The Italian windfall tax for banks - key insights and preliminary analysis

On 10 August 2023, the Italian Government approved Law Decree No. 104 (the “Decree”), converted by Law 9 October 2023, No. 136, which introduced a one-time only extraordinary windfall tax for banks (the “Bank WT”). The Bank WT is calculated based on the increase in the net interest margin.

The Bank WT is aimed at striking the surplus profits realized by financial institutions as a consequence of the European Central Bank's interest-rate hikes, using the relevant proceeds to support mortgage holders and cut taxes on households and business activities. It is worth noting that other EU Countries such as Spain and Hungary have already introduced similar extraordinary levies.

The revenue generated from this special tax is designated for a specific section within the national budget. This revenue will be periodically redistributed into a specialized fund managed by the Ministry of Economy and Finance ("MEF"). The purpose of this fund is to finance programs related to the First Home Guarantee Fund, as well as various initiatives intended to alleviate the fiscal burden on households and enterprises.

During the conversion of the Decree into law, the original text underwent significant modifications.

An analysis of the key elements of the revised Bank WT is outlined below.

1. KEY INSIGHTS

a. Taxpayers in Scope

From a subjective standpoint, the Bank WT applies to Italian resident banks as defined under Article 1 of the Legislative Decree No. 385 of 1993 (so-called Italian Bank Act) as well as Italian branches of foreign banks, without any exemptions for smaller credit institutions.

b. Tax Rate and Base

The Bank WT is determined by applying a 40% rate levy to the interest margin – as accounted under item 30 of the profit and loss account scheme drafted according to the standards approved by the Bank of Italy (“P&L”) - relating to the fiscal year prior to that in progress as of 1 January 2024 that exceeds the same margin by at least 10% in the fiscal year prior to that in progress on 1 January 2022 [1].

The interest margin in item 30 of the P&L is derived from the algebraic difference between:

• interest income and similar income (item 10),
• interest expenses and similar expenses (item 20).

In items 10 and 20 of the P&L, as specified by the Bank of Italy, should be entered:

• interest income and expenses,
• income and expenses similar to interest, such as income from trading in financial assets, from assets and liabilities measured at fair value, and from derivative contracts.

c. Cap

The Bank WT shall in no case exceed 0.26% of the total amount of risk exposure on an individual basis, determined in accordance with paragraphs 3 and 4 of Article 92 of Regulation (EU) No. 575/2013, with reference to the closing date of the fiscal year prior to the one in progress on 1 January 1 2023 [2]. This provision, inserted at the time of the conversion into law, aims at overcoming the issues related to the impact of government bonds on the determination of the maximum amount of the tax, which was significant in the original wording of the Decree, thus increasing the applicable cap.

d. Payment Deadlines

The Bank WT must be paid by the sixth month following the end of the fiscal year preceding the one in progress on 1 January 2024 (i.e., by 30 June 2024 for most banks). For banks that approve financial statement later than the end of the fourth month following the end of the relevant fiscal year, the deadline for the payment of the Italian Bank WT is the end of the month following the one in which the financial statement is approved.

Banks having a fiscal year not aligned with the calendar year, where the payment deadline of the Bank WT falls within calendar year 2023, the relevant payment will be due during calendar year 2024, but in any case, no later than 31 January 2024.

e. Alternative to the Payment

The final version of the Decree, as modified by the amendments, provides that, instead of paying the Bank WT, taxpayers may opt to allocate to an extraordinary non-distributable capital reserve (an amount not less than two and a half times the Bank WT), when approving the financial statements for the fiscal year prior to the year ending 1 January 2024. If the reserve is distributed, it would result in the payment of the tax with a surcharge equal to the annual interest rate on ECB deposits.

f. Prohibition on Cost-Shifting

It is expressly prohibited to transfer the burden arising from the Bank WT onto the costs of services rendered to enterprises and end consumers. To ensure compliance, monitoring will be conducted by the Competition and Market Authority.

g. Tax Non-Deductibility

According to the Decree, the Bank WT is neither deductible for corporate income tax (IRES) purposes nor for regional business tax purposes (IRAP).

h. Assessment, Penalties and Collection

With regard to the Bank WT assessment, penalties, collection and litigation process, same rules valid for income tax purposes shall apply.

2. PRELIMINARY ANALYSIS

a. Determination of the Tax Base

The tax base appears to include items that do not necessarily reflect current interest rate trends and would therefore be unrelated to the “windfall profits” associated with them. For example, according to the Bank of Italy's guidelines, net interest income could include income and expenses similar to interest, such as income from all financial assets held and income from loans. In addition, for the purpose of calculating the tax base, the rules seem to exclude the relevance of other management costs that are not included in net interest income.

The ECB, in its Opinion of 12 September 2023, released upon request of the MEF, expressed concerns mainly related to the possibility that the tax might also apply to taxpayers who, far from making additional profits, had instead incurred losses. The ECB then noted, inter alia, that the Bank WT may not be proportionate to the profitability of credit institutions and their ability to generate capital, as the tax base does not take into account the entire business cycle and does not include, inter alia, operating expenses and the cost of credit risk. Consequently, the ECB highlighted the importance of structuring the tax in a way that does not impede individual credit institutions from maintaining robust capital reserves or from making adequate allowances for increased asset write-downs and credit quality deterioration. The amendments approved during the conversion in law are expressly aimed at solving such issues.

b. Tax Non-Deductibility

The provisions under discussion may raise some concerns as regards the non-deductibility of the Bank WT from direct taxes. Indeed, as per the interpretation put forward by the Italian Constitutional Court, income attributable to business activities should be taxed after accounting for costs. The Bank WT, which functions as a “tax cost” inherently related to the taxpayers’ business activities, should logically be deductible from the taxable base for direct taxes.

c. Application of the Alternative Payment Option to permanent establishments of foreign banks

The application of the alternative to the payment is unclear for permanent establishments of foreign banks. Indeed, branches generally do not approve a financial statement, lack an actual net equity capable of "absorbing" the creation of an extraordinary reserve, and do not distribute profits. Given these unique characteristics, there is an urgent need to clarify how the alternative should be applied for Italian permanent establishments of foreign banks.

d. Offsetting of tax credits

At this stage it is unclear whether the debt arising from the Bank WT can be offset against tax credits. Notably, paragraph 6 of Article 26 of the Decree states that for the purposes of the assessment, application of penalties, collection and litigation process concerning the Bank WT, the provisions on corporate income tax apply. It does not, however, provide any clearance regarding the applicability of Article 17 of Legislative Decree No. 241 of 1997, especially concerning the potential for offsetting tax credits. This becomes a point of interest for those who opt not to utilize the alternative to payment.

e. Determination of weighted assets

Clarifications will be needed on whether the 0.26% limit on weighted assets should be calculated based on a stand-alone basis or if there is room to apply the consolidated weighted assets. Additionally, there's ambiguity about whether this limit should be calculated by reference to risk-weighted assets of Italian entities of the group only or at global level. The manner in which this limit is determined could in fact have substantial implications on the scope and revenue generated by the Bank WT. This issue was also explicitly noted by the ECB, which emphasized the need for additional clarification, particularly to ascertain the tax burden that would likely be imposed on credit institutions directly supervised by the ECB.

Moreover, as regards the calculation of the 0.26% threshold, it is worth noting that Italian branches of EU banks are subject to the regime applicable in the Country of residence of the headquarter, including the rules on balance sheet and calculation of total exposure to risk. Although these are matters harmonized under European regulations, material discrepancies amongst EU Countries may arise. It will therefore be relevant to ascertain whether there are asymmetries in the calculation of the exposure to risk of the entities subject to the Bank WT.

f. Application in the case of extraordinary transactions

Lastly, it would be crucial to provide additional clarification or guidance in relation to the impact of extraordinary transaction (such as mergers and acquisitions) executed during the period used for estimating the Bank WT.

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Chiomenti will continue to monitor subsequent developments.

1. In the initial version of the Decree, the tax was levied on the larger of the increases (provided those increases exceeded 10 percent) in the interest margin between the fiscal years ending 1 January 2023 or 1 January 2024. According to the accompanying technical report for the new amendment, the text safeguards against the likelihood that taxpayers may engage in activities to reduce the taxable base before the period ends. This is ensured by a provision in the final sentence of paragraph 2, stating that any improper determination of the taxable base could be challenged as an abuse of law, in accordance with paragraph 10-bis of Law 212 of 2000.

1. Conversely, the original regulations of the levy provided a cap of 0.1% of total assets for the fiscal year prior to the year ending 1 January 2023.