Italy: New definition of permanent establishment aligned with BEPS Action 7

April 30 2018

Over the past decade, permanent establishments (PE) have emerged as one of the hottest topics of dispute during tax inspections in Italy and have also frequently been the subject of contention in the context of tax courts. This has applied especially in relation to the way foreign companies have opted to use the structure to set up their businesses in Italy (the so-called 'undisclosed PE'). And considering the operational impact that a PE risk may trigger, it has become even more crucial to evaluate the possible consequences on the supply chains of the new definitions and concepts brought about by the OECD's work in relation to the BEPS project (in particular, Action 7: Preventing the Artificial Avoidance of Permanent Establishment Status).

This article summarises first a recent Italian Regional Tax Court case regarding PE. Subsequently, it provides a very brief summary of the new definition of PE that Italy introduced as of January 1 2018, aligning the domestic PE definition (i.e. Article 162 of the Corporate Income Tax Code) with the new provisions of BEPS Action 7, then embedded in the November 2017 version of the OECD Model Tax Convention and Commentary.

Decision No. 4871/2017 of the Regional Tax Court of Lombardy

On November 23 2017, the Regional Tax Court of Lombardy rejected the appeal of the Italian tax authorities concerning the existence of a PE of an English company in Italy.

An Italian company was subject to an assessment for corporate income tax purposes. In particular, according to the Italian tax authorities, the following elements revealed the presence of an undisclosed PE of the English company in Italian territory:

The existence of a services agreement between the English company and the resident entity that obliged the latter to a monthly based reporting activity;
According to third parties' statements, an employee of the resident company had the power to act in name and on behalf of the English company; and
The agreement between the Italian company and the English one was ruled by English law.

The Italian company appealed against the tax assessment before the Provincial Tax Court of Milan and succeeded in having its position recognised as correct by a tax judge. In turn, the Italian tax office appealed before the Regional Tax Court of Lombardy, which confirmed the decision of the Provincial Court.

More precisely, the Regional Tax Court argued that:

The existence of a monthly based reporting activity was a common business practice;
The third parties' statements were inconsistent and conflicted with the Italian company's employees' statements; and
The fact that the agreement between the two companies was ruled by English law did not indicate a subordination of the resident company in respect of the English company, but rather was a common business practice by which the party in the 'stronger' position imposed the application of its domestic law in order to rule an agreement.

Permanent establishment definition

The domestic definition of 'permanent establishment' is set forth by Article 162 of Presidential Decree number 917 dated December 22 1986, and has been recently amended by the 2018 Budget Law so as to align it with the revised approach presented in the final report on Action 7 of the OECD BEPS project.

In particular, the amendments introduced provide that:

A 'significant and continuous economic presence' in Italian territory may entail the existence of a PE, even if the business model has been structured in such a way that does not give rise to a physical presence in Italy;
Persons that, acting on behalf of non-resident enterprises, habitually conclude contracts, or participate in the conclusion of contracts that are routinely concluded by such enterprises without material modifications, may give rise to an agency PE, unless they qualify as independent agents;
Persons that act exclusively or almost exclusively on behalf of one or more closely related enterprises do not qualify as independent agents; and
A construction or installation site, or the exercising of supervision activity connected to it, could be considered a permanent organisation only if such activity has a duration of more than three months.

Furthermore, the 2018 Budget Law has introduced an anti-fragmentation rule under which the activities performed by closely related enterprises at one or more fixed places of business should be analysed on an aggregated basis for the purpose of assessing whether they may qualify as preparatory or auxiliary, provided that the business activities carried on by the closely related enterprises constitute complementary functions that are part of a cohesive business operation.

Final remarks

Considering the fast-changing tax and operational environment, cross-border operations (and multinational groups in particular) are nowadays required to perform in-depth revision of their existing business models. In fact, brand new provisions already implemented, or about to be enforced, both at a domestic and an international level, cannot be ignored and ultimately require a re-thinking of the supply chains and consequent attribution of profit in light of functions performed, risks assumed and assets used.

In such a landscape, the BEPS project may be considered the starting point of a new era and has been triggering relevant changes in governmental policies to tackle base erosion and profit shifting. It is not only the revised definition of PE and, for example, country-by-country reporting, that are worth considering, but also anti-tax avoidance measures, proposals for web tax and a common corporate tax base which must also now be placed at the top of the agendas of all interested parties.