17 July 2013 International Tax Alert News from the Global Tax Desk Network Italy s Supreme Court rules on the deduction of expenses related to transactions with Black List entities On 8 May 2013, the Italian Supreme Court upheld the appeal of an Italian company regarding the deduction of costs incurred for the purchase of goods from a black listed entity. 1 Italian tax law provides specific deduction requirements for resident companies entering into arrangements with foreign black list suppliers for any payments made to the latter entities (i.e., for the purchase of goods and services, royalties, etc.) as well as for any other costs incurred in connection with such transactions. Specifically, an increased burden of proof is required for tax deduction purposes. The Italian company must be in the position to: (i) provide evidence of the economic substance of the black list supplier or (ii) demonstrate that the transaction at stake responds to an actual business interest and that it was actually carried out. In the respective case, the taxpayer demonstrated the existence of an actual business interest in that the foreign supplier was able to grant competitive prices, as well as provide timely deliveries and general reliability. Background Article 110(10) of the Italian tax code (ITC) limits the deductibility of expenses and other costs related to transactions with certain nonresident entities and professionals by imposing an increased burden of proof.
Such expenses are not deductible unless the resident company proves that: The nonresident supplier carries on a real activity, i.e., it has economic substance (First Exemption); or The relevant transaction responds to an actual business interest and it actually took place (Second Exemption). At the time of the facts of this case (1999), the rule applied only in the case of dealings with related entities while the current version has been expanded to apply to dealings with third parties. 2 The above-mentioned proof can be provided either in the course of a tax assessment or in advance by way of a tax ruling. 3 In either case, Italian companies dealing with black listed providers are required to disclose the relevant transactions in their tax return. 4 Ministerial Decree of 23 January 2002 provides a list of black listed countries and territories, as well as black listed entities (Black List). 5 Clarifications on the rule under discussion have been provided by the Italian tax authorities through the years. On 6 October 2010, the tax authorities issued Ministerial Circular No. 51/E which clarified that: 6 The term resident entity must be interpreted as including Italian permanent establishments of foreign entities; The term resident in a state or territory mentioned in the black list must be interpreted as including permanent establishments of Italian entities and entities resident in a white list country; and The term expenses must be interpreted as including all kind of costs and expenses such as depreciation/amortization and capital losses. With respect to the First Exception (economic substance of the foreign supplier), the mentioned Circular stated that, while it can represent good evidence, a link between the foreign black list supplier and the local market is not required by the rule under discussion (this view had reversed the Revenue position stated with Ruling No. 100 of April 2009). With respect to the Second Exemption (i.e., proof that the transaction relates to an actual business interest and that it was actually carried out), the mentioned Circular provided a list of elements (such as the price, the delivery conditions, etc.) which should be taken into account when the business interest test is performed. They also recognized that the organizational, commercial, and productive constraints may force an Italian company to buy from a black list supplier, by specifically indicating that a centralized procurement group company supplying all subsidiaries is permitted. Moreover, the authorities recognized that even a higher price may be justified, in comparison to prices made by other potential suppliers, taking into account all facts and circumstances. Facts An Italian company was subject to an assessment for corporate income tax purposes with reference to FY 1999. Among other things, the Italian tax authorities challenged the deduction of costs incurred with reference to the purchase of photographic reels from a company resident in Liechtenstein, a country included on the Black List. Supposedly, the supplier was also the parent company of the Italian taxpayer. The Italian company brought proceedings against the tax assessment in front of the Tax Court of first instance and won. The Italian tax authorities appealed against the first level of judgment before the Tax Court of second instance. The Tax Court of second instance confirmed the judgment of the first instance and invalidated the action of the tax inspectors that disallowed the deduction of the costs sustained by the Italian company. In particular, the Tax Court of second instance believed that the transactions between the Italian taxpayer and its supplier met a real business purpose and that the Italian tax authorities did not demonstrate the control by the foreign entity over the Italian company. 2 International Tax Alert Global Tax Desk Network
The Supreme Court decision The Italian tax authorities appealed before the Italian Supreme Court by claiming first that the court of second level was wrong in assuming as not proved the ownership relationship between the Italian taxpayer and the foreign entity. The Italian tax authorities also asserted that the court of second level was wrong in determining that the transactions at stake lacked business purpose. Furthermore, the Italian tax authorities claimed that the decision issued by the court of the second level was not duly supported by legal reasoning. Despite the arguments brought forward by the authorities, with judgment no. 10749/2013 of 8 May 2013, the Supreme Court confirmed the decision of the Tax Court of second instance by stating that the transactions put in place by the Italian taxpayer met an actual business interest because of not only the competitive prices of goods acquired, but also other important facts including the punctuality in the delivery and reliability of the supplier. Conclusions This case is a positive development as it demonstrates that the tax courts are more and more open in accepting a series of factual elements that in practice may reveal the existence of a business interest in dealing with black list suppliers. However, the described controversy shows how problematic it can be for Italian taxpayers to provide arguments in favor of either the First or Second Exemptions during the tax audit process. In this respect, Italian companies involved in transactions with either related or unrelated entities located in black list countries may consider the opportunity to file the First and Second Exemption evidence in advance by way of filing a tax ruling request. International Tax Alert Global Tax Desk Network 3
Endnotes 1. Judgment no. 10749/2013. 2. At that time (i.e., prior to the 2004 reform of the ITC) the rule was included in Article 76(7bis)(7ter) ITC. 3. A positive tax ruling will protect the taxpayer from any assessment as long as the facts represented in the ruling request remain the same through the years. The Revenue shall respond within 120 days from the filing unless additional documentation is requested (if there is no answer within the 120 day term, the taxpayer may send a notice to the Revenue and if no answer is received within an additional 60 days, the ruling outcome is deemed to be positive). As to the term for the filing, the request is filed in due time (i.e., in advance) if the response by the Revenue is received within the deadline for the filing of the tax return related to the year in which the Italian company carried out the black list transaction. For example, if a taxpayer has its fiscal year coinciding with the calendar year and a tainted transaction is carried out in 2013, the relevant claim should be filed no later than 1 June 2014, provided that the statutory deadline for the filing of the return expires on 30 September 2014. 4. Specific disclosures of dealings with black list countries are also required for VAT purposes. 5. The Black List is divided into three sections: a) The first section contains the countries and territories regarded as having a privileged tax regime under any circumstance. The list includes: Andorra, Anguilla, Aruba, the Bahamas, Barbados, Barbuda, Belize, Bermuda, the British Virgin Islands, Brunei, the Cayman Islands, the Channel Islands, the Cook Islands, Djibouti, French Polynesia, Gibraltar, Grenada, Guatemala, Hong Kong, the Isle of Man, Kiribati, Lebanon, Liberia, Liechtenstein, Macau, Malaysia, the Maldives, the Marshall Islands, Montserrat, Nauru, the Netherlands Antilles, Nevis, New Caledonia, Niue, the Philippines, Oman, the Solomon Islands, St. Helena, St. Kitts, St. Lucia, St. Vincent and the Grenadines, the Seychelles, Tonga, the Turks and Caicos Islands, Tuvalu, the US Virgin Islands, Vanuatu and Samoa. b) The second section contains the countries regarded as having a privileged tax regime, with the exception of certain specific activities, and in particular: - Bahrain, excluding companies that carry out exploration, extraction and refining in the oil industry; - Monaco, excluding companies whose turnover derives for more than 25% from outside the principality; - Singapore, excluding the Central Bank and other entities that manage the official reserves of the state; and - The United Arab Emirates, excluding companies that carry out exploration, extraction and refining in the oil industry. c) The third section contains the countries and territories that are generally deemed not to have a privileged tax regime which, due to specific offshore legislation or other tax incentives, are in any case deemed to be tax havens with regard to specified low-tax activities. This section includes the following countries: - Angola, with respect to oil companies that benefit from the exemption from oil income tax, to companies which benefit from exemptions or reductions of tax in industries essential to the Angolan economy and to investments provided for by the Foreign Investment Code; 4 International Tax Alert Global Tax Desk Network
- Antigua, with respect to international business companies that carry out their activity abroad, such as those under the International Business Corporation Act No. 28 of 1982 and subsequent amendments and integrations, and to companies that manufacture authorized products such as those under Law 18 of 1975 and subsequent amendments and integrations; - Costa Rica, with respect to companies deriving income from foreign sources and companies engaged in hightechnology activities; - Dominica, with respect to International companies carrying out their activity abroad; - Ecuador, with respect to companies carrying out their activity in the free trade zones that benefit from the exemption from income taxes; - Jamaica, with respect to companies manufacturing for foreign markets and enjoying the tax benefits of the Export Industry Encouragement Act and to companies located in the territories indicated in the Jamaica Export Free Zone Act; - Kenya, with respect to companies established in the export processing zones; - Mauritius, with respect to certified companies engaged in export services, industrial development, tourism management, industrial construction and clinics and that are subject to lower than ordinary corporate tax, to off-shore companies and to international companies; - Panama, with respect to companies deriving income from foreign sources, as defined under Panama legislation, to companies located in the Colon Free Zone and to companies carrying out their activity in the export processing zone; - Puerto Rico, with respect to companies engaged in banking activities and to companies under the Puerto Rico Tax Incentives Act of 1988 or the Puerto Rico Tourist Development Act of 1993; - Switzerland, with respect to companies not subject to cantonal and municipal taxes, such as holding, auxiliary and domiciliary companies; and - Uruguay, with respect to companies carrying out banking activities and to holding companies that carry out exclusively off-shore activities. The said decree specifies that the Black List is automatically updated to include entities established in the above mentioned States which benefit from tax reliefs/benefits substantially similar to those mentioned therein, either by virtue of agreements or other acts issued by the local administration. 6. For additional details please refer to our International Tax Alert Guidance on new Italian CFC rules and black list rules of 18 October 2010. International Tax Alert Global Tax Desk Network 5
For additional information with respect to this Alert, please contact the following: Ernst & Young, LLP, Italian Tax Desk, New York Emiliano Zanotti +1 212 773 6911 emiliano.zanotti@ey.com Andrea De Nigris +1 212 773 0478 andrea.denigris@ey.com Aldo Bono +1 212 773 3216 baldassare.bono@ey.com Ernst & Young, Studio Legale Tributario, Italy Domenico Borzumato +39 02 8514 503 domenico.borzumato@it.ey.com Marco Magenta +39 02 8514 529 marco.magenta@it.ey.com Mario Ferrol +39 335 122 9904 mario.ferrol@it.ey.com Global Tax Desk Network of Ernst & Young LLP in the United States Argentina Australia Austria Belgium Brazil Canada China Czech Republic Denmark Finland France Germany Hungary Iceland India Ireland Israel Italy Japan Luxembourg Mexico Netherlands Norway Pan-Africa Poland Russia Scandinavia Spain Sweden Switzerland Taiwan Turkey United Kingdom Asia Pacific Business Group Central European Business Group Eastern European Business Group EMEIA Financial Services Latin American Business Center 6 International Tax Alert Global Tax Desk Network
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