1. Introduction: What are CFCs and Why Were They Introduced?
Controlled Foreign Corporations (CFCs) are legal entities located in countries with low-tax regimes or "tax havens" that are controlled by a person or entity residing in a country with a normal tax system. The CFC rules were created as a tool to combat base erosion and profit shifting (BEPS).
The main objective of these regulations is to prevent a company or individual residing in Italy from transferring their profits to a controlled foreign company that does not conduct a genuine business activity but is used solely to benefit from a much lower tax burden. Italy, like many other countries, has therefore introduced specific rules to tax these profits, even if they have not been distributed as dividends.
2. The Italian Legal Framework: Article 167 of the TUIR
The Italian CFC regime is primarily governed by Article 167 of the Italian Consolidated Income Tax Act (TUIR). This article establishes that income earned by a foreign CFC is not taxed when it is distributed (e.g., as a dividend), but is attributed transparently to the controlling party resident in Italy, as if it had been generated directly by them. This "anticipatory" taxation mechanism is the core element of the discipline.
The legislation has been significantly amended over the years, particularly with the implementation of the EU's Anti-Tax Avoidance Directive (ATAD), which has unified and strengthened anti-avoidance rules among member states. These changes have redefined the criteria for applying the rules, making them broader and more complex.
3. Requirements for the Application of the Rules
The application of the CFC rules is not automatic; it requires the simultaneous presence of two main conditions: the control condition and the location condition.
a) The Control Condition
The control condition is considered met when a person or entity residing in Italy, either alone or together with other resident persons related by family or affinity, holds:
Formal control, which is the majority of voting rights in the ordinary shareholders' meeting of the CFC.
Substantial control, which is the ability to exercise a dominant influence over the management of the CFC.
A profit participation exceeding 50%.
The concept of control is broad and is intended to cover all forms of influence that allow the resident party to "steer" the foreign company's decisions.
b) The Location Condition
The CFC must be located in a country or territory that has a nominal tax rate of less than 50% of the tax rate applicable in Italy. Previously, the regime was based on a "black list" of countries considered tax havens. With the changes introduced by the ATAD, the criterion has become objective and quantitative, based on the effective tax level of the income produced by the CFC.
This new approach aims to target not only traditionally defined tax havens but also countries that offer special or favorable tax regimes leading to a very low effective tax rate.
4. Exemptions: The "Escape Clauses"
The CFC regime includes certain "exits" or exemptions that allow the controlling party to avoid the transparent taxation, even if the control and location conditions are met.
The two main exemptions are:
Proof of a genuine economic activity: The application of the CFC regime can be avoided if the taxpayer demonstrates that the foreign company carries out a genuine industrial or commercial activity as its main business. It must not be a "shell company" or a mere vehicle for managing passive investments. The proof of economic activity is based on various indicators, such as the presence of qualified employees, adequate offices and structures, and the conduct of real commercial operations.
Effective taxation not significantly lower: If the CFC, despite being located in a country with a low nominal tax rate, demonstrates that it has been effectively taxed on an income not significantly lower than what it would have been subject to if it were a resident of Italy. This condition is more complex to prove and requires a comparative analysis between the actual foreign tax burden and the hypothetical one in Italy.
5. The Transparency Taxation Mechanism
If the conditions for applying the regime are met and there are no exemptions, the CFC's income is attributed to the controlling party resident in Italy, regardless of its distribution. This means the income is considered "received" by the Italian taxpayer and therefore taxed in their hands.
The determination of the CFC's income is done by applying Italian tax rules, as if the foreign company were an IRES (Italian corporate income tax) subject. This can involve a complex recalculation of foreign financial statements according to Italian accounting principles and tax laws.
If the income is later actually distributed by the CFC (e.g., as a dividend), it will not be taxed in Italy to avoid economic double taxation. The taxes paid abroad by the CFC can be partially or fully deducted from those owed in Italy through a tax credit.
6. Parties Involved and Practical Implications
The CFC regime applies to both legal entities (resident companies and commercial bodies) and individuals who hold a controlling stake.
For businesses, the main impact is the complexity of accounting and tax management, which requires recalculating the financial statements of foreign subsidiaries and careful documentation to prove the potential applicability of an exemption.
For individuals, the regime represents an obstacle to holding stakes in foreign investment companies, especially in countries with favorable tax regimes.
The CFC rules also impose specific reporting obligations in Form Redditi, Section FC, where taxpayers must report data related to their holdings in controlled foreign companies.
7. Changes Introduced by the ATAD Directive (Legislative Decree 142/2018)
Legislative Decree No. 142 of 2018, which implements the ATAD Directive, has substantially amended Article 167 of the TUIR. The main changes are:
Abandonment of the "black list" criterion: As mentioned, a quantitative criterion based on effective taxation was introduced.
New tax threshold: The regime applies if the CFC's nominal tax rate is less than 50% of the Italian one.
Redefinition of exemptions: The conditions for obtaining an exemption have become stricter, requiring stronger proof of a genuine economic activity.
Broadening of the scope: The rules now also apply to non-residents who are, however, fiscally domiciled in Italy.
The CFC regime is a cornerstone of international anti-avoidance regulations, and understanding it is crucial for anyone holding stakes in foreign companies. For a specific and up-to-date analysis, consulting a qualified professional remains the safest option.