Following a legislative process which began in 2013, the Italian Government on September 14 2015 enacted a decree addressing a wide array of international tax matters, including one of the most controversial Italian tax rules – article 110, paragraph 10 of the Income Tax Code (ITC) – which relates to transactions with parties resident in tax havens.
The rule – which entirely denied the deduction of cost deriving from such transactions – was initially enacted in 1992 and in its initial version referred only to related party transactions. Some years later, the scope of application was enlarged to include unrelated party transactions, but with no corresponding adaptation of the cases of exemption. As a result, the deduction of the cost on the head of the Italian party was subject to the demonstration that either the foreign supplier had an actual business structure (to an unrealistic level of detail, in the case of an unrelated party) or that the transaction was justified by a sound business interest of the buyer (a requirement which has been subject to wide interpretation over the years).
With effect from the tax year in progress as of the date of publication of the decree, the new rule is greatly improved in terms of proportionality, since the denial of deduction now concerns only the portion of cost which exceeds arm’s-length, rather than the entire cost as it was in the earlier text. Also, the business structure requirement has been abandoned.
The resulting rule maintains the ‘sound business interest’ exemption and seems to suggest that a non-arm’s-length transaction with an enterprise of a low tax jurisdiction can be justified on other grounds even if, at present, it is not easy to anticipate which justifications will be accepted in the administrative and court practice.
As to the determination of the arm’s-length conditions, the new legislation makes reference to the domestic definition of the ITC. It may be argued that, as a matter of fact, the OECD Guidelines will have some influence on the evaluation of the ‘black list’ transactions, even though the range of methods may be limited by the obstacles to access information in unrelated party transactions.
The reform goes along with the recent changes, also enacted in 2015, to the list of tax havens based on the new sole criterion of the absence of an information exchange agreement. Many countries which were on the list have been deleted in the latest version (Decree April 27 2015): this is the case with the Netherlands Antilles, the Philippines, Malaysia, the UAE, Singapore, Costa Rica and Mauritius. States which have recently entered into a tax information exchange agreement (TIEA) with Italy, like Switzerland, Liechtenstein and Monaco or into a full tax treaty, like Hong Kong, are likely to be deleted from the list in the near future.
The restoration of the ordinary deduction regime for the deduction of cost deriving from transactions with treaty countries has also solved the conflict of the Italian rules at stake with the cost deduction non-discrimination clause contained (without exceptions) in Italian treaties signed before 1992 (when the Italian rule was introduced). The conflict remains, especially in the case of Switzerland; since prevalence should be given to the treaty, the effect of the Italian cost deduction limitation rule is rather restricted.
Giovanni Rolle (giovanni.rolle@taxworks.it) WTS R&A Studio Tributario Associato, a principal International Tax Review correspondent.
