Domestic tax consolidation
Companies belonging to the same group can elect for domestic tax consolidation. This regime allows the determination of a single IRES taxable base comprised of the taxable income and losses of each of the participating entities. The tax consolidation does not operate for IRAP purposes.
Where an overall tax loss position arises, this can be carried forward and used against future consolidated taxable income. Conversely, tax losses arising in fiscal years preceding the domestic tax consolidation election can be carried forward and used only by the company to which these losses belong.
The taxable basis determined by each company participating in the tax consolidation arrangement is included in its entirety. No apportionment is made in relation to the percentage of control.
In order to validly elect the Italian domestic tax consolidation regime, the following conditions must be met:
- The consolidating entity must be an Italian tax resident company, and it must hold, directly or indirectly, more than the 50% of the share capital of the consolidated entities (so called ‘legal control’).
- This control must be in place from the beginning of the tax period for which the tax consolidation is applied for.
- All of the companies participating in the group must have the same year-end.
The consolidation arrangement operates on an elective basis. Taxpayers may select whether to be included or not, and it is not necessary for all the Italian group/sub-group companies to jointly elect for the tax consolidation.
Once the election is made, it cannot be revoked until three fiscal years have passed.
The election is also allowed to Italian 'sister' companies or PEs in Italy of foreign companies resident in EU/European Economic Area (EEA) countries with which Italy has entered into an agreement that ensures an effective exchange of information. An Italian entity should be designated to exercise the option, acting as a consolidating entity.
The election is silently renewed at the end of the three-year period.
Worldwide tax consolidation group
A worldwide tax consolidation group is available, allowing the consolidation of foreign subsidiaries.
In addition to the requirements set out for the domestic tax group system, the following conditions apply:
- The ultimate parent company must be either owned by individuals who are tax residents of Italy or listed on the Italian Stock Exchange.
- The option must be exercised for all foreign companies (under the ‘all in, all out’ principle).
Income for each company is apportioned in the tax consolidation based on the actual percentage of control exercised by the ultimate parent company that is an Italian tax resident.
A number of additional requirements need to be fulfilled in order for a worldwide tax consolidation to be operative, including a mandatory audit of the financial statements of all the foreign subsidiaries.
Once the election is made, it cannot be rescinded for five fiscal years. The option is silently renewed at the end of the related period.
Income derived from operations with non-resident corporations that directly or indirectly control the Italian entity, are controlled by the Italian entity, or are controlled by the same corporation controlling the Italian entity have to be valued on the basis of the arm’s-length nature of the goods transferred, services rendered, and services and goods received if an increase in taxable income is derived there from. Possible reductions in taxable income as a result of the arm’s-length principle are allowed:
- on the basis of mutual agreement procedures or the EU Arbitration Convention
- on the conclusion of tax audits performed under international cooperation procedures, where the results are agreed by the tax authorities involved, or
- through a specific application filed by an Italian taxpayer where a final adjustment has been made in a country that has a double tax treaty (DTT) in place with Italy that allows an acceptable level of information exchange.
Statutory rules on transfer pricing are set out in Article 110, paragraph 7, of the Italian Income Tax Code (TUIR), which has been amended, making specific reference to the arm’s-length principle. Before this amendment, the Italian Transfer Pricing Law used the concept of ‘normal value’ (valore normale) as the basis for pricing inter-company transactions. This concept was similar to the OECD arm’s-length principle, although not precisely the same and potentially open to various interpretations. The new definition formally endorses the OECD standard by providing that inter-company transactions are determined based on the ‘conditions and prices that would have been agreed in comparable circumstances between independent parties acting at arm’s length’.
Furthermore, on 14 May 2018, the Italian Ministry of Finance published a Decree providing key principles to assist implementation in the provisions contained in the revised wording of TUIR, aligning Italian transfer pricing rules with international standards, taking into account the OECD BEPS Project and the 2017 OECD Guidelines. The Decree addresses only points of principles, while the Regulation issued by the Italian Revenue Agency on 23 November 2020 (‘Provvedimento del Direttore dell’Agenzia delle Entrate’, prot. 2020/360494) includes operational and procedural guidance.
Penalty protection regime with transfer pricing documentation support
Transfer pricing rules provide for a penalty protection regime in case of transfer pricing audit, provided that the taxpayer has prepared proper documentation detailing the compliance of inter-company transactions with the arm's-length principle.
The Regulation issued by the Italian Revenue Agency on 23 November 2020, as provided for in Article 8 of the Ministerial Decree dated 14 May 2018, introduces significant and substantial changes to the rules related to the 'proper' transfer pricing documentation that shall be prepared in order to support the arm’s-length nature of the inter-company transactions, according to the Article 110, paragraph 7, of the Italian Income Tax Code, and establishes the new requirements for accessing the penalty protection regime.
The Regulation applies to transactions incurred between Italian entities and non-resident entities belonging to the same group (transfer pricing rule are not applicable to domestic transactions). No specific methods have been introduced to test the arm’s-length nature of transactions; reference is made to the OECD Guidelines and to the Decree of 14 May 2018, which is in line with OECD recommendations. An exception exists for corporations involved in on-line advertising and related ancillary activities that are required not to use cost-based indicators for transfer pricing purposes, unless an advance pricing agreement (APA) has been defined with the tax authorities on this.
Based on the transfer pricing Regulation, taxpayers can obtain penalty protection if they provide the Italian tax authorities with:
- Local File and Master File drawn up in the specific format detailed in the Regulation and in Italian language. However, the Master File can be presented in English language, as well as the information in annexes (i.e. inter-company contracts, existing unilateral and bilateral/multilateral APAs, and other tax rulings to which the local tax jurisdiction is not a party and which are related to controlled transactions described in the Local File).
- Notification that documentation has been prepared and available by checking the specific box in the annual CIT return.
- Electronic signature of the legal representative of the company (or their delegate) and timestamp to be applied to the entire documentation package by the filing of the annual corporate income tax return.
The documentation can be prepared only with reference to some of the inter-company transactions (cherry picking); in such a case, the penalty protection regime is applicable with exclusive reference to the covered operations.
In addition to Master File and Local File, a specific documentation is required as a necessary condition for applying the simplified approach for the so-called ‘low value adding services’, which has to include (i) a description of the inter-company services, (ii) related inter-company services agreements, and (iii) supporting files through which such transactions are computed. Such documentation, arguably, should also be included within the Local File for penalty protection purposes.
Documentation must be provided to the tax authority upon request, within 20 days, in the electronic format.
Transfer pricing documentation must be prepared each year on a company-by-company basis. Small and medium companies (defined as those with an annual turnover of less than EUR 50 million, with an exception made for the resident entities and PEs in Italy that are part of foreign multinational enterprise [MNE] groups; the turnover must be computed considering also the revenues of directly and/or indirectly controlling entities) can update the economic analysis only every three years, provided that the comparability analysis is based on publicly available sources and no significant change between the fiscal years have occurred. Otherwise, it is necessary to update the economic analysis each year. All the other sections of the report have to be updated each year, even for small and medium companies.
Relief from penalties is granted for both IRES and IRAP applicable to transfer pricing adjustments to taxpayers who have prepared transfer pricing documentation in line with Italian Regulation.
Advance pricing agreements (APAs)
According to Article 31-ter (entitled 'Advance agreements with businesses with an international activity') of the Presidential Decree no. 600 dated 29 September 1973, the Italian Tax Assessment code, taxpayers may apply for an APA procedure. It is possible to obtain bilateral and multilateral APAs where a double taxation agreement has been concluded by Italy and the partner states based on article 25, paragraph 3 of the OECD Model Convention. The procedure is available for companies engaged in 'international activity' and can cover transfer pricing issues, allocation of profit to PEs, dividends, the existence or otherwise of an Italian PE, royalties, and interest. In 2015, the scope of the APA has been extended to also cover the entry and exit values of assets and liabilities on change of corporate tax residence.
The agreement executed between the tax authorities and the taxpayer is binding for the fiscal year during which the agreement is executed and for the following four fiscal years and can then subsequently be renewed.
Rollback provisions are available as follows:
- For unilateral APAs, rollback is permitted for fiscal years still subject to tax audits, provided that no changes occurred to the agreed conditions and circumstances and no inspections or tax audit or administrative activities started.
- For non-unilateral APAs, rollback is permitted as of the fiscal year during which the APA request was filed with the tax authorities. However, rollback is allowed also to previous fiscal years, still subject to tax audit, provided that:
- the same factual and legal circumstances exist for these periods on the basis of the agreement stipulated with the competent authorities of foreign countries
- the taxpayer has requested the roll back in the APA request
- the competent authorities of foreign countries agree to extend the agreement to previous years, and
- no inspections or tax audits or administrative activities started in relation to these fiscal years.
Country-by-country (CbC) reporting
CbC reporting has been introduced in Italy for MNE groups with consolidated group revenues of at least EUR 750 million. With this report, any MNE group shall disclose annually and for each tax jurisdiction in which it conducts business the information set out therein.
The template of the CbC report includes:
- aggregate tax jurisdiction-wide information relating to the global allocation of the income, the taxes paid, and certain indicators of the location of economic activity among tax jurisdictions in which the MNE group operates (Table 1)
- a listing of all the relevant entities for which financial information is reported, including their jurisdiction of tax residence and incorporation (if different) and their main business activity (Table 2), and
- additional information that may be useful to understand the mandatory information provided in the CbC report (Table 3).
The group entity responsible for the submission of the CbC report is the ultimate parent entity. However, where some conditions are met, the report shall be submitted by the entities resident in Italy for tax purposes.
Penalties are levied in case of missed or untrue communication (penalties can range from EUR 10,000 to EUR 50,000).
The CbC report shall be filed within 12 months of the last day of the reporting fiscal year of the MNE group. Moreover, the deadline for the notification of the CbC status to the Italian tax authorities is within the deadline for the submission of the income tax return.
Italy no longer has thin capitalisation rules per se. Instead, net interest expense is deductible only up to an amount equal to 30% of gross operating margin (see Interest expense in the Deductions section for more information).
Controlled foreign companies (CFCs)
An Italian company that controls, either directly or indirectly, a foreign enterprise, company, or other entity is required to consolidate the taxable income arising in proportion to the percentage of shareholding held, irrespective of whether the profits have been distributed or not.
Income from CFCs is taxed separately from the other taxable income of the business at the standard IRES rate (i.e. other tax losses cannot be used to offset CFC income). Foreign taxes paid by the CFCs are recoverable by way of a corresponding tax credit.
Dividends received by an Italian shareholder from a CFC are excluded from taxable income up to the amount of the taxable income attributed under the above CFC provisions. The excess of any dividends over income already included through the CFC regime is fully taxable in the hands of the shareholder.
Exemption from CFC rules can be achieved by means of an advance ruling from the Italian tax authorities showing that the CFC entity carries on a substantive economic activity by using employees, equipment, assets, and premises.
The CFC rules apply to controlled companies that jointly meet the following conditions:
- The effective tax rate is less than 50% of the effective tax rate that such companies would apply if they were resident in Italy.
- More than 1/3 of the revenues derive from passive income including those deriving from trading goods and supplying services to associated enterprises with no or low economic value.