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Transfer pricing disputes: a matter of evaluation rather than evidences


The allocation of the burden of proof is one of the key issues in the context of tax litigations on transfer pricing. This is mainly due to the nature of the transfer pricing, itself, which is substantiated by high degree of evaluation so that the identification of the party responsible to give evidence about the compliance of the transactions with the arm's length principle is crucial.

Under Italian legislations the regime of proofs is regulated at three different provisions: the civil code ("c.c."), the code of civil trials ("c.p.c.") and the legislative decree no. 546/1992 ("D.Lgs. 546/1992").

Conventionally the regime of the burden of proof is set forth by art. 2697 c.c. which imposes claimant asking for the protection of a right to prove the facts that underpin it, and requires the judge to reject the claim if such proof lacks. This regime triggers a number of corollaries. In the first place, there is the "principle of non-dispute" (see art. 115 c.p.c.), according to which the facts alleged by a party which are not rebutted by the counterparty are considered as proven evidence. In the second place, there is the so called "principle of proximity of the proof", originated by case-law, which allotted the burden of proof to the party considered "closer" to facts (e.g., delivering of envelopes or parcels for which case-laws placed the burden on the recipient to prove what was received regardless of who can take advantage of the circumstance).

In principle, the rule set by art. 2697 cc. applies to tax litigations and tax disputes on TP and arm's length principle as follows: the tax authorities must prove circumstances causing an increase in the tax burden (e.g. higher revenues) while the taxpayer those leading to a decrease (e.g. higher costs).

Tax litigations on TP and the burden of proof

Despite the matter at hand is governed by widespread principles (also at an international level), the definition of an arm's length price for intercompany transactions of goods and services raises concern which does not appear to be a matter of proof nonetheless a matter to be solved in the light of the general rule of the burden of proof. To the contrary, the transfer pricing dispute seems to function on a completely different level compared to proof.

In this regard, as a preliminary remark, one should consider that transfer pricing, unlike price agreed, does not reflect historical facts. Whilst, transfer pricing is the result of an evaluation or, better, the result of a methodological choice and its correct application. In fact, when discussing about transfer pricing, the dispute revolves around two questions: (1) what's the correct method to the case? and (2) what result does the application of the correct method bring?

These questions are clearly different from those characterizing the probative matter under which one does not ask whether a given claim by a party is correct but whether it is true.

There is a clear departure from the basic rules if one just considers that the so-called "judgment of correctness" is a judgment that always requires an element of comparison, of a tertium comparationis, an element that is not conceivable in situations where probative matter exists.

Some examples can give clearer idea. Wondering if a certain transaction is priced in compliance with arm's length principle fully diverges from asking questions such as "it's raining today", "someone shot at someone" or "company X bought a good for which he paid an amount equal to Z".

Therefore, when a tax system disqualifies the price agreed between the parties in inter-company transactions in favor of a different and hypothetical price, also that tax system deliberately departs from a "world of facts" to enter a "world of hypothesis". This world of facts neither can be assessed under terms of "truth" or "falsity" nor, therefore, under probative terms but rather under merely evaluative terms.

By just excluding factual elements pertaining transfer pricing process (e.g. elements relating to comparable or functions performed by the companies), the transfer pricing dispute, then, cannot be decided based on the principle of the burden of proof but rather only on the basis of the correct application of the legal and technical rules that characterize the identification of the probable price between independent parties.

The transfer pricing as probative, rather than factual matter

By denying factual nature to transfer pricing and by excluding transfer pricing from evidences bring very important consequences from the point of view of the application of both the tax assessment and tax litigation procedures.

From the point of view of the application of tax assessments, preliminary it is worth to outline that under Italian tax system taxes are assessed exclusively through an administrative procedure while the tax dispute is a substantial verification of the correctness of the assessment performed by tax administration.

Specifically, the allegation for higher taxes is made through an administrative assessment notice (i.e., deed of assessment) containing both the quantification of the higher tax and the explicit factual and legal reasons behind the allegation (the "motivation"). When the taxpayer appeals the deed of assessment, before the relevant tax court, he does not claim to the judges for the declaration of non-existence of the obligation of higher tax but rather he claim for the annulment of the deed of assessment because it is based on an incorrect motivation (for inconsistency of the factual or incorrect interpretation of the rules).

From this point of view, approaching the transfer price not as a probative matter implies that a deed of assessment on transfer pricing must elaborates on the method chosen by the taxpayer and its application to ground the reasons these are considered incorrect. To this end, neither commonly used clauses, nor the mere claim that the method used is wrong nor even the contrast of a different method or calculations may sufficiently ground the deed of assessment. In the lack of that grounds, the deed of assessment should be subject to annulment. This is particularly true when discussing overestimated costs. Should the transfer price be regarded as a fact, the deed of assessment would have simply denied the correctness of the price: this would be sufficient to allocate the taxpayer with the burden of proof. Whilst, the mere negation of a circumstance would not be enough to challenge the tax deductibility of a cost, since it is an evaluation procedure and because of a general principle of correctness and credibility recognized to taxpayers. Therefore, it is crucial that tax authorities explicitly substantiate reasons leading to consider incorrect the choices and/or calculations made by taxpayer.

Yet, the disqualification of the probative nature may lead relevant consequences at tax litigation level such as the following.

In the first place, the principles and procedural rules relating to the proof and the burden of proof cannot apply whilst only those principles and procedural rules relating to interpretation of law or evaluation could: for instance, the "principle of proximity of the proof" or the deadlines for filing the means of proof could not apply.

Another important consequence relates to the process of appeal before the Italian Supreme Court. In this regard, it should be noted that the Italian legal system generally prevents a review of the evidentiary material before the Italian Supreme Court so that by denying the nature of probative matter to transfer pricing allows to overcome this matter.

Additionally, it must be observed that in situations where the tax courts denies the correctness of the price applied by the taxpayer, the consequences will not fall within the burden of proof rules as they will be addressed along the line of any other evaluation / interpretative elements under the taxpayer-tax authorities interplays. Moreover, due to the principle stipulating far a presumption of correctness in favor of the taxpayer behaviors, the tax court must first evaluate the logical-legal (rather than factual) reasonableness of the reasons underlying the dispute of underestimation of revenues or overestimation of costs and, only if it resolves against taxpayer, either new method or calculation proposed by tax authorities could be scrutinized in conjunction with defensive argument of taxpayer. Even in case of tax dispute on costs, therefore – contrary to what happens, for example, when cost is alleged as non-existent – it will not be sufficient to disqualify cost or to provide evidences in order to stem a defensive "counteraction" on taxpayer, as it will be necessary that the tax court is convinced that allegation are properly grounded.


The change over the approach on transfer pricing tax disputes proposed here involves a departure from certain obligations and charges laid on the parties of a tax dispute (including tax courts), and how they are called to perform their function.

Of course, the extent of the change and the consequences it may trigger highly depend on the nature (administrative and / or judicial) recognized to the process of application of rules and the assessment of higher taxes.

In any case, however, it seems a necessary and fundamental change to better solve the matter and to make the most of the evaluative nature of this phenomenon.