Italian tax authorities have become increasingly involved in mutual agreement procedures (MAPs) with foreign competent authorities in order to avoid double taxation, mostly as a result of an approach to transfer pricing audits that has become more aggressive in recent years.
With a view to providing consistent guidance to the Tax Administration and taxpayers, on 5 June 2012 the Italian Revenue Agency (IRA) released Circular no. 21/E (the Circular) which provides important clarifications of several outstanding issues, with particular reference to the interplay between MAPs and the remedies available for taxpayers under Italian legislation.
This clarification will prove extremely useful to all multinational entities with affiliates in Italy that have been notified of a tax assessment (particularly in the transfer pricing area), when determining the best strategy to pursue in order to avoid double taxation.
The Circular points out the distinction between the two different types of MAP. They are established pursuant to either a bilateral Double Taxation Convention (DTC) or the EU Arbitration Convention no. 90/436/CEE of 23 July 1990 on the elimination of double taxation in connection with the adjustment of profits of associated enterprises (the AC).
MAPs Established Pursuant to a Double Taxation Convention
All DTCs entered into by Italy include a MAP provision corresponding to Article 25 of the Organisation for Economic Co-operation and Development (OECD) Model Convention. A distinctive character of MAPs established pursuant to a DTC is that, as clearly explained by the OECD Commentary on Article 25, the DTC provision implies that the competent authorities of the two contracting States only have a duty to negotiate using their best endeavours, and not an obligation to achieve a result.
Some of the most recent DTCs entered into by Italy (including the one between Italy and the United States) also include an arbitration clause similar to that provided by Article 25.5 of the OECD Model Convention, as amended in 2008. However, this clause generally provides that arbitration is not mandatory, but is subject to the prior consent of the two contracting countries. In some cases, the effectiveness of the clause is subject to a prior exchange of notes between the two countries, which has not yet occurred between Italy and the United States.
From a procedural perspective, the IRA acknowledges the international best practices as outlined by the OECD Manual on Effective Mutual Agreement Procedures (MEMAP) and in relation specifically to transfer pricing—by chapter IV of the OECD Transfer Pricing Guidelines. The Circular sets forth in detail the procedure that should be followed by taxpayers in order to initiate a MAP pursuant to the applicable DTC. It is worth noting that most of the DTCs entered into by Italy provide for just two years to present the case to the competent authorities, as opposed to the three year term provided by Article 25.1 of the OECD Model Convention. In this respect, the Circular clarifies that the two year term starts from the day of notification of a tax assessment that results in taxation not in accordance with the provisions of the DTC (e.g., a transfer pricing adjustment that results in double taxation).
During the course of the MAP, the role of the taxpayer is very limited. In principle, the procedure is only carried out by the competent authorities of the two countries involved, without the participation of the taxpayer. However, the Circular clarifies that the taxpayer has a right of information and can request to be heard by the competent authorities. In addition, particularly when transfer pricing matters are disputed, the IRA acknowledges the recommendation provided by the OECD Commentary on Article 25, which states that the taxpayer must be given every reasonable opportunity to present the relevant facts and arguments of the case to the competent authorities, orally or in writing.
As regards interplay with domestic Italian remedies, the Circular confirms that, with reference to Article 25.1 of the Model Convention, the wording “irrespective of the remedies provided by the domestic laws” (or equivalent) means a MAP is not an alternative to the domestic contentious proceedings, that must in any case be initiated preventively when the claim is related to an assessment of Italian tax that is not in accordance with the DTC.
The co-existence of domestic litigation and MAPs may theoretically generate conflicting results. As a general rule, however, no conflict can arise if a final judgment (i.e., one that is not subject to further appeal) is issued by an Italian court before the competent authorities have reached an agreement under the MAP, as the Italian Tax Administration cannot derogate from that final judgment. In this case, double taxation may not be avoided, unless the competent authorities of the other country involved grant a corresponding adjustment. If the competent authorities are able to reach an agreement before a final judgment is issued by an Italian court, then the taxpayer can choose whether to accept this agreement and waive the litigation proceedings, or refuse the agreement and continue with litigation.
The general rules on interim collection of taxes when litigation is pending also remain applicable in cases where the MAP is initiated pursuant to a DTC. The remedies available ordinarily for the taxpayer to obtain the suspension of the interim payment (suspension can be granted—upon certain conditions—either by the same tax office that issued the tax assessment or by the tax court) also remain applicable.
The Circular also takes the innovative step of confirming that the competent authorities may decide to extend their agreement to fiscal years following the years the MAP refers to, if the facts have remained unchanged and the taxpayer explicitly accepts the extension.
MAPs Established Pursuant to the Arbitration Convention
In contrast with a MAP pursuant to a DTC, a MAP established pursuant to the AC implies that there is a binding obligation on the competent authorities of the EU Member States involved to achieve the elimination of double taxation in connection with transfer pricing adjustments. If the competent authorities fail to reach the agreement within two years from the submission of the case, they must set up an advisory commission that is required to deliver its opinion on the elimination of double taxation. This opinion is not binding on the competent authorities if they reach an agreement, but if they fail to reach an agreement, they are obliged to follow the advisory commission’s opinion.
In principle, the IRA acknowledges the Revised Code of Conduct for the effective implementation of the Convention on the elimination of double taxation in connection with the adjustment of profits of associated enterprises (Revised Code of Conduct), adopted by the EU Council Resolution no. 2009/C322/01.
With regard to Article 8.1 of the AC (which establishes that the competent authority of a contracting Member State is not obliged to initiate the MAP or to set up the advisory commission if one of the enterprises involved in the transfer pricing adjustment is liable to a “serious penalty”), the Circular notes that Italy, in its unilateral declarations in the Annex to the AC, has pointed out that “The term 'serious penalties' means penalties laid down for illicit acts, within the meaning of the domestic law, constituting a tax offence”. In this respect, the Revised Code of Conduct recommends that Member States clarify or revise their unilateral declarations “in order to better reflect that a serious penalty should only be applied in exceptional cases like fraud”. In acknowledging this recommendation, the Circular clarifies that the only two cases of serious penalty that may prevent the Italian competent authority from refusing to give access to a MAP pursuant to the AC are tax frauds punishable by Italian law under Articles 2 and 3 of Legislative Decree no. 74/2000. The Circular also adds that, as a general rule, these cases should not occur when transfer pricing adjustments are concerned (in fact they have never occurred in practice so far), because—even though transfer pricing matters may give rise to criminal offences under Italian law—they normally fall outside the scope of a tax fraud under the meaning of Articles 2 and 3. Therefore, following the recommendation of the Code of Conduct, a “serious penalty” under the meaning of Article 8.1 of the AC should be applicable only in exceptional cases.
As regards the interplay between the AC and domestic remedies, the Circular notes that, as Italy does not permit the competent authorities to derogate from the decisions of the Italian judiciary, the set up of the advisory commission under Article 7 of the AC is only possible if the taxpayer has allowed the time provided for appeal to expire, or has withdrawn the appeal before a decision has been delivered, pursuant to Article 7.3 of the AC. As a consequence, if the taxpayer has filed—but not withdrawn—an appeal, and a judgment is issued by an Italian court before the competent authorities have reached an agreement under the MAP, no advisory commission will be set up and the double taxation cannot be avoided. The only exception to this is if the competent authorities of the other country involved grant a corresponding adjustment.
The interim collection of the taxes owing as a consequence of the transfer pricing adjustment may be suspended by the IRA after it has verified the admissibility of the MAP request filed by the taxpayer. However, the Circular points out that, for the suspension to be granted, it is necessary that the taxpayer withdraws any appeal filed, as the MAP established pursuant to the AC is, as a whole, an alternative to the judicial remedies (including the suspension of interim collection granted by the tax court) available under domestic law. This may attract some criticism, as domestic litigation is in fact an alternative remedy to the set up of the advisory commission, although not an alternative to the agreement reached by the competent authorities of the EU Member States involved.
The Role of the Taxpayer
As with MAPs established pursuant to a DTC, MAPs established pursuant to the AC allow for very little involvement by the taxpayer. Only the taxpayer’s right of information and right to present to the competent authorities relevant facts and arguments relating to the case to the competent authorities are recognised.
Interplay Between MAP and Settlement With the Italian Tax Authorities
Both taxpayers and the IRA prefer generally to avoid litigating transfer pricing cases in front of the tax courts, owing to the extremely technical nature of the subject matter and the subsequent unpredictability of the courts’ decisions. Tax assessments involving transfer pricing adjustments are therefore often settled before going to court (accertamento con adesione) or after the taxpayer has filed an appeal but before the court issues its judgment (conciliazione giudiziale). Settlements are also appealing because they reduce the prospect of paying a penalty. Penalties for transfer pricing adjustments range from 100 per cent to 200 per cent of the higher tax assessed (unless the taxpayer has fully complied with the documentation requirements, in which case no penalty is applicable).
One of the most important issues that taxpayers and advisors needed clarification on was the interplay between MAPs and the various forms of settlement with the Italian Tax Administration available under Italian law. The Circular has addressed this point with reference to both MAPs established pursuant to a DTC and MAPs established pursuant to the AC.
In both cases, the Circular concludes that settling the tax assessment prevents the taxpayer from initiating a MAP. If the MAP was already initiated, it prevents the Italian Tax Administration from reaching an agreement with the competent authorities of the other country involved, which changes the terms of the settlement agreed with the taxpayer. This means, if the taxpayer settles the case, double taxation may not be avoided, unless the competent authorities of the other country grant a corresponding adjustment.
This may, however, attract some criticism, particularly with regard to MAPs established pursuant to the AC. The only situation in which the advisory commission cannot be set up is when there is a judgment from the court that the Tax Administration cannot disregard. This may perhaps include the conciliazione giudiziale, because the agreement reached by the taxpayer and the Tax Administration is validated formally by a court’s decision. But in any other case, there seems to be no sufficient ground for excluding the MAP in the case of an accertamento con adesione, as the AC is binding on EU Member States, irrespective of any settlement they may have reached unilaterally with the taxpayer.
The IRA’s position might result in a contrast with the AC that could lead to an infringement procedure before the European Court of Justice. It should, however, be possible to overcome this position by filing the request for the MAP in the Member State of residence of the affiliate that entered into the intercompany transactions that led to the challenge by the Italian tax authorities.
The McDermott Difference
McDermott Will & Emery is a leading law firm in transfer pricing planning and advisory, evaluations and documentation, and dispute resolution. Please direct questions on the Italian Mutual Agreement Procedures to Mario Martinelli at +39 06 462024 1 or mmartinelli mwe.com. Please direct other transfer pricing questions to Mark Martin, Head of McDermott's Transfer Pricing Group, at +1 713 653 1719 or mrmartin mwe.com.