In the context of intra-group relations, the determination of transfer prices is a crucial issue for the correct allocation of results between related entities. The Italian regulatory regime—and many other jurisdictions that adopt the principles of the Organization for Economic Cooperation and Development (OECD) on transfer pricing requires that the counterparts of intra-group transactions be determined “at arm’s length.”
Within this framework, the penalty protection regime emerges as a mechanism that encourages taxpayers to adopt practices of documentation, transparency, and proactive availability of information.
This article analyzes this regime, the formal and substantive requirements imposed on taxpayers, the criteria for the adequacy of documentation, and the risks that may remain even when the basic requirements are apparently met.
Italian regulatory framework
In Italy, transfer pricing regulations are based on Article 110, paragraph 7 of the Testo Unico delle Imposte sui Redditi (TUIR), which imposes the obligation to determine the corresponding amounts for intra-group transactions in accordance with arm’s length conditions, in line with the principles of the Organization for Economic Cooperation and Development.
As a preventive measure, Article 1, paragraph 6 of Legislative Decree No. 471/1997 establishes that adequate documentation may lead to the exclusion of penalties for false declarations, when certain transfer pricing requirements are met.
The fundamental instrument for such protection consists of the preparation and submission of transfer pricing documentation, comprising the Master File and the Local File, which must comply with both formal and substantive requirements, in accordance with Italian Tax Authority (Agenzia delle Entrate) resolution No. 360494 of November 23, 2020.
Requirements for access to the penalty protection regime
In order for taxpayers to benefit from the penalty protection regime, at least the following requirements must be met:
- Duly prepared documentation, including the master file and local transfer pricing documentation.
- Communication of the existence of such documentation in the corresponding tax return.
- Presentation of the documentation to the Tax Authority in the course of access, inspections, verifications, or other audit activities.
It should be noted that the mere presentation of the documentation during an audit phase does not oblige the Tax Administration to automatically recognize protection against penalties, even if the formal requirements are met, if the documentation does not substantially contain the information necessary for verification.
Suitability of documentation: substantive vs. formal approach
A key issue is how the notion of “suitability” of transfer pricing documentation is interpreted. According to Circolare 26.11.2021, n. 15/E of the Agenzia delle Entrate, suitability should be assessed not with a purely formal approach (“complete checklist”), but with a substantive approach, i.e., focused on whether the documentation allows the tax authorities to carry out a conscious and informed analysis of the transfer pricing policy adopted by the taxpayer.
In line with this, Italian case law has reiterated that what is relevant is not the absolute perfection of the analysis, but rather that the company has provided the Administration with the necessary elements to enable it to carry out the verification (e.g., functionality, risks assumed, comparability, method, selection of comparables).
For example:
- The Lombardy Regional Tax Court held that what is essential is not the perfection of the documentation, but that the company has made it available to the Administration and that it contains the information used to determine transfer prices. (Judgment No. 2454, June 1, 2017).
- In a subsequent decision, the same court considered a single transfer pricing manual applicable to several companies in the group to be valid, provided that it includes all the information required by the regulations. (Judgment No. 5225, November 28, 2018).
- For its part, the Provincial Tax Court of Milan emphasized that what is truly relevant is the availability, clarity, and timeliness of the documentation, in line with the principle of taxpayer cooperation and transparency enshrined in the Taxpayer Statute. (Judgment No. 2099, May 13, 2021).
- However, a more recent ruling by the Lombardy Regional Tax Court denied the application of the penalty protection regime, even though the documentation submitted was substantially consistent, due to a formal omission in the communication—the failure to check the corresponding box in the quadro RS of the tax return. (Judgment No. 85, January 10, 2024).
Practical considerations and recommendations for taxpayers
From the perspective of the transfer pricing and international taxation expert, the following considerations and operational recommendations can be derived:
- Although absolute perfection in the analysis of comparables or functionality is not required, it is essential that the documentation sets out the transfer pricing policy in a reasonably clear and verifiable manner, including the method, selection of comparables, assumptions made, functions and risks, and group structure.
- It is essential to clearly indicate on the tax return that transfer pricing documentation is available and that the penalty protection regime is being opted for (i.e., by checking the flag on the corresponding form), as failure to do so may lead to the loss of the benefit, even with substantially adequate documentation.
- The administration is not bound to grant protection if, despite the formal requirements, the information is incomplete or inauthentic. In this sense, certain methodological imperfections do not exclude protection, but concealment, lack of transparency, or absence of data may do so.
- Taxpayers must adopt a proactive attitude of collaboration, tax compliance, and fiscal transparency, understanding that the transfer pricing regime and protection against penalties are part of a logic of collaborative taxation. The objective is not to penalize taxpayers who, even with certain imperfections, submit consistent documentation, but rather to penalize evasive or opaque behavior.
- From a practical and risk management perspective, multinational companies and groups with intra-group operations should establish internal transfer pricing policies that document and periodically update the main reports: local documentation, master report, and country-by-country report, including risk and comparability analyses, and ensuring their availability for possible reviews by the tax authority.
- During the internal audit or documentation preparation phase, it is advisable to evaluate not only formal compliance (indexes, signatures, time stamps, etc.), but also the substantive robustness of the analysis: Does the documentation allow the auditor to understand how intragroup prices were set? Is the selection of comparables justified? Were functions and risks adequately documented?
Conclusion
The penalty protection regime linked to transfer pricing documentation is a key mechanism for mitigating the risk of penalties for false or incorrect reporting in the area of intra-group transactions. However, its effectiveness depends on compliance that goes beyond mere formalism: the documentation must be substantially adequate, suitable for verification by the tax authority, and the company must adequately communicate its existence and make it available.
In international practice, this means that transfer pricing policies must coexist with a culture of compliance, transparency, and tax cooperation, which helps reduce the risk of adjustments and penalties and strengthens the taxpayer’s defense against audits.
Strengthen the robustness of your transfer pricing documentation
At TPC Group, we have a team specializing in transfer pricing and international taxation that can help you assess the coherence, consistency, and technical adequacy of your documentation, as well as identify potential tax risks and opportunities for improvement in your intra-group policies. Ensure regulatory compliance and strengthen your company’s position with the tax authorities.
Source: Ratio