The TP circular from Italy emphasizes the importance of thorough comparability analysis

The TP circular in Italy emphasizes the need for businesses to conduct a more thorough comparability analysis as part of their benchmarking strategy.

The latest circular (N 16/E) on transfer pricing (TP) issued by the Italian Revenue Agency on May 24 emphasizes the importance of companies focusing on the qualitative aspect of their benchmarking analysis through the use of the arm's-length range (ALR).


More debate about comparability is expected, according to Luca Tortorella, an associate at the Milan law firm Gatti Pavesi Bianchi Ludovici, but the need for strong analysis is clear.


"We expect that disputes on comparability remain arguments to be discussed during the tax audit phase or in the tax courts. The performance of a very good comparability analysis from a qualitative perspective remains key ," Tortorella says.

The arm's-length principle (ALP) is often represented by a range of values rather than a single figure. According to the circular, when transactions are identified as equally reliable, meaning entities can use the entire range in accordance with OECD guidelines.


When comparability issues persist and there is no way to identify or quantify such defects, companies should use the interquartile range. This will improve the range's dependability.


According to the TP team at Vodafone Italia, transactions that do not have the same degree of comparability must refer to this narrow range, which is identified by using statistical tools to eliminate extreme results or outliers.


"When the range includes results of relatively equal and high reliability, any point in the range between the first and third quartile satisfies the arm’s-length principle," Tortorella explains.


Despite the use of statistical tools like the interquartile range, issues with comparability may persist. Other measures of central tendency, such as the median, can help taxpayers reduce the risk of error.


In addition, the circular stated that taxpayers could use loss-making businesses as comparables when authorities previously eliminated businesses that were in a loss-making position.


According to Tortorella, the circular does not provide "an automatic green light to the use of the full range." It does, however, give advice on when the entire range can be used and when other methods should be considered.


In terms of the burden of proof, all values – full or narrow – are considered compliant with the ALP, which means tax authorities will not make any adjustments. According to Vodafone Italia's TP team, if taxpayers fail to do so, they will be required to provide appropriate documentation.


The importance of results included within the range being compliant with the ALP is also stressed by Aaron Meneghin, head of group tax at Italian luxury brand Valentino.


"If instead the price or margin of the controlled transaction falls outside such range, the taxpayer has to justify that the arm's-length principle is satisfied in any event," Meneghin says.


"Otherwise, the tax administration must make an adjustment by determining the point within the range that best satisfies the arm's-length principle, limiting the adjustment to the minimum or at the maximum value of the ‘full range’, depending on which is closer to the value applied by the taxpayer," he continues.


To avoid the tax authority making adjustments, the company will need to provide documentation. If this is not the case, the tax adjustments will be made to the closest point between the taxpayer's choice and the range's point, whether full range or interquartile.


According to Tortorella, this could limit the use of the median, which is frequently used by tax officers and can cost businesses a lot of money.


"It should be limited to peculiar cases," he says.


Overall, the challenges that TP teams will face will revolve around determining the degree of comparability when deciding whether to use the full or interquartile range.


According to Marco Bettini, TP at accounting firm Crowe Valente, despite all efforts to make transactions homogeneous, such as those outlined in the OECD guidelines, there may still be some comparability biases.


This could have an impact on the range that is determined. In the case of homogeneous comparability, Vodafone Italia's TP team discovered that "openness" to the entire range is the most important factor.


“If the company is able to sustain the analysis by proper documentation, all points within the range have to be considered as accepted or compliant with the ALP," says Vodafone Italia's TP team.


According to the TP team, the circular confirms the need for a thorough benchmarking analysis in order to maintain respect for the ALP.


While the circular from Italy does not make any significant changes, it does provide operational guidance to businesses and tax authorities. It emphasizes that using the entire range is not automatic, and that when conducting a TP study, the qualitative aspect of comparability analysis is still crucial.

By fLEXI tEAM