Transfer pricing framework in Italy: formal alignment to the OECD principles

This Decree represents the realisation of the first step of an overhaul of the domestic discipline started almost one year ago with the enforcement of Law Decree No. 50/2017 amending Article 110 (7) of Presidential Decree No. 917/1986 – i.e. the Corporate Income Tax Code (TUIR).

Article 59 of Law Decree No. 50/2017 amended some important aspects of the Italian transfer pricing legislation. In particular, this reform replaced the reference to the 'normal value' under Article 9 (3) of the TUIR with a more modern definition of the arm's-length principle, fully in alignment with the provisions contained in the OECD Model Tax Convention and in the OECD transfer pricing guidelines. This Law Decree entrusted also the Ministry of Economy and Finance to issue a Decree setting out the general guidance for the correct application of the arm's-length principle in line with international best practices.

Following that input, on February 21 2018, the Italian Ministry of Economy and Finance launched a public consultation, intending to involve professionals and all interested parties in the new Decree's drafting.

At the end of this process, on March 21 the Italian Ministry of Economy and Finance made public all comments and contributions received in the preceding 30 days, submitting contributions and proposals to make the draft Decree more effective.

Then, on May 8 2018, the Ministry (together with representatives of the Central Revenue and of the tax police) met professionals and other interested parties in order to share their final views before the release of the official Decree.

The new Ministerial Decree of May 14 2018 represents a turning point in the action moved by the Italian legislator in the complex matters of transfer pricing, which substantially affects the supply chain of multinational enterprises. The ultimate goal is to create a modern domestic framework in alignment with the most recent developments shared at international level, especially after the implementation of the OECD BEPS project and the actions taken by the EU. Besides, further regulations and operational guidelines will soon come from the Italian Revenue Agency in order to provide practical indications both to multinational groups and to the local tax office in charge of the tax inspections in the field.

The Decree defines the guidelines to implement the application of the arm's-length principle to intercompany transactions. As clearly ruled in 2015 by the so-called Internationalisation Decree No. 147, the principle applies exclusively to cross-border transactions, so excluding those operations that occurred among related entities that were resident in Italy.

The Decree provides preliminary definitions of:

• Associated enterprises;

• Participation in management, control or equity;

• Independent enterprises;

• Controlled transactions; and

• Financial indicator.

In this respect, a relevant fact to note is that the multinational group has to be identified not only with reference to the share capital control of one entity to another entity. Rather, as already stated by the Ministry of Finance in Circular Letter No. 32/1980, the notion of 'control' should be extended to cover all hypotheses of economic influence, whether potential or actual, which could be inferred from such single circumstances.

Accordingly, further clarifications and examples are expected from the Central Revenue in order to provide clarification on such an important aspect of the application of the transfer pricing principles and methodologies.

The Decree outlines the criteria by which a commercial or financial transaction between independent companies (an uncontrolled transaction) could be considered comparable to a transaction between associated enterprises (a controlled transaction).

In particular, the Decree identifies the 'relevant economic characteristics' and recalls the 'five comparability factors' that permit the characterisation of the real nature of the transactions in order to carry out a proper analysis: contractual terms, functions performed by each of the parties to the transaction, characteristics of property transferred or services provided, economic circumstances of the parties, market conditions in which the parties operate, and business strategies pursued by the parties.

As regards the functions performed, particularly worth noting is that the taxpayer is requested to present not only the specific intercompany transaction under review, but also how such operations are integrated in the supply chain of the group and – ultimately – how they contribute to the value creation.

Adopting the OECD principles and the 'most appropriate method rule', the Decree describes the transfer pricing methodologies applicable and designates the criteria for selecting the relevant one to be applied in each specific case. The five methods identified are:

• Comparable uncontrolled price;

• Cost plus method;

• Resale price method;

• Transactional net margin method; and

• Profit split method.

In addition, Article 4 permits also the adoption of alternative methods provided that the taxpayer can demonstrate that it would be impossible to adopt the abovementioned methodologies; and only then if the application of the alternative method leads to a coherent outcome with respect to the outcome that would be reached between two independent enterprises engaged in a comparable transaction.

Generally, the arm's-length principle has to be applied and verified as regards every single intercompany transaction. Nevertheless, the Decree indicates the circumstances in which two or more transactions may be tested on an aggregated basis (i.e. homogeneous, bundled, or complementary operations).

The Decree introduces a specific definition of 'arm's-length range' as the range of values that comprises all transactions comparable to the tested transaction. It also explains the concept according to which if the financial indicator (price or margin) does not fall within the arm's-length range and the tax authorities rectify it in order to make it fall within the latter, the taxpayer still has the right to present arguments demonstrating that the conditions of the controlled transaction satisfy the arm's-length principle. The tax administration may in any case disregard such arguments [only] upon proper examination.

Due to the large amount of debate and discussion that often arises (especially during tax inspections) concerning the point of the range that should be selected as the most appropriate to reflect a market remuneration/profitability, practical input and additional clarification are expected from the Central Revenue.

Article 7 – recalling the latest July 2017 version of the OECD guidelines – introduces a simplified procedure for calculating the relevant remuneration for low-value-adding services. In fact, for these kinds of services it is possible to aggregate direct and indirect costs adding a 5% mark-up in order to have an arm's-length remuneration.

Low-value-adding services are defined as ancillary and non-core activities of the multinational group, not requiring the use of high-value intangibles and not entailing substantial risks.

The Decree entrusted to a decision of the Director of the Italian Revenue Agency the updating of the provisions relating to the so-called 'penalty protection regime', the transfer pricing documentation and the indication of the criteria on the basis of which such documentation could be considered appropriate to verify compliance with the arm's-length principle, so granting the non-application of administrative penalties in cases of challenges under a tax inspection.

The documentation will be considered suitable in all cases in which it provides the Italian tax authorities with all the information needed for a proper transfer pricing analysis, regardless of the method used and the selection of comparable companies identified in the comparability analysis. Similarly, the documentation will be considered suitable even if it is incomplete or contains partial inaccuracies that do not compromise the audit activity.

Additional provisions for further implementation of the transfer pricing requirements will be delivered periodically by the Italian Revenue Agency, also in light of the updates to the transfer pricing guidelines that are to be released by the OECD.

Barbara Scampuddu	Gian Luca Nieddu

Barbara Scampuddu (barbara.scampuddu@hager-partners.it) and Gian Luca Nieddu (gianluca.nieddu@hager-partners.it)

Hager&Partners

Tel: +39 02 7780711

Website: www.hager-partners.it