How to save Italian Estate and Gift tax: set up a US Non-Grantor Trust before moving to Italy

In this article we will analyze a very important characteristic of US Trusts highlighted by the recent Circolare n. 34/E of the Agenzia delle Entrate (the Italian IRS) that focuses on the Italian fiscal aspects of Foreign Trusts.
When a US person wishes to move to Italy but wants to keep his investments in the US, it's possible to save the Italian Estate and Gift Tax (Imposta sulle Donazioni) by setting up a US Non-Grantor Trust before moving to Italy.
Let's see why and how to do it.


Before starting the analysis, you can take a look at the following links, regarding American Citizens that set up Non-Grantor Trusts and move to Italy:




These articles put the focus on the importance of setting up a US Non-Grantor Trust for US persons that want to move to Italy while keeping their financial investments in the US.
The third article (written in Italian) focuses in particular on how to avoid taxation issues when in the US investments there are Mutual Funds or ETF or Hedge Funds.

A PRELIMINARY OBSERVATION

A very important difference between American and Italian laws on Trust is that in America the income produced inside the Non-Grantor Trust and for which this Trust has already paid the taxes is automatically considered "principal".
"Principal" is also the value of the assets put inside the Trust. 
See the following case.

EXAMPLE 0

A US person (Grantor) segregates in Year N financial investments for 4 millions euro inside a US Non-Grantor Trust.
After 1 year, the value of the Trust is 4,2 millions euro, as the financial investments have produced interests, dividends and capital gains for 0,3 millions euro and the Trust have paid 0,1 millon in taxes on these incomes.

American qualification of the Trust:

Beginning principal: 4 millions euro;
This value is qualified as PRINCIPAL;

Net income produced by the investments: 0,2 millions euro
This value is qualified as PRINCIPAL.

So, whenever the Trustee makes a distribution, it is always something coming out of the Principal (we are not considering here the case in which the Trustee gives the "Income Distribution Deduction" to the beneficiary).

Italian qualification of the Trust:

Beginning principal: 4 millions euro;
This value is qualified as PRINCIPAL;

Net income produced by the investments: 0,2 millions euro;
This value is qualified as INCOME.

So, in the case of a distribution to a beneficiary, it's always important for Italian fiscal reasons, to know whether the funds come from the BASKET OF THE PRINCIPAL or from the BASKET OF INCOME, as the fiscal treatment could be different.

For this reason, it's always very important for the Italian Fiscal approach to keep track of the stratification of the different layers of net income and of principal (especially in the case the Grantor want to segregate some assets at the beginning and some other assets in another moment). 
For our Clients we take complete care of this important aspect, as we keep track analytically of every layer of principal and income: these aspects are very important but also very complicated to deal with and too difficult to consider by the Trustee, that is usually a person living in the US with low familiarity with the Italian taxation problems.

ITALIAN GIFT TAX: CHANGE OF APPROACH FOR TRUST

Now, let's see another reason why a US Non-Grantor Trust is a must for the American Citizen who wants to move to Italy.

The Circolare n. 34/E of 20 October 2022 has finally accepted the view that setting up an Italian or a Foreign Trust is not, per se, a reason to apply Italian Gift Tax when the Grantor put his funds and assets inside the Trust.
Circolare n. 34/E has confirmed the more correct approach of applying the Italian Gift Tax (Imposta di Donazione) only when the beneficiaries of the Trust will receive the assets that were put inside the Trust by the Grantor.
This is a major shift in the way the Italian Fiscal Authorities addresses the Trust.
Let's see the following example to better understand this change.
 
EXAMPLE 1
 
An American Citizen (the Grantor) with two daughters decides in year N to set up a US Non-Grantor Trust and puts 4.000.000 euro in financial assets inside this Trust. The daughters are the beneficiaries of the Trust and the entire family is resident in Italy from a fiscal point of view.
After a couple of years, in year N+2, the Trustee makes a distribution of the beginning principal of 200.000 euro to each daughter. 
 
Before the Circolare n. 34/E:
The American Citizen, being fiscal resident in Italy, should have paid the Italian Gift Tax (Imposta di Donazione) on the entire sum of 4 millions euro at the moment in which he put the financial assest inside the Trust, even if:
- the assets the Grantor has put inside the Trust were held on American soil;
- the Trust was a US Trust.

To understand how Italian Gift Tax works, let's say that there is an exemption threshold of 1 million euro for every child if the donor is the parent; so the calculation of the tax is the following:
 
Total value of assets put inside the  Trust: 4 millions euro;
Exemption threshold for the first daughter: 1 million euro; 
Exemption threshold for the second daughter: 1 million euro; 
Taxable value for Italian Gift Tax: 4 - 1 - 1 = 2 millions euro.
Italian Gift Tax rate for donations from parents to children: 4%
Total Italian Gift Tax: 4% x 2 millions euro = 80.000 euro.
 
After the Circolare n. 34/E:
Nothing is due at the moment in which the assets are segregated inside the Trust, as there is no transfer of wealth from the father to the daughter.
In year N+2 the beneficiaries receive 200.000 euro each from the Trustee.
Now we can apply the Italian Gift Tax, but there is nothing to pay, as the exemption threshold is higher (1 Million per child) than the distribution received.
Obviously, the 200.000 distribution of will reduce the exemption threshold of each daughter to 800.000 euro; once the threshold limit is exhausted, the Italian Gift Tax is applied with the tax rate of 4%.

ANOTHER IMPORTANT NEW

This shift of the Agenzia delle Entrate is a very important new, but it's not the most important one for the American Citizen, as Circolare 34/E has clarified also that no Italian Gift Tax is ever applied to distributions to beneficiaries of assets put in Trust by the Grantor when both the following two conditions are met.
 
FIRST CONDITION
The assets that are segregated inside the US Non-Grantor Trust are all held in the US and not in Italy.
 
This is pretty much our hypothesis, as the Non-Grantor Trust is created to protect the US investment from the problematic double taxation issues that we have already mentioned in the links above.
So we are considering financial accounts held in America, bank account held in America, Real Estate in the US ans so forth.
 
SECOND CONDITION
The assets and funds have been segregated inside the Trust while the Grantor was still fiscal resident in the US, thus before moving to Italy.
 
Let's see some more examples to better understand how these two conditions work.
 
EXAMPLE 2 
 
We can take the same exact situation as in the Example 1, with the following differences:
- the Grantor has put the 4 millions euro inside the US Non-Grantor Trust in year N while he was resident in America from a fiscal point of view;
- the 4 millions euro was held in a US financial account.
 
As we said before in Example 1, Circolare 34/E confirms that there is no Italian Gift Tax on the beginning contribution of 4 millions euro in the Trust by the Grantor.
But now, we can say that when the daughters will receive the distributions from the Trustee in year N+2, these distributions will be considered out of the Italian Gift Tax realm, as the segregation of the 4 millions euro inside the Trust was made when the Grantor was fiscal resident in the US and not Italy.

To apply Italian Gift Tax (Imposta di Donazione) to the beneficiaries, there must always be at least one of these two requirements:
 
- the assets that are put in Trust must be in Italy
 
- the donor (the Grantor of the Trust) has Italian fiscal residency at the moment in which he segregated the assets inside the US Non-Grantor Trust.
 
If no one of these two requirements is met, there is no Italian Gift Tax for the beneficiaries when they receive distribution of principal.
 
EXAMPLE 3

Suppose that we are in the same environment as Example 2, but this time the daughters received the entire 4 millions euro in Year n+2: is there any Italian Gift Tax?
 
No, there will be NO Italian Imposta di Donazione, as the distributions are out of the Italian Gift Tax realm at all.
For the same reason the distribution of 4 millions (2 millions for each daughter) will not cause any erosion of their exemption thresholds, that in fact remain intact to 1 millions for each daughter.
 
EXAMPLE 4

Suppose that we are in the same environment as Example 2, but this time the Grantor has put inside the US Non-Grantor Trust the following assets:
 
- a real estate property he had previously bough in Italy (keep in mind that in Example 2 he was fiscal resident in the US when he has put the assets inside the Trust);
- US financial assets.
 
In this case, if the Trustee makes distributions of the beginning principal from the US Financial assets, there would be no application of Italian Gift Tax, as both of the two above mentiones conditions are met.
But in case the Trustee would assign the Italian house to the two daughter, the first condition is NOT met and thus there will be application of Italian Gift Tax.
 
EXAMPLE 5

Suppose that we are in the same environment as Example 2, but this time the Grantor has put the assets inside the Trust January 4 of Year N.
Then he moves with the entire family to Italy on February 4 and he remains all year N in Italy.
In this particular case, is the second condition met?
No, as the Grantor would put the assets inside the Trust in Year N before moving to Italy but he must be aware that he will be considered fiscal resident of Italy for the ENTIRE YEAR N, as he moves in Italy the 4 February of Year N, spending thus more than 183 days in Italy.

It would have been sufficient to put all the assets inside the Trust by 31 December of the Year N-1, in order to save the Italian Imposta di Donazione.
 
It's important also to notice the following points.
 
1. When we talk about principal (see the preliminary observation above) we are talking of all the values and assets that the Grantor will segregate inside the Trust, at the beginning of the life of the Trust, but also during the life of the Trust. In case some of these contributions done by the Grantor are made while he was fiscal resident in US and some other are made while he was fiscal resident in Italy, the Trustee must keep track of these facts, as the distributions to beneficiary connected from the contributions made while he was fiscal resident in Italy are subject to Imposta di Donazione, while the other no.
 
2. LIVING TRUST AND OTHER GRANTOR TRUST do not give the same benefit in saving the Italian Gift Tax.
Distributions from Living and other Grantor Trust to beneficiaries that are fiscal resident in Italy, especially after the death of the Grantor, are always subject to Italian Estate and Gift Tax (Imposta di Successione e  Donazione) if the Grantor dies while he is fiscal resident in Italy.
Only the US Non-Grantor Trust that are compliant with the Italian laws can have the benefit of saving the Italian Gift Tax. 

3. Our Tax Firm can assist all US Persons that want to set up a US Non-Grantor Trust that is compliant with Italian Laws by collaborating with US Lawyers, as this compliance is crucial if the Grantor wants to have the tax benefits we have described in this article and in the other articles linked above.

 
SUMMARY: A GREAT ADVANTAGE WITH NO RISK OF TAX ELUSION
 
In the end, what is important to remember is that if the American Citizen is planning to move to Italy and is already keen on setting up a US Non-Grantor Trust, it will be very important to make a preliminary consultation in order to see if it's possible to set up the Trust while the Grantor is still fiscal resident in the US: this point will save the Italian Gift Tax on the distribution of the beginning principal and it's a move that is completely legal, as Circolare n. 34/E has clarified that there is no risk of tax elusion in setting up a US Non-Grantor Trust and then move to Italy.


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Enrico Povolo