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Benefit test for deductibility of royalties  

by Verbena Caravella | Jul 28, 2021 | Blog

Do you know what is the role of the Benefit Test within the intercompany services?

The OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, published in July 2017, introduced the so-called “benefit test ” to evaluate the arm’s length of the intercompany services provided by related companies belonging to the same multinational Group, stating that the activity performed by the service provider must be considered on the basis of the actual benefit obtained by the service recipient, i.e. considering the improvement of the service recipient’s economic or commercial position. Consequently, it is important to verify whether an independent company, operating in similar market circumstances, would have paid a remuneration in line with that paid by the beneficiary of the intra-group service to its counterparty.


The deductibility of costs under Italian law

Article 109 of the Italian Income Tax Act (Presidential Decree no. 917/1986, “TUIR”) establishes that the deductibility of costs is allowed when the two requirements of existence and inherency are met. While the proof of the existence of the relevant costs can be provided through the accounting documentation, the proof of inherency is more complex, as the taxpayer has to demonstrate that the costs are incurred for such activities or assets which generate revenues or other income and which contribute to increase the business income. However, the Italian legislation needs to be interpreted on the basis of the new OECD principle, to the extent that the inherency of the costs must be assessed on the basis of its economic usefulness, that could be verified through parameters other than of the increase in the business income.




The deductibility of royalties: the recent decision of the Italian Supreme Court

Royalties paid by a company to its related counterparty to obtain the license to use intangible assets (e.g., industrial know-how, trademarks, patents, etc.) represent deductible costs under Article 109 TUIR. However, the benefit achieved by the licensee may not be detectable in the short period, especially if the criterion for assessing the economic usefulness used is the profitability increase of the licensee.

The Italian Supreme Court recently ruled on a case concerning the payment of royalties by the Italian subsidiary to the parent company for the transfer of technical know-how used for the manufacture and distribution of motor vehicles. After stating that for the burden of proof of the costs’ inherency is not sufficient the attachment of the intercompany agreement and the invoices of the payments, the Court argued that the taxpayer must demonstrate the actual or potential usefulness obtained from the services received and remunerated with the payment of the royalties.


Final remarks

Although with the analyzed decision the Italian Supreme Court ruled against the taxpayer, many items of the conclusions show, also through references to previous decisions, an alignment with the criterion of inherency expressed by the OECD with the “benefit test” rule.

It should be noted that the judges go beyond the immediate impact of the cost on the increase of the business income, by adopting the criterion of the objectively determinable usefulness.

On the basis of this approach, the burden of proof should met, when the taxpayer demonstrates that the payment of the cost will consist in an objective benefit that could be assess in the medium-long period in terms of qualitative increase in production processes, consolidation of the position on the local market or a wider products portfolio. Even if these factors do not produce a current increase in profitability, they constitute objectively assessable conditions for the improvement of the economic position of the service recipient.



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