Italian Supreme Court Sets Out a Position on the Use of the External and Internal CUP Method

July 19, 2023

The Italian Supreme Court, in its decision No. 11625 of April 2023, introduced relevant Transfer Pricing amendments.  

1. Background

The discussion originated from the Tax Agency’s assessment concerning the tax adjustment for the tax year 2015. Thereby, part of the interest expense deducted by an Italian company related to a loan granted by the German parent company was disallowed, given that it constituted a violation of the Italian Transfer Pricing legislation. 

2. First Instance Decision

The judges of the first instance decided on the inadmissibility of the tax assessment notice based on two grounds.  

  • The misuse of the external CUP method criterion by the Tax Agency to price the transactions under the Arm’s Length Principle. Instead, the correct criterion was the internal CUP method, noting that the analysis of Article 9 of Presidential Decree No. 917 of 1986 shows a preference for the interest rate comparison over the internal comparison.   
  • The income Transfer absence from Italy to Germany. Thus, the conditions for the application of Article 110, paragraph 7, of Presidential Decree No. 917 of December 22, 1986, are not met.  

3. Supreme Court Decision

According to the judges of the Italian Supreme Court, both grounds were considered sufficient, on their own, to support their decision.   

Likewise, they point out that the choice of the appropriate method depends on the specific context and the relevant economic characteristics underlying the related-party transactions. Therefore, the OECD Transfer Pricing Guidelines principles must be mainly considered to ensure a proper functional analysis to guarantee the correct application of the selected method.   

Although both the internal and external CUP methods are admissible, the former has certain advantages that, in some cases, may result in the “best method”: 

  • Greater access to internal information: Related companies of a multinational group have direct access to information on internal transactions and costs incurred. Therefore, precise and complete data for the application of the internal CUP method are more accessible;  
  • Greater specificity of internal transactions: Related company transactions can be very specific and tailored to the needs of the multinational group. Goods or services internally rendered may significantly differ from those exchanged on the open market. In such cases, the internal CUP method may assess more accurately and appropriately the transfer prices.  
  • Reduced risk of comparability analysis: The search for comparable transactions between independent companies can be complex. There may be significant differences between internal and external transactions regarding terms, risks assumed, and other relevant variables. The CUP internal method implementation considers such differences better, which reduces comparability risks and provides a more solid basis for determining transfer prices. 
Source: International Tax Review  19/07/23