CAAD 161/2018-T: IRC Cost Deductibility, Transfer Pricing & Shareholder Activity Rules

ARBITRAL DECISION

The arbitrators hereby agree

I – Report

1. A... SGPS S.A., with the tax identification number..., with registered office at Rua ... no...., ...-... Maia, hereby requests the constitution of an arbitral tribunal, pursuant to the provisions of articles 2, no. 1, paragraph a), and 10 of Decree-Law no. 10/2011, of 20 January, to assess the legality of the tax acts for additional assessment of Corporate Income Tax (IRC) and assessment of compensatory interest, in the total amount of €287,822.98, relating to the tax year 2012, as well as the act of dismissal of the gracious complaint lodged against those assessment acts.

The request is grounded in the following terms:

The expense incurred with the travel of the certified accountant, within the scope of the audit of consolidated accounts of A... SGPS, constitutes an expense indispensable for the obtaining of income and the maintenance of its source of production, which must be fiscally accepted, pursuant to article 23 of the IRC Code, it being the responsibility of the Tax Authority to prove that such expense was incurred in the personal interest and not in the interest of the company.

With regard to operational expenses for the provision of services to subsidiary companies, the Applicant notes that it plays a leadership role throughout the B... Group, as occurs with any holding company of a multinational group, through the issuance of strategic directives and the expansion of the Group, with the purpose of increasing dividend distribution, and also provides management and administration services of high added value, assisting and complementing the implementation of extraordinary measures by the subsidiary companies.

In that sense, the Applicant classified the activities of management control and expansion, for purposes of the transfer pricing regime, under the concept of shareholder activity, insofar as they do not provide any direct and immediate benefit to the subsidiaries and any potential advantage that the subsidiaries may obtain is accessory and solely attributable to the fact that they form part of the Group.

Operations carried out with shareholder activity, comprising management control and group expansion, are not susceptible to invoicing to the subsidiaries, insofar as the direct and immediate beneficiary of this activity is A... SGPS in view of the return on its investment, and this activity differs from the provision of intra-group services, which, comprising management and administration services for the benefit of the subsidiaries, may already be charged to such entities.

In determining the transfer price applicable to billable intra-group service provisions, the Applicant applied the net margin method of the transaction, reaching, by agreement with its subsidiaries, a provisional hourly rate of €154.21 (corresponding to the value of €140.19 plus a profit margin of 10%) to be invoiced throughout 2012 and which would be adjusted, with the approval of the accounts for that year, according to the eligible expenses incurred by A... SGPS.

For the determination of the effective hourly rate, the Applicant determined the eligible expenses in the total amount of €5,062,968.00, which was used to determine, compared with the total hours consumed (37,983), at the end of 2012, the effective price of €133.30, to which it applied the profit margin of 10%, fixing that price at €146.63.

Thus, the allocation of the "contracted hourly rate" of €154.21 to the hours consumed with the provision of intra-group services complies with the criteria provided for in article 63 of the IRC Code and in Ordinance no. 1446-C/2011, of 21 December, and, consequently, the additional IRC assessment resulting from the correction to the taxable matter in the amount of €2,064,733.08 should be partially annulled, inasmuch as it suffers from the vice of violation of law by error in the legal assumptions.

Furthermore, the Tax Authority bears the burden of proof and, in the scope of the inspection procedure, must carry out all necessary steps to satisfy the public interest and the discovery of material truth (articles 58 and 75 of the General Tax Law), wherefore the Tax Inspection Services, by not carrying out all necessary steps to determine material truth, in order to understand the meaning of the eligible expenses and the billed value and to understand the method of fixing the hourly price practiced, violated the principle of investigation and the principle of discovery of material truth, and ended up reaching an illegitimate and unjust result, violating the principle of justice (article 266, no. 2, of the Portuguese Constitution) and the principle of contributory capacity (article 13 of the Constitution and article 4 of the General Tax Law).

The Applicant further disputes the amount of €43,681.01 which the Tax Authority considers to correspond to expenses incurred by A... SGPS with travel to provide audit services or other services to the subsidiary companies and which should be subject to invoicing to those companies. However, the audit services considered constitute the exercise of shareholder activity by the holding company, through management control, and, in that sense, qualify as expenses incurred in the exercise of shareholder activity.

The Tax Authority further considered as representation expenses, pursuant to no. 7 of article 88 of the IRC Code, the amount of €44,006.05, relating to expenses incurred with leadership meetings and meetings and general assemblies for the approval of accounts, understanding that representation expenses are basically all those made for the representation of the company to third parties, such as clients, suppliers and any other persons or entities, which include the company's employees.

Now, the leadership meeting consists of an event organized by A... SGPS that brings together several administrators and managers of the B... Group, with a view to discussing various business matters and, at the same time, allowing fraternization among Group employees, and the expenses inherent to that function should be understood as expenses with activities of social utility, pursuant to article 43 of the IRC Code, which are excluded from the concept of representation expenses.

On the other hand, the expenses incurred with meetings and general assemblies to discuss and approve the accounts are intended to allow A... SGPS to effectively perform its management control functions, and, in that way, constitute expenses incurred for the conduct of the economic activity of A... SGPS and not for purposes of representation, and, as such, cannot also be qualified as representation expenses.

The Tax Authority responded as follows.

With regard to representation expenses recorded with the travel of the certified accountant, it should be considered that the expense does not relate to a subordinate employment relationship, wherefore it is an expense for which a third party is responsible, which at most could be invoiced to the Applicant as a service provision. Furthermore, with respect to the qualification of the amount recorded as a deductible expense, it is the responsibility of the taxpayer to prove its indispensability for business interest, as follows from no. 1 of article 23 of the IRC Code in conjunction with no. 1 of article 74 of the General Tax Law.

As for the operational expenses for the provision of services to subsidiary companies, what is verified is that the information provided in the Transfer Pricing Documentation refers to the comparable data used to justify the application of the 10% profit margin, and not to the hourly rate/price charged to the subsidiaries, and such expenses lack substantiation both as to the assumptions for price formation and as to the variable of hours consumed. And there is no violation of the principle of investigation and the discovery of material truth, inasmuch as the Applicant was notified, on 7 October 2016, to provide clarifications specifically on the terms and conditions of the operations carried out within the scope of special relationships and it was on the basis of the accounting documents presented and the Transfer Pricing Documentation that the Inspection Services formed their conviction as to the correction of the taxable matter.

As for the expenses incurred with travel for the provision of services to subsidiary companies, in the amount of €43,681.01, the Tax Authority considered that this amount corresponds to partial amounts that are not justified as being indispensable for the realization of its income or gains or for the maintenance of its source of production, or are not substantiated as to their purpose, or are not proven from an accounting and documentary perspective.

Finally, the expenses incurred with leadership meetings and meetings and general assemblies for the approval of accounts, which were subject to autonomous taxation, and which include expenses incurred by the employer entity for the benefit of its employees, cannot be framed within the concept of activities of social utility and are instead subsumable within the provision of article 88, no. 7, of the IRC Code as representation expenses, which may relate not only to clients and suppliers, but also to any other persons or entities.

1. Following the proceedings, the meeting referred to in article 18 of the Rules of Procedure of Tax Arbitration (RJAT) was held in which the testimonial evidence indicated by the parties was produced.

In successive arguments, the parties gave their opinions on the probative results arising from the elements of the case and the testimonial evidence produced and, furthermore, maintained their previous positions.

1. The request for the constitution of the arbitral tribunal was accepted by the President of CAAD and notified to the Tax Authority as provided for by the applicable rules.

Pursuant to the provision of paragraph b) of no. 2 of article 6 of the RJAT, as amended by article 228 of Law no. 66-B/2012, of 31 December, the arbitrators were designated by the parties, having designated the president arbitrator.

The collective arbitral tribunal was thus constituted by the undersigned, who communicated their acceptance of the assignment within the applicable period.

The parties were duly notified of such designation and did not express any intention to refuse it, pursuant to the combined provisions of article 11, nos. 4 and 5, of the RJAT and articles 6 and 7 of the Code of Ethics.

Thus, in accordance with the provision of no. 7 of article 11 of the RJAT, as amended by article 228 of Law no. 66-B/2012, of 31 December, the collective arbitral tribunal was constituted on 5 July 2018.

The arbitral tribunal was regularly constituted and is substantively competent, pursuant to the provisions of articles 2, no. 1, paragraph a), and 30, no. 1, of Decree-Law no. 10/2011, of 20 January.

The parties have judicial personality and capacity, are legitimate and are represented (articles 4 and 10, no. 2, of the same diploma and 1 of Ordinance no. 112-A/2011, of 22 March).

The proceedings do not suffer from any nullities, having invoked the exception of res judicata.

It is within our purview to assess and decide.

II – Substantive Analysis

Findings of Fact

1. The facts relevant to the decision of the case which may be considered established are as follows:

• The Applicant was subject to a tax inspection, pursuant to Service Order no. OI2016..., relating to the tax year 2012, the report of which constitutes the grounds for the disputed assessment.

• The Applicant conformed to part of the corrections to the taxable profit made by such inspection.

• To the extent relevant to the present dispute, the Tax Authority made purely arithmetical corrections to the IRC taxable matter in the total amount of €2,643,973.34 and corrections to autonomous taxation in the amount of €4,400.60:

• On 1 September 2017, the Applicant lodged a gracious complaint regarding the said portion of the additional IRC assessment.

• On 4 January 2018, the Applicant was notified of the decision dismissing such gracious complaint.

• In 2012, the "operational expenses" of the Applicant were €6,438,485.17 and its "operational income" was €4,263,469.00.

• The Applicant, in addition to "operational income" received, in 2012, from its subsidiaries, dividends in the amount of €35,969,613.57.

• The said "operational expenses" were incurred by the Applicant in the exercise of its shareholder activity and in the provision of services to its subsidiaries.

• The exercise of shareholder activity by the Applicant implies the existence of a multidisciplinary specialized structure, designed to gather the information that allows it, as a shareholder, to determine the changes in the activity and management of its subsidiaries that it deems necessary, as well as to draw up preliminary studies to assess the viability of the creation or acquisition of new industrial units, within the scope of the expansion and internationalization strategy;

• The Applicant provides services to its subsidiaries, namely staff training, monitoring and assistance in negotiations of complex contracts, monitoring and assistance in the preparation of projects, cost containment plans and expense control.

• The Applicant considered as a tax deductible expense the amount of €3,462.66, incurred with the payment of the travel of its Certified Accountant within the scope of the analysis of consolidated accounts.

• In 2012, the Applicant re-billed to its subsidiaries €1,164,687.00, corresponding to expenses incurred in their interest, and considered expenses of €323,958.45 as attributable exclusively to its activity as a shareholder.

• To determine the hourly rate/price of the services provided to its subsidiaries, the Applicant listed and quantified a set of "eligible expenses" (purged of the values referred to in the preceding item), expenses that it considered to be common to its activity as a shareholder and to the provision of services to its subsidiaries.

• According to the Applicant, such expenses reached, in 2012, €5,062,968.00

• The Applicant determined that its employees, assigned to both its shareholder activity and the provision of services to the subsidiaries, had worked, in 2012, a total of 37,983 hours.

• Having thus determined a cost/hour, for the year 2012, of €133.30.

• To the cost/hour thus determined, the Applicant, to determine the value/hour of the services provided to its subsidiaries, applied a gross margin (mark-up) of 10%, which resulted in a price/hour, in 2012, of €146.63, corresponding to the effective price applicable in 2012.

• To enable invoicing to its associated companies throughout the year and compliance with the principle of period specialization, the Applicant, using the methodology described above, but starting from the "eligible expenses" relating to 2011, had determined an hourly rate of €154.21 ("contracted price")

• This "contracted price" was the one effectively practiced in 2012, since the agreements entered into by the Applicant only provided for the correction of the "contracted price" (and invoiced) when there was a deviation of more than 20% in relation to the "effective price" of the year in question, which did not occur in 2012.

• The Applicant considered that its employees, in 2012, had spent a total of 19,379 hours providing services to the subsidiaries.

• Wherefore it invoiced to its subsidiaries 19,379 hours x €154.21 ("contracted price"), in the total amount of €2,988,435.59,

• The TA did not accept this division of hours between shareholder activity and the provision of services to the subsidiaries, but, accepting the value of the "eligible expenses", corrected, relating to 2012 (€5,106,649.01) applied to this value the margin of 10% (mark-up) established by the Applicant, that is, multiplied €5,106,649.01 by 1.10%).

• Wherefore, pursuant to the transfer pricing regime, it fixed the amount of income obtained by the Applicant with the provision of services to its subsidiaries at €5,617,313.81 (and not in the amount of €2,064,733.089, determined by the Applicant).

• The Applicant incurred expenses in the amount of €43,681.01, according to table 12 of the tax inspection report, which it did not invoice to its subsidiaries.

• The Defendant considered that the expenses identified in table 15 of the inspection report, in the total amount of €44,006.05, should be qualified as representation expenses, wherefore they would be subject to autonomous taxation, in the amount of €4,400.60.

Unproven Facts

It was not alleged or proven what the hourly rate/price would be contracted between independent companies for the provision of services identical to those provided by the Applicant to its subsidiaries.

The Tribunal formed its conviction as to the proven facts on the basis of the documents attached to the petition and in the administrative proceedings attached by the Tax Authority with the reply and the testimonial evidence produced.

Matters of Law

1. The Applicant disputes the additional IRC assessment resulting from arithmetical corrections to taxable profit, made in the course of an inspection procedure, which relate to the following aspects: (a) non-acceptance as a tax deductible expense of the amount of €3,462.66, incurred with the payment of travel of the Certified Accountant, which the Tax Authority understands to be the responsibility of a third party; (b) correction made in the context of transfer pricing, in the amount of €2,064,733.089, on the grounds that they are not attributable to expenses of the shareholder function; (c) addition to taxable income in the amount of €43,681.01 concerning expenses incurred with travel for the provision of services to subsidiary companies, on the grounds that they are not proven nor justified from a business perspective; (d) consideration as representation expenses of amounts in the sum of €44,006.05 made with leadership meetings and general assemblies for the approval of accounts.

These are the issues that must be clarified.

Classification of the expense for the travel of the certified accountant as a deductible expense

1. The Applicant considered as a tax deductible expense the expense incurred with the payment of the travel of the certified accountant in the context of the analysis of consolidated accounts. The Tax Authority, in the inspection report, justifies the non-acceptance of this expenditure as a tax deductible expense with the following grounds: "Now, since the Certified Accountant is not an employee of A... SGPS, the expense in question is the responsibility of third parties, since the beneficiary of that charge is responsible for its travel in work, and may, if it so wishes, invoice it to the acquirers for the services provided by it. Then this expense, in the amount of €3,462.66, cannot contribute to the formation of the taxable result".

It follows from the provisions of article 23, no. 1, of the IRC Code, in the wording in force at the date of the facts, that the consideration of costs or losses for tax purposes depends on a requirement of indispensability for the realization of income or gains which are subject to tax. In fulfilling the concept of indispensability, there is firm case law understanding to the effect that what is required is merely an economic causal relationship, in the sense that it is sufficient that the cost is incurred in the interest of the company, in order, directly or indirectly, to obtain profits. To say that a cost must translate a relationship with the activity can only mean that there must be a relationship with the global economic operations of operation or with the operations or management acts that are part of the pursuit of the entity's own interest that assumes such costs.

It is within this comprehensive framework that the new wording introduced by Law no. 2/2014, of 16 January, should be understood, which, aiming to implement a greater degree of certainty in the concrete application of deductibility criteria, came to establish as a general principle that expenses related to the activity of the taxpayer incurred or borne by it are deductible, reinforcing the idea that the connection with business activity is sufficient, regardless of the actual contribution to income subject to tax (see Final Report of the Commission for the Reform of Corporate Income Tax, 30 June 2013).

In the present case, the Tax Authority did not question the existence of the travel, nor the amount spent, nor the fact that it was undertaken in the business interest of the Applicant, questioning only the "modus operandi" as to the accounting procedure of invoicing, understanding that the expense should have been invoiced by the certified accountant, as an independent professional, to A... SGPS as the acquirer of the service provision.

However, in practice, the expense in question would always be borne by the Applicant and, where high-value expenses are involved, as in this case, nothing seems to justify that the service provider should bear the charge between the moment it incurs in the realization of the expense and the moment it is reimbursed by the client. Especially when this does not result in any tax advantage for the taxpayer.

In fact, from the perspective of taxation of the income of an individual, it is irrelevant whether the taxpayer has incurred an expense that is later reimbursed or whether the expense is directly borne by the company acquiring the services. And from the perspective of taxation of the income of a legal entity, the expense would always have to be attributed to the company, regardless of whether it is evidenced by an invoice issued by the certified accountant or by the taxpayer subject to the tax.

The deductibility of the cost, in these circumstances, appears to be justified by a principle of tax neutrality, understood in a broad sense as a prohibition of excessive influence on the activity of taxpayers.

Transfer Pricing

1. The Applicant determined, for the tax year 2012, eligible expenses in the amount of €5,062,967.91, incorporating the provision of services to subsidiary companies, based on the contracted hourly rate of €140.19, plus a profit margin of 10%, and the shareholder activity, which it considered not chargeable to the subsidiaries as it did not generate an economic benefit for those entities. It thus declared the amount of €2,998,235.00 by reference to the invoicing of 19,379 billable hours.

In the Tax Inspection Report, it was understood that it was not possible to corroborate the method used to determine the eligible expenses, nor the hourly rate/price, nor the distribution of hours between intra-group activity and shareholder activity, and, as it was considered that the principle of competition in the determination of taxable profit was violated, a correction was made to the taxable matter in the amount of €5,617,313.81, corresponding to the totality of the expenses determined by the taxpayer (€5,062,967.91) plus the amount of €43,681.01 relating to service provision which was found not to have been considered by the taxpayer, and to which the operational margin of 10% was applied.

To reach this conclusion, the Tax Authority starts from the following line of reasoning:

• Formula for calculating the hourly rate: the assumptions that based the formation of this price were not demonstrated in the course of this inspection procedure, nor was it stated that the same is subject to the principle of arm's length;

• The matrix for distributing hourly work does not include all employees of SGPS and was not demonstrated, in this inspection procedure, the temporal distribution presented, that is, evidence was not presented that each of those employees of their working hours in the manner as presented in that matrix;

• Shareholder hours: the taxpayer does not describe the costs which it considers to be those of the shareholder nor does it demonstrate which activities developed by each of its employees it qualifies as attributable to SGPS as a shareholder.

Further on these matters, in another excerpt, the Tax Inspection Report makes the following clarification: "However, at no point in the Transfer Pricing Documentation is the substantiation demonstrated for the contracting of a 'contracted hourly rate' as the price of the services provided nor are the assumptions that led to the value applied presented without mark-up of €140.19. Moreover, neither the transfer pricing documentation nor the response to point 1.1 of the notification given on 2016.10.07 (...) demonstrate or explain the hourly distribution of the different employees of A... SGPS between 'Shareholder Hours' and 'Total Hours Charged'. Moreover, the consultation of the monthly salary declarations clarifies that this hourly distribution matrix does not include all employees of A... SGPS (...).

The Report concludes that the services provided to subsidiary companies do not have the characteristic of shareholder activity, since the direct beneficiaries are the subsidiary companies and no independent entity would be willing to incur charges to provide another entity with the conditions necessary for its proper functioning, from which it follows that it is "not consistent with the arm's length principle set out in § 1.52 of the OECD Report for no passing on of the costs incurred by A... SGPS to its subsidiaries".

In light of all these considerations, what is at issue, in the first instance, is the application of the method for determining transfer prices within the scope of service provision between entities that are in a situation of special relationships, in order to verify whether the prices applied are in accordance with the arm's length principle.

In accordance with the provisions of article 63 of the IRC Code, the taxpayer must adopt the conditions that would normally be agreed between independent entities (no. 1) through the use of the method or methods capable of ensuring the highest degree of comparability between the operations or series of operations which it carries out and other substantially identical ones, in normal market situations or in the absence of special relationships (no. 2).

The application of this principle must be based on an individualized analysis of the operations, with a view to comparing the conditions practiced in a transaction between related entities and those practiced between independent entities.

The Tax Authority argues that in the inspection procedure the hourly rate/price applied by the Applicant in the relationship with its subsidiaries was not demonstrated. But the fact is that the Administration did not indicate what the hourly rate/price would have been that would have been contracted between independent companies for the provision of the same services - nor was such proof made in the course of the arbitral proceedings – and the correction to the taxable matter proposed by the Tax Inspection Report was based, not on the hourly rate/price that would normally be applicable in market conditions, but rather on the disregard of certain expenses as being inherent to the shareholder function. For that purpose, the hourly rate/price used by the Applicant to calculate the eligible expenses was taken into account.

That is, the Tax Authority, although it invoked that the hourly rate/price defined for the provision of services to subsidiary companies is not substantiated in the Transfer Pricing Documentation, did not draw any consequence from that – specifically for the purpose of making the correction based on the price that would be contracted between independent entities -, and ended up validating the price indicated by the taxpayer.

In this context, the issue that is of interest to address, and which has a direct impact on the judgment of the case, relates to the alleged mischaracterization of the expenses that are attributed to shareholder activity and which determined the correction of the taxable matter that is the object of dispute in the context of the arbitral request.

1. At this level of analysis, the Applicant argues that, as a holding company, it develops three major groups of activities thus characterized: management control of its subsidiaries, expansion and internationalization, and provision of administration and management services.

Management control consists basically of an analysis that the holding company makes of its subsidiaries in order to examine, evaluate and control the status of its shareholdings, and which is designed to gather, through its professionals, the information previously prepared by its subsidiaries and analyze it in order to define business strategy.

On the other hand, within the scope of the expansion and internationalization strategy, it is the responsibility of A... SGPS to implement new industrial units in competitive markets through the acquisition and constitution of shareholdings, which it manages centrally, in order to increase dividend distribution.

Thus, the Applicant concludes that the activities of management control and expansion and internationalization integrate, for purposes of the transfer pricing regime, the concept of shareholder activity, insofar as (i) they do not provide any direct and immediate benefit to the subsidiaries, that (ii) any potential advantage that the subsidiaries may obtain is accessory and solely attributable to the fact that they form part of the Group, and that (iii) they are exercised for the shareholder A... SGPS to actively and centrally manage its subsidiaries with the intention of obtaining a return on its investment.

As also appears from the Transfer Pricing Documentation, the Applicant understands that the costs related to shareholder activity, such as the aforementioned management control and internationalization and expansion costs "should not be charged to subsidiary companies as they do not result from the normal provision of a service with economic value or are associated with a cost that they would not have to incur if they did not belong to an economic group."

In these terms, the Applicant did not include these costs as expenses chargeable to the subsidiary companies, limiting the expenses of that type to those related to the provision of administration and management services, in the total amount of €2,998,235.00.

Placed in these terms, the issue that must be clarified does not properly relate to transfer pricing but to the characterization of the provision of intra-group services.

To answer the question of whether an intra-group service was provided when the activity is exercised for the benefit of one or more members of the group by another member of that group, it will be necessary to verify whether the activity presents for the recipient an economic or commercial interest that strengthens its social position, which implies, in turn, that it be ascertained whether, in comparable circumstances, an independent company would have been willing to pay another independent company to carry out this activity or whether it would have carried it out itself internally.

The answer will have to be found on a case-by-case basis, but it may be considered, as a general matter, that there is place for the provision of intra-group services when a member of the group aims to satisfy a specific need of one or more companies in the group. In other cases, an intra-group activity may be exercised in relation to members of the group when they do not need this activity and would not be willing to remunerate this service if it were independent entities. It is this case when a member of the group (generally the parent company), as a shareholder, exercises activities related to shareholdings in one or more members of the group, it being understood that these are costs of the shareholder function that do not have to be passed on to the subsidiary companies.

They are described as examples (a) the costs of activities inherent to the legal structure of the parent company itself, such as the organization of general shareholders' meetings, the issuance of shares of this company and the charges with the operation of the supervisory board, (b) the costs relating to the obligations of the parent company regarding the presentation of accounts and activity reports, and (c) the charges relating to the mobilization of the resources necessary for the parent company to acquire its shareholdings (on all these matters, cf. OECD – Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, §§ 7.6 to 7.10, Tax Science and Technology Notebooks, no. 189, Lisbon, 2002).

In the present case, what is verified is that the Applicant provided to the subsidiary companies, not only administration and management services, which were remunerated by those entities, but also activities of management control and expansion and internationalization, which consisted, on the one hand, in the gathering of information on the situation of each of the subsidiary companies intended to define business strategy, and, on the other hand, in the drawing up of preliminary consulting studies to assess the viability of acquisition or constitution of new industrial units. It being that for that purpose A... SGPS had its own personnel structure that would travel to the headquarters of the subsidiary companies and gather and process the information that was conveyed to the parent company.

It appears to be activities inherent to the proper management of shareholdings that are designed to define strategic guidelines, to control the activity of the subsidiary companies and to drive the growth and development of the Group and from which the associated companies can only benefit indirectly insofar as they form an integral part thereof.

To counter this point of view, the Tax Inspection Report merely considers that "the costs which it considers to be those of the shareholder are not described by the taxpayer, nor does it demonstrate which activities developed by each of its employees it qualifies as attributable to SGPS as a shareholder", and this was the material ground which determined that all eligible expenses, in the amount of €5,062,967.91, were considered chargeable to the subsidiary companies.

However, the facts established go in the direction of considering that the Applicant had its own structure that gathered and processed information intended to allow the control of the activity and management of its subsidiaries, and that also had the function of drawing up preliminary studies to assess the viability of the creation or acquisition of new industrial units, within the scope of the expansion and internationalization strategy. And it is also proven that this activity, considered to be related to the shareholder function, differed from that of services provided exclusively for the benefit of the subsidiary companies, which were subject to invoicing to those entities. Furthermore, the distinction between these two types of activities is also sufficiently characterized in the Transfer Pricing Documentation.

There is therefore no sufficient reason to disregard the activities that the Applicant declared as corresponding to the shareholder function. And in any case, by virtue of the rule of material evidence law that results from article 74 of the General Tax Law, it was the Tax Authority that had the burden of proving that these activities were not carried out or correspond to services provided to the subsidiaries within the scope of intra-group commercial relationships that could not have been included in the shareholder cost.

By all of this, the request is also successful in this respect.

Addition to taxable profit of the amount of €43,681.01

1. The Tax Authority added to the operational expenses declared by the taxpayer, in the amount of €5,062,967.91, the amount of €43,681.01, corresponding to expenses which it considered to be equally eligible for purposes of invoicing to the subsidiaries. These expenses are described in table 12 of the Tax Inspection Report as referring to travel and internal audits.

The correction is justified in the Report in the following terms: "[M]eanwhile, the analysis of the expenses considered by A..., SGPS as not chargeable and which were not re-billed to the subsidiaries demonstrated the existence of charges incurred by the taxpayer whose justification of indispensability for the realization of its income or gains or for the maintenance of the source of production proved necessary and was requested through notification given on 2016.12.13. Indeed, as a result of the response presented by the taxpayer, the documents that follow correspond to charges which, as they concern expenses incurred by SGPS with travel to provide audit services or other services to the subsidiaries, should be considered (...) as eligible for purposes of invoicing to the subsidiaries.

The Applicant counters that the activity under analysis does not concern an audit procedure of the accounts of the subsidiary companies, but constitutes the exercise of shareholder activity by the holding company through management control and that, as such, the charges borne should be qualified as costs of the shareholder and do not have to be subject to invoicing to the subsidiaries.

The answer to this question cannot depart from that which was formulated in the preceding item regarding the overall amount of expenses declared by the Applicant as associated with the shareholder function.

The Tax Inspection Report refers the operational expenses declared as a cost of the shareholder to the regime of provision of services to the subsidiary companies and justifies this correction - as was set out - by the fact that the costs which it considers to be those of the shareholder were not described by the taxpayer nor were it demonstrated which activities developed by each of its employees are qualified as attributable to SGPS as a shareholder. It will have been on the basis of these same assumptions that the Report includes the expenses not considered by the taxpayer as chargeable to the subsidiaries.

However, from the facts established as proven it results that the Applicant, through a group of its own staff, exercised activities of management control of its subsidiaries and expansion and internationalization, which can be qualified as shareholder function, and that do not conflict with the provision of intra-group services exclusively for the benefit of the subsidiaries.

The Applicant questioning, in the arbitral request, the qualification made by the Tax Inspection Report as to the expenses with travel and audits, it was the responsibility of the Tax Authority to bear the burden of proof that these expenses correspond in fact to services provided to the subsidiaries within the scope of intra-group commercial relationships.

This proof not having been made, one arrives at a situation of uncertainty as to the relevant facts which will have to be resolved to the detriment of the party bearing the burden of proof (articles 346, final clause, of the Civil Code, and 414 of the Code of Civil Procedure).

Representation Expenses

1. The Applicant accounted as fiscally deductible expenses the expenses related to leadership meetings, general assemblies for the presentation and approval of accounts, meetings for presentation to banks, presentation of semi-annual accounts and travel within the scope of analysis of consolidated accounts, in the total amount of €44,006.05.

The Tax Inspection Report, starting from the provision of article 88, no. 7, of the IRC Code, considered that these expenses constitute representation expenses, and as such are subject to autonomous taxation at the rate of 10%, understanding that the beneficiaries of representation expenses may be clients, suppliers and "any other persons or entities", here including the company's own employees, concluding that "representation expenses are basically all those made for the representation of the company to third parties".

The said provision of article 88, no. 7, of the IRC Code provides as follows:

Charges relating to representation expenses are taxed autonomously at the rate of 10%, considering as such, in particular, expenses incurred with receptions, meals, travel, outings and shows offered in the Country or abroad to clients or suppliers or also to any other persons or entities.

The introduction of the autonomous taxation mechanism has in view, as is known, to prevent and avoid that, through these expenses, companies proceed to the distribution of hidden profits or allocate income which may not be taxed in the sphere of the respective beneficiaries, also having the objective of combating fraud and tax evasion.

In the present case, what is at issue is not the realization of the expenses nor their specific purpose, but rather the proper interpretation of the concept of "representation expenses".

In fact, the Tax Authority formulates an extremely broad concept of representation expenses, by which all expenses made for the representation of the company to third parties are integrated in this type of expense, including among the third parties who may be beneficiaries of this type "the company's own employees".

It seems clear that representation expenses are expenses motivated by business reasons but which, in some way, can benefit third parties external to the company or to the group of companies, being this the case of the payment of meals, expenses arising from invitations and payment of tickets for shows to persons with whom the company has or intends to have business relations.

They are not to be qualified as representation expenses the expenses incurred with travel and accommodation of administrators and employees to participate in leadership meetings or in general assemblies, of the company itself or of subsidiary companies, as they are displacements directly related to normal business activity. As they are not the expenses arising from fraternization meetings when they only involve administrators and employees, and not other persons outside the company.

The request is also successful on this point.

Compensatory Interest

1. The Applicant also disputes the assessment of compensatory interest in relation to the IRC tax assessment act.

Pursuant to article 35, no. 1, of the General Tax Law, "compensatory interest is due when, due to a fact attributable to the taxpayer, the assessment of all or part of the tax due or the payment of tax to be paid in advance, or withheld or to be withheld within the scope of tax substitution is delayed".

As has been common understanding, the compensatory interest owed pursuant to the said provision constitutes a civil remedy intended to indemnify the Tax Authority for the loss of availability of a sum that was not assessed in a timely manner. As it is an indemnity of a civil nature, it is only exigible if there is a nexus of causality between the action of the taxpayer and the delay in assessment and this action can be culpable by reason of fault or negligence.

The success of the arbitral request makes the payment of compensatory interest necessarily not exigible, and so on this point as well the request is successful.

Prejudiced questions.

Given the legal solutions reached at the infra-constitutional level, the examination of formal defects of administrative activity and constitutional issues that were also invoked is prejudiced.

III – Decision

For these reasons, it is decided to annul the assessment act no. 2017... and the assessment act for compensatory interest no. 2017..., in the total amount of €287,822.98, and, consequently, to annul the act of dismissal of the gracious complaint lodged against those tax acts.

Value of the Case

The Applicant indicated as the value of the case the amount of €287,822.98, which was not contested by the Defendant and corresponds to the amount of the assessment which was intended to be opposed, wherefore the value of the case is fixed at that amount.

Notify.

Lisbon, 3 January 2019,

The President of the Arbitral Tribunal

Carlos Fernandes Cadilha

The Arbitrator Panelist

Rui Duarte Morais

The Arbitrator Panelist

Manuel Pires (dissenting as per the dissenting opinion attached)

DISSENTING OPINION

I do not concur with the decision, for the following reasons:

1. As regards travel expenses as a deductible expense, it is important to consider that an option concerning the mode of performing acts relevant for tax purposes can only be exercised if such option is legally permissible, which does not occur in the case, with the principle of tax neutrality, properly understood as to its scope of application, not leading to the opposite, in any of its modalities: reference to provisions that conform to an ideal system of taxes, as opposed to "tax expenditure" (Douglas Kahn) or when the purpose of the tax is to provide revenue or, more restrictively, when the tax does not have the effect of pressing the taxpayer to assume certain behavior, or the tax should be established in such a way that public charges are distributed according to ability to pay or still that taxes should minimally alter the conduct of taxpayers, with the consequence of minimally altering the demand and supply of goods and services or not favoring certain activities over others, implying economic efficiency (absence of interference) and equity (non-discrimination), not taxing differently equal situations, so as not to generate distortions.

2. Regarding the question of transfer pricing, the burden of proof on the TA should arise only when what is affirmed by the TP was substantiated with objectively verifiable control. Otherwise, the inversion of such burden would occur without difficulty and would not be, therefore, sufficient justification for it not to occur as it should, with the practice hardly controllable or, a fortiori, uncontrollable, and as such are the cases where, given the circumstances, proof to the contrary would far exceed reasonableness. In the case decided, in which what was written is applied, the reason for the dispute resides in facts derived from the action of the TP: poor preparation of the relevant documentation, not containing fundamental information, which it was incumbent upon it to provide, and the failure to provide appropriate explanations, qualitatively and quantitatively, when requested. Furthermore, it should also have been included in the established facts, with necessary consequence in the decision, the character of "chargeable" (amounts to which the TP was entitled) – expressly and clearly attributed in a document prepared by the TP, contained in Annex II of the Inspection Report – to €5,062,968.00, a highly relevant amount in the TA's correction, an amount which, moreover, as appears from the said Report, does not exhaust the expenses of types included therein, the difference not having been subject to correction. That document, expressly and clearly mentioning the character of the amounts included therein as "chargeable", does not include expenses of another nature, that is, "eligible", inasmuch as partially. Although subsequently, integrated into the general problem of that part of the proceedings, they were invoked as of that other nature, specific and concrete explanation was never given, as was required, or, a fortiori, justification for the alteration, notwithstanding successive corrections, when referred to as "eligible", during the production of testimonial evidence.

3. Regarding representation expenses, the diversity of their respective legal understanding and, on the part of the TP, qualifications, the purposes of autonomous taxation and the "obscurity" of expenses under review would imply a deeper examination of the matter.

For all the reasons written above and as a consequence, it should also have been decided that there is an obligation to pay compensatory interest.

Manuel Pires