The extended tax amnesty programme in Italy has freed significant resources within the tax authorities, now facing a smaller number of assessable years. This circumstance has significantly increased the number of tax audits. When Italian companies belonging to multinational groups are audited, almost invariably, cross-border transactions in general, and transfer pricing in particular, form the object of thorough scrutiny.
In this framework, any instrument available to give taxpayers more certainty should be very welcome.
Now Italian and foreign taxpayers engaged in international activities have one more notable instrument to achieve certainty, pursuant to the introduction into Italian law of a new ruling procedure (the international ruling) (Article 8 of Legislative decree No. 269 of 30 September 2003, converted into Law No 326 of 24 November 2003). The procedure-which is aimed at reaching an agreement between the Italian tax authorities and the taxpayer on certain international tax issues, including transfer pricing-has been available since July 2004, following the issue of implementing provisions (Implementing decree of 24 July 2004).
The procedure may concern both the interpretation of the law and the analysis of factual circumstances. The possibility to rule on factual circumstances is the most interesting innovation if compared to existing ruling procedures (so-called interpello) that address only the interpretation of a specific piece of legislation based on the facts described by the taxpayer, but not reviewed by the tax authorities, if a similar interpretative doubt has not formed the object of a previous ruling.
Scope
The scope of the international ruling procedure is limited to certain specific cross-border tax issues, including transfer pricing. The issues that can be submitted to the tax authorities through the international ruling (Article 2, paragraph 2, letter (c), of the implementing decree) are:
the computation of transfer prices;
the application of provisions, including treaty provisions, regarding dividends, interest or royalties paid to or by non-residents;
the application of provisions, including treaty provisions, regarding items of income, other than dividends, interest or royalties, paid to or by non-residents; and
the application of provisions, including treaty provisions, regarding the attribution of income or losses to the Italian permanent establishment of a non-resident enterprise or to the foreign permanent establishment of a resident enterprise.
The scope of the procedure covers virtually all tax issues arising in cross-border transactions: the ruling may address the application of domestic, treaty and EC law provisions (including Directive 90/435/EEC of 23 July 1990, Parent Subsidiary Directive, and Directive 2003/49/EC of 3 June 2003, Interest and Royalties Directive). The procedure, however, covers only the application of direct taxes, whereas value-added tax (VAT) and other indirect taxes fall outside the scope of the procedure.
Eligible persons
The law stipulates that enterprises with an international activity have access to an international standard ruling procedure, with main reference to transfer pricing, interest, dividends and royalties regimes [Article 8(1) of Legislative decree No. 269/2003].
The procedure is thus available to persons qualifying as "enterprises with an international activity". The definition of the term includes (Article 1, letter (a) of the implementing decree):
resident enterprises subject to transfer pricing legislation;
resident enterprises participated by non-residents or owning a participation in non-residents;
resident enterprises paying to, or receiving from, non-residents dividends interest or royalties; and
non-resident enterprises carrying on their activity in Italy through a permanent establishment.
The applicant is required to demonstrate that it qualifies as "enterprise with an international activity" pursuant to the above definition (Article 2, paragraph 2, letter (b), of the implementing decree). Tax authorities may request additional documentation after the ruling request has been filed in the course of the procedure envisaged by the implementing provisions.
Resident enterprises
First, the procedure is available to resident enterprises subject to transfer pricing legislation (see above). Transfer pricing provisions apply to resident enterprises that, directly or indirectly:
are controlled by a non-resident company;
control a non-resident company; or
are controlled by the same company that controls a non-resident company.
For transfer pricing purposes the concept of "control" is defined broadly and includes "all cases of potential or effective economic influence", including, for instance, the exclusive sale of products manufactured by the other party, the inability to operate without capital, products and technical cooperation given by the other party, and family relationships between the parties or common members of the board of directors or of managerial staff (Circular letter issued by the Ministry of Finance No. 22/2267 of 22 September 1980).
Resident enterprises owning a participation in, or participated by, non-residents have access to the international ruling, irrespective of the amount of the participation (see above). This allows the use of the ruling procedure to deal with the tax issues pertaining to any cross-border income derived in relation to any financial instruments issued or held by Italian enterprises.
Non-resident enterprises
The procedure can be activated also by non-resident enterprises, provided that they carry on their activity in Italy through a permanent establishment (see above). Accordingly, non-residents without an Italian permanent establishment are not eligible for the procedure, even though they may be subject to tax in Italy. It is not clear whether non-residents with a permanent establishment may access the procedure on items of income that do not pertain to the activity of the permanent establishment.
Procedure
The procedure is activated by the enterprise and the request must be filed with specialized tax offices, in Rome and Milan, which are in charge of international rulings.
The application must include the identification of the relevant transactions and of the parties involved and the interpretation by the taxpayer. In the case of transfer pricing rulings, the applicant must also explain the control relationship (see above), the pricing method(s) used and the reasons why such methods are the most appropriate in the specific case to determine the arm's-length price.
The outcome of the procedure is an agreement between the Italian tax authorities and the enterprise. Such agreement is binding for both parties for the tax period in which the agreement is finally reached and for the two following periods, unless changes occur in the relevant factual or legal circumstances.
The implementing decree sets out the details of the international ruling procedure. Within 30 days from the filing of the ruling request, the competent tax office invites the enterprise for a meeting whose purpose is to assess the completeness of the information provided, to request additional documentation if necessary and to schedule the step-by-step process.
During the procedure, tax officers have ample powers to assess factual and legal circumstances that may be relevant for the ruling. Powers include access to the premises of the resident enterprise or of the Italian permanent establishment, at agreed dates, to gather all necessary information to carry out the procedure.
The implementing decree further stipulates that the whole procedure must last no more than six months, starting from the filing of the ruling request. However, such period does not include the possible period required for the Italian tax authorities to obtain relevant information from foreign tax authorities. At the time of writing, due to its very recent introduction, there are no indications as to the average duration of the procedure.
If the factual or legal circumstances change during the validity of the ruling, the same can be revised. In particular, the ruling must contain an agreement on the procedure for the tax authorities to verify the compliance with the ruling and the permanence of the legal and factual circumstances on which the agreement is based. Should these change, the agreement can be amended. Moreover, if the legal and factual circumstances do not change the enterprise may apply for the renewal of the agreement at the expiry date. Particularly, within 90 days of the expiry of the agreement, the enterprise may apply for the renewal; in such a case a 15-day period is available to the tax authorities to either accept or reject the request.
Exchange of information
Although the agreement does not necessarily require the cooperation of the tax authorities of other countries involved, the law states that pursuant to European law, the tax administration sends a copy of the agreement to the competent tax authorities of the States of residence or establishment of the enterprises with which the taxpayers enter into the transaction.
Information is to be exchanged between the tax authorities of the EU member states involved pursuant to Directive 77/799/EEC of 19 December 1977 on exchange of information. It is doubtful to what extent such exchange of information will be carried on in respect of non-EU member states.
Obviously, the agreement between the Italian tax authorities and the enterprise is not binding upon the foreign tax authorities. Indeed, the international ruling is meant to prevent possible future conflicts between the Italian tax authorities and the enterprise, and not to eliminate double taxation issues that may arise in a cross-border context and that may be dealt with in the context of bilateral or multilateral mutual agreement procedures.
Possible use of the international ruling
The most interesting application of the international ruling is undoubtedly in transfer pricing. It is too early to comment on the effectiveness of the procedure. However, the first applications indicate that it may constitute a fruitful instrument to improve certainty for businesses and reduce controversies between taxpayers and tax authorities. It is too early to derive statistics on, for example, the documentation requested or the methods used. However, the first indications are that the submission of a comparability analysis based on external data is essential for the taxpayer to progress in the procedure.
Other interesting areas of application shall be the application of thin-capitalization rules, beneficial ownership clauses laid down by tax treaties or EC legislation, foreign tax credit provisions and the qualification of income from financial instruments as dividend or interest for domestic, treaty and/or EC law purposes.
Recent experience shows a significant increase in number and size of challenges by the Tax Authorities on international transactions: all businesses falling within the definition of "enterprises with an international activity" should seriously consider the use of the international ruling procedure to avoid controversies.
