Antonello Lupo Giuseppe Battaglia January 14 2010 Google Italy Faces Tax Investigation: A Threat to the Internet Business Model? Portolano Cavallo Studio Legale | E-commerce - Italy Antonello Lupo, Giuseppe Battaglia E-commerce IntroductionFactsImplicationsCommentIntroductionAccording to recent press reports, the Guardia di Finanza, Italy's tax police, has been investigating the directors of Google Italy for a €50 million tax evasion. The investigation reportedly turns on whether the internet search company's subsidiary can be considered an undisclosed permanent establishment of its Irish parent company.Although the Milan Public Prosecutor's Office will not pursue criminal charges, the tax authorities may launch their own assessment on the basis of the investigation. Future developments could have much wider implications for the e-commerce sector. Google's business and marketing model is common to many other internet companies and a decision against Google Italy could adversely affect other companies with similar operating structures. FactsThe investigation is believed to relate to the recharacterization of Google Italy as a permanent establishment of its parent company.The subsidiary renders marketing services to its Irish parent company and is remunerated on a cost-plus basis with an 8% mark-up. The subsidiary's manager has reportedly issued a declaration to the tax police which states that it negotiated advertising contracts between the parent company and the latter's Italian clients, the parent company's involvement being limited to signing contracts that had been negotiated by the subsidiary and signed by the client.Article 162(6) of the Income Tax Code provides that a resident or non-resident entity which habitually concludes contracts (other than purchase contracts) in Italy in the name of a non-resident enterprise is considered the permanent establishment of the latter.(1) Moreover, the Supreme Court has held that: (i) participation in contract negotiations can be construed as an activity entailing the presence of a permanent establishment; and (ii) a contract is deemed to be concluded by an agent if it is negotiated by the agent and merely signed by the principal.(2) ImplicationsThe investigation may represent a significant indication of the tax authorities' approach to the business models of multinational corporations in the field of e-commerce. Internet companies can operate in almost any jurisdiction with little or no need for a physical presence, thus potentially eroding the taxation rights of national authorities. Many internet companies use structures which are similar, if not identical, to that under investigation in this case. Local subsidiaries are engaged - to varying degrees - in the marketing of the website and the sale of online advertising space. The website is owned by another group entity, which collects the revenues from all sales in all countries in which the website operates; in return, the local subsidiaries receive a fee from that entity. A similar model is used in the television industry: some satellite television channels operate from a central base, with local subsidiaries selling advertising space on the channel to local clients on behalf of a central entity. However, determining whether the investigation heralds a serious threat to other e-commerce operators will depend not only on an analysis of the company's structure, but also on the way in which operations are carried out in practice. For example, one internet company may use a local marketing team for the general promotion of its website, whereas another may also give its marketing team responsibility for other roles, such as surveying the market to identify prospective clients.Comment The outcome of the investigation will offer a significant precedent for the tax authorities' assessment of multinational internet companies and their business models. If the tax authorities successfully challenge the subsidiary's tax position in this case, it will affect the way in which foreign companies structure their Italian operations, particularly in light of an increasingly aggressive approach to permanent establishments and intra-group transfer pricing. Multinational companies, especially those operating in the fields of television and the Internet, would be well advised to follow the dispute closely. Internet companies with a similar business model should consider whether pre-emptive tax-structuring changes could minimize the impact of an adverse outcome for Google Italy.For further information on this topic please contact Antonello Lupo or Giuseppe Battaglia at Portolano Colella Cavallo Studio Legale by telephone (+39 066 976 541), fax (+39 066 976 544) or email ([email protected] or [email protected]).Endnotes(1) This article is in line with Article 4(4) of the Double Tax Convention between the countries, which provides that a person acting in Italy on behalf of an enterprise in Ireland, other than an agent of independent status "shall be deemed to be a permanent establishment in [Italy] if [that person] has, and habitually exercises in [Italy], an authority to conclude contracts in the name of the enterprise, unless his activities are limited to the purchase of goods or merchandise for the enterprise".(2) The Philip Morris Case, Decision 7682, May 25 2002.