By Marco Greggi (Professor, International Tax Law, University of Ferrara)
The Italian Finance Ministry, on February 21, 2018, published for stakeholders’ comments two draft transfer pricing regulations. The first Regulation is a proposed decree that deals with substantive aspects of transfer pricing regulations (analyzed in this article), while the second Regulation concerns corresponding adjustments (procedural aspects). The second Regulation on corresponding adjustments will be analyzed in a forthcoming article.
The objective of the regulations is to make the most of the base erosion and profit shifting (BEPS) experience and findings, within the framework of BEPS Actions 8, 9, and 10, which are expressly cited in the opening remarks to the regulations. The public consultation will remain open until March 21, 2018, and the actual release of the regulations will arguably follow irrespective of the outcome of the elections in two weeks from now.
Italy’s traditional position on transfer pricing
The Italian position on transfer pricing has always been unique in its own way. The first provisions dealing with the issue date back to 1980s and were adopted right after the OECD Report of 1979 (the fundamental Circular Letter of the Tax Office – No. 32 – released in 1980 was simply an Italian translation of the OECD Report). However, the legislator did not update the text of the provisions (now part of the Income Tax Act, Article 110, §§ 7 and sub.) to the changes that occurred in the international arena and never gave specific instructions on how arm’s length price should be calculated.
The legislator’s silence allowed case laws, academic writings, and Tax Office instructions to flourish so as to adjust the application of the discipline to the ever-changing business landscape, including the most recent update to the definition of “associated enterprises” introduced by the Supreme Court in a landmark case last year (Italian Supreme Court Case No. 27018 decided on November 15, 2017).
The proposed transfer pricing regulation
The objective of the draft Regulation is two-fold: on the one hand, it aims at the codification of the transfer pricing discipline, while on the other, it would ensure that the audit procedures in the years to come are followed in line with the OECD guidance. The proposed decree is slim: 7 articles encompassing definitions, fields of application, transfer pricing methods for the determination of arm’s length price, the notion of comparability, a constructive approach, and a “confidence interval” to be used during reassessment, when the taxpayer’s arguments are actually challenged.
Definition of associated enterprises
The definition of “associated enterprises” is entirely consistent with the OECD guidance and updates the previous legislation that made reference to the concept of “controlled” enterprises (dating back to the 1942 Civil code, Article 2359), thus stressing the importance of de facto control more than what was done in the past. This is the situation, for instance, of possible companies’ interlocked directorates that might determine a situation of control, which in the past was not always validated by courts. Italian tax judiciary has always been careful in assessing a “control” situation in de facto situations (see for instance the “Gazprom – ENI” case decided by the Milan Tax Court of Appeal on July 12, 2013, n. 112).
Transfer pricing methods
The transfer pricing methods for the determination of the arm’s length price are listed in Article 4 and they are in line with the OECD’s guidance: the Ministry has added a hierarchy, making comparable uncontrolled price (CUP) method prevail over other methods, and the transactional ones (such as TNMM) recessive vis-a-vis the more traditional ones. Despite the sophisticated efforts by the Tax Office and by the Tax Police, the Italian Tax judiciary had always stressed the importance of methods based on price comparison, and a plain and simple approach to single business operation.
It is also important to remember that the Italian domestic tax law provides for a definition of “normal business value,” – equivalent to “arm’s length” – to be used in a number of situations falling outside the scope of transfer pricing discipline. It is also crucial to note that, now, application of the arm’s length principle would not always lead to a value, but rather a “confidence interval” (with a minimum and maximum) within which the tax value can be found (Article 6 of the proposed Regulation). The objective is to mitigate the harsh aspects of transfer pricing audit in the country, granting some flexibility in doubtful cases.
The need for flexibility seems to inspire Article 5 of the proposed Regulation as well, namely, the provision allowing a constructive approach to business transactions. The provision allows the Tax Office to take several transactions in conjunction to assess the arm’s length price consistent with an aggregated approach.
Moving closer to OECD’s transfer pricing guidance
The overall picture that emerges from the proposed Regulation in its current version is presenting an international tax system committed to respecting and fully complying with OECD’s findings and recommendations.
The Italian Tax Office and Tax Police in the past have always been over-enthusiast adopters of transfer price regulations, making the most of the audit possibilities, and in some cases to the detriment of legal certainty of business transactions. Hope is that this sort of codification via Ministry Regulation will increase businesses’ trust in the country’s legal and tax framework. The move will also facilitate foreign investments as audit decisions of the Tax Office would, in a way, be more predictable and the decision-making process of the Tax Court would be clearer and robust.