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Transfer pricing methods
Which transfer pricing methods are used in your jurisdiction and what are the pros and cons of each method?
Article 4(2) of the draft Transfer Pricing Decree lists the accepted transfer pricing methods, which are consistent with those provided in the July 2017 Organisation for Economic Cooperation and Development (OECD) Transfer Pricing Guidelines:
- the comparable uncontrolled price (CUP) method;
- the resale price method;
- the cost-plus method;
- the transactional net margin method; and
- the profit split method.
Preferred methods and restrictions
Is there a hierarchy of preferred methods? Are there explicit limits or restrictions on certain methods?
Based on Article 4(1) of the draft Transfer Pricing Decree, the evaluation of controlled transactions should be made by selecting the most appropriate transfer pricing method in the specific circumstances. Consistent with the July 2017 OECD Transfer Pricing Guidelines, the draft decree states that the selection process will consider:
- the respective strengths and weaknesses of the accepted methods listed in Article 4(2);
- the appropriateness of the method considered in view of the nature and features of the controlled transaction, as determined through a functional analysis, taking into account used assets and assumed risks;
- the availability of reliable information, in particular on uncontrolled comparable transactions; and
- the degree of comparability between controlled and uncontrolled transactions, taking into account the reliability of any adjustments needed to negate the effects of any differences between them.
The draft decree softens the hierarchy of transfer pricing methods consistent with the OECD Transfer Pricing Guidelines. Based on Article 4(3), where a traditional transactional method and a transactional profit method can both be applied in light of the above criteria, the traditional transactional method is preferable. Moreover, taking into account the above criteria, where the CUP method and another transfer pricing method can both be applied, the CUP method is preferred.
According to the draft decree:
- the arm’s-length principle does not require the application of more than one transfer pricing method for a given controlled transaction;
- taxpayers can apply a method not listed in Article 4(2), provided that none of the accepted methods can be reasonably applied to valuate a controlled transaction at arm’s length and the outcome of such alternative method is consistent with that of comparable uncontrolled transactions between independent enterprises; and
- where a taxpayer has selected the transfer pricing method using the above criteria, the choice will be respected by the tax authorities and, accordingly, the assessment as to whether the controlled transactions are at arm’s length will be made by applying the chosen method.
What rules, standards and best practices should be considered when undertaking a comparability analysis?
Based on Article 3(1) of the draft Transfer Pricing Decree, an uncontrolled transaction is deemed to be comparable to a controlled transaction for transfer pricing purposes if:
- there are no significant differences in the conditions of the transactions that may affect the financial indicator to be used when applying the most appropriate method; or
- accurate comparability adjustments can be made to the conditions of the controlled transaction in order to eliminate the effects of any significant differences.
Article 3(2) of the draft decree states that, in order to assess whether two or more transactions are comparable, it is necessary to consider the relevant comparability factors, including:
- the contractual terms of the transaction;
- the functions performed by each of the parties to the transaction, considering the assets used and risks assumed;
- the characteristics of any transferred property and services provided;
- the economic circumstances of the parties and the market conditions in which they operate; and
- the business strategies pursued by the parties.
Are there any special considerations or issues specific to your jurisdiction that associated parties should bear in mind when selecting transfer pricing methods?
Transfer pricing methods should be selected in line with the criteria set out in the draft Transfer Pricing Decree (and, once released, in the final regulations) and the OECD Transfer Pricing Guidelines. In particular, the draft decree clearly endorses the OECD transfer pricing methods, selection criteria and soft hierarchy between them.
Before the amendments made by Decree 59/2017, intercompany transactions had to be evaluated based on the ‘normal value’ of the supplied goods and services, which is defined in Article 9(3) of the Income Tax Code. However, the definition is not fully consistent, at least from a legal perspective, with the OECD arm’s-length principle. Although the OECD’s guidelines were generally considered the main point of reference for Italian transfer pricing matters, there was no clear legal basis for this, which has led to the adoption of inappropriate approaches in tax audits and case law.
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