Global Tax Alert (News from Transfer Pricing) | 14 November 2013
Italy's Supreme Court holds seller's market is used to determine fair market value
On 23 October 2013, Italy’s Supreme Court issued a controversial decision on the concept of fair market value as provided by the Italian Income Tax Code (IITC).1
With this recent decision (Decision) the Supreme Court concluded that the relevant market to look at when determining the arm’s length value in an intercompany sale should be the one where the seller is located, as opposed to the buyer’s market.
As background, Italy’s statutory rules on transfer pricing are set out in Article 9 and Article 110 of the IITC. In particular, Article 9(3) states that “fair market value” means the average price or consideration paid for goods and services of the same or similar type, carried on at market conditions and at the same level of business, at the time and place in which the goods were purchased or the services were rendered. For the determination of the fair market value, reference should be made, to the extent possible, to the price list of the provider of goods or services. In the absence of the provider’s price list, reference should be made to the price lists issued by the Chamber of Commerce and to professional tariffs, taking into account usual discounts.
An Italian company (Company) belonging to a multinational group and having its parent company in Belgium was subject to an assessment for corporate income tax purposes with reference to FY 1997.
The Italian tax authorities challenged the fact that the price of the goods sold to the Belgian parent was not arm’s length because it was lower than the consideration received by the Company for sales of the same product to Italian third party customers. The consideration paid by the Italian third party customers was 44% higher than the one paid by the Belgian related party.
The Company appealed and won before the tax courts of first and second instance by claiming that the market to be considered in determining the normal value of the goods sold should be the one where such goods are commercialized and distributed (i.e., Belgium), as opposed to the market of the seller (i.e., Italy).
The tax authorities appealed to the Supreme Court by stating that the court of second instance erroneously looked at the prices in the buyer’s market. In this respect, the tax authorities observed that the judges of the second instance did not take into consideration that “a comparison with local unrelated parties would have not been possible in the case at stake because the only comparable parties in Belgium were members of the same group of the Company.”
The Supreme Court reversed the judgment of the previous courts and sent the case back to the court of second instance by providing specific guidelines for the application of Article 9(3).
The Supreme Court decision
The Supreme Court stated that among the various criteria provided by the OECD for the determination of the transfer pricing between companies of a multinational group, the Italian legislature has picked the Comparable Uncontrolled Price (CUP) method which is regulated by the mentioned Article 9(3).
Then, by interpreting the aforesaid provision, the Court established the following principles:
a) The main criterion to establish the fair market value of a cross-border transaction must be, to the extent possible, the price list of the provider of goods or services;
b) If the provider’s price list is not applicable, reference should be made to the price lists issued by the Chamber of Commerce and to professional tariffs;
c) Only if criteria under a) and b) are not applicable, the fair market value must be determined by reference to the average price or consideration paid for goods and services of the same or similar type, carried on at market conditions and at the same level of business, at the time and place in which the goods were purchased or the services were performed – the market relevant in determining the normal value is the market of the seller (i.e., Italy in this case).
As a first consideration, it appears clear that the Decision, and the reported reference to the market of the seller, should be read in the context of CUP analyses only as opposed to all transfer pricing methods.
Also, the conclusion of the Supreme Court appears in contrast with the position expressed by the Italian Revenue in Circular Letter no. 32 of 22 September 1980 which specifically states that “the market of reference should in principle be (especially for tangible goods) the one where the buyer is located” and that “prices for the same type of product can be justified by the different location of the transferee.” Furthermore, the language of Article 9(3) makes reference to the “place in which the goods were purchased” which does not seem at all obvious that it should be intended as the place where the seller is located (as opposed to the one where the buyer is located). In this respect, the Decision does not seem to provide due consideration to factors that may affect the selection of the market, such as the stage of commercialization, the profile of the customer and other circumstances.
In addition, the Court’s statement regarding the choice of the CUP method by the Italian legislature seems rigid. In this respect, Italian Revenue Circular Letter no. 42 of 12 December 1981 already provided specific clarifications on the hierarchy of transfer pricing methods by asserting that methods should apply with certain flexibility depending on the circumstances.
Taking into account the limited background information disclosed in the Decision as well as the above considerations, the Supreme Court interpretation that, when applying the CUP method, the market of reference should automatically be the seller’s market, appears in contrast to existing guidance.
1. Case no. 24005/2013.
For additional information with respect to this Alert, please contact the following:
Studio Legale Tributario in association with Ernst & Young, Milan
- • Davide Bergami
+39 02 851 4409
- • Massimo Bellini
+39 02 851 4428
- • Domenico Borzumato
+39 02 851 4503
- • Giusy Bochicchio
+39 02 851 4650
Studio Legale Tributario in association with Ernst & Young, Bologna
- • Livio Zallo
+39 06 8556 353
Ernst & Young LLP, Italian Tax Desk, New York
- • Emiliano Zanotti
+1 212 773 6516
- • Andrea De Nigris
+1 212 773 0478
- • Fabio Rousset
+1 212 773 9302
EYG no. CM3961