Italy vs HSBC Milano, September 2019, Supreme Court, Case No 23355

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HBP is a company resident in the United Kingdom, which also carries on banking business in Italy through its Milan branch (‘HSBC Milano’), which, for income tax purposes, qualifies as a permanent establishment (‘PE’ or ‘branch’) and grants credit facilities to Italian companies and industrial groups, including (from 1996) Parmalat Spa.

HBP brought separate actions before the Milan Provincial Tax Commission challenging two notices of assessment for IRPEG and IRAP for 2003 and for IRES and IRAP for 2004, which taxed interest expense (147,634 euros for 2003 and 143,302 euros for 2004) on loans to Parmalat Spa. (€ 147,634, for 2003; € 143,302, for 2004) on loans from the ‘parent company’ in favour of the ‘PE’, and losses on receivables (€ 9,609,545, for 2003, and € 3,330,382, for 2004), as negative components unduly deducted by the permanent establishment, even though they related to revenues and activities attributable to the ‘parent company’.

According to the Office, the PE is considered, from a tax point of view, to be an autonomous entity distinct from the parent company, both under domestic and supranational law, and is therefore, in accordance with Article 7(2) of the Convention between Italy and the United Kingdom for the avoidance of double taxation, subject to the same tax regime as independent entities, with certain consequences from the point of view of the quantification of its income.

The Milan Provincial Tax Commission (CTP), with judgment No. 117/2010, allowed the appeals and annulled both notices as they lacked the “necessary tax basis”.

The Lombardy Regional Administrative Court, with the judgment in question, after hearing the United Kingdom bank, upheld the Agency’s appeal, disregarding, first of all, the appellant’s objection that the 60-day deadline had not been met, pursuant to Article 12(7) of the Statute of Taxpayers’ Rights, with respect to the notice of assessment for 2003 (“notice for 2003″), on the grounds that the tax assessment notice took account of the urgency of the matter in view of the very short time remaining before the expiry of the time limit for assessment action.

As regards the substance of the assessments, with reference to the dispute concerning interest expense, the CTR held that it was deductible only in respect of interest accrued on an amount exceeding the notional endowment fund of €6.3 million (equal to the minimum amount of the banks’ initial capital, according to Bankitalia’s provisions), which could be deducted under Article 7 of the Convention, in order to ensure the principle of free competition between the permanent establishment and the Italian credit institutions.

With regard to loan losses, the CTR stated that: ‘Article 109 TUIR refers to the principle of correlation between costs and revenues […] mentioned in the notices of assessment. Article 110, paragraph 7 of the TUIR refers to the principle of free competition”, according to which the components of income, deriving from intercompany transactions with companies not resident in the territory of the State, are valued on the basis of the “normal value” of the goods sold and services received, which entails the equal tax treatment of companies carrying out banking activities, with the determination of a notional endowment fund, which aims to avoid favouring undercapitalised companies.

It therefore agreed with the calculations made in the notices of assessment in which, on the finding that the branch, which did not have the regulatory capital (amounting to €45,435. 337, determined in relation to the amount of the credit lines granted to Parmalat Spa) required from an independent party, had transferred to the “parent company”, in the form of interest expense on loans received from the latter, 71.18% of the profits accrued on the “Parmalat credit”, retaining the remaining 28.82%, for the principle of correlation between costs and revenues, for the purposes of their tax deductibility, only 28.82% of the “Parmalat losses” were charged to the “PE”, amounting in total, in the two-year period from 2003 to 2004, to euro 18. 174.135.
Finally, the CTR confirmed the legitimacy of the administrative sanctions for violation of tax regulations, excluding the objective uncertainty of the latter.
6. HBP appeals for the annulment of this judgment, on the basis of ten grounds, illustrated by a memorandum pursuant to Article 378 of the Code of Civil Procedure, to which the Agency resists with a counter-appeal.

Judgement of the Supreme Court

(a) the permanent establishment, from a tax point of view, is a distinct and autonomous entity with respect to the ‘parent company’, the income of which, produced in the territory of the State, is subject to tax, pursuant to Article 23, paragraph 1, letter e), T.U.I.R.;
(b) Article 7, paragraph 2, of the Convention between Italy and the United Kingdom against double taxation, entered into on 21 October 1988 (and ratified by Law n. 329 of 1990, ), provides for the application of Article 7, paragraph 2, of the Convention between Italy and the United Kingdom.
(b) Article 7, paragraph 2, of the Convention between Italy and the United Kingdom for the avoidance of double taxation, concluded on 21 October 1988 (and ratified by Law No. 329 of 1990), which provides that where an enterprise of a Contracting State carries on business in the other Contracting State through a permanent establishment situated therein, there shall in each Contracting State be attributed to that permanent establishment the profits which it might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a permanent establishment.
(c) the OECD Commentary (§ 18. 3.), with respect to the said Article 7, has clarified that the permanent establishment must be endowed with: “a capital structure appropriate both to the enterprise and to the functions it performs. For these reasons, the prohibition on deducting expenses connected with internal financing – that is to say, those which constitute a mere allocation of the parent company’s own resources – should continue to apply generally.”.
In the present case, the Regional Commission complied with the above principles of law when it held that the Convention placed limits on the deductibility of the negative components of the Italian branch’s income, understood both as interest expense and as expenses connected with the management of the loan (in the case in point, these were losses on loans and commission charges for the assignment of loan agreements).

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