Transfer Pricing: allocation of the burden of proof

With Order No. 1374 of 18 January 2022, the Supreme Court commented again on the allocation of the burden of proof in transfer pricing disputes, pursuant to Article. 110, paragraph 7, of the TUIR, confirming once again, in line with previous case law, that the tax authorities is obliged to prove that the price charged in an intercompany transaction does not comply with the arm's length price (ex multis Supreme Court, judgment no. 27636 of 12/10/2021 and Supreme Court, judgment no. 1232 of 21/01/2021).

In the specific case under discussion, an Italian company belonging to a multinational group, through the fictitious interposition of its direct parent company based in the Netherlands, purchased goods from group's manufacturing companies located in privileged taxation countries.

During the investigation, the Tax Authority recovered for taxation the mark-up percentage applied by the Dutch parent company to the Italian company, which was considered not inherent because the latter's intervention in the distribution chain was deemed uneconomic.

Tax Authorities also recovered for taxation the revenues of the audited company on the basis of arm’s length value because the high fees paid by the Italian company to the Dutch Parent Company for the purchase of goods from the Italian companywere considered instrumental in allocating most of the tax base  to the group's manufacturing companies based in countries with privileged taxation.

The Italian company, through its appeal before to the Supreme Court, with regard the transfer pricing issues challenged the  incorrect application of the provisions provided by the art. 2697 of the Italian Civil Code governing the apportioning of the burden of proof, because Tax Authorities had not submitted conclusive and relevant documents useful to demonstrate that the mark up charged in the controlled transactions did not comply with the arm’s length  principles.

As a matter of fact, the finding was not based on the application of the transfer pricing valuation methods provided for by the OECD guidelines, or by the Circular of the Tax Authorities no. 32/9/2267 of 1980, but was based exclusively on the excessive, inconsistent and unexplained variability of the purchase prices and the mark-up applied by the Dutch company, elements  considered sufficient to prove  the allocation of income generated in Italy tax heavens.

The Court examined the case and ruled that:

  • the "arm’s length", or rather the "non- arm’s length", of the price of an intercompany transaction must be proved by the tax authorities, which must provide evidence that the same transaction, if performed between independent parties, would have generated a higher income for the for the Italian company. however  Tax Authorities is not obliged to prove the higher incidence of national taxation compared to cross-border taxation;
  • the inadequacy of the  controlled transaction price must be always identified with the aid of one of the methodologies used within the transfer pricing regulations’ framework, in accordance with the OECD Guidelines;
  • if a transaction is nevertheless entered into that is not comparable with similar transactions entered into by the taxpayer under competitive and similar market conditions, the taxpayer bears the burden of proving that the transaction was carried out at arm's length. In that case, the taxpayer should also give an account of the economic/commercial reasons for which that transaction would have been concluded, which may include the position taken by the company within the group (CJEU 31 May 2018 Case C-382/16).

Edited by Luciano Fiorentino

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