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20 May 20245 minute read

The Italian Supreme Court ruled on accurate comparable selection and burden of the proof

The related Italian Supreme Court’s decisions No. 10499/2024 and No. 10577/2024 analyse the domestic transfer pricing regulation (based on Article 110, paragraph 7 of Presidential Decree No. 917/1986) and the burden of proof concept with respect to transfer pricing matters.

The Supreme Court confirmed and emphasized the importance of proper comparability when assessing whether an intercompany transaction has occurred according to the arm’s length principle and, more specifically, when applying a transfer pricing methodology. Thereby, when performing economic analyses, the Italian Tax Authority (ITA) shall follow the OECD Transfer Pricing Guidelines and international best practice in order to be able to prove that the taxpayer did not act in compliance with transfer pricing regulations.

This decision is relevant as the highest Tribunal of Italy included valuable interpretations of the OECD Transfer Pricing Guidelines in matters that come up in cases handled by other courts globally.

What are the key takeaways?
  • The Italian Supreme Court’s decision confirmed previous precedents, highlighting the importance of the accurate application of transfer pricing principles especially when performing economic analysis and selecting appropriate comparable independent companies as a result of a transfer pricing methodology application.
  • This judgment confirms the current position that taxpayers have the burden of the proof with respect to transfer pricing matters.
  • The importance of the OECD Transfer Pricing Guidelines as a pivotal resource for interpreting tax regulations on international dealings, a model of transparency and equity in managing cross-border transactions.

The case at hand refers to a tax assessment notice on regional production tax for FY 2009, issued to Ufi Filters S.p.A. (the “Company”) by the ITA. The latter aimed at rejecting the Company’s deductibility of cost incurred with respect to the purchase of automotive filters from Chinese related entities, namely Ufi Filters (Shanghai) Co. Ltd and Sofima Automotive Filter (Shanghai) Co. Ltd. The ITA argued that the net cost plus mark ups applied to the transactions (39.77% and 17.2%, respectively), were way above the arm’s length range of the economic analysis performed by themselves. Thus, the ITA alleged that these entities charged Ufi Filters S.p.A. with prices above the normal market price and, therefore, the Company aimed at shifting profits outside Italy. The Italian taxpayer had apparently not prepared any documentation (e.g., local file) to support its transfer prices.

Initially rejected by the Provincial Tax Commission of Milan (CTP), Ufi Filters S.p.A.’s appeal was later upheld by the Regional Tax Commission of Lombardy (CTR), which ruled in favour of the taxpayer and provided for the annulment of the tax assessment notice. The ITA subsequently appealed this decision to the Italian Supreme Court.

Issues raised by the Italian Tax Authority

The CTR challenged the appropriateness of the six Chinese comparable independent companies selected by the ITA. The ITA, in turn, argued that, when taxpayer’s assessments are challenged, it is their responsibility to demonstrate the correctness of their transfer prices and, therefore, in the case at hand, the Company should have provided appropriate evidence to support the high profitability margins earned by its Chinese subsidiaries.

In light of the above, the two main issues at stake were:

  • An appropriate comparable selection based on the actual comparability factors; and
  • The burden of proof with respect to transfer pricing matters.
The judgement from the Italian Supreme Court

With respect to the appropriate comparable selection, the Italian Supreme Court confirmed the ruling of the CTR, stating that the six Chinese comparable companies selected by the ITA showed comparability defects if compared to the intercompany transactions with respect to

  • The goods exchanged (e.g., cabins, tanks, gearboxes and similar vs. high technology filters);
  • The geographical location and conditions (rural areas of China vs. Shanghai); and
  • The functions, risks, and assets used.

While the functional profile of the Company was regarded by the ITA as the core comparability factor to be considered for the transfer pricing methodology’s application (i.e., cost-plus method), no specific description was used to substantiate it and to justify why the six Chinese independent companies were selected as comparable.

In light of the above and with respect to the burden of the proof issue, the Supreme Court ruled that the ITA was not capable of providing appropriate evidence to justify the tax assessment containing the transfer pricing adjustment. Indeed, according to the Supreme Court’s precedents in this regard, the ITA does not have to prove the transfer pricing tax avoidance but only the fact that the intercompany transactions have occurred at prices allegedly lower than the ones normally applied in arm’s length conditions. On the other hand, the taxpayer, based on the principle of proximity of proof pursuant to Article 2697 of the Italian Civil Code, has the burden to support that transactions took place at arm’s length prices.