Transfer Pricing Administration in Italy 2.0: Are all the Questions Finally Answered?

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1 Milan, 23 February 2018 Transfer Pricing Administration in Italy 2.0: Are all the Questions Finally Answered? On February 21, 2018, the Italian Ministry of Economy and Finance ( MEF ) launched a public consultation on the implementation measures associated with the application of its domestic transfer pricing provision, i.e. Art. 110, Par. 7, of Presidential Decree n. 917 of 1986 ( TUIR ). In particular, the MEF released for public comments the following draft documents: i. a draft of the Ministerial Decree (the Draft Ministerial Decree ) recalled by Art. 110, Par. 7 of TUIR (as amended by Art. 59 of the Law Decree n. 50/2017); ii. a draft Notice of Italy s Commissioner of Revenue Agency (the Draft Notice ) provided for by Art. 31-quater of Presidential Decree n. 600 of 1973 regarding the newly-introduced procedure allowing taxpayers to obtain a unilateral downward transfer pricing adjustment in lieu of activating the ordinary instrument of mutual agreement procedures ( MAPs ); and iii. the translation of the relevant parts of the 2017 OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations. The public consultation will end on March 21, 2018 and will be followed by the release of the final version of the three documents. Executive Summary Overall, the publication of the three documents highlights a turning point in the relationship between the tax administration and the taxpayer, targeting a more proactive approach by Italy s revenue bodies (i.e. the Revenue Agency, or Agenzia delle Entrate and the Italian tax police, or Guardia di Finanza ) vis-à-vis the taxpayer. Such new approach reflects a new attitude of the tax administration aimed at both increasing tax compliance of

2 SMEs and MNEs, as well as preventing costly and lengthy disputes on a technical topics often source of controversy. In this regard, it shall be warmly welcomed with favor the use of an OECD-style public consultation process, with the proactive involvement of taxpayers in the introduction process of significant secondary legislation. The new, long-awaited, transfer pricing regulations seems to supersede the previous guidance contained in the outdated Circular Letter n. 32 of 1980 and is consistent with the recommendations of the OECD as submitted in the Final BEPS Reports of Actions 8 to 10. In this respect, it will be interesting to see how the new transfer pricing guidance will be received by the local tax offices, which have still made use of the previous recommendations of the above-mentioned Circular n. 32 of The latter document at times is at odds with the recommendations contained in the July 2017 version of the OECD Transfer Pricing Guidelines (e.g. with respect to use of a fixed rate for royalty payments arising from the commercial exploitation of intangibles). In this regard, Italy s Minister of Finance, Mr. Pier Carlo Padoan acknowledged the concern of many taxpayers, focusing on inconsistent approach of local versus central tax offices in the administration of transfer pricing. To this end, Minister Padoan announced the launch of a cascade training for tax officials on duty in provincial and regional offices, instrumental at creating a level playing field in the enforcement of transfer pricing provisions. Such initiative should be welcomed as it aims at guaranteeing a more consistent and OECD-compliant approach in the management of the arm s length principle, irrespective of the administrative unit involved. Moreover, the regulations present some innovative features such as (i) the formal and no longer implied introduction of the OECD Transfer Pricing Guidelines in Italy s tax system and (ii) the newly introduced procedure for unilateral downward adjustments by the Draft Notice. Such features arguably place Italy within the rank of tax administrations with an advanced legislative framework in place. However and as further elaborated below, some improvements and further clarifications to the Drafts documents are needed to render the new guidance effective also from a practical standpoint. The Draft Ministerial Decree and the Italian translation of the 2017 OECD Transfer Pricing Guidelines The Draft Ministerial Decree on the application of Art. 110, Par. 7 addresses some significant issues generally subject of controversy during audits, such as (i) the definition of what amounts to control relevant for the definition of associated enterprises, (ii) the selection of the most appropriate transfer pricing method and (iii) the identification of an arm s length range. Notwithstanding the above, the Ministerial Decree seems to fall short of not taking a clear stance on some of the most controversial issues with respect to which a mere reference to the 2017 version of the OECD Transfer Pricing Guidelines seems not to be sufficient. For instance, a clear position is not yet taken on the identification of which point of the range (e.g. the median) the taxpayer should place itself in the event the tax administration carries on a transfer pricing adjustment or if each point within the mentioned range may be deemed comparable. The hope is that these concerns will be taken into account during the release of the final version of the draft decrees. More in detail, the Ministerial Decree seems to not clearly identify a process to set the criteria for determining a proper comparable set (e.g. what criteria to be adopted during the quantitative screening process, when to use loss-making comparables, or when the use of domestic comparables has to be preferred vis-à-vis foreign ones). The introduction of

3 the translated version of the 2017 version of the OECD Transfer Pricing Guidelines ( TP Guidelines ) is arguably a step ahead in making Italy s transfer pricing regime aligned with international best practices, yet it does not overcome the actual issues faced by taxpayers during audits. Interestingly, not the entirety of the TP Guidelines has been translated, but only those parts which are of direct relevance for Italy. For instance, no reference to the part of the TP Guidelines discussing formulary apportionment has been included, clearly highlighting the strict adherence by Italy to the arm s length principle and to the OECD officially recognized transfer pricing methods. Based on the above, some of the key highlights of the Draft Ministerial Decree may be summarized as follows: The definition of the term associated enterprises seems to be expanded vis-à-vis the definition contained in the domestic provision of Art. 110, Par. 7. In particular, based on the Draft Ministerial Decree, it seems that companies under the control of the same individual would fall within the definition of associated enterprises; It is clarified that both juridical and de facto control falls within the definition of control; An alignment with the order of analysis of comparability factors as provided by the new Chapter I of TPG2017 is introduced. This recognition may entail that the notions of risk management (with that of control over risk embedded in it) and financial capacity to assume risk as further detailed in Section D.2 of Chapter I of the OECD Transfer Pricing Guidelines assume a central role in any transfer pricing analysis, with the need of accurately reflecting it in the taxpayer transfer pricing documentation package; The softened hierarchy of transfer pricing methods as endorsed by Chapter II of the 2017 TP Guidelines is expressly endorsed, e.g. the CUP method is deemed as the most appropriate method in the event all methods could be reliably applied. Along the same line of reasoning, in the event both the traditional and transactional methods may be reliably applied, the former should take precedence; A real game changer is represented by Art. 4, Par. 6 of the Draft Ministerial Decree, when a provision is introduced whereby the tax administration is bound to respect the choice of the transfer pricing method by the taxpayer, insofar as the latter has met all the conditions required for the selection of the most appropriate methodology. This provision might have a significant impact on a number of ongoing disputes in Italy whereby the tax administration challenges the selection of a certain methodology without elaborating further on the criteria adopted for dismissing that chosen by the taxpayer; Full recognition of the portfolio approach in the performance of the comparability analysis. Such express endorsement may have a significant impact as often tax assessments have been issued based on a discretionary and unsound non-recognition of the portfolio approach by the tax administration; According to Art. 6 of the Draft Decree, consistently with the guidance provided for by the OECD TP Guidelines, it seems that every point included in the range meet the requirements of the arm s length principle insofar as each point within the mentioned range may be deemed comparable. This entails that, should the profit level indicator ( PLI ) of the entity under review fall outside the arm s length range, the tax administration will adjust the profitability of the entity in order to make it fall within the range. From a practical standpoint, the new guidance does not seem to overcome the actual issue, often subject of controversy with the tax administration, associated with the identification of the exact point of the range to be deemed at

4 arm s length in situations where a TP adjustment has been performed. Further administrative guidance on this specific point would be necessary; The Draft Ministerial Decree concludes by stating that further guidance will be provided also considering the relevant updates in the OECD TP Guidelines. The Draft Notice on unilateral downward adjustments As regards the innovative administrative procedure introduced by Art. 31-quarter and further elaborated by the Draft Notice, it strives to eliminate the lengthy discussions taking place between competent authorities in the ordinary context of MAPs 1, at the same time trying to reduce the relevant inventory of MAP cases to be discussed at the Competent Authority level. The Draft Notice arguably places Italy ahead of the majority of OECD s tax administrations as it eliminates unilaterally the economic double taxation arising from a foreign transfer pricing adjustment insofar as the latter is final in its determination and consistent with the arm s length principle. The Draft Notice provides that, in the event the submission for the unilateral downward adjustment is accepted (within 30 days from its submission by the taxpayer), the APA and MAP Office will have 180 days to finalize the procedure with a final a notice informing the taxpayer of the acceptance or rejection of the request. The Draft Notice seems to leave a couple of important issues open, which can be summarized as follows. Firstly, Art. 4, Par. 2, provides the opportunity for the Italian Revenue Agency to activate the instruments of international co-operation (i.e. exchange of information) to assess the accuracy of the information provided for by the taxpayer. If that is the case, the ordinary term of 180 days to complete the procedure is deemed to be suspended, without further indication on when and under what circumstances it will be reinstated. The vagueness as regards to the timing might be construed as discretionary power to be exerted by the tax administration. As a result, it would be useful if it could be better clarified in the final version of the Commissioner s Notice. Moreover, it is also worth noting that, on top of the requirements for the Italian taxpayer of having received an adjustment, which is deemed consistent with the arm s length principle and final in its amount based on the provisions of the foreign administration, the taxpayer according to Art of the Draft Notice will still be entitled to activate a MAP based on either the relevant bilateral tax treaty or the EU Arbitration Convention for the elimination of double taxation in case of adjustments of profits of associated enterprises. It seems that such provision may arguably create some difficulties for the Italian tax administration, particularly in those instances where the Italian Revenue Agency agrees with the primary transfer pricing adjustment carried out by the foreign tax administration, but it challenges its amount. For instance, assume that Company B, resident in country X and subsidiary of the Italian Company A, receives an assessment notice by the local tax administration issuing a final primary adjustment of 100. Company A submits the unilateral downward procedure based on Art. 31-quater to the Italian Revenue Agency, which is accepted. The Italian Revenue Agency agrees to grant the corresponding downward adjustment to an amount up to 80, therefore leaving the remaining 20 subject to double taxation. In such a scenario, Italy s APA and MAP Unit may consider not to grant the corresponding adjustment altogether, as it would be more convenient to discuss the entire amount in an ordinary MAP procedure. In this respect, it seems that Art. 6.1 of the Draft Notice already provides for the opportunity of opening a MAP, but if that is the case the inventory of bilateral procedures for Italy might rise dramatically, with the related difficulty in managing it. On the other hand,

5 though, denying the access to MAP in the event the procedure of Art. 31-quater is activated would place Italy contravening the recommendations of Action 14 of the BEPS project 2, which is one of the minimum standards of the G-20/OECD initiative every country part of it has to implement. An express clarification also on this point would be welcomed. 1 Notwithstanding the introduction of the new procedure, Italy has recorded a significant progress with the management of the MAP inventory, as in 2017 more than 130 MAP cases have been discussed by Italy s competent authority, with the successful completion of 70 of them. 2 OECD (2015), Making Dispute Resolution Mechanisms More Effective, Action Final Report. DISCLAIMER: This publication is provided by Ludovici Piccone & Partners and has been duly and professionally drafted. However, the information contained therein is not a legal advice and cannot be considered as such. Ludovici Piccone & Partners cannot accept any liability for the consequences of making use of this issue without a further cooperation and advice is taken. MILAN - ROME - LONDON Home page Ludovici Piccone & Partners 2017