Tax Law
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Tax Law
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Lesson 1
Taxes are the income of states, and they let the states work. Three main categories: 1. Penalties and Fines 2. Contractual Activities 3. Tax (main source) The number one includes some amount of money to pay because of something against the law. The second category talks about the State’s industry and some privatization and also bond contract. The last is the most important and it could be divided in other three categories: A. Imposte: is due in case that an individual shows the ability to pay B. Tasse: paid for services that the State gives us C. Contributi: to pay for the building of infrastructures that give us benefits Some topic that we could find in the first category: Tax on income: ability to pay tax about income, both personal and factory income VAT (value at the tax): when there is a consumption of goods or services, its regulated by European Legislation Inheritance tax: tax on some money or goods that you receive from a dead person Gift tax: you receive money (donation) Transfer tax: tax on moving properties to one state to another Customs duty: tax that you have to pay when a foreign good enter in another state passing the board. In Europe there are uniform rules about customs (free circulation of goods and people) Excises: (Spirits, fuel, cigarettes), usually applies to goods that are used a lot or in order to disallowed some goods (dangerous items). Wealth tax: is a tax on your wealth, it’s applied on the ability to have some assets In Italy we have three main important articles regarding tax. Art. 23 of Italian constitution: Principle of legality: “No tax can be imposed if it doesn’t have a legal basis”, so if the parliament doesn’t approve it. Art. 53 of Italian constitution: Principle of ability to pay: “Tax can not be apply if there isn’t an ability to pay”, ability to pay means have an economic strength. For example if my company has a loss, I don’t have the ability to pay. It doesn’t regard to tasse because they are linked to service that I received. So thanks to this article under a certain level of money (vital minum standard) there is a NO TAX AREA, in which you don’t have to pay tax. The second paragraph of article 53 also says that tax system has to be built with progressive system. In the proportional system there is a fixed Tax rate and you pay proportionally on your amount of income. In the progressive system (regarded to the principle of ability to pay) there is some “step” and at the beginning a No tax area; the progressive system is the first effect of the principle ability to pay. Example of progressive system: We have 5 different steps. 1= 0-20, 2= 21-40 3= 41-70 4= 71-100 5= 100.000<
I have a total income for 150.000€ Steps 0-20.000 21.000-40.000 41.000-70.000 71.000-100.000 100.000< I have to pay a total amount of 53.000€!
% 15 20 30 40 50
Amount 3000 4000 9000 12000 25000
Second effect: No retroactivity, if there is a new taxes you will pay it only since that moment and in the future. Third effect: implies that in case of tax there is the presumption of ability to pay, but you could demonstrate the contrary. Art. 75 of the Italian constitution: for some topic is not allowed referendum. In fact it is no possible to have a referendum regarding tax. Taxes, custom duties and excises are regulated also by European Union laws, for example if a European citizen wants to leave his country he should pay the leaving tax, but this tax it is against European laws because it is against the freedom of moving of goods and people.
Lesson 2
First of all we have to find out who has to pay taxes. In order to decide if someone could be considered a taxpayer we have three questions: Who? So focus on individual (subjective requirement) What? So focus on which profit or income is taxable (objective requirement) Where? So focus on place (territoriality) If situation has the answer at all these three questions the tax could be applied. 1. Definition of taxpayer: who is liable to tax, so the company/individual/entity liable to tax, it means to provide some administrative requirements. 2. Determinate the taxable basis: we can use two methods, as we saw before, the progressive and the proportional one. The parents in a family are considered as two different taxpayers or as single one? Under the progressive system the parents are considered as a single unit otherwise the no tax area is doubled. In the most of case for individual we use the progressive system, instead for entities the proportional one. If I’m the owner of entities I prefer to be taxed as an individual or as an entities? It is preferable to be taxed as entities because in this way I could reinvest the money in the entities without other taxes, instead if I’m taxed as individual I have to pay taxes also on the reinvestment.
Lesson 3
Amortization: is related to tangible assets, divided in: Fixed assets (more than one year), and current assets (less one year). Depreciation: is related to intangible assets. Both amortization and depreciation split the costs of assets equally in different years. But I don’t care of the revenues, I’m interest in net income, so the objective requirement is the taxable income. Two systems in order to identify taxable income: 1. Global system: any increase of wealth and income is under taxation, and there is one single tax rate for all income. 2. Schedular system: we can divide the income in different basket:
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Employment income Income from real estate Income from capital Business income Professional income Other income Each category has a different set of rules and some has also different tax rate. Gift: The gift is taxable also in the hand of the donee that in the hand of donator, but in order to avoid double taxation on the same income the donator could deduct the tax paid on the gift. The problem is that in the progressive system with this method the splitting/shifting of the income is encouraged in order to avoid tax, because in this way we can lower the tax rate. For this reason every type of income (also gift) related to employment relationship are taxable. The gift and the other present are taxed at the fair market value; there are some exceptions for example in Italy under a certain level the employer could give some gift or goods for free (but he has to produce them on your own).
Lesson 4
Which type of income could be taxed? For example if an employee is fired and so he receives some money as refund, this amount of money should be taxed? It could be a substitution of salary so in scheduler system it could put in employment income so it is taxable, but it could be considered as an damaged compensation, and so it isn’t taxable. So for the occasional income: In the global system you have to check if there is an increase of wealth and check what the law says about it. In the scheduler system you have to check if it could be put in one categories and also check what the law says. Taxable income under the scheduler system: Business income: characteristics: organized and not occasional. All the incomes coming on this organized system are considered business income. I can find the taxable income in the balance sheet of the company. The problem is to verify if the all expenses are really related to the activity business and so deductible, because if the expenses are not related to the business activity they aren’t deductible. Employment income: salary and tax is calculated on the gross salary, here we don’t have deduction because employee doesn’t have expenses for his work. Sometimes we have some for fait deduction. Income from profession: we have the same problem of business income, we have to check if expenses are related to the professional activity or if they are personal expenses and so non-deductible. In some cases there are some deduction that don’t depend on source of income but they depend on subjective position. We have two ways in order to recuperate the some expenses: 1. Tax credit: tax credit is on the tax liability, so it not depends on the tax rate. 2. Deduction: tax deduction applies on income and so it depends on the tax rate. In the progressive system is preferable tax credit because it is independent from the tax rate. If I’m under a global system and my I have a loss as a company I can offset the total amount of income.
For example, as a company I have a loss of -500€, but thanks other income I have a total amount for 1600€. In this case I can offset the total amount so: 1600-500=1100, and this is ma taxable income, on which I will apply my tax rate. If I’m under a scheduler system my loss doesn’t offset the total amount of the other income, but it will offset the income of the next year. Example: year 1: -500€ so zero tax; year 2: 1000€ so here: 1000-500=500 and at this amount I will apply my tax rate.
Lesson 5
Tax Avoidance ≠ Tax Fraud and Tax Evasion Tax Evasion: when you lie to the State. You have an income for 1000€ but you record an income for 800€; or you record the right amount but at the end of the year you say to the State that you don’t have enough money to pay tax. Tax Fraud: You lie also in this case to the State, but using false documents. For example: There is a company in Italy it has revenues for 10 million and operative costs for 6 million, but it writes in the balance sheet a service cost for 3,5 million received by an a Bermuda company (under my control or something like that) so ma taxable income is 500.000 and not 4 million. Tax Avoidance: Active behaviour, it doesn’t imply false documents. You formally take some step thanks that you could avoid some tax or take down your total taxable income. Example: Company A has three important businesses and company B wants to buy one of that business, so A create a company C, which is now the owner of the business, and B will buy the business directly to C, in this way B avoid transfer tax. We can see also the case of Interposition; it is the Maradona’s case: He was a football player for Napoli F.C. and he has to pay Italian tax, but he set up a company in Jersey and he gives it all his imagine right; so his salary from Napoli is split between the player and this company, he avoids tax on part of his salary. This company is an interposition of Maradona. In Italy tax avoidance was treated by law only in a few particular case (Art.23). In the 2005 change the approach to avoidance, thanks to General ant-abuse principle: tax authority could attack any transaction that could give you some tax advantages, even if there isn’t a legal provision dealing with type of transaction. Could this be an abuse of law? Because maybe the State declares as avoidance behaviour a transaction that seems against law but there isn’t the certain, so maybe against the principle of certainty. Now the abuse of law is regulated, in fact the Supreme Court said that it isn’t abuse of law because it is based on the Art.53, so avoidance behaviour can be taxed. A company can ask previously if one transaction could be considered abusive behaviour or not and if the answer is negative the transaction is protected to future issue. Following the Art.25 if the transaction happened before the 2005 it could not be punished, if it happened after the 2005 it could be punished. Example D&G Dolce and Gabbana have a royalties’ income coming from the D&G S.P.A. on which they pay tax and the D&G S.P.A deduct the 30% of this cost, but year-by-year they transfer part of the trademark to a company in Luxemburg started by them. So in this way they continue to deduct the cost but pay less tax transferring the trademark in Luxemburg.
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For the State this is a case of avoidance otherwise the D&G should prove to have an economic reason to do that. International Avoidance Treaty shopping: Italian company has to pay the royalty to an Us company so it gives 100 to Us, but 15 are for taxes, so the Us starts another company in Hungary where the tax rate is lower, so Italy pays always 100 but only 5 (thanks to treaty) in tax and thanks to the treaty between Hungary and USA 0% so 95 to Us company. This thing is legal only if the Hungarian company is the beneficial owner. Beneficial owner means: to have the legal right to obtain the income and also use it and not transfer it to another company. Costs to tax heaven: Cost occurred in a tax heaven State are suspicious, they could be false and done only to reduce the taxable income. The law provides that every cost paid to heaven countries are only under some characteristic: 1) Heaven company has to have a real structure 2) There is economic interest. I have to prove one of these in order to deduct the cost. Controller Foreign Company Legislation: Italian company holds 60% of Ch company, the problem here is that Italian company could decide to not distribute the CH’s dividends and so it doesn’t pay tax on that, so for law consider the income of the Ch company as an a direct income of the Italian company for the 60%, in this way Italian company pay tax every year (tax deferral). Exception: 1) Ch company has real structure 2) The structure doesn’t lead tax advantage, for example it is in a State with higher tax rate. Foreign residence company: Company A wants to sell company B, but it wants to avoid tax on capital gains so it creates company C in Luxemburg (because the favourite condition on capital gains), it sells B to C and after C sells to the buyer. In this situation C is presumed to be residence in Italy (watching at the control), and also if the majority of main manager are Italian it is presumed that it is residence in Italy.
Lesson 6
The costs of fixed assets could be split during different years, so for example there is no problem with machinery because it is treated as fixed assets. We could have problem with some other costs as Research costs: because if I consider it as an intangible fixed asset I can split the cost in different year and it rises my profits or I could consider it as a cost so put in one year and it lowers my profits. Tax-exempt income: an income could be exempted in order to avoid double taxation or because it isn’t include in no category. Double taxation: 1. Economic: same income is subjected to tax twice in the hands of two different taxpayers (dividends). 2. Juridical: same income is subjected to tax twice in the hands of one single taxpayer (cross boarder transaction). Dividends in Italy: the 95% of dividends is not taxable the 5% is taxable because in Italy it is allowed to deduct expenses related to dividends but not all are really related to dividends so I pay this 5% for fait taxation in order to repay the wrong deduction. If I have to pay interest on a loan but I use this amount of money in something that could give me tax-exempt income, I can’t deduct the interest expenses (otherwise I will have at the same amount of money one deduction and also an exemption). Accounting is important because is strictly related to tax thanks time, because the accounting period is different to the tax one.
Cash Method: in the cash method for deduction is important the moment in which you pay. Accrual Method: for deduction is important the amount used during the year. We should use the accrual method when we have an accounting system, otherwise is difficult to follow that method. Cash method is better for the individual income and individual categories. Director case: If my company pay 10 million to his director as his salary, but it doesn’t give him the money so in the balance sheet I have a deduction of my profit thanks this cost. When in the future I will pay it that amount of money will be taxed, and if he will refuse the money, the 10 million will be budgeted as an extraordinary income and so taxed at the same.
Lesson 7
When there are cases of double taxation we have three solutions, and in all the three methods we have two different level of taxation, one is at the company level the other is at the individual level. 1. Classical: company level: income 100€, Cit (corporate income tax) 30% so tax=30€, income after tax=70€; the individual receives his dividends, so at individual level: taxable income 70€, Iit (individual income tax) 50% so tax=35€, so Net income=35€. In this example the effective tax rate applied is 65%. This method is usually applied at dividends coming from countries in the black list. 2. Exemption: company level: income 100€, Cit 30% so tax=30€ and the income after tax=70€, the individual receives the dividends so at individual level: taxable income=0 because in the full exemption method the dividends are exempted, so Iit 50% and tax=0, so Net income 70€. Effective tax rate applied is 30%, which is the company tax rate. 3. Imputation: company level: income 100€, Cit 30% so tax=30€ and income after tax=70€; the individual receives dividends, so at individual level: taxable income=70+30, because I have to gross up for the amount of tax already paid at company level tot=100€, Iit 50% so tax=50€ but I have a credit vs tax authority for 30€ (amount equal at the tax paid by company) so tax=50-30=20€, Net income=7020=50€. Effective tax rate applied is 50%, and the effective tax rate is equal to Iit. The imputation method has some problem at international level, in fact if the company is abroad it is difficult receive the credit, the two States have to have an agreement and also both using the imputation method. So the different countries modified in some cases the imputation method in exemption method. For example in Italy on dividends, if you have a qualified participation, at the second level as a company you are exempted for 95% and Cit 25% as individual 50% and Iit 50%. Instead if you have a non-qualified participation you are not exempted and your Iit is 20%. This in order to simplify the rules and also it is to incentive the investments in companies.
Lesson 8
World Wide Taxation Principle: Most of the states in the world tax the residence people on all your income and also the foreign people on income maturated in the State. The double residency it is another case of International double taxation (juridical). If an individual works in State A but his family live in State B (so centre of vital interests) in which way he has to pay the taxes?
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State B will tax all income and the State A will tax only the income maturated there. Only for a few states, as USA and Philippines, citizenship is very important in tax issue. In fact if an individual has an US citizenship but he is residence in Italy, both State would want to tax all income. This is a case of issue between Citizenship and Residency. So we have four cases: conflict of jurisdiction, double residency, issue between citizenship and residency and succession tax. International double taxation convention: it is a bilateral international treaty in order to avoid international double taxation. OECD did this treaty. 1. Some provisions prohibit states to tax the income coming from individual or company not resident in that state, but it could be taxed only by the state of residency. Example: a company is residence in State A but it has some income coming from State B (but without having permanent establishment), in this case the income could be tax only by State A. 1.1. Provisions on capital gains on sale of shares: company X, residence in State A, wants to sell company Y (located in State B) to a third company, the capital gains coming out this transaction could be tax only by the State of residency (Marzotto’s case). 2. Provisions establishing some limitation to the taxation power of the State of source. These provisions concern: dividends, interests and royalties. Example: company of State A holds a company in State B (100%) and so it receives dividend, which is going to be taxed in the State A of residency, but also in the State B of source at maximum at 10%. 3. Provisions fully allow taxation by State of source. These provisions apply to real estate, permanent establishment and employment income. For these cases the all income is taxed only in the resident State but the income arising from different State could be fully taxed also in that State. In the second and third cases there is a mechanism in order to avoid double taxation, it is the Foreign Tax Credit that is a credit for the taxes paid abroad against the resident taxes on the same income. We have two systems: 1 Credit System (classical): Company in State A has a factory in State B. The company has income for 5000 and in State A it pays tax on all income, tax rate 33%, so tax=1650. 1000 coming from the factory in State B, son also there it pays tax on 1000, tax rate 40%, so tax in B=400. Having paid taxes also in B, the company has the right to have a credit against A, so it can lower that amount from the taxes of A, but I can deduct the taxes applying at 1000 the tax rate of A so=330. At the end it pays 400 in B and 1320 in A. This method is convenient if the tax rate of resident country is higher than the tax rate of source State, so I can deduct the all taxes paid. 2 Exemption System: the same example but at this time I consider only 5000-1000=4000 as income for the State A and at that amount I apply the tax rate 33%, tax=1320. In the State B the situation remain the same so I have 1000, tax rate 40% I pay 400. It is convenient if the source State is a tax heaven one or it has a lower tax rate. The problem is to determine the State of residence. Individual: 1. Formal criteria: registration 2. Substantial criteria: residence, spends time (more than 180 days) and domicile (center of vital interests/family).
The proceeding: 1) Formal criteria, if no formal criteria 2) Permanent situation, 3) Centre of vital interests, 4) Place where he spends more time, 5) Citizenship and 6) Two states try to find a solution. Companies: 1. Formal criteria: legal seat 2. Substantial criteria: core business and place of management. The most important is the place of management.
Lesson 9
Partnership: Entrepreneur entities made on individual, here we have completely separation between individual and capital, but at least one individual has unlimited responsibility with his private patrimony on company’s liabilities. Most the times tax authorities use a transparent method for tax, so they taxed the partner, because there aren’t dividends and so the profit goes directly to partner. Italian system: tax applied on the partnership but after allocated as business income to the partners, so no distinction between dividends and other income coming from partnership. Other system: the incomes from partnership are not allocated at the partner all together but separately, maintaining the separation. If I’m Italian and I have a qualified partnership in a UK company: in Italy the incomes from partnership are treated as business income (so not transparent) and in the case that I have some dividends they are taxed in UK 50% and in Italy 20%, so I pay withholding tax and so that dividends don’t go into the tax return and I don’t have tax credit. Companies could finance themselves recurring on Debt or Equity. The differences: Debt: passive interest, deductible (passive interest), repayment of capital and it is granted. Equity: dividends, non-deductible, repayment of capital less flexible and not granted. So we have the Thin Capitalization Rules, stating about D/E ratio, which tries to increase the capitalization of companies. Example: if your company has D/E ratio higher than X, the passive interest that exceed that limit they will not be deductible. In EU more rigid: you cannot deduct passive interests for more than 30% of your gross income, in order to avoid tax avoidance and also to have more solid companies with a good D/e ratio. Companies’ reorganizations: if my company has a field bought at 100, but now I can built on it so it’s value increase, I should pay tax on this increase of value? For the interpretation rules I have to appreciate it (so pay tax) but it is very difficult to follow the change of value every year; instead for conservative I have to appreciate it only if I realized this increase of value. Taxable purpose: tax on the acquisition value and when I sell it I will pay tax on the capital gain. Realization events: when the assets go out the company. In the merge: you could say it is a realization event because the old company doesn’t exist anymore and the accounting books show it. But someone could say that it is an incorporation event so the old company still exists substantially. You will pay tax when you sell it, maybe for civil purpose you don’t have profit, but for tax purpose you have it.
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Example: we have one individual who has shares of company A paid 10 but now fair value 40, and a second one who has shares of company B paid 20 but now fair value 40. They merge the two companies so the fair value of the new shares is 80. They have two solutions: 1. They change the old shares with the new with the higher value, and so they pay tax now. 2. They maintain the old shares and when they sell the shares and so they will pay tax on the gain between the acquisition value and the realization value (fair value). This because the state wants to give me the possibility to reorganize my company in the best way for my business, this method is called rolling overtax, it is allowed only for some type of transactions. For example the EU’s companies can restructure themselves (merge) without paying tax because it is a good thing for market.
Lesson 10
Permanent establishment: I’m taxed on my income coming abroad if in that country I have a permanent establishment. Italy has a lot of treaty but with some states there isn’t so it is useful to have a domestic definition. If a Netherlands company has maritime broken in Genova, under the treaty the maritime broken is considered as permanent establishment and so Italy can tax income coming from maritime broken in Genova. But for Italian domestic law the maritime broken isn’t a permanent establishment, so? In general the treaty prevails to domestic law if it avoid the double taxation, if it doesn’t avoid double taxation and the domestic law instead do it so I apply the domestic law. General definition of permanent establishment: fixed place of business through which the business of an enterprise is fully or in part carry out. In order to define something as a permanent establishment you need four elements (all the four elements): 1. Place of business (existence): physical place, it isn’t necessary the presents of people and employee (ex coffee machine), or if the server of e-commerce is in the country it is considered as permanent establishment. It is irrelevant the owner and the tittle, it is important that I use it; and also it is not important the exclusive using of the place (ex office hotel). 2. Fixed business: Permanency: if you use a building one year in a country it is considered as a permanent establishment (in Italy three months). There is a general rule, “rule of time”, if you have a seaside bath and you use it only 4 months per year, but It stay all year in Italy it is considered as a permanent establishment (in order to look at seasonal business). 3. Fixed business: Geographical link: identifiable in a particular place, issue with the business with the mobile place. So businesses on the road are considered as permanent establishment because there are a commercial and geographical coherence. For boat is more complicated, it isn’t a permanent establishment if there is a geographical link (ex boat between Alaska and San Francisco). 4. Business relationship: between foreign enterprise and office: the permanent establishment doesn’t exist if the enterprise doesn’t carry out the business there, so you can attribute the income at the establishment in the country only if the foreign company carries out its business in that office/establishment (not permanent establishment the representative office).
You have to be able to allocate some income in that office or establishment. Example of building Dam. French company has to build a dam in Russia and it sets up a company in Switzerland for supervising activity. In Russia only the French company is taxed because it has a permanent establishment there, but the Swiss company isn’t taxed because it gives only intellectual services. In Italy both the French and the Swiss company are taxed, the Swiss because it gives intellectual services to a company which has a permanent establishment in Italy (domestic law). Negative list: place deemed to not be a permanent establishment. 1. Material: Warehouse and deposit, purchase office (only costs and not income), representative office. 2. Related to personal permanent establishment: if I’m a representative seller in state B of a company in state A and I have the power to negotiate and to conclude contracts I can be considered as a permanent establishment; someone in order to avoid tax makes the seller negotiate but the contract is signed by the company in state A, but for OCED what it is important is who de facto concludes the contract and not the formal sign. Other example: A in state X control B in state Y, is B a permanent establishment of A? It is not relevant the situation of control, it is relevant to check if B has the four qualifications in order to be considered a permanent establishment, and if in B there is something of A at disposition of B (material permanent establishment) or if in B there is someone who works for A at disposition of B (personal permanent establishment.
Lesson 11
Philips Morris case, years 80-90 when cigarettes were under AAMS (administration autonomy monopoly of state), and so we pay tax when we buy a packet of cigarettes. AAMS purchased and sold Philip’s Morris cigarettes or it paid royalties in order to use some of its brands but the cigarettes were produced by AAMS. AAMS bought cigarettes from foreign producer then it put the cigarettes in deposit and after the cigarettes was distributed to the tobacco shops. Philip Morris controlled Intertaba, a company in Italy, which sold the filters to AAMS. Intertaba was allowed to control the deposit of cigarettes in order to check the quality of them and also to see if AAMS did its best in order to sell both the cigarettes (Philip Morris and AAMS cigarettes). In fact there was a conflict of interest because the monopoly was the distributor for Philip Morris but it also produced its cigarettes so it was a competitor of Philip Morris. So between the Producer Company and Intertaba there was a service contract, so the producer paid a fee to Intertaba and it controlled the chain. Every four year the distribution contract between AAMS and producer was renegotiated and Intertaba attended to those meeting as translator. So for tax authority Philip Morris had a material permanent establishment and a personal permanent establishment. Supreme Court: 1 principle: when you have a personal permanent establishment, you have to check if the personal permanent establishment attends to negotiation (it is no important the power). Second principle: Intertaba was performing a service, so in these situation it could be considered as a company which carries out the business of producer, so it was a permanent establishment. Transfer pricing: important for taxation of multinational company. Principle: Compel two companies of two different states to use the right price.
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Example: Italian company sells goods to Swiss company for 100 (which is controlled or under influence dominance by Italian company), then Swiss company sells it for 150 to USA, the suspect here is that the Italian company tries to shift the incomes selling at lower price the goods, so in Italy it pays tax on less income, and then selling it at higher price to USA (using Swiss company) so in Swiss it pays much less taxes. So in this case we have to apply the market price between two independents companies. So if the market price is 120, in Italy I have to pay tax on 120 and not on 100. Exactly the same for the opposite situation, if Italian company buys at higher price from Swiss one, maybe it tries to have higher costs in order to reduce the net income resulting from the balance sheet. Three cases: 1) Controller sells to controlled 2) Controller buys from controlled 3) A buys from B both controlled by C. Three methods in order to determinate the right market price: 1. Comparable uncontrolled price method: compare the price with a different transaction. If company A (Italian company) buys Tv from company B (tax heaven) for 1000, but if another Italian company buys very similar Tv from another company at lower price (800), for the tax authority the right market price is 800 (they could say are not equal, different brand ecc..). Tax authority has the burden of proof. This is external check, but we can have also internal check: if the B company sells the same Tv to other Italian company but at lower price. This method doesn’t work in two cases: 1) Incomparable goods/items, 2) Comparable goods/items but with different conditions of sale, in this case we can use the method only after adjusting the price. In some cases the price could be different because of the different volume and quantities of goods bought. 2. Resale price method: use when you cannot compare the items. Items are unique. CH company (controlled by IT company) sells to IT company the unique medicine at 1000 and then IT sells it for 1100, so it has a margin of 10%. We have to check if in this market it is a coherence margin or not, so we have to see if other medicine distributor has a margin of 10%. If the margin of the other distributor is higher the tax authorities says that I have to reduce my costs in order to have the same margin of the other distributor. For example the others have margin of 20%, so I reduce the costs from 1000 to 916 in this way if I sell at 1100 my margin is 20%. 3. Cost plus method: we use in the case in which we don’t have comparable items and case of distribution. The Italian company (controls the CH) is the producer, the CH company is the purchase. The producer sells to Ch goods at 1000, IT Company spends to do those goods 550. Tax authority says that in this field the margin is of 300% so IT should sell the goods at 1650+550=2200. So 1000 it isn’t the right price, it must be higher; so tax authority considers the price of 2200, which is considered the right market price. Pro: this method is simple Cons: sometimes difficult because every company has a different method of accounting.
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Lesson 1
Taxes are the income of states, and they let the states work. Three main categories: 1. Penalties and Fines 2. Contractual Activities 3. Tax (main source) The number one includes some amount of money to pay because of something against the law. The second category talks about the State’s industry and some privatization and also bond contract. The last is the most important and it could be divided in other three categories: A. Imposte: is due in case that an individual shows the ability to pay B. Tasse: paid for services that the State gives us C. Contributi: to pay for the building of infrastructures that give us benefits Some topic that we could find in the first category: Tax on income: ability to pay tax about income, both personal and factory income VAT (value at the tax): when there is a consumption of goods or services, its regulated by European Legislation Inheritance tax: tax on some money or goods that you receive from a dead person Gift tax: you receive money (donation) Transfer tax: tax on moving properties to one state to another Customs duty: tax that you have to pay when a foreign good enter in another state passing the board. In Europe there are uniform rules about customs (free circulation of goods and people) Excises: (Spirits, fuel, cigarettes), usually applies to goods that are used a lot or in order to disallowed some goods (dangerous items). Wealth tax: is a tax on your wealth, it’s applied on the ability to have some assets In Italy we have three main important articles regarding tax. Art. 23 of Italian constitution: Principle of legality: “No tax can be imposed if it doesn’t have a legal basis”, so if the parliament doesn’t approve it. Art. 53 of Italian constitution: Principle of ability to pay: “Tax can not be apply if there isn’t an ability to pay”, ability to pay means have an economic strength. For example if my company has a loss, I don’t have the ability to pay. It doesn’t regard to tasse because they are linked to service that I received. So thanks to this article under a certain level of money (vital minum standard) there is a NO TAX AREA, in which you don’t have to pay tax. The second paragraph of article 53 also says that tax system has to be built with progressive system. In the proportional system there is a fixed Tax rate and you pay proportionally on your amount of income. In the progressive system (regarded to the principle of ability to pay) there is some “step” and at the beginning a No tax area; the progressive system is the first effect of the principle ability to pay. Example of progressive system: We have 5 different steps. 1= 0-20, 2= 21-40 3= 41-70 4= 71-100 5= 100.000<
I have a total income for 150.000€ Steps 0-20.000 21.000-40.000 41.000-70.000 71.000-100.000 100.000< I have to pay a total amount of 53.000€!
% 15 20 30 40 50
Amount 3000 4000 9000 12000 25000
Second effect: No retroactivity, if there is a new taxes you will pay it only since that moment and in the future. Third effect: implies that in case of tax there is the presumption of ability to pay, but you could demonstrate the contrary. Art. 75 of the Italian constitution: for some topic is not allowed referendum. In fact it is no possible to have a referendum regarding tax. Taxes, custom duties and excises are regulated also by European Union laws, for example if a European citizen wants to leave his country he should pay the leaving tax, but this tax it is against European laws because it is against the freedom of moving of goods and people.
Lesson 2
First of all we have to find out who has to pay taxes. In order to decide if someone could be considered a taxpayer we have three questions: Who? So focus on individual (subjective requirement) What? So focus on which profit or income is taxable (objective requirement) Where? So focus on place (territoriality) If situation has the answer at all these three questions the tax could be applied. 1. Definition of taxpayer: who is liable to tax, so the company/individual/entity liable to tax, it means to provide some administrative requirements. 2. Determinate the taxable basis: we can use two methods, as we saw before, the progressive and the proportional one. The parents in a family are considered as two different taxpayers or as single one? Under the progressive system the parents are considered as a single unit otherwise the no tax area is doubled. In the most of case for individual we use the progressive system, instead for entities the proportional one. If I’m the owner of entities I prefer to be taxed as an individual or as an entities? It is preferable to be taxed as entities because in this way I could reinvest the money in the entities without other taxes, instead if I’m taxed as individual I have to pay taxes also on the reinvestment.
Lesson 3
Amortization: is related to tangible assets, divided in: Fixed assets (more than one year), and current assets (less one year). Depreciation: is related to intangible assets. Both amortization and depreciation split the costs of assets equally in different years. But I don’t care of the revenues, I’m interest in net income, so the objective requirement is the taxable income. Two systems in order to identify taxable income: 1. Global system: any increase of wealth and income is under taxation, and there is one single tax rate for all income. 2. Schedular system: we can divide the income in different basket:
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Employment income Income from real estate Income from capital Business income Professional income Other income Each category has a different set of rules and some has also different tax rate. Gift: The gift is taxable also in the hand of the donee that in the hand of donator, but in order to avoid double taxation on the same income the donator could deduct the tax paid on the gift. The problem is that in the progressive system with this method the splitting/shifting of the income is encouraged in order to avoid tax, because in this way we can lower the tax rate. For this reason every type of income (also gift) related to employment relationship are taxable. The gift and the other present are taxed at the fair market value; there are some exceptions for example in Italy under a certain level the employer could give some gift or goods for free (but he has to produce them on your own).
Lesson 4
Which type of income could be taxed? For example if an employee is fired and so he receives some money as refund, this amount of money should be taxed? It could be a substitution of salary so in scheduler system it could put in employment income so it is taxable, but it could be considered as an damaged compensation, and so it isn’t taxable. So for the occasional income: In the global system you have to check if there is an increase of wealth and check what the law says about it. In the scheduler system you have to check if it could be put in one categories and also check what the law says. Taxable income under the scheduler system: Business income: characteristics: organized and not occasional. All the incomes coming on this organized system are considered business income. I can find the taxable income in the balance sheet of the company. The problem is to verify if the all expenses are really related to the activity business and so deductible, because if the expenses are not related to the business activity they aren’t deductible. Employment income: salary and tax is calculated on the gross salary, here we don’t have deduction because employee doesn’t have expenses for his work. Sometimes we have some for fait deduction. Income from profession: we have the same problem of business income, we have to check if expenses are related to the professional activity or if they are personal expenses and so non-deductible. In some cases there are some deduction that don’t depend on source of income but they depend on subjective position. We have two ways in order to recuperate the some expenses: 1. Tax credit: tax credit is on the tax liability, so it not depends on the tax rate. 2. Deduction: tax deduction applies on income and so it depends on the tax rate. In the progressive system is preferable tax credit because it is independent from the tax rate. If I’m under a global system and my I have a loss as a company I can offset the total amount of income.
For example, as a company I have a loss of -500€, but thanks other income I have a total amount for 1600€. In this case I can offset the total amount so: 1600-500=1100, and this is ma taxable income, on which I will apply my tax rate. If I’m under a scheduler system my loss doesn’t offset the total amount of the other income, but it will offset the income of the next year. Example: year 1: -500€ so zero tax; year 2: 1000€ so here: 1000-500=500 and at this amount I will apply my tax rate.
Lesson 5
Tax Avoidance ≠ Tax Fraud and Tax Evasion Tax Evasion: when you lie to the State. You have an income for 1000€ but you record an income for 800€; or you record the right amount but at the end of the year you say to the State that you don’t have enough money to pay tax. Tax Fraud: You lie also in this case to the State, but using false documents. For example: There is a company in Italy it has revenues for 10 million and operative costs for 6 million, but it writes in the balance sheet a service cost for 3,5 million received by an a Bermuda company (under my control or something like that) so ma taxable income is 500.000 and not 4 million. Tax Avoidance: Active behaviour, it doesn’t imply false documents. You formally take some step thanks that you could avoid some tax or take down your total taxable income. Example: Company A has three important businesses and company B wants to buy one of that business, so A create a company C, which is now the owner of the business, and B will buy the business directly to C, in this way B avoid transfer tax. We can see also the case of Interposition; it is the Maradona’s case: He was a football player for Napoli F.C. and he has to pay Italian tax, but he set up a company in Jersey and he gives it all his imagine right; so his salary from Napoli is split between the player and this company, he avoids tax on part of his salary. This company is an interposition of Maradona. In Italy tax avoidance was treated by law only in a few particular case (Art.23). In the 2005 change the approach to avoidance, thanks to General ant-abuse principle: tax authority could attack any transaction that could give you some tax advantages, even if there isn’t a legal provision dealing with type of transaction. Could this be an abuse of law? Because maybe the State declares as avoidance behaviour a transaction that seems against law but there isn’t the certain, so maybe against the principle of certainty. Now the abuse of law is regulated, in fact the Supreme Court said that it isn’t abuse of law because it is based on the Art.53, so avoidance behaviour can be taxed. A company can ask previously if one transaction could be considered abusive behaviour or not and if the answer is negative the transaction is protected to future issue. Following the Art.25 if the transaction happened before the 2005 it could not be punished, if it happened after the 2005 it could be punished. Example D&G Dolce and Gabbana have a royalties’ income coming from the D&G S.P.A. on which they pay tax and the D&G S.P.A deduct the 30% of this cost, but year-by-year they transfer part of the trademark to a company in Luxemburg started by them. So in this way they continue to deduct the cost but pay less tax transferring the trademark in Luxemburg.
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For the State this is a case of avoidance otherwise the D&G should prove to have an economic reason to do that. International Avoidance Treaty shopping: Italian company has to pay the royalty to an Us company so it gives 100 to Us, but 15 are for taxes, so the Us starts another company in Hungary where the tax rate is lower, so Italy pays always 100 but only 5 (thanks to treaty) in tax and thanks to the treaty between Hungary and USA 0% so 95 to Us company. This thing is legal only if the Hungarian company is the beneficial owner. Beneficial owner means: to have the legal right to obtain the income and also use it and not transfer it to another company. Costs to tax heaven: Cost occurred in a tax heaven State are suspicious, they could be false and done only to reduce the taxable income. The law provides that every cost paid to heaven countries are only under some characteristic: 1) Heaven company has to have a real structure 2) There is economic interest. I have to prove one of these in order to deduct the cost. Controller Foreign Company Legislation: Italian company holds 60% of Ch company, the problem here is that Italian company could decide to not distribute the CH’s dividends and so it doesn’t pay tax on that, so for law consider the income of the Ch company as an a direct income of the Italian company for the 60%, in this way Italian company pay tax every year (tax deferral). Exception: 1) Ch company has real structure 2) The structure doesn’t lead tax advantage, for example it is in a State with higher tax rate. Foreign residence company: Company A wants to sell company B, but it wants to avoid tax on capital gains so it creates company C in Luxemburg (because the favourite condition on capital gains), it sells B to C and after C sells to the buyer. In this situation C is presumed to be residence in Italy (watching at the control), and also if the majority of main manager are Italian it is presumed that it is residence in Italy.
Lesson 6
The costs of fixed assets could be split during different years, so for example there is no problem with machinery because it is treated as fixed assets. We could have problem with some other costs as Research costs: because if I consider it as an intangible fixed asset I can split the cost in different year and it rises my profits or I could consider it as a cost so put in one year and it lowers my profits. Tax-exempt income: an income could be exempted in order to avoid double taxation or because it isn’t include in no category. Double taxation: 1. Economic: same income is subjected to tax twice in the hands of two different taxpayers (dividends). 2. Juridical: same income is subjected to tax twice in the hands of one single taxpayer (cross boarder transaction). Dividends in Italy: the 95% of dividends is not taxable the 5% is taxable because in Italy it is allowed to deduct expenses related to dividends but not all are really related to dividends so I pay this 5% for fait taxation in order to repay the wrong deduction. If I have to pay interest on a loan but I use this amount of money in something that could give me tax-exempt income, I can’t deduct the interest expenses (otherwise I will have at the same amount of money one deduction and also an exemption). Accounting is important because is strictly related to tax thanks time, because the accounting period is different to the tax one.
Cash Method: in the cash method for deduction is important the moment in which you pay. Accrual Method: for deduction is important the amount used during the year. We should use the accrual method when we have an accounting system, otherwise is difficult to follow that method. Cash method is better for the individual income and individual categories. Director case: If my company pay 10 million to his director as his salary, but it doesn’t give him the money so in the balance sheet I have a deduction of my profit thanks this cost. When in the future I will pay it that amount of money will be taxed, and if he will refuse the money, the 10 million will be budgeted as an extraordinary income and so taxed at the same.
Lesson 7
When there are cases of double taxation we have three solutions, and in all the three methods we have two different level of taxation, one is at the company level the other is at the individual level. 1. Classical: company level: income 100€, Cit (corporate income tax) 30% so tax=30€, income after tax=70€; the individual receives his dividends, so at individual level: taxable income 70€, Iit (individual income tax) 50% so tax=35€, so Net income=35€. In this example the effective tax rate applied is 65%. This method is usually applied at dividends coming from countries in the black list. 2. Exemption: company level: income 100€, Cit 30% so tax=30€ and the income after tax=70€, the individual receives the dividends so at individual level: taxable income=0 because in the full exemption method the dividends are exempted, so Iit 50% and tax=0, so Net income 70€. Effective tax rate applied is 30%, which is the company tax rate. 3. Imputation: company level: income 100€, Cit 30% so tax=30€ and income after tax=70€; the individual receives dividends, so at individual level: taxable income=70+30, because I have to gross up for the amount of tax already paid at company level tot=100€, Iit 50% so tax=50€ but I have a credit vs tax authority for 30€ (amount equal at the tax paid by company) so tax=50-30=20€, Net income=7020=50€. Effective tax rate applied is 50%, and the effective tax rate is equal to Iit. The imputation method has some problem at international level, in fact if the company is abroad it is difficult receive the credit, the two States have to have an agreement and also both using the imputation method. So the different countries modified in some cases the imputation method in exemption method. For example in Italy on dividends, if you have a qualified participation, at the second level as a company you are exempted for 95% and Cit 25% as individual 50% and Iit 50%. Instead if you have a non-qualified participation you are not exempted and your Iit is 20%. This in order to simplify the rules and also it is to incentive the investments in companies.
Lesson 8
World Wide Taxation Principle: Most of the states in the world tax the residence people on all your income and also the foreign people on income maturated in the State. The double residency it is another case of International double taxation (juridical). If an individual works in State A but his family live in State B (so centre of vital interests) in which way he has to pay the taxes?
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State B will tax all income and the State A will tax only the income maturated there. Only for a few states, as USA and Philippines, citizenship is very important in tax issue. In fact if an individual has an US citizenship but he is residence in Italy, both State would want to tax all income. This is a case of issue between Citizenship and Residency. So we have four cases: conflict of jurisdiction, double residency, issue between citizenship and residency and succession tax. International double taxation convention: it is a bilateral international treaty in order to avoid international double taxation. OECD did this treaty. 1. Some provisions prohibit states to tax the income coming from individual or company not resident in that state, but it could be taxed only by the state of residency. Example: a company is residence in State A but it has some income coming from State B (but without having permanent establishment), in this case the income could be tax only by State A. 1.1. Provisions on capital gains on sale of shares: company X, residence in State A, wants to sell company Y (located in State B) to a third company, the capital gains coming out this transaction could be tax only by the State of residency (Marzotto’s case). 2. Provisions establishing some limitation to the taxation power of the State of source. These provisions concern: dividends, interests and royalties. Example: company of State A holds a company in State B (100%) and so it receives dividend, which is going to be taxed in the State A of residency, but also in the State B of source at maximum at 10%. 3. Provisions fully allow taxation by State of source. These provisions apply to real estate, permanent establishment and employment income. For these cases the all income is taxed only in the resident State but the income arising from different State could be fully taxed also in that State. In the second and third cases there is a mechanism in order to avoid double taxation, it is the Foreign Tax Credit that is a credit for the taxes paid abroad against the resident taxes on the same income. We have two systems: 1 Credit System (classical): Company in State A has a factory in State B. The company has income for 5000 and in State A it pays tax on all income, tax rate 33%, so tax=1650. 1000 coming from the factory in State B, son also there it pays tax on 1000, tax rate 40%, so tax in B=400. Having paid taxes also in B, the company has the right to have a credit against A, so it can lower that amount from the taxes of A, but I can deduct the taxes applying at 1000 the tax rate of A so=330. At the end it pays 400 in B and 1320 in A. This method is convenient if the tax rate of resident country is higher than the tax rate of source State, so I can deduct the all taxes paid. 2 Exemption System: the same example but at this time I consider only 5000-1000=4000 as income for the State A and at that amount I apply the tax rate 33%, tax=1320. In the State B the situation remain the same so I have 1000, tax rate 40% I pay 400. It is convenient if the source State is a tax heaven one or it has a lower tax rate. The problem is to determine the State of residence. Individual: 1. Formal criteria: registration 2. Substantial criteria: residence, spends time (more than 180 days) and domicile (center of vital interests/family).
The proceeding: 1) Formal criteria, if no formal criteria 2) Permanent situation, 3) Centre of vital interests, 4) Place where he spends more time, 5) Citizenship and 6) Two states try to find a solution. Companies: 1. Formal criteria: legal seat 2. Substantial criteria: core business and place of management. The most important is the place of management.
Lesson 9
Partnership: Entrepreneur entities made on individual, here we have completely separation between individual and capital, but at least one individual has unlimited responsibility with his private patrimony on company’s liabilities. Most the times tax authorities use a transparent method for tax, so they taxed the partner, because there aren’t dividends and so the profit goes directly to partner. Italian system: tax applied on the partnership but after allocated as business income to the partners, so no distinction between dividends and other income coming from partnership. Other system: the incomes from partnership are not allocated at the partner all together but separately, maintaining the separation. If I’m Italian and I have a qualified partnership in a UK company: in Italy the incomes from partnership are treated as business income (so not transparent) and in the case that I have some dividends they are taxed in UK 50% and in Italy 20%, so I pay withholding tax and so that dividends don’t go into the tax return and I don’t have tax credit. Companies could finance themselves recurring on Debt or Equity. The differences: Debt: passive interest, deductible (passive interest), repayment of capital and it is granted. Equity: dividends, non-deductible, repayment of capital less flexible and not granted. So we have the Thin Capitalization Rules, stating about D/E ratio, which tries to increase the capitalization of companies. Example: if your company has D/E ratio higher than X, the passive interest that exceed that limit they will not be deductible. In EU more rigid: you cannot deduct passive interests for more than 30% of your gross income, in order to avoid tax avoidance and also to have more solid companies with a good D/e ratio. Companies’ reorganizations: if my company has a field bought at 100, but now I can built on it so it’s value increase, I should pay tax on this increase of value? For the interpretation rules I have to appreciate it (so pay tax) but it is very difficult to follow the change of value every year; instead for conservative I have to appreciate it only if I realized this increase of value. Taxable purpose: tax on the acquisition value and when I sell it I will pay tax on the capital gain. Realization events: when the assets go out the company. In the merge: you could say it is a realization event because the old company doesn’t exist anymore and the accounting books show it. But someone could say that it is an incorporation event so the old company still exists substantially. You will pay tax when you sell it, maybe for civil purpose you don’t have profit, but for tax purpose you have it.
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Example: we have one individual who has shares of company A paid 10 but now fair value 40, and a second one who has shares of company B paid 20 but now fair value 40. They merge the two companies so the fair value of the new shares is 80. They have two solutions: 1. They change the old shares with the new with the higher value, and so they pay tax now. 2. They maintain the old shares and when they sell the shares and so they will pay tax on the gain between the acquisition value and the realization value (fair value). This because the state wants to give me the possibility to reorganize my company in the best way for my business, this method is called rolling overtax, it is allowed only for some type of transactions. For example the EU’s companies can restructure themselves (merge) without paying tax because it is a good thing for market.
Lesson 10
Permanent establishment: I’m taxed on my income coming abroad if in that country I have a permanent establishment. Italy has a lot of treaty but with some states there isn’t so it is useful to have a domestic definition. If a Netherlands company has maritime broken in Genova, under the treaty the maritime broken is considered as permanent establishment and so Italy can tax income coming from maritime broken in Genova. But for Italian domestic law the maritime broken isn’t a permanent establishment, so? In general the treaty prevails to domestic law if it avoid the double taxation, if it doesn’t avoid double taxation and the domestic law instead do it so I apply the domestic law. General definition of permanent establishment: fixed place of business through which the business of an enterprise is fully or in part carry out. In order to define something as a permanent establishment you need four elements (all the four elements): 1. Place of business (existence): physical place, it isn’t necessary the presents of people and employee (ex coffee machine), or if the server of e-commerce is in the country it is considered as permanent establishment. It is irrelevant the owner and the tittle, it is important that I use it; and also it is not important the exclusive using of the place (ex office hotel). 2. Fixed business: Permanency: if you use a building one year in a country it is considered as a permanent establishment (in Italy three months). There is a general rule, “rule of time”, if you have a seaside bath and you use it only 4 months per year, but It stay all year in Italy it is considered as a permanent establishment (in order to look at seasonal business). 3. Fixed business: Geographical link: identifiable in a particular place, issue with the business with the mobile place. So businesses on the road are considered as permanent establishment because there are a commercial and geographical coherence. For boat is more complicated, it isn’t a permanent establishment if there is a geographical link (ex boat between Alaska and San Francisco). 4. Business relationship: between foreign enterprise and office: the permanent establishment doesn’t exist if the enterprise doesn’t carry out the business there, so you can attribute the income at the establishment in the country only if the foreign company carries out its business in that office/establishment (not permanent establishment the representative office).
You have to be able to allocate some income in that office or establishment. Example of building Dam. French company has to build a dam in Russia and it sets up a company in Switzerland for supervising activity. In Russia only the French company is taxed because it has a permanent establishment there, but the Swiss company isn’t taxed because it gives only intellectual services. In Italy both the French and the Swiss company are taxed, the Swiss because it gives intellectual services to a company which has a permanent establishment in Italy (domestic law). Negative list: place deemed to not be a permanent establishment. 1. Material: Warehouse and deposit, purchase office (only costs and not income), representative office. 2. Related to personal permanent establishment: if I’m a representative seller in state B of a company in state A and I have the power to negotiate and to conclude contracts I can be considered as a permanent establishment; someone in order to avoid tax makes the seller negotiate but the contract is signed by the company in state A, but for OCED what it is important is who de facto concludes the contract and not the formal sign. Other example: A in state X control B in state Y, is B a permanent establishment of A? It is not relevant the situation of control, it is relevant to check if B has the four qualifications in order to be considered a permanent establishment, and if in B there is something of A at disposition of B (material permanent establishment) or if in B there is someone who works for A at disposition of B (personal permanent establishment.
Lesson 11
Philips Morris case, years 80-90 when cigarettes were under AAMS (administration autonomy monopoly of state), and so we pay tax when we buy a packet of cigarettes. AAMS purchased and sold Philip’s Morris cigarettes or it paid royalties in order to use some of its brands but the cigarettes were produced by AAMS. AAMS bought cigarettes from foreign producer then it put the cigarettes in deposit and after the cigarettes was distributed to the tobacco shops. Philip Morris controlled Intertaba, a company in Italy, which sold the filters to AAMS. Intertaba was allowed to control the deposit of cigarettes in order to check the quality of them and also to see if AAMS did its best in order to sell both the cigarettes (Philip Morris and AAMS cigarettes). In fact there was a conflict of interest because the monopoly was the distributor for Philip Morris but it also produced its cigarettes so it was a competitor of Philip Morris. So between the Producer Company and Intertaba there was a service contract, so the producer paid a fee to Intertaba and it controlled the chain. Every four year the distribution contract between AAMS and producer was renegotiated and Intertaba attended to those meeting as translator. So for tax authority Philip Morris had a material permanent establishment and a personal permanent establishment. Supreme Court: 1 principle: when you have a personal permanent establishment, you have to check if the personal permanent establishment attends to negotiation (it is no important the power). Second principle: Intertaba was performing a service, so in these situation it could be considered as a company which carries out the business of producer, so it was a permanent establishment. Transfer pricing: important for taxation of multinational company. Principle: Compel two companies of two different states to use the right price.
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Example: Italian company sells goods to Swiss company for 100 (which is controlled or under influence dominance by Italian company), then Swiss company sells it for 150 to USA, the suspect here is that the Italian company tries to shift the incomes selling at lower price the goods, so in Italy it pays tax on less income, and then selling it at higher price to USA (using Swiss company) so in Swiss it pays much less taxes. So in this case we have to apply the market price between two independents companies. So if the market price is 120, in Italy I have to pay tax on 120 and not on 100. Exactly the same for the opposite situation, if Italian company buys at higher price from Swiss one, maybe it tries to have higher costs in order to reduce the net income resulting from the balance sheet. Three cases: 1) Controller sells to controlled 2) Controller buys from controlled 3) A buys from B both controlled by C. Three methods in order to determinate the right market price: 1. Comparable uncontrolled price method: compare the price with a different transaction. If company A (Italian company) buys Tv from company B (tax heaven) for 1000, but if another Italian company buys very similar Tv from another company at lower price (800), for the tax authority the right market price is 800 (they could say are not equal, different brand ecc..). Tax authority has the burden of proof. This is external check, but we can have also internal check: if the B company sells the same Tv to other Italian company but at lower price. This method doesn’t work in two cases: 1) Incomparable goods/items, 2) Comparable goods/items but with different conditions of sale, in this case we can use the method only after adjusting the price. In some cases the price could be different because of the different volume and quantities of goods bought. 2. Resale price method: use when you cannot compare the items. Items are unique. CH company (controlled by IT company) sells to IT company the unique medicine at 1000 and then IT sells it for 1100, so it has a margin of 10%. We have to check if in this market it is a coherence margin or not, so we have to see if other medicine distributor has a margin of 10%. If the margin of the other distributor is higher the tax authorities says that I have to reduce my costs in order to have the same margin of the other distributor. For example the others have margin of 20%, so I reduce the costs from 1000 to 916 in this way if I sell at 1100 my margin is 20%. 3. Cost plus method: we use in the case in which we don’t have comparable items and case of distribution. The Italian company (controls the CH) is the producer, the CH company is the purchase. The producer sells to Ch goods at 1000, IT Company spends to do those goods 550. Tax authority says that in this field the margin is of 300% so IT should sell the goods at 1650+550=2200. So 1000 it isn’t the right price, it must be higher; so tax authority considers the price of 2200, which is considered the right market price. Pro: this method is simple Cons: sometimes difficult because every company has a different method of accounting.
