Where a foreign entity deems there is a risk that a permanent establishment (PE) may be determined in Italy, it may now initiate a procedure with the Italian Revenue Agency designed to mutually assess whether a PE exists, and enter into a cooperative compliance program if a PE is ascertained to exist.
The Italian Revenue Agency has now issued regulations on PE voluntary disclosure. Such regulations had been expected since 2017, when the Italian Parliament issued provisions, “Procedure of cooperation and enhanced relationship between nonresident companies and the Italian tax administration,” aimed at improving the relationship with taxpayers in instances of possible presence of a hidden PE.
In 2017, the Italian Parliament introduced a new provision (art. 1 bis of Law Decree no. 50/2017, converted in Law no. 96/2017 “Law Decree") which identified a specific procedure aimed at assessing on a voluntary basis whether a PE of a foreign entity could be deemed to be present in Italy. In particular, if a foreign entity is concerned by the possible risk of being subject to a PE assessment in case of audit, it is entitled to approach the Italian tax administration to request the mutual evaluation of the existence of a PE for past years, based on a procedure of cooperation (the Procedure).
In practice, this provision has not been effective until now, in the absence of specific guidelines regulating the Procedure.
The Italian Revenue Agency finally issued the regulations on April 16, 2019 and provided the expected indications on the Procedure and related timing, identified the competent tax office of the Revenue Agency in charge of the Procedure and coordination with other tax offices in charge of the assessment, and clarified the obligations and opportunities in the case of a positive assessment of a PE of a foreign entity.
The above opportunity may be welcomed by multinational groups, following the Organization for Economic Co-operation and Development base erosion and profit shifting (BEPS) project and the position taken by the Italian tax authorities in the interpretation of the PE concept.
Who is the PE Voluntary Disclosure Aimed at?
The provision is aimed at those foreign entities belonging to multinational groups which may be concerned that activity performed in Italy might give rise to a hidden PE, taking into account the activity also performed in the country by other affiliate Italian companies belonging to the same multinational group.
The analysis of the business model of the group must be examined adopting a holistic approach.
The quantitative requirements to opt for the Procedure were already indicated in the Law Decree and consist of:
- 1 billion euros ($1.12 billion) of revenues reported in the consolidated financial statement of the multinational group; and
- 50 million euros of revenues in Italy arising from sale of goods and/or the provision of services realized also through the support of affiliate companies in Italy providing affiliated services.
These thresholds must be verified over a period of the three financial years prior to that of the application for the Procedure.
The Procedure cannot be pursued in a case where the foreign entity is aware of ongoing audits, inspection and criminal investigation aimed at the assessment of a PE of the same foreign entity in Italy, even in a case where the notification of the audit has been served to the affiliate Italian company carrying out ancillary services.
However, the opening of other types of audits, for instance a general audit for corporate income tax purposes, does not prevent the application of the Procedure, and the cooperative compliance office in charge of the Procedure will coordinate its activity with other tax offices to assure the consistency of their activities.
How Does the PE Voluntary Disclosure Work?
The Regulations contain a detailed description of the information that the application request should contain and how it should be set out.
Foreign entities have to file a specific form to start the Procedure, including all the legal and factual reasons that may raise concerns regarding the possible deemed presence of a PE in Italy, as well as all the documentation necessary to explain the activity performed and the transfer pricing method applied (e.g. transfer pricing master file, country file of the Italian affiliate companies, description of the business model).
The request is addressed to the Cooperative Compliance Tax Office which is in charge of the entire PE assessment procedure, including that related to the identification and attribution of the profit to the PE where the Procedure determines the presence of a deemed PE in Italy for corporate income tax and value-added tax (VAT) purposes.
The open meeting with the taxpayer starts once the preliminary review of documentation by the Cooperative Compliance Tax Office is completed. The dialogue and open discussion with the foreign entity implies that the Cooperative Compliance Office has access to the affiliate companies’ employees and to other information deemed relevant for the execution of the procedure.
Such methodology is already known to taxpayers since it is adopted in the context of the advance pricing agreement procedure (APA). However, in contrast to the APA, which entitles taxpayers not only to agree the transfer pricing methods applied between affiliate entities, but also to request a preventive assessment of the existence of a PE in Italian territory only on condition that no activity is actually initiated on Italian territory, the Procedure is aimed at assessing the possible presence of a PE in Italy based on activities already performed by the relevant multinational group over the past years.
In the case of positive determination of a PE presence, the Revenue Agency and the foreign entity will establish the taxable basis of the PE which was not subject to taxation in Italy for fiscal years for which the period to file the tax return has already expired. The PE assessment will consider those fiscal years for which the statute of limitation is not yet expired, taking into account the extension of the statute of limitation applicable in the case of omitted tax returns by the PE, based on the more recent rules effective as of 2016 (i.e., six years from the end of the year in which the relevant tax return should have been filed).
The Regulations have clarified that the Cooperative Compliance Tax Office will handle all aspects of the Procedure, i.e., identification of the presence of a possible deemed PE and of the revenues to be attributed to it.
The Cooperative Compliance Office will therefore be entitled to carry out audit activity in respect of the functions performed in Italy by the foreign entity and through affiliate companies, to make onsite visits to the locations where the activities are carried out, interview employees, and raise additional questions or ask for additional documentation to be provided, always in consultation with the company itself.
The Tax Assessment Office is only competent for the final phase of the Procedure, the collection of the tax applicable on the revenues allocated to the deemed PE, as established at the end of the consultation between the foreign entity and the Cooperative Compliance Office. It will therefore be the Tax Assessment Office which will invite the taxpayer to settle the tax debts owed by the PE and which will release a final settlement deed.
The Procedure is completed and the benefits are granted to the foreign entity only in the case of full payment of taxes and penalties due by the deemed PE.
Advantages of PE Voluntary Disclosure
The Procedure represents an opportunity for multinational companies with a presence in Italy to remove uncertainty relating to their business models and the risk of audit aimed at assessing the presence of a deemed PE. Italy has always maintained a strict interpretation of the PE concept, based on the landmark Philip Morris case, recently reinforced by the BEPS measures and the introduction of a new domestic definition of PE. A PE assessment may give rise to significant tax exposure in terms of both taxes and penalties (the minimum amount is 120 percent of the allegedly evaded tax).
In addition, omitting to file a tax return has criminal ramifications.
In contrast to the process of a regular tax audit, in the Procedure it is the foreign entity that presents to the competent office its own statement regarding legal grounds, business model, and economic analysis. This will certainly put the foreign entity in a better position than that of trying to rebut the factual and legal conclusions drawn by the tax auditors in the context of their investigations.
In the event that the procedure ends with the identification of a PE, the foreign entity is entitled to settle the corporate income tax and VAT due on the taxable basis determined during the consultation with the Cooperative Compliance Office, benefiting from penalties reduced to 20 percent (i.e., 1/6 of 120 percent of the higher taxes due).
A relief from any criminal ramifications—arising from the possible challenge of an hidden PE with consequent filing of the tax return—will also be granted, although this will be subject to the condition of full payment of the amounts agreed upon during the Procedure. In case of omitted (full or partial) payment of the sums due as a result of the assessment deed, the Italian tax authorities may assess the taxes, full penalties and related interest by the end of the fiscal year subsequent to the issuance of the settlement deed, irrespective of any expiration of the statute of limitation for tax periods included in the settlement deed.
Once the payment is made, the foreign entity’s PE may autonomously decide to access the cooperative compliance regime implemented in Italy by Legislative Decree no. 128/2015, irrespective of the thresholds currently provided by the above-mentioned legislation.
The cooperative compliance regime is aimed at promoting reinforced forms of dialogue and cooperation between the tax authorities and taxpayers having already put in place a tax control framework, i.e., a mechanism of detection, measurement, management and control of ‘‘tax risk’’, where ‘‘tax risk’’ is defined as the risk of managing an undertaking in violation of tax rules or diverging from the aims and principles of the tax system. A new relationship with the Italian tax administration will continue, based on principles of dialogue, transparency and cooperation.
On the other hand, in the case of a negative PE assessment, the business model of the foreign entity is secure from any possible subsequent tax audit (to the extent that the legal facts represented by the foreign entity to the Revenue Agency in the Procedure do not change).
Risks and Benefits of the Procedure
Irrespective of the actual subjective and quantitative requirements, it is worth noting that the Procedure is designed for those foreign entities that may be subject to audit in Italy on a possible PE assessment based on their business model, the activity carried out in Italy and also through other affiliate entities. The development of the notion of PE (the “significant economic presence”) at a global level and the approach generally taken by the Italian Revenue Agency in tax audits is certainly an incentive to consider entering the Procedure.
Therefore, if foreign entities believe that there might be the risk that an audit may lead to a PE assessment, this provision offers an opportunity to anticipate any discussion with the Revenue Agency in a context of open dialogue.
The decision to explore the Procedure also implies the possibility for the multinational group to revise the business model and functions performed in Italy, and eventually, the “supporting activities” performed by the affiliate company.
As mentioned above, the analysis of the affiliate company’s role will be based on a holistic approach, taking into account the activity performed globally and the combination of the functions performed by one or more entities belonging to the same multinational group, the direct/indirect economic link allegedly existent between the activity performed by affiliate companies, and the revenues generated in Italy by the multinational group.
It is clear that reference to affiliate companies is made in order to avoid fragmentation of operations among multiple group entities in order to qualify for the exceptions to PE status for preparatory and affiliate activities, in line with the notion of PE in the provisions of Italian law and at BEPS level.
The exercise will not be straightforward and attention should be paid to the functions actually attributable to the hidden PE.
The Procedure can lead to a determination of a taxable basis attributable to the PE for both corporate income taxes and VAT, even though the concept of PE from a VAT perspective will have to be accurately evaluated, since it is not necessarily the case that a PE for corporate income tax purposes implies a PE for VAT purposes.
Moreover, the Regulations clearly indicate that in case of a negative assessment for a PE, the analysis might be pursued with a different competent tax office focused only on transfer pricing issues. Therefore, multinational companies which intend to explore the Procedure have to be prepared to defend and, eventually, review their transfer pricing policy, in case attention moves onto this aspect in the course, or at the end, of the procedure.
In conclusion, the new provisions on PE assessment and access to the cooperative compliance regime may represent an opportunity for multinational companies with a presence in Italy, aimed at removing uncertainty relating to their current business models and the risk of tough audits. The discussion on the existence of a PE in Italy will be played out in a context different from that of an audit or settlement proceeding, where the interest of the players are different (e.g. defense of business model v. cash interest).
The Regulations have clarified some point of concerns which had remained unclear for two years, in particular in respect of the relevant office of the Italian tax administration in charge of the PE assessment and the coordination activity in the same administration in the case of audits in progress.
On the other hand, the Regulations open the door to other, possible “sensitive” aspects, in particular in respect of the interference of the Procedure with ordinary activity performed in Italy by other entities, in the case of interview of employees, and access to the operating seat of other companies in Italy.
Another point of concern is the possible ramifications of the Procedure on the VAT side. The notion of PE for corporate income tax cannot automatically be applied for VAT purposes; the concept of “sufficient degree of permanence” and “suitable structure in terms of human and technical resources” being in this regard relevant from a VAT perspective, and also in light of the principles stated by the Court of Justice of the European Union.
The positive aspect is that the dialogue is open and the discussion may lead to a different conclusion on a case-by-case analysis.
Giuliana Polacco is a Counsel and Annarita De Carne is an Associate with Studio Professionale Associato a Baker & McKenzie.
The authors may be contacted at: email@example.com; firstname.lastname@example.org