Newsletter Private Equity - 6/2011 EN

Preface
This new issue of our newsletter begins with a brief overview of the state of health of the private equity industry, providing some flash, data and comments on major market trends in Italy and internationally.
We open our discussions with a presentation of the main changes introduced by Decree Law no 112/2008 on the transfer of shares in a limited liability companies.
We then would like to share some ideas on the process of listing of the SPAC and the institution of the trust.
There is also a brief note on the judgement No 16605 of July 15, 2010 in which the Supreme Court intervened on identifying the legal nature of the mutual fund.

We bring this issue to a close with three articles on tax matters. The first one deals with the latest main provisions on real estate funds. The second note summarise the clarifications provided by the Internal Revenue Service in relation to tax incentives to management. The last article contains some brief reflections on the deductibility of passive interest in leveraged buyouts.
As always, we hope that our newsletter will be of interest to you and offer some food for thought. We are of course available for any further information on the topics we have discussed thus far, and we remind you that any suggestion is welcome on other topics to be covered in future issues.

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

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Editorial: a brief overview on the state of health of the private equity industry
Below is a brief overview of market trends in 2010 and some related thoughts..
1. General considerations: It is a shared opinion among GPs that, contrary to some negative forecasts made in the midst of the post-Lehman crisis, private equity industry has demonstrated the ability to confront and successfully overcome the recession. After two years of very bad trends, 2010 marked a turnaround in investments. Much has changed however in the industry, particularly in terms of (i) lower leverage and greater equity contributions, (ii) focus on value creation at the operational level of portfolio companies, and (iii) holding periods generally longer than in the past.
2. Investments: As far as investments are concerned, 2010 marked a strong recovery, recording a global increase by 40% approx. in terms of number of transactions and 130% in volumes compared to 2009. Given the enormous amount of cash (so-called “dry powder”) available to funds for new investments (estimated in an amount of approx. one trillion dollars, of which approximately 25% allocated to Europe) and the pressure felt by GPs to deploy capital within the next two/three years, GPs are optimistic for a recovery of the market even more pronounced in the coming years.
3. Leverage: The use of leverage is a will probably continue to be greatly reduced compared to the past, registering (i) an average multiple of senior debt to EBITDA of 3.5 to 4.0 x and (ii) greater use of equity contribution from sponsors (40-50%).
4. Exit: Exits carried out in 2010 were about double compared to those carried out during 2009 and their total value was even greater. Considering the fact that many of these investments have been made by funds raised between 2004 and 2005 (which, therefore, unless an extension has been agreed upon by the investors, are approaching maturity) and the appetite of GPs to return to make capital distributions to their investors, we expect a strong recovery of exits for the years to come. In addition to the traditional secondary buyouts (sponsor-to-sponsor), we expect a great return on the market of strategic buyers which now have cash available to make new investments and an increased presence of Chinese and Indian investors in the European market. With the revival of the IPO market, we also expect an increase of “dual track” transactions.
5. Fund raising : despite a slight recovery compared to 2009, 2010 has continued to be affected in a significant way by the post-Lehman crisis. For the next few years, GPs expect the majority of their LPs to maintain or even increase their own allocation to private equity but also a higher selection from investors and investment managers (both in terms of due diligence and in terms of negotiation on fees and fund rules).
6. Restructuring : we expect that the refinancing and restructuring of the debt will continue throughout 2011. There is still concern, in particular, that the financing of mega-deals which have been completed at the market peak in 2006-2007 (which will mature starting from 2012 onwards) will have to be most probably refinanced. This implies, of course, the erosion of the equity value of PE investments.

Franco Agopyan
(franco.agopyan@chiomenti.net)
 

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Transfer of quotas of limited liability company1 pursuant to article no. 36, paragraph 1-bis of the Law Decree no. 112/2008 and notary authentication
Law Decree dated June 25, 2008 no. 112, converted into law, with amendments, by Law dated August 6, 2008 no. 133 ("Decree 112/2008") introduced an important change concerning the transfer of quotas of limited liability company.
Specifically, article no. 36, paragraph 1-bis of Decree 112/2008 provides as follows: "The deed of transfer provided under article 2470, second paragraph, of the Italian Civil Code can be executed by means of digital signature pursuant to the applicable law and regulations concerning the signing of the documents on electronic form, and it has been filed by a certified intermediary ("intermediario abilitato"), pursuant to article 31, paragraph 2-quater, of the Law dated November 24, 2000, no. 340, within thirty days, at the relevant Companies Register where the company has its registered office ".
Before such amendment, under Italian Law the sole way to transfer the quotas of a limited liability company was the execution of a deed authenticated by a Notary Public and filed by the latter at the Companies Register where the company has its registered office, pursuant to the procedure set forth by article 2470, second paragraph, of the Italian Civil Code ("ICC").
The provision introduced by Decree 112/2008 provides that the deed whereby the ownership of the quotas of a limited liability company is transferred can be also executed by the parties by means of digital signature, in accordance with the applicable law concerning the signing of the documents on electronic form. In such a case, the applicable law authorized those persons registered at the roll of the accountants (commercialisti), chartered accountants (ragionieri) and qualified accountants (periti commerciali) (well know, under Italian Law, as certified intermediary ("intermediario abilitato")), which owned the digital signature system, to file, within thirty days, the deed of transfer on electronic form at the relevant Companies Register where the company has its registered office, as provided for the Notary Public by article 2470 of the ICC.
Based on the aforementioned regulations (article 36, paragraph 1 bis Decree 112/2008 and article 2470 of the ICC) the deed of transfer of the quotas of a limited liability company should be drafted, alternatively:
i) on paper form with the parties’ signature, or
ii) on electronic form with the parties’ signature through the digital execution.
In the case under point (i) above, article 2470 of the ICC shall apply and, for the effect, the deed shall be filed at the Companies Register only by the Notary Public who has authenticated the parties’ signature.
Under point (ii) above, the deed of transfer shall be filed by the certified intermediary (“intermediario abilitato”).
We would like to point out that such new regulations have been interpreted by the decisions issued by the Court of the Companies Register (Giudice del Registro delle Imprese) of Vicenza (decisions no. 2498/2009 and 3817/2009, as referred by the opinion rendered on July 31, 2010 by the Court of the Companies Register (Giudice del Registro delle Imprese) of Grosseto) whereby it has been ordered the cancellation by the Companies Register of the recording of the deed of transfer of quotas of limited liability company executed by means of electric form – without the notarial from - pursuant to the procedure set forth by article 36, paragraph 1-bis of Decree 112/2008.
With the above decisions, the Court of the Companies Register (Giudice del Registro delle Imprese) of Vicenza pointed out that the procedure set forth by article 36, paragraph 1-bis, is not an autonomous process, since the notarial form of a deed of transfer is still required for its recording in the Companies Register. Therefore, pursuant to such decision, in order to register the deed of transfer at the Companies Register, and, for the effect, to make it effective with respect to third parties, the parties’ signature needs to be authenticated by a Notary Public.
Such decision is based on the assumption that article 36, paragraph 1-bis of Decree 112/2008 - providing that the deed of transfer can be executed by the parties by means of digital signature - makes reference to the Digital Administration Code (Codice dell’Amministrazione digitale) (Legislative Decree March 7, 2005 no. 82, “DAC”) which provides two types of digital signature: simple (article 24 DAC) and notarized (article 25 DAC). Pursuant to the Court’s opinion if the new procedure provided under article 36, paragraph 1-bis of Decree 112/2008 had referred to the simple digital signature without the notarial form, it would have contained the formula “in derogation of article 2470”.
The Court also asserted that the presence of the Notary Public is necessary to guarantee the identity of the parties, their capacity and power to act as well as their will and, generally, to check the legal requirements of the deed of transfer for its recording at the Companies Register.
In contrast, if the procedure provided under article 36 paragraph 1-bis of Decree 112/2008 is an autonomous process, the certified intermediary (intermediario abilitato) should not be obliged to carry out the above checks, which would remain unfulfilled if the recording in the Companies Register of a deed executed not in notarial form should be admitted.
Consequently, the completion of a transfer of quotas only with the presence of a certified intermediary (intermediario abilitato) would provide less guarantees of truthfulness and it would be against the principle of authenticity of the documents subject to the recording at the Companies Register.
Pursuant to Court’s opinion, article 36, paragraph 1-bis of Decree 112/2008, is a standard rule which introduces the option to transfer the quotas through the execution of the relevant deed by means of the digital signature but which does not exclude the notarization of such signature in accordance with article 25 DAC. Therefore such rule introduces a complex system pursuant to which the parties, following the drafting of the deed (on paper or on electronic form), with or without the assistance of the relevant consultants, have to obtain the notarization of their signature by the Notary Public. Once obtained a certified copy of such deed on electronic form by the notary public, they could request to the certified intermediary (intermediario abilitato) to file the deed of transfer at the Companies Register.
On such point, it is noted that the National Council of the accounting experts (Consiglio Nazionale dei dottori commercialisti e degli esperti contabili) issued an opinion, reaching the opposite conclusion than the Court, believing that, based on a different interpretation of the new regulations, the procedure set forth under article 36, paragraph 1-bis is a perfect alternative to the one provided under article 2470 of the ICC and, for the effect, it does not require the notarization of the digital signature.
In light of the various positions assumed by the court, on one hand, and by some authors and professional associations, on the other hand, it is possible that a new legislation would clarify if article 36, paragraph 1 bis, gives rise to a new and independent alternative procedure than that provided under article 2470 of the ICC.
Pending such clarifications, the presence of the Notary Public remains essential in order to avoid possible subsequent non-recording or cancellation of the deed by the Companies Register and, for the effect, the ineffectiveness of the relevant transfer.
Filippo Modulo
(filippo.modulo@chiomenti.net)
Luca De Matteis
(luca.dematteis@chiomenti.net)

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The listing of the SPAC and the institute of trust
The SPAC (Special Purposes Acquisition Companies) are companies which are designed to be listed for the sole purpose of acquiring or merging with the operating companies (business combination), by using the proceeds derived from the subscription of the securities issued by the SPAC in the context of the listing.
The listing process
The listing of a SPAC usually takes place with the issuance of financial instruments (consisting of shares and warrants) which are placed on the market with a view to being acquired and (less frequently) exchanged by the investors. The proceeds raised from the subscription of such financial instruments are deposited into a blocked bank account (escrow account) or (as the practice of the SPAC with shares listed on regulated markets in the U.S. has shown) in a bank account established by a trustee appointed by the SPAC pursuant to a specific agreement (investment management and trust agreement). To the extent provided for by this agreement, the amounts so deposited are then invested in low-risk securities of prompt liquidation, thus making sure repayment to the investors of at least the principal amount of such securities.
Once listed, the SPAC usually has a period of time (from 12 to 18 months) to select an operating company to be acquired (target company) and enter into with such company or its shareholders a letter of intent setting forth the main terms of the business combination, and about 24 months to complete the transaction that will be financed through the cash paid by investors and deposited in the current account.
Once the operating company has been selected, the shareholders are solicited to approve the transaction based on the documentation (i.e. proxy statement) as prepared to illustrate the main terms and conditions of the transaction and, therefore, to allow the informed exercise of the voting right. The completion of the transaction is subject to approval by a certain majority of shareholders pursuant to the by-laws of the SPAC.
Shareholders may vote in favor of the transaction (thus benefiting from the proceeds of the sale) or, alternatively, against it by exercising their redemption right attaching to the shares owned by them (thus receiving back the sum initially deposited in the trust account plus any accrued interest thereon and proceeds derived from the investment of cash). However, the investors are free to sell the financial instruments subscribed by them prior to the approval of the business combination by the shareholders’ meeting.
Usually the directors of the SPAC buy securities issued by it prior to listing by investing an amount (ranging from 2% to 5% of the proceeds derived from the placement of the aggregate financial instruments issued by the SPAC) designed to be deposited in the trust account in order for it to become part of such account and be subject to any relevant use.
The role of the trust
From a survey carried out on the SPAC in the U.S. and European market it appears that the institution of the trust plays a central role in the listing and, therefore, is often preferred by GPs to the simple deposit in an escrow account. This for two reasons. First, the deposit of the amounts on a bank account opened in the name of the trustee affords the SPAC great flexibility in using such amounts for the purposes of the business combination, provided that investors vote in favor of the transaction. Second, a bank account opened in the name of the trustee allows the SPAC to segregate any amount held therein from the other assets of the SPAC until completion of the business combination.
The agreement (or the other instrument) establishing the trust is normally entered into between the SPAC and the trustee at the time of listing of the securities issued by the SPAC. Recitals of such agreement expressly set out the role of the trust account (being the account in which the money paid by the underwriters of the securities is to be deposited and then invested) and the services to be rendered by the trustee. The trust agreement basically governs the following three aspects: (i) the transfer to the trustee of the proceeds received by the SPAC as a result of the listing of the securities, (ii) the investment of such proceeds by the trustee upon instructions of the SPAC; the trustee would be required to invest and reinvest the amount from time to time deposited in the bank account into financial instruments of the kind agreed upon by the parties (all proceeds derived from such financial instruments shall then be deposited in the trust account and be part of the trust property), (iii) the release by the trustee to the investors or the SPAC of the trust property (as possibly increased further to its investment).
The final distribution of the trust property presents the most delicate aspects of the institute. The liquidation of the trust account may only take place upon receiving by the trustee of a notice to that effect sent by the SPAC (termination notice), pursuant to which the SPAC may notify the trustee of: (i) the imminent completion of the business combination within a certain final term; the SPAC may anticipate providing a separate notice to the trustee setting forth (a) the names of the investors who have approved the transaction and whose investment will be used for the completion of the transaction, and (b) the names of the investors who have not approved the transaction and, therefore, will be entitled to receive back the sums initially paid by them which have been deposited in the trust account, or (ii) the impossibility to achieve a business combination within the agreed final term; the SPAC may anticipate providing a separate notice to the trustee setting forth the actions required to effect the liquidation of the trust account in favor of the investors.
The trust will cease when the trustee will have completed the liquidation of the trust account in accordance with the trust agreement and the termination notice. Any failure to provide a termination notice to the trustee within a given date subsequent to the final term agreed upon by the parties for the completion of the transaction would authorize the trustee to terminate the trust by depositing the trust property with the competent court.
The responsibility of the trustee
Usually, under the agreement establishing the trust, the trustee disclaims any liability for damages arising out of acts (or omissions) on the part of the trustee carried out in performing the tasks assigned to it, save for acts or omissions constituting fraud or gross negligence as finally determined by the court. To protect his position, the trustee may request in writing to the SPAC any instructions as deemed appropriate for the conduct of its activities, possibly indicating the specific actions it intends to take and the deadline within which to provide such instructions. In the absence of any indication by the SPAC within the deadline, the trustee may act (in accordance with the provisions of the trust agreement) without the consent of the SPAC thus avoiding incurring any liability.
In fact, as suggested by the practice followed by the GPs, the trustee is afforded no discretion in performing the tasks assigned to it under the trust agreement. The activities of the trustee is always somewhat constrained, with little room to exercise discretionary powers, especially with respect to how to invest the money held in trust. In essence, the practice records about a compromise solution such that the trustee may receive full exemption from liability provided that it limits to perform its activities in accordance with the instructions received from the SPAC.
Finally, a few thoughts on the mechanism usually set out in the trust agreements to deal with the resignation and removal of the trustee. Under such agreements the trustee is almost always granted the right to withdraw at any time (resignation) by serving a written notice to the SPAC. To protect the interests of investors (which are the ultimate beneficiaries of the services rendered by the trsutee), the trust may be revoked by the SPAC only in case of breach by the trustee of its obligations set out in the trust agreement.

Franco Agopyan
(franco.agopyan@chiomenti.net)
Michele Cera
(michele.cera@chiomenti.net)

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Recent court decisions on the legal nature of the mutual fund
On July 15, 2010, with judgment no. 16605, the Supreme Court has ruled for the first time on the matter of the identification of the legal type of an investment fund (“Fund”).
The Supreme Court has stated, based upon the definition set forth in Article 1, first paragraph, letter (j) of the Legislative Decree no. 58/98 (“TUF”), that the Fund represents a separate pool (patrimonio separato) set up by a management company (“SGR”) rather than an independent entity (as on the contrary it has been deemed by the State Council according to its opinion dated May 11, 1999, no. 608, in which it has been supported the thesis of the subjectivity of the Fund, deemed as a legal entity separate from and opposite to each of the unitholders and to the SGR).
Indeed, the Supreme Court has pointed out that there are no significant normative elements supporting the thesis of the subjectivity of the Fund and, moreover, it has pointed out that the Fund does not have the capacity to determine itself autonomously because it lacks of any organizational structure with an external relevance (differently from a non-recognized associations or a partnership or a special social welfare and assistance fund as established pursuant to Article 2117 of the Civil Code, which, although they do not have a legal personality, are deemed as centre of charges, also from a procedural point of view).
The Supreme Court does not consider the unitholders’ Fund meeting as relevant evidence of this capacity to determine itself autonomously (although Article 37, paragraph 2bis of TUF assigns to this body the power to bind the SGR in certain matters, such as those indicated by the law or those provided for in the Fund’s Regulation (Regolamento del fondo) and subject to the unitholders’ Fund resolution): on the contrary, the Court consider the unitholders’ Fund meeting having the same role and functions as the bondholders meeting, as provided for in Article 2417 of the Civil Code, or as the special meeting of the holders of any participant financial instruments, as provided for in Article 2447 octies of the Civil Code. Therefore, the unitholders’ Fund meeting only permits the unitholders to express their preferences on the choices made by the SGR on certain matters concerning the unitholders themselves, and to exercise a right of veto on the proposals made by the SGR, without imposing their unilateral will to the SGR.
On the contrary, based upon the provision set forth in Article 1, first paragraph, letter from (n) to (q), Article 36 and Article 39 of the TUF and the other relevant secondary laws, the Supreme Court has stated that the Fund needs the SGR to set it up, to manage it and to establish the rules governing its operations, having the power to take any decision on the merger or the demerger (with the consequential changes of the Fund’s Regulation) and, above all, to respond vis à vis the unitholders of the management activity carried out in respect of the Fund.
As a consequence, no relationship definable as “mandate” or “mandate with power of representation” (both of which requiring the existence of two different subjects) can exist between the Fund and the SGR and thus, in the case of a purchase of goods made by the SGR in the interest of Fund (or any other contractual activity carried out by the SGR in the interest of the Fund), these goods shall not to be entitled to the Fund, but to the SGR which has established the Fund, which has the legal entitlement on these assets and, thus, the judicial right to represent the Fund in any trial regarding such assets. Please note that the legal entitlement and the judicial right to represent the Fund in a trial belongs to the management company which acted as promoter even if the promoter does not coincide with the management company which acts as manager. It has been understood that the SGR is required to ascribe to the Fund the effects of the purchase of the assets (being the unitholders the “real” owners of them) and, thus, it is required to note in the registry a valid record likely to make the existence of the relevant connection known to any third party.

Carmelo Raimondo
(carmelo.raimondo@chiomenti.net)
Alessandra Alfei
(alessandra.alfei@chiomenti.net)

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New tax regime of real estate investment funds
On 13 May 2011, the Law Decree no. 70/2011 (hereinafter the “Decree”) has been approved. As a consequence, a new set of provisions is now applicable with reference to the tax treatment of real estate investment funds.
1. Definition of investment fund
The Decree at stake did not modify the definition of investment fund which remained the following: “the separate pool of assets collected, by the means of one or more issues of units, from a plurality of investors for the purpose of investing such assets on the basis of an agreed investment policy; divided into units pertaining to a plurality of participants; managed on collective basis, in the interest of participants and separately from such participants”.
2. New tax treatment of real estate investment funds and investors
The Decree under discussion did not modify entirely the tax treatment of real estate investment funds. In fact, a new particular tax regime is now applicable to profits distributed by real estate investment funds with reference only to particular categories of investors.
Having in mind the above, the ordinary tax regime set forth by Law Decree no. 351/2001 keeps on being applicable to funds whose units are held only by the following investors:
a) Italian State or other public entities;
b) Italian investment funds;
c) Italian pension funds;
d) Insurance companies provided that certain conditions are met;
e) Italian financial intermediaries;
f) All the above-mentioned persons whether resident in a country with which Italy has an effective exchange of information provision (i.e. “white list countries”), according to art. 168-bis of the Presidential Decree no. 917/1986 (hereinafter, the “Italian Tax Code”);
g) Italian private entities, whose purpose is in accordance with those prescribed by law for banking foundations, and Italian mutual entities;
h) Italian special purpose vehicles whose shares are held by the above mentioned persons by more than 50%.
Moreover, the Decree provides that, in case the units are held not only by the aforementioned persons, profits deriving from real estate investment funds shall be subject to taxation no matter if their distribution with reference to entities or individuals holding more than 5% of the fund units.
The above mentioned percentage is calculated at the end of the relevant fiscal period or, if shorter, at the end of the fund’s management period.
It is to be noted that in order to determine the percentage at issue, it shall be taken into account the units held, both directly and indirectly, by (i) fiduciary companies, (ii) inter-posed persons, (iii) companies in which the persons at stake have a majority of the votes exercisable at a regular meeting and (iv) companies in which the persons at stake have sufficient votes to exercise a dominant influence at a regular meeting. Further, all the units held by family members pursuant to art. 5, par. 5 of the Italian Tax Code need to be added together for the purposes of the above calculation.
As a consequence, profits gained by real investment funds shall be fully taxed in the hands of investors if they hold more than 5% of the units, regardless of their distribution.
In case of disposal of units by the aforementioned investors, the relative capital gains realized by a person who is not carrying out a business activity are not subject to the ordinary applicable regime pursuant to which a substitute tax of 12,5% is levied, but they shall be included in the taxable income for 49,2% of their amount.
3. Temporary tax regime
Investors taxed on accrual basis on the profits realized by the real estate investment fund, hall pay a substitute tax of 5% on the average value of the units held as of 31 December 2010. The substitute tax may be paid either by the investor (within the period provided for the termination payment of Personal Income Tax - “IRPEF”) or by the management fund company (Società di gestione del risparmio – “SGR”). In this last case, the tax is payable in two instalments in December 2011 (50%) and in June 2012 (50%). It shall be noted that if the management company is unable to collect the tax due, it is entitled to liquidate the unit pertaining to the investor.
4. Fund Liquidation
In case of real estate investment funds whose units were held, as of 31 December 2010, by one or more investors subject to be taxed regardless of the distribution of profits, any SGRs may put such funds into liquidation.
As a result, a specific tax regime applies. In particular, a substitute tax of 7% is levied on the net value of the fund as of 31 December 2010, and it shall be paid in three instalments in March 2012 (40%), in March 2013 (30%) and the remaining part in March 2014.
Liquidation procedures shall terminate in five years. Accordingly, annual results shall be subject to a substitute tax of 7% which shall be paid by 16 February of the next relevant year.
4.1. Tax regime applicable to the distributions of profits during the liquidation period
During the liquidation period, profits distributed by SGRs shall not be taxed up to the amount previously subject to the substitute tax (7%). Moreover, it is worth mentioning that even in case of capital gains realized upon by the sale of units at the end of the liquidation procedures, in order to calculate the relevant fiscal purchase price, it shall be taken into consideration only the amounts previously subject to the substitute tax at stake. Capital losses eventually realized are negligible.
4.2. Indirect tax regime applicable to liquidation procedures
All deeds relating to liquidation procedures are subject to both registration tax and mortgage and cadastral taxes at a lump sum of 168 €. In case of disposal of assets subject to VAT, the relative VAT shall be paid by the acquirer according to the reverse charge method. Furthermore, during the liquidation period, contributions of a pool of assets made to real investment fund are not subject to VAT. Only registration tax in addition to mortgage and cadastral taxes are levied at a lump sum of 168 €.
5. Tax Treatment of Foreign Investors
Pursuant to the provisions set forth by the Decree, distributions of profits made to foreign investors holding less than 5% of the fund units are now subject to a 20% withholding tax (eventually to be reduced under the provisions of the relevant double taxation treaty). If no double taxation treaty applies, the rate is 20%. Further, capital gains are not subject to tax pursuant to art. 5 of the Legislative Decree no. 416/97.
It is worth noting that prior to the introduction of the abovementioned provisions, distributions of profits and capital gains to foreign investors resident in white-list countries were generally exempt from the 20% withholding tax. However, this exemption now only applies to specific entities, such as pension funds and collective investment schemes that are tax residents in white-listed jurisdictions as well as international organizations and central banks.

Massimo Antonini
(massimo.antonini@chiomenti.net)
Giuseppe Andrea Giannantonio
(giuseppeandrea.giannantonio@chiomenti.net)

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Italian Tax Authorities clarify the tax regime applicable to incentive plans of managers
Introduction
Remuneration of managers working in the financial sector has been subject to new regulations both at an international and European level.
With reference to the Italian context, it is worth mentioning the new provisions issued by the Bank of Italy that aim at regulating the incentive plans for prominent manager (the so called “risk takers”).
As will be seen more in details later on, in line with the above regulations and the agreements reached by G20 members, it’s important to highlight the new provisions set forth by the Law Decree no. 78, May 31, 2010 as converted, with modifications, into Law no. 122, July 30, 2010 and their interpretations provided by the Italian Tax Authorities through both the Circular Letter no. 4/E, February 15, 2011 and the ruling no. 11, March 31, 2011.
2. Summary of the Law no. 122/2010
The Law no. 122/2010 did introduce, with regard to executives working in the financial sector, an additional taxation of 10% on variable compensations (i.e. stock options, other bonuses and payments, etc.) in case it exceeds for at least three times the fixed remuneration.
The aforementioned additional taxation shall be applied with reference to all variable compensations paid to mangers from May 31, 2010 on, even if these compensations pertain to previous years duties.
3. Scope
The provision under discussion applies only to the financial sector. According to the interpretations provided by the Italian Tax Authorities, the scope of the provision is limited to the following subjects: (i) banks (ii) management fund companies (SGR – Società di gestione del risparmio) (iii) stock broker companies (SIM – Società di intermediazione mobiliare) (iv) financial intermediaries (v) entities issuing electronic money (vi) entities undertaking financial activities pursuant to art. 59, par. 1, lett. b) Legislative Decree no. 385, dated September 1, 1993 (TUB – Testo unico Bancario) (vi) holdings which manage or simply hold interests in financial, insurance or industrial companies.
4. Managers subject to additional taxation
The additional tax rate of 10% shall be applicable to the following persons:
(i) subordinate employees pursuant to art. 2095 of the Italian Civil code, with reference only to executives;
(ii) employees whose contracts are consistent with the provisions set forth by Legislative Decree no. 276/2003 related to regular ongoing collaborations (i.e., members of the board of directors, members of the board of auditors etc.).
It shall be noted that the determination of the variable amount that shall be subject to additional taxation may give rise to some problems in case the manager is also entitled to receive a payment according to a different work contract or employment relationship. As a consequence, it shall be pointed out the risk for taxable persons to be subject to additional taxation even if, for instance, they receive a payment from companies which are not their employers.
A final point to bear in mind is that the provision comes to be applicable with reference to managers working in the financial and banking sector even if they have performed their activities abroad. In this case, the additional taxation shall be applied to the compensation as indicated in their relative work contracts, regardless of the provisions laid down by art. 51 par. 8-bis of the Italian Tax Code (forfeit taxation on employment income carried out abroad).
5. The relation existing between the variable and fixed compensation
The additional taxation applies if both the following conditions are met:
(i) the compensation paid to the employee comprehends both a variable and fixed amount;
(ii) the variable amount exceeds by at least three times the fixed amount.
In such a case, with regards only to the variable amount of the compensation, an additional tax rate of 10% shall apply.
It is important to note that the term variable compensation makes reference to both cash and financial instruments payments. In other words, not only stock options remuneration shall be included in calculating the total amount of the variable compensation, but it shall be taken into account the fair value of other financial instrument incentives such as stock grants, phantom stocks and bonus shares. The amount at stake shall be calculated in accordance with the provisions set forth by art. 9 of the Italian Tax Code. Moreover, the amount paid by the employees to be entitled to receive the financial instrument payments shall be deducted from the value of the variable compensation.
As already mentioned above, the variable amount subject to additional taxation shall be identified considering only the contractual terms without taking into account neither the fiscal relevance of the compensations nor the years of competence of the compensations at issue. Accordingly, the fixed amount of the compensation as indicated in the relative work contract (regardless of any pension contributions and withholding taxes) is to be compared with the variable amount accrued in the same year. In conclusion, the amount subject to additional taxation shall come to existence just in case the accrued cash and financial instruments compensation exceeds by three times the fixed compensation accrued in the same period. As a consequence, any deferred payments shall be disregarded.
6. Procedures for the application of the additional taxation
The additional tax rate of 10% shall be applied on cash basis.
In case the compensation is paid in more tax periods, the additional tax rate shall be levied once the aforementioned threshold has been crossed. In such circumstances it shall be noted that the fixed amount of the compensation to take into consideration shall be the one provided by the contractual terms in the relevant accrued period of the variable compensation.
The withholding agent shall be the person entitled to apply the additional taxation at stake through the relative withholding.

Massimo Antonini
(massimo.antonini@chiomenti.net)
Annalisa Reale
(annalisa.reale@chiomenti.net)

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Deductibility of interest expenses with reference to leverage buy-out operations: new courts decisions
1. Introduction
In the last few years, the tax assessment activity of the Italian Tax Authorities did also focus on leverage buy-out operations, primarily in order to deny the deduction of interest expenses relating to the loan assumed by the special purpose vehicle for the acquisition of the target company.
In light of the new decisions of both the Italian Supreme Court and lower Italian Tax Courts, it is worth pointing out the following remarks.
2. The decision of the Italian Supreme Court no. 1372/2011
The decision of the Italian Supreme Court at stake did focus on tax advantages obtained through an operation which can be summarized as follows:
(i) a purchase, through a loan assumed by a special purpose vehicle, of a controlling interest in an associated company of the buyer;
(ii) a subsequent merger through incorporation of the acquired company with the acquiring one.
With regard to the above illustrated case, the Italian Tax Authorities did take the view that the taxpayer, in order to deduct a considerable amount of interest expenses, had used the leverage buy out scheme with no sound economic reasons.
In particular, the operation at stake was exclusively intended to obtain a tax advantage, given that the same results might have been obtained in a more linear way through a merger with a co-exchange of interests between the two companies, without incurring in interest expenses as a consequence of the loan assumed by the special purpose vehicle.
Consequently, the Tax Authorities claimed that the deduction should have been denied and the taxable base increased.
This being stated, the Italian Supreme Court ruled that the operation at stake shall not be regarded as abusive given that a true holding reorganization had been carried out. Particularly, the Supreme Court acknowledged that, even if the purpose of companies might have been realized more easily through a merger with a co-exchange of interests, this does not imply that such solution shall be regarded, sic et simpliciter, as the most linear and that any other structure as abusive.
Accordingly, the Court upheld the appeal of the taxpayer and allowed the deduction of the interest expenses incurred for the purpose of acquiring the controlling interest of the company subsequently merged.
3. The decision of the Regional Tax Court of Lombardy no. 36/2011
The case submitted to the Regional Tax Court of Lombardy was related to a particular leveraged buy-out operation carried out by a company, which already had the control of the target entity, in order to acquire the remaining minority third party interest. Even in the case at stake, the Italian Tax Authorities automatically denied the deduction of the interest expenses incurred by the special purpose vehicle subsequently merged in the acquiring company.
In fact, the operation under discussion was regarded as abusive. According to the Italian Tax Authorities, it had been realized with the only purpose to obtain a tax advantage, given that the acquiring company already controlled the majority interest in the target company. No sound economic reason may be identified in such an investment.
That being said, the Regional Tax Court of Lombardy stated, on one hand, that several sound economic reasons may be identified in the acquisition of a minority interest in an already controlled company. On the other hand, these intentions shall be properly taken into account before regarding as abusive the behaviour of the taxpayer. Consequently, the interest expenses, incurred with the only purpose to realize the operation at stake, shall be considered fully deductible. Moreover, according to the judges of the Regional Tax Court, the use of a special purpose vehicle shall be viewed as the best means in order to raise the necessary funds for the following reasons:
i) the money lender has the certainty that the debt has been assumed;
ii) the money lender can impose to the vehicle to not assume other debts;
iii) the money lender has a double guarantee on the stakes of both the target company and the special purpose vehicle.
4. Conclusions
The decisions at stake highlight the tendency of the Italian Tax Authorities to adopt an aggressive stance and to deny the deduction of interest expenses incurred in leverage buy-out operations by claiming back the lack of any sound economic reasons.
However, new particularly welcome decisions pay attention to the purposes intended to be realized by the taxpayers and address in detail the arguments that shall ground the tax assessments.

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

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