Designers Domenico Dolce and Stefano Gabbana received a 20-month suspended jail sentence in Italy Wednesday on charges of tax fraud. A judge also ordered the label to pay a fine of 500,000 euros ($670,000).
The pair was convicted of not paying taxes on 200 million euros ($268 million), and of selling the Dolce & Gabbana and D&G brands to Luxembourg holding company Gado (a combination of both designers' names) in 2004 with the aim of not paying taxes on royalties of 1 billion euros ($1.3 billion).
The ruling was shocking to not only the fashion house's legal team, which plans to appeal, but also to international tax expert Tim Larson, who noted that the overall idea behind Dolce & Gabbana's tax scheme is legal in Italy.
"The fundamental baseline strategy is moving some of their intellectual property to another jurisdiction and be taxed at a lower rate," said Larson, a partner at accounting firm Marcum. "That's what Apple's doing, that's what Google's doing — many companies are doing it." These include American fashion labels, like Michael Kors. (Michael Kors paid a 37% tax rate, according to its latest filing, which also lists as a business risk pending legislation "that would, if enacted, treat us as a U.S. corporation for U.S. federal income tax purposes.")
Larson, who expects Wednesday's ruling to get overturned on appeal, likened the Italian government making an example of Dolce & Gabbana, one of the country's most high-profile and glamorous companies, to Congress grilling Tim Cook on Apple's $100 billion in holdings in Ireland, where the tax rate is 12.5%.
Erecting tax structures in other countries isn't illegal in the U.S. or Italy, which have comparable tax rates, but governments don't like them because they "highlight the shifting of profits from one jurisdiction to lower tax jurisdiction," said Larson. "But when you dig into the rules, it holds up."
Companies setting up these tax structures have to follow certain rules, like hiring a certain number of employees — they can't just erect empty companies for show alone. A prosecutor in Dolce & Gabbana's case described the label's Luxembourg company as a shell that didn't make administrative or financial decisions — or, to use her more poetic phrasing, "a sort of cloud with the consistency of gas." But, "such a reputable fashion design company is not going to risk something just to save a little bit of tax money," Larson said. "That's why I'm sure they had their ducks in a row."
The designers are not likely to go to jail, because in Italy, jail sentences of less than two years don't usually have to be fulfilled.