Italian Supreme Court Reverses Course on Permanent Establishment Issue

With its Ruling n. 3769 issued on March 9, 2012, the Italian Supreme Court significantly departed from its previous line of decisions on the issue of characterization of a foreign-owned Italian company as the permanent establishment of its foreign parent.

The case in which the ruling has been issued involved Boston Scientific S.p.A., an Italian joint stock company ("BS SPA") whose stock is  owned for 99 percent by Boston Scientific B.V. ("BS B.V.") a Dutch company  and for the remaining 1 per cent by Boston Scientific Corporation, a U.S. corporation ("BS USA"), which in turn controls BS B.V.

BS USA was engaged in the business of designing, manufacturing and selling medical equipment and devices. BS SPA operated as commission agent for BS B.V. for the purpose of the marketing and sale of the products of BS USA in Italy and the EU. 

From the summary of the facts as reported on the Supreme Court Judgment it appears that BS SPA acted under the management direction and control of BS B.V,, operated exclusively for BS B.V. as its only  client  and signed sales contracts with customers under its own name although in the interest of and pursuant to the final approval from BS B.V.    

The Italian tax agency took the position that BS SPA lacked economic and legal independence from BS B.V. and it operated as agent of BS B.V. according to the substance of its business dealings with its principal and final customers, even though it normally signed the contracts in its own name.  As a consequence, the tax agency re-characterized BS SPA as the permanent establishment of BS B.V. in Italy and assessed additional taxes and penalties on BS B.V., which should have accounted separately for its sales of products carried out in Italy through BS SPA, file its own Italian corporate tax return and pay the Italian corporate income tax on its net profits from its Italian sales accordingly.

Both the Italian Tax Court and the Appellate Court ruled in favor of the taxpayer and rejected the agency re-characterization and tax assessment, motivating their decisions with the fact that BS SPA had its own separate business organization of which it sustained all the costs, had assumed the economic risks of its business operations and was legally bound by the contracts it signed with the final buyers of the products under its own name as seller.

The Supreme Court affirmed the decision of the Appellate Court concluding that it was sufficiently and adequately motivated and that the grounds for appeal set forth by the tax agency were not sufficiently explained and could not be considered.

The Court in particular referred to the provisions of article 5 of U.S.-Italy tax treaty and argued that the Italian tax agency failed to explain the reasons why those provisions should be read in a way to create a permanent establishment when an Italian company contracts under its own name and risks and bears the economic cost of its business organization through which it conducts its business in Italy, for the sole fact that it is owned and controlled by a foreign company and operates under the supervision and directions of its foreign parent company.

Ruling 3769 is very encouraging. Indeed, the ruling seems to depart from the Supreme Court's previously established case law stemming form its 2002 decisions in the Philip Morris case and to provide more clarity for foreign businesses which plan to expand their operations into Italy. 

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