Taxing authority and tax law
Tax authority: Amministrazione Finanziaria (Administration of Finance and Revenue Authority)
Tax law: Embedded within the Presidential Decree No. 917 of 22 December 1986, where transfer pricing is regulated in Article 110 (7) and Articles 9 (3)-(4)
Relevant regulations and rulings
Law Decree no. 78 of 31 May 2010 introduced, for the first time, a specific transfer pricing documentation provision in the Italian tax law. Article 26 outlines that if the taxpayer provides tax authorities with proper transfer pricing documentation during a tax assessment, no tax penalties (currently varying from 100% to 200% of the additional taxes) will be applied on possible tax adjustments brought by the tax authorities if they determine the intercompany transactions are not in compliance with the arm’s length. On 29 September 2010 the Commissionaire of the Italian Revenue Agency released a “provvedimento” (operational instructions) to implement the provisions endorsed in Article 1 (2-ter) of Legislative Decree No. 471, which was enacted on 18 December 1997. On 15 December 2010, Circular Letter 58/E has been released to interpret the new rules. The new documentation discipline still presents some open points.
The Instructions basically implement the EU Code of Conduct on transfer pricing by also following the OECD approach but provide for very specific requirements that multinationals should comply with in assembling their transfer pricing file. Compliance with the Instructions will protect taxpayers from tax penalties on adjustments arising from transfer pricing audits. Current provisions provide for very high penalties ranging from 100% to 200% of any additional taxes. Among the most significant implications of the new requirements are:
- The need to assess the type of entity which exists in Italy in order to determine the type of documentation to be prepared in order to avoid penalties (holding, sub-holding, subsidiary, permanent establishment)
- The requirement to advise the Revenue Authority of the existence of current transfer pricing documentation for the current tax year with the filing of the tax return
- To advise the Revenue Authority of the existence of transfer pricing documentation for open tax years before 29 December 2010 (communication)
- Notwithstanding a “Master-file approach,” to have country specific documentation prepared
- The need to take steps to protect the taxpayer from a challenge by tax inspectors that the documentation prepared may be viewed as either incomplete or untrue, which could negate penalty protection
Notice to the Revenue Authority, indicating that transfer pricing documentation exists for FY2010 (and subsequent FYs), must be filed each year together with the annual tax return. For previous fiscal years subject to tax audits, a communication must be provided by the taxpayer within 28 December 2010. Late notices will only be deemed effective as long as filed prior to the beginning of any tax inspection.
Strategic risk management decisions need to be made by each taxpayer, possibly in coordination with central management.
It is not clear whether and to what extent previous Circular Letter Nos. 32/9/2267 of 22 September 1980 and 42/12/1587 of 12 December 1981 are still valid, at least as internal administrative guidelines.
According to the Italian Supreme Court (Corte di Cassazione) Decision No. 22023 of 13 October 2006 burden of proof rests on the tax authority for transfer pricing issues. According to the Supreme Court, and following the 1995 OECD guidelines, in the jurisdictions where the burden of proof is on the tax authority, the taxpayer is not obliged to give evidence that the transfer prices comply with the arm’s length principle unless the tax authority has already proved (prima facie) that the taxpayer has not complied with the arm’s length principle. It has to be seen how such an approach may be impacted by the new documentation discipline.
OECD guidelines treatment
The Italian transfer pricing rules are mainly provided by the tax law provisions within Presidential Decree No. 917/86 in conjunction with the above-mentioned Article 26 Law decree 78/2010, converted into Law 122 of 30 July 2010.
The Italian representatives actively participated in the OECD discussion on business restructuring as well as in the approval of the final TP guidelines release in July 2010. So far the only case law on cross-border business restructurings Ernst & Young is aware of is Ruling No. 124, dated 7 November 2006, in which the Revenue Agency deemed as occurred a sort of transfer of business concern (not specified if going concern or single assets) abroad in the case of a British insurance company which, after having operated on the Italian market for a certain number of years through a permanent establishment, subsequently provided directly its services to the Italian customers, by appointment of a fiscal representative in Italy (free supply of services).
Priorities/pricing methods
Transactional-based methods, such as CUP, Resale Price and Cost Plus, are preferred over profits-based methods. Under the new transfer pricing documentation rules taxpayers are expected to perform every year an industry, group and company analysis with a detailed functional and risk analysis, including an indication of potential changes in the functions performed, assets used and risks assumed compared to the previous tax year will have to be provided for, with specific reference to changes if occurred in the context of a business restructuring.
The selection of the transfer pricing method entails a description of the selected transfer pricing method and of the underlying reasons determining its consistency with the arm’s length. This should also cover the outcome of the comparability analysis that has determined the selection of the transfer pricing method deemed to be the most appropriate to the circumstances of the case. Should a transactional profit method be selected when a traditional transactional method could be applied in an equally reliable manner, it should be explained why the latter had been excluded. The same explanation applies in case of a selection of a method other than the CUP method, in the event the latter could potentially be chosen.
As to the criteria for the application of the selected transfer pricing method, an accurate description of the procedure followed by the taxpayer for the selection of comparable transactions will have to be provided and, if needed, a clear description of the underlying reasons for identifying a specific arms’ length range.
The acceptability of possible Pan-European benchmarks is not expressly mentioned and is one of the open points.
Transfer pricing penalties
If and when the above mentioned new TP Documentation regime is (deemed) not applicable, general penalties for underpayment apply (Legislative Decree No. 471). In particular, in a case where the tax return has been filed, standard administrative penalties apply in the amount equal to a minimum of 100% up to a maximum of 200% of the additional tax or the minor tax credit assessed by Italian tax authorities. This penalty applies with reference to single taxes when:
- The taxable income declared is lower than the one assessed
- The taxes declared are lower than those due, or
- The tax credit declared is greater than the one due to the taxpayer
The same penalties apply where undue tax allowances or deductions from the taxable income have been declared in the tax return. Interests on taxes or additional taxes due also apply. Because of the relatively high amount of potential tax revenue in a transfer pricing audit, tax officers almost “automatically” refer assessments to public prosecutors to explore possible criminal tax law ramifications, as permitted under Legislative Decree No. 74 of 10 March 2000. Some mitigation is provided by Article 7, whereby taxpayers are supposed to disclose their transfer pricing policy in their financial statement. Hopefully the new transfer pricing documentation would not only help on administrative penalties but also in demonstrating indirectly the good faith of taxpayers in case of possible tax criminal challenge.
Penalty relief
In addition to the above, Circular Letter 58/E dated 15 December 2010 provides further details on how to deal with the new rules in terms of Master-file versus domestic documentation’s contents (depending on taxpayers’ status), specific discipline for small-medium-size companies, conditions under which the transfer pricing documentation can be deemed effective, etc. Although some open points still exist, it is clear that taxpayers are expected to act transparently and in good faith. If not, not only the bona fide concept is in danger but taxpayers take the risk of harsher penalties. Some specific instructions are provided for tax assessments already occurred before the new provisions, as well as for tax assessments activities started between 28 December 2010 and 30 June 2011 (regime transitorio).
Documentation requirements
Documentation must be drafted on a yearly basis with respect to the transactions carried out by the taxpayer falling into the scope of paragraph 7 of Article 110 of Presidential Decree No. 917 and it must be available in each of the taxable periods subject to audit according to the ordinary provisions.
The filing of the Documentation does not bind the tax authorities to the application of Article 1, paragraph 2-ter of the Legislative Decree No. 471, when:
- Notwithstanding the compliance with the formal structure referred to in Articles 2.1. and 2.2., the documentation delivered in the course of an audit is not complete and consistent with the provisions endorsed by the current decision
Or - The information provided for in the delivered documentation is inconsistent. Omissions or partial inaccuracies that do not hamper either the activity carried out by the auditors, or the accuracy of the outcome of such analysis, does not impede the application of Article 1, paragraph 2-ter of the Legislative Decree No. 471.
Documentation deadlines
For future fiscal years taxpayers shall communicate to the Italian Revenue Agency the availability of proper documentation in the yearly income tax return.
In general, the submission of documentation to the tax authorities must be executed within and not beyond 10 days upon request. In case, during an audit or any other assessment activity, supplementary information is needed, the said supplementary information must be provided either within seven days upon request or in a longer time period depending on the complexity of the transactions under analysis, to the extent that the above period is consistent with the time of the audit. Once these terms are elapsed, the tax authorities are not bound by the application of Article 1 paragraph 2-ter of the Legislative Decree No. 471.
Statute of limitations on transfer pricing assessments
There is no specific statute of limitations on an assessment for transfer pricing. In principle, the general statute of limitations period for tax purposes applies. Therefore, tax assessments must be notified to the taxpayer by 31 December of the fourth year following the year for which the tax return has been filed. If the tax return has been omitted or is treated as null and void, the assessable period for the relevant year is extended by one additional year. Furthermore, for companies that do not benefit from the 2002/2003 Italian Tax Amnesty, the assessable period is extended by two additional years.
In case of a potential tax criminal law ramification tax officers may invoke a specific law that in principle allows the doubling of the five years standard statute of limitations.
Return disclosures/related-party disclosures
Italian companies must officially communicate (in documents, correspondence, register of companies) whether they are managed and controlled by another company and the name of the related company (Article 2497-bis of the Italian Civil Code). Financial statements should include essential data of the managing or controlling company’s financial statement and relations with related parties (Articles 2424, 2427, 2428 and 2497-bis of the Italian Civil Code). Costs and expenses vis-à-vis parties located in black listed countries are also expected to be reported and monitored under a specific discipline with a burden of proof shifted on taxpayers.
Audit risk/transfer pricing scrutiny
The risk of transfer pricing scrutiny during a tax audit is high. In fact, transfer pricing receives the greatest scrutiny. Italian tax authorities usually challenge the price of intercompany transactions that do not comply with the arm’s length principle or that result in a mismatch between the characterization of entities and their remuneration. There appears to be a tendency toward challenging transfer pricing in combination with issues related to tax havens, deemed permanent establishments, business restructuring and abuse of law.
Italy is particularly active in challenging taxpayers on deemed permanent establishments. Following the Italian Supreme Court’s “Philip Morris” case, additional case law is developing in this respect.
In addition, there is generally greater tax audit activity and particular attention paid to large taxpayers, where the Italian tax authorities are devoting greater resources in intelligence and monitoring activities on multinationals. Likewise, the Circular Letter No. 6/E issued by Central Revenue Agency on 25 January 2008 provides operating guidelines to tax authorities in relation to the prevention and combat of tax avoidance, and among the most delicate and crucial areas to be assessed, it mentions intercompany transactions and transfer prices according to the provisions of Article 110 (7) of the Presidential Decree No. 917. Legislative Decree No. 185 issued on 29 November 2008 introduced the category of “large” taxpayers stating that “in relation to the corporate income tax and VAT returns of relevant size companies, the Central Revenue activate substantial controls by the year following the one of the filing,” where “relevant size companies are the ones which achieve a (yearly) turnover not lower than EUR 300m. Such threshold will be reduced to EUR 100m by 31 December 2011.”
In addition, the Italian Supreme Court is developing a broad concept of “abuse of law,” deemed to be inspired by the Italian Constitution Law, that is trying to introduce a general anti-avoidance principle potentially applicable to all the operations that appear to be carried out for tax reasons only, without a clear underlying business purposes.
APA opportunity
With Article 8 of Legislative Decree No. 269, enacted 24 November 2003, the Italian government introduced a unilateral ruling system mainly relating to transfer pricing, dividends and royalties. The law has been enacted with the “Provvedimento del Direttore dell’Agenzia delle Entrate,” dated 23 July 2004. This document provides a number of practical guidelines to apply and conduct the ruling program.
On 21 April 2010 the Central Directorate for Tax Assessment released the first Italian International Standard Ruling Report. This provides a number of statistical details that may be useful for taxpayers interested to explore an APA negotiation, including pre-filing. For taxpayers incline to support their transfer pricing policy under the new Italian transfer pricing documentation regime, the APA opportunity may become even more attractive.
Since Italy provides a variety of tax rulings, the interactions between the APA and the other tax rulings should be evaluated on a case-by-case basis.
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