TRANSFER PRICING IN CORPORATE INTERNATIONALIZATION.

The presence of business relationships between companies of the same multinational group or between subsidiaries/related companies, located in different jurisdictions, requires special attention to international taxation issues, as the maximization of corporate profit may occur, in addition to the use of economies of scale or group economies, also through tax expedients, in order to have mainly lower taxation: it follows that the transfer prices of the goods and services, transfer pricing, exchanged between them could differ from their real market value; the aforementioned could take place within a group of companies with common strategic perspectives, given the lack of opposition of different interests, usually characteristic of transactions entered into between independent economic entities. 

The underlying business causes of transfer pricing can be many:

• extra-tax motivations, such as cash needs, moving capital from one nation to another, the need to reduce entrepreneurial risks, influence credit rating, reduce operating costs, and so on,
• tax motivations, such as lower effective taxation in view of lower rates on corporate income or concessions at the tax base determination stage, detaxation of certain categories of passive income, such as royalties, and so on.

Globalization and the recent economic crisis have certainly amplified the use of transfer pricing, as corporate groups have suffered significant negative consequences, both in terms of assets and cash flows, while simultaneously generating increased controls and inspections by tax authorities. 

---

CURRENT REGULATIONS

On the subject, the main regulatory source in force in Italy is Article 110, paragraph 7 of the TUIR, Testo Unico sulle Imposte dei Redditi (Income Tax Consolidation Act): "The components of income deriving from transactions with companies not resident in the territory of the State, which directly or indirectly control the company, are controlled by it or are controlled by the same company that controls the company, are determined with reference to the conditions and prices that would have been agreed upon between independent parties operating in conditions of free competition and in comparable circumstances, if an increase in income results. The same provision shall also apply if a decrease in income results ..." Consequently, issues may arise for tax purposes when transfer pricing is contrary to free trade and free competition regulations for OECD purposes, as the transfer prices may be different from the true value of the good or service exchanged: in such a case, if the consideration for the supply of goods or services is lower/exceeding the market value, there is a transfer of income with respect to competitive conditions, from the transferor to the transferee or from the supplier to the principal. Therefore, the transaction must take place on the basis of a fair market value and not on the basis of a subjective valuation, the result of mere tax advantages: normally, the fairness of the price is assessed following the OECD guidelines; there are 5 main methods of valuation and for each transaction carried out, the method deemed most appropriate must be chosen. 

The transfer pricing discipline applies to:

• Italian companies 
  • that control companies headquartered abroad, are controlled by companies headquartered in foreign jurisdictions, have a permanent establishment abroad,
• Italian permanent establishments of companies based in foreign jurisdictions.

In these cases, the discipline applies to all positive and negative components of business income; in addition, another requirement

for there to be application of the discipline is that of control and, under Article 2359 of the Civil Code, a distinction is made:

• de jure control, for companies in which another company has a majority of the votes that can be exercised in the ordinary shareholders' meeting,
• internal de facto control, for enterprises in which another company has sufficient votes to exercise a dominant influence in the ordinary shareholders' meeting,
• external or contractual de facto control, for enterprises that are under the dominant influence of another company by virtue of contractual ties with it.

In general, Ministerial Circular No. 32/1980 extends the concept of control "to any hypothesis of potential or actual economic influence," thus giving rise to the need for concrete verification of the existence or non-existence of common governance, between the two companies. 

---

THE ROLE OF THE PROFESSIONAL 

In relation to transfer pricing, the professional activity of the Certified Public Accountant and Auditor is supportive to companies: he or she can assist the company in determining the correct intercompany pricing policies, as well as in preparing the necessary documentation in order to comply with regulatory obligations. However, given the recent events of economic crisis, it is more difficult as it is more difficult to carry out preliminary comparative analysis, such as comparability analysis and search for comparable transactions and entities, considering that the elements of crisis constitute a not inconsiderable disturbance and condition the transactions themselves, inevitably carried out in relation to the needs of the group, even to the detriment of individual operating entities. 

In light of what has been stated, the figure of the professional could become even more that of a business consultant, structuring possible solutionsto transfer pricing, from a short- and long-term perspective:

• short term 
  • inclusion of companies with operating losses; short-term review of intra-group contractual arrangements in terms of functions, risks, and assets, the main elements to be reshaped, especially in a multinational group; evaluation of preventive agreements with tax authorities;
• long term
  • business restructuring, which is a structured corporate reorganization of trade and financial relations between transnational member firms, including substantial renegotiation of existing agreements or redefinition of intercompany flows. Basically, elements such as functions, assets, and risks are permanently shifted within the multinational group in order to generate a parallel shift of incomewithin the group itself, for example, by selling business units or changing distribution agreements. The economic reasons are classic: improvement of the production chain, reduction of group losses, maximization of profit. Production in individual countries can also be reorganized, taking greater advantage of economies of scale, which are crucial within a group, for example by relocating to countries where lower labor costs can be accessed. Generally, the relocation takes place in countries where specific bonus tax regimes are in place: in Italy there is the Patent Box, a bonus IRES and IRAP percentage exemption scheme for companies that relocate the R&D function as well as owned intangibles to Italy.

 

Edited by: Luigi Alfredo Carunchio, Chartered Accountant and Statutory Auditor

You can download the article in PDF here

For more information:

luigicarunchio@valoreassociati.it

The firm supports clients in business internationalization