Transfer Pricing IRC Assessment Annulled: CAAD Arbitration Case 423/2015-T on Group Taxation

ARBITRAL DECISION

I. Report

1. On 09-07-2015, the company A..., LDA., NIPC..., filed a request for the constitution of a collective arbitral tribunal, pursuant to the combined provisions of articles 2 and 10 of Decree-Law no. 10/2011, of 20 January (Legal Regime for Arbitration in Tax Matters, hereinafter referred to only as RJAT), with a view to declaring the illegality and consequent annulment of the assessment of Corporate Income Tax (hereinafter "IRC") and respective compensatory interest, identified with no. 2012..., issued by the Tax and Customs Authority, relating to the taxation period of 2008, in the amount (to be refunded) of €28,855.42 and the respective Statement of Account Adjustment, identified as document no. 2012..., which resulted in an amount payable of €8,117.46.

2. Pursuant to the provisions of paragraph a) of no. 2 of article 6 and paragraph b) of no. 1 of article 11 of Decree-Law no. 10/2011, of 20 January, as amended by article 228 of Law no. 66-B/2012, of 31 December, the Ethics Council appointed the arbitrators of the collective arbitral tribunal: His Honour Counselor José Baeta Queiroz, His Honour Prof. Doctor Luís Menezes Leitão and His Honour Prof. Doctor António Martins, who communicated their acceptance of the appointment within the applicable deadline.

3. Having notified the parties of this appointment on 28-08-2015, neither party manifested an intention to challenge the appointed arbitrators, whereby the tribunal is regularly constituted to hear and decide on the subject matter of the proceedings.

4. The allegations supporting the Claimant's request for an arbitral ruling are, in summary, as follows:

4.1 The Claimant carries out the activity of production and commercialization of covers, foams, upholstery and metal structures for motor vehicle seats (CAE...–R3), being classified for IRC purposes under the Special Regime for Group Company Taxation (hereinafter "RETGS"), as the holding company.

4.2 The consolidation perimeter of its group also includes the following companies (all collectively hereinafter referred to as "Group"):

• B... S.A., legal entity no. ... (hereinafter "B...");

• C... S.A. (hereinafter "FSI");

• D... Lda. (hereinafter "Escapes"); and

• E..., Unipessoal Lda. (hereinafter "E...")

4.3 Through Official Letter no..., of 30 August 2011, B... was notified that a tax inspection action would be initiated, which began on 15 November 2011 and ended on 20 December 2011.

4.4 Following this, on 20 December 2011, B... was notified of the Draft Conclusions of the Inspection Report and, subsequently, on 22 February 2012, of the Tax Inspection Report (hereinafter "Report B...") with the conclusions and corrections resulting from the inspection carried out on its individual accounts.

4.5 As the holding company, the Claimant was notified, in compliance with Service Order no. OI2012..., issued on 16 February 2012, of the conduct of an internal inspection procedure relating to the financial year 2008 with the objective of reflecting in the taxable income of the Group the corrections made by the AT as a result of the inspection procedure carried out on the subsidiary company B..., having been notified, on 7 March 2012, of the Draft Conclusions of the Inspection Report and, subsequently, on 4 April 2012, of the Tax Inspection Report (hereinafter "Final Report"), in which technical corrections to the taxable base for the financial year 2008 were proposed.

4.6 Subsequently, on 17 May 2012, the Claimant was notified of the Assessment, which, taking into account the values stated in the "Statement of Account Adjustment" no. 2012..., resulted in an amount payable of €8,117.46, with a payment deadline of 20 June 2012 – payment which the Respondent made on that date.

4.7 On the same date, it was notified of the "Statement of Interest Assessment", identified as Compensation no. 2012..., with the specification of the calculation of compensatory interest.

4.8 On 13 September 2012, the Claimant filed an administrative challenge to the Assessment.

4.9 Following this, the Claimant was notified by the AT, on 18 December 2012, of the draft decision to reject the challenge filed, having exercised its right to respond in prior hearing, which was submitted to the AT on 5 March 2013.

4.10 Notwithstanding the arguments put forward by the Claimant at that time, the AT maintained the position set out in the Final Report, having notified the Claimant, through Official Letter no. ... of 28 March 2013, of the decision to reject the administrative challenge filed.

4.11 Now, not accepting either the Assessment or the arguments on which the AT based its decision to reject the challenge, the Claimant filed, on 30 April 2013, a hierarchical appeal of the decision rejecting the administrative challenge, which appeal was rejected, as per Official Letter no. ... notified to the Claimant on 10 July 2015.

4.12 The correction to B...'s taxable profit, in the amount of €3,189,298.00, with the consequent correction to its tax losses, which was subsequently reflected in the Respondent, as the holding company of the Group, resulting in the Assessment that is now being challenged, originated from the correction made by the AT to the terms and conditions on which the related party transactions involving B...'s activity of manufacturing covers for seats were carried out.

4.13 In the course of its business, B... carries out various transactions with related entities.

4.14 In the year 2008, these transactions were as follows:

Revenues:

• Sales of goods and other products (covers for motor vehicle seats): €31,114,707, distributed among the following related entities:

• Respondent: €663,105;

• E... (Portugal): €497,626;

• F... (Spain): €53,410;

• G... (Spain): €340,784;

• H... (Morocco): €21,314;

• I... (France): €9,274,251;

• J... (France): €995,667;

• K... (France): €17,048,019;

• L... (France): €4,262;

• M... (France): €2,215,414;

• N... Poland: €105; and

• O... Tunisia: €750.

• Other Income (various pass-throughs, including pass-throughs to related entities for personnel and transportation costs): €226,895, distributed among the following related entities:

• Respondent: €6,761;

• E... (Portugal): €5,388;

• F... (Spain): €4,188;

• H... (Morocco): €4,278;

• P... (France): €740;

• M... (France): €45,764;

• I... (France): €5,625;

• J... (France): €82,385;

• K... (France): €50,063;

• O... Tunisia: €4,749.

• L... (France): €10,240; and

• Q... (Czech Republic): €6,764.

Costs:

• Acquisition of intra-group services (administrative support, industrial services and central services): €1,769,450, distributed among the following related entities:

• Respondent: €326,293;

• M... (France): €1,125,109;

• R... SA (France): €148,600; and

• S... (France): €169,448.

• Purchases of goods and other products (acquisition of components from the group, essential to B...'s production process): €550,486, distributed among the following related entities:

• Respondent: €28,744;

• P...(France): €132,078;

• M... (France): €15,865;

• J... (France): €870;

• L...(France): €378,496; and

• Q... (Czech Republic): (€5,567).

• Acquisition of fixed assets (machinery acquired from the group): €313,289, distributed among the following related entities:

• Respondent: €121,069;

• I... (France): €2,900; and

• Q... (Czech Republic): €189,320.

• Other charges (pass-throughs of invoices from independent suppliers and other allocations of central costs distributed among group companies): €408,058, distributed among the following related entities:

• Respondent: €151,440;

• E...(Portugal): €4,630;

• F...(Spain): €5,046;

• G...(Spain): €1,947;

• T... (France): €5,900;

• M...(France): €93,799;

• R... SA (France): €13,088;

• I... (France): €55,733;

• J... (France): €24,470;

• K... (France): €16,192; and

• L... (France): €35,813.

• Financial costs (loan obtained from the Respondent, whose balance at 31.12.2008 was €3,109,521):

• Respondent: €179,272.

• Royalties payable under a know-how license agreement entered into with M...:

M...(France): €635,100.

4.14 B...'s total revenues in 2008 amounted to €31,482,583.00, of which €31,341,602.00 were obtained from related entities.

4.15 In this regard, and in compliance with the provisions of article 63 of the CIRC and article 13 of Administrative Regulation no. 1446-C/2001, of 21 December (hereinafter "Regulation"), B... prepared a transfer pricing file, in which it detailed those which, by reference to each type of related party transactions (mentioned above), it considered to be the methods capable of ensuring the highest degree of comparability between the transactions it carried out and other substantially identical transactions carried out between unrelated entities.

4.15 For the reasons detailed in the economic analysis report of transfer prices of B..., relating to the financial year 2008, the methods considered most appropriate by B... were as follows:

• Regarding the sale of goods and other products: cost plus method, with the profitability indicator selected being the gross margin [calculated through the ratio between gross profit (i.e., the difference between sales revenue and the cost of goods sold and materials consumed) and the cost of goods and materials consumed];

• Regarding the acquisition of certain intra-group services: indirect allocation method, in accordance with allocation keys indexed to the type of services provided and the benefit resulting therefrom for B...;

• Regarding royalties: another method based on a variable of the comparable uncontrolled price method;

• Regarding intra-group financing: comparable uncontrolled price method.

4.16 Without calling into question the individualized analyses carried out in certain transactions (those referred to in the previous article), and in the impossibility of conducting an individualized analysis of the other related party transactions carried out (purchases of goods and other products, acquisition of certain intra-group services, acquisition of fixed assets, other charges and other income), B... decided to carry out an analysis of its overall activity in order to assess whether, in addition to the individually tested related party transactions, also at the operational level, and also considering these transactions, B... would be obtaining a market return.

4.17 The method used in this supplementary analysis was the comparable profits method, which, although not expressly provided for in the Portuguese regime, is nonetheless acceptable (see paragraph b), of no. 3, of article 63 of the CIRC and paragraph b), of no. 1, of article 4 of the Regulation). It should be noted that, in the application of this method, the profitability indicator selected was the net cost plus (calculated through the ratio between operating profit and total operating costs).

4.18 The results of the analyses conducted by B... pointed to the following conclusions:

• Regarding the sale of goods and other products: in applying the cost plus method, B... determined a gross margin, in the year 2008, of 57.1%. The companies taken as comparables showed, for the period 2005 to 2007, gross margins ranging from a minimum of 19.1% to a maximum of 82.9%. It can thus be concluded that, in the transactions of sales of goods and other products by B... to related entities, terms and conditions of arm's length were established, i.e., substantially identical to those that would have been obtained if these transactions had been carried out with independent entities;

• Regarding the acquisition of certain intra-group services: from the application of the allocation keys, B... concluded that an appropriate relationship resulted between the economic benefit obtained by it and the costs incurred for the services rendered to it;

• Regarding royalties: the royalties paid by B... corresponded to 2% on the net sale of products associated with the transferred technology. The companies taken as comparables determined royalty rates ranging from a minimum of 2% to a maximum of 5%. It can thus be concluded that the royalty rate applied to the agreement entered into between B... and M... was substantially identical to that which would have been practiced between independent entities; and

• Regarding intra-group financing: the financial costs paid by B... corresponded to an annual interest rate corresponding to the Euribor rate, plus a spread that varied between 0.45% and 1.70%. The companies taken as comparables determined interest rates ranging from a minimum of 3.24% to a maximum of 7.74%. It can thus be concluded that the interest rate applied to the financing agreement entered into between B... and the Respondent was substantially identical to that which would have been practiced between independent entities.

4.19 Regarding the analysis of B...'s overall activity, the application of the comparable profits method determined a net cost plus of (-) 6.9% in the year 2008, whereas the companies taken as comparables determined net cost plusses ranging from a minimum of (-) 1.3% to a maximum of 11.1%.

4.20 To justify the lower profitability margin of B..., regarding the analysis of its overall activity, various justifications were presented by the Claimant, all of them based on the severe economic crisis that affected the motor vehicle industry in 2008 and, consequently, that of its components such as B... and the Respondent.

4.21 The Claimant considers that, in what seems relevant to it for the purposes of this request for an arbitral ruling, the Report B... reflects the following position of the AT:

• It is presumed that it does not contest the methods adopted by B... regarding financial costs, royalties and acquisition of certain intra-group services;

• It does not accept the conclusions reached by B... from the application of the cost plus method, considering that the profitability indicator considered [gross margin, calculated through the ratio between gross profit (i.e., the difference between sales revenue and the cost of goods sold and materials consumed) and the cost of goods and materials consumed] "does not prove to be the most appropriate for purposes of verifying compliance with the Arm's Length Principle in these transactions (…)".

4.22 However, after having disregarded the application of the cost plus method and after having considered that B... did not demonstrate that the comparable profits method was the most appropriate for the related party transactions in question (sale of goods and other products), the AT nowhere in its report addresses what then is the "(…) method or methods capable of ensuring the highest degree of comparability between the transactions or series of transactions that (B...) carries out and other substantially identical ones, in normal market situations or 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" (no. 2, of article 63, of the CIRC).

4.23 Instead, it took the comparable profits method – a method that B... had used to test the individually untested transactions, and with merely supplementary effects of the individually tested transactions – and decided, without any substantiation – which is hereby alleged for all legal purposes – that this should be the method to use to ensure compliance with the Arm's Length Principle.

4.24 The weaknesses that are pointed out to B...'s comparability study are essentially the following:

• B... did not disregard companies with sales below €3,000,000, a limit that the AT considered appropriate as a result of the provisions of article 13 of the Regulation and paragraph b), of no. 2 of article 262 of the Commercial Companies Code.

o It should be noted that B... had only considered companies whose operating revenues amounted to at least €1,000,000 in each of the 3 years selected;

o However, this decision by B... was not accepted, as the AT considered that the limit of €3,000,000 "(…) is based on the underlying principle that entities subject to similar obligations are to be taken as comparable. (…) The criterion 'size of the entity taken as comparable' will facilitate the exclusion of 'start-up' companies and/or 'companies in a liquidation phase' (and consequently, not comparable with the company under analysis), but, essentially, this criterion contributes to ensuring that the comparable entities perform functions similar to the 'tested party' and present a similar competitive position" (p. 32 of the Draft Report B...).

• B... used a comparable (U... SL) which "(…) in the opinion of the Tax Inspection (…) does not ensure a reasonable degree of comparability (…)" (p. 38 of the Draft Report B...).

4.25 To these alleged weaknesses the AT added others, which it reproduced in the Report B..., namely:

• The activity of the companies taken as comparables "(…) does not consist of the activity of manufacturing covers for motor vehicle seats, but in an activity that B... understood to consider as similar to this (…)";

• "(…) There is a difference between B...'s sales volume in 2008 and that presented by the comparable entities (…)";

• "(…) The number of employees at B... is substantially lower than that presented by the comparable entities (…)".

4.26 Despite all the weaknesses found, the AT limited its inspection action to the following:

• It retained as appropriate comparables 7 of the 13 companies used by B... that presented operating revenues below €3,000,000;

• It retained as a comparable U..., despite having stated (p. 39 of the Draft Report B...) that "(…) the value of the weighted average of the profitability indicator considered is strongly influenced by the value for 2007 which is clearly inconsistent with the previous behavior of this entity (…) the observation in question (2007 financial year) presents characteristics of an outlier whereby (U...) should have been excluded from the analysis carried out" (our emphasis);

• It considered that arm's length conditions would be satisfied if it limited its action to attending to the interquartile range, basing this consideration on the provisions of §3.57 of the OECD Guidelines, from which it infers that "(…) whenever the comparability study presents limitations, the use of statistical measures (e.g. interquartile range), limiting the amplitude of the interval, may foster the reliability of the analysis";

• However, considering that B... had, in the course of the inspection process, alleged that it had in 2008 been affected by extraordinary situations that reflected a crisis in the automotive components sector – situations which, it should be said, the AT contested in its entirety – it decided that the correction to be advocated would be based on the value relating to the second quartile of the arm's length range, i.e., (+) 2.4%.

• It is from the correction of a net cost plus of (-) 6.9% to a net cost plus of (+) 2.4% that results the correction of taxable profit of €3,189,298.00 contained in Report B... and in the Final Report, which results in the corresponding correction in the value of the Group's tax losses and leads to the assessment of the surtax and the respective compensatory interest, reflected in the Assessment that is now being challenged.

4.27 This position was subsequently confirmed, both in the decision rejecting the administrative challenge and in the decision rejecting the hierarchical appeal.

4.28 Discretion stricto sensu, as the faculty of choosing one among several legal options, with a view to implementing an aim defined by law, does not appear to have acceptance in the context of tax law, insofar as in this branch of law, a constitutional principle of typicality prevails (article 103, no. 2 of the Constitution of the Portuguese Republic, hereinafter "CRP").

4.29 However, this figure of discretion in the strict sense is distinguished from another – that of free margin of appreciation or technical discretion of the AT.

4.30 In its activity of freely assessing facts or determining concepts, the AT is not authorized to choose, on a case-by-case basis, the outcome which, among several acceptable in the eyes of the law, proves to be more advantageous to the public interest, according to criteria of convenience and opportunity. It simply has, according to its experience and technical knowledge, autonomy in the choice of criteria that allow it to assess the facts in question, in order to find the most just and appropriate solution for the concrete case.

4.31 In the Claimant's opinion, it follows from what has been set out above that the AT cannot use article 63 of the CIRC and the Regulation to discretionarily choose one of several possible taxation outcomes, but only to substantiatedly analyze the reasons why it considers that the path chosen by the taxpayer is not the most appropriate and replace it with the most appropriate – which will be the one that will lead to the application of the legal norms, whether of the IRC, whether of the Regulation, or even of the OECD (which, although soft law, nonetheless have a relevant role in the interpretation of the methods for determining the arm's length principle, for which article 63 of the CIRC provides and which the Regulation so well embraces).

4.32 No. 3 of article 77 of the General Tax Law ("LGT") requires the AT to comply with certain requirements in substantiating the corrections to the taxable base made by application of article 63 of the CIRC.

4.33 Indeed, the application of article 63 of the CIRC implies increased care in substantiation, which obliges the AT to describe the special relationships, indicate the obligations unfulfilled by the taxpayer, apply the methods provided for in the law and quantify their respective effects.

4.34 In particular, paragraph c) of that provision requires the AT, after substantiating the obligations unfulfilled by the taxpayer (as referred to in paragraph b) of the same provision), to apply the "methods provided for in the law" – the law providing, for each situation only one method – the most appropriate – imposing further that priority be given to so-called traditional methods, among which is the cost plus method (no.1, of article 4 of the Regulation, in particular paragraphs a) and b)).

4.35 It is true that, in applying the "methods provided for in the law", the AT may use any elements at its disposal, with the AT's "duty to substantiate the elements of comparison" being considered adequately observed "even if from such elements are purged data capable of identifying the entities to whom they refer".

4.36 But it is no less true that, from this exercise, only one conclusion can result, namely that, after the same, the AT is bound to apply the method most appropriate to ensure the arm's length principle in the transactions or series of transactions it is analyzing (and correcting).

4.37 The Claimant thus submits that, regarding the burden of proof in the application of transfer pricing rules, the following should prevail:

It is the taxpayer's burden to prove that the transactions it carried out with related entities complied with the rule of no. 1 of article 63 of the CIRC – thus is it required, as the AT notes, by the provisions of no. 6 of article 63 of the CIRC and no. 1 of article 13 of the Regulation;

If it meets the requirements of no. 3 of article 13 of the Regulation, this proof will necessarily be contained in the Transfer Pricing File that it will have to prepare; otherwise, it must be in a position to demonstrate that, in determining that price, the method or methods that ensure the highest degree of comparability with identical or similar transactions between unrelated entities were adopted. This burden falls to it;

However, it cannot be an impossible burden, nor can it be required, at each moment, and given the complexity of these matters, that it be infallible in the adoption of the appropriate method. What seems essential to us is that there is an effort to state convincing factual and legal elements of the adequacy and correctness of the judgment on which the taxpayer based itself to conclude that a given method is the one that ensures the highest degree of comparability with identical or similar transactions between unrelated entities;

When a Transfer Pricing File exists, the presumption must be that the taxpayer stated these factual elements, compared the different methods in search of the most appropriate and took a position that is duly substantiated in that file;

Organized as it is in accordance with the law, the elements contained in the Transfer Pricing File are presumed to be true and prepared in good faith – by virtue of no. 1 of article 75 of the LGT;

If the AT considers that this is not the case, i.e., that the method adopted by the taxpayer is not the most appropriate method, then, in our opinion, it must demonstrate this – in other words, if it invokes this fact, then no. 1 of article 74 of the LGT imposes upon it the burden of proving it;

That is, the taxpayer must be able to prove that it used the most appropriate method. If it fails in this proof, because the AT considers it thus and the tribunal confirms it, then nonetheless, the law provides that to the prices practiced with related entities the most appropriate method must be applied. Now if the AT considers that this proof was not made, it then has the obligation to seek itself the method that is most appropriate;

In that search it may avail itself of the elements mentioned in paragraph c) of no. 3 of article 77 of the LGT but cannot fail to use them in strict observance of the principle of legality that governs article 63 of the CIRC, that is, that from that search, it must result the application of the method most appropriate to ensure the application of the arm's length principle.

4.38 The AT considers that the most appropriate method for B...'s transactions relating to the sale of goods and other products is not the cost plus method, considering that the profitability indicator considered [gross margin, calculated through the ratio between gross profit (i.e., the difference between sales revenue and the cost of goods sold and materials consumed) and the cost of goods and materials consumed] "does not prove to be the most appropriate for purposes of verifying compliance with the Arm's Length Principle in these transactions (…)".

4.39 If it is true that B... did not take into consideration the totality of production costs, it is no less true that, as it explained to the AT in a letter sent on 15 December 2011, the costs it took into consideration (COGS) are representative of a relevant portion of the totality of production costs of a motor vehicle seat cover and fully qualified to measure the verification of the arm's length principle.

4.40 Moreover, when it analyzed the results obtained by the 13 comparable companies, B... only took into consideration – for the calculation of the gross cost plus – the cost of goods sold and materials consumed of those 13 companies, with the exclusion of any other costs.

4.41 That is, by selecting as a profitability indicator – for purposes of applying the cost plus method – the gross margin, B... did not fail to apply the same indicator to measure the gross margin of the companies it used as comparables.

4.42 In Report B..., the AT does not question any of these data, nor even the value of any of the comparable companies (with the exception of U... SL, which it disqualifies and then ends up including in its exercise).

4.43 Given the foregoing, the Claimant considers that it made the proof required of it by no. 6 of article 63 of the CIRC and by no. 1 of article 13 of the Regulation and – in the same way that it demonstrated, and the AT accepted, that the comparable uncontrolled price method was the most appropriate for intra-group financing transactions, that a method based on a variable of the comparable uncontrolled price method was the most appropriate for transactions relating to royalties and that the indirect allocation method was the most appropriate for certain intra-group services – demonstrated that the cost plus method was the most appropriate for the transactions of "sales of goods and other products".

4.44 Insofar as the Respondent demonstrated that the method it used complied with the provisions of article 63 of the CIRC, which is hereby alleged for all legal purposes, the AT, in disregarding, without more, this method, incurred in a violation of law, whereby the Assessment issued should be annulled, with the other legal consequences.

4.45 But even if it were to be understood that B... did not fulfill the burden of proof imposed on it, the Claimant alleges that:

• The AT never substantiates, nor does it present any argument in this regard, regarding the disregard of the cost plus method as the most appropriate method to assess compliance with the arm's length principle in the transactions relating to "sales of goods and other products",

• The AT merely questions the formula used by B... to calculate the gross margin,

• Now, paragraph b) of no. 1 of article 4 of the Regulation establishes that the application of non-traditional methods can only be set aside when it is concluded that the same (a) cannot be applied or (b) "even if they can be applied, do not allow obtaining the most reliable measure of the terms and conditions that independent entities would normally agree, accept or practice".

4.46 The Claimant considers that the gross profit margin used by it was consistent with that it used for all the companies it took as comparables (the formula and the variables were exactly the same, as demonstrated in articles 90 to 93 above), whereby the result of this analysis was reliable and credible, and cannot be set aside solely because it did not take into consideration the totality of production costs.

4.47 But even if the AT did not wish to accept this formula, the answer should always have been to save the traditional method, determining the adjustments that corresponded to it, as required by no. 3 of article 8 of the Regulation.

4.48 Based on the foregoing, the Claimant considers unlawful, due to lack of substantiation, the disregard of the cost plus method, which, in the terms set out, proved to be the most appropriate to ensure compliance with the arm's length principle.

4.49 In the case of B..., the AT, after disregarding the application of the cost plus method – had one of 3 possible paths to take:

• If it considered that the comparable profits method was the most appropriate (to measure transactions relating to "sale of goods and other products"), but that the problem lay with the comparable entity U... SL, then §3.56 of the OECD Guidelines provided that it limit itself to eliminating that comparable:

o In that case, if the other comparables did not present insurmountable obstacles, the AT should have corrected B...'s operating result from (-6.9%) to (+1.8%);

• If it considered that the comparable profits method was the most appropriate (to measure transactions relating to "sale of goods and other products"), but that the problem lay with the comparable entity U... SL, and the fact that 7 other comparable companies should be eliminated because they had sales below €3 million, then §3.56 of the OECD Guidelines still provided that it limit itself to eliminating these comparables:

o In that case, if the other comparables did not present insurmountable obstacles, the AT should have corrected B...'s operating result from (-6.9%) also to (+1.8%),

• If it considered that other problems persisted, in addition to these, which put into question the very value of the comparable profits method and the comparables used in general, then the AT could not ensure the arm's length price with these data because, not serving the Respondent's thesis, they could not then serve the AT's thesis.

4.50 It happens that the final result applied by the AT [correction to (+ 2.4%)] is not reconciled with any of these 3 possible paths.

4.51 Indeed, in Report B..., the AT wavers between disregarding B...'s entire transfer pricing file for the year 2008, finding defects in all comparables, to disregarding only U...SL

4.52 However, after all the considerations made by the AT, it ends up concluding as follows (p. 43 of Report B...): "If the inclusion of the comparable entity U...SL is to be accepted, one should attend to the interpretation contained in §3.57 of the OECD Guidelines, which states that whenever the comparability study presents limitations, the use of statistical measures (e.g. interquartile range), limiting the amplitude of the interval, may foster the reliability of the analysis".

4.53 That is, it resolves the "problem" by accepting everything it had considered did not ensure compliance with the arm's length price, and limiting itself to excluding the minimum percentile of the arm's length range. The legal support for this decision: §3.57 of the OECD Guidelines!

4.54 Now, in the Claimant's opinion, it is exactly this approach that the law prohibits. Because §3.57 of the OECD Guidelines aims only to address situations in which it is not possible to identify or quantify the comparables that present a lower degree of comparability. For when that identification is possible, the solution is not that of §3.57 but that of §3.56 (elimination, with the corresponding effects, that is, application of the minimum percentile within the arm's length range, that is, in this case, (+1.8%)).

4.55 It is further important to take into account what is provided in §3.60 of the OECD Guidelines, which states as follows: "If the relevant condition of the controlled transaction (e.g., price or margin) is within the arm's length range, no adjustment should be made".

4.56 That is, from the moment the AT decides to include U... SL, as well as 7 of the 13 companies with sales below €3 million, two paths opened to it:

• Either it did not accept the explanations that B... offered to justify why its operating profitability (-6.9%) deviated from the minimum value of the arm's length range (which, if we consider the inclusion of U... SL, was (-1.3%)), and applied this minimum value (correction from -6.9% to -1.3%) or

• It accepted these explanations and did not alter B...'s operating profitability, or altered it to a value that lay below this minimum (-1.3%) and above the aforementioned (-6.9%).

4.57 What, in the Claimant's opinion, the law prohibited it from doing, was a path (which was the one it followed) by which, under the pretext of accepting B...'s explanations, the AT corrects its operating profitability, not to the minimum value of the arm's length range (- 1.3%), not to a value that lay between that and B...'s operating profitability, but to + 2.4%.

4.58 Moreover, it is a path that the Claimant cannot understand: so, after all, the explanations justifying B...'s lower profitability compared to the arm's length range, which went from a minimum of (- 1.3%) to a maximum of (+ 11.1%), are accepted, and then B...'s lower operating profitability is refused to be accepted, or even that profitability is fixed at the minimum threshold of the arm's length range?

4.59 It was incumbent on the AT to demonstrate that the comparable profits method was the most appropriate – stripped of the cost plus method – to ensure the arm's length principle in the transactions relating to "sale of goods and other products", proof which, in the Claimant's opinion – given what was set out above and the weaknesses that the AT decided to point out to that method – the AT did not make, a fact that cannot fail to be valued against it.

4.60 The inspection action carried out on B... was carried out following another inspection action, carried out on the Claimant, covering the financial years 2007 and 2008, which had given rise to a draft tax inspection report and a final report notified to the Respondent on 15 December 2010, and we will refer below to the draft tax inspection report – hereinafter "Report FAA".

4.61 Like B..., the Claimant also prepared a transfer pricing file in which it detailed those which, by reference to each type of related party transactions, it considered to be the methods capable of ensuring the highest degree of comparability between the transactions it carried out and other substantially identical ones, carried out between unrelated entities.

4.62 And, like B..., the Claimant also tested the operating return it obtained in the financial year 2008 through the comparable profits method, with the profitability indicator chosen being the net cost plus.

4.63 Based on the application of this method, an arm's length range was identified that varied between a minimum of (-) 1% and a maximum of (+) 9.3%.

4.64 Since the net cost plus of the Claimant in the financial year 2008 had been (-) 0.6%, it was possible to conclude that its operating return was contained within the arm's length range.

4.65 However, and despite considering that the Claimant could not carry out an aggregate analysis of its transactions – and therefore that the comparable profits method was not appropriate to demonstrate compliance with the arm's length principle – the AT ended up applying that method to correct the operating result of the Respondent for 2008, from (-) 0.6% to (+) 0.4%.

4.66 However, in doing so the AT did not base itself on the data determined in the period 2005 to 2007, but only and exclusively on the data determined in 2008.

4.67 Naturally, it is not the inspection of the Claimant that is at issue here, but what it wishes to highlight with references to its own inspection, is that in Report B..., the AT decided to adopt a completely different position.

4.68 On the one hand, whereas in the case of the Claimant the AT considered that it had not conducted an individualized analysis of the transactions carried out, in the case of B... it completely ignored the individualized analysis carried out, and from which resulted the application to goods and other products sold, of the cost plus method.

4.69 That is, in the case of B..., it disregarded the traditional method, without even considering what is required by no. 3 of article 8 of the Regulation, which provides that: "(…)[W]henever the transactions are not comparable in all aspects considered relevant and the differences produce a significant effect on the gross profit margin, the taxpayer must make the necessary adjustments to eliminate such effect, in order to determine the adjusted gross margin corresponding to that of the comparable uncontrolled transaction".

4.70 On the other hand, by disregarding the 2008 data of B... (attached to p. 40 of Report B...), which pointed to an interquartile range that varied between + 1.4% and + 6.4%, the AT made a completely different decision from that it had made for the Claimant.

4.71 Similarly, if the AT had used the 2005/2007 data, as it did, but had removed from the list of comparable companies U..., as it had insisted on in its reports, then the correction should have been made to the lowest of the intervals reached after that removal, that is + 1.8%.

4.72 In the Claimant's opinion, the AT is wrong, because the principle of legality requires that, in transfer pricing matters, the AT does not use any criteria, but rather seeks, in each case, a solution that allows reaching the arm's length price, thus also respecting the principle of taxation on actual income.

4.73 This amounts to saying that the Assessment of which we are now complaining is also unlawful for being based on a purely discretionary exercise by the AT, and not in function of the law (article 63 of the CIRC).

4.74 Furthermore, the AT "forgot" to substantiate how the correction it proposed should be taken into account by the Claimant.

4.75 Since, in transfer pricing matters, pursuant to no. 11 of article 63 of the CIRC, when "(…) corrections are made necessary for the determination of taxable profit by virtue of special relationships with another IRC or IRS taxpayer, in the determination of the taxable profit of the latter the appropriate adjustments must be made that are a reflection of the corrections made in the determination of the taxable profit of the former", principle that also applies when a Convention to Avoid Double Taxation is to be applied.

4.76 The omission of any reference regarding these questions is a serious omission of the AT's duty of substantiation, since from it results the impossibility of applying to the correction made the correlative adjustments that Portuguese law, as well as the Conventions Against Double Taxation entered into by Portugal, have come to guarantee to taxpayers.

4.77 The Claimant drew the AT's attention to this fact, and to all these questions, both in the administrative challenge and in the hierarchical appeal, but the answer the AT understood to give it was simply this, regarding the transactions carried out with Group companies (RETGS): "It should be noted that as determined in article 20 of the aforementioned Regulation, the adjustments to be made pursuant to the provisions of no. 1 of article 17, should be made after the passage in judgment whether administrative or judicial, of the positive corrections to taxable profit resulting from non-compliance with the arm's length principle in related party transactions" and this regarding transactions carried out with non-resident related entities: "In the case of related party transactions having occurred with non-resident entities, it is up to these entities to make the request for adjustment with their tax authorities".

4.78. It is true that no. 1 of article 20 of the Regulation establishes that these adjustments should be made within a period of 180 days counted from the passage in judgment "of the decision, whether administrative or judicial, of the positive corrections made to taxable profit (…)", but it is also true that it adds to this sentence the following: "(…) of the other taxpayer (…)".

4.79 In the case of the Claimant, there is not, as it is good to see, from the fiscal point of view, another taxpayer, as in the RETGS, all companies of the Group (thus, Claimant, B... and E...) are taxed as if they were a single taxpayer.

4.80 That is, insofar as the correction addresses all transactions carried out with related entities involved in the activity of manufacturing motor vehicle seat covers, the Assessment could not have failed to consider from the outset the impact that this correction would result in the consolidated taxable results of the Claimant.

4.81 When the AT refuses to make this "correlative adjustment" it is not merely violating the provisions it itself cites and says it applies – no. 11 of article 63 of the IRC Code and no. 1 of article 21 of Regulation 1446-C/2001 – but is effectively imposing on the Claimant a double taxation, which results automatically effective by the fact that it and B... are taxed under the RETGS.

4.82 Such inertia, in addition to violating the principle of legality and taxation on actual income, would also be violating the principle of good faith and, in particular, the provisions of no. 2 of article 266 of the CRP, article 55 of the LGT, article 10 of the Code of Administrative Procedure and articles 5, 6, 7, 9 and 21 of the Supplementary Regime of Tax Inspection Procedure (RCPIT).

4.83 The second aspect concerns the correlative adjustments regarding the part of the correction made by the AT that is allocable to transactions carried out between B..., on the one hand, and the other related entities, resident in France, Spain, Poland, Czech Republic, Morocco and Tunisia.

4.84 The problem, it is true, relates to the fact that the corrections proposed by the AT to B... are not based on transactional methods but on a method that measures the adequacy of the operating profitability margin of each company with the similar margin of other companies (unrelated).

4.85 That is, the corrections proposed by the AT are not directed to the transactions carried out with related entities, but to the adjustment, upward, of the profitabilities determined by B... in the financial year 2008 – which means it does not allow B... an allocation of the correction to the transactions actually carried out with each of its related party counterparts, non-resident, preventing these from requesting the appropriate correlative adjustments from the tax authorities of their Countries.

4.86 The AT responded to the Claimant saying very briefly that "In the case of related party transactions having occurred with non-resident entities, it is up to these entities to make the request for adjustment with their tax authorities".

4.87 The question is to know exactly what correlative adjustments each of these related entities should request.

4.88 And the answer to this question cannot fail to be given within the scope of the same inspection procedure in which the primary correction occurs, first of all because, whether the Arbitration Convention or the Double Taxation Conventions, impose a period of two or three years for this correlative adjustment to be requested, a period counted from the moment when the measure susceptible to originating a double taxation is notified.

4.89 Now, as it is good to see, it is impossible to comply with these deadlines if the non-resident related entities do not know what adjustments they should request, in the context and within the scope of the inspection in which the primary correction operates, for, if international law – which Portugal cannot fail to comply with –, grants them a period of two or three years counted from the moment that B... is notified of the measure susceptible to originating double taxation (i.e., at the moment of notification of the Assessment), then, at that moment, they cannot fail to be determined the criteria on which these adjustments depend.

4.90 Furthermore, article 63 of the CIRC is a provision which has as its object transfer prices "in commercial transactions, including, in particular, transactions or series of transactions on goods, rights or services, as well as in financial transactions (…)" (no. 1).

4.91 That is, no correction can be complete if it is not carried out by reference to the commercial or financial transactions of the taxpayer, which is equivalent to saying that, when the AT decides to correct the taxpayer's transfer prices through the application of a non-transactional method – i.e., a method that determines the arm's length price by reference to global criteria – it cannot then fail to allocate this correction to the commercial or financial transactions carried out by this taxpayer, under penalty of failing to comply with the provisions of no. 1 of article 63 of the CIRC.

4.92 If we check the content of the Assessment, we will easily find that:

• from it does not result that there has been any correction to the tax losses of the Claimant, as nothing is indicated in this regard in the corrected amounts;

• it indicates tax losses of zero, when, even after the correction, the Claimant would continue to have reportable losses of €4,623,084.49;

• it indicates a refund amount of €28,855.42 – with no explanation being given for the respective calculation, obliging the Claimant to individual accounts to seek to understand the relationship between this number and the corrections made;

• the accrual and reversal transactions mentioned in that document are not, even minimally, explained.

4.93 These shortcomings constitute a clear violation of the right to substantiation constitutionally guaranteed insofar as they prevent the Claimant from fully understanding the Assessment and thus safeguarding its rights by contesting the arguments and calculations made by the AT.

4.94 It should be noted, in this regard, that the Claimant is not unaware that, at the basis of the Assessment, is Report B... drawn up by the AT; however, it is unable to ascertain to what extent the corrections made are reflected in the Assessment, in particular why tax losses of €0.00 are indicated (when in reality these are €4,623,084.49), because a refund of €28,855.42 is determined and, subsequently, an amount payable of €8,117.46.

4.95 Now, in the case under discussion, the Claimant is unable to understand the Assessment drawn up, which has made it impossible for the taxpayer to have concrete knowledge of the motivation of the act.

4.96 Indeed, even if it were admitted that the reference to another document, supported by an Inspection Report, would be sufficient for substantiation of the act (as the AT claims when it mentions in the Assessment the "substantiation already referred to") – which is not granted – note that, even seeking to establish a relationship between these documents, it is not possible to ascertain with certainty the reasons for the exigibility of this tax and the manner in which the corrections made in respect of the Final Report were calculated and reflected in the Assessment resulting in tax payable by the Claimant.

4.97 In this regard, it should be emphasized that the tax assessment procedure cannot be understood as a puzzle that taxpayers must patiently attempt to put together, choosing from among several pieces the one that fits in the already constructed part, characterized by a succession of hermetic acts, without any explanation, impossible to comprehend beyond the amount payable and the deadline for payment, being that in the present case it is the conviction of the Claimant that the said duty of substantiation was not observed, insofar as an average taxpayer (and even a taxpayer with training and knowledge above average) cannot understand the calculations made by the AT, nor why tax losses of €0.00 are indicated (when in reality these are much higher), or why a refund of €28,855.42 is determined and, subsequently, an amount payable of €8,117.46.

4.98 To this extent, the Assessment of which we are now complaining cannot fail to be considered unlawful, for violation of the provisions of article 268 of the CRP, a provision that guarantees to parties the right to express and accessible substantiation of all acts that affect rights or legally protected interests, and in that vein also unlawful for violation of the provisions of article 77 of the LGT.

4.99 The Claimant proceeded, on 20 June 2012, to pay the amount of tax determined.

4.100 Pursuant to no. 1 of article 43 of the LGT, compensatory interest is due when it is determined that there was an error attributable to the Services in the payment of the tax debt in an amount greater than that due.

4.101 As set out above, the Assessment and respective compensatory interest suffers from a defect of violation of law, due to incorrect interpretation and application of the law, which constitutes an error attributable to the Services, whereby compensation interest is requested at the legal rate in force, from the day following the overpayment, until the date of issue of the respective credit note, pursuant to the terms prescribed in articles 43 of the LGT and 61 of the CPPT.

1. For its part, the Respondent Tax and Customs Authority presented a response, in which it defended itself, in summary, in the following terms:

5.1 First, it gave as reproduced the inspection report underlying the assessment which it attached to the administrative record.

5.2 Indeed, through service order number OI2011... issued on 29 August 2011 by Order of the Head of the Division of Non-Financial Companies – II, by delegation of powers from the Director of Services, an inspection action was conducted on the Claimant, with the notice letter sent through Official Letter no., of 30 August 2011.

5.3 The purpose of the inspection action, of partial scope, focused on the Corporate Income Tax (IRC), aiming, in particular, to assess whether the terms and conditions practiced in related party transactions are in conformity with the Arm's Length Principle provided for in number 1 of article 58 of the IRC Code, and focused on the financial year 2008.

5.4 On 15 November 2011, the inspection action commenced with a copy of the Service Order being delivered to the taxpayer, as required by article 51 of the RCPIT.

5.5 On 20 December 2011, the Diligence Note was delivered to the taxpayer, in compliance with the provisions of no. 1 of article 61 of the RCPIT and the inspection action concluded.

5.6 The purpose of the inspection action had a partial scope regarding the Corporate Income Tax (IRC), aiming, in particular, to assess whether the terms and conditions practiced in related party transactions are in conformity with the Arm's Length Principle provided for in number 1 of article 58 of the IRC Code, and focused on the financial year 2008.

5.7 According to the Functional Analysis Report of Transfer Prices, it is stated that: "Initially, B... appears as a manufacturer of motor vehicle components that operated on a just-in-time basis for the ... Portuguese, located in Setúbal. Following the closure of this multinational company, B... was deactivated during 1998 and 1999, subsequently being relocated to Vouzela, being reborn with its current business activity. Thus, from 2001 to early 2005, B... provided only cutting and sewing services to A.... From that date on, B... ceased to be a service provider entity to become fully integrated into the value chain of the products it manufactures".

5.8 Regarding this type of transactions and because we are in the context of special relationships (not contested by the Claimant), B..., pursuant to no. 1 of article 13 of Regulation 1446-C/2001, of 21/12, and no. 6 of article 58 of the IRC Code should maintain the documentation relating to the policy adopted in determining transfer prices.

5.9 Related party transactions concern five types, namely:

• Sales of goods and other products;

• Analysis of B...'s overall activity;

• Acquisition of Administrative Support Services to A...;

• Payment of royalties to M... for know-how licensing;

• Intra-group financing.

5.10 The values associated with related party transactions are as follows in the following table:

[Table content preserved as in original]

5.11 The inspection services determined negative operating and tax results in the sphere of B..., carrying out an aggregate analysis of the years 2006, 2007 and 2008.

5.12 According to the Transfer Pricing File, B... indicates that the Cost Plus Method was used and as a profitability indicator, the Gross Margin calculated through the ratio between gross profit (i.e., the difference between sales revenue and the cost of goods sold and materials consumed) and the cost of goods sold and materials consumed.

5.13 In turn, it concluded that the gross return obtained is within the arm's length range determined by the set of companies considered as comparables (interquartile range varying between 36.7% and 72.3 for the financial year 2005 to 2007) given that in 2008 B... determined a gross margin of 57.1%.

5.14 Now, the set of companies considered as comparables are the same companies that relate to the overall activity of manufacturing covers for motor vehicle seats, but in this case, the indicator considered was the gross margin.

5.15 According to the Inspection Services, the profitability indicator considered by B... does not prove to be the most appropriate for purposes of verifying compliance with the Arm's Length Principle in these transactions, given that the cost base considered does not incorporate all costs directly related to the activity of "Sale of goods and other products", not incorporating the totality of production costs of a motor vehicle seat cover (approximately 60%).

5.16 According to the Tax Inspection Services, the analysis carried out by B... did not allow any conclusion to be drawn regarding the adherence to the Arm's Length Principle in "Sales of goods and other products", insofar as the gross margin that was calculated for each of the entities taken as comparables was obtained through the following ratio (Sales revenue – Cost of materials) / Cost of materials.

5.17 Thus, we are not facing a gross margin in the sense of comparing the selling prices of manufactured products minus the industrial cost of the products sold (as we are facing an industrial entity).

5.18 That is, B... merely compared the extent to which the selling price of manufactured products covered the cost of materials incorporated into production.

5.19 It was thus concluded that the analysis carried out does not allow the drawing of any conclusion regarding adherence to the Arm's Length Principle in these transactions, as it should have included in the cost base all those related to the manufacturing activity (ex: labor costs of the manufacturing sector, insurance, etc.).

5.20 Now B... acknowledges that the ratio used for purposes of applying the cost plus method does not take into consideration the totality of production costs of a motor vehicle seat cover (approximately 60%).

5.21 As a supplementary measure, a comparability study was carried out regarding the overall analysis of B...'s activity using the SABI commercial database (having additionally carried out a review of this study using the OneSource database).

5.21 The transfer pricing method used was the comparable profits method which is based on the comparison of a profitability indicator, which is calculated with reference to the overall activity of the taxpayer and a set of independent entities considered comparable.

5.22 The application of the comparable profits method was based on the search process referred to above, within which 13 independent companies were identified, of which 12 are resident in Spain and one in Portugal.

5.23 The profitability indicator used was the net cost plus, determined through the division of operating profit by total operating costs.

5.24 The following table contains, for the ratio "net cost plus", the values determined by Sasal in the financial years indicated there:

[Table content preserved as in original]

5.25 Based on the values determined by the comparable entities, the following interval was determined:

[Table content preserved as in original]

5.26 From the comparison of the "Net Cost Plus" indicator of B... (-6.88%) with the values of the range constructed from the data of the entities taken as comparables by the taxpayer in the Transfer Pricing File relating to the financial year 2008, B... presented a value below the minimum value of this range (-1.3%; 11.1%), whereby the Inspection Services concluded that the conditions practiced diverge from those that would be practiced between independent entities.

5.27 As described in number 2.1 of point III 1.1.1 of the inspection report contained in the administrative record, between B... and the entities indicated there exist special relationships by virtue of paragraphs a) and b) of no. 4 of article 58 of the IRC Code, whereby, in conformity with number 1 of that article, in these related party transactions terms or conditions substantially identical to those that would normally be contracted, accepted and practiced between independent entities in comparable transactions must be contracted, accepted and practiced.

5.28 As contained in the inspection report the grounds were presented on which in the related party transactions carried out by B..., during the financial year 2008, and which were subject to the presentation of a comparability study in the Transfer Pricing File, terms and conditions of arm's length were not established, whereby it is considered that there was a violation of the provisions of no. 1 of article 58 of the IRC Code.

5.29 B... sought to justify the framing outside the range contained in the Transfer Pricing File, alleging that:

• It had start-up costs with new projects;

• The impact of the 2008 global crisis on B...'s operating activity sphere, with the data used as comparables (2005-2007) still not incorporating this effect;

• Realization of significant investments in tangible fixed assets.

5.30 However, the Inspection Services understood that the limitations resulting from the weaknesses identified, the OECD recommends that the amplitude of the interval to be considered be limited (eg: through the consideration of the interquartile range), in order to increase the degree of comparability of the entities taken as comparables and to increase the reliability of the approximation to arm's length terms and conditions.

5.31 In the same vein, number 5 of article 4 of Regulation 1446-C/2001, of 21/12, establishes that the interval of values to be considered for purposes of determining normal market conditions should be composed of a set of values that ensure a reasonable degree of comparability.

5.32 Now if weaknesses were identified in the comparability study carried out by the taxpayer, this means that there are points within this interval that do not ensure the same degree of comparability as the others, which will naturally be the extremes of the same insofar as independent entities developing similar activities tend to determine similar values.

5.33 Therefore, for purposes of determining the amount of violation of the Arm's Length Principle, the interquartile range of the comparability study contained in the Transfer Pricing File was attended to. From the application of the Arm's Length Principle provided for in no. 1 of article 58 of the IRC Code from which results that B...'s taxable result is undervalued by €3,189,298.

5.34 A positive correction to the taxable profit declared by the taxpayer – in the amount of €3,189,298, pursuant to the provisions of article 58 of the CIRC (current article 63 of the IRC Code), was made.

5.35 The additional assessment contested, relating to the taxation period of 2008, was originated by the corrections made in the internal inspection action report of partial scope to the subsidiary company B..., S.A..

5.36 The Claimant, in its capacity as holding company of the Group covered by the Special Regime for Group Company Taxation, contests both the correction promoted to B...'s taxable profit, in the amount of €3,189,298.00, with the consequent correction to its tax losses that came to be reflected in the Claimant as holding company, as well as the consequent assessment of the surtax and compensatory interest, which resulted in an amount payable of €8,117.46.

5.37 The correction to the taxable profit has at its basis a transfer pricing adjustment translated into the disregard of the global profitability indicator (designated by net cost plus) of -6.9% to a net cost plus of + 2.4%.

5.38 The AT submits that, within the scope of the inspection action, it complied with the duty to substantiate the corrections, as prescribed in no. 3 of article 77 of the LGT, meeting the requirements there stated by proceeding in particular to the analysis, both of the methods used by the taxpayer for the determination of transfer prices, comparing each one of them, in order to elect the method or methods considered most appropriate to ensure the arm's length principle, and of the comparability analysis contained in the Transfer Pricing File (hereinafter, TPF) and as a result of the deficiencies detected, proceeded to quantify the adjustments corresponding to the deviation in the observance of the arm's length principle.

5.39 Indeed, within the scope of the activity developed, B... carried out related party transactions of different nature, namely:

5.40 Categories of transactions carried out in the three-year period 2006-2008 Values in Euros

[Table content preserved as in original]

5.41 The inspection action with a view to assessing whether, in conformity with the provisions of no. 1 of article 58 of the IRC Code, in related party transactions terms and conditions substantially identical to those that would normally be contracted, accepted and practiced between independent entities in comparable transactions were practiced, focused, first, on the transactions "Sales of goods and other products".

5.42 The departure from the Cost Plus Method (MCM) - Regarding transactions of sale of goods and other products to related entities, although the validity of the method selected by B... was not called into question in itself – the Cost Plus Method – it was however considered that the form of calculation of the profitability indicator selected did not prove, in light of the nature and specific circumstances of the company's activity, to be the most appropriate for purposes of verifying compliance with the arm's length principle in these transactions, for the following reasons:

• the gross margin was calculated through the ratio between gross profit (i.e., the difference between sales revenue and the cost of goods sold and consumed) and cost of goods sold and consumed;

• given that this is a manufacturing activity, the cost of products sold – motor vehicle seat covers - should incorporate all costs directly related to production and only the cost of materials consumed; and

• the ratio used for purposes of applying the cost plus method incorporates approximately 60% of the totality of production costs.

5.43 Thus, notwithstanding B..., as a result of the comparability analysis carried out, based on a sample of 13 independent companies taken as generically comparable, concluding that the gross return obtained – translated by the Gross Margin calculated according to the formula referred to above - was within the arm's length range (interquartile range), the deficiencies affecting the calculation of the indicator used are susceptible to skew the result of the analysis, removing its reliability, and therefore was disregarded as valid for purposes of assessing compliance with the arm's length principle.

5.44 According to paragraph 2.42 of OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administration (hereinafter Guidelines), "(…) If the cost plus method were being applied, the mark ups being compared in the controlled and uncontrolled transactions would be the difference between the selling price by the manufacturer to the distributor and the costs of manufacturing the product, divided by the costs of manufacturing the product.(…)", that is, when the transactions in question have as their object manufactured products, the calculation of the "gross margin" indicator should take as its basis the "manufacturing costs".

5.45 Thus, by not taking into consideration in the calculation of the cost of goods sold and materials consumed a significant part of manufacturing costs, namely, the costs relating to personnel engaged in production, it is no longer possible to ensure with a minimum of certainty whether the results obtained in the comparability analysis of "gross margin" would be those obtained by B....

5.46 The position of the Claimant is not correct that, even so, the AT should have endeavored to save the traditional method, determining the adjustments that corresponded to it, pursuant to no. 3 of article 8 of the Regulation.

5.47 Because the AT could not be given the burden of such an exercise, which would involve complex calculations, in terms of management accounting, which B... itself did not wish to carry out, having, alternatively, resorted to another methodology to confirm the results of the application of the Cost Plus Method.

5.48 Indeed, the discomfort and insecurity associated with the results of the use of the Cost Plus Method are apparent in the Report on Economic Analysis of Transfer Prices

5.49 That is, the reasons for the selection of the comparable profits method were accepted by B... itself which likewise recognized it with sufficient merits to qualify it as the most appropriate method, having in mind the facts and specific circumstances of its activity and the data available for analysis.

5.50 Faced with this option of B... for recourse to the comparable profits method and given the reservations raised as to the reliability of the result obtained with application of the Cost Plus Method to ensure whether the arm's length principle would be observed, the AT could not fail to verify its application, especially since, faced with the diversity of related party transactions carried out by B..., this method was the one that proved most apt to assess the overall operating return obtained by the Company in its activity.

5.51 Consequently, the alleged illegalities in which, according to the Claimant, the AT incurred, stated in article 53 of the PI, for not substantiating the reasons why the Cost Plus Method is not the most appropriate method to determine the arm's length price and for not promoting the adjustments referred to in no. 3 of article 8 of Regulation no. 1446-C/2001, do not proceed, as explained above.

5.52 In this way, the application of the comparable profits method although, as is recognized by the Claimant, this method is not expressly provided for, either in no. 3 of article 63 of the IRC Code, or also in no. 1 of article 4 of Regulation no. 1446-C/2001, is subsumible in the residual category of "another appropriate method" reserved for cases in which the traditional methods cannot be applied or, even if they can be applied, do not allow obtaining the most reliable measure of the terms and conditions that independent entities would normally agree, accept or practice.

5.53 The profitability indicator selected for purposes of comparison with independent entities taken as comparables was the net cost plus corresponding to the ratio between operating profit and total operating costs.

5.54 The comparability analysis carried out by B... was based on a set of 13 independent companies that had already been subject to selection in the context of the application of the Cost Plus Method, which allowed the construction of an interval of weighted average margins of arm's length conditions, with reference to the net cost plus, for the period 2005-2007, whose minimum and maximum limits were respectively -1.3% and 11.1%, the median of 4.7% and with the interquartile range situated between 2.5% and 6.7%.

5.55 Comparing the values of the interval with the values of this indicator recorded by Sasal (contained in the Table below, it is verified that these, besides being negative, in any of the years, are below the minimum limit of the arm's length range.

[Table content preserved as in original]

5.56 The reasons provided by B... to justify why the net cost plus indicator calculated for 2008 lay below the minimum threshold of the range (-1.3%) and therefore outside the arm's length range, pointed to specific circumstances of the Company's activity, resulting from the business cycle and the conjunctural crisis of the motor vehicle components sector.

5.57 The AT's Inspection Services did not consider that the explanations provided had sufficient relevance to determine the carrying out of adjustments to the values of the arm's length range.

5.58 In an attempt to refine the consistency of the comparability analysis, in order to, pursuant to the provisions of no. 5 of article 4 of Regulation no. 1446-C/2001, lead to a range of values that would ensure a reasonable degree of comparability and to find the value of overall return of the activity that best conformed to the arm's length principle, IT conducted a more analytical exercise and, in that context, began by analyzing the selection criteria of entities taken as comparables.

5.59 Thus, having as a basis one of the criteria susceptible to affecting the comparability of data from observations extracted from entities in the sample, referred to in paragraph 3.43 of the Guidelines, which relates to economic size assessed in terms of Sales, Assets or Number of Employees, the question was raised as to whether the selection threshold of entities should not have been aligned with the value of net sales and other revenue, fixed in no. 3 of article 13 of Regulation no. 1446-C/2001, of €3,000,000, for purposes of the obligation to have the Transfer Pricing File.

5.60 However, as easily appears from the RIT (point 4.2, in fine) the use of this criterion was not found to be determining for the exclusion of U... or other companies selected, once recognized that this is one of the selection criteria that should be subject to consideration not in isolation but, rather, together with other factors.

5.61 In a second step, the reasons were analyzed why the data relating to U... SL- the only entity taken as comparable, which, for the net cost plus indicator, presented, in the three-year period 2005-2007, a weighted average value that was negative (-1.3%) which resulted exclusively from, in 2007, having registered a value of -7.9%, as the values of 2006 (+2.1%) and 2005 (+1.3%) were positive – deviated from the other observations of the range and the way in which the bias resulting therefrom could be neutralized.

5.62 In line with the guidance contained in paragraphs 3.56, 3.59 and 3.63 of the Guidelines which recommend that [document truncated at character limit]