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Italian TP compliance and the challenges of drafting TP documentation

Sponsored by

Cordeiro Guerra & Associati

Cecilia Bonazza and Roberto Cordeiro Guerra of Cordeiro Guerra & Associati explore how multinational enterprises should face the challenges of transfer pricing documentation in Italy.

In the Italian regulatory framework, controlled transactions between associated enterprises (an Italian resident entity and a non-resident counterparty) are subject to domestic transfer pricing (TP) rules. Therefore, income derived from such transactions should be determined according to the arm’s-length principle. Italian tax authorities can challenge the transfer prices applied by the resident entity and assess a higher income through a TP adjustment. In such a case, penalties ranging from 90% to 180% of the higher tax due are applied.

Multinational enterprises (MNEs) are not obliged to prepare and file any mandatory documentation for TP purposes. Nevertheless, they might elect to prepare a set of TP documents to support the application of the arm’s-length principle to inter-company transaction. ‘Appropriate’ TP documentation could grant the taxpayer protection from penalties in case of assessments (‘penalty protection’).

An administrative measure was published in November 2020 (the 2020 Measure) through which the Italian Revenue Agency provided some updated guidance concerning TP documentation. Consequently, the regulatory framework could amount to a burdensome compliance process for MNEs wishing to prepare TP documentation.

Regulatory framework concerning TP documentation

With the aim of implementing the EU Code of Conduct on TP documentation, Italy introduced two specific provisions allowing relief from penalties in case of assessment on TP adjustments (the ‘penalty protection provisions’) if the following conditions are jointly met:

  • During accesses, inspections, audits or other preliminary activity concerning TP adjustments, the taxpayer hands over to the tax authorities a set of documentation to attest the compliance of the value applied in the assessed transactions with the arm’s-length principle;

  • The documentation provided is formally and substantially appropriate (appropriateness test). This includes a formal aspect (i.e. the masterfile and localfile are in line with the standards set by a measure of the Director of the Italian Revenue Agency) and a substantial aspect (i.e. the tax authorities considers documentation suitable to provide the auditors with all the elements to assess the compliance with the arm’s-length principle); and

  • The taxpayer has previously communicated to the tax authorities, by flagging a specific box in the related tax return, that it has TP documentation available with reference to that financial year (‘previous communication’). Provided that the aim of the penalty protection provision is to reward virtuous enterprises which cooperate with the tax authorities, some courts have held the position that failing to provide previous communication could amount to a formal violation, still allowing the cooperative entity to benefit from the penalty protection.

Tax authorities adopted the first measure on September 29 2010 setting the formal and substantial standards necessary to verify the consistency of the transfer prices applied with the arm’s-length principle.

The 2020 Measure introduced some material amendments to the previous measure, with the aim of updating the domestic framework and making it consistent with the 2017 OECD Guidelines. This is of particular relevance given that the appropriateness test takes into account compliance with the standards set by the tax authorities and it could result in granting or denying penalty protection.

The updates included in the 2020 Measure described below are most likely to have an impact on the compliance burden of MNEs.

  • Previously, only Italian holding or sub-holding companies were required to provide the tax authorities with a master file (concerning the group) and a local file (regarding the enterprise), while Italian controlled entities should only provide country specific documentation. Starting from 2020 a full set of TP documents, composed of a masterfile and a local file should be drafted by all enterprises (including Italian permanent establishments) entering into controlled transactions, regardless of their status as a holding, sub-holding or a controlled entity.

  • The 2020 Measure broadened the scope of the information and data to be provided, aligning the content of the documentation with the OECD Transfer Pricing Guidelines and BEPS Action 13. Among the most relevant, two are worth mentioning:

  • The country file should include detailed information concerning financial data of the domestic entity, usually requested only in the context of an audit (e.g. a financial computation statement reconciling the financial data used in determining transfer prices at an arm’s-length value with the financial statements); and

  • The masterfile should include more detail on profit generation factors, group strategy with reference to intangibles and inter-company financial operations.

  • A significant number of documents should be attached to TP documentation, including the group consolidated financial statements, all APAs on TP and cross-border advance rulings signed with, or issued by, the tax administration of the countries in which the group operates and a copy of all inter-company agreements concluded by the local entity referring to the controlled transactions represented, including any cost sharing agreements in which the company is involved for cost sharing in which the company participates should be attached.

  • Specific documentation (or specific section to the local file) should be drafted for low-value adding services (whose arm’s-length value can be determined by MNEs with a simplified approach). Such documentation should include, among others, a description of the services, the agreements regulating the provision of services, the allocation criteria used and the underlying reasons for such choice.

  • MNEs can now elect to prepare a ‘partial’ set of documents with reference only to a specific set of controlled transactions. This will limit penalty protection to TP adjustment of the operations described.

  • Documentation should be sealed with a digital signature and a time stamp before the deadline of filing the annual tax return. Moreover, the 2020 Measure appears to have limited the circumstances in which it is possible to amend the annual tax return after its filing to include communication of availability of TP documentation.

  • As a result of the above, documentation is subject to a stricter ‘appropriateness test.’

Moreover, the combination of three of the above: (i) Master file extension to controlled entities; (ii) Time stamp seal; and (iii) Updated ‘appropriateness test,’ could have a significant impact on the compliance burden of the multinational enterprises, as explained in more detail below.

Impact of strict timing requirements

According to the 2020 Measure, documentation should be sealed with a digital signature and a time stamp before filing the relevant annual income tax return deadline. As a result, the full set of documents should be drafted, finalised and sealed before the final date (generally by November 30 of the following year for calendar year entities).

Failure to do this within the required timeframe may result in a set of documents not passing the appropriateness test thus excluding the taxpayer from the penalty protection regime.

Clarifications could be expected on whether the annexes should be sealed with the time stamp as well. The wording of the 2020 Measure seems to suggest that the seal should cover the whole set of documents. This implies that all attachments should be available to group entities before the tax return deadline.

While the OECD highlights that the drafting of TP documentation before the filing of the annual return is best practice, in the Italian framework it is now considered mandatory.

Challenges associated with this requirement are numerous. For example, controlled entities may not receive the master file or the necessary group information and data within the Italian deadline. Similarly, a MNE could be unable to timely gather all the financial information to be included in the Local file concerning associated enterprises which have been counterparties in controlled transactions.

The compliance burden gets heavier with respect to the availability within the provided timeframe of the documents to be attached to the set (e.g. consolidated financial statements of the group, existing uni/bi/multilateral TP agreements, cross-border rulings, APAs, including those to which the entity is not a party but that are related to the inter-company transactions described).

The 2020 Measure clarifications – having regulatory nature – seems a particularly strict interpretation of the penalty protection provisions – having statutory nature: as highlighted, the penalty protection provisions do not require the drafting of documentation or the gathering of annexes at any time before the audit, that usually occurs several years after.

Denying penalty protection to taxpayers for formal violations such as omitting the time stamp before the tax return deadline seems to be in contrast with the aim of the mechanism; that is to reward the cooperative behaviour of virtuous taxpayers, who provide the authorities with the necessary elements during the course of the audit to perform an appropriate arm’s-length assessment.

Therefore, it is advisable for the tax authorities to provide formal confirmation on whether the omittance of a time stamp will imply that penalty protection will be denied.

Previous communication to the tax authorities

Ordinarily, the taxpayer would flag a specific box in the annual tax return to attest the availability of TP documentation. Failure to do so would result in a breach of penalty protection provisions, although some courts have held that a similar violation is of a formal nature, not preventing a cooperative entity to benefit from the penalty protection.

The 2020 Measure narrowed the circumstances in which the taxpayer, who failed to check the box in the relevant annual return, can amend its position before any assessment: this can only happen in the event of a subsequent filing of an ‘adverse’ integrative tax return that implies an increase in taxable basis or a reduction in a tax credit due to a previous misapplication of the arm’s-length principle. Clarifications are expected in order to extend this possibility to cases in which the integrative tax return results in a lower taxation.

Given the strict interpretation regarding the time stamp, communication to the authorities is starting to appear as a formal requirement. Thus, a substance-over-form approach on the timing of the communication appears particularly desirable, given that the time stamp certification together with the handover of the documentation during an assessment should be considered sufficient for attesting the compliance within the timeframe provided for drafting the set of documents. Such an approach would also be consistent with the position held by some courts of law on the formal nature of violations concerning communication.

The ‘appropriateness’ test

Tax authorities are not automatically bound to apply penalty protection to cooperative taxpayers handing over the set during the course of an audit: TP documentation is subject to further scrutiny to verify its ‘appropriateness.’

As anticipated, the ‘appropriateness’ test includes both formal and substantial aspects. With reference to the former, the 2020 Measure expressly includes the digital signature and the time stamp as formal requirements. The tax authorities can deny penalty protection if these requirements are not met. Documentation that appears compliant with the formal scheme but lacks an overall complete set of information or provide data that are not wholly or partially truthful should not pass the ‘appropriateness test.’ Formal omissions or partial inaccuracies not likely to impact the analysis of the tax authorities should not compromise the penalty protection application.

Penalty protection should be granted in all circumstances in which the TP documentation is compliant in all material respects (formally and substantially) with the new standards and it provides the tax authorities with all the relevant elements to carry out an analysis on the arm’s-length conditions applied. Failure to pass the ‘appropriateness test’ should be specifically motivated by the auditors in case of negative judgment.

The 2020 Measure further clarifies that ‘appropriateness’ of the set of documents should be assessed regardless of the fact that the tax authorities identify the TP methods applied or the comparable transactions/independent parties selected in the documentation as the applicable one.

Final remarks

The standards set by the 2020 Measure are quite burdensome and increase compliance costs of the national entities entering into controlled transactions. The impact is quite significant considering that the tax authorities, during an assessment, often assume that the lack of TP documentation is in itself a reason to justify TP adjustments resulting in a higher tax debt.

This new strict position raises some questions as to the reasonableness of the compliance efforts required by the MNEs, and, ultimately as to whether the new approach of the tax authorities is actually compliant with some of the clarification included in the 2017 OECD Transfer Pricing Guidelines, that recommend as follows: “it is therefore important for countries to keep documentation requirements reasonable” to “ensure mindful attention to the most important matters” as well as “where a jurisdiction requires particular information to be kept for transfer pricing audit purposes, such requirements should balance the tax administration’s need for information and the compliance burdens on taxpayers”.

Click here to read the 2021 TP Special Focus guide


Cecilia Bonazza



Cordeiro Guerra & Associati

T: +39 055 200 16 11


Cecilia Bonazza is an associate at Cordeiro Guerra & Associati.

Cecilia advises Italian and international clients in relation to tax matters concerning domestic and cross-border transactions as well as tax structuring of extraordinary transactions in mergers and acquisitions (M&A), real estate and financial areas.

Cecilia is a law graduate from Bocconi University, qualified as a lawyer, and member of the Milan Bar. She holds an executive master’s degree in wealth management and tax planning concerning individual and family estates from Bocconi University School of Management in Milan.

Roberto Cordeiro Guerra


Senior founding partner

Cordeiro Guerra & Associati

T: +39 055 200 16 11


Roberto Cordeiro Guerra is the founding partner of Cordeiro Guerra & Associati and professor of tax law and international taxation at the University of Florence.

Roberto is qualified to practice before Supreme Jurisdictions and he advises individuals, sports people and artists, companies and multinationals in tax litigations, tax audits and settlements with the Italian tax authorities on a wide range of issues, including TP, direct tax issues, VAT and other indirect tax issues.

Roberto is on the management board of the Association of Italian Tax Law Professors. He is president of the Local Chamber of Tax Lawyers in Florence.

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