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In ruling no. 22023 delivered on October 13, 2006 the Italian Supreme Court held that the tax administration, when adjusting prices of cross border transactions entered into between related parties under Italian transfer pricing rules, has to provide satisfactory evidence that by setting prices other than at arm’s length the taxpayer has obtained an unfair tax advance and reduced its overall tax liability.

The tax administration bears to burden of proof and, if it is unable to demonstrate that there has been a shift of taxable income from Italy to a low tax jurisdiction, with a reduction of the taxpayer’s global effective tax rate, transfer pricing adjustments are not valid and should be set aside.


The facts concern a case in which an Italian company would purchase vehicles from its foreign affiliates and distribute them in the Italian market. In the purchase contracts the Italian company would undertake the obligations to maintain and repair the cars and liabilities for damages from the use of the vehicles that would lie in principle upon the foreign related manufacturers and liabilities. The Italian company incurred costs for repairs and maintenance under the guaranty provided to customers but would not receive any fee or compensation for relieving its foreign affiliates of the obligation for repair and maintenance that would lie upon them as a matter of law.

The tax administration argued that the prices charged for the purchase of the vehicles were not at arm’s length because they did not take into account a reasonable compensation for the maintenance and repair obligations assumed by the Italian company in favor of its foreign affiliates, and that costs incurred by the Italian company unlawfully reduced its taxable income in Italy to the benefit of its foreign affiliates. Therefore, the tax administration reduced the purchase prices by an amount equal to the amount of that compensation and assessed higher profits upon the Italian company, under the domestic transfer pricing provisions of old Tax Code section 76, now section 110(7).

The taxpayer challenged the assessment and won both at the trial and appellate level, on the basis that there was no proof that by setting the purchase prices as appearing from the contracts with its affiliates and not charging fees for the maintenance and repair services costs the taxpayer had actually pursued or obtained any tax advantage. The case then went to the Supreme Court for its final decision on this specific issue.


Italian transfer pricing rules are contained in articles 110 (7) and 9(3) of the Tax Code.

Article 110(7) provides that transactions between a resident enterprise and foreign entities that control, are controlled by or under common control with the resident enterprise must be carried out at arm’s length. The concept of resident enterprise is wider than resident companies and includes resident partnerships and Italian permanent establishments of foreign enterprises. Control includes both factual and legal control.

The arm’s length standard is defined at article 9 with reference to the fair market value price charged for similar goods or services exchanged at the same or similar terms in the same market and under the same conditions.

The tax administration in its Circular no. 32/9/2286 of September 22, 1980 and Circular no. 42 of December 12, 1981 referred to the OECD 1979 transfer pricing guidance as directly applicable to supplement Italian law provisions. This should extend also to the subsequent versions and updates of OECD transfer pricing reports and guidelines.

Transfer pricing rules have the objective of policing cross border transactions between related companies to prevent tax avoidance by manipulating prices of controlled transactions and shifting income to low tax jurisdictions. However, based on the language of the applicable statutory provisions, the application of transfer pricing rules should not depend on the fact that there has been actual avoidance of tax in the specific case. Indeed, this would seem to be the more direct scope of anti avoidance provisions.


Italian tax law contains general tax avoidance provisions at article 37-bis of Presidential Decree no. 600 of September 29, 1973. They apply to specific types of transactions based on the fact that they lack economic substance and business purpose and have been entered into solely for the purpose of obtaining undue tax advantages[1].

Furthermore, the Italian Supreme Court has applied the anti abuse rule embedded in the EU Sixth Directive on VAT[2] and elaborated by the European Court of Justice in its decision in Halifax[3], and domestic civil code rules denying legal effects to contracts that lack valid consideration in order to challenge the tax benefits of tax avoidance transactions[4].

Finally, beneficial owner, anti conduit and look through rules are used in the cross border context to contrast treaty shopping and EU directives abuse and to subject to full tax profits derived from tax haven countries.


In the decision that we comment the Supreme Court has been requested to rule on the relationship and interaction among the different sets of rules referred to above. The Court argued that those rules have the same rationale, which is contrasting tax avoidance.

It drew a parallel between the EU tax law anti abuse principle applying in the VAT area and the transfer pricing rules and held that transfer pricing adjustments cannot be enforced unless there has been actual avoidance of tax.

It also ruled that, in order to determine whether there has been actual avoidance of tax, the tax administration bears the burden to prove that the taxpayer, by appropriately setting the prices of controlled transactions has been able to move income to low tax foreign jurisdictions and benefit from lower tax rates applicable to its foreign affiliates, compared to the higher tax rate applicable to the Italian company, with an overall reduction of the group’s effective tax rate.

The Court also addressed the issue that, pursuant to the guarantee for the vices and defects of the vehicles undertaken by the Italian company, the Italian company incurred costs (for maintenance and repair) that reduced its income to the benefit of its foreign affiliates that had not paid any compensation to the Italian company for this services. The tax administration had argued that this arrangement was fictitious and aimed only at generating deductible costs upon the Italian company.

In this respect, the Court held that under article 11 of the Vienna Convention the contractual terms of the intra group transactions could be drawn from the instructions and directives of the foreign parent regularly applied by the Italian subsidiary and need not be necessarily embodied in a written agreement, and1995 OECD transfer pricing guidelines also require to impute the terms of the transaction based on its substance and the way it was actually performed.

Since no evidence had been brought to show that that guarantee agreement was not a bona fide arrangement and had not been actually carried out, it had to be respected for tax purposes.


Supreme Court’s ruling 22023 represents the first case in which the Supreme Court has linked transfer pricing adjustments and tax avoidance. Specific proof of tax avoidance as prerequisite of transfer pricing adjustments may be difficult to be provided.

If reference has to be made to effective tax rates (as it would seem to be the case), that proof would require a reliable determination of a vast array of foreign tax rules concerning timing of deductions, deferral of income recognition, computation of income and deductions etc. in order to determine foreign effective tax rate, and a complex analysis of the tax profile of the taxpayers companies involved (net operating loss carryovers or credits may put them in a zero tax bracket).

Information about foreign law is usually difficult to obtain (not to mention to fully master and understand), and the same is for information on foreign companies tax records on the basis of which to determine the effective rates of tax.

It is reasonable to anticipate that, in any future case, the Court may be inclined to accept such proof on the basis on a very rough comparison of domestic and foreign nominal tax rates, when foreign jurisdictions involved are low or zero tax countries.

However, well-advised taxpayers engaged in reasonably complex cross-border deals have now an additional argument to rely upon to challenge transfer price adjustments.

The Court has been very clear in placing the burden of proof of tax avoidance upon the tax administration. Therefore, in some cases this argument may indeed prove quite useful to defend transfer-pricing policies of foreign multinationals with business operations in Italy.

[1] Those provisions have been expanded through the years and now are quite comprehensive. They include (among other things) mergers; spin offs; liquidations; capital distributions; contributions of assets to newly formed or existing companies; assignment of tax credits; transfer of assets among consolidated affiliates; balance sheet classification of stock, bonds and derivative transactions to the extent they determine the tax treatment of the transaction, and use of intermediate entities to benefit from the EU interest and royalty directive. However, their requirements – absence of economic substance and sole anti avoidance purpose – remain relatively strict.
[2] EU Council Sixth VAT Directive no. 77/388/CEE of May 17, 1977.
[3] Halifax plc. at al v. Commissioners of Customs and Excise (C-255/02), February 21, 2006.
[4] Supreme Court’s rulings no. 20398 of October 21, 2005 and no. 22932 of November 14, 2005 deny tax effects to dividend-washing transactions pursuant to general civil code anti-fraud and lack-of-consideration principles. Supreme Court’s ruling no. 10353 of May 5, 2006 applies the VAT anti abuse principle.

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