Introduction and Legal Framework
In April 2017, the Italian government issued a Decree with the aim, among the other, to: (1) amend the Italian transfer pricing legislation, in order to better align it with OECD’s arm’s length principle; and (2) provide the possibility for the Italian tax authorities to grant a corresponding adjustment, unilaterally.
Against this background, the Italian Ministry of Economy and Finance has recently launched a public consultation on two draft regulations containing implementation measures of the above new rules. The consultation is open until March, 21.
The two draft regulations:
- Provide guidance on the application of the arm’s length principle, based on the international best practices (the "first regulation")
- Contain the procedure for obtaining unilateral corresponding adjustments (the "second regulation")
Along with the draft regulations, an Italian translation of the Organisation for Economic Development and Co-operation (OECD) transfer pricing guidelines 2017 (OECD Guidelines) has been published. In general, the aim of the Italian Legislator is to fully align Italy’s transfer pricing rules with the outcomes of the OECD Base Erosion and Profit Shifting (BEPS) project.
This tax insight presents a summary of this recent development and key takeaways.
Key Features of the First Regulation
The first regulation provides details on the application of the arm's length principle for transactions within related entities (the "controlled transaction"). Specifically, it covers:
- The definition of "related entities" by including both juridical and de facto control over the entity as well as the definition of control over risk and capital, by including a 50 percent threshold of ownership
- The concept of comparability factors that aligns with the ones set forth in the OECD Guidelines: the five comparability factors are (1) contractual terms, (2) functions, assets and risks of the parties to the transaction, (3) characteristics of the goods or services, (4) economic and market circumstances and (5) business strategies
- A list of four criteria that require consideration when determining the most appropriate method, consistent with the guidance on method selection provided in the OECD Guidelines. Also consistent with the OECD Guidelines the first regulation specifies a preference for the comparable uncontrolled price method in cases where such method can be applied with equal reliability to any other approved methods. In this respect, the first regulation clarifies that if the taxpayer has met all the conditions required for the selection of the most appropriate method, the Italian tax authority is bound to respect the method chosen by the taxpayer
- The identification of arm's length range, which is composed of the range of prices or margins that result from the application of the most appropriate transfer pricing method. The first regulation further specifies that where the result of a controlled transaction falls outside the arm's length range, any adjustment by the tax authority is to be made to any point inside the arm's length range
The first regulations apparently only aims at securing the foundations for the application of the arm's length principle. The intention of the Italian tax authority, however, is to issue one or more circular letters with more detailed guidance, also on the basis of the feedback received as a result of the public consultation.
Key Features of the Second Regulation
The second regulation provides details on domestic procedures for unilateral downward adjustments. A corresponding adjustment can be requested where the primary transfer pricing adjustment is (1) final; (2) deemed consistent with the arm’s length principle; and (3) carried out by the competent authority of a foreign Country with which a double tax treaty is in place that provides an adequate exchange of information.
The second regulation sets out the requirements for the submission of the application and terms by which the Italian tax authority has to accept (or reject) the application (i.e. 30 days) and finalise its position (i.e. 180 days). Notwithstanding the terms, the Italian tax authority has the possibility to delay or suspend the term of 180 days to complete the application, in certain circumstances, e.g. in case the Italian tax authority deems necessary to access reliable information from the foreign competent authority.
Taxpayers are still eligible to apply to the mutual agreement procedure (MAP) in case the domestic procedure does not result in the sought outcome.
Key takeaways include:
- Italian government is fully aligning its transfer pricing rules to international standards
- Regarding the first regulation, when a transfer pricing adjustment needs to me made, the Italian tax authority should not automatically adjust the taxpayer's profit level indicator to the median of the arm's length range, as it appears to be often the case in practice
- Regarding the second regulation, the domestic procedure for the unilateral corresponding adjustment may reduce the time for taxpayers to eliminate double taxation deriving from a transfer pricing assessment made by a foreign tax authority. However, taxpayers should consider that, if dissatisfied with the outcome, they need to file a MAP request and, in turn, delay the time before being eligible to access arbitration, if available
Considering that the first and second regulations are still in draft, we are monitoring their development closely. For more information on this or other transfer pricing issues generally, please contact the authors, your regular DLA tax advisor or Joel Cooper or Randall Fox, Co-Heads of International Transfer Pricing.
See our APA and MAP Country Guide for more information about MAP assistance.