CAAD Decision 410/2014-T: IRS Withholding Tax (Retenção na Fonte)

Process: 410/2014-T

Date: November 12, 2014

Tax Type: IRS

Summary

In Process 410/2014-T, SGPS company A challenged IRS withholding tax assessments totaling €182,318.07 covering tax years 2009-2012, plus compensatory interest. The dispute arose from a Portuguese Tax Authority inspection that examined share acquisition transactions between the company and its majority shareholder Dr. C, who held 99.99% ownership and served as chairman of the board. The Tax Authority determined that special relationships existed under Article 63 of the Corporate Income Tax Code (CIRC), triggering transfer pricing analysis requirements. The inspection focused on transactions involving shares in companies H, SA and I, SGPS, arguing that related-party transactions must comply with arm's length principles—meaning terms and conditions substantially identical to those contracted between independent entities in comparable operations. The company initiated arbitration proceedings before the Administrative Arbitration Center (CAAD) in June 2014, challenging the legality of the withholding tax liquidations. A collective arbitral tribunal was constituted in August 2014 with three appointed arbitrators. The proceedings followed written pleadings format after dispensing with oral hearings. The case illustrates important principles regarding IRS withholding obligations on transactions between related parties, the application of transfer pricing rules to SGPS holding companies, and the proper methodology for determining whether special relationships warrant tax adjustments. Companies subject to similar withholding tax assessments based on related-party transactions can utilize CAAD arbitration as an alternative dispute resolution mechanism, with expedited timelines compared to traditional tax court proceedings. The case demonstrates how Portuguese tax authorities scrutinize Form 13 filings and apply special relationship provisions to challenge transaction valuations.

Full Decision

ARBITRAL DECISION

The arbitrators Dr. Jorge Lopes de Sousa (arbitrator-chairman), Dr. Henrique Curado and Prof. Doctor António Martins, appointed by the Deontological Council of the Administrative Arbitration Center to constitute the Arbitral Court, constituted on 07-08-2014, agree on the following:

1. Report

SGPS, S.A. (hereinafter "A"), a company with registered office in... Amadora, with the unique number of registration and collective person in the Commercial Registry Office of Lisbon..., came, pursuant to the provisions of articles 2nd, no. 1, letter a), 5th, no. 3, letter a), 6th, no. 2, letter a), 10th, no. 1, letter a) and no. 2, all of Decree-Law no. 10/2011, of 20 January, to request the CONSTITUTION OF A COLLECTIVE ARBITRAL COURT with a view to the declaration of illegality of the assessments of withholdings at source of Personal Income Tax (IRS) and of compensatory interest

– no. 2013..., dated 2-01-2014, in the total amount of € 55,275.94, relating to the year 2009;

– no. 2014..., dated 10-01-2014, in the total amount of €.52,361.55, relating to the year 2010;

– no. 2014..., dated 10-01-2014, in the total amount of €.45,792.74, relating to the year 2011;

– no. 2014..., dated 10-01-2014, in the total amount of €.28,887.84, relating to the year 2012.

The request for constitution of the arbitral court was accepted by the President of CAAD on 03-06-2014 and notified to the Tax Authority and Customs Authority on 04-06-2014.

Pursuant to the provisions of letter a) of no. 2 of article 6th and of letter b) of no. 1 of article 11th of the RJAT, the Deontological Council appointed as arbitrators of the collective arbitral court the signatories, who communicated acceptance of the assignment within the applicable timeframe.

On 21-07-2014 the Parties were duly notified of this appointment, having not manifested intent to refuse the appointment of the arbitrators, in accordance with the combined provisions of article 11th no. 1, letters a) and b) of the RJAT and articles 6th and 7th of the Deontological Code.

In conformity with what is provided in letter c) of no. 1 of article 11th of the RJAT, the collective arbitral court was constituted on 07-08-2014.

By order of 01-10-2014 the meeting provided for in article 18th of the RJAT was dispensed with and it was determined that the proceedings should proceed with written pleadings.

The Parties submitted written pleadings.

The Arbitral Court was duly constituted and is competent.

The parties enjoy legal personality and capacity and are legitimate (arts. 4th and 10th, no. 2, of the same diploma and art. 1st of Regulation no. 112-A/2011, of 22 March).

The proceedings are not affected by nullities and there is no obstacle to the appraisal of the merits of the case.

2. Factual Matters

2.1. Established Facts

The following facts are considered established:

a) In compliance with the internal order DI... of 06-06-2013 for the years 2008 and 2009 and the service orders OI..., OI..., OI... and OI..., by order of 30-08-2013, an external tax inspection was determined for the periods 2009, 2010, 2011 and 2012, of the Applicant;

b) The said Service Orders were opened with the activity code..., for an external analysis of partial scope, relating to withholdings at source of IRS that fall on the years 2009, 2010, 2011 and 2012, following an analysis of Form 13 – "Securities, Autonomous Warrants and Derivative Financial Instruments".

c) The Applicant has as its corporate purpose the management of shareholdings, corresponding to CAE..., consisting of the management of shareholdings in other companies, as an indirect way of exercising economic activity, being the parent company of Group B;

d) In the Commercial Registry Office it appeared that administration was exercised by the following persons;

[Names redacted]

e) The Tax Inspection concluded that the aforementioned Chairman of the Board of Directors C was the de facto administrator of the company, basing itself on the following facts;

– in 2009 a financial leasing contract was entered into, which was signed by the aforementioned administrator;

– on 16-05-2008 the minutes no. 6 of the Board of Directors was signed by the same person;

– in 2013 an authorization for bank account debit was signed by the same person;

– in Forms 22 and annual declarations – IES for the years 2009 to 2012, the aforementioned administrator appears as legal representative;

f) It is referred to in the Tax Inspection Report, whose content is hereby reproduced, the following, among other things:

111.4. Description of the facts and diligences performed

111.4.1. Characterization of the transaction

Following an analysis of Form 13 – 'Securities, Autonomous Warrants and Derivative Financial Instruments", presented periodically by Banks, it was found that A proceeded to the acquisition of the following shares (Annex 3):

[Details redacted]

From the analysis of the models 13 it appears that the aforementioned acquisition of shares in H, SA, was carried out to Dr. C, shareholder of the company under analysis, where he holds a shareholding of 99.99% and performs administrative functions.

Regarding the acquisition of shares in I, SGPS no information was available concerning the seller and the actual value of the transaction.

III.4.2. Existence of special relationships

Given what was previously mentioned, it is verified that between the seller – Dr. C, and the purchasing company A there are special relationships, as defined in art. 63° (formerly 58th) of the Code of Personal Income Tax (CIRC).

Indeed, no. 4 of that regulation establishes that "It is considered that there are special relationships between two entities in situations where one has the power to exercise, directly or indirectly, a significant influence in the management decisions of the other, – ", with letters a) and c) specifying the following:

• letter a) "An entity and the holders of the respective capital, or spouses, ascendants or descendants of these, who hold, directly or indirectly, a shareholding of not less than 10% of the capital or voting rights";

• letter c) "An entity and the members of its governing bodies, or any bodies of administration, management or direction, and their ascendants and descendants" -

It happening that, tax legislation disregards in operations between related entities, any possible effects arising from relationships of influence and/or proximity of the participating parties.

Indeed, no. 1 of the aforementioned art. 63rd of the CIRC (former art. 58°), determines that "In commercial operations, including in particular operations or series of operations on goods, rights or services, as well as in financial operations, carried out between a taxpayer and any other entity, whether or not subject to IRC, with which it is in a situation of special relationships, terms or conditions substantially identical to those which would normally be contracted, accepted and practiced between independent entities in comparable operations must be contracted, accepted and practiced."

To this end the taxpayer must adopt "... the method or methods capable of ensuring the highest degree of comparability between the operations or series of operations that it carries out and other substantially identical ones, in normal market situations or in the absence of special relationships, as per no. 2 of art. 63rd of the CIRC (former art. 58th).

For its part, Regulation no. 1446-C/2001, of 21/12, applicable to the matter in question by reference to no. 13 of art. 63rd of the CIRC, came to specify its most relevant aspects, giving practical applicability, certainty and legal security to the aforementioned rules.

In summary, the Tax Administration has legitimacy to question the aspects relating to the operations under consideration, both as to their nature and as to their value.

(...)

III.4.4. Analysis of the elements presented and collected

From the analysis carried out on the elements presented by the Taxpayer, by Dr. C, as well as of the entities circularized, we found the following situations:

Regarding point 1. (sub-letters 1 A) to 1. H) of the notice served on A, the following is referred to:

Board of Directors Minutes

In a Board of Directors meeting of 2008/05/06, where Administrators Mr. Dr. C, Mr. J and Mr. Dr. E were present, it was deliberated "... regarding the purchase, by the company, of shares in I, SGPS, SA, and H, SGPS, SA." The acquisition of 420,000 shares of I, SGPS, SA was deliberated, taxpayer no. ... at the unit price of € 2.55, totaling € 1,071,000.00 as well as the acquisition of 945,046 shares of H, SGPS, SA, taxpayer no. ..., at the unit price of € 2.58, totaling € 2,438,218.68 (Annex 9).

It is noteworthy that under art. 397th of the Commercial Companies Code (CSC), the Chairman of the Board of Directors Dr. C, (seller of the shares) was prevented from voting, therefore abstained from voting.

Share Purchase and Sale Agreement

As confirmed by the company's officers, no agreement was entered into between the company and the seller of the shares (Annex 10).

Report and Opinion (interim) of the Sole Auditor

In order to comply with the legal provisions established in no. 2 of art. 397th of the Commercial Companies Code (CSC), on 20 May 2008, the Statutory Auditor Dr. L issued a Report and Opinion of the Sole Auditor regarding the acquisition by company A, from shareholder and administrator C, of the shareholdings held by him in H, SGPS, SA and I, SGPS (Annex 11).

The Statutory Auditor's opinion characterizes the transaction, using two declarations issued by Bank M, dated 30 January 2008, wherein it is declared that the average value of transactions in titles of I, SGPS, SA carried out in 2007 amounted to 2.55 € per title transacted; while the average value of transactions in titles of H, SGPS, SA, carried out in 2007, amounted to 2.58 € per title transacted. In the report and opinion of the Sole Auditor it is further stated that these were the "... values that served as the basis for setting the price of the transaction under consideration"

Failure to submit Form 4

In the context of accessory obligations, art. 138th of the CIRS, establishes that sellers and purchasers of shares and other securities are obliged to submit a declaration in official form –Form 4, within 30 days following the completion of operations on securities. However, this requirement was not met, either by the seller or by company A.

Accounting record of the acquisition of the shares

From the analysis carried out on the accounting records of the company, it was verified that in the year 2008 a financial investment of € 3,509,218.68 was recorded, relating to 945,046 shares of H, SGPS, SA (€ 2,438,218.88), and 420,000 shares of I, SGPS, SA, (€ 1,071,000.00) which were reflected in the accounting in account 41131 – financial investments as the counterpart of account 2559 shareholders – C, as follows discriminated (Annex 12):

Debit 41131 – financial investments – capital shares - other companies €2,438,218.68
Debit 41131 – Financial investments – capital shares – other companies € 1,071,000.00

Credit 2559 – shareholders – other operations – C € 3,509,218.68 acquisition of shares (document no. 23, journal 6 July 2008)

Payments made by A to the shareholder and administrator

From the analysis carried out on the accounting records and bank transfers made by company A to Dr. C, it was verified that since 2008 the following payments were made on account of this transaction:

[Details of payments listed]

Transfer of the Shares

According to the elements presented by the taxpayer, it is verified that the agreement for the purchase and sale of shares was made in May 2008, and it was at that date that the seller of the shares communicated his intention to sell and requested the order for transfer of titles to I, SGPS, SA and H, SGPS, SA (Annex 14). However, all the statutory formalities for its effective transfer were only met in October 2008, for the shares of I, SGPS, SA, and April 2009 for the shares of H, SGPS, SA, dates appearing in Form 13 as referred to in point III.4.1.

Justification and supporting documents that justify the agreed values and proof of application or compliance with the Arm's Length Principle

As we were informed by the company's officers "... the purchase price of the shares was calculated based on the average value of transactions carried out in 2007, according to the declaration of 30/1/2008 issued by Bank M....". Attached are two declarations issued on 30 January 2008 by Bank M referring to the following (Annex 15):

"It is declared, for the due purposes, that the average value of transactions of titles of H, SGPS, SA, carried out in 2007, amounted to 2.58 Euros per title transacted"; (Annex 15);

"It is declared, for the due purposes, that the average value of transactions of titles of Company I, SGPS, SA, carried out in 2007, amounted to 2.55 Euros per title transacted" (Annex 15);

However, no other supporting document to the declared values was presented.

Given this situation, Bank M itself (currently Bank F) was circularized and despite having been requested "... all documents/elements issued by your entity in the context of these transactions" we were presented with the supporting documents for the preparation of Form 13 and exchange of correspondence between the holder of the shares, A, Bank M and the issuing companies, in order to proceed with the transfer of ownership of the shares.

However, we were not shown any documents that prove the average selling price of the shares. Highlighting the fact that, in the elements presented by Bank itself and those included in Form 13 (Annex 3), the actual purchase price of the shares of I, SGPS does not appear. Only the total value of € 420,000.00 appeared, corresponding to the nominal value of each share, when the selling price amounted to € 1,071,000.00.

It is thus verified that Bank M does not always have knowledge of the actual selling prices of the shares, it is only the depositary entity of the shares and is the entity that presents Form 13.

We thus conclude that the supporting documents for the determination of such average selling prices were not presented, either by the company, or by Bank M itself, nor by the Statutory Auditor (which based itself on the declarations of Bank M for the issuance of its opinion on the purchase of shares - Annex 11 and 15), which are of difficult proof, as we can see:

– In Form 13 the actual selling values of all share transactions of the issuing entities in question do not always appear. We have as an example the value appearing in Form 13 of the transaction of shares of I, as mentioned above (Annex 3),

– These are not stock exchange listed companies,

– In order to comply with the right of preemption in share transfers, provided for in the bylaws of the issuing companies, the communications made by shareholders are only proposals for sale of shares, they do not prove that the transactions were completed and at the prices stated therein.

Thus, it was not proven what the average price of transactions of the titles of the said companies was, so that they could be used as the average comparable market price, method used by the taxpayer to prove the application of the arm's length principle.

It should be noted that it was still during the course of 2008 that the suspicion generated by the news that came public, involving companies of group N, their governing bodies, suspicions of unlawfulness, and the loss of its largest asset, Bank M, nationalized under Law no. 62nd-A /2008, of 11 November, contributed to the negative results shown in the period of 2008 and consequently made it difficult for investors to attempt to recover applications made in some companies of group N.

It should further be added that as early as February 2008, Mr. O requested his resignation from the presidency of Bank M and in May various complaints of harmful management came to light.

In view of the facts set out, we are obliged to conclude that the arm's length principle was not followed in the share purchase operations by A from its administrator and shareholder, Dr. C, with whom there are special relationships, as established in art. 63rd of the CIRC.

Terms or conditions substantially identical to those that would normally be contracted, accepted and practiced between independent entities were not contracted, accepted and practiced.

The conditions under which the operations for the purchase of the aforementioned shares took place, accomplished by the company to Dr. C, specifically the price of € 2.55 and 2.58 per share, is only justifiable by virtue of the special relationships existing between the parties.

Thus, it is concluded that the operation of purchase of the shares representative of the capital of H and I, by A from its Administrator, was structured so as to obtain clear advantages for the latter so as to be compensated for a value that it would not be able to obtain if it sold them to an independent entity.

It should be noted that the value of the alienation of shares held in H by Dr. C, was at the time excluded from taxation, under no. 2 of art. 10th of the Code of Personal Income Tax (CIRS), for IRS purposes, because they were held for more than 12 months. Thus, the overvaluation of the price per share, in the sphere of the seller, would not have impact for taxation purposes for IRS but only on the value of the financial investment recorded in the purchasing company and on the price to be paid for each share to the seller, in this case administrator and shareholder of the purchasing company. That is, realized between related entities and that directly or indirectly may influence the realization of the transaction.

Determination of the value of the shares

The sale of shares between related entities must respect the terms and conditions that would be established between entities in the absence of those special relationships, between independent entities in comparable operations, applying to this effect the transfer pricing regime, provided for in art. 63th of the CIRC and Regulation no. 1446-C/2001, of 21 December.

Pursuant to no. 3 of art. 63rd of the said regulation the following methods are established.

• letter a) – of the comparable market price; of the reduced resale price or the cost plus method;

• letter b) – the profit split method, the net profit margin method or another, when the methods referred to in the previous point cannot be applied or, where they can be, do not allow obtaining the most reliable measure of the terms and conditions that independent entities would normally agree, accept or practice.

Given that the company was not listed on the stock exchange and that no actual sales prices by other independent entities are known, it would not be possible to apply letter a) of the aforementioned regulation.

As mentioned above, the taxpayer presented two declarations issued by Bank M. However, these are only declarations, the taxpayer did not prove the determination of the actual value of purchases and sales. And on the other hand it was not within the knowledge of the taxpayer and of Bank M itself the actual prices of all purchases and sales of shares of the entities in question.

As referred to in the previous point, the value of the alienation of shares held in H, in I by Dr. C, was excluded from taxation, under no. 2 of art. 10th of the Code of Personal Income Tax (CIRS), for IRS purposes, because they were held for more than 12 months.

Thus, the overvaluation of the price per share, in the sphere of the seller, would not have impact for taxation purposes for IRS but only on the value of the financial investment recorded in the purchasing company and on the price to be paid for each share to the seller, in this case administrator and shareholder of the purchasing company. That is, realized between related entities and that directly or indirectly may influence the realization of the transaction.

Not being possible the application of letter a) of no. 3 of art. 63rd of the CIRC, the Tax Administration must resort to other methods for the determination of the arm's length price, namely the method provided for in art. 15th of the Stamp Tax Code (CIS), the one approached by letter b) of no. 2 of art. 52nd of the CIRS (the value determined based on the last balance), among others, which fit within the discipline of art. 4th of Regulation no. 1446-C/2001, of 21/12, as follows discriminated:

Given that the purchase price was established between the seller and buyer in May 2008, the last available accounts were those reported as of 2007/12/31. Thus, based on the last approved consolidated accounts of H, SGPS, as of 2007/12/31 (Annex 16), it is verified that, taking into account the total of equity capital and the total number of shares of H, the value of these would only amount to € 1.178896352 each, substantially lower than the purchase value of the company € 2.58, determined as follows:

Balance Sheet of H, SA as of 2007/12/31 (Annex 16)

shareholding – acquisition of shares
no. of shares 945,046
cost per share €2.58
value of the cost of the shareholding € 2,438,218.68
investee – H, SA
no. of shares 470,825,000
nominal value of each share € 1.00
total equity capital € 555,172,000
value of each share € 1.178896852 (€ 555,172,000.00 /470,925,000 = 1.178896052)
value of the shareholding based on the accounts as of 2007/12/31
no. of shares 945,046
value of each share €1.178696652
value of the shareholding € 1,114,111.75 (845,046x1.178896852)
impairment value € 1,324,106.93 (€ 2,438,218.68 – € 1,114,111.75)

Given that the price was agreed between the seller and buyer in May 2008, the last available accounts were those reported as of 2007/12/31. Thus, based on the last approved accounts of I, SGPS, as of 2007/12/31 (Annex 17), it is verified that, taking into account the total of equity capital and the total number of shares of I, SGPS, the value of these would only amount to € 1.163177891 each, substantially lower than the purchase value of the company € 2.55, determined as follows:

Balance Sheet of I, SGPS as of 2007/12/31 (Annex 17)

shareholding – acquisition of shares
no. of shares 420,000
cost per share € 2.55
value of the cost of the shareholding € 1,071,000.00
investee – I, SGPS, SA
no. of shares 172,200,000
nominal value of each share € 1.00
total equity capital € 200,299,232.85
value of each share € 1.163177891 (€200,299,232.85 /172,200,000 = 1.163177891)
value of the shareholding based on the accounts as of 2007/12/31
no. of shares 420,000
Value of each share €1.163177891
value of the shareholding €488,534.71 (420,000x1.163177891)
impairment value € 582,465.29 (€ 1,071,000.00 – € 488,534.71)

The determination of this value also aligns with what is established in letter b) of no. 2 of art. 52nd of the CIRS, determined based on the last balance of H and I.

Although the accounting record of the financial investment was made at acquisition cost, when the accounts were closed as of 2008/12/31, the Statutory Auditor included the following reserve in the CLC "...The company acquired, in the year 2008, about 945,000 shares of H, SGPS, SA and 420,000 shares of I, SGPS, SA for the total amount of 3.5 million euros (average cost of about 2.57 euros). Given the current financial and patrimonial situation of these companies, a provision should be recorded for adjustments relating to these investments."

Thus, and in accordance with the rules of the POC and DC – Accounting Directive no. 9, financial investments resulting from the acquisition of shareholdings, in particular the acquisition of shares, establishes the equity method as a method of accounting for investments that is characterized by, at all times the account 41 – Financial investments, reflecting the real situation of equity capital of the investee. That is, with the equity method the account 41 - financial investments, is adjusted by the percentage variations occurring in the equity of the investee. Negative variations imply a decrease in the account 41 – financial investments. A positive variation implies an increase in the same account. The objective of this method is to ensure that the acquisition cost recorded in the account 41 – financial investments, is adjusted for variations occurring in the equity capital of the investee, motivated by results obtained.

Based on the financial statements of the companies H, SGPS, SA and I, SGPS, SA available at the date of acquisition, that is 2007/12/31, the value of the shares would be substantially lower than the value at which the acquisition was made, as verified in the calculations presented above.

Conclusion:

Given what was previously mentioned, the following is concluded:

the agreement for purchase and sale of shares in H and I was entered into on 2008/05/06;

the purchase price of the shares was defined based on two declarations from Bank M, in which it is declared that the average value of transactions of titles of the companies, carried out in 2007 amounted to € 2.58 and 2.55. However, no supporting documents for the determination of those average values were exhibited;

circularized Bank M, it did not present to us documents supporting the determination of the aforementioned values. Highlighting the fact that Bank M is only the depositary entity of the shares and does not always have knowledge of the actual transaction price of the shares, to exemplify, it is verified that, in the case in question, in Form 13 presented by Bank M, the actual selling value of shares in I does not appear;

circularized the entity that issued the interim Opinion of the Sole Auditor, we verified that it only references the declarations issued by Bank M, on the average value of transactions, no other supporting document having been exhibited to support the determination of the aforementioned value;

it was in 2008 that the suspicion generated by the news that came public involving companies of group N, their governing bodies, suspicions of unlawfulness, the loss of its largest asset, Bank M, nationalized on 11 November contributed to the negative results shown in 2008, generating the decrease in the value of shares, which consequently made it difficult for investors to attempt to recover applications made in some company of group N;

it was as early as February 2008 that Mr. O requested his resignation from the presidency of Bank M and in May various complaints of harmful management came to light;

in the legal certification of the accounts, regarding the year 2008, it is stated that "... the company acquired, in the year 2008, about 945,000 shares of H, SGPS, SA and 420,000 shares of I, SGPS, SA for the total amount of 3.5 million euros (average cost of about 2.57 euros). Given the current financial and patrimonial situation of these companies, a provision should be recorded for adjustments relating to these investments.";

not being the shares listed on the stock exchange, to assess the actual value of each share, recourse was made to the financial statements of H and I as of 2007/12/31, finding that the value of each share only amounted to € 1.178896852 and € 1.163177891, respectively;

despite these situations, the seller, also shareholder and administrator of A was compensated for part of the selling value at the price of € 2.58 and 2.55 per share;

given the existence of special relationships between the purchasing and selling entities, as defined in art. 63rd of the CIRC, and not having proven the comparable market price, the tax administration will have to determine the arm's length price which is defined in law;

thus, in accordance with what was previously mentioned, the value of € 1.178896852 and € 1.163177891, for calculating the economic advantage of these transactions is the most correct, since, it was the value determined based on the last approved accounts of H and I, at the date on which the agreement for purchase and sale of the shares was established, May 2008.

III.5.5. Tax Classification and Quantification of Corrections to Tax – IRS Withholdings

III.5.5.1. Taxation of Advances on Profits

Given what was previously mentioned, a total amount of € 3,509,218.68 was agreed. However, in accordance with the actual value of each share, of € 1.178896852 and € 1.163177891 an economic advantage total of € 1,906,572.22 was determined, as follows discriminated:

[Table of calculations]

Given that the amounts were made available to the shareholder in various tranches, that advantage was distributed according to the percentage already paid, as follows discriminated:

[Distribution details]

It is noted that amounts paid in 2008 are not taken into account, since it is a period barred by prescription as defined in art. 45th of the LGT. On the other hand, until the date full payment of the contract has not yet been made, so only the amounts made available since 2009 until the date of inspection will be taken into account.

As referred to by the company's officers, between the seller and buyer no payment plan was established and these were made with respect to the entirety of the acquisition of shares in H, SGPS, SA and I, SGPS (Annex 10).

As has been exposed throughout the report, it is verified that the amount at which the shares were recorded does not correspond to their actual value, so the € 773,664.77 were withdrawn from the company, from 2009 to 2013, for the benefit of Dr. C.

It is thus verified that the economic advantage obtained by the shareholder with the realization of this transaction, amounted to € 236,337.21, € 232,262.42, € 196,404.36 and € 108,660.78 respectively in 2009, 2010, 2011 and 2012. Thus, the amounts made available to the administrator and shareholder, which were recorded in his current account (255.9) did not result from a loan nor from payment of salaries, so, under letter h) of no. 2 of art. 5th of the Code of Personal Income Tax (CIRS), it is considered that they constitute advances on profits.

Given the aforementioned, the bank transfers made to Dr. C, were recorded in his current account and did not derive from salaries and did not result from loans. Thus, the difference between the value of transmission of shares entered in the current account of the shareholder and the actual value of the shares should be considered as an advance on account of profits and consequently as income from capital.

Thus, in accordance with what is defined in point 2 of letter a) of no. 3 of art. 7th, the aforementioned income are subject to taxation for IRS purposes, from the moment they are made available to the partner.

This type of income is subject to withholding at source as a final measure at the liberatory rate of 20%, 21.5% or 28% as provided for in letter c) of no. 1 of art. 71st of the CIRS (former letter c) of no. 3 of art. 71st).

The company should thus have withheld the amount of € 47,267.44, € 46,452.48, € 42,226.94 and € 27,165.20, respectively in 2009, 2010, 2011 and 2012 and delivered to the State Treasury by the 20th of the month following that in which they are due in accordance with what is stipulated in no. 3 of art. 98th of the CIRS by force of what is provided in letter a) of no. 2 of art. 101st and in the dates listed below:

[Details of payment dates and amounts]

III.6. Summary of Corrections

[Details of corrections]

g) The Applicant was notified to exercise the right to a hearing on the draft Tax Inspection Report and did not comment;

h) Subsequently, the final report was prepared, whose content is hereby reproduced, which was subject to an opinion by the Chief of Team and then an order by the Chief of Division, whose content is hereby reproduced, referring to, among other things, the following:

I agree with the Opinion of the Chief of Team and with the attached tax inspection report.

The account of the tax situation observed justifies and supports the corrections proposed for IRS withholding at source, with reference to the years 2009, 2010, 2011 and 2012.

The justification is based on the provision/establishment of the rules contained in letter h) of no. 2 of art. 5th, 71st, 98th and 101st, all of the CIRS, combined with arts. 81st to 84th of the LGT.

Proceed as proposed.

Send the Case Files to the Finance Service of Amadora 3.

Notify.

Lisbon, 23 December 2013

i) Following the corrections made, the Tax Authority and Customs Authority made the following assessments relating to failure to withhold IRS at source and compensatory interest:

– no. 2013..., dated 02-01-2014, in the total amount of € 55,275.94, being € 47,267.44 of IRS and € 8,008.50 of compensatory interest, relating to the year 2009, with payment deadline of 03-03-2014;

– no. 2014..., dated 10-01-2014, in the total amount of €.52,361.55, being € 46,452.48 of IRS and € 5,909.07 of compensatory interest, relating to the year 2010, with payment deadline of 10-03-2014;

– no. 2014..., dated 10-01-2014, in the total amount of € 42,226.94, being € 42,226.94 of IRS and € 3,565.80 of compensatory interest, relating to the year 2011, with payment deadline of 10-03-2014;

– no. 2014..., dated 10-01-2014, in the total amount of €.28,887.84, being € 27,165.20 of IRS and € 1,722.64 of compensatory interest, relating to the year 2012, with payment deadline of 10-03-2014 (documents attached with the request for arbitral pronouncement);

j) On 16-05-2014, the Applicant provided guarantee in the amount of € 235,000.00 with a view to the suspension of the enforcement proceedings instituted for compulsory collection of debts relating to the tax acts that are the subject of this proceeding (document no. 3, attached with the request for arbitral pronouncement, whose content is hereby reproduced)

k) On 02-06-2014, the Applicant submitted the request for constitution of the arbitral court which gave rise to this proceeding.

2.2. Justification of Factual Matters

The determination of factual matters is based on the Tax Inspection Report and on the documents specifically indicated attached with the request for arbitral pronouncement.

3. Matters of Law

3.1. Acts that are the Subject of the Proceeding

The tax arbitral proceeding, as an alternative means to the judicial impugnation process (no. 2 of article 124th of Law no. 3-B/2010, of 28 April), is, like this, a procedural means of mere legality, in which the aim is to eliminate the effects produced by illegal acts, annulling them or declaring their nullity or non-existence [articles 2nd of the RJAT and 99th and 124th of the CPPT, applicable by force of what is provided in article 29th, no. 1, letter a), of that].

Therefore, post hoc justification is irrelevant, and the acts whose legality is questioned must be appreciated as they were practiced, and the court cannot, upon finding the invocation of an illegal ground as the basis of the administrative decision, appreciate whether its action could be based on other grounds.

In the case in question, although the Tax Authority and Customs Authority states in article 36th of its response that "the correction in question was not based on the application of what is provided in no. 11 of article 63rd of the CIRC, but was based on the principle inherent in no. 4 of article 36th of the LGT", the fact is that no reference to article 36th, no. 4 of the LGT is found in the Tax Inspection Report, but only, of these rules, to article 63rd of the CIRC.

On the other hand, in the order of the Chief of Division referred to in letter h) of the factual matters established, which fell upon the Tax Inspection Report and is the act that determines the corrections made, it is stated, in addition to agreement with the Report, the following: "The justification is based on the provision/establishment of the rules contained in letter h) of no. 2 of art. 5th, 71st, 98th and 101st, all of the CIRS, combined with arts. 81st to 84th of the LGT".

Thus, it is in light of the Tax Inspection Report and of this order that the legality of the IRS withholding at source assessments contested must be appreciated.

3.2. Summary of the Factual Situation

On 08-05-2008, the Applicant A SGPS, SA, acquired from its majority shareholder and administrator Dr. C, shares of H SGPS, SA at the price of € 2.58 (945,046 shares for € 2,438,218.68) and shares of Company I SGPS, SA, at the price of € 2.55 (420,000 shares for the price of € 1,071,000.00).

The Tax Authority and Customs Authority understood that "the sale of shares between related entities must respect the terms and conditions that would be established between entities in the absence of those special relationships, between independent entities in comparable operations, applying to this effect the transfer pricing regime, provided for in art. 63rd of the CIRC and Regulation no. 1446-C/2001, of 21 December".

The Tax Authority and Customs Authority understood, in sum, that, in those transactions, there was overvaluation of the prices agreed per share between related parties, and that the market value of the shares corresponds to 1.178896852, as regards H SGPS, SA, and €.1.163177891 with respect to I SGPS, SA, having found these values through the total of equity capital of these companies, reflected in the financial statements relating to 31-12-2007, divided by the total number of shares of the respective company.

The Applicant imputes to the conduct of the Tax Authority and Customs Authority the following defects:

– incorrect application of article 63rd of the IRC Code;

– non-existence of taxable event – violation of no. 1 and letter h) of no. 2 of article 5th of the IRS Code and of no. 2 of article 10th, all of the IRS Code;

– illegality due to non-existence of duty of tax substitution.

3.3. Violation of Article 63rd of the IRC Code

Although the order of the Chief of Division that indicates the justification of the corrections made does not make reference to article 63rd of the CIRC, it is unequivocal that it is included in the legal justification of those corrections, for it is on the basis of the concept of special relationships defined in it that is justified in the Tax Inspection Report, with which that order manifests agreement, the non-acceptance of the share selling prices and the search for arm's length prices.

Moreover, beyond abundant references to article 63rd of the CIRC included in the Tax Inspection Report, it is expressly referred to in it, among the "Violations Verified", that article 63rd.

As stated, shares of H SGPS, SA were sold at the price of € 2.58 (945,046 shares for € 2,438,218.68) and shares of Company I SGPS, SA, at the price of € 2.55 (420,000 shares for the price of € 1,071,000.00).

The values that served as the basis for setting the price of the transaction in question were the values appearing in two declarations issued by Bank M, dated 30-01-2008, in which it is declared that the average value of transactions in titles of I, SGPS, SA (I, SGPS, SA), carried out in 2007, amounted to € 2.55 per title transacted and that the average value of transactions in titles of H, SGPS, SA (H SGPS, SA), carried out in 2007, amounted to € 2.58 per title transacted.

3.3.1. Position of the Applicant

The Applicant argues that, although it is undeniable that there are special relationships between the Applicant and its shareholder in question, it is false that a price substantially identical to that which would normally be contracted between independent entities in comparable operations was not contracted, in accordance with the provisions of no. 1 of article 63rd of the IRC Code.

The Applicant further argues that, given the presentation of two declarations from an independent entity – the credit institution depositary of the titles – issued on 30 January 2008, under which the average value of transactions in titles of the companies in question, carried out in 2007, amounted to € 2.58 and € 2.55 per title transacted, the tax administration limits itself to rejecting the reliability of such declaration without any valid justification, and that the Tax Authority and Customs Authority does not demonstrate that, at the date of the transaction, the contracted price differed from that which would be contracted between unrelated parties.

The Applicant further argues that the criterion used by the tax administration to demonstrate the deviation from the market price of the shares, based on the value of equity capital in the Balance Sheet, is manifestly unsuited to the purpose, it being known that price adjustments for the sale of shares and company valuations almost never are based exclusively on this specific financial element and that this criterion is not even provided for in the law or regulation on transfer pricing.

The Applicant further says the tax administration uses elements not available at the date of the transaction and that, according to the information available at the date of the acquisition of shares in H SGPS, S.A., the company's financial situation was that of a net asset of € 8,567,641,000.00, of a consolidated result of 29,626 thousands of euros and a positive individual result of the year, in the amount of € 21,971,754.57, applied to legal and free reserves

The Applicant further states that the Tax Authority and Customs Authority states that the determination of the value of the shares by it made was based on the last available accounts, reported as of 31-12-2007, but it is verified that in truth accounts not available at the date of the transaction are used, that is, the balance sheet as of 31-12-2008.

The Applicant further notes that there are other evidences of compliance with market prices and refers to page 19 of the Report published on the aforementioned Bank of Portugal website that 4,513,169 shares of H SGPS, S.A. were acquired, in the year 2007, at the unit value of € 2.78 and 875,665 shares were sold at the unit value of € 1.97.

The Applicant argues, finally and on this point, that in the situation in question there is no question of transfer prices and that the supposed over-price paid by the Applicant for the financial investments does not even have a reflection on taxable profit, that is, there is no inflation of tax costs, so the invocation of article 63rd of the IRC Code proves to be devoid of meaning.

3.3.2. Position of the Tax Authority and Customs Authority

The Tax Authority and Customs Authority states that no documents considered as providing due support to the declared transaction values were presented, nor were any documents exhibited that prove the average selling price of the shares, highlighting the fact that, in the elements presented by Bank M itself and those included in Form 13, the actual purchase price of shares in I, SGPS, did not appear, appearing only the total value of € 420,000.00, corresponding to the nominal value of each share, when the selling price amounted to € 1,071,000.00.

The Tax Authority and Customs Authority further states that the supporting documents for the determination of such average selling prices were not presented, either by the Applicant, or by Bank M itself, nor by the Statutory Auditor, which are of difficult proof, and that it was not proven what the average price of transactions in titles of the said companies was, so that they could be used as average comparable market price, method used by the Applicant to prove the application of the arm's length principle.

The Tax Authority and Customs Authority argues that the conditions under which the operations for the purchase of the aforementioned shares took place, accomplished by the company to the shareholder, specifically the price of € 2.55 and 2.58 per share, is only justifiable by virtue of the special relationships existing between the parties, with the operation of purchase of shares representative of the capital of H and I, by the Applicant to the shareholder, having been structured in order to obtain clear advantages for the latter, so as to receive a value that it would not be able to obtain if it sold them to an independent entity.

The Tax Authority and Customs Authority further states that, not being possible the application of letter a) of no. 3 of article 63rd of the CIRC, it resorted to other methods for the determination of the arm's length price, namely the method provided for in letter b) of no. 2 of article 52nd of the CIRS (the value determined based on the last balance), among others, which fit within the discipline of article 4th of Regulation no. 1446-C/2001, of 21/12, given that the purchase price was established between the seller and buyer in May 2008, the last available accounts were those reported as of 31-12-2007.

The Tax Authority and Customs Authority further states that its own article 63rd of the CIRC, in letter b) of no. 3, which extends the possibility to other methods not defined in this regulatory framework – without specifying which – when "the methods referred to in the previous point cannot be applied or, where they can be, do not allow obtaining the most reliable measure of the terms and conditions that independent entities would normally agree, accept or practice", that based on the financial statements of companies H SGPS, SA and I, SGPS, SA, the value of the shares would be substantially lower than the value at which the acquisition was made and that any market expectation that could influence the price of shares, in the period under analysis, would only negatively influence that price, given the situation in which H found itself from the beginning of January 2008.

The Tax Authority and Customs Authority further states that from the analysis carried out on the accounts of H, SGPS, SA, reported as of 31-12-2007, and those appearing on the Bank of Portugal website mentioned in point 61 of the petition, it is verified that the former have reflected € 88,014,000 of impacts recognized in Retained Earnings and that this situation justifies the total value of equity used by the Respondent entity of € 555,172,000, given the values mentioned in the petition of € 643,186,000.

The Tax Authority and Customs Authority further argues that the correction in question was not based on the application of what is provided in no. 11 of article 63rd of the CIRC, but was based on the principle established in no. 4 of article 36th of the LGT and that the correction was not based on the application of the transfer pricing regime, it was only following the elements provided by the Applicant and other entities that the value of the shares was determined, proceeding thereafter to the determination of the excess value, justification this, which, by what was referred to regarding the irrelevance of post hoc justification cannot be considered.

3.3.3. Appraisal of the Question

3.3.3.1. Legal Reference Framework

The analysis which the court conducts on this point is based on the legal framework which is presented as follows.

A) Article 63rd of the CIRC, being of particular relevance the following provisions:

"1 — In commercial operations, including in particular operations or series of operations on goods, rights or services, as well as in financial operations, carried out between a taxpayer and any other entity, whether or not subject to IRC, with which it is in a situation of special relationships, terms or conditions substantially identical to those which would normally be contracted, accepted and practiced between independent entities in comparable operations must be contracted, accepted and practiced.

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 operations or series of operations that it carries out and other substantially identical ones, in normal market situations or in the absence of special relationships, taking into account, in particular, the characteristics of the goods, rights or services, the market position, the economic and financial situation, the business strategy, and other relevant characteristics of the taxpayers involved, the functions performed by them, the assets used and the allocation of risk.

3 — The methods used must be:

a) The comparable market price method, the reduced resale price method or the cost plus method;

b) The profit split method, the net profit margin method or another, when the methods referred to in the previous letter cannot be applied or, where they can be, do not allow obtaining the most reliable measure of the terms and conditions that independent entities would normally agree, accept or practice.

B) Regulation 1446-C/2001, from which the following stands out:

Article 1st

General Rules on the Arm's Length Principle

1 – In operations carried out between a taxpayer subject to IRS or IRC and any other entity, whether or not subject to these taxes, with which it is in a situation of special relationships, terms and conditions substantially identical to those which would normally be contracted, accepted and practiced between independent entities in comparable operations must be contracted, accepted and practiced.

2 – The application of the principle set out in no. 1 must, as a rule, be based on an individualized analysis of the operations, except in those situations, in particular those listed in the following letters, in which the analysis may be carried out on an aggregate basis or by series of operations,....

Article 6th

Comparable Market Price Method

1 – The adoption of the comparable market price method requires the highest degree of comparability with emphasis both on the object and other terms and conditions of the operation and on the functional analysis of the intervening entities.

2 – This method may be used, in particular, in the following situations:

a) When the taxpayer or an entity belonging to the same group carries out a transaction of the same nature as has as its object a service or identical or similar product, in quantity or value analogous, and in terms and conditions substantially identical, with an independent entity in the same or similar markets;

b) When an independent entity carries out an operation of the same nature that has as its object a service or an identical or similar product, in quantity or value analogous, and in terms and conditions substantially identical, in the same market or in similar markets.

Article 14th

Relevant Information

In order to comply with the obligation referred to in the previous article, the taxpayer must obtain or produce and maintain informative elements, in particular regarding the following aspects:

(…)

c) Detailed identification of the goods, rights or services that are the object of the operations linked, and of the terms and conditions established, when such information does not result from the contracts entered into;

(…)

g) Contracts and other juridical acts practiced both with related entities and with independent entities, with the modifications that occur and with historical information on their compliance, and moreover the following elements must be provided when they do not appear expressly in the existing juridical instruments or when the practice followed deviates from that agreed in them: (…)

3.3.3.2. Appraisal by the Court

Ascertaining whether in the operations between the Applicant and its majority shareholder and administrator terms or prices substantially identical to those which would normally be contracted between independent entities in comparable operations were contracted constitutes the first question posed by the Applicant which should be answered.

The use of comparable market price, as provided for both in article 63rd of the CIRC and in articles 6th and 14th of Regulation 1446-C/2001, requires that the information supporting the use of this method be such as to clearly prove, and as broadly and completely as possible, the basis for determining that comparable price.

The documents issued by Bank M, dated 30-01-2008, which appear as annexes to the proceeding, and in which it is declared that the average value of transactions in titles of I, SGPS, SA (I, SGPS, SA), carried out in 2007, amounted to € 2.55 per title transacted, and further that the average value of transactions in titles of H, SGPS, SA (H SGPS, SA), carried out in 2007, amounted to € 2.58 per title transacted, suffer, in the court's view, from notorious fragilities, when analyzed in light of their probative force to support the Applicant's thesis.

Indeed, such declarations have no statistical support of operations in which such prices were determined. There are no quantified elements, which could have been attached to these declarations, which show the objective basis of such prices. The signature itself that appears in them does not identify the responsible party who produced them, and what functions he then had at Bank M that would qualify him for this certification function. In sum, in these declarations there are not only lacunae in terms of form but, perhaps even more relevant, there are deficiencies in substance.

In truth, the requirements – transcribed above – of articles 6th and 14th of Regulation 1446-C/2001 are far from being satisfied. Invoking a market price, one should show comparable operations – identifying at least some – and respective prices, or the elements provided should include some proof of similar operations that show the comparability of the prices practiced in the transactions in shares between the Applicant and its shareholder.

As also the OECD stresses in its respective Guidelines (p.108, underlining by the court): "In order for the process to be transparent, it is considered a good practice for a taxpayer that uses comparables to support its transfer pricing, or a tax administration that uses comparables to support a transfer pricing adjustment, to provide appropriate supporting information for the other interested party (i.e. tax auditor, taxpayer or foreign competent authorities) to be able to assess the reliability of the comparables used."

The Applicant further alleges that, in addition to this factual basis arising from the declarations of Bank M, it would further be observed on page 19 of the Report published on the Bank of Portugal website that 4,513,169 shares of H, S.A. were acquired, in the year 2007, at the unit value of €.2.78 and 875,665 shares were sold at the unit value of € 1.97.

This is the Report and Accounts for 2007 of H, SGPS, S.A. On that page a summary table is presented showing the total quantity of shares sold and acquired by H, as well as the total amounts involved and the average price. It is also indicated that there were transactions of shares in the company, among the company and its shareholders, and from these transactions the values determined regarding prices arise.

The information extracted from the aforementioned Report and Accounts of H does not dispel the insufficiency of proof already highlighted with respect to the declarations of Bank M.

Once again, these are aggregated values, without factual, statistical basis, or individualization of operations that would allow creating a clear conviction that they would be comparable market prices. Furthermore, in the said transactions of company shares, it is not known which ones were completed between shareholders that could constitute, in light of the criteria of article 63rd of the CIRC, related parties, it being unknown whether, and to what extent, the prices appearing in the said table of the Report and Accounts of H for 2007 were practiced between independent entities.

Being the court convinced that the bases on which the Applicant rests its position according to which the price of € 2.55 for titles of I, SGPS, SA (I, SGPS, SA), and € 2.58 for titles of H, SGPS, SA (H SGPS, SA), are insufficient, there should now be inquiry as to whether the method used by the Tax Administration is revealed to be appropriate.

The Applicant points out to this method two incongruences: that it is not provided for in the law regarding transfer pricing, and furthermore that the market value of a company departs, as a rule, from its accounting value.

On the first point, article 63rd, no. 3, of the CIRC establishes (underlining by the court):

3 — The methods used must be:

a) The comparable market price method, the reduced resale price method or the cost plus method;

As observed, the method of accounting value is not expressly listed in the five (comparable market price, reduced resale price, cost plus, profit split and net profit margin of operations) that article 63rd, no. 3, of the CIRC provides in individualized form.

However, analysis must be made of whether such method could have place in the expression "or another, when the methods referred to in the previous letter cannot be applied or, where they can be, do not allow obtaining the most reliable measure of the terms and conditions that independent entities would normally agree, accept or practice".

Now, in a share transaction, comparable market price is the standard method. Indeed, the remaining four expressly provided for in article 63rd, no. 3, are of very difficult application. With the company listed, the market price will, in principle, be available. Not being listed, and with transactions between related parties and independent entities, in comparable conditions, can such transactions be documented juridically and economically and thus obtain comparables considered reliable.

However, if comparable market price has not been demonstrated, the accounting value of the shares may, in general theory, fall within the "others" methods provided for. Unless the Applicant shows the evident unsuitability of such a way to obtain the price that would be practiced in comparable operations between independent entities.

Does the applicant succeed in refuting this method? The Applicant asserts, it is true, that only by mere chance will the market value of shares coincide with the accounting value. The Court also understands this.

Indeed, there will be cases, normally in situations of general economic growth, in which the so-called goodwill (value of intangible assets internal not reflected in the balance sheet, such as the competence of administration, the prestige of the company in the market, customer loyalty, the reputation of its goods or services, the effectiveness of its production and distribution network, and many others) could raise the market price above accounting value.

Conversely, in times of recession, the market price, incorporating expectations of decline in future benefits, could fall well below accounting value. There will thus be negative goodwill, as will be the case of a large number of companies, at the present time, in Portugal.

Having the Tax Administration used the accounting value, and the Applicant being able to refute it, how could it have done so? By showing that, in the concrete case of H, there would be objective, quantifiable factors that would depart from (for the Applicant's thesis only it would be of interest to prove that they would depart upward, that is, raising the market price above accounting value) the value used by the Tax Administration as the appropriate reference in the valuation of the transactions in question.

However, such counter-proof is not made. The generic allegation that market price will depart, as a rule, from accounting value, does not suffice. It was necessary to prove that, in the case of H, in 2008, it would depart, in a positive sense (i.e., evidencing a certain goodwill), for what reasons this would happen and what quantitative impact it would have on the price.

In conclusion, the method used by the Tax Administration, being legally admissible, although as a residual method, was not decisively put in question by the Applicant.

There remains, on this point, the question of knowing whether the accounting value determined by the Tax Administration will be well applied, or whether, as the Applicant argues, it refers to equity capital of the 2008 balance sheet, when this could not exist at the date of the transactions, which would make the value used by the Tax Administration incorrect.

The Tax Administration uses data referred to the end of 2007, although such data appear in the 2008 accounts, in comparison of the two balance sheets. That is to say, during 2008 the values of equity capital of 2007 were revised, allocating to the 2007 accounts (and thereby reducing equity capital) in the components of reserves and retained earnings amounts that rose to about 88 million euros.

It is from this allocation in 2008, to the accounts relating to December 2007, that the divergence pointed out by the Applicant arises. For it, the equity capital relevant in the calculation of the value of shares would be 643.18 million euros, observed in the 2007 accounts and issued when that year was closed.

For the Tax Administration it would be this amount reduced by 88 million euros, that is, 555.17 million euros, relating to the balance sheet of 2007, but appearing this when the disclosure of the 2008 accounts, in which certain values relating to the net situation of 2007 were adjusted.

Thus, if in 2008 there was allocated – to the 2007 accounts – a value of 88 million euros (which also affected equity capital of 2007 and not the result of 2008) such means that, in substance, the value of capital of 2007 would be more reduced than appearing in the report of H that can be consulted on the Bank of Portugal website. That is: it is certain that in the closing of accounts of 2007 these adjustments of 88 million euros would not yet have been recorded, but it was precisely during the year 2008 – and recall that the transactions in question occurred in May 2008 – that such adjustments were recognized. Thus, the value economically more relevant of equity capital to support the value of shares in mid-2008 will thus be closer to 555.17 than to 643.18 million euros. The actual value of capital in 2007 would already be materially influenced, even by the accounts of the net situation in which the adjustments were made, in light of latent misalignments, only corrected in 2008. A price formed between informed buyers and sellers, in May 2008, would take into account this factuality.

However, given the evidence collected, doubts cannot but remain that the values of equity capital of the companies in question in May 2008 were those which the Tax Administration considered to be relevant to effect the assessment, doubts which, by force of article 100th, no. 1, of the CPPT cannot but be valued in favor of the Applicant and not against it.

But, not guaranteeing this defect an effective protection of the Applicant's rights, including because an alternative justification is indicated in the referred order of the Chief of Division, the continuation of the appraisal of the defects imputed by the Applicant is imposed, as is implicit in no. 2 of article 124th of the CPPT, subsidiarily applicable pursuant to article 29th, no. 1, of the RJAT.

3.4. Non-existence of Taxable Event – Violation of no. 1 and Letter h) of no. 2 of Article 5th of the IRS Code and of no. 2 of Article 10th, All of the IRS Code

The Tax Authority and Customs Authority understood to treat the overvaluation which it understood to exist in the sale to the Applicant of shares by the administrator and majority shareholder as being an advance on account of profits, basing itself on article 5th, no. 2, letter h) of the CIRS, which establishes, referring to no. 1 of the same article, that are considered income from capital the fruits and other economic advantages that comprise "the profits of entities subject to IRC made available to the respective associates or holders, including advances on account of profits, with exclusion of those referred to in article 20th".

It is said in the Tax Inspection Report on this tax classification, which is reaffirmed in the order of the Chief of Division:

It is thus verified that the economic advantage obtained by the shareholder with the realization of this transaction, amounted to € 236,337.21, € 232,262.42, € 196,404.38 and € 108,660.78 respectively in 2009, 2010, 2011 and 2012. Thus, the amounts made available to the administrator and shareholder, which were recorded in his current account (255.9) did not result from a loan nor from payment of salaries, so, under letter h) of no. 2 of art. 5th of the Code of Personal Income Tax, it is considered that they constitute advances on account of profits.

In accordance with what is stipulated in no. 1 of art. 5th and letter h) of no. 2, both of the CIRS, are considered income from capital the fruits and other economic advantages, namely the profits of entities subject to IRC made available to the respective holders, including advances on account of profits. Dr. C, were recorded in his current account and did not derive from salaries and did not result from loans. Thus, the difference between the value of transmission of shares entered in the current account of the shareholder and the actual value of shares should be considered as an advance on account of profits and consequently as income from capital.

The company should thus have withheld the amount... and delivered to the State Treasury by the 20th of the month following that in which they are due in accordance with what is stipulated in no. 3 of art. 98th of the CIRS by force of what is provided in letter a) of no. 2 of art. 101st and in the dates listed below: [details].

However, in the case in question, it is manifest that the amount credited in the shareholder's account does not have the nature of a distribution or advance of profits, nor was proof made that profits existed and that there was any deliberation in the sense of distributing profits or making an advance on account of them.

And, to trigger the rule of letter h) of no. 2 of article 5th of the CIRS, it is necessary, first and foremost, that there be profits that are made available or advanced to associates.

On the other hand, although article 6th, no. 4, of the CIRS establishes a presumption that "entries in any current accounts of partners, entered in commercial or civil companies in commercial form, when they do not result from loans, provision of work or exercise of corporate offices, are presumed to be made as account of profits or advance of profits", it is found that this rule is not even invoked in the justification of the corrections made.

In any case, this presumption is rebuttable, by force of what is provided in article 73rd of the LGT and, in the case, it results from the proof produced that the amounts entered in the shareholder's account were by way of payment of shares acquired and not by way of advance or distribution of profits, so, if the Tax Administration, secretively, intended to apply this presumption it is rebutted by the proof produced.

On the other hand, beyond article 36th, no. 4, of the LGT, not having been used to justify the corrections made, there is confusion of the Tax Administration about its scope by invoking it in the present proceeding, post hoc, to justify the corrections.

In truth, article 36th, no. 4, of the LGT, in establishing that "the qualification of the juridical business effected by the parties, even in authentic document, does not bind the tax administration" refers to the irrelevance of the qualification before the terms of the business, allowing the Tax Administration to attend to these and not to the qualification attributed by the parties. But, that rule only allows the Tax Administration to ignore the juridical qualification of the business attributed by the parties and not to disregard the very terms in which it was made and its efficacy in light of civil or commercial law. That is, having the transmission of shares taken place through contracts through which the ownership of shares was transmitted through a price, one is before typical contracts of purchase and sale (article 874th of the Civil Code), allowing that article 36th, no. 4, the Tax Administration to consider irrelevant any other juridical qualification which the parties in the contracts might eventually have attributed to it, such as, for example, loan contracts, or work contracts. But, what that article 36th, no. 4, does not allow is that contracts whose terms fill the requirements typical of the contract of purchase and sale, are fiscally treated as if they were contracts of some other type whatsoever.

A contract for purchase and sale of shares, which is a transaction of bilateral nature, does not conceptually merge with unilateral acts such as the distribution of dividends or its advance.

On the other hand, as the Applicant well argues, the ineffectiveness of the contract of purchase and sale with its proper effects, could only be considered ineffective, for fiscal purposes, if there had been use of the general anti-abuse clause, which appears in article 38th, no. 2, of the LGT which, that one does allow, disregarding for fiscal purposes, the terms of the businesses practiced in the circumstantial setting provided for therein.

In the case in question, beyond the Tax Administration not even venturing in the Tax Inspection Report or in the order of the Chief of Division that the prerequisites for the application of the general anti-abuse clause were filled, there is immediately an insurmountable obstacle to its application which is the lack of the mandatory authorization of the Director-General of the Tax Administration and Customs Authority, provided for in article 63rd, no. 7, of the CPPT.

Therefore, it must be concluded that the Applicant is right, in invoking the non-existence of the taxable event (advance on account of profits) in which the contested assessments were based.

It is concluded, thus, that the assessments whose declaration of illegality is requested in this proceeding, in having as a prerequisite that the amounts in which the assessments were based constitute advances on account of profits, are affected by the defect of error over the prerequisites of law, namely letter h) of no. 2 of article 5th of the CIRS.

Thus, the request for arbitral pronouncement is warranted on the basis of this defect which renders the assessments illegal.

3.5. Question of Prejudiced Knowledge

The defect referred to in the previous point ensures effective and stable protection of the Applicant's rights, since it prevents the possibility of renewal of the acts of assessment whose declaration of illegality is requested.

Thus, knowledge of the question of illegality due to non-existence of accessory duty of tax substitution, which the Applicant also invokes, is prejudiced, as it is useless.

4. Indemnification for Undue Guarantee

The Applicant further formulates a request for indemnification for undue guarantee.

As results from letter j) of the factual matters established, on 16-05-2014, the Applicant provided guarantee in the amount of € 235,000.00 with a view to the suspension of the enforcement proceedings instituted for compulsory collection of debts relating to the tax acts that are the subject of this proceeding.

In accordance with the provisions of letter b) of article 24th of the RJAT, the decision of the arbitral court on the merits of the claim for which no recourse or impugnation is possible binds the tax administration from the end of the period provided for recourse or impugnation, and this must, in the exact terms of the success of the arbitral decision in favor of the taxpayer and until the end of the period provided for the spontaneous execution of judgments of the tax courts, "restore the situation that would exist if the tax act that is the subject of the arbitral decision had not been practiced, adopting the acts and operations necessary for that purpose".

In the legislative authorization on which the Government based itself to approve the RJAT, granted by article 124th of Law no. 3-B/2010, of 28 April, it is proclaimed, as a primary guideline of the institution of arbitration as an alternative form of jurisdictional resolution of conflicts in tax matters, that "the tax arbitral proceeding should constitute an alternative procedural means to the judicial impugnation process and to the action for the recognition of a right or legitimate interest in tax matters".

Although article 2nd, no. 1, letters a) and b), of the RJAT uses the expression "declaration of illegality" to define the competence of the arbitral courts operating in the CAAD and does not make reference to constitutive (annulling) and condemnatory decisions, should be understood, in harmony with the referred legislative authorization, that included in its competencies are the powers that in a judicial impugnation process are attributed to tax courts in relation to acts whose appraisal of legality falls within their competencies.

Although the judicial impugnation process is essentially a process of mere annulment (articles 99th and 124th of the CPPT), therein may be rendered condemnation of the tax administration in the payment of indemnificatory interest and indemnification for undue guarantee.

In truth, although there is no express rule in that sense, it has come to be understood peacefully in tax courts, since the entry into force of the codes of the 1958-1965 tax reform, that in a judicial impugnation process request for condemnation in the payment of indemnificatory interest can be cumulated with the request for annulment or declaration of nullity or non-existence of the act, because in these codes it is referred that the right to indemnificatory interest arises when, in a gracious reclamation or judicial proceeding, the administration is convinced that there was error of fact attributable to the services. This regime was, subsequently, generalized in the Code of Tax Procedure, which established in no. 1 of its article 24th that "there will be right to indemnificatory interest in favor of the taxpayer when, in a gracious reclamation or judicial proceeding, it is determined that there was error attributable to the services", then, in the LGT, in whose article 43rd, no. 1, it is established that "indemnificatory interest is due when it is determined, in a gracious reclamation or judicial impugnation, that there was error attributable to the services from which results payment of the tax debt in amount superior to that legally due" and, finally, in the CPPT in which it was established, in no. 2 of article 61st (to which corresponds no. 4 in the wording given by Law no. 55-A/2010, of 31 December), that "if the decision that recognized the right to indemnificatory interest is judicial, the period for payment counts from the beginning of the period of its spontaneous execution".

Regarding the request for condemnation in the payment of indemnification for provision of undue guarantee, article 171st of the CPPT, establishes that "indemnification in case of bank guarantee or equivalent unduly provided will be requested in the proceeding in which the legality of the exigible debt is controverted" and that "indemnification must be requested in the reclamation, impugnation or recourse or in case its ground is supervenient within 30 days after its occurrence".

Thus, it is unequivocal that the judicial impugnation process encompasses the possibility of condemnation in the payment of undue guarantee and is even, in principle, the appropriate procedural means for formulating such request, which is justified by evident reasons of procedural economy, since the right to indemnification for undue guarantee depends on what is decided regarding the legality or illegality of the assessment act.

The request for constitution of the arbitral court and for arbitral pronouncement has as a corollary that it will be in the arbitral proceeding that the "legality of the exigible debt" will be discussed, so, as results from the express tenor of that no. 1 of the referred article 171st of the CPPT, it is also the arbitral proceeding that is appropriate to appraise the request for indemnification for undue guarantee.

Moreover, the cumulation of requests relating to the same tax act is implicitly presupposed in article 3rd of the RJAT, when speaking of "cumulation of requests even though relating to different acts", which allows one to understand that cumulation of requests is also possible regarding the same tax act and requests for indemnification for indemnificatory interest and condemnation for undue guarantee are susceptible of being encompassed by that formula, so an interpretation in this sense has, at least, the minimum of verbal correspondence required by no. 2 of article 9th of the Civil Code.

The regime for the right to indemnification for undue guarantee appears in article 53rd of the LGT, which establishes the following:

Article 53rd

Guarantee in Case of Undue Provision

The debtor who, to suspend execution, offers bank guarantee or equivalent, will be indemnified totally or partially for the prejudices resulting from its provision, should it have maintained it for a period superior to three years in proportion to the vesting in administrative reclamation, impugnation or opposition to execution which have as object the debt guaranteed.
The period referred to in the previous number does not apply when it is verified, in gracious reclamation or judicial impugnation, that there was error attributable to the services in the assessment of the tax.
The indemnification referred to in number 1 has as maximum limit the amount resulting from the application to the guaranteed value of the rate of indemnificatory interest provided for in this law and can be requested in the proceeding itself of reclamation or judicial impugnation, or autonomously.
The indemnification for provision of undue guarantee will be paid by deduction from the revenue of the tax of the year in which the payment was made.

In the case in question, it is manifest that the errors underlying the assessments are attributable to the Tax Authority and Customs Authority, since the corrections and assessments were of its initiative and the Applicant in nothing contributed to those errors being practiced.

Therefore, the Applicant has the right to indemnification for the guarantee provided.

There being no elements that allow determining the amount of indemnification, the condemnation will have to be effected with reference to what comes to be assessed in execution of this decision [articles 609th, no. 2, of the Code of Civil Procedure and 565th of the Civil Code, applicable pursuant to article 2nd, letter d) of the LGT].

5. Decision

Accordingly, the arbitrators agree on the following:

I) To declare that the assessments:

– no. 2013..., dated 02-01-2014, in the total amount of € 55,275.94, relating to the year 2009;

– no. 2014..., dated 10-01-2014, in the total amount of € 52,361.55, relating to the year 2010;

– no. 2014..., dated 10-01-2014, in the total amount of € 45,792.74, relating to the year 2011;

– no. 2014..., dated 10-01-2014, in the total amount of € 28,887.84, relating to the year 2012;

are illegal and must be annulled.

II) To condemn the Tax Authority and Customs Authority to indemnify the Applicant for the undue guarantee provided, in the terms and according to the procedure provided for in article 53rd of the General Tax Law.

III) To condemn the Tax Authority and Customs Authority to restore the situation that would exist if the above-mentioned acts had not been practiced, adopting the acts and operations necessary for that purpose, in the terms provided for in article 24th, letter b), of the Regulation of the Arbitral Tax Proceedings.

This is what the arbitrators decide.

Lisbon, 14 November 2014

(signed)

Dr. Jorge Lopes de Sousa
(Arbitrator-Chairman)

Dr. Henrique Curado
(Arbitrator)

Prof. Doctor António Martins
(Arbitrator)

Frequently Asked Questions

Automatically Created

What is IRS withholding tax (retenção na fonte) and when does it apply to employee compensation in Portugal?

IRS withholding tax (retenção na fonte) is an advance tax collection mechanism where the entity paying certain income must withhold and remit IRS amounts directly to the Portuguese Tax Authority before paying the beneficiary. For employee compensation, withholding tax applies to salaries, wages, bonuses, and other employment-related income paid by employers. The employer acts as substitute taxpayer, calculating the withholding amount based on progressive IRS tax tables considering the employee's anticipated annual income and personal circumstances. Withholding rates vary depending on income levels and whether the employee has dependents. The withheld amounts are credited against the employee's final IRS liability when filing the annual tax return. In the context of Process 410/2014-T, the Tax Authority assessed withholding obligations on transactions between a holding company and its administrator-shareholder, examining whether proper IRS withholding rules were followed for income arising from share transactions involving parties with special relationships as defined under Article 63 of the Corporate Income Tax Code.

Can a company challenge IRS withholding tax assessments through CAAD arbitration proceedings?

Yes, companies can challenge IRS withholding tax assessments through CAAD (Centro de Arbitragem Administrativa) arbitration proceedings. Process 410/2014-T demonstrates this mechanism, where the company filed an arbitration request pursuant to Decree-Law 10/2011 seeking declaration of illegality of withholding tax liquidations covering multiple years. CAAD provides an alternative dispute resolution forum to traditional tax courts, offering expedited proceedings typically resolved within 6-12 months. To initiate arbitration, the taxpayer must submit a formal request within the legal deadline (generally 90 days from notification of the contested act or decision), pay the applicable arbitration fee, and specify the legal and factual grounds for challenging the assessment. The CAAD President accepts or rejects requests based on formal requirements, then appoints arbitrators (single arbitrator or three-member panel for amounts exceeding certain thresholds). Arbitral tribunals have jurisdiction over most IRS disputes including withholding tax assessments, and their decisions are binding and enforceable, subject only to limited grounds for appeal to administrative courts on procedural or jurisdictional issues.

What are the legal grounds for disputing retroactive IRS withholding tax liquidations by the Portuguese Tax Authority?

Legal grounds for disputing retroactive IRS withholding tax liquidations include: (1) violation of arm's length principle requirements under Article 63 of the Corporate Income Tax Code when challenging transfer pricing adjustments affecting withholding obligations; (2) incorrect application of special relationship definitions or failure to prove qualifying relationships existed; (3) procedural irregularities in the inspection process such as exceeding legal timeframes or failing to provide proper notification; (4) substantive errors in calculating withholding amounts or applying incorrect tax rates; (5) lack of factual basis supporting the Tax Authority's conclusions about transaction values; (6) prescription of the right to assess based on statutory limitation periods; (7) violation of legal certainty principles or legitimate expectations; (8) errors in determining the legal nature of income subject to withholding; and (9) unconstitutionality of applied legal provisions. In Process 410/2014-T, the taxpayer challenged assessments arguing the Tax Authority incorrectly characterized transactions and applied transfer pricing rules. Taxpayers must present detailed factual and legal arguments supported by documentation demonstrating why the original withholding tax liquidations were unlawful, often requiring economic analyses proving market-rate compliance for related-party transactions.

How does the CAAD arbitral tribunal process work for IRS withholding tax disputes covering multiple tax years?

The CAAD arbitral tribunal process for IRS withholding tax disputes covering multiple tax years follows these stages: (1) Filing—taxpayer submits arbitration request identifying all contested liquidation notices with respective amounts and tax years, paying the arbitration fee; (2) Acceptance—CAAD President reviews formal requirements within 5 days and notifies the Tax Authority; (3) Appointment—the Deontological Council appoints arbitrator(s) based on dispute value and complexity; parties have 10 days to challenge appointments; (4) Constitution—tribunal formally constitutes once appointment deadlines expire; (5) Preliminary conference—tribunal may hold meetings under Article 18 RJAT to organize proceedings, or dispense with them as in Process 410/2014-T; (6) Written pleadings—both parties submit detailed arguments and supporting documentation; (7) Evidence phase—tribunal may order additional evidence, expert reports, or witness testimony; (8) Final arguments—parties present closing submissions; (9) Deliberation—tribunal analyzes arguments and reaches decision; and (10) Decision—tribunal issues written arbitral award declaring assessments legal or illegal, typically within 6 months of constitution. When multiple tax years are challenged simultaneously, the tribunal examines each year's assessment separately while considering common legal issues that may apply across all periods.

What compensatory interest (juros compensatórios) obligations arise from IRS withholding tax corrections in Portugal?

Compensatory interest (juros compensatórios) obligations arising from IRS withholding tax corrections in Portugal are governed by the General Tax Law (LGT) and calculated automatically when the Tax Authority determines that withholding tax was not properly collected or remitted. The interest accrues from the date the tax should have been paid (typically the deadline for remitting withheld amounts, usually the 20th day of the month following the income payment) until the date of actual payment or enforcement. The interest rate is set annually by ministerial order and aims to compensate the State for the delayed receipt of tax revenues, not to penalize the taxpayer. In Process 410/2014-T, compensatory interest was included in all four liquidation notices as mandatory additions to the principal withholding tax amounts assessed for 2009-2012. Importantly, if the taxpayer successfully challenges the underlying withholding tax assessment through arbitration or judicial proceedings and obtains a favorable decision declaring the liquidation illegal, the compensatory interest obligation is also eliminated since it depends on the validity of the principal tax debt. Conversely, if assessments are upheld, the interest continues accruing until full payment, potentially increasing substantially for multi-year disputes.

IRS Withholding Tax on Employee Benefits: CAAD Arbitration Decision 410/2014-T

Table of Contents

Summary

Full Decision

ARBITRAL DECISION

1. Report

2. Factual Matters

2.1. Established Facts

III.5.5. Tax Classification and Quantification of Corrections to Tax – IRS Withholdings

III.5.5.1. Taxation of Advances on Profits

III.6. Summary of Corrections

2.2. Justification of Factual Matters

3. Matters of Law

3.1. Acts that are the Subject of the Proceeding

3.2. Summary of the Factual Situation

3.3. Violation of Article 63rd of the IRC Code

3.3.1. Position of the Applicant

3.3.2. Position of the Tax Authority and Customs Authority

3.3.3. Appraisal of the Question

3.3.3.1. Legal Reference Framework

3.3.3.2. Appraisal by the Court

3.4. Non-existence of Taxable Event – Violation of no. 1 and Letter h) of no. 2 of Article 5th of the IRS Code and of no. 2 of Article 10th, All of the IRS Code

3.5. Question of Prejudiced Knowledge

4. Indemnification for Undue Guarantee

5. Decision

Frequently Asked Questions

Tags

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Table of Contents

IRS Withholding Tax on Employee Benefits: CAAD Arbitration Decision 410/2014-T

Table of Contents

Summary

Full Decision

ARBITRAL DECISION

1. Report

2. Factual Matters

2.1. Established Facts

III.5.5. Tax Classification and Quantification of Corrections to Tax – IRS Withholdings

III.5.5.1. Taxation of Advances on Profits

III.6. Summary of Corrections

2.2. Justification of Factual Matters

3. Matters of Law

3.1. Acts that are the Subject of the Proceeding

3.2. Summary of the Factual Situation

3.3. Violation of Article 63rd of the IRC Code

3.3.1. Position of the Applicant

3.3.2. Position of the Tax Authority and Customs Authority

3.3.3. Appraisal of the Question

3.3.3.1. Legal Reference Framework

3.3.3.2. Appraisal by the Court

3.4. Non-existence of Taxable Event – Violation of no. 1 and Letter h) of no. 2 of Article 5th of the IRS Code and of no. 2 of Article 10th, All of the IRS Code

3.5. Question of Prejudiced Knowledge

4. Indemnification for Undue Guarantee

5. Decision

Frequently Asked Questions

Tags

FRESH Legal Group

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Table of Contents