ARTICLE 23

Relief from Double Taxation

Paragraph 1

Paragraph 1 provides that each Contracting State will undertake to relieve double taxation in the manner set forth in this Article.

Paragraph 2

The United States agrees, in subparagraph 2(a), to allow to its citizens and residents a credit against U.S. tax for the appropriate amount of income tax paid to Italy. The credit under the Convention is allowed in accordance with the provisions and subject to the limitations of U.S. law, as that law may be amended over time, so long as the general principle of this Article, i.e., the allowance of a credit, is retained. Thus, although the Convention provides for a foreign tax credit, the terms of the credit are determined by the provisions, at the time a credit is given, of the U.S. statutory credit.

As indicated, the U.S. credit under the Convention is subject to the various limitations of

U.S. law (see Code sections 901 - 908). For example, the credit against U.S. tax generally is limited to the amount of U.S. tax due with respect to net foreign source income within the relevant foreign tax credit limitation category (see Code section 904(a) and (d)), and the dollar amount of the credit is determined in accordance with U.S. currency translation rules (see, e.g., Code section 986). Similarly, U.S. law applies to determine carryover periods for excess credits and other inter-year adjustments. When the alternative minimum tax is due, the alternative minimum tax foreign tax credit generally is limited in accordance with U.S. law to 90 percent of alternative minimum tax liability. Furthermore, nothing in the Convention prevents the limitation of the U.S. credit from being applied on a per-country basis (should internal law be changed), an overall basis, or to particular categories of income (see, e.g., Code section 865(h)).

Subparagraph 2(a) also provides for a deemed-paid credit, consistent with section 902 of the Code, to a U.S. corporation in respect of dividends received from a corporation resident in Italy of which the U.S. corporation owns at least 10 percent of the voting stock. This credit is for the income tax paid by the corporation of Italy on the profits out of which the dividends are considered paid.

Subparagraph 2(b) provides, in general, that Italy’s covered taxes are income taxes for U.S. purposes. This provision is based on the Treasury Department’s review of Italy’s laws. However, in the case of the regional tax on productive activities (l’imposta regionale sulle attività produttive) (“IRAP”), referred to in paragraph 2(b)(iii) of Article 2 (Taxes Covered), only that portion specified in subparagraph 2(c) is considered to be an income tax for purposes of Article 23.

Under the prior Convention, Italy’s local income tax (l’imposta locale sul redditi) (“ILOR”) was a covered tax and was considered an income tax for purposes of the U.S. tax credit under Article 23. However, effective January 1, 1998, Italy repealed ILOR (as well as certain other taxes, including a local social security tax) and enacted IRAP, which applies to Italian residents as well as non-residents of Italy with a permanent establishment in Italy. Unlike ILOR, IRAP is calculated without a deduction for labor costs and, for certain taxpayers, without a deduction for interest costs. For example, the IRAP tax base for a manufacturing company generally equals gross revenue from sales in Italy, with certain deductions including cost of goods sold, rent and depreciation (but with no deduction for interest or labor expenses). The IRAP tax base for a bank or other financial institution generally equals interest and other income received, with certain deductions including interest paid, rent and depreciation (but with no deduction for labor expenses). The initial IRAP tax rate generally is 4.25 percent (5.4 percent for banks and other financial institutions).

The portion of IRAP specified in subparagraph 2(c) is intended, in general, to approximate that portion of IRAP that is imposed on the business profits of a taxpayer, and which therefore represents a tax on net income. The portion of IRAP that is considered to be an income tax pursuant to subparagraph 2(c) is calculated as follows:

portion considered an applicable total amount paid income tax under = ratio X of IRAP paid or subparagraph 2(c) accrued

The “applicable ratio” is calculated as follows:

applicable adjusted total tax base upon ratio = base ÷ which IRAP is actually imposed

The “adjusted base” equals the greater of: (a) Zero (0), or (b) The total tax base upon which IRAP is actually imposed, less the total amount of labor and interest expense not otherwise taken into account in determining the total tax base upon which IRAP is actually imposed

In general terms, the amount of IRAP paid or accrued that is considered an income tax under this formula is determined by multiplying the amount of IRAP paid or accrued to Italy by a fraction, the numerator of which represents an amount approximating the taxpayer’s business profits (including deductions for interest and labor expense) that were subject to IRAP, and the denominator of which equals the actual tax base upon which Italy imposed IRAP. In the case of a non-financial institution, the interest expense deduction in the numerator refers to gross interest expense (rather than net interest expense)

The following examples illustrate these calculations:

Example 1. M is a manufacturing company resident in the United States, with a permanent establishment in Italy. M has the following items of income and expense attributable to the permanent establishment in Italy:

Gross Revenue subject to IRAP $100,000 Rent/Depreciation Expense 40,000 Labor Expense 20,000 Interest Expense 10,000

The tax base upon which IRAP is imposed equals $60,000 ($100,000, less $40,000 rent/depreciation expense). No deduction is allowed under Italian law for the labor and interest expenses in calculating IRAP. Accordingly, M pays IRAP equal to $2,550 (4.25 percent rate, multiplied by $60,000).

For purposes of determining the portion of this tax that is considered an income tax under subparagraph 2(c), the “adjusted base” equals $30,000 ($60,000 base upon which IRAP is actually imposed, less $20,000 labor expense and $10,000 interest expense that were not otherwise taken into account in determining the actual IRAP tax base). The “applicable ratio” equals ½ ($30,000 adjusted base, divided by $60,000 actual IRAP tax base). Accordingly, the portion of IRAP that is considered an income tax under subparagraph 2(c) equals $1,275 (½ applicable ratio, multiplied by $2,550 total amount of IRAP paid).

Example 2. B is a bank resident in the United States, which conducts banking activities

through a permanent establishment in Italy. B has the following items of income and expense attributable to the permanent establishment in Italy:

Gross Revenue subject to IRAP $100,000 Rent/Depreciation Expense 20,000 Labor Expense 15,000 Interest Expense 60,000

The tax base upon which IRAP is imposed equals $20,000 ($100,000, less $20,000 rent/depreciation expense and $60,000 interest expense). No deduction is allowed under Italian law for the labor expense in calculating IRAP. Accordingly, B pays IRAP equal to $1,080 (5.4 percent rate, multiplied by $20,000).

For purposes of determining the portion of this tax that is considered an income tax for purposes of subparagraph 2(c), the “adjusted base” equals $5,000 (the $20,000 base upon which IRAP is actually imposed, less the $15,000 labor expense that was not otherwise taken into account in determining the actual IRAP tax base). The “applicable ratio” equals ¼ ($5,000 adjusted base, divided by $20,000 actual IRAP tax base). Accordingly, the portion of IRAP that is considered an income tax for purposes of subparagraph 2(c) is $270 (¼ applicable ratio, multiplied by $1,080 total amount of IRAP paid).

Paragraph 3

In paragraph 3, Italy agrees to allow its residents a credit against Italian tax for U.S. taxes on income. With respect to items of income that the United States may tax under the Convention (other than solely by reason of the saving clause applied to U.S. citizens), Italy may include such items of income in the tax base of its residents except as otherwise provided by the Convention. In such a case, the U.S. taxes that are covered taxes under paragraphs 2(a) and 3 of Article 2 (Taxes Covered) will be allowed as a credit against the Italian tax liability in an amount not to exceeding the proportion of Italian tax that such items of income that are taxable by the United States bear to the total income of the taxpayer.

Italy will not give a foreign tax credit in cases where the taxpayer has elected under Italian law to pay a final withholding tax on an item of income, e.g., dividends, thereby excluding that income from the tax base subject to the ordinary rates of tax.

Italy does not grant an indirect credit comparable to the credit authorized by section 902 of the Code. However, under Article 2359 of Italy’s tax law, a portion of the dividends received by an Italian corporation from a foreign subsidiary (defined in terms of 10 percent ownership or a “controlling interest”) are excluded from the tax base.

Paragraph 4

Paragraph 4 provides special rules for the tax treatment in both States of certain types of income derived from U.S. sources by U.S. citizens who are resident in Italy. Since U.S. citizens, regardless of residence, are subject to United States tax at ordinary progressive rates on their

worldwide income, the U.S. tax on the U.S. source income of a U.S. citizen resident in Italy may exceed the U.S. tax that may be imposed under the Convention on an item of U.S. source income derived by a resident of Italy who is not a U.S. citizen.

Subparagraph (a) of paragraph 4 provides special credit rules for Italy with respect to items of income that are either exempt from U.S. tax or subject to reduced rates of U.S. tax under the provisions of the Convention when received by residents of Italy who are not U.S. citizens. The tax credit of Italy allowed by paragraph 4(a) under these circumstances, to the extent consistent with the law of Italy, need not exceed the U.S. tax that may be imposed under the provisions of the Convention on a resident of Italy that is not a U.S. citizen. Thus, if a U.S. citizen resident in Italy receives U.S. source portfolio dividends, the foreign tax credit granted by Italy would be limited to 15 percent of the dividend -- the U.S. tax that may be imposed under subparagraph 2(b) of Article 10 (Dividends) -- even if the shareholder is subject to U.S. net income tax because of his U.S. citizenship. With respect to royalties arising from the use of, or right to use, a copyright of literary, artistic or scientific work described in paragraph 3 of Article 12 (Royalties), Italy would allow no foreign tax credit, because its residents are exempt from U.S. tax on this class of income under Article 12.

Paragraph 4(b) eliminates the potential for double taxation that can arise because subparagraph 4(a) provides that Italy need not provide full relief for the U.S. tax imposed on its citizens resident in Italy. The subparagraph provides that the United States will credit the income tax paid or accrued to Italy, after the application of subparagraph 4(a). It further provides that in allowing the credit, the United States will not reduce its tax below the amount that is taken into account in Italy in applying subparagraph 4(a). Since the income described in paragraph 4 is U.S. source income, special rules are required to resource some of the income to Italy in order for the United States to be able to credit the Italy’s tax. This resourcing is provided for in subparagraph 4(c), which deems the items of income referred to in subparagraph 4(a) to be from foreign sources to the extent necessary to avoid double taxation under paragraph 4(b). The rules of paragraph 4(c) apply only for purposes of determining U.S. foreign tax credits with respect to taxes considered to be income taxes pursuant to subparagraph 2(b) of Article 23 (Relief from Double Taxation).

The following two examples illustrate the application of paragraph 4 in the case of a U.S. source portfolio dividend received by a U.S. citizen resident in Italy. In both examples, the U.S. rate of tax on residents of Italy under paragraph 2(b) of Article 10 (Dividends) of the Convention is 15 percent. In both examples the U.S. income tax rate on the U.S. citizen is 36 percent. In example I, the Italian income tax rate on its resident (the U.S. citizen) is 25 percent (below the U.S. rate), and in example II, the Italian income tax rate on its resident is 40 percent (above the U.S. rate).

Example I Example II Paragraph 4(a)

U.S. dividend declared $100.00 $100.00 Notional U.S. withholding tax per Article 10(2)(b) 15.00 15.00 Italian taxable income 100.00 100.00 Italian tax before credit 25.00 40.00 Italian foreign tax credit 15.00 15.00 Net post-credit Italian tax 10.00 25.00

Example I Example II Paragraphs 4(b) and (c)

U.S. pre-tax income $100.00 $100.00 U.S. pre-credit citizenship tax 36.00 36.00 Notional U.S. withholding tax 15.00 15.00 U.S. tax available for credit 21.00 21.00 Income resourced from U.S. to Italy 27.77 58.33 U.S. tax on resourced income 10.00 21.00 U.S. credit for Italian tax 10.00 21.00 Net post-credit U.S. tax 11.00 0.00 Total U.S. tax 26.00 15.00

In both examples, in the application of subparagraph 4(a), Italy credits a 15 percent U.S. tax against its residence tax on the U.S. citizen. In example I the net Italian tax after foreign tax credit is $10.00; in the second example it is $25.00. In the application of subparagraphs 4(b) and (c), from the U.S. tax due before credit of $36.00, the United States subtracts the amount of the U.S. source tax of $15.00, against which no U.S. foreign tax credit is to be allowed. This provision assures that the United States will collect the tax that it is due under the Convention as the source country. In both examples, the maximum amount of U.S. tax against which credit for Italian tax may be claimed is $21.00. Initially, all of the income in these examples was U.S. source. In order for a U.S. credit to be allowed for the full amount of Italian tax, an appropriate amount of the income must be resourced. The amount that must be resourced depends on the amount of Italian tax for which the U.S. citizen is claiming a U.S. foreign tax credit. In example I, Italian tax was $10.00. In order for this amount to be creditable against U.S. tax, $27.77 ($10 divided by .36) must be resourced as foreign source. When Italian tax is credited against the U.S. tax on the resourced income, there is a net U.S. tax of $11.00 due after credit. In example II, Italian tax was $25 but, because the amount available for credit is reduced under subparagraph 4(c) by the amount of the U.S. source tax, only $21.00 is eligible for credit. Accordingly, the amount that must be resourced is limited to the amount necessary to ensure a foreign tax credit for $21 of Italian tax, or $58.33 ($21 divided by .36). Thus, even though Italian tax was $25.00 and the U.S. tax available for credit was $21.00, there is no excess credit available for carryover.

Paragraph 5

Paragraph 5 provides a resourcing rule for purposes of the U.S. foreign tax credit in situations where an individual who is a dual national of both the United States and Italy is taxable by Italy pursuant to subparagraph 1(a) of Article 19 (Government Service) and by the United States pursuant to the saving clause of paragraph 2 of Article 1 (Personal Scope). This provision is explained in more detail above in the discussion of Article 19.

Relation to Other Articles

By virtue of the exceptions in subparagraph 3(a) of Article 1 this Article is not subject to the saving clause of paragraph 4 of Article 1 (Personal Scope). Thus, the United States will allow

a credit to its citizens and residents in accordance with the Article, even if such credit were to provide a benefit not available under the Code (such as the re-sourcing provided by subparagraph 4(c) and paragraph 5).