In a dramatic shake-up of the backline for Sunday's match, Smith is demoted to the bench while Henry Slade is jettisoned from the 23 altogether, with Fraser Dingwall making his first Test appearance since last year's Championship.
The reshaped midfield sees Dingwall slot in at inside centre, with Ollie Lawrence remaining in the No.13 jersey.
Daly, who scored the winning try in the 26-25 win against France after coming off the bench, is preferred at fullback with Fin Smith retaining his place at fly-half.
Former skipper Jamie George returns at hooker to earn his 100th cap, becoming the seventh England player to reach the century milestone.
"Reaching 100 caps is a wonderful achievement that reflects Jamie's talent, dedication and hard work," Borthwick said.
Marcus Smith had been Borthwick's first-choice 10 but was shifted to fullback for England's last two games in the tournament, thrilling one-point wins against France and Scotland.
But, against Scotland, he looked uncomfortable and barely ran with the ball while his defending was targeted.
On the decision to drop him, Borthwick said: "It's brilliant for England to have such high-quality players. You'll have seen Elliot's impact off the bench and I'm looking forward to seeing Marcus Smith off the bench against tiring defenders, in space."
Dingwall, who won his last England cap more than a year ago, will be in familiar company in England's back line. His inclusion means five of the seven backs to start on Sunday will be from Premiership champions Northampton.
Alex Mitchell will continue his half back partnership with Smith, with Ollie Sleightholme on the left wing and Tommy Freeman on the right.
England were criticised for kicking away possession against Scotland and will be looking to build a positive points difference against an Italy side thrashed by France last time out.
Borthwick's side are third and have minus three difference although they retain an outside chance of winning the title.
England team: 15-Elliot Daly, 14-Tommy Freeman, 13-Ollie Lawrence, 12-Fraser Dingwall, 11-Ollie Sleightholme, 10-Fin Smith, 9-Alex Mitchell, 8-Tom Willis, 7-Ben Earl, 6-Tom Curry, 5-Ollie Chessum, 4-Maro Itoje (capt), 3-Will Stuart, 2-Jamie George, 1-Ellis Genge.
