Credit funds insight - issue 7 29 Nov 2016 Recent developments could open new opportunities for lending into Italy

Direct lending activity in Italy

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Historically foreign funds have not been allowed to lend to Italian borrowers for regulatory reasons. From a tax perspective such lenders suffered Italian withholding taxes on interest payments. For these reasons the so-called opaque “IBLOR” or “Italian bank as lender of record” structures were put in place whereby the loan was granted by an Italian bank (the lender of record) which was financed through collateral posted by foreign funds.


What you need to know

  • Historically foreign funds have not lent to Italian borrowers for regulatory and tax reasons.
  • EU alternative investment funds can now potentially grant loans to Italian enterprises without Italian withholding tax on interest payments. There are still issues for CLOs and non-EU funds.
  • Funds that are not allowed to lend into Italy could consider structuring their funding operations using bonds, benefiting from a withholding tax exemption on the interest.
  • EU alternative investment funds can now potentially lend to Italian borrowers without application of Italian withholding tax on interest payments.  


The funds guaranteed the borrower’s obligations to the Italian bank under the loan and posted cash deposits as collateral. The intended tax regime of opaque “IBLOR” structures was that no withholding tax was applicable on the interest payments made to the Italian banks (or Italian branch of a foreign bank) nor on the interest and guarantee fees due from such Italian banks/branch to the funds. The Italian tax authorities challenged opaque “IBLOR” structures as tax abusive schemes giving rise to tax litigation and tax settlement proceedings. More recently (from June 2014) the Italian government and the Italian parliament have started to introduce measures aimed at easing the granting of funding to Italian enterprises, also allowing certain types of foreign credit funds to lend directly into Italy.

Under article 26 of Decree 600/1973 interest payments made by Italian borrowers to foreign lenders (not acting through an Italian permanent establishment) are subject to a 26 per cent withholding tax (such rate of tax may be reduced under tax treaties). There are exceptions to this rule, one being applicable to foreign lenders that are EU banks, EU insurance companies and institutional investors established in the so called white list countries. White list countries include all EU countries, as well as the US, Japan, China, Brazil and, since August this year, the Cayman Islands, Jersey, Guernsey, Switzerland, and several others. Leaving aside EU banks and insurance companies, which are not the particular focus of this article, the exemption from the interest withholding tax (the WHT Exemption) is applicable to institutional investors if all of the following conditions are met:

  • the borrower is an “enterprise” – an ordinary commercial company would qualify as such. However, it is unclear whether borrowers that are investment funds would qualify as enterprises for these purposes (prevailing opinion is that borrowers that are investment funds do not qualify for the WHT Exemption);
  • the financing is medium long term – i.e. it has a maturity longer than 18 months and one day;
  • the lender is an institutional investor, established in a white list country and subject to regulatory supervision in the country of establishment (this being the Regulated Institutional Investor Requirement) – institutional investors (regardless of whether they are liable to tax or not) are “those entities which, regardless of their legal or tax status (…), have as their principal activity that of managing investments on their own account or on behalf of third parties, such as insurance companies, investment companies, investment funds, SICAV (Open-end investment companies) and pension funds” (see Decree 12 12 2001). According to rulings of the Italian tax authorities (though not specifically issued for the purposes of the WHT Exemption) an entity is deemed to be subject to regulatory supervision if either the entity itself or the asset manager is subject to supervision and such supervision amounts to an initial authorisation and to ongoing controls by the relevant regulator. This latter interpretation has been recently confirmed by the Italian tax authorities in a private (not available to the public) ruling (the 2016 Private Ruling) dealing with a French FCT (fond commun de titrisation) that purchased a loan receivable on the secondary market from an EU bank. In the 2016 Private Ruling the Italian tax authorities acknowledge that, even if the fund itself is not subject to regulatory supervision, but the asset manager is subject to regulatory supervision, the Regulated Institutional Investor Requirement (for the purposes of the WHT Exemption) would be met; and
  • the lender is fully compliant with Legislative Decree 1 September 1993, n. 385 – i.e., the Italian law governing lending activities towards the public in Italy (this being the Reserved Activity Requirement). This condition has been introduced in the text of article 26 of Decree 600/1973 in tandem with the enactment of new rules governing direct lending in Italy by EU alternative investment funds (as defined under the AIFMD) (the AIFs). The rationale for these changes in law, as stated in the government explanatory notes (to article 17 of Decree 18/2006) is to grant the WHT Exemption to foreign, EU credit funds (EU AIFs) subject to the same conditions as applicable to Italian credit funds (Italian AIFs). Indeed, EU AIFs are permitted to grant loans directly to Italian borrowers (other than private consumers), if the relevant EU AIF meets the following conditions: (i) it is authorised, in its home EU country, to directly invest in loans, including loans funded with its assets; (ii) it is a closed-ended investment scheme having structural features similar to Italian AIFs investing in loans; (iii) in its home EU country it is subject to regulatory supervision on risk limits and allocation, including on maximum leverage corresponding to those applicable to Italian AIFs investing in loans. Furthermore managers of EU AIFs planning to lend in Italy must notify their intention to the Bank of Italy and may commence such activity only upon expiry of a 60-day period from such notification (in such period of time, the Bank of Italy may decide to forbid such activity). These conditions from (i) to (iii), including the obligation to notify the Bank of Italy are referred to as the “AIF Conditions”. It is unclear whether the AIF Conditions would only be required if the AIF were to directly lend in Italy, i.e., to originate and grant the loan, or also if the AIF were to purchase on the secondary market a loan originated by a bank.

Application to Funds

Turning then to the application of those rules to common fund structures, they don’t help non-EU Funds. That is because the newly enacted legislation on direct lending only refers to EU alternative investment funds, with the consequence that the WHT Exemption is not applicable to non-EU funds (because the Reserved Activity requirement would not be met) even if they are established in white list countries (other than EU countries).

AIFs which, in principle, could qualify for the WHT Exemption are, for example, Luxembourg FCP, SICAV, SICAF RAIF, Irish QUIAIF, French FCT, etc. (assuming that the AIF Conditions are met). A doubt may be raised (as no circular or public rulings have been issued yet by the Italian tax authorities on the matter) where the AIF is established as a partnership, since Italian AIFs cannot be formed with such a legal form. The fact that the AIFM Directive covers AIFs established as partnerships should take the direction of also allowing partnerships that are EU AIFs to benefit from the WHT Exemption. Conversely, as CLOs generally do not fall within AIFMD, they do not meet the Reserved Activity Requirement, nor the Regulated Investor Requirement and, hence, the WHT Exemption would not be available to them.

In a recent private ruling the Italian tax authorities considered the case of a French fond commun de titrisation (the FCT) buying a portion of a facility from a branch of an EU bank. The ruling acknowledges that the fund itself is not subject to regulatory supervision, while the asset manager is subject to regulatory supervision. The tax authorities concluded that the WHT Exemption should be applicable to interest payments made by the Italian borrower to the FCT.

In any event, in case of doubt as to the proper qualification of the lender, for WHT purposes, the lender or the borrower can apply for an advance ruling in order to request the opinion of the Italian tax authorities.

Alternative Bond Structures

If the relevant fund cannot lend directly into Italy (for example because the relevant credit fund is not established in the EU), bonds could be an alternative funding structure, as follows:

  • The borrower, instead of borrowing a loan, issues bonds listed on a regulated EU Market or an EU multilateral trading facility, and the relevant fund subscribes for such bonds. No withholding tax will be applicable in Italy on the interest on the bonds if the holder/relevant fund is an institutional investor established in a white list country. In this case, the exemption is applicable even if the institutional investor is not subject to regulatory supervision, provided that it has skills and expertise in financial instruments and it has not been created to hold the investments for a limited number of investors established in non-white list countries; or
  • The borrower borrows a loan from an Italian securitisation vehicle which obtains the funding by issuing bonds to the relevant fund. This scheme requires, inter alia, that a bank or other financial intermediary makes the creditworthiness analysis and retains a minimum 5 per cent investment in the bonds under the skin-in-the-game rules. No withholding tax is applicable on the interest from the borrower to the securitisation vehicle and no withholding tax is applicable on the interest on the bonds on the same basis as above, i.e. the holder/relevant fund is an institutional investor established in a white list country.

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The information provided is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to. Readers should take legal advice before applying it to specific issues or transactions.

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