Italien fashion group, Dolce & Gabbana s.r.l. (hereinafter DG s.r.l.), the licensee of the Dolce&Gabbana trademark, entered into a sub-licensing agreement with its subsidiary Dolce&Gabbana Industria (hereinafter DG Industria or Industria) whereby the former granted to the latter the right to produce, distribute and sell products bearing the well-known trademark throughout the world and undertook to carry out promotion and marketing activities in return for royalties.
DG s.r.l., in order to carry out promotion and marketing activities in the U.S.A., made use of the company Dolce&Gabbana Usa Inc. (hereinafter DG Usa) with contracts in force since 2002; in particular, on March 16, 2005, it entered into a service agreement whereby DG Usa undertook to provide the aforesaid services in return for an annual fee payable by DG s.r.l.; this consideration is determined on the basis of the costs analytically attributable to the provision of the agreed services in addition to a mark up, i.e. a mark-up, determined in a variable percentage based on the amount of the cost. In order to verify the fairness of the consideration, the parties have provided for the obligation of analytical reporting as well as an amicable settlement procedure through an auditing company.
Lastly, DG s.r.l., DG Usa and DG Industria entered into another agreement, supply agreement, whereby DG Industria appointed DG Usa as its distributor for the USA in mono-brand shops, DG Usa committed to DG s.r.l. to adapt the shops to its high quality standards functional to increasing brand awareness, and DG s.r.l. committed to pay a service fee. The service contribution was recognised in relation to the costs exceeding a percentage of the turnover realised through the mono-brand sales outlets.
In the course of an audit, the Italian Revenue Agency made the following findings in relation to the tax year 1 April 2004 to 31 March 2005:
first, it denied the deductibility from the taxable income for IRES and IRAP purposes of part of the fees paid by DG s.r.l. to DG USA under the service contract and precisely:
a) of the costs of certain services (in particular, it recognised the costs for commercial sales, executive consultant, advertising Madison sales, advertising all others and not the others), because, provided that these were generic services, falling within the normal activity of the reseller of goods, remunerated by the resale margin, and that the reimbursable costs were defined generically, without provision of a ceiling, a reporting method and prior approval by DG s.r.l., it pointed out that it could only recognise the costs rendered in the interest >>also of the parent company<<;
b) the portion corresponding to the chargeback of the mark-up, referring to Revenue Agency Circular No. 32/80 on intra-group services, where it provides that the mark-up in favour of the service provider is recognisable only where the services constitute the typical activity of the service provider and not for those services rendered by the parent company that have no market value or are attributable to the general management or administrative activity of the parent company;
secondly, it denied the deductibility of the consideration paid by DG s.r.l. to DG Usa under the supply agreement, pointing out that the costs to be considered for the purposes of the contribution would be generically identified, there would be no obligation of adequate reporting or prior approval, which would in fact transfer to DG s.r.l. the risk of substantial inefficiencies of DG Usa, a risk that no independent third party would have assumed, and that the party had not adequately demonstrated that the costs corresponded to the normal value of the costs inasmuch as the documentation produced, relating to other fashion groups, concerned persons who were also owners of the mark, directly interested in its development and promotion.
DG s.r.l. brought an appeal before the Provincial Tax Commission of Milan, which rejected it. An appeal was then brought before the Regional Tax Commission of Lombardy which was likewise rejected.
In particular, the Regional Tax Commission, for what is relevant herein rejected the preliminary objections (failure to contest the recovery by means of a report; insufficiency and contradictory motivation);
reconstructed the subject matter of the dispute, pointing out that the Agency had contested some costs of the service agreement, excluding their inherent nature; for the costs deemed inherent, it had recalculated the amount, excluding the mark-up; for the supply agreement, it had re-taxed the costs, excluding their deductibility due to lack of inherent nature in relation to the service agreement, it confirmed that the costs for the excluded services were not inherent, because:
a) DG Usa also carried out activities pertaining to the retailer DG Industria, distributor of Dolce&Gabbana branded products in the U.S. and the costs were connected to this marketing activity;
b) the correlation deducted by the company between the costs recharged to DG s.r.l. and the revenues that the latter obtains as a result of the royalties paid by DG Industria, because the costs connected to services intended to increase sales are those of the retailer and not of the licensee of the trademark, to which are inherent only the costs intended to increase the prestige of the trademark itself;
c) the costs incurred in the interest of both DG s.r.l. and DG Usa is not relevant and the only cost items recognisable in favour of the former are those pertaining exclusively to its relevance;
d) for the purpose of proving congruity, the expert’s report by Prof. Lorenzo Pozza and the certification by Mahoney Cohen & company were irrelevant, since they were mere opinions that were not binding on the administration;
(e) the mark up was not deductible since the services rendered by DG USA were rendered in the interest of both DG s.r.l., licensee of the mark, and DG Industria, reseller, and it was not possible to take into consideration the actions of the latter in favour of Itierre s.p.a., reseller and therefore different from DG s.r.l.;
(f) the recharging of costs to DG s.r.l. was formally obligatory in the antero but largely left to the discretion of the taxpayer as to the quantum;
(g) the taxpayer had not provided any evidence as to the retroactive effect of the contract;
in relation to the supply agreement, confirmed that the fees paid by DG s.r.l. to DG Usa were non-deductible as costs because they were not inherent, being DG s.r.l.
DG s.r.l. was merely a licensee of the trademark and therefore, in the event of an increase in its value, it would have had to pay a higher price to the owner of the trademark, also excluding the validity of the taxpayer’s observations on transfer pricing (a study prepared by Price Waterhouse Coopers that takes into account only companies belonging to multinational groups but not independent companies, as required by the OECD guidelines).
Judgment of the Supreme Court
The Court partially upheld the appeal of DG s.r.l. and referred the case back to the Court of Second Instance.
Excerpts
“4.2. According to the established case law of this Court, the burden of proof as to the existence and relevance of the costs incurred rests on the taxpayer who claims to have received the service, on the basis of the general rules on deductible costs (Cass. 18/08/2022, no. 24880; Cass. 04/04/2013, no. 8293; and with respect to intra-group transactions Cass. 10/05/2021, no. 12268; Cass. 11/01/2018, no. 439).
On the basis of this premise, this Court has held that, where the costs whose deductibility is at issue arise from intercompany agreements, the presentation of the contract concerning the services provided by the parent company to the subsidiaries and the invoicing of the consideration cannot be deemed sufficient, requiring, on the contrary, the specific allegation of those elements necessary to determine the actual or potential utility obtained by the subsidiary receiving the service (Court of Cassation 18/07/2014, no. 16480; in similar terms see also Court of Cassation 28/06/2019, no. 17535).
4.3. The CTR, therefore, did not err when it found it necessary to refer to a necessary advantage or utility for DG s.r.l., while it does not appear objectionable, as a breach of law, to consider whether or not such utility was present and whether it was proved in the case at hand, because the appellate judges correctly attributed the burden of proof to the party.”
“The cardinal principle of transfer pricing is the remuneration of transactions between related parties at the economic conditions that would have been agreed upon between independent parties.
Ministerial Circular No. 32/80, which has been referred to several times in the record, examined intra-group service contracts, pointing out that even at the time, specific services were frequently exchanged between the various subsidiaries or between the parent company and the individual affiliates, and that in certain cases, a considerable number of activities were centralised at the parent company or one of its divisions, which is entrusted with the exclusive function of providing services to the various units of the company.
In such cases, as a general rule, in relation to the profit margin in favour of the service-providing subsidiary, the circular agreed that it should be recognised only >>with respect to those services which constitute the main object of its activity<<. Instead, >>the profit margin should not be recognised: a) for those services that are closely related to the structure of the group, that do not form part of the institutional activity of the service-providing enterprise, and that do not result in services with an economic market value; b) for services that are formally provided by one of the affiliated enterprises that acts as an “intermediary” between the affiliate and an independent enterprise that is the actual service provider; c) for those services that are attributable to the general management and administrative activity performed by the parent company<<.
The Circular, then, within this category, went on to give specific relevance to the >>cost sharing arrangements<<, agreements entered into by various units of the group located in different countries, whereby the costs relating to research, but also to other services available within the group, are distributed among the various affiliates in relation to the benefits that each unit may derive from their use, pointing out that in such cases the share of each subsidiary’s contribution paid as a profit margin for the parent company will be deemed inadmissible, and this on the ground that the distribution of costs is not the object of its institutional activity.
The OECD Guidelines, in turn, on the subject of service contracts, provide both that >>Almost all multinational groups enter into agreements to provide their entities with a wide range of administrative, technical, financial and commercial services. These services may include management, coordination and control functions for the entire group. The cost of providing such services may be borne initially by the parent company, by one or more specifically designated group members (‘a group service centre’) or by other group entities. An independent enterprise in need of a service may acquire it from a provider specialising in that type of service or bear the cost itself (i.e. in-house). Similarly, an entity of an MNE group needing a service may acquire it from an independent company or one or more associated companies belonging to the same MNE group (i.e., intra-group) or take it on itself<< (para. 2) as well as cost sharing agreements, defined as >>a cost sharing agreement is an agreement between undertakings to share contributions and risks in the joint development, production or obtaining of intangible goods, tangible goods or services with the objective that such intangible goods, tangible goods or services create benefits for the business carried on by each of the participants<< (para. 8.3).
With respect to the former, >>once it has been established that an intra-group service has been provided, it becomes necessary, as with other types of intra-group transfers, to determine whether the amount of the payment is determined on the basis of the arm’s length principle. This means that the payment for intra-group services will have to be that which would have been made and accepted between independent enterprises under comparable circumstances. Thus, for tax purposes, such transactions are not to be treated differently from comparable transactions between independent enterprises, simply because the transactions take place between associated enterprises<< (para. 7.19) and >>depending on the method used to determine an arm’s length price for intra-group services, it is necessary to know whether the price should be such that it brings a profit to the service provider. In an arm’s length transaction, the independent enterprise is inclined to charge for services in such a way as to make a profit rather than to provide the services at cost price. To establish an arm’s length price, it is equally necessary to consider the economic alternatives available to the party to whom the service is provided<< (para. 7.35).
Well, in the present case, the CTR held that there was a cost sharing agreement by denying the company’s objection, based on the fact that the services for the recognised costs had been rendered in its exclusive interest, and in doing so it valorised the circumstance that the costs were only partially re-charged to it, but this consideration appears evidently contradictory with the assumption, which it itself shared, of considering as inherent only the costs for the services rendered in the exclusive interest of the company, a fact placed at the basis of the assessment. It is in fact common ground that the mark-up applied to the costs recognised as deductible is in dispute.”
“7.1 In addition to the foregoing considerations on the subject of intra-group contracts, this Court has already held that the costs of promoting trademarks may also be inherent in the business activity of their licensee on the ground that the licensee may also derive a benefit from incurring such costs in order to increase its own business activity, such possibility having to be ascertained in fact, in the individual concrete cases (thus Cass. 27/04/2012, no. 6548; Cass. 22/02/2013, no. 4518; Cass. 22/12/2014, no. 27198).
Therefore, in para. 3, the CTR erred in holding that the costs for the so-called advertising support were not inherent >> as DG s.r.l. was a mere licensee of the mark and that in the event of an increase in its value it might have had to pay a higher price to the owner of the mark<<, on the assumption, therefore, of a substantial uneconomicity of the same (not relevant, however, as seen, to assess the inherent nature), moreover formulated only in a hypothetical way, but, on the one hand, apodictically denying that the licensee of the trade mark can have an advantage from the advertising of the trade mark, whereas the same CTR acknowledged the receipt of royalties by DG USA and, on the other hand, obliterating the specific fact (omission censured by today’s appellant expressly in ground 4. 2) that DG s.r.l., although not the owner, had assumed, in the licence agreement, the obligation to improve the reputation of the mark and to promote it.”
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