The constant attention of the Italian Tax Administration for exchanges made with operators established in the so called "black-listed" countries and the difficulty, for the tax payer, to obtain the disapplication of the rules enforcing the non-deductibility of those costs, make the discipline foreseen by article 110, paragraph 10 of the Republic Presidential Decree nr. 917 dated December 22nd 1986 a recurrent theme of tax assessments and particularly sensitive for those companies working with foreign suppliers.
2. ENFORCED LAWS
The main rule regarding the deductibility of costs deriving from transactions incurred with "black-listed" countries is included in the paragraph 10 of article 110 of the Italian General Tax Law (T.U.I.R.) that provides: "Expenses and other negative incomes deriving from exchanges incurred with enterprises resident or located in countries or territories different from the ones included in the (white) list identified by the article 168-bis of this Republic Presidential Decree, are not deductible from corporate income for tax purposes. This deduction is allowed for exchanges incurred with enterprises resident or located in European Union member states or within the European Economic Space included in the list of the mentioned decree".
The discipline of black-listed countries is applicable to all subjects running an enterprise within the Italian territory.
Under some clarification of the Italian Tax Agency this discipline is applicable also to exchanges incurred with:
- the Permanent Establishment of an enterprise incorporated in a country with ordinary taxation regimen, placed in a black-listed country (i.e. the PE of a French enterprise, established in Hong Kong);
- the Permanent Establishment of an enterprise incorporated in Italy, placed in a black-listed country (i.e. the PE of an Italian enterprise, established in Cayman Islands);
Non deductible costs are, in example:
- expenses suffered to purchase goods and services;
- amortizations and depreciations of assets purchased from a black-listed country;
- social security and pension contribution;
- losses on goods and credits;
- accruals for risks on credits and currencies exchanges;
In general are not deductible all costs and expenses deriving from exchanges incurred with a black-listed enterprise or professional.
The above limitations become not applicable when the enterprise resident in Italy is able to demonstrate that those exchanges (purchases) have been made without any intention of evading Italian taxes on income.
In particular the non-deductibility can't be applied when the company:
- includes deducted amounts in its Income Tax Return showing them separately from all the other costs (the income tax return form foresees a specific box to outline those black-list expenses)1;
- within 90 days from the request by the Italian Tax Agency is able to demonstrate with appropriate supporting documents:
that the foreign seller located in a black-listed country runs a commercial business (first exemption);
that exchanges incurred have been made under a specific economic interest and have been concretely executed.
The Tax Administration is not obliged to consider has satisfactory the proofs and demonstrations given by the tax payer, but, in this case, they have to motivate their decision within the assessment notified to the company.
Moreover the Italian enterprise can ask for the disapplication of this law with a pre-emptive request under the rules set by article 21 of the Law nr. 413 dated December 30th 1991 ("interpello") submitting in advance to the Tax Agency all proofs of effective economic interest and execution.
The black-listed discipline is:
- NOT applicable to exchanges with non resident operators for which are applicable articles 167 and 168 of the Republic Presidential Decree 917/1986 (Controlled Foreign Companies);
- APPLICABLE also to services purchased from professionals established in black-listed countries.
3. HOW THE TAX PAYER CAN DEMONSTRATE THE DEDUCTIBILITY OF BLACK LIST COSTS
Under a tax assessment the audit is made with the analysis of documents provided by the tax payer under the two exemptions foreseen by the law mentioned above.
In fact, financial offices are obliged, before issuing the tax notice, to notify the audited company with a document request under paragraph 11 of the article 110 and the tax payer has 90 days to demonstrate the existence of the two exemptions.
The tax payer, to reject Agency's remarks and support expenses deductibility, can use the following defences:
1) the effective running of an economic business by the seller established in the black-listed country (called 1st exemption);
2) the concrete execution and the effective economic interest of the exchanges made with the enterprise placed in the black-listed country (called 2nd exemption).
We'd like to outline that the existence of a Tax Treaty to avoid double taxation undersigned by the two countries involved containing a non-discrimination clause as per article 24, paragraph 4 of the OECD Model, should make the provisions set by article 110, paragraph 10, not applicable. This because, according to the consolidated jurisprudence, the treaty rule should prevail on internal laws.
4. THE 1ST EXEMPTION – EXISTENCE OF AN ECONOMIC BUSINESS
The Italian tax payer has to demonstrate that the foreign (black-listed) company:
- Runs a true and concrete commercial activity (business), employing personnel and using assets adequate to run the said activity;
- Owns an organised structure suitable to run the business.
With reference to the documentation to be produced in order to demonstrate the effectiveness of the business run in the black listed country, the Agency has recognized as valid the following items:
- A detailed survey on the business and the organization used to run the business itself of the blacklisted company including governing laws and bylaws, board of directors' resolutions, employment agreements and job descriptions, local authorizations issued by local authorities, availability of premises and productive buildings);
- Fiscal and accounting documentation (financial statements, income tax returns, appraisal and surveys, list of sales' invoices);
- Copies of renting agreements of the offices and of any warehouse;
- Certification issued by local authorities certifying the payment of local taxes on income;
- Copies of invoices for utilities related to premises used for the business;
- Copies of employment agreements for employees, confirming their duties and positions;
- Bank statements showing movements concerning the commercial business;
- Insurance contracts pertaining employees and premises;
- Healthcare certifications and administrative certifications confirming the suitability of premises used in the business.
5. THE 2ST EXEMPTION – EXISTENCE OF REAL ECONOMIC INTEREST AND CONCRETE EXECUTION
The tax payer, in order to demonstrate the real economic interest of the exchange made with a black-listed supplier has to demonstrate that the exchange has been concretely executed and the exchange is based on real economic reasons different from obtaining a tax advantage.
This means that:
- The exchange had a concrete economic reasons supported by managerial and entrepreneurial spirit;
- It is made at fair and average conditions and responds to usual managerial opportunities.
The Tax Agency has several times required a comparison between the price of the exchange made with the black-listed suppliers and the price of the same service in case it should have been supplied by a non black-listed supplier.
The proof of a concrete economic interest can be given by the analysis of:
- The price of the transaction;
- The presence of accessorial costs (warehousing);
- The advantages deriving from buying from a unique supplier;
- The unavailability of the same products with other suppliers;
- Logistics advantages in buying from a supplier nearest to the market served;
- Timing of the exchanges (i.e. times of delivery);
- The existence of organizational and/or commercial restrictions (ownership by the same group of companies).
Regarding the effective execution of the exchange, the tax payer can prove it with:
In case of goods,
- the custom's documentation;
- copies of purchase orders;
- copies of commercial agreements;
- copy of the correspondence incurred.
Since collecting all the above mentioned documents within the 90 days available could result a challenging exercise, we'd like to strongly recommend to collect all of them in advance, at the beginning of every business relationship with operators established in a black-listed countries and store them safely in order to have them immediately available in case of audit by Italian Tax Authorities.
6. PERIODICAL REPORTING REQUIREMENTS FOR EXCAHNGES WITH BLACK-LISTED COUNTRIES
Staring from July 1st 2010 the Italian government has introduced new VAT reporting requirements, for transactions involving "black-listed" countries and transactions otherwise considered as "highly risky" from a tax point of view.
The new VAT reporting rules have been added to existing reporting requirements already included in annual income tax return (Modello UNICO).
Differently from the existing reporting requirements, the new liability will be broader in scope and more detailed.
7. BOUNDED TAX PAYERS
All Italian VAT subjects (individuals and companies, including the ones registered in Italy just for VAT purposes either with a fiscal representative or through a direct VAT identification), are required periodically to communicate, through a dedicated web connection with the Italian national tax Authority (Agenzia delle Entrate), an electronic file containing all their relevant transactions with customers whose legal address, place of business or domicile is located in one of the "black-listed" countries as per the 2 lists detail at the following chapter 3.
8. RELEVANT VAT TRANSACTIONS TO BE INCLUDED IN THE FORM
According to the new rules, in addition to purchases, sales to black-listed countries (including goods and services) have to be reported on a periodical basis.
This means that all transactions involving black listed countries are relevant for this communication, being them relevant for Italian VAT, zero-rated, exempt or "out of the scope".
Therefore, the periodical form to be submitted will show:
- Sales of goods;
- Sales of services;
- Purchases of goods;
- Purchases of services.
Each exchange will be indicated by specifying the quota attributable to operations subject to Italian VAT, operations not subject to Italian VAT, operations exempt or when out of the scope.
9. BLACK LISTED COUNTRIES
In Italy the "Black list" decree (Decrees 21/11/2001 and 04/05/1999 issued by the Ministry of Economy and Finance) specifically identifies "high risk countries", from a tax point of view.
In facts, the Italian tax legislation limits the deductibility of a series of costs that are strictly related with a company which have legal address, place of business or domicile in one of the "black-listed" countries as seen by the Italian tax authorities.
Basically these countries do not provide adequate fiscal or financial information on companies that are resident and working in these countries compared with other companies located anywhere in the world. "Black listed" may also involve certain EU jurisdictions e.g. Cyprus, Malta, Luxembourg and other European countries like Switzerland, Liechtenstein, Andorra, San Marino, Monaco as well as other states, e.g. Singapore, Oman, Uruguay, Hong Kong, etc. Currently, there are altogether more than 70 blacklisted jurisdictions.
In addition to the above, please consider that the law allows for the list to be reduced or expanded in the future to exclude or include countries, special industries or particular persons on an ad hoc basis. Black listed countries without exemption are:
Alderney (Isle del Canal)
Gibuti (ex Afar and Issas)
Guernsey (Channel Islands)
Herm (Channel Islands)
Isle of Man
Turks and Caicos,
British Virgin Islands
US Virgin Islands
Jersey (Channel Islands)
Kiribati (ex Gilbert Island)
Saint Kitts and Nevis
Saint Vincent and Grenadine
Sant'Elena Sark (Channel Islands)
Tuvalu (ex Ellice Island)
Black listed countries with specific exemptions:
United Arab Emirates
Black listed countries with specific restrictions or distinctions:
10. INFORMATION TO BE INCLUDED IN THE NEW COMPULSORY FORM
The filing should be performed electronically on with two different basis, depending on the turnover.
- Monthly basis form: taxpayers, whose quarterly black listed operations turnover exceeds € 50.000 either in respect of the quarter concerned or in respect of any of the 4 quarters preceding the one in which the listing is to be filed and for each type of operations (i.e. transfers of goods made, provisions of services made, purchases of goods made, provisions of services received), will be entitled to file the data on a monthly basis;
- Quarterly basis form: taxpayers, whose quarterly black listed operations turnover does not exceed € 50.000 either in respect of the quarter concerned or in respect of any of the 4 quarters preceding the one in which the listing is to be filed and for each type of operations (i.e. transfers of goods made, provisions of services made, purchases of goods made, provisions of services received), will be entitled to file the data on a quarterly basis.
The limit of € 50.000 have to be calculated for each type of operations.
The deadline is the end of the month following the relevant period.
11. PENALTIES CONNECTED TO THIS FORM
Current penalties range from € 516 to € 4,130 for missing reporting liability deadlines or incomplete reporting in compulsory information or amounts.
1 Violations made up to December 31st 2006 are punished with a penalty from 100% to 200% of the income tax calculated on non-deductible costs not included in the tax return, while violations made starting from January 1st 2007 are punished a 10% penalty on amounts not included with a minimum of Euro 500,00 and a maximum of Euro 50.000,00. In both cases the tax payers has to demonstrate the deductibility of those costs under the 2 exemptions described, in case of tax audit, in order to see them recognised as deductible costs.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.