Among the hallmarks indicated in Annex 1 to Legislative Decree n. 100, i.e. among the indicators of a possible tax avoidance intent, those listed under letter E are relevant to transfer pricing. For the purposes of the regulation under analysis, these hallmarks are relevant only when enacted without complying with the arm’s length principle; they are not subject to the main benefit test i.e. to the assessment of whether a tax advantage is the main benefit expected from the arrangement.
The existence of transactions under letter E of the Annex implies an integration of reporting obligations, if the prerequisites set forth by the regulation are met, including time requirements.
There are various hallmarks relevant to arrangements implemented or implementable among associated enterprises . Of course, these arrangements also need to be analysed to assess whether the conditions agreed upon comply or not with the arm’s length principle, though they are relevant under other aspects. Therefore, shared methodologies, both on a domestic and international level, need to be applied.
Below we will focus only on those hallmarks listed under letter E, i.e. safe harbour, hard to value intangibles and business restructuring. These topics have been the focus of OECD studies for years, have been analysed in depth within the BEPS project and are extensively analysed in the latest version of the OECD Transfer Pricing Guidelines.
Before analysing these three hallmarks in detail, I wish to make two preliminary points, the first concerning the definition of associated enterprise. It is easy to notice that the definition contained in art. 2, para. 1, letter e) of Legislative Decree n. 100 is wider than the one provided under Ministerial Decree dated 14 May 2018 as well as under the Guidelines, for the purposes of determining the arm’s length price. The definition is further extended by Ministerial Decree dated 17 November 2020 with reference also to hard to value intangibles.
The decision made by the EU legislator and thus also by the domestic one, is objectionable since it causes transaction to be subject to transfer pricing regulations, which will not - neither for the past nor for the present - be subject to said regulation in most States. Therefore, mapping these transactions through the analysis of the transfer pricing documentation is partial and risks not to identify all arrangements potentially subject to the reporting obligation.
Moreover, the further extension introduced by the Ministerial Decree by explicitly recalling both the definition of associated enterprise and letters C, point 1 and E, point 2 of Annex 1 is not self-explanatory. The reference to the definition of associated enterprise contained in the Legislative Decree automatically implied its application to all cases to which reference was made - in the same Legislative Decree - to associated enterprises.
The further reference to two specific letters of Annex 1 is not clear: in particular, it would be helpful to understand whether such reference is just a superfluous specification, as already included in the definition, or whether the aim is that of identifying two difference subjective perimeters of analysis, the first relevant to safe harbours and business restructuring and the second one relevant to hard to value intangibles only.
I deem the first hypothesis to be the correct one, also in the light of what contained in the Commission working party IV, direct taxation, according to which the term “intercompany” under letter E, point 3 refers to associated enterprises.
The second preliminary remark concerns the legitimacy of the reference to the OECD Guidelines to interpret the transactions under letter E. I believe this is the case, since both the legislator and the Revenue Office have been making reference to the Guidelines for years as a source of inspiration of the regulation and as interpretation aid and because Legislative Decree no. 100 recalls Ministerial Decree dated 14 May 2018 which, in turn, recalls the Guidelines.
Reference to the Guidelines is also made in the document issued by the Commission working party IV, direct taxation. For the sake of completeness, I wish to underline that the use of the Guidelines to interpret the Italian regulation, i.e. the arm’s length principle, is considered legit also by judicial decisions concerning the merits and by the case law of supreme courts.
It goes without saying that the whole provision being analysed and the directive which it implements in Italy make explicit reference to action 12 of the BEPS project, i.e. Mandatory Disclosure Rules and to the OECD works.
After making these preliminary remarks, I move on to analyse the three categories of transactions.
First of all, let’s focus on the definition contained in the Ministerial Decree: safe harbour is “a regime which, with reference to specific categories of transactions, preliminarily establishes certain rules and minimum parameters complying to which enterprises are exempt from providing further evidence required under the transfer pricing regulation or practice”.
Safe harbour is thus a provision or an interpretation practice which, upon assessing given conditions, grants taxpayers the possibility to determine the price applicable to an intercompany transaction as a lump sum, without carrying out a comparability analysis.
The definition contained in the Italian norm is different from the definition provided in the OECD Guidelines: “A safe harbour in a transfer pricing regime is a provision that applies to a defined category of taxpayers or transactions and that relieves eligible taxpayers from certain obligations otherwise imposed by a country’s general transfer pricing rules”.
The Italian norm actually restricts safe harbours to categories of transactions, whereas the OECD refers to categories of transactions and categories of taxpayers.
Aim of the safe harbours is that of limiting the effort required from taxpayers with reference to transactions which could not justify the administrative burden that the analysis of intercompany transactions normally requires. The OECD, which in the 1995 version of the Guidelines expressed a negative judgement on safe harbours, reviewed its position in the following years.
The OECD now recognises, on the one hand, that safe harbours can have the legit aim of simplifying and reducing the administrative burden and, on the other hand, that they can be subject to misuses from both the financial authorities and groups, generating double taxation or double non-taxation, respectively.
The OCED considers bilateral or multilateral safe harbours commendable to minimise the risk of misuses and also provides examples of agreements that the financial administrations could conclude with reference to the different categories of conceivable safe harbours.
Letter E, point 1 refers to unilateral safe harbours, i.e. enacted only in one of the States involved in the transaction, without involving the others. This emphasises the margin of discretion which the case being analysed implies which consequently may give rise to abuses.
Regardless of an explicit agreement reached by two or more States, safe harbours recognised as legit by the OECD and which therefore obtained the consent of the other member States, are not to be considered as unilateral and thus they do not fall within the scope of application of this norm.
The abovementioned Commission party IV, direct taxation, also follows this direction stating that “The commission Services took the view that national rules on safe harbours should be “unilateral” when they depart from the international consensus, as this is enshrined in the OECD transfer pricing guidelines”. This applies also in case only one of the two States involved in the transaction decided to make use of the safe harbour provision.
The easiest example regards low value added services. This type of services was identified and described in the BEPS project, described in action 8-10 and thus integrated in the Guidelines issued further to the project and still in force. As a final note, the recent order by the Revenue Office Director expressly provides for a reformulation of the structuring of the documentation apt to the disapplication of the administrative sanctions in case of a transfer pricing dispute.
Based on these assumptions and remarks, I deem that no safe harbour exist today in Italy. They existed in the past, further to the introduction of Revenue Office Circular Letter no. 32 of 1980 concerning the consistency of royalties.
This had been correctly received as limiting the arm’s length principle as it did not reflect what agreed between independent parties in the free market, but it unquestionably identified thresholds which, not requiring specific analyses, could result in advantages in case the intangible asset had no characteristics which would lead to presume that a third party would pay a royalty for its use.
The existence of a safe harbour needs to be ascertained by all enterprises resident in States applying this norm for all transactions they carry out.
The definition of hard to value intangibles is contained in the Legislative Decree and reaffirmed in the Ministerial Decree and perfectly mirrors the definition provided in the abovementioned OECD Guidelines. In particular, hard to value intangibles are “those intangible assets or rights on intangible assets for which, when transferred among associated enterprises:
First of all, it is worth noticing that the norm considers the “transfer of intangible assets”; in the further definition, nonetheless, it refers to “intangible assets or rights on intangible assets”. Said norm thus applies both to the transfer of all rights (full ownership) relevant to an intangible asset and to the transfer of some of the relevant rights, i.e. typically to license agreements.
It is also worth reminding that the Guidelines, when dealing with intangible assets, on the one hand confirm the applicability of principles and criteria already indicated for tangible assets and services, whereas, on the other hand, recognise that intangibles often have unique characteristics and therefore the potential to generate revenues and to create future benefits which might differ greatly. If the uniqueness and the forecasting and valuation difficulties concern all intangible assets, this is all the more true and evident for hard to value intangibles, since, from this point of view, they represent a subgroup of intangible assets.
The Legislative Decree, therefore, provides a clear scope of application of letter E, point 2, limited to a specific type of intangible assets, to which the Guidelines dedicate various paragraphs.
The reason behind this choice is evident: the specific valuation difficulties can be exploited to transfer an intangible from a high-tax jurisdiction into a low-tax one in the initial phases of its lifecycle, when a lower valuation can be obtained basing on more contained development and turnover forecasts.
The above should not be confused with the inherent uncertainty characterising transfer pricing which could imply that, upon inspection, the analyses carried out and the comparables used be disregarded by the inspectors. This does not mean, in particular, that the asset is a hard to value intangible, but simply that the taxpayer and inspector have a different interpretation of facts and circumstances, as well as of comparability.
It is clear nonetheless that, in such situation, it is particularly important, when carrying out such transactions, to have a documentation allowing to provide evidence of the information available and the valuations performed. Should these transaction be subject to inspection, actually, it could be difficult to retrace all information and data available and thus the defence could be undermined.
The third type of cross-border arrangement regulated by letter E concerns business restructuring operations. In this case neither the Legislative Decree nor the Ministerial Decree provide a definition of such transactions. The Guidelines indicate that “In the context of this chapter, business restructuring refers to the cross-border reorganisation of the commercial or the financial relations between associated enterprises, including the termination or substantial renegotiation of existing arrangements”. These transactions normally imply the centralisation of functions, risks and intangible assets.
The typical business restructuring operation frequently concluded in past years were the conversion from fully fledged manufacturer into contract manufacturer or toller, or the conversion from fully fledged distributor into limited risk distributor. Basing on a literal interpretation of the norm and according to the Guidelines’ approach, the typical corporate reorganisation operations, such as mergers, demergers and contributions, should not fall within this category. I wish to point out, nonetheless, that according to some administrations, on the contrary, such corporate operations also fall under letter E, point 3.
The legislator’s focus on this type of transactions is justified by the fact that, over the years, transaction consisting more in formal rather than substantial conversions have been carried out for tax avoidance reasons.
The legislator does not require that all business restructuring operations be reported, but only those which had a significant impact on the transferor’s income statement. The reporting obligation actually applies to operations for which “the transferor’s or transferors’ yearly forecasted profits gross of interest and taxes (EBIT), in the three-year period further to the transfer, is lower than 50% of their yearly EBIT forecast without the transfer”.
I believe that particular attention should be paid to this quantitative aspect. Similarly to what mentioned above about hard to value intangibles, also in this case it is crucial to be able to provide evidence, in case of a future inspection, of information and data available when the transaction was carried out. The difficulty to forecast possible trends has increased in the current period due to the effects of pandemic, which can radically change the outcomes reasonably expected.
I point out this aspect to remind that, in normal conditions, a cross-border arrangement is to be reported within 30 days from the day in which it was made available to the taxpayer or its implementation began. The assessment of the existence of reporting conditions should be carried out simultaneously to the operation. The availability of documentary evidence supporting the valuations made in that moment is thus essential.
It should be noted nonetheless that, when in doubt or for the sake of prudence, it is not wise to conclude that it is better to proceed with unjustified reporting rather than omitting them. Of course, in order to address most doubts, a prompt publication of clarifications by the Revenue Office would be welcome.
