidiaries resident in white-list countries by introducing the paragraphs 8-bis and 8-ter.
The provision of the paragraph 8-bis applies where both the following conditions are met:
•The effective CFC rate of taxation is less than 50% of the tax rate that would be applicable if the company was resident in Italy; and
•The CFC has more than 50% passive income as defined in paragraph 5-bis (see above).
Even if the aforementioned circumstances are both met, the taxpayer may avoid the application of the CFC rules by submitting a preliminary ruling to the Italian Tax authority. This procedure constitutes the exclusive way in order to prove that the structure at stake was not a wholly artificial arrangement created for tax avoidance purposes.
3.1 Effective tax rate lower than 50% of the Italian hypothetical burden
The Circular letter No. 51/E provides some clarifications as to how to compare the effective tax burden of the foreign corporation with the hypothetical Italian one. It is specified that the following taxes shall be taken into account:
•In case a Convention to avoid double taxation is in force, the comparison shall be made considering all the taxes which the Convention applies to;
•In case no Convention has been entered, the hypothetical Italian tax burden shall comprise the corporate income tax (IRES “Imposta sui redditi delle società”) and the relating local surcharges. For the effective foreign tax burden purposes, it shall be considered only the income taxes with no regards to the collection agent (i.e., local taxes shall be included).
The effective foreign tax rate shall be determined as a ratio between the tax burden relating to the taxable income and the gross profit as resulting from the financial statements drawn up according to the local rules of the Country where the CFC is established. It is worth mentioning that:
•In order to calculate the rate at stake, only the current taxes shall be considered;
•In case the CFC entered into a foreign tax consolidation scheme, the only taxes that will be considered are those levied on the CFC itself with no regard to the global tax burden of the group;
•Foreign tax credits and withholding tax payments previously deducted shall not be considered;
•Eventual tax reductions granted to the taxpayer (e.g., according to international rulings or pricing arrangements) shall be taken into consideration;
•Eventual tax exemptions granted to the shareholders of the company shall be considered;
The effective domestic tax rate shall be determined starting from the financial statements of the subsidiary drawn up according to the local rules of the Country of establishment.
In addition to the considerations previously stated for the effective foreign tax rate, which apply also to the effective domestic one, it is worth mentioning that:
•The value for accounting purposes attributed to the assets of the CFC shall be the one relating to the taxable period previous to that in which the comparison is made;
•Depreciations, amortization and provisions shall not be deducted in any case;
•Tax losses, determined according to the abovementioned provisions, may be carried forward according to the ordinary rules provided by art. 84 of the Italian Tax Code.
3.2Tax ruling, paragraph 8-ter
In line with the criteria set forth by the ECJ in the Cadbury-Schweppes case (C-197/04), the Italian tax legislator issued a new provision, laid down by par. 8-ter, according to which the CFC regime shall not apply in case the foreign entity does not represent an artificial structure aimed at achieving an undue tax advantage. The guidelines provided by the Italian Tax authority clarify that the taxpayer may prove the substance of the structure by considering all the EU legislation principles relating to the concept of “artificial structure”.
4.Black-list dividends
Article 47 par. 4 and article 89 par. 3 of the Italian Tax Code set forth the tax regime applicable to dividends received by individuals deriving from companies or entities located in black-list countries.
The abovementioned provisions do not apply where:
•The income derived by the CFC entity is taxed by transparency in the hands of the resident taxpayer according to art. 167 ITA; dividends received are exempt from taxation up to the income previously attributed (art. 167 par. 7)
•The Italian taxpayer, through the submission of the ruling to the Italian Tax authority (art. 167 par. 5 lett.b), demonstrates that the participation in the CFC has not the effect of localizing the income in black-list countries since the beginning of the holding period of the participation at stake.
4.1Taxation of dividends distributed by European conduit subsidiaries, deriving from black-list countries.
The tax regime at stake also applies if the black-list subsidiary is held indirectly, through a participation in a European entity (European Conduit).
According to EU law principles, the regime set forth by art. 89 par. 3, setting out the full taxation of the dividends, may not be applied if it is proven, through an advance ruling, that the participation in the foreign entity does not achieve the localization of income in black-list countries. This exemption shall be demonstrated on a case-by-case basis with respect to the European precedents pursuant to which, in order to assess if the operation that a taxpayer carries out is effectively aimed at achieving an undue tax advantage, the competent Tax authorities shall conduct, in any case, a global analysis of the operations at stake.
In case the foreign parent company receives dividends deriving from both black-list and white-list countries, it is necessary to track the origins of such dividends, with the support of adequate documentation.

Massimo Antonini (massimo.antonini@chiomenti.net)
Raul Papotti (raul.papotti@chiomenti.net)

torna su

Updating on the iter of the adoption of the Directive in the field of the management of alternative investment funds
On 19 October 2010, during the Council ECOFIN the Ministers of finance, reached an agreement on the disputed Draft Directive concerning the management of the hedge funds and of the other alternative investment funds, the so-called “AIFM Directive” (“Alternative Investment Fund Managers”) (“Draft Directive”), aimed at (i) developing an internal European market for the managers of alternative investment funds through the creation of an harmonised regulatory framework which monitors and supervises the activities of such managers within the European Union, irrespective of whether that they are established inside the EU or not; (ii) fixing the rules for authorization, management, administration and transparency of the managers of alternative investment funds; and (iii) complying with the commitments undertaken by EU at the July 2010 G-20 Summit in Pittsburgh ,with reference to the actions that must be undertaken in order to protect the interests of the investors by means of a stricter control of the activities of the managers of alternative investment funds.
On 27 October 2010, during the “trialogue meeting”, the European Parliament, the European Commission and the Member States of the EU approved the Draft Directive, with some minor amendments.
Therefore, on 11 November 2010, the draft was submitted to the plenary session of European Parliament which adopted a final text that the European Council should formally approve in order to complete the iter for the adoption of the AIFM Directive. The AIFM Directive should entry into force at the beginning of 2011 with the obligation for the Member States to implement it by the beginning of 2013.
The Draft Directive is essentially based on the compromise proposal presented on 15 October 2010 by the Belgian Presidency of the Council of European Union that aimed to find an agreement on some crucial questions (regarding, in particular, the obtainment of the European passport by the managers of alternative investments fund of third countries and the rules for the circulation of alternative investment funds established outside the EU, the scope of the Directive, the functions of the depository, the transparency obligation and the limits and the control of the leverage) that, in more than 18 months of debate both between institutions and between Member States, represented the most disputed issues on the content of the future rules.
In particularly, the Draft Directive:
•introduces the so-called “passport”, which will allow the managers of the alternative investment funds that will comply with the rules and with the requirements provided by the Draft Directive to market their services throughout the EU on the basis of a single authorisation (which may be obtained from each Member State). For the EU managers which market EU alternative investment funds, the passport system will entry into force already in 2013, when the AIFM Directive will have to be transposed by the Member States (so called “European passport”). On the other hand, managers of non-EU alternative investment funds which manage and market within the EU and EU managers which manage non-EU alternative investment funds will be entitled to receive the passport only from 2015, i.e. after a transition period of two years during which the national regimes of each Member States will still apply. Once this period has elapsed, for a further transition period of three years the harmonised regime of the European passport will coexist with the national regimes of the Member States, that will have to respect specific conditions of minimum harmonisation. Once such period of coexistence has elapsed, it has foreseen that the national regimes will be repealed.
•with specific reference to the scope of the Directive, provides a “de minimis” dimensional threshold that is balanced by a proportionality principle aimed at tailoring the provisions to smaller managers. Pursuant to Article 2 of the Draft Directive, indeed, the managers of alternative investment funds whose assets under management, including any assets acquired through use of leverage, in total do not exceed a threshold of 100 million Euro or 500 million Euros (when the portfolio includes funds which are not leveraged and which do not grant redemption rights exercisable during a period of 5 years following the date of constitution of each fund) are subject to an “ad hoc” supervisory regime under which they will need register by the national authorities and will have to comply the minimum criteria of transparency provided by the Draft Directive. Furthermore, the Draft directive provides an “opt in” system, according to which such managers will be granted the benefits and the passport system if they decide to adhere to and fully comply with the regime of the Directive;
•imposes to the managers of alternative investment funds the appointment of a qualified and independent depositary in charge of the control of the activities of the fund, of the cash flows and of the related assets. Furthermore, the depositary shall be liable vis-à-vis the investors for any damages suffered by them due to the losses of financial instruments managed for the fund. Further, in order to protect the interests of the investors, the Draft Directive establishes in a detailed way the features of the depositary and the circumstances in which is possible to delegate the functions of depositary to a sub-depository;
•imposes to the managers of the alternative investment funds strict obligations of transparency, aimed at ensuring that the investors receive full and complete information on the activities of the fund and the management of the related risks. In particular, the managers of the alternative investment funds must regularly provide information over the results and the management of the risks, together with a clear description of the policy of the investment;
•introduces limits on the use of the leverage and imposes obligations of communication to the managers which substantially recur to the leverage, vis-à-vis both the investors and the competent authorities of the home Member State. In particular, the manager will have to prove that the limits of the leverage which are fixed for each fund that he managed are reasonable and that he permanently respects such limits. Moreover, the competent authorities will identify the extent to which the use of leverage by the managers of the alternative investment funds contributes to the build-up of systemic risk in the financial system or risks of disorderly markets. If it is necessary in order to insure the stability and integrity of the financial system, the competent authority of the home Member State of the manager – after notifying to the European Authority of Financial Markets (“ESMA”), to the European Systemic Risk Board (“ESRB”) and, if it is required, to the competent authorities of other Member States directly concerned – may impose limits on the level of leverage that the manager can employ;
•introduces measures aimed at limiting the practice of asset stripping, restricting the distribution and the reduction of capitals in the two first years after the purchasing of a company by a manager of an alternative fund investment. The aim is to avoid that the managers of the alternative funds investment decide to acquire the control of a company with the only purpose to realise an immediate profit, by means of the so-called “asset stripping”;
•gives to ESMA and to ESRB an active role in the implementation of the regular framework of control and supervision established by the new rules, in order to promote a consistent application of the new rules within the EU, facilitating the European passport system both for EU and non-EU managers of alternative investment funds and coordinating the activity of the national authorities.
The European Commission welcomed the adoption by the European Parliament of the Draft Directive that, in its opinion, has maintained unchanged the objectives and the structure of the Commission’s proposal.
In particular, Commissioner Barnier said that the agreement on the text of the Draft Directive is the first step toward a more stable and secure financial system in Europe, given that the entry into force of the AIFM Directive will increase transparency, reinforce investor protection and strengthen the internal market in a responsible and non-discriminatory manner.
President Barroso underlined that the adoption of the Draft Directive by the Parliament - which coincides with the G20 Summit meeting in Seoul - is another example of how the EU is leading the way in implementing the commitments adopted within the G20.

Stefania Bariatti (stefania.bariatti@chiomenti.net)
Adele Sodano (adele.sodano@chiomenti.net)

torna su