Italian Supreme Court Ruling Sets Precedent in Transfer Pricing Disputes

In a landmark decision, the Italian Supreme Court of Cassation has overturned a long-standing position of the Italian tax authorities, setting a highly significant precedent in the realm of transfer pricing (TP). The ruling, which was delivered on July 16, 2023, has been hailed by tax experts as a decisive affirmation of the guidelines set forth by the Organisation for Economic Co-operation and Development (OECD) regarding the treatment of comparables in TP cases.

The case in question stemmed from a tax assessment issued by Italy’s tax authority in 2012, which challenged the pricing of intra-group services provided by Convergys Italy to a related entity in the Netherlands. The tax authority argued that a 5% markup applied to the call center services was too low and, after reassessing the arm’s-length range, opted for a median value of 7.42%. This adjustment led the tax authority to conduct a revised benchmark analysis, which was subsequently challenged by Convergys.

However, the Supreme Court rejected the tax authority’s approach, ruling that the elimination of comparables based solely on their low or negative margins is inconsistent with OECD guidelines. The court stated that Italy’s tax authority cannot automatically dismiss comparable entities with low or negative margins when applying the Transactional Net Margin Method (TNMM).

Maikel Verhoeven, managing director at Quantera Global in the Netherlands, commented on the significance of the case, noting that it demonstrates the aggressiveness of Italian tax authorities. "A 5% markup on costs for call center services would probably seem reasonable to almost all [TP] practitioners," Verhoeven said. He praised Convergys for challenging the tax authority’s position in court, adding, "Although MNEs are often framed by media as being focused on avoiding taxes, this case shows that tax authorities are not always reasonable."

Verhoeven also emphasized the importance of using the interquartile range to determine whether a transaction is at arm’s length, rather than focusing solely on the median. "This is in line with common practice and clear OECD guidance," he explained. He further stressed the necessity for companies to be well-prepared and have proper documentation in place, stating, "This shows, as in other case law, that having your compliance in order and set up well is key to avoid getting stuck with the burden of proof."

Ciro Pisacane, a TP partner at BDO in Milan, highlighted the broader implications of the ruling, noting that it marks the first time the Supreme Court has endorsed the view that loss-making companies can be considered normal in an arm's-length market. He pointed out that the OECD guidelines do not mandate the automatic exclusion of loss-making companies, provided that their losses are aimed at achieving better performance in the future.

Pisacane also referenced the judgment’s consideration of start-up or bankrupt companies, emphasizing the need for careful judgment in determining whether a situation is "physiological and therefore acceptable or pathological [and] to be disregarded."

Sebastiano Sciliberto, an executive partner at Eversheds Sutherland in Rome, described the ruling as a potential turning point in TP assessments involving the TNMM. He noted that while lower tax courts have issued rulings favoring the inclusion of loss-making companies as comparables, this Supreme Court ruling could lead to greater consistency in the application of TP principles. "The reasoning followed by Italy’s Supreme Court is very straightforward," Sciliberto remarked, expressing hope that similar rulings will follow to consolidate this approach over time.

The ruling also carries wider implications, according to Antonfortunato Corneli, a tax partner at EY in Milan. Corneli highlighted that the decision reaffirms the principle that the burden of proof in a TP challenge lies with the tax authorities. Similarly, Gianni Bitetti, a partner at Bernoni Grant Thornton in Milan, described the ruling as "groundbreaking," noting that it underscores the validity of considering companies with negative financial outcomes as comparables under certain conditions.

Luca Purpura, tax director at DLA Piper in Milan, and Federico Pacelli, a partner at the firm, emphasized the ruling’s potential impact beyond Italy, suggesting it could influence tax audits and court decisions at both European and international levels. "Indeed, this judgment also creates a precedent that could influence not only future tax audits in Italy, but also foreign tax courts at a European [and] international level, with a view to harmonizing the application of [TP] principles," they said.

This ruling marks a significant step towards a more balanced interpretation of the OECD’s Transfer Pricing Guidelines, offering greater certainty for taxpayers as they prepare their TP documentation and seek to reduce the risk of disputes with tax authorities.

By fLEXI tEAM