Carlo Cicala, Dynasty Trust Presentation

Circolo Canottieri Aniene, 7th February 2022

I would like to extend my gratitude to President Di Salvo for his introduction, President Santoro for his insightful presentation, and my dear friends Notary Papi and Alessandro Riccioni. I also thank all of you for dedicating your time and the Club for hosting me.

Today, I shall discuss a particularly interesting aspect of generational business transfer through the use of trust, specifically when a business is owned by a company.

The challenge here is straightforward: an entrepreneur identifies a family member deemed most suitable to succeed them in running the business and plans the transfer of company shares.

This transfer can be effected using various instruments, not solely a trust. The simplest and most well-known is the will, or succession due to death. However, the primary issue with a will is the uncertainty regarding the timing of death, hence the succession and generational transfer timeline remains unpredictable.

Conversely, donation offers a definitive date for the generational transfer, occurring while the entrepreneur is alive.

Yet, both wills and donations face the problem of safeguarding the legitimate rights. Typically, there is a designated successor to lead the company, but other family members are entitled to a portion of the entrepreneur’s estate. It is crucial to arrange matters so that the other family members (legitimate heirs) have no reason to contest the generational transfer, thus avoiding succession disputes. Theoretically, this problem can be solved by ensuring that the entrepreneur allocates monetary assets (or other assets besides company shares) to the other family members, ensuring no one feels their rights are violated quantitatively.

However, this problem is further complicated by the fact that, under our legal system, calculations to determine if a legitimate share has been infringed are made posthumously, taking into account the value of assets at the time of death. This can create discrepancies, as the business may have significantly appreciated in value since it was donated or since the will was made, potentially leading to judicial disputes.

Hence, in 2006, the family agreement was introduced as a new tool. With the family agreement, all benefits of donation are realized as the productive asset transfer occurs immediately, while the entrepreneur is still alive, with an additional advantage: if executed according to the law, the transfer of shares cannot be contested at the time of death. Assets transferred via the family agreement are not subject to reduction provided all those entitled to a share of the entrepreneur’s legitimate estate participate in the agreement, including other family members who are not recipients of the family business. These family members must be compensated for their legitimate share calculated based on the business’s value at the time the agreement is signed, thereby theoretically preventing future inheritance disputes.

Nonetheless, the family agreement presents a significant problem: the immediate transfer of the business also requires the immediate satisfaction of other family members’ (non-recipients of the business) shares, which might not be feasible at the time. This leads to situations where the business transfer is appropriate, but the timing for compensating other family members is not, potentially delaying until the entrepreneur’s death.

For these reasons, the family agreement has seen limited use, a result that has disappointed those who invested significant effort into its study.

Thus, we turn to the trust for company shares. Through this instrument, an entrepreneur can transfer company shares to a trustee, who will then transfer them to the designated successor at a future date, possibly upon the occurrence of specific conditions (e.g., reaching adulthood, completing studies), and even after the entrepreneur’s death.

How does this reconcile with protecting legitimate heirs? While the family agreement offers exemption from reduction, a trust provides another possibility. The trustee can be tasked with satisfying the legitimate heirs’ claims from the trust’s assets, calculating the required amounts at the time of the entrepreneur’s death. In simpler terms, the entrepreneur may not know the exact amount needed to satisfy the reserved quotas when establishing a dynasty trust, as it depends on the value of the assets at the time of succession. The trustee would handle these calculations and distributions, thereby eliminating potential succession disputes from the root.

Fiscal Instruments: Exemption from Indirect Taxes

Having discussed the civil law mechanism, let’s address the equally important practical issue: taxation.

Our legal system aims to facilitate the generational transfer of businesses from a tax perspective. In 2006, alongside the family agreement, a significant total exemption from succession and donation tax was introduced for all business transfers to certain family members.

This exemption applies only to the transfer of businesses or controlling shares of a company. According to tax regulations, it is insufficient to simply transfer controlling shares; the transferred company must effectively control a business. For example, transferring 100% of a holding company that only controls 20% of an operating company (and conducts no other business activities) does not qualify for the exemption.

This clarification is crucial because without the exemption, the generational transfer of company shares via trust is subject to indirect taxes (succession tax), albeit with allowances for family transfers (e.g., between father and son).

Importantly, no indirect tax applies at the time of the asset’s transfer into the trust. This was conclusively established only last August, when the Revenue Agency conceded to jurisprudence, affirming that with a trust, indirect taxes are payable only when the asset enters the beneficiary’s estate, not when it enters the trustee’s estate.

Direct Taxes: Transparent and Opaque Trusts

Regarding direct taxes, it is essential to understand that while the trust has tax subjectivity, certain peculiarities must be acknowledged, especially in a generational trust context.

Dividend tax does not always fall on the trust, as one might logically assume. The trustee, as the shareholding entity, would presumably pay the dividend tax. However, the Revenue Agency’s established practice is that, in some cases, the tax falls on the trust beneficiary, regardless of whether the beneficiary has received the income. This occurs in what is termed a “transparent trust,” where the beneficiary has the right to receive the trust’s income, and taxes on dividends from shares fall on the beneficiary.

Conversely, in an “opaque trust,” where the beneficiary does not have an immediate right to income, and the trustee has discretionary power over income distribution, the tax falls on the trust. This scenario arises when the trustee is expected to evaluate the beneficiary’s needs for disbursements (e.g., educational expenses, medical procedures), and the subsequent income transfer to the beneficiary is tax-exempt.

A particular case worth mentioning is an opaque trust engaging in commercial activities, such as investments in other shares. Such a trust enjoys a 95% exemption on the taxable base, with any subsequent income transfer to the beneficiary remaining tax-exempt.

Conclusion: The Role of Fiscal Practices in Trust and Beyond

In conclusion, I have extensively discussed the fiscal profile of trusts, emphasizing its dominance in both volume and importance.

This focus stems from several reasons. Firstly, the fiscal profile of any act is always crucial, including real estate transactions. However, the trust involves an additional complexity, as it incorporates foreign legal principles into our system through an international convention.

The trust is well-known to our judges, both ordinary and tax judges, as well as the fiscal authorities. These authorities play a critical role in defining the fiscal effects of trusts, often leading to discrepancies between the civil and fiscal interpretations of the trust, as evidenced by the Revenue Agency’s previous stance that property transfers into a trust are subject to proportional tax—a position corrected by subsequent jurisprudence.

In practice, the Italian fiscal system frequently views economic operations differently from the civil law perspective, a trend not unique to trusts. For example, a share transfer perceived as such in civil law might be recharacterized as a business transfer for tax purposes, or a purchase transaction might be deemed “non-existent” only for tax purposes, attributing the purchase to a different party.

Furthermore, our tax system includes a general anti-abuse rule, allowing any economic operation to be disregarded if it lacks valid economic reasons beyond tax savings. This can lead to a trust being deemed fiscally non-existent, even if civilly valid, highlighting the importance of understanding these fiscal intricacies.

Lastly, I acknowledge the potential fiscal pitfalls, where the tax system’s perspective diverges unexpectedly from civil law, a topic I explore further in another forthcoming publication. Thank you.