Following an audit of Otis Servizi s.r.l. for FY 2007, 2008 and 2009 an assessment of additional taxable income was issued by the Italian tax authorities.
The first part of the assessment related to interest received by OTIS in relation to the contract called “Cash management service for Group Treasury” (hereinafter “Cash Pooling Contract”) signed on 20 March 2001 between OTIS and the company United Technologies Intercompany Lending Ireland Limited (hereinafter “UTILI”) based in Ireland (hereinafter “Cash Pooling Relief”). In particular, the tax authorities reclassified the Cash Pooling Agreement as a financing contract and recalculated the rate of the interest income received by OTIS to be between 5.1 and 6.5 per cent (instead of the rate applied by the Company, which ranged between 3.5 and 4.8 per cent);
The second part of the assessment related to of the royalty paid by OTIS to the American company Otis Elevator Company in relation to the “Licence Agreement relating to trademarks and company names” and the “Agreement for technical assistance and licence to use technical data, know-how and patents” signed on 1 January 2004 (hereinafter referred to as the “Royalty Relief”). In particular, the tax authorities had deemed the royalty agreed upon in the aforesaid contracts equal to 3.5% of the turnover as not congruous, recalculating it at 2% and disallowing its deductibility to the extent of the difference between the aforesaid rates.
Not satisfied with the assessment an appeal was filed by OTIS.
The Regional Tax Commission upheld the assessments and an appeal was then filed with the Supreme Court.
Judgment of the Supreme Court
The Court decided in favour of OTIS, set aside the assessment and refered the case back to the Regional Tax Commission in a different composition.
Excerpt related to interest received by OTIS under the cash pooling contract
“In the present case, the Agenzia delle Entrate redetermined the rate of the interest income received by the OTIS in relation to the contract between the same and UTILI (cash pooling contract) concerning the establishment of a current account relationship for the unitary management of the group treasury. UTILI, as pooler or group treasurer, had entered into a bank account agreement with a credit institution in its own name, but on behalf of the group companies. At the same time, OTIS had mandated that bank to carry out the various tasks in order to fully implement the cash pooling agreement. Under this contract, all participating companies undertook to transfer their bank account balances (assets or liabilities) daily to the pooling company, crediting or debiting these balances to the pool account. As a result of this transfer, the individual current account balances of each participating company are zeroed out (‘zero balance cash pooling’).
Notwithstanding the fact that the tax authorities do not dispute that this is a case relating to “zero balance cash pooling” (a circumstance that is, moreover, confirmed by the documents attached to the appeal), it should be noted that the same practice documentation of the Revenue Agency leads to the exclusion that, in the hypothesis in question, the cause of the transaction can be assimilated to a loan. In particular, in Circular 21/E of 3 June 2015, it is stated (p. 32) that “with reference to the sums moved within the group on the basis of cash pooling contracts in the form of the so-called zero balance system, it is considered that a financing transaction cannot be configured, pursuant to Article 10 of the ACE Decree. This is because the characteristics of the contract – which provides for the daily zeroing of the asset and liability balances of the group companies and their automatic transfer to the centralised account of the parent company, with no obligation to repay the sums thus transferred and with accrual of interest income or expense exclusively on that account – do not allow the actual possibility of disposing of the sums in question in order to carry out potentially elusive transactions’. These conclusions are confirmed in the answer to Interpretation No. 396 of 29 July 2022 (p. 5) where it is specified that ‘cash pooling contracts in the form of the so-called zero balance stipulated between group companies are characterised by reciprocal credits and debits of sums of money that originate from the daily transfer of the bank balance of the subsidiary/subsidiary to the parent company. As a result of this contract, the balance of the bank account held by the subsidiary/subsidiary will always be zero, since it is always transferred to the parent company. The absence of the obligation to repay the remittances receivable, the reciprocity of those remittances and the fact that the balance of the current account is uncollectible and unavailable until the account is closed combine to qualify the negotiated agreement as having characteristics that are not attributable to a loan of money in the relationship between the companies of the group’.
That being so, the reasoning of the judgment under appeal falls below the constitutional minimum in so far as the CTR qualified the cash pooling relationship as a loan on the basis of the mere assertion that “the obligation to repay each other by the closing date of the account is not found in the case”. In so doing, the Regional Commission identified a generic financing contract function in the cash pooling without distinguishing between “notional cash pooling” and “zero balance cash pooling”, instead excluding, on the basis of the same documentation of practice of the Tax Administration, that in the second case (“zero balance”), a loan contract can be configured.
The reasoning of the contested decision does not therefore make the basis of the decision discernible, because it contains arguments objectively incapable of making known the reasoning followed by the judge in forming his own conviction, since it cannot be left to the interpreter to supplement it with the most varied, hypothetical conjectures” (Sez. U. no. 22232 of 2016), the trial judge having failed to indicate in a congruous manner the elements from which he drew his own conviction, thus making impossible any check on the accuracy and logicality of his reasoning (Cass no. 9097 of 2017).”
Excerpt related to royalty paid by OTIS under the licence agreement
“Although the legislative amendment was aimed at the need to bring the national legal system into line with the criteria for identifying transfer prices between multinational companies outlined by the OECD, the interpretive perspective had already previously evolved in line with the principle of free competition as set forth in Art. 9 of the OECD Model Convention, which provides for the possibility of subjecting to taxation profits arising from intra-group transactions that have been governed by terms different from those that would have been agreed upon between independent enterprises in comparable transactions carried out in the free market, it being noted that the OECD Guidelines of 1995 (OECD, Guidelines, 1995) already provided that “[t]he selection of a transfer pricing method is always aimed at finding the most appropriate method for a particular case. For this purpose, the following should be taken into consideration in the selection process: the respective advantages and disadvantages of the methods recognised by the OECD; the consistency of the method considered with the nature of the controlled transaction, determined in particular through functional analysis; the availability of reliable information (in particular on independent comparables) necessary for the application of the selected method and/or the other methods; the degree of comparability between controlled transactions and transactions between independent enterprises, including the reliability of comparability adjustments that are necessary to eliminate significant differences between them. No method can be used in all eventualities and it is not necessary to demonstrate the non-applicability of a given method to the circumstances of the particular case”.
That being said, it must be noted that the CTR completely failed to examine the economic studies produced by the taxpayers and, therefore, to verify in concreto which of the various applicable methods was the most congruous for the correct determination of the royalty in the present case.”
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