Tax Reform Update: International Experience to Mark Italian Way to Cooperative Compliance
An Introduction and Historic Perspective
Enhanced relationships with Tax Authorities, tax co-operative compliance, until now they were definitions of something which many people thought would never be applicable in Italy.
The Italian tax system has always been characterized by a rule which we might name “act and assess”.
For many decades taxpayers made their interpretation of tax law, supported by their tax advisors or tax specialists, and in the lag of some years, the case being, Tax Authorities made their assessment, approving or denying the validity of the interpretation.
Also, the application of rules officially interpreted by Tax Authorities in their official practise was not the safe harbor all the time.
The only way to get through was starting a litigation before a Tax Court, where in many cases judges were not “fully” independent, both because sometimes they were former officers of the Tax Administration and sometimes they were tax professionals.
Italian tax practitioners were not astonished to see that sometimes different Sections of the same Tax Court might arrive at opposite conclusions in respect of the same rule and case.
A turn towards modernity came in the year 2000, with the enactment of the “Statute of the rights of the taxpayer” (“Statuto dei diritti del contribuente”), Law 212 of 2000, which came into force after huge efforts from, the at the time Undersecretary of Finance, Prof. Gianni Marongiu, who resisted attacks from bureaucracy who did not want to bring in such significant changes to the system.
Ruling request was introduced. Tax Authorities were compelled to provide an answer to the request of interpretation by taxpayers if the case was new and never officially dealt before. Such answer came—and comes—four months from submission, extendable to eight months if Tax Authorities need more documentation or information. The usual practise is that the term of eight months is “ordinary” when the case is complex.
The weakness of the ruling is that it is valid only in respect of the specific taxpayer who submitted the request and does not have general validity to the public.
Ideally, the same ruling request submitted to a geographically different Tax Authority might have a different response. To minimize such risk, the Italian Tax Agency has central structures that coordinate ruling issues in order to prevent contradictions, and this central control system effectively works well.
A further weakness, which especially foreign investors do not like, is that Tax Authorities are allowed to change their mind after the issue of the ruling, so taxes may be charged afterwards, while no penalties are applicable.
OECD issued an important paper on this subject in 2013, “Co-operative Compliance: A Framework: From enhanced relationship to co-operative compliance”.
In the “current state of play” paragraph of the paper, Italy is mentioned as not yet having a formal co-operative compliance model, but a Large Business Division (“Grandi Contribuenti”) was implemented in 2009 and a risk based approach had become a common driver of the action of the Italian Tax Agency. Investigation focus essentially remained on high risk taxpayers.
Tax Cooperative Compliance in the New Law – The New Scenario
The current tax reform has become the occasion for a large step ahead in this direction.
On April 21, 2015, the Government enacted a draft legislative decree under the law for tax reform (“Delega fiscale”, Law 11 March 2014 n.23), which provided for an important step towards better clarity and certainty of the tax system.
This new set of rules is a further decisive turn of the Italian tax system. In respect of very large taxpayers at a first stage and then scaling down to other taxpayers in a few years’ time, it changes the underlying rationale from the “act and assess” to a new one where early certainty and “no surprise” features are the drivers of a new relationship with the Italian Tax Agency.
As a sort of preliminary canapé in view of this change, which will take place by the end of the current month, the Italian Tax Agency has issued guidelines to all local tax offices where they are ordered to give up litigations on a list of nine issues which were being still litigated though the Italian High Court had declared several times that the tax payer was right and the Tax Agency was wrong.
As far as we remember, it never happened before that the Tax Agency had taken such a stand on nine issues all in one shot. In the past they normally took one issue at a time.
Matters are relevant for individuals and not for companies, so we are not going to provide details. However, this behavior is absolutely relevant.
The New Provisions in More Detail
The articles of the legislative decree related to cooperative compliance are from 3 to 8.
The regime is not compulsory and at present is limited both to taxpayers with a global turnover not lower than 10 Billion Euros plus taxpayers who submitted to their request to participate to the Pilot project launched two years ago, about one hundred. In fact, the Tax Agency had invited Tax Directors of very Large Taxpayers to participate in meetings in order to openly discuss tax cooperative compliance. Among many requests, only a selected number was admitted to the project.
In any case, the number is very limited. However, it is stated that the regime will be extended progressively to taxpayers with a turnover of one hundred Million Euros, which is the official category of Large Taxpayers. The Government plans to potentially applying this new regime to all Italian Large Taxpayers—all in all, more than one thousand taxpayers—within a three-year time framework.
Further than a good track record of timely and proper traditional tax compliance, there are new preliminary conditions that interested taxpayers must meet in order to be admitted into the tax cooperative compliance program.
Condition number one is to have good governance and efficient internal control systems which will determine a clear attribution of duties and tasks to internal functions; condition number two is to have in place efficient procedures to spot, measure and manage tax risks at all company levels; and condition number three is to have efficient procedures to allow remedial actions in a very short timeframe.
Some Italian doctrine is starting to criticize these conditions, which seem too theoretical and scarcely defined.
We do not share this view.
First of all, there is a specific precedent in the Italian system represented by regulatory rules for banks. On the 2nd of July 2013, the Bank of Italy updated its corporate governance rules for banks by also introducing for the first time the duty of banks to put in place a “tax risk control and monitoring” as an inevitable part of the internal control system.
No specific guidelines were provided and banks have had to evaluate what to do according to best practise and in accordance with their existing internal control system and business model.
Thus, though internal bank organisations have specific features—especially the Compliance and Risk Management functions, which are compulsory—Italian banks may now also become a very good benchmark to identify best practices for non-banks.
As stated in the Government report, the culture of tax risk is still weak in Italy, but this does not entail that steps ahead should not be made.
Due to the “act and assess” culture applied until now, the idea of setting up written procedures in order to monitor and manage tax risks, plus internal processes in order to attribute more specific responsibilities to internal functions or divisions in this domain, will for sure raise concern and tentative push backs, but will be put in place in the end.
The new provisions also indicate the duties and engagements of the Tax Agency, the duties and engagements of the Taxpayers and the related benefits for the latter.
The Tax Agency will have to inspire its action to principles of proportionality and reasonableness, publish updated lists of operations which are considered having an aggressive tax planning ground, promote clear and transparent relationships in a spirit of collaboration with the taxpayers, provide early certainty to the taxpayers and respond to requests as quickly as possible, and keep on due account the evaluation provided by the Board of Directors, Top Management, Auditors, Board of Statutory Auditors, and Supervisory Authorities.
On their side, further than what was stated above about setting up and maintaining a good and sound governance and internal control system, taxpayers will have to keep a collaborative and open behavior, put in place all suggestions related to such systems proposed by the Tax Agency, timely submit all issues which may constitute a tax risk, promote an internal culture inspired by honesty, transparency, and respect of tax law.
The effects and benefits of such new regime are the following:
1. A shared evaluation of tax risks is reached before a tax return is submitted—“early certainty” and “no surprise” principle—if tax risks are illustrated before the submission of the tax return and views are not shared with the Tax Agency, in any case, administrative penalties are reduced to 50% and cannot exceed their minimum amount in the forwarding tax assessment. Today penalties could be applied—and have sometimes indeed been applied—in their highest measure—250% of taxes due.
2. Much shorter terms to issue tax rulings. This feature is extremely relevant for taxpayers. The Italian Tax Agency will provide feedback about the suitability of the request and enclosed documentation in 15 days—today the term may be four months. The term for a response is 45 days from the request or from the date the further documentation is provided.
All in all, the worst case scenario for a response will be two months—if there is no delay in providing the documentation requested—while the current term is eight months. The difference is groundbreaking.
3. If a criminal proceeding is starting, the Public Prosecutor is officially informed by the Tax Agency on its cooperative compliance regime, and details about the internal organisation are also provided.
This rule is not really very clear, but will be clearer as soon as the reform of tax criminal offences are put in place—a draft law should be submitted next week and approval probably by next September.
4. No guarantees to be provided in order to obtain tax refunds.
The New Role of Tax Advisors
The new regime will also require a new mindset from tax advisors who work with Large Taxpayers.
Their role will be on one side to provide tax advice not only addressed to the companies but potentially suitable to convince also the Tax Authorities before a submission of the tax return is put in place.
Tax risks will have to be spotted well in advance in order both to illustrate them to the Tax Agency or to submit a tax ruling request.
If the company chooses to go ahead following a tax opinion without sharing the Tax Agency view, thus being aware of the application of penalties and potential start of a criminal proceeding—which is almost common sense for a Large Taxpayer—tax opinions provided will always have to be “very strong opinions”, with the meaning this concept currently has in the market.
Let’s also not also forget that in banking issues, external advisors are liable to penalties applied by Banking Supervisory Authorities.
Furthermore, the tax advisor will also have to provide some advice on best practices on how to monitor and manage tax risks at all organizational levels.
Testing internal processes and the whole internal control system is also a further support that the tax advisor may provide.
This entails a strong knowledge of the company activity, business model, key people mindset, and all that is needed to apply good solutions at the lowest costs.
In a nutshell, for tax advisors this is the new frontier of “Client proximity”.