Loss-making Italian airline Alitalia could return to profit by 2017 under a turnaround plan presented by Etihad Airways as part of tie-up talks between the two carriers, an Italian government source said on Thursday.

Alitalia was kept afloat by a government-engineered 500 million euro ($686 million) rescue package last year but needs to find a cash-rich partner quickly to revamp its flight network or risk having to ground its planes.

Abu Dhabi-based Etihad has been looking at a possible investment in Alitalia since the start of the year. But the prospect of large job cuts at Alitalia and the airline's debt of at least 800 million euros have been major hurdles in the talks.

The source said Etihad's plan sees Alitalia reaching a net profit of 108 million euros by 2017, revenues of 3.66 billion euros and earnings before interest, tax, depreciation and amortisation of 526 million euros, but its proposal is tied to demands around debt that have yet to be tackled.

"This is a base for negotiations," the source told Reuters. "The numbers could still change considerably in the course of the talks."

A tie-up with the Gulf carrier could bring Alitalia the money it needs to invest in a new strategy focused on long-haul routes to counter its struggles to compete against low-cost airlines and high-speed trains on domestic and regional flights.

The source said Etihad would like to turn Rome's Fiumicino airport into an intercontinental hub by adding seven long-haul routes in three years, boosting connections to European capitals from the Linate airport outside Milan and increasing the number of weekly long-haul flights from the northern Malpensa airport.

The source added that Alitalia's creditor banks, including Italy's top two lenders Intesa Sanpaolo and UniCredit , have offered to convert two thirds of the airline's debt into equity and write off the remainder, but their offer falls short of the demands put forward by the Gulf carrier.

According to the proposal, Etihad, which sources close to the matter have said could invest more than 500 million euros in exchange for a 49 percent stake in the Rome-based airline, wants banks to write off up to 560 million euros of Alitalia's debt and to extend the maturity of 140 million euros of senior debt to 2021.

Intesa declined to comment. UniCredit, Alitalia and Etihad could not immediately be reached for comment.

One of the latest options put forward by Alitalia is the possibility of turning the carrier into a holding company which would take on the majority of the airline's debt.

Alitalia's business operations, including its fleet and flying slots, would then be transferred to a new firm, that would be controlled by the holding company, and in which Etihad could invest directly via a capital increase. - Reuters