In a request for official interpretation (interpello), the Italian tax administration (Agenzia delle Entrate) recently had to deal with the question of whether a Liechtenstein Foundation with Italian beneficiaries was to be classified as fiscally transparent or as non-transparent (opaque) (Interpello 9/2022 of January 9, 2022).
The Foundation had been established in the early 1980s by nine founders residing in Italy and the Foundation’s assets consisted mainly of forest property located in Austria. The founders have all passed since quite some time and the current beneficiaries are the second and third generation descendants of the founders, all of whom also reside in Italy. The Foundation had sold its property in Austria in 2020 and wanted to distribute the proceeds of the sale to the numerous beneficiaries.
The applicants and beneficiaries of the Foundation therefore requested binding confirmation from the tax authority as to whether the expected distribution would be tax-free income for the beneficiaries or whether the realized capital gain would be attributable for tax purposes to the Foundation direclty or rather to the beneficiaries.
The Foundation has three bodies: the Board of Foundation, the Advisory Board and the Assembly of the Beneficiaries.
The Board of Foundation consists of two non-residents of Italy who act independently, free of instructions and at their own discretion. Beneficiaries or persons close to them may not be appointed as members of the Board of Foundation. The Board of Foundation may only be dismissed by the Advisory Board for good cause.
The Advisory Board consists of six members elected from among the members of the class of beneficiaries. The powers of the Advisory Board are the appointment and dismissal of members of the Foundation Board for good cause, as well as a right to be heard and to be informed with regard to the administration of the Foundation and, in particular, in the event of the sale of significant parts of the Foundation’s assets or the dissolution of the Foundation.
The sole power of the Assembly of the Beneficiaries is the appointment and dismissal of members of the Advisory Board.
The beneficiaries have no direct or indirect power of disposal over the Foundation’s assets and, in particular, no legal claim. The members of the class of beneficiaries have all been designated by name and have been disclosed to the Austrian tax authorities.
In terms of Foundation governance and recognition as a taxable subject, the Foundation thus met the rather strict criteria for opaque (non-transparent) foundations dictated by the Austria-Liechtenstein tax treaty, so that from an Austrian tax point of view (location of the assets) the Foundation is likely to be recognized as non-transparent and thus separate tax subject.
In its reply, the Italian tax authority firstly stated that a Liechtenstein family foundation should be treated for tax purposes in the same way as a trust, on the taxation of which there exists now quite extensive literature and case law in Italy.
The tax authority then stated that it was essential for the affirmation of tax opacity that the Foundation Board had the effective power of administration and disposal over the Foundation’s assets. The Foundation governance as described above had only been introduced in 2020, e.g. eight (!) days before the sale of the forest property. Previously, the Assembly of Beneficiaries was considered the supreme body of the Foundation and had extensive powers, while the Foundation Board had a mostly a passive role. This circumstance or bad timing was the downfall of the petitioners because, according to the authority, the tax assessment very much had also to take into account the original foundationFdocuments and the previous governance of the Foundation. But the tax authority also saw the new Foundation governance as detrimental to the desired lack of tax transparency because, according to the facts of the case, the Foundation Board could not act entirely independently of the Advisory Board. In particular, the right to dismiss the Advisory Board (consisting of members of the class of beneficiaries), although only exercisable for good cause, was considered by the tax authority to be a tax-damaging influence of the beneficiaries on the Foundation governance.
The good news is that the legal view of the tax authority still had no adverse tax consequences for the beneficiaries. This is because the capital gain realized by the Foundation on the forest property, which was attributed to the beneficiaries personally due to the Foundation’s tax transparency, nevertheless resulted in tax exemption because the acquisition under civil law (by the Foundation) had occurred more than five years before.
Furthermore, the authorities have taken an interesting, but also strongly criticized, legal view on the issue of inheritance tax. The tax authority affirmed the application of the Italian inheritance tax on the distribution amount, although the founders had all died many years ago and the current beneficiaries were in part not their direct heirs. The Agenzia delle Entrate justified its opinion by stating that, according to the Foundation regulations, the original beneficiary rights of the founders had passed to the current beneficiaries by virtue of inheritance law, but overlooked the fact that the beneficiary rights cannot be inherited and can therefore be passed only by virtue of the Foundation regulations, but not by virtue of inheritance law.
While the Foundation structure in question would most likely have been recognized as fiscally opaque under Austrian or even German tax law, the recognition as separate tax subject under Italian tax law failed because the influence of the beneficiaries was deemed to be too high.
This case is an example of the recurring challenge in advising on the balancing act between the necessary separation of assets and powers and the independence of a foundation on the one hand and the desired or necessary control by stakeholders of a Foundation (especially beneficiaries) on the other. It is often a skill, but also a huge effort of daily advisorywork to find and enable the balance between the flexibility offered by Liechtenstein Foundation law and the – usually very strict – requirements of foreign tax jurisdictions for the recognition of a fiscally non-transparent structure.