Unfair competition by violation of tax laws: the Milan IP Court on the “permanent establishment” in Italy

(An Italian version is published also on Diritto24 – Il Sole 24 Ore)

The Milan IP Court recently dealt with the competitive effects of the violation of tax rules on “permanent establishment” in Italy (order of 16.11.2015, Judge Mrs Gandolfi). These are essentially the rules, including in particular Art. 162 of the Income Tax Law, under which a foreign company is considered as working permanently in Italy, and is therefore liable for the payment of relevant taxes, despite its foreign residence.

Specifically, a known photo agency complained that an equally well-known Irish competitor practised prices in Italy that were lower than those of the market due to a violation of the tax laws, thus committing an act of unfair competition under Art. 2598 (1)(3) Civil Code. According to the applicant, in fact, the respondent could undercut those prices only thanks to the fact that, while its Italian subsidiary promoted and agreed on business transactions, it was the same Irish company that formally executed the agreements, invoiced and collected the proceeds. This would have enabled it to save on income taxes, which are much lower in Ireland than in Italy, and also to apply the reverse charge mechanism, thus avoiding the financial exposure otherwise determined by the need to pay VAT to the tax authorities before having received its payment from the customers. Thus, the respondent’s production costs would be much lower, which would unduly enable it to offer photographs at lower prices, to the detriment of competitors that respect the tax laws. The applicant hence requested that an interim injunction be issued against the respondent, enjoining the latter from “further carrying out the acts of unfair competition described“, with the establishment of a penalty and an order of publication of the decision.

The Judge handling the case appointed an expert witness to assess whether the respondent in fact had a permanent establishment in Italy. In accordance with the conclusions of the latter, the Judge noted that indeed it had, considering inter alia that: the Italian subsidiary had a decisive role in the definition of important trade agreements of the Irish company; contracts negotiated by the Italian subsidiary were systematically sent to and approved by the Irish company; the staff of the Italian subsidiary reported to the Irish company; Italian employees’ remuneration was partly determined as a percentage on the earnings of the group in Italy; the Italian subsidiary was paid exclusively with the payment of its operating costs and had no business risk, since the costs and benefits of its business were laid with the Irish company and the Italian subsidiary had the Irish company as its sole client.

In conclusion, the Judge therefore considered that – within the limits of the summary assessment of preliminary proceedings – the respondent appeared to have a permanent establishment in Italy pursuant to Art. 162 Income Tax Law, and that there was therefore a prima facie case of violation of the tax laws that would require the respondent to pay taxes in Italy. Hence, the Judge said, the respondent had a tax saving, in addition to an advantage in terms of the possibility of not anticipating huge amounts of VAT before having received them.

Nevertheless, the Judge pointed out that the apparent violation of the tax laws did not automatically also amount to an act of unfair competition to the detriment of the applicant pursuant to Art. 2598 Civil Code: “as it is known, not every breach of laws that impose costs (including taxes) affects fair competition: it is necessary that the infringement of the law also damage competitors. In other words, it is necessary that the undue savings be actually exploited to support a downward price which competitors, being law-abiding and as such burdened with higher costs, cannot cope“.

In this case, the Judge found that the applicant had not proven the anti-competitive effects of the respondent’s tax law violation, in particular not having provided evidence that the prices charged by the respondent were unsustainable for tax law-abiding competitors. Accordingly, no interim injunction could be issued by the court: as it could not order the respondent to comply with the tax rules (which are already imposed and sanctioned by the law), and as these were interim injunction proceedings, it could only enjoin the respondent from practising unsustainable prices for competitors, for which, however, there was the aforementioned lack of evidence.

Despite the dismissal of the motion, however, the court, given the ascertained tax malpractice, ordered that each Party bear its own legal fees, and sent the case to the Prosecutor’s Office and the Revenue Agency for the assessment of criminal offences and for the tax assessments of the case.