Transfer pricing challenges for asset managers under the Italian IME
December 2024 | SPECIAL REPORT: CORPORATE TAX
Financier Worldwide Magazine
December 2024 Issue
The 2023 Italian Budget Law (Law 29 December 2022 No.197) introduced the Investment Management Exemption (IME) regime, and amended the definition of permanent establishment (PE) for Italian income tax purposes.
In brief, the IME provides for a safe harbour regime, ensuring that, under certain conditions, foreign investment vehicles do not trigger a PE in Italy due to the activities of their asset managers. This reform aligns Italy with other jurisdictions, such as the UK, making the Italian market more competitive and attractive for investment funds.
However, transfer pricing (TP) implications must be closely monitored, as the IME requires asset managers to be remunerated at arm’s length, following specific guidelines.
The IME in a nutshell
The IME provides for a non-rebuttable presumption under which the activities carried out in Italy by the asset managers of foreign investment vehicles do not give rise to a PE provided that certain conditions are met.
The IME applies to any entity that is primarily or exclusively focused on managing investments on its own or on behalf of third parties, including collective investment undertakings, institutional investors, and other entities subject to prudential supervision and regulation.
Indeed, according to the new provisions, asset managers in Italy will be considered independent vis-à-vis the foreign investment vehicle if the following conditions are met. First, the foreign investment vehicle and its foreign-controlled entities are established in a ‘white-list’ jurisdiction. Second, the foreign investment vehicle complies with the independence requirements established in the implementing decree. Third, the asset manager does not hold directorship or supervising offices and it is not entitled to more than 25 percent of the profits of the foreign investment vehicle and its foreign-controlled entities. Lastly, the asset manager receives a remuneration supported by adequate TP documentation.
Although the Italian minister of economy and finance issued an implementing decree on 22 February 2024 providing certain clarifications, certain interpretative issues still persist. For instance, based on the plain reading of the new provisions it would seem that management companies could be excluded from the scope of IME application.
In any case, if the requirements are not met, the existence of a PE in Italy must still be assessed on a case by case basis.
TP guidelines on the IME regime
One of the essential requirements for the IME is that the asset manager’s remuneration must be in line with the arm’s length principle. To prove this, the manager must maintain adequate TP documentation that complies with Italian TP rules and thus be eligible to benefit from the penalty protection regime.
In this respect, in February 2024, Italian tax authorities issued specific TP guidelines for IME purposes (IME TP Guidelines), which outline the guidance to select the most appropriate TP methods to determine arm’s length remuneration; by all means, on the basis of the nature and type of services provided from Italy.
The IME TP Guidelines identify each particular type of investment management services that include: (i) management services (e.g., buying, selling or trading of financial instruments, including derivatives, equity interests and credits); (ii) administrative services (e.g., legal and accounting services, client reporting, asset valuation – including for tax purposes – and compliance monitoring, managing investor registers, distributing proceeds, issuing and redeeming shares or quotas, and contract settlement); and (iii) marketing services (e.g., activities aimed at promoting the subscription or purchase of shares or quotas through direct or indirect offers or promotions to investors).
For these services, the IME TP Guidelines provide that the comparable uncontrolled price (CUP) method is generally the most reliable TP method to be used.
However, if CUP is not applicable, the profit split method (PSM) becomes the most appropriate if both parties involved bear the same economically significant risks and the parties separately assume closely related significant risks. If neither CUP or the PSM can be applied reliably, any other methods in the Organisation for Economic Co-operation and Development (OECD) TP guidelines can be used, except those based on a financial indicator tied to costs.
That said, in cases where it is demonstrated that the transaction does not involve the assumption of economically significant risks, the arm’s length price can be determined using other methods described in the OECD TP guidelines, including those based on costs.
On the other hand, the IME TP Guidelines identify certain connected and instrumental services, which include promotional activities (e.g., investment advisory services that help develop and promote investment management services) and ancillary activities (e.g., economic and financial research, data analysis, communication of financial information, managing IT and data processing services, real estate management, and administrative and accounting services).
For these services, the IME TP Guidelines provide that the arm’s length remuneration can be assessed using any method provided by the OECD TP guidelines, including cost-based methods, unless economically significant risks are assumed. If such risks are assumed, the above outlined rules related to investment management services apply.
The criteria outlined in the IME TP Guidelines are fully aligned with the OECD TP guidelines, particularly regarding the selection of the most appropriate TP method. Indeed, the IME TP Guidelines reinforce the importance of a thorough functional analysis, emphasising the identification and allocation of economically significant risks.
Economically significant risks for the asset management industry
In a TP context, economically significant risks are those that have a substantial impact on the profit potential of a business opportunity. These risks are crucial in determining how profits or losses are allocated among associated enterprises within a multinational group. Accurately identifying and allocating these risks is essential to ensuring that TP is in line with the arm’s length principle.
In this respect, it is fundamental to bear in mind that – to assume economically significant risks – an entity must have both the capability to make decisions regarding the particular risk and the financial capacity to bear the consequences if the risk materialises. Indeed, control over risk involves making decisions about taking on, laying off or declining a risk-bearing opportunity and responding to the risks associated with the opportunity.
In this regard, the OECD TP guidelines (paragraph 1.71) state that: “Determining the economic significance of risk and how risk may affect the pricing of a transaction between associated enterprises is part of the broader functional analysis of how value is created by the MNE group, the activities that allow the MNE group to sustain profits, and the economically relevant characteristics of the transaction.”
Thus, determining whether a risk is “economically relevant” involves assessing its connection to the business’s value chain and key value drivers. The analysis should focus on how the risk affects critical elements that drive value creation, influencing the choice of the most appropriate TP method.
Regarding the asset management industry, identifying and assessing economically significant risks is critical to understand how value is created and how profits or losses are allocated within a multinational group. This process requires a thorough understanding of the value chain, particularly how risks align with key strategic decisions, such as investment choices, portfolio management and operational efficiency.
A key characteristic of this industry is that profits are often people-driven, as the value generated largely depends on the activities of individuals in critical roles (e.g., management, investor relations, and decision makers for investments).
Considering this, for value chain analysis purposes reference could be made to the authorised OECD approach, which emphasises the importance of focusing on the significant people functions (or key entrepreneurial risk-taking functions) – those who perform economically relevant tasks – when conducting a functional analysis of a PE.
Considering the above and based on our experience, a typical value chain in asset management includes functions such as fund design, marketing, distribution, investment management, risk management and several administrative services. The most significant risks within this value chain are: (i) the potential for losses due to the inability to meet investor redemption requests or liquidate investments efficiently (i.e., liquidity risk); (ii) the impact of market fluctuations on asset performance (i.e., market risk); (iii) the track record of the sponsors or managers (i.e., reputational risk); (iv) non-compliance with relevant regulatory regulations, which could lead to suspension or cessation of activities (i.e., regulatory risk); and (v) fluctuations between the asset-base currency and the currencies of those regions where investments are made (i.e., currency risk).
Allocating these risks is therefore fundamental to carrying out a proper TP analysis, particularly concerning the actual delineation of the transaction, identifying the functional profile of the parties, and thus determining the TP policy’s consistency with the arm’s length principle.
Key considerations
The IME TP Guidelines emphasise risk analysis, particularly the identification of economically significant risks, which are often misaligned with the actual functions performed by entities within multinational asset management groups. Although the IME TP Guidelines are designed for the IME regime, their principles are also relevant for determining the most appropriate TP policy, even if the group does not benefit from the IME.
Multinational asset management groups should closely examine the activities performed and carefully assess how risks are allocated, particularly with respect to marketing and distribution or discretionary advisory functions, where risks are often not properly identified despite their key role in value creation.
Thoroughly reviewing the consistency of TP policies is therefore essential to ensure compliance with the arm’s length principle, taking into account the IME TP Guidelines, to which asset managers should refer in their TP documentation.
It is also equally important to conduct a comprehensive review of the value chain, as functions and risks are spread across different entities, and there is no industry standard. This further highlights the need to select the most appropriate TP method.
By aligning their TP policies with the IME TP Guidelines, multinational asset management groups can mitigate PE and TP risks while ensuring compliance with the arm’s length principle. Other challenges still need to be considered by asset managers relocating to Italy under the €200,000 flat tax regime, to ensure proper regulatory structuring.
Raul-Angelo Papotti is a partner and Umberto Lorenzi and Rui Hui Hong are associates at Chiomenti. Mr Papotti can be contacted by email: raul.papotti@chiomenti.net. Mr Lorenzi can be contacted by email: umberto.lorenzi@chiomenti.net. Mr Hong can be contacted by email: ruihui.hong@chiomenti.net.
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Raul-Angelo Papotti, Umberto Lorenzi and Rui Hui Hong
Chiomenti