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Italy: Undisclosed dependent agent PE in Italy: Trends and operational impacts

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In recent years multinational groups have, sensibly, modified their business models to keep up with globalisation and safeguard their competitiveness.

In recent years multinational groups have, sensibly, modified their business models to keep up with globalisation and safeguard their competitiveness. Traditional 'country-specific' structures gave way to 'global' models in which the group acts as a unique company worldwide and the local entities perform a part of the overall business according to their specialisation.

However, a drawback of this approach is that multinational groups have been experiencing increasing challenges on the existence of undisclosed permanent establishments (PEs).

As regards Italy, undisclosed personal (or 'agency') PEs are usually identified within the Italian local entities of the group, which are often highly specialised and considered not to be independent from the parent company.

In practice, the tax authorities ground their claim on the Italian legal entity personnel role, especially when the latter is formally an agent (or a marketing support service provider) of the foreign parent company but its employees participate in negotiations with local customers.

Tax Police Circular letter no. 1/2018 (issued on December 4 2017) is often used during tax inspections on undisclosed personal PEs in Italy because it provides a list of elements and circumstances to be carefully evaluated. They include:

  • Italian company personnel involvement in negotiations and closing of agreements for the foreign company (regardless formal attribution of representation power);

  • Evidence proving clear subordination of the Italian company towards the foreign entity;

  • Elements proving that the foreign company has the power to use Italian company assets and personnel to perform its own business in Italy;

  • Declarations made by the Italian company personnel concerning the relationship with the foreign company;

  • Declarations released by Italian customers of the foreign company affirming that, despite the agreement being signed and the invoices being issued by the latter, all negotiations take place with Italian company employees; and

  • The finding of foreign company items (e.g. stamps or headed paper), allowing the authorities to deduce that the agreement conclusion, although formally attributable to the foreign company, is actually made by Italian company employees.

When some of these elements occur simultaneously, the tax authorities usually claim that the Italian legal entity personnel carries out activities exceeding mere agency responsibilities (e.g. a crucial role in negotiating and closing sale deals with customers and hence substantially performing distribution activities on the foreign parent company's behalf). Consequently, they assess the undisclosed PE existence and attribute a taxable income to the latter, also based on the report, entitled 'Additional Guidance on the Attribution of Profits to Permanent Establishments', released by the OECD on March 22 2018.

Therefore, extreme attention should be paid to the functions performed by the Italian company personnel, among others, especially in light of the new version of Article 5, paragraphs 5 and 6 of the OECD Model Tax Convention on Income and on Capital (OECD Model), amended by Action 7 of the BEPS project.

Whilst, based on a previous version of Article 5, a PE was deemed to exist when a person "habitually exercises the right to conclude contracts in the name of the foreign enterprise", Action 7 (preventing the artificial avoidance of permanent establishment status) extends agency PE identification to cases where a legal entity or person (e.g. resident in Italy) plays a "decisive role" in closing the agreement with the customers, which are then formalised without substantial modifications by the foreign company.

Action 7 has also rewritten paragraph 6 of Article 5, specifying the cases in which a formally independent agent shall be considered as a dependent agent of the foreign company.

These new provisions have already been implemented in the Italian Corporate Income Tax Code (new version of Article 162, in force since January 1 2018), which is now aligned with most recent international developments and equips the Italian tax authorities with a sharper tool to assess undisclosed personal PEs.

As regards international law, Italy signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (MLI) on June 7 2017.

However, no ratification has occurred yet (e.g. through a dedicated law). Moreover, when signing the MLI, Italy refused to endorse new dependent and independent agent definitions (Article 12) and splitting-up of contracts rules (Article 14). Therefore, potential double taxation cases are expected on the short run to be very frequent: in fact, on the one hand, bilateral conventions signed by Italy (as the MLI has not been ratified yet) are not aligned to post-BEPS definitions of personal PE and – on the other hand – domestic provisions already made a step forward implementing Action 7 concepts.

Whereas the Italian company acts as agent for its foreign related party, undisclosed agency PE identification risk would in principle be reduced if, for example, the Italian company employees did not:

  • Negotiate terms and conditions with clients on behalf of the foreign company;

  • Release official acceptance and confirmations of purchase orders from clients;

  • Fill in order forms on the letterhead of the foreign company, to which they are eventually sent for mere signature; or

  • Exchange e-mails with the Italian clients for example managing quality compliance or other issues on behalf of the foreign company.

Moreover, the Italian company acting as agent should receive remuneration reflecting its business risk and should be aligned to that of independent players, usually equal to a percentage of the net sales generated, whilst cost-plus approaches would hardly mirror functions, assets and risks of a real agency activity.

Nevertheless, circular letter no. 1/2018 recognises that undisclosed PE challenges cannot be based only on the presumed lack of economic autonomy of the subsidiary or its operating subordination to the parent company as these are conventional aspects in highly integrated structures.

Therefore, these challenges should, whenever possible, be dealt with by trying to shift the controversy from PE identification to a mere transfer pricing issue, so identifying a higher remuneration for the Italian subsidiary to compensate the additional functions performed towards a foreign company. This lies in the mentioned circular letter of the Tax Police, which brings about a quite substantial approach and – in the end – may come up with a reduction of the litigation which would alternatively be managed either via international procedures or via local instruments to avoid domestic tax court rulings.

Besides, this could also allow avoiding severe administrative, corporate and even tax criminal ramifications often associated with undisclosed PE assessments.

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