UPDATE 2-Italy tightens tax rules on bad bank loans

The Italian cabinet on Monday signed off on an expansionary 2019 budget, boosting welfare spending, cutting the retirement age and hiking the deficit.

Italy is set to introduce a more punitive tax regime for banks, piling further pressure on a sector that is suffering due to a spike in the country's debt costs under a populist government.

The Italian cabinet on Monday signed off on an expansionary 2019 budget, boosting welfare spending, cutting the retirement age and hiking the deficit.

The government's plans have frightened off holders of Italy's 2-trillion euro debt, pushing the risk premium benchmark 10-year bonds to pay over safer German Bunds to 3 percentage points up from 1.3 in mid-May when the proposed measures first emerged.

Domestic government bonds account for 10 per cent of Italian banks' assets and lenders have seen their capital buffers eroded by the falling value of their sovereign holdings.

The ruling coalition comprising the anti-establishment 5 Star Movement and far-right League is now looking to raise 3.3 billion euros in additional revenues from lenders next year.

The budget law spreads over a period of 10 years the possibility for banks to deduct from their taxable income losses booked under the IFRS9 accounting rule.

The rule, which came into force in January, requires lenders to book expected, and no longer just actual, losses on the value of their assets.

Italian banks stepped up write-downs of soured debts under the new rule in the first quarter to speed a clean-up of their balance sheets following a deep recession that ended in 2014.

The budget also said a 10 per cent tax deduction rate on loan losses for corporate and regional tax purposes had now been put back to the end of 2026.

Giovanni Razzoli, a banking analyst at Milan-based broker Equita, estimated such a measure would slightly erode banks' capital buffers and hurt their cash reserves but not their earnings.

A government source told Reuters on Monday that banks may also be prevented from deducting in full from their taxable income interest paid to introduce an 86 per cent cap - in a hit to banks' earning which Equita's Razzoli estimated at 4 per cent.

However, a Treasury source on Tuesday said such measure could be replaced by others still under study.

The budget document also tightened the screws on advanced taxes that insurance companies have to pay on premiums. They will have to pay in advance 75 per cent of taxes on premiums in 2019 compared with the previous 59 per cent.

That rate will rise to 90 per cent in 2020 from a previous 74 per cent and to 100 per cent as of 2021.

"We need to be very careful to dealing with these issues ... because we are one of the pillars of the national system," the chairman of Italy's biggest insurer, Generali, was cited by Italian news agencies as saying on Tuesday.  

(With inputs from agencies.)