Italian Tax Authority issues circular on transfer pricing documentation rules – MNE Tax

Through Luca Tortorelle and Michele Targa, Gatti Pavesi Bianchi Ludovici, Milan

On November 26, the Italian Revenue Agency finally published the circular (circular no. 15/E) aimed at providing clarification and increasing the level of certainty on the interpretation of the new instructions relating to the modified documentation requirements transfer prices published last year.

Under regulations published on November 23, 2020, Italian transfer pricing documentation requirements for sanction protection purposes have changed significantly, increasing the administrative burden for Italian taxpayers. Last year, the tax agency also issued operational instructions regarding the appropriate new set of documents that Italian multinationals and Italian permanent establishments of foreign entities are allowed to prepare to demonstrate the correct application of the arm’s length principle. .

The new circular specifying the instructions follows the draft version published on September 20 for a public consultation procedure, which lasted until October 12 and aimed to gather the opinions and suggestions of the business tax community (companies, professionals, professional associations, etc).

The final version of the circular, published a few days before the November 30 deadline for declaring possession of transfer pricing documentation, confirmed most of the aspects already included in the draft, with the recommendations of economic operators being only partially transposed in the final version.

Penalty Protection

Before going into the details of the clarifications of the Circular regarding the contents of the local file and the main file, it is worth mentioning certain formalistic aspects that the Circular has specified must be applied by Italian taxpayers for the relief of administrative penalties.

In general, the circular confirmed what was included in the operational instructions. In other words, the transfer pricing documentation is considered compliant when the master file and the local file are correctly drafted – whether the Italian entity is a holding entity (e.g. a parent company) or a controlled entity – and that their possession is declared in a timely manner.

In case of imposition, penalty protection applies if certain conditions are met. Transfer pricing documentation should include all information to enable tax inspectors to perform an independent transfer pricing analysis (with specific reference to accurate transaction delineation and comparability analysis). The local file, master file, and associated attachments must be digitally signed by the legal representative with a digital timestamp affixed before filing the annual tax return. If the main file has already been signed by the legal representative of the entity that prepared it (for example, the parent company), this must be signed in any case also by the legal representative of the Italian entity . Finally, the possession of the documentation must be communicated by ticking a dedicated box in the annual tax return.

The Circular pointed out that a late digital signature and/or digital timestamp implies the loss of protection against penalties. However, taxpayers are permitted to disclose possession of the appropriate transfer pricing documentation at a later stage, but no later than 90 days from the original tax return filing deadline.

The circular clarified a controversial aspect regarding the late preparation of transfer pricing documentation, unfortunately denying the possibility for Italian entities to prepare the reports after the extended 90-day period but within the annual tax return filing deadline. following and before the start of any tax audit (called bonus remission). This interpretation, apparently unsupported by any particular reason, precludes taxpayers who were unable to prepare transfer pricing documentation in a timely manner from benefiting from penalty protection, even if, in the spirit of cooperation and in good faith, they intend to prepare the documentation later in the year and in any case before the tax audits.

The Circular specified that the bonus remission applies only where the transfer pricing documentation was indeed prepared in a timely manner and digitally signed with the timestamp, but the taxpayer only failed to report its possession in the corresponding tax return, thus limiting considerably the practical implementation of this remedy.

With respect to the suitability of transfer pricing documentation for sanction protection, the circular specifically mentions that sanction protection must be tested for each transaction and not “as a whole”. This is a significant innovation from the previous regime, where sanction protection applied to all documentation.

With the new interpretation given by the revenue agency, in the event of a tax assessment and if the tax office believes that a transaction was not properly described, penalties could apply to that transaction only, while other documented transactions, even if not considered aligned with the arm’s length principle, could still be protected from administrative penalties.

Master file

With regard to the contents of the main file and the local file, the circular mainly reflected what had already been pointed out in the preliminary version and specified some minor additional information which, although not indicated in the operational instructions, must be included.

For the main file, the circular confirmed that Italian entities can rely on the main file prepared by the entity directly or indirectly controlling whether this document contains the minimum level of information required by the Italian discipline (which is mainly aligned on Annex I of Chapter V of the OECD Guidelines). The Italian entity will be authorized to prepare an appendix to the main file to integrate, if necessary, the information not covered by the report prepared centrally. In this sense, it is worth mentioning that in the section on financial activity, Italian taxpayers are asked to provide additional details regarding the financial agreements that the group has in place with third parties, such as the type of agreement , the lender, the beneficiary, the date of the stipulation, duration, amount, currency, conditions, interest rate applied, as well as any guarantees given.

The circular also addressed the case where the end of the fiscal year of the controlling entity preparing the master file differs from the fiscal year of the Italian entity. In such a case, the Italian entity may present the master file referring to the financial year whose closing date precedes that for which the Italian entity prepares the transfer pricing documentation.

local file

With regard to the content of the local file, the Circular provides several clarifications.

With regard to the organizational structure, the circular specifies that the number of human resources assigned to each function of the company, as well as the description of the role of the people in charge of local management functions and their reports (in Italy and ‘stranger), must be included.

With regard to royalties and interest charges, unlike the preliminary version, the final circular incorporated the suggestions received during the public consultation and provides that the amounts must be declared on an accrual basis. The amount of the payments under the cash principle must only be communicated in the event of a specific request from the tax authorities during an audit.

The circular also clarifies the reconciliation of financial data, confirming that the tested party’s financial indicators used in the application of the transfer pricing method can be reconciled with the official financial statements on an aggregated basis.

Furthermore, with regard to internal transactions for permanent establishments, unlike the draft version, the final circular confirmed that the transfer pricing documentation only applies to Italian permanent establishments of foreign entities which have opted for the branch exemption regime, thus excluding – only days before the deadline – a large number of permanent establishments which relied on the draft circular and prepared (and in some cases declared to be in possession of) the transfer pricing documentation.

Finally, a specific mention is necessary with regard to marginal transactions. The circular pointed out that business-to-business transactions that do not exceed the threshold of 5% of the total value of business-to-business transactions (i.e. taking into account the sum of business-to-business costs and revenues) can be considered marginal and not not be fully documented. However, if these transactions are not analyzed, the protection against penalties would not apply in the event of a tax adjustment. The approach does not appear to be aligned with what is provided by the OECD guidelines, which in chapter 5 state “Tax administrations have an interest in seeing the most important information while ensuring that multinational enterprises are not so overwhelmed with compliance requirements that they fail to consider and document the most important elements.”. However, in this sense, a prudent approach seems to be to also list marginal transactions in the local file, specifying for these transactions the amount, their nature and the counterparties (including if these transactions also occur with third parties).

  • Luca Tortorella is Senior Partner at Gatti Pavesi Bianchi Ludovici, Milan.

  • Michele Targa is Senior Partner at Gatti Pavesi Bianchi Ludovici, Milan.

Esther L. Steinbach