Avoidance of double taxation: Italy-China agreement ratified

The list of agreements aimed at avoiding the occurrence of double taxation on the same income grows longer; the ratification of this tax agreement brings into force the determinations agreed between Italy and China just over five years ago, precisely on 23 March 2019.

As a matter of fact, this is not the first double taxation agreement signed by Italy and China. In Beijing, on 31 October 1986, these two Countries had already signed one, which will naturally cease to have effect upon the entry into force of that concerned here.

To this end, Article 29 of the Agreement makes its entry into force conditional on the diplomatic exchange of notifications between the two Countries, concerning the completion of the internal procedures necessary for this purpose under the respective Countries' regulations. Accordingly, it will enter into force on the 30th day following the date of receipt of the last notification.

Moreover, the agreement will be effective:

(a) relating to taxes withheld at source, on sums earned on or after 1 January of the first calendar year following the year of entry into force; and

b) relating to other income taxes relating to tax periods beginning on or after 1 January of the first calendar year following the year of enactment.

The target audience covered by the agreement includes residents of one or both of the contracting states. On the other hand, the taxes to which the latter will apply, according to Article 2, are:

- for the Republic of China:

1. the individual income tax;
2. the corporate income tax;

- for Italy:

1. the individual income tax;
2. the corporate income tax;
3. the local income tax;

Given these due remarks, the agreement under review presents some features and novelties if compared to the 1986 agreement and to the generality of similar agreements signed by Italy on same subject. In detail:

• this agreement is drafted on the basis of the OECD model;
• Regarding income from employment, in Article 15 we find an additional paragraph 4 focusing on sums received after and/or on the occasion of the termination of the employment relationship;
• There is an article dedicated to sums received by students or apprentices present in one or other State;
• There is also an article dealing with individuals who hold the position of teacher and researcher in one or other state.

As provided for in the OECD Model, Article 15 of the agreement, indexed “Dependent personal services”, provides:

• in paragraph 1, the rule of application of the territoriality principle to the income produced by the worker; this principle is intended to give prominence not so much to the position of the employer and the employee receiving the income, but more to the place where the income is produced;
• in paragraph 2, an exception to the application of the above-mentioned principle under the following three conditions:

1. the recipient is present in the other State (different from usual one) for a period or periods not exceeding in theaggregate 183 days in the calendar year concerned, and
2. the remuneration is paid by, or on behalf of, an employer who is not a resident of the other State, and
3. the remuneration is not borne by a permanent establishment or a fixed base which the employer has in the other State.

Therefore, if the three above-mentioned conditions are met, the income produced by the person will continue to be subject to taxation in the State of origin (e.g. Italy) despite the fact that it is related to work, temporarily, carried out in the other State (e.g. China).

Of this article, paragraph 4 is particularly interesting. The signatory parties aimed to immediately settle issues related to the taxation of income arising after the termination of the employment relationship. Pursuant to this provision, severance payments or other lump-sum payments of a similar nature received by an Italian resident following the loss of his or her status as a Chinese resident, in accordance with the relevant provisions in force in China, are taxable only in that other Contracting State. And vice-versa.

Guidance on the interpretation of this provision will certainly be provided by the Revenue Office. Nevertheless, its relevance is highlighted in circumstances of doubtful tax liability in relation to amounts paid on termination of employment. This is the case of redundancy incentives, indemnities in lieu of notice and severance pay, which could easily be received by the individual in a contracting state other than the one in which the employment, which gave rise to it, might have taken place.

Even with regard to the category of directors, the agreement is more explicit than others. Article 16, entitled ‘Directors’ Fees', provides that such sums and other similar remuneration which a resident of a Contracting State (e.g. Italy) receives as a member of the board of directors of a company resident in the other Contracting State (e.g. China) may be taxed in that other State (e.g. China).

Absence of the adverb only, however, raises the doubtful possibility of double taxation also in this case.

Article 20 is dedicated to students and apprentices and provides for a special exemption from taxation of certain sums for a maximum period of six years received by the person in the territory of the Contracting State other than the State of residence.

In detail, the Contracting States have provided that sums received to meet maintenance or educational expenses by a student or apprentice who is resident in one State (e.g. Italy) or who was resident in that State (e.g. Italy) immediately before going to the other State (e.g. China), and who stays in that State (e.g. China) for the sole purpose of studying there, are not taxable in the latter State (China), provided that such sums are derived from sources placed outside the territory of the latter State (China). This exemption is only enforceable for a period not exceeding six consecutive years from the date of arrival.

In Article 21, the agreement provides for the exemption from taxation of income earned in connection with teaching and research activities carried out in a Contracting State other than the State of residence for a period not exceeding three years from the first arrival of the person concerned in the territory of the latter State.

To be more precise: remuneration which an individual, who stays in a Contracting State (China) solely for the purpose of teaching, lecturing, or carrying out research activities at a school, educational institution, university, or other educational or research institution officially recognised by the Government of that State, and who is, or was immediately before such stay, a resident of the other Contracting State (Italy), receives for such activities, shall be exempt from taxation in the first-mentioned State (China) for a period not exceeding, in the aggregate, three years from the date of his arrival in that State (China).

This article ends with a provision of rather unclear interpretation by excluding from the scope of the above-mentioned exemption research income that is not ‘in the public interest’ and is ‘primarily for the private benefit of one or more specified persons’.

In conclusion, Article 23, entitled ‘Methods for the avoidance of double taxation’, cannot be ignored.

The two Contracting States, in detail, have identified the following differentiated solutions depending on the subjective status of being resident alternatively in China or Italy. Namely:

• when a Chinese resident earns Italian income, the amount of tax payable in Italy may be deducted from the Chinese tax payable by the person, up to the amount of the Chinese tax on such income calculated in accordance with Chinese tax laws and regulations;
• when an Italian resident receives taxable income in China, these items may be included in the tax base on which taxes are applied in Italy. In such a case, it is possible to deduct from the calculated taxes, the income tax paid in China, but the deduction may not exceed the portion of Italian tax payable on the aforesaid items of income in the proportion in which they contribute to the total income.

In any event, no deduction will be allowed if the item of income is subjected in Italy, under Italian law, to taxation by means of a withholding tax or to substitute tax at the same rate as the withholding tax, whether or not at the request of the recipient of the income.

On the whole, this double taxation agreement, that we will be applying, revises and updates its previous version. It extends in some cases the exemption periods already provided for - as is the case with regard to students and apprentices (the exemption period increases to six years instead of the previously indicated five) - and introduces particular new provisions - such as the fourth paragraph of Article 15.