Is Italy’s New Definition of Permanent Establishment the Right Solution to Prevent Tax Avoidance in Digital Economy?

By Enza Sonetti

Italian Budget Law has amended the domestic definition of Permanent Establishment (PE) to prevent artificial avoidance of PE status and make national legislation consistent with OECD’s Final Report on BEPS Action 7 and the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (MLI). The new definition has come into force on January 2018 and it is expected to have a considerable impact on Permanent Establishment status but its application to Italy’s existing tax treaties may be complicated due to the reservations to MLI submitted.

The new version of art. 162 of Italian Consolidated Text on Direct Taxation, extends the PE concept and covers hypothesis in which a foreign company has a significant business in Italy even though it has no physical establishment there. The amendment refers indeed, to the significant and continuous economic presence within Italian territory of a subsidiary that is set up in a way not to result as physically present in Italy. It is evident, thus, how this new concept will affect e-commerce and digital economy and help to avoid the presence of hidden PE.

Moreover, the Budget Law has modified the negative list provided by art. 162 that specifies the cases in which a fixed-base does not constitute a PE: Italy, in this respect, has decided to adopt a case by case approach as the character of preparatory or auxiliary activities that would exclude the existence of a PE, needs to be verified with reference to parent company’s activity. On the other hand, pursuant to art.13 of MLI and to tackle tax avoidance strategies, has been introduced an anti-fragmentation rule aiming to prevent artificial fragmentation of activities that, considered together or aggregated would constitute a PE.

The reform has also reviewed the notion of the dependent agent, designing a detailed definition more consistent with Final report on Action 7. According to this new definition, a person constitutes a PE if he acts on behalf of a non-resident corporation and habitually executes contracts or is involved in the conclusion of contracts without any possibility to make substantial changes to them. To tax law purposes a PE exists also if the agent is controlled by a foreign company or both are under the control of a third party that owns more than 50% of voting rights in the other.

The amendments introduced, implement the principles set in Final Report on Action 7 but need to be coordinated with MLI to which Italy, has expressed the right of not applying the entirety of articles 12 and 14 of the Convention to its Covered Tax Agreements. Therefore, they represent a relevant but a unilateral step towards the rationalisation of international tax governance and show the contradictions of autonomous strategies. Italy indeed expands the national definition of PE but on the other hand, expresses reservations and option to MLI that may provoke the unwelcome effect of not taxing incomes deriving from a different or new type of PE that should instead fall within the scope of the Convention.