CAAD Case 384/2018-T: Transfer Pricing IRC Adjustment on Shareholder Loans Under Article 63 CIRC

ARBITRATION DECISION

The arbitrators Dr. Alexandra Coelho Martins (arbitrator president, appointed by the CAAD Ethics Council), Prof. Dr. Gustavo Lopes Courinha (appointed by the Tax and Customs Authority) and Dr. Francisco Carvalho Furtado (appointed by the Taxpayer) forming the Arbitral Tribunal, constituted on 15 November 2018, agree as follows:

I. REPORT

A..., S.A., with registered office at ..., Rua ..., no. ..., ..., ...-... ..., corporate entity no. ..., hereinafter referred to as the "Claimant," came before the Arbitral Tribunal, pursuant to the provisions of paragraph a) of article 2, section 1, paragraph b) of article 5, section 3, and paragraph b) of article 6, section 2 of the Legal Regime for Tax Arbitration (hereinafter "LRTA"), requesting the constitution of an Arbitral Tribunal with a view to declaring the illegality and consequent annulment of the Corporate Income Tax (IRC) assessment act no. 2018..., of 4 April 2018, relating to the tax year 2015, which resulted in the amount payable of € 815,763.96 (eight hundred and fifteen thousand, seven hundred and sixty-three euros and ninety-six cents).

The respondent is the Tax and Customs Authority, hereinafter referred to as "TA."

The Claimant opposes the increase of € 2,217,320.86 to its taxable income for the tax year 2015, relating to financial charges incurred with respect to loans from its sole shareholder, B..., S.À.R.L., hereinafter "B...," which the TA considered non-deductible on the grounds that, in its view, they exceed the interest rate for similar loans in market conditions between independent parties, under the arm's length principle and transfer pricing rules (see article 63 of the IRC Code).

According to the Claimant, the interest rate practiced with its shareholder is market-based and does not require correction for tax purposes, in addition to advocating that the methodology used by the TA to determine market remuneration is inadequate.

It likewise questions the non-recognition of tax losses from prior years [2014], in the amount of € 101,869.23, on the grounds that, in its view, these are capable of deduction from the taxable profit of the year in question [2015].

It concludes by requesting the annulment of the tax act, which it considers illegal, seeking the condemnation of the respondent to refund the overpaid tax, plus compensatory interest. It submitted 21 documents and listed 2 witnesses.

The Claimant appointed Dr. Francisco Carvalho Furtado as Arbitrator, pursuant to the provisions of paragraph b) of article 6, section 2 of the LRTA.

The request for constitution of the Arbitral Tribunal was accepted by the Illustrious President of CAAD and automatically notified to the TA on 17 August 2018.

Pursuant to the provisions of paragraph b) of article 6, section 2 and section 3 of the LRTA, and within the time limit set out in section 1 of article 13 of the LRTA, the head of the TA service appointed Prof. Dr. Gustavo Lopes Courinha as Arbitrator.

Following the request presented by the arbitrators appointed by the parties for the president arbitrator to be appointed by the Ethics Council, the Illustrious President of the Ethics Council appointed Dr. Alexandra Coelho Martins in that capacity, pursuant to the second part of paragraph b) of section 2 of article 6 of the LRTA.

All arbitrators accepted the appointment, and the CAAD President informed the parties of this appointment on 25 October 2018, for purposes of section 7 of article 11 of the LRTA, with neither party manifesting an intention to refuse the appointment.

The Collective Arbitral Tribunal was constituted on 15 November 2018.

On 19 December 2018, the respondent filed its Answer, in which it defends itself by way of exception and by substantive objection. It submitted the administrative file ("AF").

By way of exception, it raises the material incompetence (partial) of the Arbitral Tribunal with respect to the claim, in the amount of € 101,869.23, relating to tax losses declared in 2014 that were recognized in the Arbitral Decision of case no. 378/2017-T. The respondent contends that the alleged breach of that arbitral decision, which seeks the restoration of the correct value of losses, falls within the scope of execution of judgment in the aforementioned case 378/2017-T, whose appropriate remedy would be the procedure set out in articles 146 of the Tax Procedure and Process Code ("TPPC") and 173 and following of the Code of Procedure in Administrative Courts ("CPAC"). It considers that such execution is not included within the scope of claims capable of being adjudicated by Arbitral Tribunals operating at CAAD (see article 2 of the LRTA and Order no. 112-A/2011 of 22 March), and constitutes a dilatory exception, in accordance with section 2 of article 576 and paragraph a) of article 577 of the Code of Civil Procedure ("CCP"), applicable by cross-reference of paragraph e) of section 1 of article 29 of the LRTA.

The respondent further raises the exception of untimeliness, as a precaution, on the grounds that the Claimant failed to prove notification of the assessment, which dates from 4 April 2018 (see section 1 of article 10 of the LRTA read together with section 1 of article 102 of the TPPC).

By way of substantive objection, the respondent maintains the reasoning contained in the Tax Inspection Report. It states that, in the absence of the transfer pricing file, it was primarily incumbent upon the Claimant to prove its case, by virtue of section 1 of article 74 of the General Tax Law, and that the subsequent submission of a study prepared by a consultant did not take into account the reality of the Portuguese market, as the eleven observations identified as comparable are located outside Portugal, in countries with their own characteristics, and refer to distinct sectors of activity, predominantly financial services (nine observations), as only two cases relate to the real estate sector.

The respondent adds that the risk exposure of the parent company is reduced, since it has privileged information and total control (100%) over the activity and decisions that influence the sphere of the Claimant, that the loans were intended for the acquisition of real estate, constituting a real guarantee, and that the value of the portfolio is not above market value.

Further, according to the respondent, the average interest rate disclosed by the Bank of Portugal as a reference is, given the impossibility of obtaining comparable operations, the most measured criterion, as it takes into account the Portuguese financial market. Additionally, the financing obtained from I... has characteristics that permit its use as a comparable, and its remuneration is substantially lower than that of the parent company. It was not proven that the loans presented the increased risk normally associated with subordinated debt instruments, given the guarantees constituted by the assets and rights to which the funds were applied.

Finally, the respondent expresses the view that it is pointless to hear the witnesses as it considers that the facts relevant to the decision are documented in the record, indicating, as a precaution, however, two witnesses. It concludes that the exceptions are well-founded and, in any event, that the claim is unfounded and the requests should be denied.

Notified to respond to the exceptions, the Claimant filed a reply in which it states that the request for arbitral pronouncement ("RAP") concerns exclusively the assessment of the legality of the IRC assessment act and does not imply any request for execution of judgment. The reference to the tax loss that was recognized in case no. 378/2017-T is intended solely to demonstrate that the assessment act contains a calculation error, in that it failed to consider all the elements that should have been included in its determination. With respect to untimeliness, the Claimant submits proof of account adjustment that indicates as the payment deadline 16 May 2018, so that when the arbitral action was filed, on 14 August 2018, the 90-day period set out in section 1 of article 10 of the LRTA had not yet expired, information which was known to the TA, the author of the assessment act.

By order of 14 January 2019, the conduct of witness examination was ordered, given the potential utility for establishing the facts, which took place at the meeting of 12 March 2019, at which the witnesses indicated by the Claimant and the respondent were heard, with consideration of the exceptions deferred to the end. At that meeting, the parties were notified to submit successive written submissions and the date for pronouncing the arbitral decision was set, with extension of time, pursuant to article 21, section 2 of the LRTA, given the procedural complexities involved.

Both parties submitted briefs, in which they maintained the positions they had assumed.

By order of 7 July 2019, the time for pronouncing the decision was extended, under section 2 of article 21 of the LRTA, given the complexity of the matter.

II. PRELIMINARY MATTERS. CONSOLIDATION

1. MATERIAL INCOMPETENCE OF THE ARBITRAL TRIBUNAL

The competence of courts is a matter of public law, and its determination precedes consideration of any other matter, and therefore must be addressed (see article 13 of the CPAC, by force of paragraph c) of section 1 of article 29 of the LRTA).

The material scope of arbitral jurisdiction is defined by article 2 of the LRTA and, likewise, by Order no. 112-A/2011 of 22 March, which provide that its jurisdiction covers the assessment of claims for "declaration of illegality of assessment acts for taxes, self-assessments, withholding at source and payments on account."

The Claimant identifies as the subject matter of the arbitral action the IRC assessment act relating to the tax year 2015, and deduces as its principal claim its annulment, and therefore on this point there are no doubts regarding the framing of the claim within the provision of paragraph a) of section 1 of article 2 of the LRTA.

With respect to the cause of action constituting the ground for the annulment claim, it appears from the record that the assessment act in question was based on corrections made by the Tax Inspection Services to the taxpayer's taxable income for the prior tax period, which corresponds to the calendar year 2014. What the Claimant invokes in this regard is error concerning the factual and legal presuppositions in the execution of the disputed 2015 assessment act, i.e., a matter that appears to fall within the material competence of this Tribunal. Such error arises from the failure to consider, in the quantification (calculation) of the challenged assessment, the correct value of tax losses determined in prior years and available for carryforward.

It should further be noted that the manner in which the exception was framed—as concerning the breach of an arbitral decision (and therefore judicial) determining the restoration of the correct value of losses—is susceptible to being characterized as a defect in the validity of the act (paragraph i) of section 2 of article 161 of the Administrative Procedure Code), invocable at any time and which may "be known to any authority and declared by administrative courts or by the administrative bodies competent for annulment" (section 2 of article 162 of the APC), a rule which cannot fail to be applicable by cross-reference of the LRTA and the TPPC, as the general regime for the invalidity of tax acts is that provided for in the APC.

It is true that execution of a judicial decision, if not voluntarily carried out by the TA, may be the subject of an action for execution of judgment, and this is not contradicted here. Only the perspective in question here is different and is not confused with that, nor does it compromise it, which is that of the (in)validity of the tax act, whether due to error in the factual presuppositions (annulability regime—article 163 of the APC) or due to violation of res iudicata, or judgment on the merits (nullity regime).

In light of the foregoing, the respondent's thesis that the invalidity of the assessment act, as regards the tax losses not computed, could only be reviewed in proceedings for execution of judgments cannot be accepted.

The exception of incompetence raised by the respondent therefore lacks merit, and the Arbitral Tribunal is competent ratione materiae, given the characterization of the subject matter of the case (see paragraph a) of section 1 of article 2 and article 5 of the LRTA), which concerns the declaration of illegality and annulment of a tax assessment act for IRC.

2. THE EXCEPTION OF UNTIMELINESS

The respondent argues, as a precaution, the exception of untimeliness, on the basis that the Claimant failed to demonstrate the date on which it was notified of the IRC assessment act constituting the subject matter of the arbitral claim, or the expiration of the period for voluntary payment of this tax.

Taking into account that the 90-day period for filing the request for arbitral pronouncement is counted from the expiration of the period for voluntary payment of tax obligations legally notified to the taxpayer (see paragraph a) of section 1 of article 10 of the LRTA and paragraph a) of section 1 of article 102 of the TPPC) and that this period was set by the TA itself which therefore could not be unaware of it, as it concerns documents issued by the respondent to which it has direct access and complete knowledge of their contents, the procedural conduct adopted appears worthy of censure.

In fact, the deadline for voluntary payment of IRC and compensatory interest calculated was set by the TA on 16 May 2018, so that as of the date of filing of the present arbitral action—on 14 August 2018—the 90-day period had not yet expired, corresponding to the last day of the period.

This date could readily be inferred from document no. 11 filed with the RAP—the tax enforcement citation—which indicated as the initial date for counting default interest 17 May 2018. Now, in accordance with the provisions of article 44 of the General Tax Law, default interest is counted from the expiration of the legal deadline for payment of the tax. Thus, it was imperative to conclude that the date for voluntary payment of the assessment in question would be 16 May 2018, which was further reinforced by the Claimant's submission, in response to the exception, of the account adjustment statement establishing that date as the payment deadline.

It is concluded that the exception raised by the TA is manifestly unfounded, and the request for arbitral pronouncement is timely, being submitted within the period provided for in article 10, section 1, paragraph a) of the LRTA.

3. OTHER PROCEDURAL REQUIREMENTS

The Tribunal was regularly constituted, the parties possess legal personality and capacity, have standing and are regularly represented (see article 4 and section 2 of article 10 of the LRTA and article 1 of Order no. 112-A/2011 of 22 March).

The case is not affected by nullities, nor are there obstacles to adjudication of the merits of the claim.

III. REASONING

1. FACTUAL MATTERS

Relevant to the decision, the following facts are found to be proven:

A. The Claimant was incorporated on 23 December 2013 in the form of a limited liability company, with commencement of activities on 26 December 2013 and registered with principal activity code 68100—Purchase and Sale of Real Estate, having been converted to a public limited company on 6 February 2017—see permanent certificate and Tax Inspection Report ("TIR") filed with the RAP (document 16) and with the AF.

B. The Claimant is engaged in the acquisition, for resale, of real estate and claims against financial institutions and the acquisition of debt securities for subsequent management and generation of income—TIR and testimony of C... and F....

C. For purposes of IRC, it is subject to the general regime—see TIR.

D. As of 31 December 2015, the capital stock of the Claimant consisted of 1 share with a value of 1 euro held by B..., S.À.R.L. ("B..."), an entity with registered office in Luxembourg, itself held entirely by funds managed by D...—see TIR.

E. In the tax year 2015, the Claimant had no employees and did not own any premises, with support and logistics functions for the Claimant being provided by E..., SA ("E...")—see TIR and testimony of witness C....

F. The Claimant was incorporated for the purpose of acquiring the so-called "non-performing loans" held by national financial institutions, fundamentally claims which had associated real estate collateral (mortgage claims) which would permit, in the event of probable default, the sale of the real estate, recovering the price paid for the claims plus a margin. The primary activity of the Claimant is therefore the purchase of mortgage claims. Only residually were consumer claims acquired, lacking real estate collateral—Class B claims, which did not represent even 10% of the claim portfolio held by the Claimant—see TIR and testimony of witnesses C... and F....

G. When reselling some of the real estate acquired from financial institutions, the Claimant realized losses. However, these were exceptional situations, as the Claimant generally achieved its business objectives—see document 3A filed with the RAP and testimony of witness C....

H. There are no guarantees that the sale of real estate by the Claimant will be conducted at values above the acquisition values plus management and maintenance costs associated with holding them—see testimony of witness C....

I. Repairs must be conducted on some of the real estate in order for them to be in condition for sale—see testimony of witness C....

J. The due diligence period preceding the purchase of portfolios is relatively short, not allowing for physical analysis of the entire real estate assets associated therewith—testimony of witness C....

K. Some of the real estate acquired have not yet been resold—see real estate listed in document 5 filed with the RAP and testimony of witness C....

L. On 23 December 2014, a promise contract for purchase and sale, entitled "Receivables and Properties Promissory Sale Agreement," was entered into between the Claimant and G... (G...) in the amount of € 692,000,000.00 for the acquisition of real estate and a claim portfolio—see document 4 filed with the RAP, AF and testimony of witness C....

M. In 2015 the Claimant purchased debt instruments—bonds—"Orion Class B Securitisation Notes" issued by H..., SA—see TIR.

N. In the course of the 2015 tax year, the Claimant obtained financing in the form of loans from its sole shareholder, B..., in order to have funds for the development of its activity—see TIR and testimony of witness C....

O. The loans agreed upon by the Claimant were established with reference to a maturity of 4 years and were denominated in Euros in amounts ranging from € 520,000.00 to € 10,297,607.00, bearing interest at a fixed contractual rate of 9%, on a simple interest basis—see TIR.

P. The contracts in question (loans) provide that the repayment of principal and interest occurs only at maturity, although they also contemplate the possibility of early repayment of principal and interest, without any bonus or penalty—see TIR and AF.

Q. The loan contracts do not have associated guarantees—see TIR and testimony of witnesses C... and F....

R. In order for the Claimant to carry out the investments planned in its business plan, the underlying financing needs implied, in addition to the loans, the additional contracting of credit from banking entities—see TIR and testimony of witnesses C... and F....

S. On 28 May 2015, the Claimant entered into a mortgage loan with I... ("I...") in the amount of € 5,613,072.40, with a maturity of three years and bearing interest at the 3-month Euribor rate plus a margin of 3.5%. This financing was secured by a mortgage constituted over 84 real estate properties with a total value of € 8,138,954.98—see document 6A filed with the RAP.

T. The financing contracted with I... required the Claimant, whenever sale of real estate occurred, to have the obligation to repay principal in a minimum amount of 50% of the sale price of the real estate sold—see document 6A filed with the RAP.

U. Also in accordance with the mortgage loan contract entered into with I..., the Claimant was obligated to maintain a loan-to-value ratio equal to or less than 0.65 (weight of the amount owed on the value of assets pledged as collateral) and I... could demand early repayment if the Claimant came to be held by another entity (change of shareholder)—see document 6A filed with the RAP.

V. On 19 November 2015, the Claimant entered into a new mortgage loan contract with I... in the amount of € 706,870.45, constituting as collateral a mortgage over 11 real estate properties with a total value of € 1,024,962.15—see document 6B filed with the RAP.

W. The funds from the mortgage loan contracts entered into with I... were intended for and applied to the acquisition of assets—real property—that were on the balance sheet of the financial entity that granted the loan—testimony of witnesses C... and F....

X. With respect to the tax year 2015, the Claimant did not timely submit model form 22 or the Simplified Business Information form—see TIR.

Y. Pursuant to service order no. OI2016..., dated 1 July 2016, a multi-purpose external inspection action was conducted on the Claimant for the tax year 2015—see TIR.

Z. In that connection, on 31 January 2018, the Claimant was notified of the Draft Tax Inspection Report which proposed various corrections to the IRC taxable income for the year 2015, in particular, and relevant to the present case, an increase of € 2,217,320.86 relating to non-deductible financial charges connected to loans from its sole shareholder, B..., obtained during 2014 and 2015, on the grounds that the interest rate practiced was allegedly excessive in light of the market price, considering the Arm's Length Principle and the Transfer Pricing regime, under article 63 of the IRC Code—see TIR.

AA. On 14 February 2018, the Claimant submitted Model Form 22 for IRC for the tax year 2015, in which it considered various adjustments proposed in the Draft Report referenced above, but not the correction that is the subject of this case—see document 7 filed with the RAP and TIR.

BB. In that Model Form 22, the Claimant deducted from taxable profit determined tax losses carried forward from prior years in the amount of € 199,296.22, under article 52 of the IRC Code, with € 2,000.00 relating to the 2013 tax period and € 197,296.22 relating to 2014—see documents 7, 17 and 18 filed with the RAP.

CC. By letter dated 14 February 2018, the Claimant was notified by the TA of the correction of the value of tax losses indicated in Model Form 22 for 2015 from € 199,296.22 (declared tax loss) to € 103,869.23 (corrected tax loss), with indication that against this correction it could file a petition for gracious relief or bring a judicial challenge within the terms and periods provided for in article 137 of the IRC Code, when the assessment was notified to it—see document 9 filed with the RAP.

DD. On 15 February 2018, the Claimant exercised its right to be heard in reaction to the correction of the IRC taxable income discussed in the present case, submitting a study intended to demonstrate that the interest rates applied to the loans in the tax year 2015 were in accordance with the market, and proceeded to pay the IRC self-assessed in the Model Form 22 submitted the preceding day—see document 8 filed with the RAP, TIR and AF.

EE. Subsequently, in April, the Claimant was notified of the Tax Inspection Report ("TIR") for the tax year 2015, which maintained the proposed corrections, of which € 2,217,320.86 relate to financial charges which the TA considers non-deductible, a document the full content of which is reproduced herein for all due purposes, from which the following illustrative excerpts are drawn:

"[…]

III.1.1 – ANALYSIS OF FINANCING CONTRACTED IN 2014 AND 2015 FROM THE PARENT COMPANY

In the course of the tax years 2014 and 2015, the taxpayer contracted various financing arrangements with its sole shareholder (holder of the entire capital stock)

[…]

The following table details the values recorded by the taxpayer as expenses relating to interest on financing obtained from the holder of its capital stock:

The financing contracts entered into between A... and B... supporting the financial expenses recorded were requested and obtained (all contracts were drawn solely in a foreign language).

From analysis of the aforementioned contracts, it was determined that the contractual clauses established are generically identical among the contracts, in particular with respect to the interest rate assumed and the agreement that principal and interest are repaid at the maturity of the loan.

With the exception of the amount of € 200,000.00 which is part of the financing granted by the shareholder on 20 May 2014 (in the amount of € 764,964.00), the financing in the amount of € 981,512.00 granted on 26 June 2014, and the financing granted on 28 May 2015 in the amount of € 2,726,381.00, whose amounts were credited to the demand deposit account held by the taxpayer with J..., the remaining financing was granted by the shareholder for direct payment of obligations assumed by A....

Financial expenses relating to interest payable to the shareholder for loans are recorded in account 6911—Interest on financing obtained (see Appendix 3).

Recording in the expense account (debit) occurred as a counterentry to account 272202—Accrued interest (credit) because although no debit note was issued by the shareholder, in view of the matching principle set forth in article 18 of the IRC Code, A... has been calculating interest, recording the respective value in expenses for the period as a counterentry to this account.

III.1.2 - LEGAL FRAMEWORK OF FINANCIAL EXPENSES RESULTING FROM LOAN INTEREST

Pursuant to the provisions of paragraph c) of section 1 of article 23 of the IRC Code, expenses of the period are those which are demonstrably incurred or borne in order to obtain or guarantee income subject to tax, including those of a financial nature, such as interest on borrowed capital.

Now, in accordance with the information gathered during the inspection action, the loans made in 2014 and 2015 by the shareholder were intended to provide the company with financial resources to acquire real estate. The majority of these acquisitions were characterized as being in block/packages of real estate belonging to banking institutions, essentially G... (in this case the largest deed of purchase was executed during the tax year 2015) and Banco K... SA.

As already referenced in this report, the taxpayer commenced its activity at the end of the 2013 tax year, does not have a business structure and, in fact, its initial capital stock of € 1 is not in itself sufficient for carrying out the planned activity.

It is therefore concluded that the financing conducted effectively provided the company with financial resources in order to present itself more solidly and comprehensively in the market in which it operates and to be able to acquire the real estate portfolio which it proposed.

For the reasons mentioned, the interest resulting from the loans made will generally be acceptable for tax purposes in accordance with the aforementioned article 23 of the IRC Code.

However, paragraph m) of section 1 of article 23-A of the IRC Code provides that the following are not deductible for purposes of determining taxable profit: charges for "interest and other forms of remuneration of loans and financing provided by the shareholder to the company, to the extent they exceed the rate set by order of the Government member responsible for the financial area, except in the case where the regime established in article 63 is applicable"

Thus, it is important to analyze the framing of the concrete situation in light of the Arm's Length Principle and Transfer Pricing, provided for in article 63 of the IRC Code, taking into account that these are financing arrangements granted by the sole shareholder B..., S.à.R.L. (B...) to company A....

III.1.3 - LEGAL FRAMEWORK OF THE ARM'S LENGTH PRINCIPLE AND TRANSFER PRICING IN RELATED-PARTY TRANSACTIONS

The Arm's Length Principle, enshrined in national law in section 1 of article 63 of the IRC Code, provides that "in commercial operations, including in particular operations or series of operations concerning goods, rights or services, as well as in financial operations, conducted between a taxpayer and any other entity, whether or not subject to IRC, with which it is in a situation of related-party relations, must be contracted, accepted and practiced terms or conditions substantially identical to those which normally would be contracted, accepted and practiced between independent entities in comparable operations" (emphasis added).

To determine which terms and conditions are normally agreed upon, accepted or practiced between independent entities, section 2 of the same article provides that "the taxpayer must adopt (...) the method or methods capable of ensuring the highest degree of comparability between the operations or series of operations which it conducts and others substantially identical, in normal market situations or absence of related-party relations, 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 taxpayers involved, the functions they perform, the assets used and the allocation of risk."

For this purpose, the taxpayer must select one of the methods set forth in section 3 of article 63 of the IRC Code, which are detailed in Order no. 1446-C/2001 of 21 December, which regulated transfer pricing in operations conducted between a taxpayer and any other entity.

The taxpayer must also, in accordance with section 6 of article 63 of the IRC Code, "maintain organized, in accordance with the terms established for the tax documentation process referred to in article 130, documentation relating to the policy adopted regarding transfer pricing, including guidelines or instructions relating to its application, contracts and other legal acts entered into with entities with which it is in a situation of related-party relations, with any modifications that occur and with information on its compliance, documentation and information relating to those entities and also to the companies and goods or services used as a basis for comparison, functional and financial analyses and sector data, and other information and elements which it took into consideration in determining the terms and conditions normally agreed upon, accepted or practiced between independent entities and in the selection of the method or methods used."

III.1.4 - SUBJECTION OF LOANS PROVIDED (RELATED-PARTY OPERATION) TO TRANSFER PRICING RULES

As already mentioned, for application of transfer pricing rules, it is necessary that the taxpayer conduct operations with an entity with which it is in a situation of related-party relations, and must then ensure that substantially identical terms or conditions are being contracted and practiced as would normally be between independent entities in comparable operations.

It is therefore important to know the legal definition of related-party relations and whether this applies to the case being analyzed, that is, to the loans provided by the holder of capital stock of A... in 2014 and 2015.

Section 4 of article 63 of the IRC Code defines related-party relations as situations in which one entity has the power to exercise, directly or indirectly, a significant influence in the management decisions of the other, which is considered verified, in particular, between:

a) An entity and the holders of its capital stock, or the spouses, parents or descendants thereof, which hold, directly or indirectly, a participation not less than 20% of the capital (or of voting rights); (...)

b) (...)

c) An entity and the members of its corporate bodies, or any administrative, management or supervisory bodies, and their respective spouses, parents and descendants; (…)"

With respect to the above provision, and considering that the capital stock of A... was held entirely by B..., S.A.RL (B...), an entity with registered office in Luxembourg, we can conclude that it is within paragraph a) of section 4 of article 63 of the IRC Code and consequently, in the tax year analyzed, the shareholder had the power to exercise significant influence in the management decisions of the company, with related-party relations existing between the two entities.

For the reasons stated, we conclude that the case in question—the provision of loans by the shareholder to the company—is a related-party transaction, within the terms of section 4 of article 63 of the IRC Code and paragraph b) of section 3 of article 1 of Order no. 1446-C/2001 of 21 December, and is therefore subject to compliance with the Arm's Length Principle, already referenced.

Given the volume of sales in 2014 the taxpayer was exempt from preparing the transfer pricing file, in accordance with the provisions set forth in section 3 of article 13 of the aforementioned Order referred to in section 6 of article 63 of the IRC Code.

However, with respect to the tax year 2015 this exemption no longer applied, and therefore the submission of the transfer pricing file was requested, and it was indicated that this file was still being prepared. After insistence, an indication was given that it was expected to be submitted on 17 October 2017, a fact which did not occur.

Given that we are dealing with a key element for analysis of this subject matter and given non-compliance with what the taxpayer had undertaken, a notice was issued requiring the transfer pricing file to be submitted by 22 December 2017. To date, this notice has not been complied with, and the taxpayer has submitted no document or justification. In exercising its right to be heard the taxpayer came forward to argue that, given the value of annual net sales and other income recorded in the tax year 2014, it is exempt from the obligation to prepare the aforementioned file.

From analysis of the documents supporting the accounting records, it was determined that with respect to the values assumed as expenses for the tax year there is no documentation which demonstrates the interest rate underlying the calculation of such expenses. Nor were the presuppositions inherent in the formula for calculating the 9% interest rate assumed in the financing contracted in the tax years 2014 and 2015 explained.

With respect to financing contracted in the course of the 2014 tax year, in the course of the inspection procedure conducted for this tax year, the taxpayer was questioned about the determination of the contracted interest rate, with a document drafted in English being submitted in response to the request, prepared by D..., designated L..., which is attached to this report (see Appendix 4).

Regarding the aforementioned document, in the course of the inspection procedure OI2015..., the following conclusions were drawn:

• the taxpayer classified the financing operation as a subordinated debt instrument (subordinated bonds are debt securities covered by a subordination clause, i.e., in case of insolvency of the issuing entity, they are reimbursed only after other non-subordinated debt creditors), with a high level of risk;

• as justification for the contracted interest rate, it presented an analysis of interest rates relating to senior debt, speculative investments and subordinated debt instruments. It was further stated that financing obtained from the holder of capital must be remunerated at a rate that should be between that of deeply subordinated debt and cost of equity;

• comparative graphs were further presented relating to loans with high risk levels, with the behavior of markets in Europe and the United States and graphs relating to the behavior of the remuneration of the sovereign debt of Portugal and Germany.

Regarding the document presented and in the course of the inspection procedure above referenced, certain considerations were made:

• Financing from the holder of capital stock of A... was intended to provide the company with financial resources to acquire real estate. Effectively it was verified that the funds obtained were used for this purpose.

• It was verified that real estate was acquired, for the most part, from banking institutions. The transaction value of the acquired real estate does not assume the characteristic of having inherent speculative value, and therefore there are no acquisitions of real estate at values above the market value of the goods (on the contrary in some cases they are below market value).

• It was concluded that the application of the funds obtained has reduced inherent risk both because it is applied to real estate and because this is acquired at lower prices (values below market value).

• For the reasons described above, the Tax Authority did not find plausible the comparison/justification to subordinated debt made by the taxpayer given that it was based on credits which have a high level of risk and with a maturity greater than that which was assumed contractually by B... and A.... The operations presented as comparables by the taxpayer involve neither functions, nor assets nor similar risks.

In the wake of the conclusions presented by the TA in the course of the above-mentioned inspection procedure, the taxpayer, in its response, improved its selection of operations which it considers comparable, notably in refining the comparability criteria (beginning to consider operations with identical maturities and disregarding operations with subordination characteristics) and obtained only 6 operations (with a minimum of 3.43%, a median of 6.50% and a maximum of 12%), all of them relating to entities resident outside Portugal, a fact which strongly affects the ability to consider the operations as comparable to the financing operations of the taxpayer with the holder of its capital stock.

In this context, the idea is further reinforced that in statistical terms, descriptive statistical measures allow synthesizing the data of the population or sample through a single value. Measures of central tendency are indicators which allow one to have an initial idea or summary of how the data of an experiment is distributed, providing information on the value (or values) of the random variable. Statistical inference is the process by which it is possible to draw conclusions about the population using information from a sample, with the central question being how to use the sample data to draw conclusions about the population.

Now, the size of the sample does not determine whether it is of good or poor quality; more important than its size is its representativeness, that is, its degree of similarity to the population under study. Pursuant to the recommendations contained in statistics manuals, it is considered that the minimum size of a sample should contain 30 statistical units.

Thus, in statistical terms, it is not reliable to consider a result of 6 observations to assess a population.

With respect to financing obtained in the course of the 2015 tax year, no other elements were presented during this inspection procedure. Thus, taking into account that this financing contractually establishes conditions identical to those provided for in financing obtained in 2014, in particular with respect to the 9% interest rate and the 4-year maturity, it is accepted that the parties taking part had the same presuppositions in mind that were considered in the financing contracted in 2014, with no new fact influencing the conditions assumed contractually in the financing obtained in the course of the 2015 tax year.

In this regard, relative to the prior presentations by the taxpayer, in particular regarding the operations identified as comparables, the TA concluded that the operations have distinct economic and financial characteristics, and therefore the method is not the most appropriate to provide the best and most reliable estimate of the terms and conditions that would normally be contracted, accepted and practiced in a situation of arm's length, that is, contracted between independent entities.

III.1.5 - SELECTION OF THE MOST APPROPRIATE METHOD FOR DETERMINING TRANSFER PRICE IN ACCORDANCE WITH THE ARM'S LENGTH PRINCIPLE

In accordance with the provisions of section 2 of article 63 of the IRC Code, as well as section 1 of article 4 of Order 1446-C/2001 of 21 December, the taxpayer must adopt, for determining the terms and conditions that would normally be agreed upon, accepted or practiced between independent entities, the most appropriate method for each operation or series of operations.

According to section 2 of article 4 of the aforementioned Order, the most appropriate method for each operation or series of operations is considered to be that which is capable of providing the best and most reliable estimate of the terms and conditions that would normally be contracted, accepted and practiced in an arm's length situation, with the choice to be made for the method most suitable to provide the highest degree of comparability between the related-party operations and other non-related operations and between the entities selected for comparison, which has the best quality and greatest amount of information available for its proper justification and application and which involves the least number of adjustments for purposes of eliminating the differences existing between the facts and comparable situations.

The IRC Code and the aforementioned Order enumerate the methods to be used, in line with the OECD Report guidelines, which are grouped in one of two typologies, namely:

• Traditional Methods or Transaction-Based Methods (Traditional Transactional Methods);
• Profit-Based Methods (Transactional Profit Methods).

The following transaction-based methods are identified in section 3 of article 63 of the IRC Code and section 1 of article 4 of the Order:

• Comparable Uncontrolled Price Method;
• Resale Price Method;
• Cost Plus Method;

and also the following profit-based methods:

• Profit Split Method;
• Net Margin Method.

In accordance with the most recent OECD Guidelines on transfer pricing (see § 2.1 and following of the Guidelines), the selection of one of these methods to assess compliance of a related-party transaction with the Arm's Length Principle is aimed at finding the method most appropriate for each specific case.

In this regard, and considering the provisions of § 2.3 of those Guidelines, transaction-based methods are viewed as the most direct methods of establishing whether the conditions practiced within a related-party operation are at arm's length.

Moreover, provided it is possible to identify comparable operations in the open market, the Comparable Uncontrolled Price Method constitutes the most direct and most reliable means of applying the Arm's Length Principle and should be given preference over all others.

According to section 2 of article 6 of the Order, this method can be used, in particular, under the following conditions:

"a) When the taxpayer or an entity belonging to the same group conducts a transaction of the same nature having as its subject a service or product identical or similar, in quantity or value analogous, and in terms and conditions substantially identical, with an independent entity in the same market or similar markets" (internal comparables);

"b) When an independent entity conducts an operation of the same nature having as its subject a service or a product identical or similar, in quantity or value analogous, and in terms and conditions substantially identical, in the same market or similar markets" (external comparables).

The Comparable Uncontrolled Price Method

The Comparable Uncontrolled Price Method (CUPM) consists of comparing the price paid for goods, rights or services transferred in a related-party transaction with the price paid for goods, rights or services transferred in a comparable non-related transaction.

This method may be used, in particular, when the taxpayer being analyzed or an entity belonging to the same group conducts an operation of the same nature having as its subject an identical service with an independent entity. Provided it is possible to identify comparable operations in the open market, the CUPM constitutes the most direct and most reliable means of applying the arm's length principle. Consequently, in this case this method should be given preference over all others.

In the same manner, section 1 of article 6 of Order no. 1446-C/2001 states that "adoption of the comparable uncontrolled price method requires the highest degree of comparability with impact on both the subject and other terms and conditions of the operation as well as the functional analysis of the entities involved," which means that, if it can be applied, it satisfies the condition provided for in section 2 of article 4 of the same order and is therefore considered the most appropriate method.

The Comparable Uncontrolled Price Method is thus assumed to be the most appropriate method to apply, with its preference over other methods deriving from the fact that it constitutes the most direct way to determine whether the conditions agreed upon between related entities are arm's length conditions.

Thus, provided that, as will be seen, the conditions for application of this method are met with respect to the financial operation being analyzed, the choice of this method over others is completely justified.

Rejection of the Resale Price Method

The Resale Price Method is based on the resale price practiced by the taxpayer in a comparable transaction conducted with an independent entity, involving a product acquired from an entity with which it is in a situation of related-party relations, from which is subtracted the gross profit margin practiced by a third entity in a comparable transaction (See article 7 of the Order).

This method is especially recommended for distribution activities (See paragraphs 2.14 to 2.31 of the 1995 OECD Report). Thus, given that the operations being analyzed are not classified as distribution activities, we reject the use of this method.

Rejection of the Cost Plus Method

The Cost Plus Method is based on the amount of costs borne by a supplier of a product or service supplied in a related-party transaction, to which is added the gross profit margin practiced in a comparable non-related transaction (see article 8 of the Order).

Use of this method is recommended by the OECD essentially in the case of sales of semi-finished products among associated companies, in the framework of agreements entered into among associated companies with a view to sharing equipment use or long-term supply, or when the related-party operation consists of the provision of services (see paragraph 2.32 of the 1995 OECD Report). Thus, given the transaction in dispute, we reject the use of this method.

Rejection of Non-Traditional Methods

The commonly so-called non-traditional methods (profit split method and net margin method) are only susceptible of use when the traditional methods (comparable uncontrolled price method, resale price method and cost plus method) cannot be applied (see paragraph b) in fine of section 1 of article 4 of the Order).

Given everything stated, the comparable uncontrolled price method proves to be the most appropriate in accordance with the provision of section 2 of article 4 of the Order, and will therefore be used in the search for conditions that would be practiced between independent entities in operations similar to those now being analyzed.

III.1.6 – DETERMINATION OF VALUE THAT WOULD BE PRACTICED BETWEEN INDEPENDENT ENTITIES

Search for a Comparable Operation

The application of the Comparable Uncontrolled Price Method is achieved through comparison of the terms and conditions occurring in these related-party transactions (interest on loans obtained) with those that would be set, contracted and practiced by independent entities in comparable transactions.

According to section 3 of article 4 of Order no. 1446-C/2001, two operations meet the conditions to be considered comparable if they are substantially identical, which means that their relevant economic and financial characteristics are analogous or sufficiently similar, in such a manner that the differences existing among the operations or among the entities involved in them are not susceptible to significantly affecting the terms and conditions that would be practiced in a normal market situation or, if they are, it is possible to make the necessary adjustments which eliminate the effects relevant to the differences identified.

That is, the degree of comparability between a related-party transaction and a non-related transaction should be evaluated taking into account the factors defined in article 5 of the Order.

So the conditions which ensure the arm's length principle defined in section 1 of article 63 of the IRC Code are embodied in the consideration of an interest rate applicable to loans obtained from related entities in conditions resulting from market prices for comparable operations, taking into account the use of the comparable market price method.

Internal Comparable

The A... with respect to financing contracted during the tax year 2014 did not have in its accounting any expense from interest relating to external financing, so there are not, internally, comparable operations with the financing obtained from related entities.

With respect to the tax year 2015, it was verified that company A... obtained financing from I..., with a maturity of 3 years and bearing interest at the 3-month Euribor rate plus a margin of 3.5%, and at the date of the contracts the aforementioned Euribor rate was 0.005% and -0.054%, which respectively yields interest rates of 3.505% and 3.446%.

It is therefore concluded that with respect to financing contracted in 2014 it is not possible, at the level of the company's internal operations, to obtain a comparable. With respect to those obtained in 2015, the financing obtained from I... can be used as a comparable at the level of the company's own operations.

External Comparable

One of the most usual sources of information in the selection of external comparable operations is databases. With respect to financial operations, the databases provided by the Bank of Portugal are recognized as among the most representative, given the broad coverage of data, reliability and independence, and are therefore usually used in the analysis of external comparables.

Where there is doubt as to the comparability of the operations/entities, there will be greater propensity for adjustments to take as reference central tendency indicators. Statistically, measures of central tendency are indicators which allow one to have an initial idea or summary of how the data of an experience is distributed.

Now, for the case at hand, the following analyses were conducted:

Tax Year 2014

• the interest rates disclosed monthly by the European Central Bank (ECB)—MFI Interest Rates—evidence that in annual terms the rate of 4.5% is not exceeded (see Appendix 5);

• the statistical information disclosed by the Bank of Portugal reveals that the annualized agreed rate (AAR) in the course of the tax year 2014 for financing with the characteristics of the taxpayer's financing is generally in the range between 3% and 5%, with the AAR reported to December 2014 for operations above 1 million euros being 3.48% (see Appendix 6);

• the statistical note relating to interest rates for 2014 disclosed by the Bank of Portugal notes that the reduction in interest rates was more marked in new loans granted to non-financial companies, whose average rate was fixed at December 2014 at 4.09 percent, less 99 basis points (b.p.) than in the comparable period (see Appendix 7).

From the foregoing, it can be extracted that the financing contracted by the taxpayer in the tax year 2014 is being remunerated at rates higher than those contained in the statistical information described above.

Tax Year 2015

• with respect to financing of amounts above 1 million euros to companies, the interest rates disclosed monthly by the European Central Bank (ECB)—MFI Interest Rates—evidence that in annual terms the rate of 3.56% is not exceeded (see Appendix 8);

• the statistical information disclosed by the Bank of Portugal reveals that the annualized agreed rate (AAR) in the course of the tax year 2015 for financing with the characteristics of the taxpayer's financing, in the months of March and May is, respectively, 4.49% and 3.22%. The AAR reported to December 2015 for operations above 1 million euros was 2.39% (see Appendix 9);

• the statistical note relating to interest rates for 2015 disclosed by the Bank of Portugal notes that the reduction in interest rates was more marked in new loans granted to non-financial companies, whose average rate was fixed at December 2015 at 2.98 percent, less 111 basis points (b.p.) than in the comparable period, a value which represents a historical minimum (see Appendix 10).

Now it is understood that by comparable or similar loan will be necessary to consider factors such as the amount and duration of the loan, its nature or objective, the currency in which it is specified, and the financial situation of the borrower.

In fact, and according to the words of Maria dos Prazeres Lousa, "in order to classify certain transactions as comparable we will need to consider various factors... the functions exercised by the parties, both at the level of structure and at the level of group organization, in order to compare the activities and significant responsibilities at the economic level that are exercised by associated enterprises and independent enterprises...".

Thus, although the comparable uncontrolled price method is considered the most reliable and direct method when there is sufficient information in the market regarding comparable operations, difficulties may arise in its practical application when associated companies conduct operations which they do not conduct with independent companies.

Now it is incumbent upon the taxpayer to prove that the operations which it conducted with related entities comply with the rule of section 1 of article 63 of the IRC Code, that is, it is incumbent upon the taxpayer to gather proof which allows it to demonstrate that the terms and conditions established in the transaction are governed by the arm's length principle, being entirely identical to those which would exist in a context of absence of related-party relations. Application of the arm's length principle is, however, of difficult practical implementation because it presupposes verification of a set of presuppositions from the start, such as the market structure competition and business area of the entities taken as comparables.

The comparability of the sample is only relevant if the economic characteristics of the situations in question are sufficiently similar (in particular with respect to operational activity, characteristics of the goods transacted, size of the entities).

In this context, reference is made to the OECD Guidelines on transfer pricing (viewed as an important technical-doctrinal element when transfer prices are analyzed), in particular the following paragraphs:

§ 3.56 - Establishes that whenever it is possible to conclude that an operation taken as comparable presents a lower degree of comparability than the remaining ones, it should be excluded. A recommendation to be taken into consideration with respect to the weaknesses evidenced in the studies presented by the taxpayer regarding the 2014 tax year previously reported.

The operations presented by the taxpayer with elevated rates, with reference to the 2014 tax year, relate to companies with activity in the financial sector (sector which in the years analyzed was under strong pressure).

§ 3.57 - The interpretation of this paragraph allows one to state that whenever the comparability study presents limitations, the use of statistical measures, limiting the range of the interval, may foster the reliability of the analysis.

§ 3.62 - States that when some defects in sample comparability persist, measures of central tendency such as median, mean or weighted average should be used in order to minimize the risks of error caused by comparability defects.

That is, some of the observations presented by the taxpayer (in the course of the inspection procedure conducted under OI2015...) present interest rates which are outliers and are therefore inconsistent. Statistically, the existence of outliers typically implies harm in the interpretation of the results of statistical tests applied to samples (including § 3.63 of the OECD Guidelines states that extreme results may affect the financial indicators being analyzed).

In these terms, considering that with respect to financing assumed by the taxpayer in 2014 the interval with the operations which the taxpayer considers as comparables is not corroborated by the TA given that the situations identified have characteristics which strongly influence the comparability of the operations. That is, in a first approach to frame the interest rate assumed, the taxpayer presented a range of rates which emerges from subordinated debt operations, consequently operations with elevated risk and absence of guarantee, and from entities with distinct business areas (particularly financing granted to companies in the financial area which in these years were strongly pressured by the crisis in the banking system). In a later phase, and in its response, although the taxpayer improved its selection of operations which it considers as comparables, it determines a sample of only 6 observations, which although the entities are engaged in investment activities (real estate, claim portfolios and other types of investment in general) are all located outside Portugal, a fact which affects comparability by having implicit a distinct reality from the Portuguese financial reality.

With respect to financing obtained in the tax year 2015, although no clarification was provided by the taxpayer to demonstrate that intra-group financing operations comply with the Arm's Length Principle, it is noted that there is a potential internal comparable (the financing operations which company A... obtained from I... in which it is assumed that the capital bears interest at the 3-month Euribor rate plus a margin of 3.5%, in which at the date of execution of the financing contracts the interest rates assumed respectively 3.505% and 3.446%) which may constitute an effective comparison standard provided that the necessary adjustments are introduced to eliminate the differences detected, although these are not as flagrant as it might appear since the term of 3 versus 4 years is practically negligible and, the financing obtained from I... being mortgage credit and the financing obtained from the parent company intended for acquisition of real estate portfolio, that is, both financing operations have implicit the acquisition of real estate.

In the face of difficulties in finding comparable operations and, given that the operations identified by the taxpayer present weaknesses that affect comparability with the financing operations obtained from the holder of its capital stock, the TA resorted to OECD recommendations, using statistical measures.

In these terms, in accordance with what was previously stated, the TA analyzed various statistical disclosures relating to interest rates on financing and determined the following conclusions:

Although the statistical references presented may be used as potential comparables, they may still present some limitations in comparability and consequently in the calculation of the adjustments to be made. However, they clearly evidence the gap between the financial reality existing in the market and the rates (all financing assumed contractually the rate of 9%) which were assumed in the intra-group financing.

For this reason and considering the guidelines emanated by the OECD Guidelines on Transfer Pricing, the TA services consider that for the situation at hand, the use of the average annual interest rate disclosed by the Bank of Portugal as a reference is, given the impossibility of obtaining exactly comparable operations, the most measured, given that it takes into account the characteristics of the Portuguese financial market, the amounts and the months in which the financing was assumed, and in light of all the statistical information available at the level of interest rates on financing, is that which presents a less onerous situation for the taxpayer.

Then, not being presented comparable operations by the taxpayer, the decision was made to use as a source the data from the entity Bank of Portugal, compiled by PORDATA, obtaining as the annual average of the interest rate on loan operations to companies during the tax years 2014 and 2015 the percentage of 4.89% and 3.77% respectively (see Appendix 11), as it is considered that it does not contradict all the statistical information provided by the ECB, takes into account the characteristics of the Portuguese financial market and are those which present a higher value. It is further noted that these annual averages relate to financing to non-financial, Portuguese and foreign companies resident in the Euro area. The values are calculated from a representative sample of monetary financial institutions resident in Portugal (excluding the Bank of Portugal and money market funds) weighted by the respective associated amounts.

In fact, from analysis conducted of all statistical information relating to the tax years 2014 and 2015 provided by official entities where rates are reflected which result from averages practiced in the market, the decision was made for purposes hereof to use that rate which presented a higher value, being therefore the most favorable to the taxpayer.

Given everything already stated, we conclude that the external comparables used by the taxpayer to justify the compliance of the related-party transaction with the Arm's Length Principle do not meet the requirements imposed by Order no. 1446-C/2001 of 21/12 and therefore do not provide the highest degree of comparability between the related-party operation and other non-related operations, and consequently do not satisfy the Arm's Length Principle.

It was therefore concluded that the interest rate assumed contractually by the taxpayer manifests a form of remuneration for the holder of its capital stock, as it exceeds the remuneration rates of financing used by monetary financial institutions.

Considering all the grounds adduced in the prior points, if the operations contracted between A... and B... had been entered into between independent entities, terms similar to those defined in the financial market would have been contracted, accepted and practiced, and A... would have borne a lower financing rate. Thus its taxable profit is under-quantified as a result of the recording of financial charges in excess of those which would be required under arm's length conditions, with a violation of the Arm's Length Principle enshrined in section 1 of article 63 of the IRC Code being thus verified.

III.1.6 - IMPACT OF THE VIOLATION OF THE ARM'S LENGTH PRINCIPLE ON THE DETERMINATION OF TAXABLE RESULT

Given what is stated, calculation of the impact of the violation of the Arm's Length Principle on the determination of taxable profit of A... must be conducted, considering that such transactions, in arm's length conditions and in compliance with the provision of section 1 of article 63 of the IRC Code, should involve terms analogous to those which would be defined between independent entities in comparable transactions, using for the purpose a rate of remuneration similar to the market rates indicated above.

It is not the TA's intention to disregard the transactions which the parties decided to conduct nor to interfere with the management decisions of the companies involved but merely to frame the transactions conducted in order to assess compliance with the arm's length principle defined in section 1 of article 63 of the IRC Code, with a correction being due to the taxable result (financial expenses) in accordance with section 8 of article 63 of the IRC Code and section 1 of article 3 of Order no. 1446-C/2001 in order that it not be different from what would be determined in the absence of related-party relations.

In this manner, given that the interest rates applied by the taxpayer for remuneration of the loans mentioned above at point III.1.1 of this report diverge from market rates for the purpose. The TA considered, taking into account existing guidelines for analysis of this subject matter, as a reference the average interest rates on financing practiced in Portugal in the tax years 2014 and 2015.

Accordingly, the interest rate of 4.89% is considered as a reference for financing in 2014 and the rate of 3.77% as a reference for financing in 2015, both financing granted by the holder of the entire capital stock of the taxpayer.

Given what is described, adjustment to the taxable result is proposed, in accordance with paragraph d) of section 3 of article 77 of the General Tax Law, resulting from expenses which are not accepted as tax costs, that is, charges (interest) corresponding to the excess in the interest rate considered in the loans obtained from the holder of the entire capital stock of the taxpayer.

In the following table the interest calculated as a reference by the TA is calculated, whose tax deductibility is admitted:

In sum from what is stated, we have:

Interest relating to intra-group financing, recorded by the taxpayer as expenses for the tax year | € 5,672,032.39
Interest considered by the TA with respect to the financing in analysis, taking into account the average interest rates practiced in the years in which the financing was contractually assumed | € 3,454,711.53
Difference | € 2,217,320.86

In these terms, considering the provision of article 3 of Order no. 1446-C/2001 of 21 December, which states that "whenever the terms and conditions of a related-party transaction in which a taxpayer and a non-resident entity are involved differ from those which would normally be agreed, accepted or practiced between independent entities, the former must effect in the periodic income statement referred to in article 112 of the IRC Code, a positive correction corresponding to the fiscal effects imputable to that deviation, in order that the taxable profit not be different from what would be determined in the absence of related-party relations," in section 1 of article 63 of the IRC Code and in paragraph d) of section 3 of article 77 of the General Tax Law, the