Transfer Pricing: the new appropriate documentation

Following the Ministerial Decree of May 14, 2018, providing guidelines (“the Guidelines”) concerning the application of transfer pricing rules, Provision no. 360494 (in the following “the Provision”) has been enacted last November 23, that amends radically (also introducing parts of substantial novelty) the proper documentation to allow the control of the consistency with the arm’s length principle of both conditions and transfer prices.

This provision has been enacted taking into consideration the OECD BEPS Action 13 “Transfer Pricing Documentation and Country-by-Country Reporting”, according to which all countries must follow a standardized approach (so called  three-tiered approach) that envisages the drafting of the following documentation::

• the Masterfile, that provides information concerning all the entities belonging to the multinational group;
• the Local File concerning the transactions carried out by local entities;
• the Country-by-Country Report containing information relating to the global allocation of the multinational group's income (and the resulting taxes paid) and specific economic indicators (tangible assets, number of employees, personnel costs, etc.) with reference to the various countries in which the multinational group operates.

Like the previous version of September 29, 2010, the preparation of the proper documentation in compliance with the Provision allows the non-application of penalties for fraudulent tax return in case of transfer pricing adjustments (so-called penalty protection).

The main changes contained in the text of the Provision are briefly described below.

Documentation (Par.2)

The proper documentation, drafted on an annual basis, consists of:

• the Masterfile, •designed to provide an overview of the multinational group's business, including the nature of business operations globally, general transfer pricing policies and the global allocation of income and economic activities; it can be drafted in different documents if the group carries out different activities governed by different transfer pricing policies.
• The Local File, •which provides more detailed information and the analysis of intercompany transactions concerning the local entity.

This documentation must be prepared regardless of the characteristics of the entity (holding or subsidiary of a multinational group).

Masterfile (art.2.2)

The Masterfile is organized according to the following chapters::

1. Organizational structure;
2. Business carried out by the group with the following information:
   • Main profitability drivers of the group;
   • Intercompany transactions;
   • Agreements for the provision of intercompany services;
   • Main markets;
   • Operational structure and value chain;
   • Business Restructuring.
3. Intangible assets of the group, with the following details:
   • Global strategy of the group;
   • List of intangible assets;
   • Rulings/APAs concerning intangible assets;
   • Transfer pricing policy for R&D activities;
   • Transactions concerning intangibles between related parties.
4. Intercompany financial activities with the following information:
   • Description of how the group is financed
   • Central financing functions;
   • General transfer pricing policies related to financing arrangements between associated enterprises.
5. Financial position of the group as follows:
   • Consolidated financial statements;
   • List of ruling ir APAs.

Local File (Par.2.3)

The Local File is structured in the following chapters:

1. General description of the local entity with the following details:
   • Organization chart;
   • Business carried out and entrepreneurial strategy pursued.
2. Intercompany transactions with an overview of flows and amounts. For each material transaction, the following information must be provided:
   • Description of the transactions (with indication of amount of intra-group payments and receipts for each category of controlled transactions involving the local entity, comparable transactions performed with third parties – both internal and external – and profit level indicators);
   • Comparability analysis;
   • An indication of the transfer pricing method applied
     • description of the selected transfer pricing method and of the underlying reasons determining its consistency with the arm’s length;
     • Criteria for the application of the selected transfer pricing method;
   • Results;
   • Critical assumptions made in applying the transfer pricing methodology
3. Financial information, including:
   • Annual local entity financial accounts for the fiscal year concerned, including the audited ones;
   • Information and allocation schedules showing how the financial data used in applying the transfer pricing method may be tied to the annual financial statements;
   • Summary schedules of relevant financial data for comparables used in the analysis and the sources from which that data was obtained.
4. Attachments as:
   • Copy of relevant IC ageements;
   • Copy of rulings/APAs.

Documentation for permanent establishments (Par.3)

The new instructions concern both resident permanent establishments of foreign companies and resident companies with permanent establishments abroad, compatibly.

Proper documentation for smal medium-sized enterprises (SME) (Par.4)

The Decision allows companies with a turnover or revenues not exceeding € / million 50 not to update the comparability analysis for two fiscal years subsequent to the one to which the documentation refers if the analysis is based on information found from publicly available sources and does not change substantially.

Entities that directly or indirectly control or are controlled by another entity not qualifying as an SME are not considered SMEs.

Form, extension and conditions of the proper documentation (Par.5)

The Masterfile can be prepared in Italian or English, while the Local File must be prepared in Italian.

The documents must be signed by the legal representative (or his/her delegate) by electronic signature with a time stamp to be put by the date of submission of the tax return for the year to which the documentation refers.

The documentation must be submitted in electronic format and provided within 20 days of the relevant request.

Extent and conditions of validity of the Proper Documentation (Par.5.3)

The documentation must be considered appropriate in all cases in which it provides the tax authorities with the data and information necessary to carry out an analysis of the conditions and transfer prices applied, with particular emphasis on transactions and both comparability and functional analyses. The documentation is also considered appropriate in the event that the tax authorities choose a different method of comparability or entities or transactions different from those of the taxpayer.

Penalty protection applies even in the event that the documentation contains omissions or partial inaccuracies that are not likely to compromise the analysis of the tax authorities.

The penalty protection may not be applied in the event that the documentation is presented during an audit activity and the same does not contain complete information consistent with the instructions of the Provision (including the electronic signature with time stamp) or information in full or partly untrue..

Documentation for low-value adding services (Par.7)

According to the Guidelines, low-value adding services (“LVAS”) According to the provisions of the Guidelines, services with low added value ("LVAS") are considered to be services that:

• are of a supportive nature;

• are not part of the core business of the group;
• do not require the use of unique and valuable intangibles and do not lead to the creation of unique and valuable intangible;
• do not involve the assumption or control of significant risk by the service provider and do not give rise to the creation of significant risk for the service provider..

For these services there is an obligation to prepare specific documentation highlighting the following:

1. Description of services
2. Relevant intercompany agreements;
3. Enhancement of operations;
4. Calculations.

Effective date (Par.8)

The instructions set forth in the Decision apply from the current fiscal year to the date of its publication, or for taxpayers with a calendar year from 2020.