Italy: Transfer pricing legislation not applicable to domestic intercompany transactions

With judgment No. 5859 of 2024, the Italian Supreme Court once again addressed the application of transfer pricing rules to transactions between companies within the same multinational group, where both are tax resident in Italy.

The ruling stemmed from a dispute concerning the 1999 tax year, following an assessment by the Italian Revenue Agency.

The assessment involved a company resident in northern Italy that sold goods to an affiliated company in southern Italy, which at the time benefited from favourable tax incentives aimed at fostering business activities in the Italian southern regions.

Before examining the Supreme Court's decision, it is important to recall that the application of transfer pricing rules to domestic transactions was a debated topic until the enactment of Legislative Decree No. 147/2015.

This decree definitively clarified that transfer pricing regulations do not apply to transactions between related companies that are resident or located within the national territory.

However, the Italian tax authorities may evaluate the uneconomic nature of transactions as a valid basis for analytical-inductive assessments. In such cases, the burden of proof shifts to the taxpayer to demonstrate the absence of uneconomic behaviour.

In the case at hand, the tax audit revealed that the markup applied to goods sold by the northern seller company to its southern related entity was insufficient to cover the costs incurred.

Consequently, the Italian tax authorities, invoking also transfer pricing rules and practices, issued an assessment notice increasing the markup applied to at least cover the costs incurred by the seller (10% mark-up instead of the applied 4%). The Italian tax authorities argued that this conduct was designed to shift taxable income to the related company benefiting from tax incentives.

The first-instance judges ruled in favour of the taxpayer, finding that the tax authorities had not adequately substantiated their claims. The second-instance judges upheld this decision, reasoning that the minimal markup was justified as a means of fostering social and employment growth, as well as business development.

The Italian tax authorities then appealed to the Supreme Court, which accepted their appeal and referred the case back to the second-instance judges. This time, the second-instance judges ruled in favour of the tax authorities. As a result, the taxpayer appealed to the Italian Supreme Court against the second-instance ruling.

The Supreme Court, rejecting the taxpayer’s appeal, held that the assessment of internal transfer pricing practices for tax purposes must follow the general principle established by Article 9 of the Italian Income Tax Code (TUIR) regarding “normal value”.

This principle, which goes beyond mere accounting considerations, requires that evaluation criteria align with the normal market value of payments and other income reported by the taxpayer.

According to Article 9, paragraph 3, of the TUIR, “normal value” refers to the price or consideration generally charged:

• For goods and services of the same kind or similar;

• Under conditions of free competition and at the same stage of marketing; and

• In the time and place where the goods or services were acquired or provided, and, in the absence thereof, in the nearest time and place.

It should be noted that in 2017, Italian transfer pricing regulations removed the reference to “normal value” and introduced a reference to the “arm’s-length principle”.

This change was necessary to align the national rules with the arm’s-length principle in determining the value of transactions between associated enterprises, as stated in Article 9 of the OECD Model Tax Convention on Income and Capital and outlined in the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations.

In the case at hand, the judges clarified that transactions between intragroup companies operating domestically, conducted at prices deviating from the normal market value under Article 9 of the TUIR, do not inherently indicate tax avoidance. Such deviations are merely an additional factor that may support, but cannot solely establish, a finding of tax avoidance.

Thus, the following conclusions can be drawn:

• Burden of proof on tax authorities – the tax authorities must demonstrate the existence of economic transactions between related companies conducted at prices that appear below the normal market value. However, they are not required to prove increased national taxation or a specific tax advantage.

• Burden of proof on the taxpayer – the taxpayer must justify deviations from arm’s-length prices, showing that these are reasonable given the economic context and the group’s short- to medium-term strategy, aimed at achieving lawful results consistent with competitive market principles.