Why CUP is the preferred method in Italy
A recent Italian court ruling has emphasised that comparable uncontrolled price (CUP) is the most suitable approach to quantifying an arm’s-length value.
Ruling No. 1670/2015 of the Regional Tax Court of Lombardy, filed on 21 April 2015, restated how, for the purpose of fixing transfer prices between associated enterprises, the CUP method is the most suitable approach.
It is worth recalling that, notwithstanding the so-called hierarchy of methods discarded in 2010 in favour of the “best method” application, both, the OECD Guidelines and Italian practice establish that, where it is possible to apply the price comparison method, the same is the most direct and reliable approach to ascertain whether the arm’s-length principle has been duly complied with.
In the case at issue, the Italian company purchased from its own Swiss subsidiary raw materials for the realisation of plastic closures for Tetra Pak containers and similar items.
The Italian company adopted the price comparison method because the purchased raw materials from its Swiss subsidiary (and subsequently sold to other companies within the group) were the same purchased by its third-party suppliers, not performing any processing operations on the said materials.
The tax authorities objected, first of all, to the method adopted by the group, claiming that the latter did not indicate in the transfer pricing documentation (deemed adequate by the same Revenue Office and thus, pursuant to Italian laws, such to allow the non-application of penalties related to the adjustment of transfer prices) the actual values of the average price of raw materials, but merely indicated minimum and maximum prices.
Subsequently, the tax authorities deemed the transactional net margin method applicable to the case at hand, proceeding to a specific benchmark analysis that led to the adjustment of transfer prices.
The Regional Tax Court Judges, confirming the decision issued by the Judges of First Instance, ruled in favour of the taxpayer, deeming that the latter’s behaviour was in full-fledged compliance with transfer pricing rules as the prices of the relevant commercial transaction were fixed by applying methods similar to the ones that would have been applied between/among independent parties within the arm's-length principle.
The CUP method is, therefore, the preferred method in order to comply with the arm's-length principle in intercompany relations, on condition that, however, the highest degree of similarity between the features of goods and services may be established.
Furthermore, the Judges challenged the Tax Authorities’ behaviour claiming that the latter cannot possibly raise objections related to the determination of transfer prices merely by changing the method adopted by the company under examination (for instance, by adopting the TNMM in lieu of the CUP) but rather, where possible, the method implemented by the company must be adhered to and challenged, where deemed appropriate.
According to the Regional Tax Court, it is of no consequence whether the company indicated the average market price or not. What truly matters is whether the company indicated the minimum and maximum prices of the range within which to work.
For this purpose, the Second Instance Judges refer to the OECD Guidelines, pointing out how all the values within a range may suitably represent arm's-length values. Therefore an average value, falling between the minimum and maximum price, has to be deemed quite reasonable.
In conclusion, the Second Instance Judges restated an essential principle, according to which all companies that closed the financial year with a loss cannot be simply excluded, because operating losses - as is the case for profits - need to be taken into account as a veritable operating result because they provide an effective representation of the data under comparison.
In fact, according to the Court, excluding a priori loss-making companies from the comparables set would mean “not assessing with the due and proper consideration the case submitted to the Court”.