Transfer Pricing updates in Italy
The present article provides highlights of relevant court decisions on transfer pricing and supply chain cases registered in Italy in the last 12 months. Once again, they witness these topics are in the spotlight of the Central Revenue and Tax Police, both when an Italian parent is involved as well as when the inspection is conducted on the local subsidiary of a foreign multinational.
1. Business restructuring: aggregation of intra-group transactions, economic analysis and selection of the most appropriate transfer pricing (TP) method
The provincial Tax Court of Varese, the decision n. 228/2/2018, examined the case of an Italian group that established subsidiaries in China. The Italian group, in the context of a business restructuring plan, assigned to the Chinese subsidiaries the production and sales activities in the Asian area.
In relation to the fiscal years audited (2012 and 2013), the Italian tax office challenged the prices applied in the sales of semi-finished products from Italy to China, but also the lack of a compensation for the Italian company when it sold intangibles to the Chinese subsidiaries.
The Italian company then rebutted an incorrect aggregation of different kind of intra-group transactions that the tax office made for the purpose of the economic analysis. Furthermore, the company challenged the selection of the method (TNMM cv Profit Split) and the search strategy launched in the data base for benchmark analysis.
For its part, the tax office is focusing on the functional and risk profiles of the Chinese companies and has confirmed that the production and marketing operations of the Chinese subsidiaries are not only to be qualified as routine activities. Even more, the tax office argued that the Chinese subsidiaries took advantage from the strategic development of various intangibles conducted by the Italian company. In other words, according to the Italian tax office, any compensation has been recognised to the Italian company even though the relocation of the production and sales activities in China has caused a potential loss for the audited company which should have been properly compensated according to the arm's length principle.
The provincial tax court so rejected the appeal and the taxpayer will have the change to appeal before the regional tax court.
2. Profitability: interquartile range and arm’s length principle
Through decision n. 5445/3/2018, the Provincial Tax Court of Milan confirms what has long been affirmed by The Organisation for Economic Co-operation and Development (OECD) Guidelines (already in the 1995 version) as well as recently stated by the Ministerial Decree issued 14 May 2018 and by previous case laws (i.e. among others: Provincial Tax Court of Varese 129/2/18, Provincial Tax Court of Milan 704/17/17, Provincial Tax Court of Milan 407/9/16): namely, in principle, all PLI observations falling within the arm’s length range can be deemed to represent market values.
The case concerns a dispute regarding the transfer pricing challenges raised by the Italian tax office against the local distribution company of a multinational group. The tax office, disregarding the transfer pricing analysis conducted by the taxpayer, carried out a new benchmark exercise based on the transactional net margin method ("TNMM") and adjusted the company's profitability to the median observation calculated on the financials of the deemed comparable companies so identified.
Milan Provincial Tax Court accepted the appeal and cancelled the challenges of the tax office, noting that the profitability range calculated by the tax office ''goes, for the year 2013, from a minimum value of 1.40% to a maximum of 18.28%. The audited company obtained a 8.38%. Since the last percentage falls between the minimum and the maximum, for this judge the provisions of the aforementioned ministerial decree have to be applied (i.e. Ministerial Decree 14 May 2018)''. In fact, article 6 of the mentioned Ministerial Decree provides that a controlled transaction is considered to have been carried out in compliance with the arm's length principle, if the relative financial indicator is included in the profitability range.
3. Deferred payment conditions and deemed intercompany loan
The Regional Tax Court of Emilia-Romagna (decision n. 2320/12/2018) established that an anomalous deferred payment granted by an Italian company to a foreign subsidiary may generate interest receivable subject to the transfer pricing provisions.
The case involves an Italian company that sold goods to its subsidiary located in the United States with a 360-day payment term. According to the tax office, such a deferral in payment is comparable to an interest-free loan which being among related entities should have rather generated interest receivable subject to tax.
Interest-free loans have already been subject to various and conflicting decisions issued by the Italian Supreme Court. Namely, on the one side, there have been case laws (for example, n. 27087/2014 and n. 15005/2015) which ruled that, in order to challenge the pricing of intercompany flows under the transfer pricing concepts, it is necessary that the parties explicitly agreed to generate income by such transaction. In other words, the tax administration cannot attribute the parties an intention different from the one expressly shown through operations and then challenge the tax consequences linked to the new nature assigned to the intercompany flows.
Differently, a second set of case laws (see for instance, Supreme Court decisions n. 7493/2016, n. 13387/2016 and n. 27018/2017) stated that notwithstanding the legal definition of the agreement from a mere tax standpoint, all intercompany interest-free loans should be subject to the arm’s length principle: accordingly, in alignment to the transfer pricing rules, interest compensation needs to be charged as to align the (intercompany) terms and conditions to those that would be applied between independent companies in comparable circumstances.
Leveraging this second line of interpretation, the Regional Tax Court of Emilia-Romagna confirming the decision of the Provincial Tax Court
rejected the company's appeal, stressing that the payment term granted to the foreign subsidiary was longer than that granted to third-party customers operating in the same US market so, ultimately, not in line with the arm’s length principle.
As last resort, the taxpayer has nowadays the possibility to appeal the decision of the regional tax court before the Supreme Court.
Gian Luca Nieddu - Head of Transfer Pricing & Tax Value Chain
Hager&Partners - Milan (Italy)
T: +39 02 7780711