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Insights Circular Letter Italian Tax Authorities 24 May 2022 – Clarifications regarding interpretation of terminologies “arm’s length principle” and “arm’s length range”

Circular Letter Italian Tax Authorities 24 May 2022 – Clarifications regarding interpretation of terminologies “arm’s length principle” and “arm’s length range”

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published on 2 June 2022 | reading time approx. 3 minutes


With the publication of the circular letter of 24 May 2022, the Italian tax authorities have issued clarifications regarding the interpretation of the arm's length principle and, more specifically, the notion of "arm's length range". The letter thus provides guidance on how the arm's length principle introduced into national legislation by Legislative Decree of 24 April 2017 and, more specifically, the notion of "arm's length range" defined by Implementation Decree of 14 May 2018 should be interpreted in practice.

The circular letter first provides an overview of the regulatory developments that have led to the inclusion of the concepts “arm's length principle” and “arm's length range” in the national legislation. The primary objective of including these terminologies in the national legislation was to align Italian regulations more closely to the OECD transfer pricing principles.

The letter then elaborates on the terminology of "arm's length range" defined in Article 6 of the Implementation Decree of 14 May 2018 and provides operational instructions on the correct interpretation of said concept in practice. 

Some of the clarifications and interpretations provided by the Italian tax authorities are outlined in the below bullet points:
  • The basis for the use of the "arm’s length range", is the selection of the most appropriate method and the corresponding financial indicator. Once this selection has been made, comparables from arm's length transactions can be identified and a range can be constructed;
  • The introduction of the term "arm’s length range" in the national legislation is based on Art. 3.55 of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (hereinafter "OECD Guidelines"), which clarify that "(...) because transfer pricing is not an exact science, there will also be many occasions when the application of the most appropriate method or methods produces a range of figures all of which are relatively equally reliable." The different figures within the range may be justified by the fact that the application of the arm's length principle only produces an approximation of conditions that would have been established between independent enterprises and that independent enterprises engaged in comparable transactions under comparable circumstances may not establish exactly the same price for the transaction;
  • If all values within the range have the same degree of comparability, all values within the range can be considered arm's length;
  • If, on the other hand, a range of arm's length values is determined for which it can be assumed that comparability defects exist that cannot be identified or quantified, statistical tools should be used that take account of the central tendency to narrow the range (e.g. interquartile ranges) and thereby improve the reliability of the analysis. In these cases, only the values within the restricted range should be considered arm's length;
  • If an arm's length range contains so-called "outliers" or "extreme results", further examination should be conducted to understand the reasons for such extreme results and to ensure that the underlying transaction is comparable to the taxpayer's transaction under analysis;
  • Comparable results that show a loss should also be examined in detail, especially due to the fact that an independent enterprise would not continue loss-generating activities unless it had reasonable expectations of future profits. Loss-making transactions should not be excluded "a priori", but only if the loss situation does not reflect normal market conditions or if the loss situation reflects a different level of risk than that assumed by the taxpayer in connection with the transaction under analysis;
  • If the results obtained by the taxpayer in connection with the intragroup transaction under analysis is outside the range of arm's length results, the taxpayer must provide appropriate evidence justifying the deviation. If such evidence is not provided or is insufficient, the Italian tax authorities shall adjust the results to the point within the arm's length range identified by them that is closest to the results obtained by the taxpayer;
  • The target result selected by the taxpayer should in all cases be justified to explain why this result best satisfies the arm's length principle.

The above is merely an exemplary list of the clarifications and interpretations provided by the Italian tax authorities in the circular letter. 

The clarifications do not represent innovations per se, as they largely take up and reflect points and interpretations already contained in the OECD Guidelines. 

Nevertheless, it is an important step to obtain an official document from the Italian tax authorities containing these observations and interpretations, as it signals a declaration of intent and commitment on their part to comply with these instructions. 

In particular, the statement that in the case of an adjustment, the tax authorities should choose the point within the arm’s length range that is closest to the results obtained by the taxpayer is highly relevant, as this deviates from practical experiences in the past, where tax authorities would have typically adjusted to the median of the range.

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