By Diletta Fuxa, Transfer Pricing Senior Manager, Studio Associato Servizi Professionali Integrati, Milan
The Italian tax authority (“Agenzia delle Entrate”) addressed (once again) the VAT treatment of transfer pricing year-end adjustments in its response to ruling No. 884, published on 30 December 2021.
The petitioner is an Italian company belonging to a multinational group, operating in the fashion industry, which controls four subsidiaries located in Germany, the Netherlands, Hungary, and the Czech Republic. The intercompany transaction under analysis is the sale of finished products to those subsidiaries for resale in the relevant geographic markets through the retail channel. The group’s transfer pricing policy is based on the internal CUP (comparable uncontrolled price) method. However, at the end of the year, the group performs a “sanity check” using the TNMM (transactional net margin method) to verify that the profitability (expressed in terms of “operating margin” or “return on sales”) of the foreign subsidiaries is consistent with the interquartile range (“IQR”) of the benchmark carried out.
In this respect, the petitioner points out that based on the TNMM the benchmark showed that, in the relevant fiscal year, the foreign subsidiaries achieved a marginality higher than the upper quartile of the IQR. To adjust the profitability of the foreign subsidiaries to the outcome of the benchmark analysis, the petitioner intended to issue adjustment invoices. As a consequence, the foreign subsidiaries will “record an extra cost that will decrease their EBIT and therefore their ROS net sales revenue.”
In light of the above, the petitioner requested clarification as to the VAT treatment to be reserved for the above-mentioned year-end adjustment.
In addressing the question, the Italian tax authority took the opportunity to verify whether the year-end adjustments the petitioner envisaged are consideration for an independent supply of goods and/or services, pursuant to Italian VAT rules (Articles 2 and 3 of Presidential Decree No. 633 of 26 October 1972); Or, if this is not the case, should there be an increase in the taxable amount on the original supplies of goods, pursuant to Article 13 of the above-mentioned presidential decree on VAT.
The preliminary assessment–as to whether the transfer pricing adjustments can be qualified as consideration for an autonomous supply of goods—is negative. Indeed, the sole purpose of the year-end adjustment is to bring the foreign subsidiaries’ operating margin within the interquartile range. For this reason, it is not possible to attribute to such adjustments the nature of consideration for an autonomous transaction. Consequently, the Italian tax authority carried out an investigation to understand whether the aforementioned price adjustments may affect the determination of the VAT taxable base, pursuant to Article 13 of the presidential decree on VAT.
In this regard, the tax authority observed that, in general, the rules concerning the determination of the VAT taxable amount are governed, at the EU level, by Article 73 of Directive 2006/112/EC (the VAT directive), which states as follows: “In respect of the supply of goods or services, other than as referred to in Articles 74 to 77, the taxable amount shall include everything which constitutes consideration obtained or to be obtained by the supplier, in return for the supply, from the customer or a third party, including subsidies directly linked to the price of the supply.”
According to the Italian tax authority, which refers to the relevant EU case law, Article 73 of the VAT directive (transposed into Italian law by Article 13 of the presidential decree on VAT) “constitutes the expression of a fundamental principle, the corollary of which is that the tax authorities may not charge more VAT than the amount received by the taxable person.”
For this purpose, to assess whether the year-end adjustment constitutes an increase in the VAT taxable amount of the supplies of finished products between the petitioner and its foreign subsidiaries, it is necessary to identify a direct link between the year-end adjustment and the supplies of goods originally made. In particular, it is necessary to verify that a consideration (in cash or in kind) is established for the year-end adjustment; supplies of goods or services to which the consideration relates are identified; and that there is a direct link between the supply of goods or services and the consideration.
The tax authority stressed that, in the case under analysis, the year-end adjustment, although involving for the foreign subsidiaries “the recognition of an extra cost aimed at lowering their operating margin,” are not “directly related to the original supplies of finished products made by the petitioner.”
The interpretative solution under analysis is consistent with the approach already expressed by the Italian tax authority in ruling no. 60 of 2 November 2018 and ruling no. 529 of 6 August 2021: for VAT purposes it is necessary to identify, with regard to each YEA, the existence of a direct link between the consideration and the supply of goods or services. This approach is consistent with the observations expressed by the EU Value Added Committee in the Working Paper no. 923, dated 28 February 2017 (https://circabc.europa.eu/sd/a/55d34dce-faf8-42ba-8ec6-381a98540b9c/923%20-%20VAT%20Implications%20of%20Transfer%20Pricing.pdf), as well as the paper released by the EU VAT Expert Group “Possible VAT Implications of Transfer Pricing” (https://circabc.europa.eu/sd/a/96aa53b0-f2b6-4b06-b93a-9dd07bde6e51/945%20rev%20-%20annex%20-%20opinion%20of%20the%20vat%20expert%20group%20on%20transfer%20pricing.pdf).
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Diletta Fuxa is a transfer pricing senior manager at Studio Associato Servizi Professionali Integrati in Milan.
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