Transfer Pricing Adjustments in IRC: CAAD Arbitration on Intercompany Credit Transfers (300/2013-T)

Case no. 300/2013-T

ARBITRAL DECISION[1]

1. Report

A - General

1.1. A... - , LDA, a company with registered office in Porto, Rua …, holder of tax identification number ... (hereinafter referred to as the "Claimant"), submitted on 20.12.2013 an application for constitution of an arbitral tribunal in tax matters, which was accepted, seeking the declaration of illegality of the tax act imposing an additional assessment of Corporate Income Tax (IRC) and compensatory interest for the year 2009, dated 23.11.2012.

1.2. Pursuant to the provisions of paragraph (a) of section 2 of Article 6 and paragraph (b) of section 1 of Article 11 of Decree-Law no. 10/2011 of 20 January, as amended by Article 228 of Law no. 66-B/2012 of 31 December, the Deontological Council of the Administrative Arbitration Centre appointed Nuno Pombo as arbitrator, and the parties, once duly notified, did not object to such appointment.

1.3. By order of 03.01.2014, the Tax and Customs Authority (hereinafter referred to as the "Respondent") appointed Messrs. Dr. … and Dr. … to intervene in the present arbitral proceedings, in name and representation of the Respondent.

1.4. In accordance with the provisions of paragraph (c) of section 1 of Article 11 of Decree-Law no. 10/2011 of 20 January, as amended by Article 228 of Law no. 66-B/2012 of 31 December, the arbitral tribunal was constituted on 21.02.2014.

1.5. On 25.02.2014, the highest-ranking officer of the Respondent's service was notified to present, if he so wished, a response within 30 days and to request the production of additional evidence.

1.6. On 28.03.2014, the Respondent presented its response.

B – Position of the Claimant

1.7. Following the tax inspection report notified to the Claimant on 22.11.2012, the Respondent made corrections of a purely arithmetical nature in respect of IRC for the fiscal year 2009, in the total amount of € 396,043.65 (three hundred and ninety-six thousand and forty-three euros and sixty-five cents), relating to:

1.7.1. Corrections to the value of transmission of real rights over immovable property in the amount of € 4,940.00 (four thousand nine hundred and forty euros); and

1.7.2. Corrections to the value of transmission of credits to company B..., S.A. (B...) in the amount of € 391,103.65 (three hundred and ninety-one thousand one hundred and three euros and sixty-five cents).

1.8. The Claimant accepted the corrections referred to in point 1.7.1, but did not accept those referred to in 1.7.2, against which it filed on 06.05.2013 a request for reconsideration, which was dismissed. From such dismissal, it filed a hierarchical appeal on 18.03.2013, which should be deemed to have been tacitly dismissed, due to the Respondent's failure to respond.

1.9. The arithmetical correction in question, resulting from the application of Article 58 of the IRC Code (CIRC), is based on the Respondent's conviction that in a sale of credits realised on 13.03.2009, the Claimant "would not have respected the arm's length principle", in that it transferred for € 77,868.90 (seventy-seven thousand eight hundred and sixty-eight euros and ninety cents) to B..., a company belonging to the group of companies of which the Claimant is part, credits against C…, S.A. (C...), in the amount of € 486,290.98 (four hundred and eighty-six thousand two hundred and ninety euros and ninety-eight cents) which on the same day it had acquired from D… C.R.L. (D...) for € 468,972.55 (four hundred and sixty-eight thousand nine hundred and seventy-two euros and fifty-five cents).

1.10. The Claimant, however, contends that these successive acquisition and disposition of the credits originally held by D... over C..., also of the group of companies to which B... and the Claimant belong (the Credits), cannot be assessed independently of a broader commercial operation but must rather be understood in the context that gives them meaning, which is summarily described as follows:

1.10.1. The Claimant was the leader of a consortium entered into with E... –, S.A., and with F... –, Lda., aimed at the promotion of a real estate project in Cascais, following a public tender launched by the Municipal Council of …;

1.10.2. In the scope of that real estate project, the Claimant contracted with C... to execute infrastructure works, and that company, following "serious financial difficulties during 2008", filed for insolvency on 30.09.2008.

1.10.3. On 06.10.2008 C... was declared insolvent, and a viability plan was approved, which provided for the acquisition of the credits in question and their conversion into capital, thereby ensuring the recovery of the company.

1.10.4. The insolvency plan drawn up by the insolvency administrator, dated 13.02.2009, provided, among other measures, that common creditors would be paid only 15% of their credits and in 60 monthly instalments.

1.10.5. To avoid a change of contractor on the works referred to in 1.10.2, the Claimant was willing to favour the recovery of C..., accepting to acquire for € 468,972.55 (four hundred and sixty-eight thousand nine hundred and seventy-two euros and fifty-five cents) the credits that D... held over C..., with a view to their conversion into capital.

1.10.6. That acquisition would be effected through a barter, with the Claimant transferring to D... two immovable properties which, although having a market value of approximately € 160,000.00 (one hundred and sixty thousand euros), would be valued at the time of transmission at € 494,000.00 (four hundred and ninety-four thousand euros).

1.10.7. That is, for the convenience of D..., the Credits would be sold at a price higher than their actual value, which would be offset by the disposal of the two immovable properties also at a price higher than their actual value, so that the exchange ratio would be equitable.

1.10.8. It happens that, if the operation had been conducted as originally conceived, D... would have to bear the tax on the acquisition of the immovable properties object of the barter, for which reason it imposed on the Claimant that such acquisition be made by an entity related to it, G... , Unipessoal, Lda., with the remainder of the operation remaining unchanged.

1.10.9. On 13.03.2009 the operation was therefore formalised, with the Claimant acquiring from D..., as agreed, the credits that it held over C... for € 468,972.55 (four hundred and sixty-eight thousand nine hundred and seventy-two euros and fifty-five cents) and also various equipment, transferring to G... , Unipessoal, Lda., as consideration, the two aforementioned immovable properties for € 494,000.00 (four hundred and ninety-four thousand euros).

1.11. The Claimant accordingly contends that the sale of the Credits to B... respected the arm's length principle, the terms or conditions actually practiced being those that would have been practiced between independent entities, as the Credits manifestly did not have a value of € 468,972.55 (four hundred and sixty-eight thousand nine hundred and seventy-two euros and fifty-five cents), the price at which D... transferred them to the Claimant, as moreover is evident from the insolvency plan.

C – Position of the Respondent

1.12. The Respondent, in its response, states that the provision of Article 58 of the CIRC does not presuppose fraudulent intent, aiming rather to establish parity in the fiscal treatment of group companies and independent companies.

1.13. For the Respondent, it is "evident" that the "transaction conducted within the group itself [the sale of the Credits by the Claimant to B... for a value substantially lower than what on the same day it had acquired them from the unrelated entity] was conducted with the sole objective of accounting for losses".

1.14. The Respondent recalls that the Claimant acquired from D..., with whom it has no special relationships, a set of credits for a certain value, which on the very same day were sold by it to a related entity with an impressive devaluation of 83.3%. Now, in the presence of sale prices so different for the same asset, and given the impossibility of conceiving such a strong devaluation of a particular asset without any time lapse to accommodate it, it is necessary to conclude that one of two things must be true: either the acquisition price of the Credits from D... is the market price or it is "fictional", being hardly credible, in the Respondent's view, that "the banking entity would fiction" a sale price.

D – Conclusion of the Report

1.15. On 27.05.2014, at 14:30, the hearing provided for in Article 18 of the Legal Regime of Arbitration in Tax Matters (RJAT) took place, and the statement of the manager of the Claimant, Mr. Eng. …, was heard, and the following witnesses, adduced by the Claimant, were heard:

a) …, economist; and

b) …, engineer.

1.16. At the hearing referred to in the preceding number, the representative of the Respondent did not waive the right to present his arguments, and the arbitral tribunal then, with the agreement of the parties, granted to each of the Claimant and the Respondent, and in that order, the period of 15 days to submit their written arguments, which both did.

1.17. On 12.06.2014 the Claimant submitted its arguments, which reiterate the arguments adduced in the request for arbitral pronouncement, advancing that it was a "pure logic of group organization" that dictated that the participation in the capital of C... would be held by B..., which is why the Claimant transferred the Credits to it, to be subsequently converted into capital.

1.18. The Claimant further states that the price practiced in the disposition of the Credits to B... is justified "solely and exclusively" by "the fact that it had then been agreed that the creditors of C... would receive only '15% of capital with full forgiveness of interest'", this therefore being its market value.

1.19. The Claimant further clarifies that at the date of the transaction to which we have been referring, the insolvency plan of C... was already known, "which provided for the payment of 15% of the debts in 60 monthly instalments". If that plan had not been approved and the company had proceeded to liquidation, then the market value of the Credits "would correspond to 0% of its value", which would mean that the Claimant, in that circumstance, would have borne at cost the full value of the credit acquired, in accordance with the provision then in Article 39 of the IRC Code".

1.20. On 24.06.2014 the Respondent submitted its arguments, which begin by asserting the inadmissibility of "witness testimony that contravenes agreements contrary to or additional to the content of an authentic or private document", as established in section 1 of Article 394 of the Civil Code, recalling that section 2 of the same article states that that prohibition applies "to simulated transactions and dissimulated transactions, when invoked by those who simulated them", which is why the arbitral tribunal cannot rely on the statements of the witnesses heard in the course of this proceedings, insofar as they suggest the existence of a simulated transaction between the parties who conducted the various transactions of 13.03.2009.

1.21. The Respondent recalls that the records contain two documents that do not admit countervailing evidence, namely: a contract for the assignment of credits entered into between the Claimant and D... and a public deed of sale of immovable property between the Claimant and G..., Unipessoal, Lda., entered into and executed between unrelated entities for values that, the Claimant intends to demonstrate, were simulated, inasmuch as the price at which the credits were transferred and the price at which the immovable properties were disposed of were actually much lower than that declared in those documents.

1.22. The Respondent thus concludes that the transactions referred to in the preceding number correspond to the reality and the market value of the credits in question, all the more so because, at the moment the Claimant acquired from D... the Credits, by its free and unconditional will, "the devaluation of the supposed reduction of value was already known, so that the transaction effected between the independent entities crystallized in accordance with the market, supply and demand, the value of the credits in question".

1.23. The proceedings are not vitiated by any nullity nor were any exceptions raised by the parties that would prevent the substantive examination of the case, so the conditions are met for the pronouncement of the arbitral decision.

2. Findings of Fact

2.1. Proven Facts

2.1.1. The Claimant was subject to a tax audit by the Tax Inspection Services of the Financial Directorate of Porto – …, under credential no. OI2011…, of 09.08.2011 (doc. no. 2, attached with the request for arbitral pronouncement).

2.1.2. From that tax audit corrections were made to the taxable matter relating to IRC for the fiscal year 2009, in the amount of € 396,043.65 (three hundred and ninety-six thousand and forty-three euros and sixty-five cents), which includes the amount of € 391,103.65 (three hundred and ninety-one thousand one hundred and three euros and sixty-five cents) relating to "Corrections to the value of transmission of credits to company B..., S.A." (doc. no. 2, attached with the request for arbitral pronouncement).

2.1.3. Due to the corrections to the taxable matter of IRC for the fiscal year 2009, the Claimant was notified of the acts of additional IRC assessment no. 2012…, assessment of compensatory interest no. 2012… and account settlement no. 2012…, from which resulted a balance of € 40,221.54 (forty thousand two hundred and twenty-one euros and fifty-four cents), to be paid by 07.01.2013 (doc. no. 1, attached with the request for arbitral pronouncement and Article 1 of the Respondent's response).

2.1.4. The Claimant, C... and B... are part of the same group of companies, which has the following structure (doc. no. 5, attached with the request for arbitral pronouncement and page 6/9 of the report contained in doc. no. 2, attached with the request for arbitral pronouncement):

[…]

2.1.5. On 13.03.2009 the Claimant acquired from D... credits that it held over C..., in the amount of € 486,290.98 (four hundred and eighty-six thousand two hundred and ninety euros and ninety-eight cents) for € 468,972.55 (four hundred and sixty-eight thousand nine hundred and seventy-two euros and fifty-five cents) (doc. no. 11, attached with the request for arbitral pronouncement).

2.1.6. Also on 13.03.2009 a public deed was executed whereby the Claimant sold to G... , Unipessoal, Lda., for € 494,000.00 (four hundred and ninety-four thousand euros), two immovable properties identified therein (doc. no. 13, attached with the request for arbitral pronouncement).

2.1.7. Also on 13.03.2009 the Claimant sold for € 77,868.90 (seventy-seven thousand eight hundred and sixty-eight euros and ninety cents) the Credits to B... (doc. no. 14, attached with the request for arbitral pronouncement).

2.1.8. In view of the discrepancy in the acquisition and disposal values of the Credits, the Claimant recorded a loss in its results for the fiscal year 2009 of € 391,103.65 (three hundred and ninety-one thousand one hundred and three euros and sixty-five cents) (doc. no. 2, attached with the request for arbitral pronouncement).

2.1.9. C..., as of 13.03.2009, had seen its insolvency decreed within the framework of case no. …, before the 3rd Commercial Court of … (doc. no. 7, attached with the request for arbitral pronouncement).

2.1.10. The insolvency plan dated 13.02.2009 provided for the adoption of measures aimed at the viability of C..., being the opinion of its author that the rejection of the plan would compromise the economic and financial viability of the insolvent company. The proposed measures included the "conversion of credits into capital", the "forgiveness of accrued and accruing interest for all creditors", with the exception of Social Security, and further, with respect to common creditors, the payment of only 15% of capital, in 60 equal monthly instalments, commencing on 31 January 2011 (doc. no. 7, attached with the request for arbitral pronouncement).

2.2. Unproven Facts

2.2.1. The price declared in the contract for assignment of credits entered into between the Claimant, as assignor, and B..., as assignee, does not correspond to the price that would normally be agreed, accepted or practiced between independent entities.

2.2.2. The price declared in the contract for assignment of credits entered into between the Claimant, as assignee, and D..., as assignor, corresponds to the price that would normally be agreed, accepted or practiced between independent entities.

3. Legal Questions

3.1. Question to be Decided

It follows from what has been stated above that the question to be examined is, in essence, whether the sale of the Credits to B... was not governed by the principles of arm's length, and whether the terms and conditions actually used in that transaction were not identical to those that would, under normal market conditions, be contracted, accepted and practiced between independent entities.

3.2. The Transfer Pricing Regime

3.2.1. The Arm's Length Principle – Applicable Normative Sources under the IRC

The Respondent bases the arithmetical corrections made, which were at the origin of the additional IRC assessment in question, on what it considers to be the violation of the arm's length principle, which was protected, at the date of the facts, under the regime established in Article 58 of the CIRC[2], whose first two sections establish the following:

Article 58
Transfer Prices

1 – In commercial transactions, including in particular transactions or series of transactions regarding goods, rights or services, as well as in financial transactions, conducted between a taxpayer and any other entity, whether or not subject to IRC, with which it is in a situation of special relationship, there must be contracted, accepted and practiced terms or conditions substantially identical to those that would normally be contracted, accepted and practiced between independent entities in comparable transactions.

2 – The taxpayer must adopt, for the determination of the terms and conditions that would normally be agreed, accepted or practiced between independent entities, the method or methods capable of ensuring the highest degree of comparability between the transactions or series of transactions it conducts and others substantially identical in normal market situations or in the absence of special relationships, taking into account, in particular, the characteristics of the goods, rights or services, market position, economic and financial situation, business strategy, and other relevant characteristics of the enterprises involved, the functions performed by them, the assets utilized and the allocation of risk.

In perfect accordance with the provisions now transcribed, section 1 of Article 1 of Ordinance no. 1446-C/2001 of 21 December, applicable by virtue of section 13 of the aforementioned Article 58 of the CIRC, provides that "in transactions conducted between a taxpayer subject to personal or corporate income tax and any other entity, whether or not subject to these taxes, with which it is in a situation of special relationship, terms and conditions must be contracted, accepted and practiced substantially identical to those that would normally be contracted, accepted and practiced between independent entities in comparable transactions".

3.2.2. The Purpose of the Transfer Pricing Regime and Its Requirements

The provisions alluded to in the preceding number make clear the purpose and scope of the transfer pricing regime. The legislator intended with it that transactions between entities that maintain special relationships – as is manifestly the case with the Claimant and B..., as concluded from section 4 of Article 58 of the CIRC – be subject to taxation as if they were conducted by entities that are completely independent of one another.

It is necessary to recognise that the special nature of relationships between two economic agents may impose terms and conditions that are only justified by reason of that special nature. Therefore, what is intended with the transfer pricing regime is that the taxation of those transactions be based on the values that would be agreed in normal market situations, giving the tax authority the possibility of making the corrections it deems necessary to the taxable profit of a taxpayer so that that result, for exclusively tax purposes, is what it should be in normal market conditions, thereby purging it of the tax effects attributable to the special nature of the relationships between the parties.

In order not to violate the principles of legality and ability to pay, both with constitutional dignity, it is necessary that the corrective intervention of the tax authority meet the requirements upon which the application of the transfer pricing regime depends, namely[3]:

· The existence of special relationships between the parties to a given transaction;

· The establishment, between those parties, of terms and conditions different from those that would normally be agreed between unrelated entities;

· The recognition that the special nature of the relationships of the parties is the appropriate cause of the terms and conditions actually practiced in the transaction.

As can be seen, this regime rests, simplifying, on two fundamental principles: that of arm's length and that of comparability.

3.2.3. The Principles of Arm's Length and Comparability

The arm's length principle "posits that specially related enterprises, in setting the prices of their transactions, must follow the same assumptions that would be followed by independent enterprises under normal market conditions and practices[4]".

The principle of comparability, for its part, suggests the comparison of the price practiced between specially related enterprises and that which, supposedly, would be practiced between independent enterprises[5]. This principle, under section 2 of Article 58 of the CIRC, requires the taxpayer to adopt the "method or methods capable of ensuring the highest degree of comparability" between those transactions.

In fact, to determine the arm's length price, the tax authority must apply one of the methods provided for in Article 58 of the CIRC at the time and regulated by the Ordinance to which we made reference, namely the comparable uncontrolled price method, which should take precedence over all others, as it is, in theory, the most reliable and trustworthy, since "it requires the highest degree of comparability bearing on both the subject matter and other terms and conditions of the transaction as well as the functional analysis of the entities involved", as can be read in section 1 of Article 6 of the Ordinance. One could indeed say that there cannot be comparability more credible than that which rests on the existence of two transactions occurring on the same day, concerning the same subject matter, one between independent entities and another between related entities.

3.2.4. Normal Market Situations

If it is, as it seems to us, indisputable what has been stated about the necessary comparability of the two transactions in question, the one actually practiced between related entities and the hypothetical one, that is, the one that would have occurred in normal market situations, between unrelated entities, the expressions to which the law itself makes appeal cannot but be emphasized: "normal market values" and "normal market situations". That is, the application of the transfer pricing regime, aiming at the arithmetical correction of the taxable profit of a taxpayer does not exempt from the demonstration that the terms and conditions contracted, accepted and practiced in a given transaction between related entities would be different if that same operation had been conducted between independent entities, under normal market conditions.

In essence, it is necessary, on the one hand, to demonstrate that the terms and conditions agreed between related entities do not correspond to those that would result from the transparency of the open market and, on the other, it is imperative to prove that the terms and conditions practiced by independent entities, in normal market situations, would be different.

What is intended with the foregoing is to maintain that the application of the transfer pricing regime cannot be satisfied with the mere demonstration that there has been a transaction between related entities and another, deemed comparable, between unrelated entities. And the impossibility that is here defended results from the necessity of all the requirements upon which the application of the regime in question depends being met. It is necessary to demonstrate, yes, that in a given operation between related entities, terms and conditions different from those that were (or would be) used in a comparable operation, conducted between unrelated entities, were practiced. But more: it is still necessary to prove that the terms and conditions practiced between related entities were not those that would be used in normal market situations, which implies, unless I am mistaken, a double assessment: on the one hand, on the terms and conditions actually practiced and, on the other, on the terms and conditions that are believed should be used as a reference.

It is not sufficient, then, merely to point out the divergence. It is necessary to qualify it.

It is also important to note that the burden of proof rests with the Respondent[6]. It is indeed incumbent upon the Respondent, in the present case, to demonstrate that all the requirements upon which the application of this regime depends are present, in accordance with section 1 of Article 74 of the General Tax Law.

This was, moreover, the position endorsed, and rightly so, by the learned judgment of the Supreme Administrative Court of 01.06.2005, rendered in case 228/05. This decision is of interest for the case sub judice. It deals with the acquisition and subsequent disposition of shares representing the capital of a commercial company. At one point, an entity acquires two shares, only to sell them shortly thereafter to a related entity for a value much lower than that used for the acquisition, recording consequently a negative change in equity in its accounts and negatively affecting its taxable result. The taxpayer in question did not accept the correction made by the tax authority and the Supreme Administrative Court found that the said correction had been legitimate. It thus judged that the disregard of the price practiced between the related entities was in conformity with the legal order, accepting that the taxation be carried out taking into account the value fixed in the previous transaction, between unrelated entities.

More than the solution, it is important to discern the deliberative process. The tax authority did not limit itself, in the administrative proceeding that preceded the judicial phase of the dispute, to: i) pointing out the existence of two temporally proximate transactions concerning the same asset; ii) denouncing the divergence of the values in each practiced; and iii) evidencing that in one of those transactions the parties involved were related entities. No. The tax authority (and the court) assessed the sale price of the shares that had been corrected and did so in the following terms:

"The nominal value of 3,080,000$00, which the appellant considered as the sale price of the shares, represents 13.7% of the capital of 22,500,000$00. The shareholders' equity declared at 31/12/97 amounts to 449,546,128$00, excluding the deduction of 61,087,500$00 of losses in own shares. The capital of 22,500,000$00 corresponds to values from the 1950s, when the company was founded. Among its assets is a rural property and an urban property with outdated accounting value. Its intrinsic value also includes considerable intangible value, which is manifested in its capacity to generate income, resulting from its longevity and profitability. From what has been said above, it is quite clear that the sale price of the company's own shares to SGPS does not correspond to real value, being an artificial price, impracticable between independent persons."

As can be seen from this passage, the assessment of the soundness of the correction made by the tax authority did not dispense with the careful analysis of the price practiced in the transaction concluded between related entities. Only it permitted the conclusion that that price could not be the one that would be considered if the transaction had been concluded by absolutely independent entities. In short: it was possible for the court to form the conviction that the asset subject to the transaction between related entities was undervalued; it was thus possible for the court to reach the conclusion that those shares were worth more than was considered in the transaction between companies with special relationships.

It is clear that the court's reasoning went beyond this inference. In the proceedings, it had to be demonstrated, on the one hand, that the undervaluation was due to the special relationships existing between the parties and, on the other, that the value practiced in the first transaction corresponded to what would be appropriate in normal market conditions, between unrelated entities. However, the first step was, as it had to be, the demonstration that the price practiced in the transaction between related entities was not reasonable. It was not the market price.

3.2.5. The Application of the Transfer Pricing Regime to the Case Sub Judice

a) The Position of the Respondent

Having determined the existence of special relationships between the Claimant and B..., the Respondent concludes, correctly, that the sale of the Credits by the Claimant to B... had to be analysed in light of the norms established in Article 58 of the CIRC. It then considered, rightly, that the method most suited to the case was that of the comparable market price. Now, requiring that the comparison be made with the most identical asset possible, the case allowed that the comparison be made with the very asset and on the same date, since the Claimant acquired the Credits from an independent entity, a banking entity, on the same day it transferred them to B....

The conclusion of the Respondent is crystal clear at page 8 of the tax inspection report (doc. 2, attached with the request for arbitral pronouncement): "Since the credits are the same, the transaction dates are also coincident, the taxpayer that acquired them (from an independent entity, thus without any special relationship) was the one that, on the same day, sold them (this time to an entity with which it has special relationships […]), it is concluded that this sale of the credits to company B... […] was not governed by the principles of arm's length and that terms or conditions identical to those contracted, accepted and practiced between independent entities for the same operation were not practiced in this transaction".

This is also the position of the Respondent when it dismissed the request for reconsideration presented by the Claimant (doc. 3, attached with the request for arbitral pronouncement):

"27 – The Tax Inspection Services of the AT concluded that this sale [that by the Claimant to B...]:

• was not governed by the Principles of Arm's Length

• terms or conditions identical to those contracted, accepted and practiced between independent entities for the same operation were not practiced in this transaction

28 – This is because A...

• ACQUIRED by contract for assignment of credits from … , CRL, for the price of €468,972.55

• SOLD the same credits to B... for the total price of €77,868.90

With the result that

29 – the first operation of A..., acquisition, was conducted according to the free will of the parties involved, two entities without special relationships between them

30 – the second operation of A..., sale, was conducted between entities with special relationships between them

31 – Therefore, the AT had no other option but to make a correction to taxable profit (…)"

It would not be abusive to assert that, for the Respondent, in the transaction between the Claimant and B... the arm's length principle was violated for a simple reason: that they are related entities, and there was on the same day a transaction with the same subject between unrelated entities. Now, it is necessary to recognize that the statements above reproduced do not contain conclusions, in the strict sense. Rather they are pure axioms, which is why the Respondent does not feel the need to prove, in substantive terms, on the one hand, why the sale price of the Credits to B... cannot be accepted and, on the other, why the fiscally relevant price must be the one fixed in the transaction with D.... To consider this demonstration unnecessary is equivalent to contending that there are no transactions between related entities that respect the principles of arm's length and, at the same time, that the terms and conditions agreed between unrelated entities are always those dictated by normal market conditions. Now, it seems clear to this tribunal that this is not the case.

b) The Transactions in Question

The terms and conditions practiced in both transactions, the acquisition and disposal of the Credits by the Claimant, from D... and to B..., respectively, are known.

As was sought to be demonstrated, in logical terms, the analysis of the transaction acquiring the Credits by the Claimant is posterior to the examination of the transaction disposing of those Credits to B.... And this is because it was this transaction, and not the other, that was subject to the arithmetical correction in dispute, although it is not ignored that the correction of the disposal transaction was made based on what was determined in the acquisition transaction.

As has been said, the Respondent held that the sale price of the Credits to B... could not be considered for tax purposes, for two reasons:

· Because the parties are related entities; and

· Because the value in this transaction corresponds to a devaluation of approximately 83.3% (eighty-three point three percent) compared to the price practiced in the acquisition made by the Claimant from D..., which occurred on the same day, it should be remembered.

The Claimant, still in the administrative proceeding, offered its justification, of course, for why the price practiced in that sale was what it was and not another, namely the one practiced in the acquisition. Now, C..., the debtor entity, was insolvent and its respective insolvency plan, prior, as is known, to 13.03.2009, the date of the transactions in question, provided, for the generality of creditors, "payment of 15% of capital with full forgiveness of interest, in 60 monthly instalments". The Credits, as is known, amounted to € 486,290.98 (four hundred and eighty-six thousand two hundred and ninety euros and ninety-eight cents), having been sold to B... for € 77,868.90 (seventy-seven thousand eight hundred and sixty-eight euros and ninety cents), that is, for 16% (sixteen percent) of their nominal value.

The question to which an answer must be given is this: would it make sense for unrelated entities, under normal market conditions, to agree on the purchase and sale of credits against an insolvent company for 16% (sixteen percent) of their nominal value, when the respective insolvency plan, if approved, provides for "payment of 15% of capital with full forgiveness of interest, in 60 monthly instalments"? In truth, if the insolvency plan is approved and everything proceeds as provided therein, the two values are not very different, although it is evident that the acquisition value by an unrelated entity, that is, by an entity that only cared about the quality of the credit being acquired, should reflect, at least, the financial effect of the deferral of payment, let alone the risk of non-performance.

But even if one admits that that question is not easy to answer, it seems less difficult to answer this other one: would it make sense for unrelated entities, under normal market conditions, to agree on the purchase and sale of credits against an insolvent company for 96.44% (ninety-six point forty-four percent) of their nominal value, when the respective insolvency plan, if approved, provides for "payment of 15% of capital with full forgiveness of interest, in 60 monthly instalments"? The answer to this question is, with absolute certainty, a resounding no.

Therefore, one (or even two) of the prerequisites or requirements upon which the application of the transfer pricing regime depends is lacking in the case sub judice, at least on the basis of what is sustained by the Respondent.

It seems legitimate to doubt the propriety, appropriateness or necessity of the sequence of operations conducted or the tax irrelevance of their structure. Indeed, the Claimant itself came to confess specious purposes of some of those transactions. In truth, will it be improper, hasty or misguided to admit that the sale of the Credits to B... had as its goal the realization of a loss that would allow to accommodate or compensate for the gain realized with the sale of the immovable properties, also on 13.03.2009, to ..., Unipessoal, Lda.? Would it be absurd to conceive, as the Respondent does, that the "transaction conducted within the group itself [the sale of the Credits by the Claimant to B...] was conducted with the sole objective of accounting for losses"? Perhaps not…

However, admitting this possibility cannot imply the correction of the sale value of the Credits to B... based on the argument that that price violates the arm's length principle. It is evident that, given that on the same day and with respect to the same Credits, there are two very different sale prices, one of them, at least, cannot correspond to a market price. And in the present case, if one of the prices is in need of correction, it is probably the acquisition price from D... and not the sale price to B..., for the reasons stated.

It should be noted, however, that this conjecture does not imply calling into question any documents in the record. The contract by which the Claimant acquired the Credits and the public deed effecting the transmission of the immovable properties mentioned refer to values, of course, but nowhere does it say that they are market values. None of those documents express any considerations about normal market situations. Therefore, admitting giving weight to the conditions, the context, in which these transactions were negotiated and concluded does not call into question what is stated in the documents that formalize them.

c) Conclusion

For the reasons stated, it is the understanding of the arbitral tribunal that the acts of additional IRC assessment no. 2012…, assessment of compensatory interest no. 2012… and account settlement no. 2012…, from which resulted a balance of € 40,221.54 (forty thousand two hundred and twenty-one euros and fifty-four cents), are vitiated by illegality.

4. Decision

Based on the grounds set forth above, the arbitral tribunal decides to uphold the request for arbitral pronouncement with the consequent annulment of the impugned assessments, with all legal consequences.

5. Value of the Case

In accordance with the provisions of section 2 of Article 315 of the Civil Procedure Code, paragraph (a) of section 1 of Article 97-A of the Tax Procedural Code and also section 2 of Article 3 of the Regulations on Costs in Tax Arbitration Proceedings, the case is fixed at a value of € 40,221.54 (forty thousand two hundred and twenty-one euros and fifty-four cents).

6. Costs

For the purposes of the provision of section 2 of Article 12 and section 4 of Article 22 of the RJAT and section 4 of Article 4 of the Regulations on Costs in Tax Arbitration Proceedings, the amount of costs is fixed at € 2,142.00 (two thousand one hundred and forty-two euros), in accordance with Table I annexed to said Regulations, to be borne entirely by the Respondent.

Lisbon, 22 September 2014

The Arbitrator

(Nuno Pombo)

[1] The present arbitral decision is written in accordance with the orthography prior to the 1990 Orthographic Agreement.

[2] Corresponding to Article 63 of the CIRC, currently in force.

[3] See, although with slight difference, ELISABETE LOURO MARTINS, The Burden of Proof in Tax Law, Coimbra Editora (Wolters Kluwer Portugal), 2010, pages 198 et seq.

[4] RUI DUARTE MORAIS, Transfer Prices – The Tax System on the Razor's Edge, in Journal of Public Finances and Tax Law, year 2, number 1, page 142.

[5] RUI DUARTE MORAIS, Transfer Prices – The Tax System on the Razor's Edge, in Journal of Public Finances and Tax Law, year 2, number 1, page 137.

[6] ELISABETE LOURO MARTINS, The Burden of Proof in Tax Law, Coimbra Editora (Wolters Kluwer Portugal), 2010, pages 209 et seq., with reference to extensive case law supporting what we defend.