The Italian Tax Agency has issued instructions, through Circular Letter No. 16/E of May 24, 2022, with respect to the correct and practical use of the "arm's length range" for the application of the Italian Transfer Pricing rules.
The Circular Letter clarified various principles that have already been adopted in the case of APAs and by most taxpayers, but that have sometimes been disregarded by local tax offices in the tax audits. The guidelines under discussion should be considered under the framework of the domestic provisions of the Ministerial Decree of May 14, 2018. These provisions implemented the most recent principles adopted by OECD Guidelines, in which a range of figures must be considered consistent with the arm's length principle if they consist of financial indicators (to be selected by applying the "most appropriate method") of independent parties, assumed as comparable to the tested party.
Under the described scenario, the Italian Tax Administration confirmed, in the Circular Letter No. 16/E, the following main issues:
- The arm's length principle (and the most appropriate method applicable on a case-by-case basis) usually triggers a range of comparable/financial indicators that should be equally reliable, and differences in the range are caused by the fact that the application of the arm's length principle produces an approximation of conditions that would have been agreed among independent enterprises or by the application of different prices for comparable transactions.
- Transactions between independent enterprises that have a limited degree of comparability should be eliminated from the final benchmark set.
- Other comparability mismatches should be eliminated using "statistical tools" (e.g., the interquartile range) or the application of more than one method. In such cases, each range could be used to define an acceptable range of arm's length figures or to reconsider the accuracy of the adopted methods.
- A substantial deviation among the data included in the benchmark could suggest that some of them are not reliable, therefore, if comparable entities realizing exceptionally high profit or losses (so-called "outliers") could have a material impact on the adopted PLI and further analyses are required, by excluding results not consistent with normal market conditions or reflecting a level of risks not comparable to the tested party.
- Loss-making transactions or enterprises should not be rejected out of hand but should be assessed based on specific facts and circumstances and therefore need further in-depth analysis.
In the case of a tax audit, the taxpayer shall provide proper supporting documentation to demonstrate that the controlled transaction satisfies the arm's length principle. If the taxpayer does not provide such evidence, the tax administration is permitted to assess a new arm's length value, considering the following:
- If the benchmark includes comparables of equal and high reliability, the financial indicator is adjusted by positioning from the lower or higher range value (the so-called "full range").
- Where the benchmark was subject to adjustment, the "full range" is considered as not applicable since it is not sufficiently reliable, and the first interquartile or third interquartile shall be deemed as a reliable positioning of the arm's length range (the so-called "statistical range").
- The use of a central value within the range (the median) shall be advisable to limit discrepancies deriving from a limited comparability between the controlled transaction and the relevant benchmark. Therefore, if the PLI should fall within the arm's length range (either full or statistical range) at the time the Transfer Pricing documentation is prepared, no adjustment will be necessary.
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