Documentation for “low value-adding services”

Defining “low value-adding services”

Para. 1, art. 7 of the Ministerial Decree provides for that, in order to evaluate an intercompany transaction consisting of the provision of low value-adding services, in compliance with the arm’s length principle, taxpayers are allowed to adopt a “simplified approach”. This consists in the aggregation of direct and indirect costs related to the provision of the service(s), adding a profit margin equal to 5% of said costs.

Art. 7 of the Ministerial Decree defines “low value-adding services” as those services which (i) have a support nature, (ii) are not part of the core business of the multinational group, (iii) do not require the use of intangible assets, and (iv) do not contribute to the creation of assets, or (v) do not imply the assumption or control of a significant risk for the service providing entity. The norm further provides for that services rendered by a multinational group to third parties cannot be considered as low value-adding services.

The norm is derived directly from the latest version of the OECD Guidelines dated July 2017, which the Decree refers to for interpretation reasons.

As concerns low value-adding services, the abovementioned OECD Guidelines contain a list of services which cannot be considered as such, i.e.:

• services which represent the group’s core business;
• research & development services;
• production services;
• purchasing of manufacturing or production material;
• sales, marketing and distribution services;
• financial transactions;
• mining, exploration and natural resources management services;
• insurance and reinsurance services;
• corporate senior management services.

On the contrary, the same OECD Guidelines clarify that the following activities can qualify as low value-adding services:

• accounting and auditing;
• management of credit and debit accounts;
• human resources activities;
• sourcing of data relevant to health, safety, environmental and other standards necessary for the company;
• IT services, provided that they do not represent the group’s core business;
• external communication and public relations services;
• legal services;
• activities related to tax fulfilments;
• general administrative or clerical services.

For the sake of completeness, we specify that the latest version of the 2017 UN Draft Manual on Transfer Pricing - international best practice reference for transactions with entities resident in developing countries - is wholly aligned with the OECD Guidelines as concerns low value-adding services.

The norms contained in the Provvedimento

In order to benefit from the so-called “simplified approach” for the purposes of the documentation needed for low value-adding services, the Provvedimento requires the preparations of an ad-hoc document (hereinafter, “LVAD Report”) containing specific paragraphs, in addition to the Masterfile and Local File. We specify that the introduction of the LVAD Report was already planned, since the same art. 7 of Ministerial Decree made reference to a “specific documentation” in order to be able to adopt the so-called simplified approach.

In particular, under point 7, the Provvedimento provides for that the LVAD Report include the following sections:

1. Description of intercompany services. This section must contain a description of the categories of intercompany low value-adding services rendered, specifying for each service category: the identity of the beneficiaries; the reasons for which such services are considered as low value-adding in compliance with art. 7 of the Decree of the Minister of Economics and Finance dated 14 may 2018; the reasons underlying the provision of services within the multinational group; the benefits attained or expected; the income allocation criteria selected and the reasons for which said criteria are deemed to produce results which reasonably reflect the benefits attained. Moreover, a confirmation of the profit margin applied also needs to be provided;
2. Contracts relevant to the provision of services. This section must contain the contracts or written agreements for the provision of low value-adding services and the relevant amendments, showing that the parties involved agree on the application of the chosen income allocation criteria. Said contracts or written agreements can also be represented by contextual documents relevant to the period under analysis, identifying the parties involved, identifying and describing the nature of the services and the contractual terms based on which said services are provided;
3. Valorisation of the transactions. This section must contain evidence and an explanation of the calculation supporting the determination of the aggregated direct and indirect costs related to the provision of the service and the profit margin applied, with a detailed representation of all categories and all amounts of relevant costs, including costs relevant to every service provided exclusively to a sole entity of the multinational group;
4. Calculations. This section must include, also through annexed spreadsheets, calculations demonstrating the application of the allocation criteria indicated in section 1.

The submission of the LVAS Report is subject to the terms under point 5.2 of the Provvedimento (i.e. within and no later than 20 days from the relevant request by the Tax Authorities).

It is not clear whether the LVAS Report is also subject to time stamp duties, pursuant to art. 5.1.2 of the Provvedimento. Further clarifications are awaited on this point, to be contained in a Circular Letter to be issued by the Italian Revenue Office.

It is worth recalling that point 5.3.3 of the Provvedimento provides for that “(…) the document should be considered adequate in all cases in which it provides the Tax Authorities with all data and information necessary to carry out an analysis of the conditions and of transfer prices applied (…)”. This general provision should also apply to the LVAS Report, in order for this to entitle to the application of the penalty protection regime, similarly to the Local File and Masterfile.

Closing remarks

First of all, it is important to notice the legislator’s focus on intercompany services.

This transactions could, in some cases, not be immediately recognisable, thus the need of adequate documentary evidence in order to avoid abusive practices. The ratio underlying the provisions on intercompany services is therefore the avoidance of transactions characterised by payments which do not correspond to services actually rendered, or for which no actual benefit is obtained by the recipient (this also with reference to the so-called shareholder activities, i.e. services for which charges are considered non-deductible).

In practice, in case of a tax audit, the submission of invoices as evidence of the provision of a service, without supporting contracts or spreadsheets, is often interpreted as a lack by the taxpayer.

Opting for the adoption of the so-called “simplified approach” for low value-adding services allows taxpayers to be relieved from the obligation to carry out an economic analysis aimed demonstrating that their valorisation complies with the arm’s length principle: should the conditions under art. 7 of the Ministerial Decree be complied with, upon the preparation of a LVAS Report, compliance of the transaction with the provisions of art. 10, para. 7 of the TUIR (Consolidated Text on Income Tax) is thus always recognised ex lege.

The provisions contained in art. 7 of the Ministerial Decree are thus to be considered as a safe harbour in our legislation. Nonetheless, it is also necessary to consider that since this clause originates directly from the 2017 OECD Guidelines, the provisions contained in the domestic norm under art. 7 of the Ministerial Decree have similarly been adopted by the tax administrations of all OECD member states.

Therefore, the reporting of a transaction involving low value-adding services for DAC6 purposes (a directive recently implemented in the Italian legislation) is not an applicable option, since such safe harbour is certainly characterised by “mutuality” between the tax administrations involved, which represents an exemption from reporting purposes.

Moreover, it is clear that considering the above as a “simplified approach” is misleading, as it clearly does not help simplifying: by adopting such approach, which is optional for the purposes of the supporting documentation regime, taxpayers have the further obligation to prepare a copious and in-depth documentation for a sole type of transaction, in addition to the certain obligation of preparing the Masterfile and Local File.

It is worth underlining that low value-adding services have been strictly analysed by the domestic Tax Authorities.

The provisions under art. 7 of the Ministerial Decree also apply to controlled foreign companies ex art. 167, para 4 of the TUIR. Furthermore, it is worth considering that, in case of payments for this kind of services, the transaction is in any case subject to the more general clause contained under art. 109, para. 5 of the TUIR concerning the concept of relevance, for the purposes of the deductibility of the cost from the domestic taxable base.

To this end, the information required to be included in section 1 of the LVAS Report need to include a qualitative description of the service, describing the benefits expected by the recipient.

In any case, the paragraph relevant to the expected benefits under section 1 is aligned to the so-called benefit test under OECD Guidelines, para. 7.6 and following paragraphs.

Such test usually implies an effort from taxpayers in terms of a careful analysis of the business carried out by the recipient of the service and a description of its organisational structure for the purpose of demonstrating the actual need of purchasing the low value-adding service from the foreign related company. This amount of information contributes to provide evidence of the cost deductibility, as well as of the compliance with the arm’s length principle ex art. 110, para. 7 of the TUIR.

In conclusion, it is not surprising that the specific documentation required for low value-added services, to be drafted pursuant to the indications of the Provvedimento, can be of help also for other purposes beyond the documentary obligations required for transfer pricing purposes.

For further information, please contact Valerio Palmese.