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Transfer pricing and the criminal tax regime

The publication, in the Official Gazette, of Italian Legislative Decree No. 158/2015 (effective October 22 2015), which reformed the criminal tax system, resulted in the amendment of Article 4 of Legislative Decree No. 74/2000, regulating the offence of discrepant tax return.

Thanks to the above amendment, transfer pricing adjustments deriving from tax assessments on inter-company relations between an Italian corporation and a foreign subsidiary shall be deemed irrelevant for criminal law purposes. 

Moreover, in application of the favour rei principle (confirmed by Italian Supreme Court’s ruling No. 40272/2015), such irrelevance from a criminal law perspective should also be applied retroactively.

Until publication of the Decree, the provision set forth under Article 4 of Legislative Decree No. 74/2000 (Offence of discrepant tax declaration) – apart from any quantitative thresholds, which are moreover rather easily reached by the larger enterprises – a “merely discrepant tax declaration” was punishable, even where devoid of any fraudulent intent or connotations.

Such incrimination was merely based on the subject’s behaviour for having disclosed in one of the yearly tax returns, an income or a taxable base of a lesser amount than actual figures, by reporting a lower income/profit than the actual amounts, or for fictitious losses.

Nevertheless, Article 7 of Legislative Decree No. 74/2000 set forth an exempting rule providing that inaccurate entries and value estimates (referable to transfer pricing evaluations) may not give rise to punishable facts, if the criteria effectively adopted were clearly and adequately reported in the Explanatory Note to the Financial Statements. 

The above, in view of the fact that any explicit disclosure of value, estimates criteria in the Financial Statements cannot (in any way) be regarded as being of a deceptive nature, and is clearly incompatible with the crime of wilful tax evasion.

The said specific provision further corroborates how abstract the nature of any reference to accounting entries related to value estimates is, when establishing whether a case may be criminally relevant or not.

Notwithstanding the said provision, one wonders to what extent the indications on the criteria to be adopted should be specified in order for the exempting provision, ex Article 7 above to be applicable.

As a matter of fact, the issue involved is a case of non-punishment for directors within the criminal-tax area, which – where construed in an excessively rigorous manner (requirement to indicate not only the criterion adopted, such as the “Transactional Net Margin Method” or “TNMM”, but also the percentage margin applied) would lead to the dangerous occasion/necessity of revealing industrial and/or commercial secrets.

It might be worth noting that an Explanatory Note has the limited role and function of a Civil Law document and cannot, therefore, lend itself to bearing the weight of complicated tax evaluations, such as the ones involving inter-company transfer prices; in other words, the document could not possibly be compatible with the complexity of identifying and assessing value estimates related to the determination of taxable income.

Complicated aspects, such as the ones previously reported, were the reason for which – in practice – enterprises rarely indicated and accurately reported the criteria applied in determining their transfer prices in the Explanatory Note to their Financial Statements.

The legislator had also provided a further and residual “safeguard measure” under paragraph 2, Article 7 of Legislative Decree No. 74/2000, which excludes any punishment for “value estimates which, if individually considered, vary within less than 10% from the accurate ones”.

What ensues is that incorrect value estimates, even if not supplemented by any explanations in the Financial Statements of the criteria adopted, may not – in any case – become criminally relevant if the “malfunction/discrepancy” is restricted to the above limited extent.  The aim was to create some sort of “exemption” by means of which any difficulties linked to the estimates remaining within certain percentage limits, could be eliminated.

Legislative Decree No. 158/2015 amended Article 4 of Legislative Decree No. 74/2000 in various points: in particular, by replacing the expressions “fictitious loss elements” with “non-existent loss elements” under Article 4, it established that no cost actually borne, notwithstanding its being considered non-deductible, may become criminally relevant in connection with evaded tax.  Consequently, any challenges raised by the tax authorities on the subject-matter of transfer prices need no longer be reported to the said Authorities.

By Piergiorgio Valente and Ivo Caraccioli of Valente Associati GEB Partners

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