Recently Italy’s Regional Tax Court of Lazio has given an important decision regarding the selection of methods for determining inter-company prices.

An Italian company acting as toll manufacturer on behalf of a related foreign company, set transfer prices by adding to its manufacturing costs (including full labor costs, materials costs, and overhead) a mark-up that allowed the company to achieve a 9 percent ROCE (“Return On Capital Employed”), also by means of periodic adjustments made by the foreign related party throughout the financial year.

The Revenue Agency considered the use of that method not appropriate and made an adjustment first by extending the mark-up on all the costs incurred by the Italian company or, alternatively, recalculated the transfer prices, so that the operating margin of the Italian company was in line with that determined for a set of Italian companies selected by the Revenue Agency as comparable to the company under assessment. This made the operating margin higher than the operating margin obtained by applying the 9 percent ROCE.

The Regional Tax Court challenged the Revenue Agency’s position. According to the Regional Tax Court the ROCE method must be considered applicable, because in the OECD Transfer Pricing Guidelines, it is explicitly described.  According to the Tax Court, the ROCE method is suitable for the business profile of the assessed company, which, except for the high level of capital invested, bore very limited business risks (operating solely as a toll manufacturer on behalf of the related foreign entity). The Regional Tax Court then argued that both the use of a method based on a straightforward mark-up on total costs (relevant to the core business activity) and, with reference to the transactional net margin method, the comparison with a set of companies that were not really comparable must be considered inappropriate. As a result, the court concluded that the Revenue Agency did not prove that the transfer prices used by the Italian company were not at arm’s length.

The Regional Tax Court accepted the appeal presented by the Italian company to determine the transfer prices of products (plasma derivatives) sold to the related party based on the “Return On Capital Employed” (ROCE) profit level indicator. According to the Court’s decision, taxpayers may select the most suitable method among those provided by the OECD Transfer Pricing Guidelines for purposes of determining intercompany prices.