By Diletta Fuxa (Senior Manager), Studio Associato Servizi Professionali Integrati, Member of Fieldfisher
On May 14, 2018, Italy’s Ministry of Economy and Finance issued a Decree, which lays down new transfer pricing guidelines in compliance with the provisions set forth in article 110 (7) of the Income Tax Code (Testo Unico delle Imposte sui Redditi).
The Decree is the result of a public consultation (the first of its kind) with business representatives and practitioners and represents a “breath of fresh air” in respect of the application of transfer pricing rules. Until the issuance of the Decree, the guidelines provided by the Italian tax authority were set forth in Circular No.32 of September 22, 1980, issued shortly after the 1979 OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administration. Additional clarifications on the application of the transfer pricing regime were provided vide Circular No 42 of December 12, 1981.
Aligning Italian transfer pricing law with OECD guidance
The Decree consists of nine articles that set out definitions and general principles, widely adopted in (international) practice and follows the recent amendments to article 110(7) of the Income Tax Code, which now makes express reference to the arm’s length principle with the declared purpose of aligning the domestic provision with the 2017 OECD Transfer Pricing Guidelines.
First of all, the Decree establishes the comparability criteria consistently with the OECD standard. The comparability factors are (re)affirmed. In this respect, it is odd to mention that, in the text of the Decree, the contractual terms of the transactions are considered the first comparability factor to be considered to assess comparability between controlled and uncontrolled transactions.
Transfer pricing methods
The transfer pricing methods provided in Chapter II of the OECD Transfer Pricing Guidelines are listed and accepted. It should be noted that traditional methods, especially the comparable uncontrolled price (CUP) method, are preferred over the transactional ones in situations where more than one method can be applied by the taxpayer in an equally reliable manner. The Decree also clarifies the following issues:
- The application of the arm’s length principle does not require the use of more than one method. This is consistent with the statement provided in section 2.12 of the OECD Transfer Pricing Guidelines; and
- In case of tax audit, the analysis concerning the arm’s length outcome of controlled transactions must be based on the transfer pricing method used by the taxpayer.
Arm’s length range
The Decree acknowledges that when assessing compliance with the arm’s length principle during tax audits, Italian tax authorities should consider the entire arm’s length (interquartile) range of results for the relevant profit level indicator. This clarification has been long-waited as the recurring “practice” of the Italian tax administration is adjusting the results of the taxpayers to the median of the range, triggering a rising spiral of disputes. Only in recent times, case law shows the criticism of judges in respect to this behavior of the tax authority.
The tax authority has the power to adjust the results of the taxpayers when they do not fall within the arm’s length range. As “safeguard clause,” taxpayers have the right to provide evidence supporting the compliance with the arm’s length principle of the controlled transactions. The tax administration may reject this evidence, but the rejection must be based on sound motivations.
Article 7 of the Decree expressly introduces the concept of low value-adding services, following the approach encompassed in the OECD Transfer Pricing Guidelines and providing for the simplified approach based on a 5 percent mark-up.
Transfer pricing documentation
According to the Decree, the Director of the Italian Revenue Agency will update the provisions concerning transfer pricing documentation. Currently, domestic regulations follow the principles endorsed in the Code of Conduct on transfer pricing documentation for associated enterprises in the European Union and in the OECD Transfer Pricing Guidelines as well. The requirements provide for two different set of documentation:
- The “master file,” containing common information relevant to all group members; and
- The country-specific documentation (“Documentazione Nazionale”), which should include information regarding resident companies.
The aim of the documentation for Italian transfer pricing purposes is granting penalty protection while supporting the arm’s length outcome of controlled transactions. In this respect, the Decree states that the documentation is considered appropriate whenever it provides the tax auditors with all the information necessary for scrutinizing the transfer prices. The Decree reaffirms that omissions or partial inaccuracies do not hinder the analysis of the tax inspectors and the assessment of its appropriateness.
Finally, the Decree indicates that further implementation rules will be issued considering the relevant update of the OECD Transfer Pricing Guidelines.
