MILAN — The hearing Wednesday in the ongoing tax trial of Domenico Dolce and Stefano Gabbana offered a glimpse into the past, lifting a veil on dealings unrevealed until now that could have reshaped Italy’s fashion scene at the end of the Nineties and early Aughts.

This story first appeared in the April 11, 2013 issue of WWD. Subscribe Today.

Taking the stand for the first time and responding to prosecutor Gaetano Ruta, Cristiana Ruella, general director and member of the board of Dolce & Gabbana, explained the reasons behind the designers’ decision to sell the signature and D&G brands they owned to a separate entity, the Luxembourg–based holding company Gado Srl, in 2004. “The fact that the brands were owned by the designers was a serious weakness, an element of risk, and the reasons had been made clearly evident to us by several parties and bankers,” said Ruella, who spoke calmly and unfalteringly throughout her deposition, wearing a white shirt, a black sweater and black pants, with a black-and-white printed foulard.

In a period Ruella identified as between the end of the Nineties and 2001-2002, there were three different negotiations on the table, she said. The first one was with L Capital, the investment fund controlled by LVMH Moët Hennessy Louis Vuitton. “[L Capital chairman] Daniel Piette contacted us through J.P. Morgan, as L Capital intended to enter [Dolce & Gabbana] with a minority stake. But it was made clear to us that the deal could have taken place only if the brands belonged to the company,” said Ruella. She then named Vincenzo Maranghi, the late head of Mediobanca, who she said spearheaded the acquisition of Valentino in 1998 (with Maurizio Romiti) through the now-defunct HdP, or Holding di Partecipazioni Industriali. In addition to Dolce & Gabbana, the plan was to also buy Versace, shortly after the death of Gianni Versace in 1997, to “create an Italian luxury pole [under HdP] to juxtapose to the French.” In this case, too, a must to move forward was for the brands to be within the group.

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Another interested party was Gucci, which was not controlled by French group PPR (now Kering) yet but which already owned Yves Saint Laurent and Boucheron, said Ruella. “Gucci wanted to buy Dolce & Gabbana in its entirety, and to ask the designers to continue to work within,” explained Ruella.

The executive added that she herself had “personally brought up this subject [of brand ownership] many times.” She had often urged the designers to consider unforeseen variables in their personal relationship or to envisage the potential hazard of different views on the brand. “These could entirely paralyze the activities.” She defined these reasons as “evident, almost banal,” and enough to demand a change in the structure of the company.

“Banks, suppliers, licensees, nobody saw the fact that the brands were owned by the designers in a favorable light. We had passive royalties that we paid to the owners of the brands and I was constantly told that banks did not want to finance such a company. We needed to have access to credit to develop and compete with big brands,” said Ruella, producing proof of several appointments with main bankers at the time — complete with business cards.

As reported, a public listing was also considered at the time. “Dolce & Gabbana was very small; it could only depend on the very strong talent of the designers. We did not have many choices: We could either continue alone but remain small, turn to the banks for credit, let minority shareholders in or go public. At the time, there was a lot of talk about the Bourse,” said Ruella. “To count our own brand and our own production pipeline would have been the first steps for an IPO.”

Asked by the prosecutor if, following the sale to Gado, Ruella told bankers about it, she firmly and proudly replied: “Of course I told them about the operation, there was nothing to hide, and it was all in our annual reports. You have to consider what the company was back then compared to bigger and more structured groups. We wanted to make the company more appealing to investors or for an IPO.”

The investigations that led to both designers being charged with alleged tax evasion related to the 2004 sale of the Dolce & Gabbana and D&G brands to the designers’ holding company Gado. The Italian tax police reportedly consider Gado essentially a legal entity used to avoid higher corporate taxes in Italy.

Given the “extraordinary operation,” said Ruella, Dolce & Gabbana tapped outside consultants and specialists to organize the operation: accountant Luciano Patelli and PricewaterhouseCoopers, or PwC, for the evaluation of the brands. “One of my first guidelines was for the operation to be entirely legal; our reputation is our main asset,” remarked Ruella, adding that it was Patelli who suggested setting up Gado in Luxembourg. Patelli is also charged in the trial.

During the hearing, Ruella said she trusted PwC on the evaluation of the brands, which they pegged at 355 million euros, or $463.3 million at current exchange, while the tax police calculations estimated a value of 1.1 billion euros, or $1.3 billion. “That’s why you call in consultants. I did not have the competence and did not know the methods to determine the value,” she said, adding that she did not discuss tax rates outside Italy. The designers, Ruella, Patelli, Dolce’s brother Alfonso, finance director Giuseppe Minoni and Antoine Noella are charged with omitted and unfaithful earnings declarations. The defendants have denied the charges.

“Patelli told me we were not obliged to provide a market value, but I was interested in knowing the value an experienced firm could give to Dolce & Gabbana,” said Ruella. When she found out the value, she said she was “happy to tell the designers that they had, with their own dedication and work, created such an enormous value, and this represented more than 60 percent of sales.” The brands were eventually sold to Gado for 360 million euros, or $484.4 million, because, among other issues, during the negotiation, the Dolce family acquiesced to each designer keeping his name and a possibility to launch a namesake collection.

The D&G brand has since been incorporated into the Dolce & Gabbana label, said Ruella, adding that the younger line accounted for between 35 and 40 percent of sales but was part of a strategy to position the signature brand in a higher range. Asked about the IPO, Ruella said the company “did not go public because of the situation,” noting the investigations would hinder a listing. “Reputation is a key factor for an IPO.”

Also she underscored that “30 percent of royalties were paid in Italy,” contesting that the company enjoyed Luxembourg’s 4 percent tax rate.

Asked about the role of the designers in the restructuring, Ruella said, “They were the ones who decided to sell the brand but they were not aware of the operations. They deal with creativity.”

As Minoni took the stand, one of the defendants’ lawyers, Alberto Simbari, pointed out the significant differences between the growth of actual royalties and those estimated by Italy’s Revenue Agency since 2005. For example, in 2009, royalties amounted to more than 98 million euros, or $128 million, while the agency expected more than 164 million euros, or $214 million. In 2010, Gado received 150 percent less than what the agency forecasted and 172 percent less in 2012.

Federica Marchionni, current president of Dolce & Gabbana USA, was director of licenses in the 2004-2006 period, in charge of the development of business and image of the brands. Her deposition revolved around the relationship between Gado and Motorola, which had asked Dolce & Gabbana to collaborate on the realization of its branded Razr phone for a six-month agreement. “Dolce & Gabbana’s contribution to the product was going to be minimal, as the designers were going to convey indications of color on an existing Motorola product. This was a license, but directly between Gado and Motorola, and was signed in the U.S. It was what we would call a one-shot” in the 2004-2006 period.

The next hearing is scheduled for Wednesday, followed by May 3, 15 and, tentatively, May 29.