Italian TP ruling clarifies burden of proof and method selection

A recent decision of the Italian Supreme Court (Judgment No. 15698 of May 22 2026) provides significant guidance on two of the most debated issues in transfer pricing litigation: the allocation of the burden of proof and the selection of the most appropriate transfer pricing method.

The case concerned an Italian multinational group operating in the alcoholic beverages sector. Production activities were carried out in Italy, while international distribution was conducted through foreign subsidiaries. In particular, sales in the Dutch and US markets were managed through a Dutch distribution company belonging to the group.

Following a tax audit, the Italian Revenue Agency challenged the transfer prices applied between the Italian manufacturer and the Dutch subsidiary. According to the tax authorities, the Dutch distributor earned profits that were significantly higher than those realised by allegedly comparable independent distributors. On this basis, the Revenue Agency concluded that the transfer prices charged by the Italian company were below arm’s-length levels and therefore inconsistent with the Italian transfer pricing rules.

The assessment was primarily based on the transactional net margin method (TNMM). The tax authorities found that the Dutch subsidiary achieved an operating margin of approximately 28%, whereas independent distributors operating under allegedly comparable circumstances earned margins closer to 5%. The Revenue Agency also challenged substantial marketing and advertising costs recharged by the Dutch subsidiary to the Italian parent company, arguing that such charges effectively constituted hidden price reductions that artificially increased the profitability of the foreign entity.

One of the most noteworthy aspects of the judgment concerns the allocation of the burden of proof in transfer pricing controversies. Although this issue has long been debated in Italian case law, the Supreme Court used the opportunity to restate the evidentiary principles governing transfer pricing adjustments and to clarify the respective obligations of taxpayers and tax authorities.

The taxpayer argued that the Regional Tax Court had improperly shifted the burden of proof by requiring the company to demonstrate that its transfer prices complied with arm’s-length conditions. According to the taxpayer, the Revenue Agency should have been required to prove not only the existence of intra-group transactions but also the precise extent of any deviation from market prices.

The Supreme Court rejected this argument and reaffirmed a well-established line of jurisprudence. According to the court, transfer pricing legislation is not an anti-avoidance provision in the traditional sense. Its purpose is not to sanction abusive conduct or to establish a taxpayer’s intent to obtain an undue tax advantage. Rather, transfer pricing rules are designed to prevent the artificial allocation of profits among associated enterprises operating in different tax jurisdictions and to ensure that taxable income reflects the economic outcome that would have arisen between independent parties acting under comparable market conditions.

Against this backdrop, the court reiterated a fundamental principle of Italian transfer pricing law: the tax administration bears an initial burden of proof, but that burden is limited in scope. Specifically, the Revenue Agency must demonstrate the existence of controlled transactions and provide evidence suggesting that the prices applied were prima facie inconsistent with arm’s-length conditions.

Once the tax authorities have established such a prima facie case, the burden shifts to the taxpayer. At that stage, the taxpayer must demonstrate that the transfer prices were consistent with market conditions and complied with the arm’s-length principle. This allocation of the evidentiary burden is justified by the principle of proximity to evidence, since taxpayers are generally in the best position to access and produce the information necessary to support their transfer pricing policies, including contractual arrangements, transfer pricing studies, comparability analyses, and the economic rationale underlying intra-group transactions.

The second key issue addressed by the court concerned the choice of transfer pricing methodology.

The taxpayer argued that the comparable uncontrolled price (CUP) method should have been applied because comparable transactions existed between the Italian company and independent third parties. The Revenue Agency, by contrast, relied on the TNMM, comparing the profitability of the Dutch subsidiary with that of allegedly comparable independent distributors.

The Supreme Court partially upheld the taxpayer’s position. While reaffirming that neither Italian legislation nor the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations establish a strict hierarchy among transfer pricing methods, the court recalled that the CUP method should generally be preferred whenever it can be applied with a degree of reliability comparable to alternative methodologies. This preference reflects the direct nature of the comparison and its closer alignment with actual market prices.

The court found the reasoning of the Regional Tax Court inadequate in several respects. In particular, the lower court failed to explain convincingly why the CUP method proposed by the taxpayer was unsuitable and why the TNMM constituted a more reliable alternative in the circumstances of the case.

Furthermore, the Regional Tax Court did not properly address the taxpayer’s objections regarding the comparability of the companies selected for the TNMM analysis. The taxpayer had argued that the selected comparables differed significantly in terms of products, size, and market characteristics, thereby undermining the reliability of the profitability comparison.

The Supreme Court emphasised that the selection of a transfer pricing methodology must be supported by a robust comparability analysis and by a clear explanation of why the chosen method provides the most reliable measure of arm’s-length conditions.

The decision represents an important contribution to Italian transfer pricing jurisprudence. While reaffirming settled principles concerning procedural rights and the allocation of the burden of proof, the Supreme Court underscored the need for a rigorous and well-reasoned approach when selecting and applying transfer pricing methodologies.

Importantly, the judgment does not establish the superiority of the CUP method over the TNMM in all circumstances. Rather, it confirms that the selection of the most appropriate method must be based on the specific facts of each case and supported by a transparent and robust comparability analysis.

Where a taxpayer provides credible evidence supporting the application of the CUP method, tax authorities and courts must clearly explain why such evidence is insufficient before resorting to alternative methodologies. More broadly, the decision reinforces the principle that transfer pricing adjustments cannot be based on abstract assumptions or generic profitability comparisons but must instead be grounded in a careful evaluation of the economic realities of the controlled transactions under review.