The Vatican
Photograph by Alberto Pizzoli — AFP/Getty Images
By Shawn Tully
April 1, 2015

For years, the Vatican’s primary financial adversary has been the nation that surrounds the 110 acre Papal monarchy — Italy.

Now Italy and the Holy See have reached an accord: they’ll cooperate on fiscal matters, as the Vatican works to develop transparency after a series of financial scandals.

The two nations signed a landmark agreement Wednesday that promises to resolve a major source of tension: the taxes that the Holy See’s organizations owe Italy. Many branches of the Vatican — including charities and hospitals — have major operations in Rome, Milan, and throughout Italy. Naturally, they collect contributions at mass, and donations from the wealthy that are not taxable. But the Vatican-based organizations also run hospitals, guesthouses, and lease apartments in their investment portfolios — all activities that may generate profits.

In the past, the obligation to pay taxes on what could be classified as “commercial” activities caused conflict between Rome and the Holy See. For example, the Vatican could claim that profits from a hospital sent to fund schools in Nigeria were exempt from Italian levies. Italy would take the opposite view, and demand payment. Its politicians routinely vilified the Holy See as a blatant tax-evader. In 2012, Prime Minister Mario Monti imposed levies on a big portion of the Vatican’s extensive —and formerly tax-exempt — real estate holdings, infuriating the Vatican hierarchy.

The constantly changing rules caused tremendous uncertainty for the branches of the Holy See within Italy. In fact, it’s not clear how much tax they actually paid. The new accord apparently spells out the rules in detail, and requires payments starting with the 2014 tax year. It’s likely that many hospitals, guesthouses and the like will now start sending money to Rome for the first time. Yet the Vatican also won an important concession: The Renzi government agreed to exempt Holy See’s property holding, a provision that dates from the 1929 Lateran Treaty between the two countries.

The tax accord overshadows another major advance in Vatican-Italian financial relations.

Two once-bitter adversaries, the Vatican Bank (IOR) and the Bank of Italy, are finally getting along. At the root of the conflict was the IOR’s right to withhold information on money transfers into Italy. The bank has no branches, except for the circular space, manned by multilingual tellers, in its Vatican City headquarters. Hence, it sends the funds that support, for example, a religious order in the Philippines, or contributions for a new Church in Kenya, through correspondent banks. That network reaches throughout Europe as well. The rich Catholic Church in Germany sends funds via, say, Deutsche Bank, to the IOR, earmarked for assisting charities in the developing world.

For its transfers to banks outside Italy, the Vatican Bank adhered to a standard protocol called SWIFT. It required that the IOR always disclose the identity of the sender, a standard requirement between institutions classified as “banks.” But the Bank of Italy didn’t impose the SWIFT system for the IOR, since Rome regarded the IOR not as a bank, but as a corporation, or client. As a result, the Bank of Italy never knew who was sending funds from the IOR to the banks it regulated. Was it a religious order, or a wealthy developer trying to launder funds? And the traditionally-secretive IOR wasn’t inclined to disclose any more information than absolutely required.

In 2010, the Bank of Italy pounced on the IOR. It famously froze 23 billion euros of its funds in an Italian bank. Correspondent banks, not only in Italy, but across Europe, threatened to stop accepting Vatican deposits. By 2013, the atmosphere was so charged that the Bank of Italy banned Deutschebank from processing credit card charges at the Vatican museums, forcing customers to pay in cash.

The big push for reform came with the appointment of Rene Brulhart as chief of then newly-formed AIF, the Vatican’s version of the SEC. Under a law passed in 2013, the Vatican is obligated to disclose the identity of all clients sending money to banks in Italy. The AIF assiduously enforced the requirement.

So the Vatican is slaking the coals on both the tax and banking fronts. The new chief of the Vatican’s finances, George Cardinal Pell, pledges to make the Holy See’s money matters “boringly successful.” He’s even touting a new service called Vatican Asset Management to invest funds from branches of the Church around the globe. No business organization gets more financial scrutiny than the Vatican, so becoming super-boring is the Vatican’s best route to financial salvation.

For more on how Pope Francis is reforming the Vatican’s troubled finances, read Shawn Tully’s recent Fortune article This pope means business.

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