With the globalization of chinese-owned enterprises, a growing number of enterprises are gradually being deployed globally. Both supply chains and sales involve several countries or areas. With the flow of goods, services and funds, the problem of transfer pricing is growing. The public case published by the national tax administration is taken from this paper to assist enterprises in understanding transfer pricing processes and risks。
Brief case
Company e, a limited liability company incorporated in italy, is engaged in the re-sale of household appliances and related components. In 2002 and 2003, company e purchased a wide range of products from company a, a group located in china, and deducted the procurement cost of the above-mentioned products in calculating the proceeds of its operations。
In its tax audit of company e, the italian tax authorities questioned whether the price of its products purchased from affiliated enterprises in fiscal year 2003 was in accordance with the principle of independent transactions and made a tax assessment decision ordering them to pay their taxes. Company e contested the decision of the tax authorities and turned to the regional tax court of lombardi (regio)Nal tax court of lombardy) filed an action. The local tax court has upheld company e's claim and has not endorsed the assessment decision of the tax authorities to pay the tax. Subsequently, the tax authorities appealed to the italian supreme court, which later upheld the decision of the local tax courts that the transfer pricing rules had been improperly applied and that their decision that “the burden of proof that the relevant transaction price corresponds to the market price falls on the tax authorities, not the taxpayers”。
Focus of the controversy
The debate in this case focused on the reasonableness of the price of the relevant business transaction, the basis for determining the subject and scope of the burden of proof。
(i) according to the tax authorities:
Company e violated article 76 of the old italian income tax law (as of 1 january 2004, italy introduced the new income tax law and the tax authorities claimed that article 76 of the old income tax law, i. E. Article 110, paragraph 7, of the new income tax law, which had entered into force at the time of the proceedings, was the rules governing transfer pricing), for the following reasons:
1. Under article 110, paragraph 7, of the new italian income tax act, if transactions between an enterprise and an enterprise under its direct or indirect control result in a decrease in the income of the enterprise or an increase in the cost, the transaction price shall be fixed at fair market prices, taking into account the transaction price determined by an unrelated enterprise on comparable terms and in accordance with the principle of independent transactions。
2. Tax authorities should apply comparable analysis to demonstrate whether related transactions conform to the principle of independent transactions by comparing e's financial data with other comparable companies. Analysis by the tax authorities found that company e purchased products from associated enterprises located in china at higher than market prices, resulting in an erosion of the italian tax base, subject to a mandatory tax supplement。
(ii) the local tax courts consider that:
The decision of the tax authorities to pay taxes is not supported by valid evidence, and the evidence provided by the tax authorities should provide sufficient evidence that the transaction price in connection with company e and company a clearly deviates from the market price in accordance with transfer pricing rules. In its decision, the local tax courts mentioned that the main purpose of transfer pricing rules was to prevent enterprises from transferring profits to countries where taxes were more favourable, that tax authorities had chosen only to compare data with other enterprises in the industry, and that failure to complete the full burden of proof on them was not sufficient to support their claim that company e was subject to tax replenishment in violation of transfer pricing rules。
Final award
The italian supreme court decided to quash the judgement of the regional tax court of the lombardi region and remanded the case to the lower court. The supreme court stated the following in its decision:
(i) transfer pricing rules
Transfer pricing rules are an important tool for preventing base erosion and profit transfer, primarily to ensure that the transaction prices of tncs between their different entities are consistent with the principle of independent transactions and to avoid the use of internal transactions to transfer profits。
(ii) principles governing independent transactions
The treatment of tax authorities is consistent with the provisions of article 9 of the model agreement of the organisation for economic cooperation and development on avoidance of double taxation of proceeds and property and prevention of fragmentation (usually referred to as the “oecd model”) on the principle of independent transactions, which requires that estimates based on the principle of independent transactions reflect the economic essence of the transaction。
(iii) on the subject of the burden of proof
In providing evidence, the tax authorities need not consider whether the taxpayer has actually received a tax benefit, the burden of proof being only to prove the existence of a related business transaction and the transaction price being “manifestly lower” than the market sales price. The burden of proof that the transaction price corresponds to the market price rests with the taxpayer, i. E., if the tax authority considers that the transaction price deviates from the normal level, the taxpayer should prove that the transaction price conforms to the market price。
It's a revelation about the "go-out" business
In this case, the italian supreme court clarified the rules for the allocation of the burden of proof between the tax authorities and the taxpayer in transfer pricing cases, and the burden of proof that the transaction price corresponds to the market price falls on the taxpayer. The italian revenue authority is concerned about tax avoidance by taxpayers using transfer pricing, and “go-out” taxpayers focus on identifying and preventing tax-related risks when dealing with related enterprises。
First, it is reasonable and legitimate to plan a related transaction within the group。
Before going out, firms could consider pre-empting and analysing global value chains and functional risks at the group level, and rationalizing transaction types and pricing policies to respond effectively to potential tax-related disputes, taking into account the business content and size of the enterprise。
Secondly, it is the careful preservation of the original evidence of legality。
Proactively and proactively, preserve evidence that a related transaction complies with the principle of independence. For example, pricing policy documents, functional risk analysis, economic analysis, etc。
Third is the active application of legal instruments to defend their interests。
In-depth knowledge of host country legal procedures for resolving tax disputes. At the same time, enterprises may wish to consider entering into an appointment pricing arrangement with the host country tax authorities on the pricing principles and calculation methods for future annual enterprise-related transactions, to increase tax certainty and avoid potential double taxation risks。
