Italy: Transfer pricing adjustments: VAT treatment
A ruling issued on November 2 2018 by the Central Revenue has provided clarification regarding the application of the VAT regime to transfer pricing (TP) year-end adjustments occurring between related companies belonging to the same multinational group (group).
The group is implementing a new integrated development plan aimed at the creation of products and platforms necessary for the production and marketing of X-branded goods.
The legal and economic ownership of the X brand and the related know-how belongs to a non-EU related company (Beta), which operates as 'principal' and assumes all the risks associated with the production and distribution of the goods, granting the exploitation of brand and know-how free of charge to subsidiaries engaged in the production and marketing of X-branded goods.
Alfa (the Italian entity submitting the ruling to the Central Revenue) signed an inter-company agreement with Beta under which the former undertakes to act as contract assembler for the latter. In this agreement, Alfa undertakes also to make available its equipment to Gamma, which acts as contract manufacturer within the group.
Subsequently, the products are commercialised by Beta in North America and in the rest of the world, and by Delta in Europe, the Middle East and Africa.
The X-branded goods, produced by Gamma, are purchased by Alfa at what are deemed arm's-length prices, and the sales prices from Alfa to Beta and Delta are meant to be in line with both the group policy and the market.
In accordance with the TP policy applied within the group, the agreement provides that when the profit margin of Alfa in a given fiscal year falls outside the inter-quartile range, specific adjustments must be made.
Accordingly, under the inter-company agreement, Beta must pay upward contributions to Alfa whenever the latter incurs operational losses. Those operational losses might result from the activities carried out and from the substantial costs incurred (also) for the purchase of equipment and machinery used in the manufacturing cycle.
Considering the background described above, the question Alfa submitted for clarification to the Italian Central Revenue was whether similar adjustments were relevant for VAT purposes.
In line with Working Paper No. 923/28.02.2017 of the European Commission, the Revenue Agency clarified that such adjustments may have an impact on the VAT taxable base if the following conditions are met:
A consideration is agreed among parties;
The transactions for the provision of goods or services are duly identified; and
There is a direct link between the transactions and the consideration.
Furthermore, as regards the interaction between TP and VAT, according to the European Commission's Working Paper No. 923/28.02.2017, the TP adjustments (upwards or downwards) could have VAT implications when:
"the transfer pricing adjustment could be seen as more or less consideration given in exchange for a taxable supply of goods or services already made (i.e. as an adjustment to a price already paid), leading to a modification of the taxable amount of that transaction for VAT purposes.
If an adjustment is found to constitute more or less consideration for a supply of goods or services, this could arguably lead to an increase or decrease in the VATable amount of such transactions, at least where the VAT to be paid is calculated according to Article 73 of the VAT Directive.
For there to be any VAT implications, the rules as regards the existence of a supply for consideration pursuant to Article 2(1) of the VAT Directive, there must be a supply made in exchange for consideration, and a direct link has to be established between them. This would have to be assessed on a case-by-case basis."
Based on the above, the Central Revenue did not identify a direct link between the TP adjustments and the supply of goods and services. Consequently, the adjustments under review could not be considered to have led to a modification of the VATable basis in relation to the transactions analysed.
Moreover, as regards the inter-company agreement, the Central Revenue took the position that – in light of the domestic provisions about VAT – the payment of the contribution/adjustment from Beta to Alfa did not constitute a remuneration for a specific service (so, in this case, was not subject to the VAT regime). In fact, in the situation under review, it was not possible to detect a direct connection with other identified flows, considering that the inter-company prices for goods and services had been specifically stated according to the TP policies of the Group whose arm's-length nature was proved by appropriate studies.