Hybrid Mismatch Penalty Protection Can Benefit Italian Taxpayers

In our experience, Italian tax authorities are starting to scrutinize transactions and intercompany relationships to identify potential hybrid mismatches that could be subject to anti-hybrid legislation.

Hybrid mismatch arrangements exploit inconsistencies between the tax laws of different jurisdictions, often leading to unintended tax benefits. While these arrangements don’t necessarily imply aggressive tax planning, they require careful management to mitigate associated risks.

We therefore welcome recent developments in Italian law that clarify the formal and substantive requirements taxpayers must meet to access penalty protection in the event of a tax audit concerning hybrid mismatches.

The penalty protection system provides taxpayers with significant benefits if they prepare the required anti-hybrid documentation. It shields taxpayers from administrative penalties, encourages enhanced cooperation between tax authorities and taxpayers, and shows sound tax governance. It aids compliance and risk mitigation by helping businesses navigate complex tax rules while ensuring smoother interactions with tax authorities.

The penalty protection system also provides support during tax audits to prove the correct application of anti-hybrid rules, simplifies controls, and aligns with broader compliance frameworks, such as tax control systems and Italy’s cooperative compliance program.

Italy has enacted legislation to address hybrid mismatch arrangements, aligning with the OECD’s BEPS Action 2 Report. These recommendations aim to eliminate tax mismatches arising from hybrid arrangements

The anti-hybrid rules are designed to address cross-border transactions that result in tax mismatches, such as deductions without corresponding income inclusion or double deductions, due to differing tax treatments across jurisdictions.

These rules aim to prevent tax advantages by denying deductions for specific expenses and including in the taxable base income that would otherwise remain untaxed. They apply when tax mismatches occur between related entities or within structured arrangements, typically arising from variations in the classification of financial instruments, income, entities, or permanent establishments.

In Italy, these regulations also tackle “imported mismatches” by disallowing deductions for expenses incurred by Italian entities if they indirectly support a hybrid tax benefit elsewhere within the group.

Eligibility and scope. All entities resident for tax purposes in Italy and permanent establishments of nonresident entities can prepare documentation. Taxpayers in Italy may prepare their own anti-hybrid documentation, but it is also possible to designate another entity within the Italian group to handle this on their behalf. This is particularly beneficial for multinational groups with multiple entities or permanent establishments in Italy.

For Italian entities subject to the cooperative compliance program, anti-hybrid documentation fulfills transparency obligations toward tax authorities.

Deadlines and formalities. The decree allows taxpayers to prepare documentation for past years, provided no audit activity has commenced. The same formalities for transfer pricing documentation have to be followed—the documentation must be electronically signed with a time stamp and be provided to the tax authorities within 20 days from request.

Content. The documentation has to include a mapping by entity, considering the entire corporate group and an analysis of relevant cross-border transactions. For each entity of the group, it should indicate:

• The percentage of participation in the corporate chain, the jurisdiction of tax residence and tax status in both jurisdictions (tax and investor residence)
• The presence of permanent establishments in Italy and abroad
• Participation in local tax consolidation schemes.

The documentation should provide an explanation on potential hybrid mismatches—when the transactions concluded between the group companies could give rise to a situation which the anti-hybrid legislation addresses. So it is essential to analyze thoroughly relevant transactions, providing a description of the counterparties and income items that could generate mismatches.

The documentation should clearly identify the specific hybrid cause—whether related to a financial instrument, permanent establishment, or hybrid entity—resulting in the hybrid mismatch. It also is critical to assess whether so-called reaction rules apply: These are rules designed to mitigate these mismatches by eliminating undue tax advantages. If these rules are deemed not to apply, the documentation must provide a detailed explanation as to why they don’t apply.

Businesses may face challenges in determining whether certain transactions are subject to the law’s restrictions. To mitigate this uncertainty, they should provide a detailed explanation of intercompany transactions that may be covered by the law, supported by relevant documentation.

This documentation should justify the descriptions and explain why the anti-hybrid legislation may not apply. This approach fosters compliance and ensures access to penalty protection, even if the authorities adopt a different interpretation of the transactions.

Anti-hybrid documentation serves as more than just a compliance tool—it is a critical asset during tax assessments. For tax periods not subject to investigations, audits, or controls initiated before Dec. 29, 2023, businesses should proactively prepare documentation to avoid penalties and provide evidence in potential tax disputes or litigation.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Giuliana Polacco is partner with Bird & Bird, Italy.
Francesco Drago is a senior associate, transfer pricing, with Bird & Bird, Italy.

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