Tax settlement, the application of the tax cram down gets stricter

The business crisis and insolvency code (Legislative Decree no. 14/2019) entered into force on 15 July 2022, replacing insolvency law of 1942, following a long regulatory process and many delays due to the pandemic, as well as the need to adapt the instrument originally provided by the code to European Directive (EU) no. 1023/2019 on debt restructuring and insolvency. This is a crucial reform for the safeguard of companies’ value and of creditors, and for the economic system as a whole.

In this context, the tax settlement plays an important role, manly in the current historical moment, and it is even more important due to the economic difficulties of businesses, which determined an increase in the applications for insolvency procedures to settle the relevant debts. Therefore, application problems related to the tax settlement are of topical interest.

To this regard, critical modifications were recently introduced to the bankruptcy law (in 2017), in order to implement the judgment of the EU Court of Justice and replace the previous rule providing for the impossibility to settle VAT and WHT at a reduced amount or through a deferred payment.

Based on the principles of the reform, the possibility to reduce the debt to be settled to the Revenue office is part of the more general possibility to reduce the debt to be settled to any priority creditor, provided that they are not subject to worse conditions than those under the liquidation alternative.

Therefore, there is a realignment between the companies’ and their creditors’ interests, rather than a prevalence of the latter, which can be, on the contrary, evident in a bankruptcy context, where there are no further business or labour interests to safeguard. Therefore, such realignment of interests also applies to tax and social security creditors, which no more benefit from an automatically favourable treatment compared to the liquidation option.

However, in order to prevent the risk of abusing of such procedure and pending the entry into force of the relevant supplemental or amendment legislative decree, Law Decree no. 69 dated 13 June 2023, during its conversion into Law no. 103 dated 10 August 2023, has recently introduced important updates with reference to the settlement of tax and social security debts within debt restructuring agreements, regulated under art. 63 of Legislative Decree no. 14/2019 (Business crisis and insolvency code).

The previous version of the regulation provided, even lacking acceptance by the tax authorities or social security institutions, for the possibility to proceed with a “forced” validation of debt restructuring agreements by the competent Court; this process is defined as tax cram down.

The new provision (introduced by art. 1-bis of the law decree) is however stricter than the previous one and provides that the Court can validate debt restructuring agreements, even lacking an acceptance by the tax authorities or social security institutions, as long as the following conditions are met:

Agreements cannot be aimed at the company’s liquidation;

Acceptance by the tax authorities is determining to reach the percentages established under art. 57, para 1 (60%), and art. 60, para. 1 (30%), of the business crisis and insolvency code;

The total credit due to other creditors joining the restructuring agreements must be equal to at least 25% of the total credit amount;

The settlement proposal to the tax authorities and other mentioned institutions must be advantageous compared to the liquidation alternative, which must be specifically evaluated by the Court before validating the agreement;

The settlement of debts due to the tax authorities and social security or welfare institutions must be equal to at least 30% of the amount of the relevant debts, including interest and penalties.

Should the total debt due to other creditors be lower than 25% of their total amount, save for the other conditions required, the minimum percentage to settle debts due to the tax authorities and social security and welfare institutions increases to 40%. Moreover, payment cannot be deferred for a period longer than ten years, including payment of legal interest related to the requested deferment.

The above specified modifications impact exclusively debt restructuring agreements and not tax settlement procedures defined within arrangement with creditors procedures.

The modification of the tax settlement procedure was also decided following recent validations by the Court of debt restructuring agreements through the tax Cram down process, which provided for the write-off of the value of debts due to the tax authorities and social security and welfare institutions even exceeding 90%.

Therefore, in order to avoid a distorted use of the tax Cram down (though consistent with the current law provisions), the Government introduced, during the conversion into law of Law Decree no. 69/2023, the updates specified above and, in particular, the minimum settlement limit of debts due to the tax authorities, equal to 30% or 40% depending on the specific cases.

The new conditions for the application of the tax settlement procedure, as established by the Government, will make it difficult to use it within debt restructuring agreements and, therefore, a sagging review of the minimum settlement percentages would be desirable, in order to favour a higher use of this procedure and, however, avoid the presentation of “illicit” proposals to reach an alignment between the companies’ and the creditors’ interest.