CAAD 54/2018-T: IRC Deductibility of Costs and Transfer of Charges in Intragroup Transactions

ARBITRAL DECISION (consult complete version in PDF)

They agree in arbitral tribunal

I – Report

1. A..., S.A., legal entity number ..., with registered office at ..., Place of ..., ...-... ..., hereby requests the constitution of an arbitral tribunal, pursuant to articles 2, no. 1, paragraph a), and 10 of Decree-Law no. 10/2011, of 20 January, to examine the legality of the tax acts of additional Corporate Income Tax assessment no. 2017..., relating to the taxation period of 2014, which gave rise to the statement of account reconciliation no. 2017..., in the amount of € 1,405,215.82, and further requesting condemnation to the payment of compensatory interest.

It bases the request on the following grounds.

The Claimant is a joint-stock company whose principal object is the wholesale trade in clothing and accessories, trade in ready-made garments and ready-to-wear clothing and maintains a distribution structure consisting of a network of commercial establishments totalling 824 establishments with presence in 60 countries.

The Group to which the Claimant belongs, designated as Group B..., is headed by the company C..., S.A. which is held by the company D..., S.A., an entity domiciled and tax resident in Luxembourg, and operates in the market through its own stores and franchising contracts.

Having decided to adopt a strategy of international expansion, the Group found the necessity to position itself in the market through subsidiaries of the Group's parent company, C..., and, in particular, through E... SL, in Spain, F... SARL, in France, G..., in Poland, H... GmbH, in Germany, and I... SRL, in Italy, with which the Claimant established a model of commercial relationship, the terms and conditions of which are set out in the Supply and Prime Retailing Agreement.

The Retailing Agreement establishes a partnership relationship between the Claimant and those entities, which exercise in the market the function of distributors of B... products, acting in the locations as indicated by the Claimant and under its strategic guidance, assuming such entities the nature of limited risk distributor.

The logic underlying the Retailing Agreement presupposes a model of intra-group relationship under which the Claimant's sister companies are remunerated having regard to the activity they develop and the risks they assume, through a target margin at the operational level, whereby the Claimant assumes the gains or losses arising from the business, after deducting the remuneration paid to the subsidiaries.

The Retailing Agreement acts as a catalyst element for the publicity of B..., which is proven by the increase in the number of stores between 2013 and 2015 (from 471 to 671), and a growth in sales volume exceeding 25% per year, in addition to translating into indirect effects related to the increase in the size of the Claimant and the consequent increase in its bargaining capacity with its main suppliers, with advantages in the purchase prices of the products it markets and in its gross margin.

The Prime Retailers act, therefore, as exclusive distributors of B... products in the markets where they are located, but do not have the power to set the retail prices of their products, nor do they influence the discount or sale policy, but have the right to be compensated for the functions performed and the investment borne.

For that reason, B... products are sold exclusively by A... and invoiced under normal terms, but it is agreed that said compensation operates through a guarantee of operating margin fixed at 3% to be granted to the Prime Retailer (article 5, no. 5, of the Retailing Agreement).

Thus, in the event that the resale gross margin of one of the Prime Retailers leads to an EBIT (Earnings Before Interest and Taxes) greater than 3%, A... shall issue debit notes in correction of the previously agreed selling price, with a view to restoring the target operating margin; and, conversely, whenever the EBIT of one of the Prime Retailers is less than 3%, A... shall issue credit notes in correction of the selling price that will lead to the 3% margin.

Since that operating margin can only be measured upon determination of results, the debit or credit resulting therefrom for the Prime Retailer may only translate into concrete financial flows at the end of the fiscal year, and these flows are at issue in this process.

In the context of the inspection procedure intended to analyse the Claimant's relationships with related entities in other Member States of the European Union, a correction to taxable income was proposed in the amount of € 4,742,715.00, based exclusively on the tax disregard of expenses incurred under the Retailing Agreement, which the Tax Authority (AT) understood were not deductible under article 23 of the Corporate Income Tax Code.

In broad outline, the AT argues that the amount credited by B&R under the agreement resulted, as a general rule, in excess tax paid in the jurisdictions where the other Group entities are located and less tax paid in Portugal, implying an alleged tax saving of approximately 806 thousand euros.

Now, the nuclear element of the concept of tax-deductible expense is that of the causal relationship with the company's interest and the pursuit of its respective activities, formerly regarded through the concept of indispensability of expenses for obtaining income or maintaining the source of income production.

Therefore, it will always be unacceptable any general clause that permits the Tax Administration to judge and supervise the opportunity and deductibility of business decisions that result in economic loss for the company, only being possible to eliminate expenses that present, at all, no affinity with the company's activity, such as, for example, expenses relating to private expenses of shareholders, managers or administrators, or with third parties, foreign to the company.

In this case, the connection between the expenses borne and the realization of income subject to tax is verified, and the causal relationship established between corporate interest and the activity pursued is unequivocal, and the insufficient formal support of the expenses cannot even be invoked.

The economic effects of the Retailing Agreement could, at most, have only given rise to inspective scrutiny in respect of transfer pricing, and the AT when stating that "through these agreements the group implemented for itself a kind of special taxation regime", which implied the "transfer of results from Portugal to other countries", leaves implicit that expenses borne in the context of the Retailing Agreement could be disregarded for tax purposes because they occurred between group-related companies.

However, the Tax Administration makes no demonstration that the transfer pricing principles were observed.

It finally requests the annulment of the tax act in question due to error in the legal premises in the application of article 23 of the Corporate Income Tax Code, and, should it be understood that the correction was based on article 63 of the Corporate Income Tax Code, due to lack of substantiation and clear absence of violation of the arm's length principle.

In its response, the Tax Administration argues that the remuneration attributed to the subsidiaries corresponding to an operating margin of 3% of their sales volume, under the agreement designated as Retailing Agreement, in order to guarantee them a certain operating profitability, corresponds to an assumption of expenses belonging to those companies, which ultimately results in grant financing and which, with regard to the fiscal year 2014, had a negative impact on the Claimant's economic results of €4,742,715.00.

The expenses incurred did not directly imply the obtaining of higher income for the taxpayer nor is it demonstrated that, indirectly, it had an impact on the Claimant's commercial situation, generating instead a reduction in the taxable income of A... and the consequent dispersion to other countries of the European Union.

Concluding that the determination of the tax result of each company cannot be affected by expenses that pertain to other entities, whereby although it may be understood that the business may have interest in the economic account of the group as a whole, the expenses assumed cannot be tax deductible for the Portuguese company under article 23 of the Corporate Income Tax Code.

2. Following the process, the meeting was held as referred to in article 18 of the Rules of Procedure of the Tax Arbitration Centre, in which the testimonial evidence indicated by the parties was produced.

In successive memoranda, the parties pronounced themselves on the probative results arising from the process elements and the testimonial evidence produced and, moreover, maintained their previous positions.

3. The request for the constitution of the arbitral tribunal was accepted by the President of the Tax Arbitration Centre and notified to the Tax and Customs Authority in accordance with the applicable regulations.

Pursuant to paragraph b) of no. 2 of article 6 of the Rules of Procedure, as amended by article 228 of Law no. 66-B/2012, of 31 December, the arbitrators were designated by the parties, and the president arbitrator was designated by the Ethics Council.

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

The parties were duly notified of that designation and did not express the will to refuse it, in accordance with the combined provisions of article 11, nos. 4 and 5, of the Rules of Procedure and articles 6 and 7 of the Code of Ethics.

Thus, in conformity with the provision in no. 7 of article 11 of the Rules of Procedure, as amended by article 228 of Law no. 66-B/2012, of 31 December, the collective arbitral tribunal was constituted on 7 May 2018.

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

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

The process is not affected by nullities, the exception of res judicata having been invoked.

It is within our competence to examine and decide.

II – Reasoning

Factual Matter

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

- The Claimant was the subject of an inspection procedure, authorized by Service Order no. OI 2016..., intended to analyse relationships with other entities domiciled in Member States of the European Union;

- The Claimant is a joint-stock company whose principal activity is the wholesale trade in clothing and accessories of the B... brand, operating in the domestic and international market through the operation of a network of its own stores and in franchising arrangements made with other operators;

- The Claimant is part of the B... Group, headed by the company C..., S.A. which is held by the company D..., S.A., domiciled and tax resident in Luxembourg, and which, as of 31 December 2014, had a total number of 528 stores in the domestic and international market;

- Aiming at a strategy of commercial expansion, the Group chose to position itself in the international market through subsidiaries of the parent company with a view to opening its own stores in more competitive locations.

- Which came to pass through E... SL, in Spain, F... SARL, in France, G..., in Poland, H... GmbH, in Germany, and I... SRL, in Italy;

- The implementation of stores in particularly competitive international markets, such as those mentioned in the previous paragraph, entail high investment and operating costs, especially with expenses for installation, rental contracts and employment relationships;

- The subsidiary companies act as distributors/resellers of B... products under the control and strategic management of the Claimant, in particular with regard to the location of stores, promotional campaigns and marketing activities;

- The Claimant established with the subsidiaries that were established in neighbouring countries a model of commercial relationship by means of the Supply and Prime Retailing Agreement contract.

- The remuneration of the commercialization of B... products was set in clause 5 of the Supply and Prime Retailing Agreement as follows:

1. The remuneration of the subsidiary for the functions performed under this agreement, as Prime Retailer, shall correspond to the difference between the selling prices agreed with its customers and the acquisition prices agreed with A..., S.A.

2. The acquisition price shall be calculated so that each product group can produce identical and consistent margins.

3. A list of acquisition prices thus calculated shall be provided periodically by A..., S.A.

4. The margin on each product shall be reviewed periodically in accordance with the evolution of the resale price and the general cost structure of the subsidiary to adequately compensate the subsidiary for the functions performed, own or leased goods used and risks borne under this contract.

5. Considering the factors pointed out in item 4, both parties estimate that an adequate remuneration will be the equivalent of an operating margin of 3% of its sales volume.

6. This percentage shall be reviewed in accordance with the factors set out in item 4.

- At the end of the fiscal year, the Claimant issues debit notes in correction of the price previously agreed if the operating result is greater than 3% or credit notes in correction of the price previously agreed if the operating result is less than that percentage, with a view to restoring the operating margin previously stipulated;

- The payment of that operating margin resulted in the 2014 period in a tax loss in the Claimant's results of € 4,742,715.00;

- The Tax Administration considered that the expenses borne by the Claimant in those terms are not deductible for tax purposes, according to article 23 of the Corporate Income Tax Code, insofar as these are not expenses incurred to obtain or guarantee income subject to tax;

- As of 31 December 2013 the total number of B... stores was 471;

- Between 2013 and 2015, 146 new stores opened worldwide, verifying a global growth in number of stores;

- There was also an increase in sales volume which was € 40,000,000 in 2010 and rose to € 120,000,000 in 2015;

- The Claimant was notified of the additional Corporate Income Tax assessment note no. 2017..., relating to the taxation period of 2014, which gave rise to the statement of account reconciliation no. 2017..., in the amount of € 1,405,215.82.

The Tribunal formed its conviction regarding the established facts based on the documents attached to the petition and the administrative proceeding attached by the Tax Authority with the response and the testimonial evidence produced in hearing.

Matters of Law

5. The question that arises is whether the remuneration attributed to the Claimant's sister companies domiciled in foreign countries, corresponding to 3% of the sales volume of products supplied by the Claimant, is deductible for tax purposes under article 23, no. 1, of the Corporate Income Tax Code depending on its connection with the realization of income subject to tax.

The focal point concerns the very characterization of the partnership established between the Claimant and the subsidiaries and which, in broad outline, amounts to the following.

The Claimant is part of the B... Group, which, for a strategy of commercial expansion, decided to position itself in the international market through subsidiary companies of the parent company by opening its own stores in locations in neighbouring countries that could provide greater visibility to the brand. The Claimant established a model of commercial relationship with those entities (Supply and Prime Retailing Agreement), by which they act on an exclusive basis as distributors/resellers of B... products, under the control and strategic management of the Claimant, and through remuneration for commercialization that corresponds to the difference between the prices charged to customers and the acquisition prices agreed with the Claimant, plus an operating margin of 3% on sales volume.

In this way, the Claimant assumes the gains and losses arising from the business, deducting the operating margin of the subsidiaries, performing at the end of the fiscal year an account reconciliation that implies the issuance of debit or credit notes depending on whether the operating result is greater or less than 3%, in order to maintain the profitability margin set in the agreement.

In the context of the inspection procedure intended to verify the Claimant's tax situation in relation to the subsidiaries domiciled abroad, the Tax Administration detected a tax loss of € 4,742,715.00 in the taxation period of 2014, which is solely attributed to the expenses borne with the subsidiaries under the Retailing Agreement, coming to understand that those expenses are not deductible for tax purposes because they cannot be considered as incurred or borne with the aim of obtaining or guaranteeing income subject to tax.

In a different perspective, the Claimant argues that the installation of own stores in competitive locations has advantages over franchising stores or stores belonging to independent partners, but involves significant investment and operating costs, especially because of the prices charged in rental contracts, and the remuneration provided for in the Retailing Agreement is intended to enable the operation of the distributing companies, ensuring a minimum profitability margin.

Also according to the Claimant, the expenses borne with the operating margin can generate income subject to Corporate Income Tax in the sphere of the taxpayer, either through the increase in the number of own store locations, or through the increase in sales volume.

In this sense, the Claimant emphasizes that there was a gradual increase since 2010 in the total number of stores allocated to the Group and in sales volume.

6. The answer to this question cannot but start from the concept of tax expense for purposes of article 23 of the Corporate Income Tax Code.

In light of that provision, it should be understood that the business activity that generates deductible costs must be one that results in operations that have a purpose (and not an obligatory immediate causal nexus) of obtaining income or the purpose of maintaining the potential of a source producing income. In this sense, productive activity should not be understood in a narrow sense, but rather in a broad sense, meaning activity related to a source producing income of the entity that bears the expenses. In seeking the meaning of the concept of company activity, it cannot be limited to mere or simple operations of production of goods or services, but presupposes a relationship with the overall economic operations of exploitation or with the operations or acts of management that are in the entity's own interest that assumes the costs.

In summary, it should be considered that the expenses borne by the taxpayer are deductible if the assumption of the expense was presided over by a genuine business motivation, and conversely, there is no room for tax participation when it must be concluded that the expense was determined by extra-corporate motivations, such as the personal interest of shareholders, administrators, creditors, other companies of the same group or business partners (cf. in this sense, Rui Morais, Notes on Corporate Income Tax, Coimbra, 2007, pp. 86-87 and, among others, the arbitral decision issued in Process no. 480/2016).

In this sense, the new wording introduced by Law no. 2/2014, coming to establish as a general principle that expenses related to the taxpayer's activity incurred or borne by the taxpayer are deductible, reinforces the idea that the connection with business activity is sufficient, regardless of the actual contribution to income subject to tax and aims to implement a greater degree of certainty in the concrete application of deductibility criteria (cf. Final Report of the Commission for the Reform of Corporate Income Tax, 30 June 2013).

7. Reverting to the situation at hand, it is important to note first that the payments made through contracts designated as Retailing Agreement do not constitute mere commercial discounts on sales, but involve payments of a remuneration nature that go beyond the profit that the subsidiaries could obtain through their commercial activity of reselling the goods provided to them under the contractual relationship they maintain with the Claimant.

In fact, as results from the content of the commercial partnership contract, and constitutes the established practice between the companies - as was demonstrated by the testimonial evidence produced - the Claimant does not proceed to a reduction of the selling price of the goods, but stipulates an operating margin in favour of the subsidiaries, which will be the subject of an adjustment at year end, through the issuance of a debit or credit note depending on whether the operating result is greater or less than 3% on sales volume. Even if that adjustment is understood in the Retailing Agreement as a mechanism for correcting the selling price of goods agreed between the parties, in truth, it is a matter of restoring the additional remuneration set in the contract, so that the subsidiary does not come to obtain a capital increase greater or less than the operating margin which, according to the contract's own terminology, is defined as the remuneration owed for the resale of B... products, in own stores and in competitive markets, according to the Claimant's strategic guidance.

The difference in value that may result from the issuance of debit or credit notes in the adjustment to be carried out at the end of the fiscal year, remains limited by the operating margin contractually set, so what can happen is that the Claimant comes to spend in a given year and in relation to a given subsidiary an amount less than that which would result from the application of the 3% percentage on the value of sales, which does not mean that the amount spent does not continue to correspond to the remuneration owed to the subsidiary for the function of international distributor of the Claimant's products under the B... brand.

Being that the only possible interpretation of the contract terms, and that corresponds to the practice adopted by the parties, the contractually made payments translate into a transfer of expenses between distinct entities, allowing the expenses incurred by the subsidiaries for the realization of their own profits to be borne by the Claimant up to the limit of the profitability margin that the contract ensures. These are not, in any case, concrete and determined expenses, but rather the generality of operating expenses, being, moreover, that the very objective of the Retailing Agreement, as the Claimant repeatedly does not fail to emphasize in its procedural pieces.

In fact, what is at issue is a strategy of expansion of the Claimant's business and the B... Group, which translates into the implementation of own stores, through already constituted subsidiaries, in competitive locations in neighbouring countries, in place of the franchising contract model or contracts with independent partners. But which implies - as is stated - considerable investments in installation and market conquest, with a significant weight in the overall account of expenses, of the prices of leased locations.

Thus it is understood that the purpose of the Retailing Agreement, in line with the commercial strategy defined, was to "adequately compensate the subsidiaries for the functions performed, own or leased goods used and risks borne", through the "remuneration (...) equivalent to an operating margin of 3% of their sales volume".

Nothing prevents, therefore, that the remuneration contracted by the Claimant is intended for the payment of the general operating expenses of the subsidiaries, such as local administration costs, operating expenses, worker or administrator remuneration, legal expenses, interest and other financial expenses.

Now, these are expenses external to the Claimant that are hardly framed in a business interest proper to the company. What is verified is that the Claimant bears expenses that third entities incur in the context of their own business production process.

The argument invoked in the sense of the deductibility of expenses centres on the existence of a causal nexus between the expenses borne with the subsidiaries and the business interest of the Claimant, which translates into the increase in the number of stores and in the increase of sales and in the expectation of generation in the future of actual income. This possibility may even be given as accepted, in view of the factual matter given as established, which points to a gradual increase in sales volume from 2010.

However, there is no evidence that the increase in operating results of the subsidiaries that may be associated with the overall increase in sales or the number of own stores, due to the assumption of expenses by the Claimant, may generate profits that imply, in future years, an increase in taxable profit subject to Corporate Income Tax in the national territory.

In the first place, as has been clarified, the positive results of the subsidiaries only determine, by way of compensation, a reduction of the operating margin contractually established which, at most, can only be neutralized when the increase in income earned reaches the profitability margin that is intended to be guaranteed. And in any case, that adjustment does not represent a positive component of taxable profit, but a limitation of the expenses in which the Claimant incurs with sister companies. It is true that in a general economic expectation, those positive results can lead to an increase in the Claimant's sales volume that may generate in a given fiscal year an increase in capital subject to tax. The point is that, as has been set out, the deductibility of costs is based on a relationship of economic causality, in the sense that the cost must be incurred in the interest of the company, excluding those other expenses that are incurred for the benefit of other business partners or even other companies of the same group.

That is, the concept of cost for tax purposes is not compatible with the possibility of sister companies, as holders of their own business interests, passing on to the supplier the expenses in which they incur for the pursuit of their corporate purpose. And conversely, the business interest of the Claimant does not, in tax terms, align with the payment of expenses of the customers themselves even if the assumption of those expenses can ensure in the future a higher level of profitability of their social activity.

8. Note that what is at issue here is not any evaluation of the opportunity or merit of the expenses incurred, but rather the possibility of those expenses being accounted for as tax costs in light of the criteria that derive from article 23, no. 1, of the Corporate Income Tax Code.

As everything indicates, in the circumstances of the case, the assumption by the Claimant of expenses of third parties has the nature of an instrument equivalent to the entry of own capital - which it would be incumbent upon the parent company to make - and through which the Claimant intends to influence the net result of the fiscal year by accounting for it as an expense.

In fact, taxable profit is defined in general terms as the difference between the values of the net assets at the end and the beginning of the taxation period (article 3, no. 2, of the Corporate Income Tax Code) and the first component to be considered is accounting profit, that is, the residual amount determined on the basis of accounting which remains after expenses have been deducted from income. For the determination of taxable profit, positive and negative capital variations verified in the same period and not reflected in the net result are also relevant (article 17, no. 1), with the exception of capital contributions or withdrawals, in cash or kind, in favour of the holders of capital (articles 21, no. 1, paragraph a), and 24, paragraph c)).

With capital contribution - to refer to the situation that is most relevant to the case - the taxpayer merely allocates part of its assets to its business activity in order, through those resources, to develop its business and increase assets through the obtaining of profits. It is that increase in wealth – and not properly the investment of capital – that constitutes the income subject to taxation. This is thus understood, that under the terms of the said provision of article 21, no. 1, paragraph a), the law excludes from the formation of taxable profit capital contributions (cf. António Rocha Mendes, Corporate Income Tax and Business Reorganisations, Universidade Católica Editora, Lisbon, 2016, p. 63).

What happens in the present case is that the Claimant, circumventing the principle of tax irrelevance of own capital instruments, intends to assert the entries of money for payment of the expenses of sister companies as expenses of its own business activity in order thus to obtain a reduction in its net result, without that expense being configured as a cost deductible for tax purposes.

Another aspect that is also important to bear in mind – and which is not insignificant for the legal analysis of the case – is that the contractual scheme based on expense transfer allows the importation of tax losses into the national legal system, with the consequent erosion of taxable profit verifiable in Portugal, without implying relevant tax consequences in the jurisdiction of the subsidiary companies established abroad. This is because in the event that the subsidiaries present negative results, the transfer of expenses allows the transposition into the internal system of tax losses which would otherwise be absorbed by the fiscal jurisdictions where those companies conduct their activity, whereas the gain achieved with the transfer of expenses has there a diminished tax impact as it may be neutralized by the negative results incurred by the subsidiaries.

Finally, it should be noted that the judgment in the Court of Appeal decision of 24 June 2003 (Process no. 06350/02) mentioned in the arbitral petition is not relevant for the case. It was there a matter of the punctual renegotiation of the debt of a company in an eminent situation of insolvency, when the expense incurred in that circumstance functioned as an indirect support of the commercial relationship maintained with that entity and that was indispensable to guarantee the maintenance of the source producing the income, and which the tribunal, for that very reason, considered deductible for tax purposes under article 23 of the Corporate Income Tax Code. There is, as is quite clear, no similarity whatsoever with the situation in the present case, where there is verified, by contractual means, the systematic assumption of expenses belonging to third entities so as to guarantee a minimum profitability margin in the context of their business activity.

9. Subsidiarily, the Claimant invokes the illegality of the tax act due to error in the premises, and likewise, due to lack of legally prescribed substantiation, under article 77, no. 3, of the General Tax Law, and due to manifest absence of violation of the arm's length principle, should it be understood that the additional Corporate Income Tax correction was founded on article 63 of the Corporate Income Tax Code.

From the Claimant's perspective, the possibility of a possible breach of the transfer pricing principles referred to in that article 63 may have resulted from the fact that the inspection procedure was intended for the "analysis of relationships with related entities present in other Member States of the European Union" and it was stated in the Tax Inspection Report that through the agreements concluded with the subsidiaries, "the group implemented for itself a kind of special taxation regime", which implied the "transfer of results from Portugal to other countries".

The Claimant understands that this argument may leave implicit the idea that the expenses borne in the context of the Retailing Agreement would have to be disregarded for tax purposes by virtue of such contract having been concluded between group-related companies, and hence the Claimant considers from the outset that the tax act in question is tainted with lack of substantiation under article 77, no. 3, of the General Tax Law.

The fact is that, as clearly results from the conclusions of the Tax Inspection Report (Section III.1.3), the non-acceptance for tax purposes of the expenses assumed through the Retailing Agreement was solely due to their non-deductibility under article 23 of the Corporate Income Tax Code, whereby, being that the only ground of the impugned act, it is in light of that legal framework that the legality of the Tax Administration's action must be analysed.

The reference to the "special taxation regime" and the "transfer of results from Portugal to other countries" can only be understood in the context of that article 23, with no reference being made at any time in the Report to transfer pricing or to the provision of article 63.

Since, therefore, no question pertaining to that matter is at issue, there is no need to take notice of those invoked defects and, for reasons of identity, the doctrine of the arbitral decision issued in Process 109/2015-T, which refers to the duty of substantiation and the burden of proof of the Tax Administration when the transfer pricing regime applies, does not apply to the case.

The request is therefore entirely without merit, with there consequently being no place for the reimbursement of any amounts that have been paid, and for compensation for provision of improper guarantee and the payment of compensatory interest, as also requested.

III – Decision

Therefore, it is decided to judge the arbitral request entirely without merit.

Value of the Case

The Claimant indicated as value of the case the amount of € 1,411,497.80, which was not contested by the Respondent and corresponds to the value of the assessment that was intended to be challenged, whereby that amount is fixed as the value of the case.

Lisbon, 20 December 2018

The President of the Arbitral Tribunal

Carlos Fernandes Cadilha

The Arbitrator Member

António Martins (dissenting according to the dissenting opinion attached)

The Arbitrator Member

Gustavo Courinha

Dissenting Opinion

Despite the high regard for the Honourable Arbitrators who subscribed to it, I do not agree with the position that prevailed in this Decision for the reasons I proceed to set out.

1- The interpretation of article 23 of the Corporate Income Tax Code and its application to the concrete case

The Decision develops regarding article 23 of the Corporate Income Tax Code, in a sense which I follow, an interpretative position in which the following is stated:

"In light of that provision, it should be understood that the business activity that generates deductible costs must be one that results in operations that have a purpose (and not an obligatory immediate causal nexus) of obtaining income or the purpose of maintaining the potential of a source producing income…". (…) "In summary, it should be considered that the expenses borne by the taxpayer are deductible if the assumption of the expense was presided over by a genuine business motivation…" (...) "In this sense, the new wording introduced by Law no. 2/2014, coming to establish as a general principle that expenses related to the taxpayer's activity incurred or borne by the taxpayer are deductible, reinforces the idea that the connection with business activity is sufficient, regardless of the actual contribution to income subject to tax"

In the wording of article 23 of the Corporate Income Tax Code, in force in 2014, having abandoned the requirement of "indispensability", the question stands out of whether expenses present a purpose, or a potential, for generating income subject to tax. The actual obtaining of income is not required, in an obligatory nexus with expenses, which is well understood, as this would amount to refusing the deduction of any expense in a situation of business failure. Neither the letter nor the spirit of the law determines that expenses must, as a condition of deductibility, generate taxable profits. The law leads to the interpretation that, given that expenses have a purpose generating income (business purpose), and that generation is foreseeable or estimated, the general condition of deductibility established in article 23 of the Corporate Income Tax Code is fulfilled.

Should the business go badly, or there be management errors, or in a certain period losses occur, or the business prove ruinous, the central point within deductibility is the demonstration that the act performed, giving rise to the expense, had, at the date it was carried out, potential for generating income subject to tax. The eventual verification, a posteriori, that the volume of income generated, or profits obtained, did not reach such expectations does not prevent the deductibility of the expense, provided that the economic rationality or business motivation of the decision that gave rise to the assumption thereof is shown.

If this is the proper interpretation of article 23 of the Corporate Income Tax Code in the 2014 wording, I do not see how one can refuse the deduction of the expenses discussed in this Process based on arguments that appear in the Decision and which I proceed to cite:

"The argument invoked in the sense of the deductibility of expenses centres on the existence of a causal nexus between the expenses borne with the subsidiaries and the business interest of the Claimant, which translates into the increase in the number of stores and in the increase of sales and in the expectation of generation in the future of actual income. This possibility may even be given as accepted, in view of the factual matter given as established, which points to a gradual increase in sales volume from 2010.

However, there is no evidence that the increase in operating results of the subsidiaries that may be associated with the overall increase in sales or the number of own stores, due to the assumption of expenses by the Claimant, may generate profits that imply, in future years, an increase in taxable profit subject to Corporate Income Tax in the national territory.

In the first place, as has been clarified, the positive results of the subsidiaries only determine, by way of compensation, a reduction of the operating margin contractually established which, at most, can only be neutralized when the increase in income earned reaches the profitability margin that is intended to be guaranteed. And in any case, that adjustment does not represent a positive component of taxable profit, but a limitation of the expenses in which the Claimant incurs with sister companies. It is true that in a general economic expectation, those positive results can lead to an increase in the Claimant's sales volume that may generate in a given fiscal year an increase in capital subject to tax. The point is that, as has been set out, the deductibility of costs is based on a relationship of economic causality, in the sense that the cost must be incurred in the interest of the company, excluding those other expenses that are incurred for the benefit of other business partners or even other companies of the same group."

In the first passage of the quotation the possibility is accepted that the Retail Agreement (hereinafter, RA), in determining that the claimant support as an expense an amount that remunerate the sister companies in an operating margin of 3% of sales, fits within the business interest of the Claimant, in view of the increase in the volume of its business.[1] It is stated afterwards that there is no evidence (i.e., proof, demonstration) that the overall increase in sales or the number of own stores may generate profits that imply, in future years, an increase in taxable profit in the national territory.

I do not see that article 23 of the Corporate Income Tax Code imposes such conditions. Article 23 merely determines that the expense has the purpose of contributing to the obtaining of income (e.g., cf. article 20 of the Corporate Income Tax Code, sales, provision of services, other operating income, financial income, etc.) subject to tax.

Accepting that the RA results in a growth in activity, through an increase in the number of stores in the countries where the sister companies with which said agreement was concluded are active, and an increase in sales, I believe the Claimant's interest and the relationship of the expenses resulting from the RA with its activity are shown. And the condition of the existence of "evidence" that such agreement may generate, in the future, "taxable profit" does not result from the provision of the Corporate Income Tax Code analysed here.

Placing such emphasis on the demonstration or proof that the RA "may generate profits that imply, in future years, an increase in taxable profit subject to Corporate Income Tax in the national territory" and, simultaneously, not taking into account the evidence[2] appearing in the records, submitted by the Claimant, which is based on elements at the disposal of the parties[3], and was not contested by the Respondent, not enough attention was paid, in my view, to matters that could be relevant. The following table is a notable example of this:

Faced with the data, particularly in the case of the sister company in Spain (E...), responsible for the overwhelming part (75%) of the increase in sales proven in the table, within the scope of sister companies with which RA was concluded, two conclusions can be drawn, in my opinion:

a) that, associated with the RA, there is an increase in the Claimant's sales volume and, therefore, in its activity and its income (sales) subject to tax, since the sales of the sister companies result from purchases, contracted and exclusive, from the Claimant;

b) that the cost associated with the RA has the potential to produce, even by itself alone, taxable net income.[4] And that, with such proven possibility existing, it would not be judged that "in any case, that adjustment does not represent a positive component of taxable profit, but a limitation of the expenses in which the Claimant incurs with sister companies".

The Decision (after accepting the possibility of a causal nexus between the expenses here disputed and the Claimant's interest, "in view of the factual matter given as established") concludes that the guarantee of a 3% margin is always disconnected from the business interest of the Claimant and from the consequences on its sales and other income. And it seems to me to assume that even when, "in any case", in sister entities the margin is above 3%, the positive effect of the RA only reduces the expenses that the Claimant assumes and which are always and exclusively within the sphere of said companies. In sum, that the Claimant, in guaranteeing a 3% margin to sister companies that distribute the Claimant's products exclusively, under its commercial guidance and in accordance with its strategy of internationalization, is only acting in light of the interests of others and absorbing expenses that in no way concern it. I do not accompany, at all, such a position, in light of what I understand to be proven.

The numerical translation of the Decision's position, as to the specific effects of the RA mechanism[5], would be, if I interpret it correctly, the following. Assume that in a certain year, the Claimant guarantees a 3% margin of a sister company with which it concluded an RA along the lines set out in the records, and which presents at year end a 5% margin. In that case it receives the Claimant 2% as compensation. In a second case, suppose that the sister company's margin is 7% and the Claimant receives 4%. Such margins depend, as I will show better below, on the increase in sales of the sister company, and consequent purchases from the Claimant, and on the cost or expense structure of the former. Certain operating expenses such as rents, insurance, and even, to a certain extent, personnel, have a certain fixed component, and the increase in sales induces, consequently, the growth of the operating margin of the sister company. In such circumstances, the guarantee of the 3% operating remuneration has the potential to increase the sales thereof, by reducing the risks it incurs in such commercial expansion, and inverts the result of the RA.[6]

Returning to the example above, in the case where the sister company's margin amounts to 5%, there is an income of 2% in the Claimant, associated with an expense of 3%. The expense of 3% is not, therefore, independent of the income of 2%. Deciding that in any case there is no positive component of taxable profit, the Decision calls into play, first, something that article 23 does not impose. Second, it sees only an expense of -1%, derived from (-3% +2%) where there is an expense of 3% incurred with the purpose, or to obtain, income (+2%).

The following scenario, ventured above, in which the margin is supposed to be 7%, shows that the RA has even potential to generate taxable profit solely by the contractual effect of the margin (-3% in expenses, +4% in income), even ignoring the potentially lucrative effect of the increase in the Claimant's sales to sister companies. And when it is concluded that the 3% expense functions always and solely as a transfer of expenses of the sisters to the claimant, totally unconnected with the latter's business interest, a conclusion is expressed which I do not share, as it goes against the logic of relationships between companies that pursue economically rational ends.

The table shown above evidences that the assumption of sister companies' expenses has associated with it a potential for generating income (sales), and indeed shows more than a potential, presents actual growth of such sales. The Decision accepts this connection between the RA and the growth of the Claimant's business volume. In the established facts (see paragraph G), it is given as demonstrated, what results from the contractual text of the RA, that:

"The subsidiary companies act as distributors/resellers of B... products under the control and strategic management of the Claimant, in particular with regard to the location of stores, promotional campaigns and marketing activities".

But then it requires that such fact be associated with evidence, or proof, that the RA "may generate profits that imply, in future years, an increase in taxable profit subject to Corporate Income Tax in the national territory".

Article 23 of the Corporate Income Tax Code does not require, much less in the 2014 version, as is emphasized in the part where the Decision interprets the meaning of the provision, such numerical or factual demonstration. However, in the case in the records, an increase in sales associated with the RA is even shown, accepted even in the Decision's logic. Such increase implies that the claimant benefits from the margin generated by such sales, since it presents profits, as shown in the Reports and Financial Statements attached to the records. And, complementarily, there being in the case of the Spanish company, a reversal of the result of the RA, such proves income derived from the guarantee of margin. Thus, in the future, it is plausible, or potentially possible, that such income, when the margin of sister companies exceeds 6%, generate further taxable profits. The margin for 2016 in E... is already approaching 6% (cf. note 3, above) and the economic logic of the RA has the potential to provide higher margins, as is emphasized in the records.[7]

The Decision moves away from all these aspects to conclude as follows:

"It is true that in a general economic expectation, those positive results can lead to an increase in the Claimant's sales volume that may generate in a given fiscal year an increase in capital subject to tax. The point is that, as has been set out, the deductibility of costs is based on a relationship of economic causality, in the sense that the cost must be incurred in the interest of the company".

If it is considered that the positive results expected, emerging from the RA, may lead to an increase in the Claimant's income and even capital increase subject to tax, the condition contained in article 23 of the Corporate Income Tax Code is largely fulfilled. This consists solely in relating the expense to a purpose or aim of obtaining income. To conclude this point: accepting the interpretation of article 23 that the Decision follows, accepting that there is an increase in stores and sales (income) derived from the RA and therefore potential for generating profit, with evidence in the records that the RA can, by itself, generate income (and not mere reduction of expenses), and being plausible that it could, even solely by itself, provide expectations of taxable profit, I do not see how one can conclude in this way, denying that the assumption of the 3% margin is always foreign to the Claimant's interest, given that it has been proven that the sister companies are subordinate to the strategic and business interest thereof. And to show more fully, now in an economic sense, the interest of the claimant in the RA, let us enter into the point that deals with it.

2. The economic logic of the RA and its interest for the Claimant

2.1 Economic Features of the RA

The Decision, in the established facts, cites, from the RA, article 5, in which the conditions for remuneration of 3% of operating margin on sales are stipulated. In document 6 attached to the records, which contains the text of the RA, in the case of E... (Spain) signed in 2011, other elements are still visible which, as I believe, would appear important to analyse the question of the Claimant's interest in the conclusion of said RA. Thus:

- The Claimant signed a franchising contract with the sister entity in 2001, which until 2009 resulted in the opening of 11 stores.

- The Claimant and the sister company intended to implement a new type of contractual relationship, in which E... purchases products exclusively from the Claimant and markets them under the strategic and commercial guidance of the Claimant.

- The sister company makes investments in "prime located" stores, in accordance with the strategy defined by the Claimant.

Additionally, it is shown[8] that the evolution of the number of stores in Spain was as follows:

Between 2001 and 2009, with a franchising contract, 11 stores opened. With the RA, in 3 years (2012 to 2014), 102 stores opened. The expansion of sales of the sister company (and therefore of the claimant as exclusive supplier) associated with such expansion, and its potential and real contribution to income generation, has already been shown in the previous point.[9] Additionally, it is also shown in the records that the expansion of sales in stores in Portugal versus those existing in countries where entities with which RA was concluded are located is as follows:

To these uncontested elements, which do not appear in the list of established facts, different relevance could have been given in the Decision, as they reinforce the obvious connection between the RA, the Claimant's activity and its business purpose. And how is the guaranteed 3% margin linked to that purpose?

The answer to the previous question is simple. The expansion of a company such as the claimant in international markets can be carried out according to various legal-economic alternatives. In a first alternative, the claimant could negotiate with independent entities strategic-commercial conditions identical to those of the RA: exclusive supplier, strategic determination, etc. It would be unthinkable that such independent entities would not demand remuneration, a price, for subordinating their activity to the Claimant's interest, to its business purpose. By allocating assets and other resources to the sale of the claimant's products, moreover with loss of strategic and commercial autonomy, they demanded such compensation; as their business function would come to be subordinate to the Claimant's interest. The transfer pricing file attached to the records shows that the 3% operating margin is consistent with that demanded by independent entities to carry out the economic-contractual operations that emerge from the RA.[10]

In a second alternative, the Claimant could, from the national territory, make the investments, bear the operating and financial costs and obtain the income that such strategy would imply. In that case, even if, at most, the claimant never obtained taxable profit, as long as the motivation of international expansion of activity was (as it is) economically justified and rational, the expenses would be deductible.

As decided in the Supreme Administrative Court Decision of 27.06.2018, issued in the context of process no. 01402/17, which still dealt with the pre-2014 version of article 23, in which the concept of indispensability stood out, clearly more demanding than the wording in force in 2014 as to the condition of deductibility:

"As regards the indispensability of costs, as the reference doctrine (…) and also the most significant case law have been stating, the concept to which article 23 of the Corporate Income Tax Code refers has been linked to costs incurred in the interest of the company or borne within the scope of activities stemming from its corporate purpose. Only when costs result from decisions that do not meet such requirements, namely when they do not present any affinity with the company's activity, should they be disregarded.

In sum, it would not be the absence of profits, in this second route alternative to the RA, that would determine the non-deductibility of the expenses borne. It would suffice to provide proof that international expansion had potential to generate income and affinity with the company's activity.

The company, in its contractual autonomy freedom, chose the RA. The choice involves expenses assumed with regard to sister companies. What must be analysed is whether such expenses are pure expenses of third parties assumed without any business or economic purpose (income generation) or whether, being originally from the sisters but coming to be passed on to the sphere of the Claimant, they are within the interest of this. Its business interest has already been shown, but look more carefully at the rationality underlying the claimant's option.

2.2 Economic Objective of the Transaction

The logic of the RA and its impact on sales is simple and economically rational and is developed at length in the records. Assume, for example, that company A contracts with company B that the latter will sell high-end shoes in a major city, purchased exclusively from A.

In the first scenario, A contracts with B a quantity discount based on sales. In the second scenario, a discount is stipulated on A's sales to B, so that B obtains an operating margin of 3%. In which of the scenarios will B have greater incentive (and lower risk) to sell the shoes purchased from A?

I am convinced that it is in the second. By having the guarantee of a margin that covers its operating costs, B will be able to embark on the search for more attractive store locations, on stronger marketing campaigns, on the hiring of more qualified personnel, etc., to increase sales. In the first scenario, the discount, only on sales, still leaves the risk of other expenses (e.g., personnel, rents, energy) not being covered and B being able to suffer a loss. And thus B retracts from its commercial policy. It is therefore the second scenario, more conducive to sales of A to B, and expected benefits, the logical mechanism inducing the RA here in question. The OECD Guidelines cited in the Process are clarifying on the rationality and interest of such a strategy.[11]

The following example permits quantifying the operation of the strategy, economically rational, underlying the RA, the explanation of which appears in the records and was developed in the testimonial evidence and to which the Decision could have attributed greater weight in the factual analysis and in the decision grounds.

Thus, assume that an entity ALFA sells to a sister company under the conditions set out in the RA. In scenario 1 the sales of the sister company amount to 100, in scenario 2 to 150 and in scenario 3 to 200. Purchases from the supplying entity – equivalent to the Claimant – represent 60% of sales, and the expense structure, where some fixidity is assumed, encompassing rents, personnel, etc. is as set out in the following table.

Scenario 1

Scenario 2

Scenario 3

Sales of sister company

100

150

200

- Cost of goods (sales of claimant)

60

90

120

- Rents

15

20

25

- Personnel expenses

10

12

15

- Other operating expenses

20

22

24

Total operating expenses of sister company

105

144

184

= Operating margin

-5

6

16

Payment (-) / receipt (+) by claimant

- 8

+1.5

+10

Margin of sister company after RA effect (3% of sales)

3

4.5

6

The table shows, in a sense identical to what actually happened in E..., the generation of income (+1.5) associated with an expense (- 4.5) in scenario 2. In scenario 3, there is not only income but also profit (+4=10 - 6). Now with 2016, as previously shown, the margin of E... already close to 6%, it is plausible to admit that the simple mechanics of the RA have the potential to generate profits. (However, as I have already mentioned, the law requires only a purpose for obtaining income).

The Decision, if I read it correctly, would see in "scenario 3" of the table above solely an expense foreign to the interest of ALFA (and therefore not deductible) of the value of 6. What is verified, however, is that the expense of 6 is associated with income of 10, since the sister entity has in the RA an incentive to increase sales and purchases from ALFA. In this scenario 3, even paying 10 to ALFA the sister entity obtains an operating margin greater (+6) (double in absolute value) than in "scenario 1" (in which it was +3). This only happens through the effect of increased sales volume, which is not disconnectable from the effect of economic incentive of the RA on the sister company. This is therefore a genuine business motivation and involved a legal design of the RA that has advantage for both parties intervening in it, as economic rationality would determine.

The sense of the evolution of the Claimant's sales that the table contains is proven in the records. The evolution of the specific financial effect of the RA is proven in E..., which reached "scenario 2", and can plausibly reach "scenario 3".[12] The remaining sisters, should they reach the expected sales scale, could, by the logic of the RA, present potential for income generation.

When in the Decision it is stated that: "The fact is that the Claimant bears expenses that third entities incur in the context of their own business production process",

I believe that, with due respect, it is forgotten that the activity developed by the sisters is carried out in a manner subordinate to the Claimant's guidance and business purpose. That is, that the "business production process" of sister companies is strongly determined by their relationship with the Claimant through the RA. The Claimant thus bears expenses of an activity that does not constitute an autonomous business or production process of sister entities, independently determined by them, but rather broadly developed in the context of the Claimant's business purposes.

This would suffice, in my view, to admit the deductibility of the expenses disputed within the scope of article 23 of the Corporate Income Tax Code. From the RA flows a mutual interest in increasing the sales of all parties involved. There are in the records reflections that such rationality had an impact on the Claimant's income.

That bearing of sister companies' expenses is thus, businesswise, a cost of the claimant with a view to obtaining benefits in its sphere: stores, sales and activity increased, and consequent increase in income; and potential for profitability. In the case of the records, the assumption of such 3% expenses constitutes economically the price or remuneration in light of the sisters' accession to the RA and to the claimant's interest (exclusivity of sale of products, loss of strategic autonomy, obedience to the claimant's commercial directives, etc.).

3. The substantiation on the application of article 23 of the Corporate Income Tax Code

The Tribunal and, consequently, the Decision to which I dissent, is free to assess the elements at its disposal. However, I believe that, in the concrete case, it would not be entirely unreasonable, in the global structuring of the Decision, to specifically assess the arguments used in the Respondent's Report to deny the deductibility of expenses under article 23 of the Corporate Income Tax Code.

The Respondent, in the section of the Inspection Report entitled "Analysis of the form of the transaction versus the substance of the same" raises questions such as the transfer of results, grant financing, the creation of a regime particular to the group taxation, as motivations or consequences of the RA. In sum, that the RA would perhaps have objectives of evasive tax planning. Such assertions would imply the invocation of tax norms quite different from article 23 of the Corporate Income Tax Code as preventing the deductibility of expenses inherent in the RA. And therefore, the Respondent, in order to apply to the case article 23 of the Corporate Income Tax Code, sustains the thesis that there is no relationship between the expenses of the RA and the activity and sales of the Claimant.

The four grounds that appear to me most relevant to the thesis sustained, to deny relationship between the RA and any benefits of the Claimant, appear in the conclusions of the Tax Inspection Report and would be the following:

a) there is no connection between the RA and the Claimant's sales, because the discount on the margin of sister companies only takes place at year end, when sales have already been made;

b) inventories do not benefit from such discount;

c) the discount on the margin does not depend on quantities or selling prices;

d) it cannot be alleged that without the RA the business between the claimant and the sister companies would not exist.

These are arguments tainted by the factuality of the case. The operating margin is determined, as is known, at year end, when accounts close, hence it is only then that the expense (discount) to be borne by the Claimant is calculated to adjust to 3% the operating margin of the counterparties. This does not mean that, throughout the year, the sales of these (and concomitant purchases from the Claimant) are not positively affected by the RA provisions.

As to inventories, it would suffice to read the RA, in its article 3, no. 3, on the possibility of returning unsold inventories to the Claimant, to make this argument of the Inspection irrelevant.

On the third point, the Respondent's witness acknowledged that the discount, or adjustment of operating margin, to 3% of sales, depends on sales. And it would not even need that, as the operating margin, resulting from the difference between sales and operating costs, obviously depends on quantities sold and selling prices.

On the last one, the question is not whether the business would not exist, it is whether without the RA the expansion in the number of stores and sales would be the same. The facts I referred to earlier, and which appear in the records, are clear on the positive impact of the RA on the number of stores and on the income generated in the Claimant's sphere.

4- Final Notes on "Substance and Form", Case Law and "Transfer of Results"

The assertions that the RA might possibly have been presided over by a certain motivation of international fiscal management, and not a business interest of the Claimant, are, as I have said, ventured by the Respondent. The Decision, pointing to possible subjective intentions of the Claimant, emphasizes that the RA would have permitted the latter to escape the tax regime of own capital instruments, as the expenses of the RA are equivalent to financing in own capital, which would not be deductible.

I see no relevance in this in the context of article 23 of the Corporate Income Tax Code and what is determined therein as the general condition for deductibility of expenses. And such a line of reasoning would imply that deductibility be denied to certain expenses which article 23, no. 2, explicitly accepts: discounts. And this is noted by the claimant, in a perspective to which the Decision also does not give the attention it would deserve.

Thus, should company A transact with a related company B (e.g., a foreign sister company) in such a way that the latter may benefit systematically from a 10% discount on sales, previously contracted, and assuming that during several fiscal periods company B presents a consumption of raw materials of 700 (purchases from A) and other operating costs of 350, and its sales are 1000, then its operating margin will be -50 = (1000-700-350).

The discount that A grants to B will be a total of 70 (10%*700). This implies, after the effects of the discount, a positive margin in B of the value of 20; reduces its charges, and increases those of A, transferring costs from B to A, in a financial implication similar to the RA, except in the calculation base, but of equal financial consequences.

In the example above, the discount also makes it possible to pay operating expenses, such as personnel, rents, etc. And even extra-operating, such as financial expenses.[13] That is, although it is calculated on sales and not from the operating margin, the transfer of means from A to B enables the latter (given the fungibility of monetary means) to bear any type of charge with those funds it received (or that it ceased to pay and thus remain in its assets).

Also here, following the logic of the Decision, there would perhaps be equivalence to capital contributions, which would bear the impact of losses of B.

Article 23 expressly permits the deductibility of such discounts, which do not even have associated the possibility of reversal of the financial result, as the RA; and also does not condition such deductibility on the geographical location of A and B. Why does article 23 permit the deduction of such discount? Certainly because it has the potential to increase sales of A to B, A's activity and income. The logic of the RA is the same.

It runs through the Decision, if I read it correctly, the perspective according to which the RA functions as a kind of financial and fiscal management mechanism transferring expenses and profits according to the conveniences of a group. I do not see that article 23 of the Corporate Income Tax Code can serve as the basis for this economic-fiscal analysis. Article 23 of the Corporate Income Tax Code, as Saldanha Sanches stated, cannot be considered as a general anti-abuse clause avant la lettre…"[14]. Rui Morais[15] states that in the assessment of the subsumption of expenses to article 23, account must be taken of the objective intent of the transaction – the business interest. That is, considerations on topics such as transfer of results, a supposed special taxation regime resulting from the RA, the possible intent of the Claimant to avoid the tax regime of own capital instruments, do not fit with such norm but rather with others well known in the tax system.

I also dissent from the Decision on the relevance of the "Hummel Case"[16]. Where the Decision sees irrelevance for the case in the records, I see a decision that deserved to have another influence on the decision. When in the Decision it is stated that, in that Hummel case:

"…the expense incurred in that circumstance functioned as an indirect support of the commercial relationship maintained with that entity and that was indispensable to guarantee the maintenance of the source producing the income, and which the tribunal, for that very reason, considered deductible for tax purposes under article 23 of the Corporate Income Tax Code. There is, as is quite clear, no similarity whatsoever with the situation in the present case, where there is verified, by contractual means, the systematic assumption of expenses belonging to third entities so as to guarantee a minimum profitability margin in the context of their business activity",

what would need to be added is that to that systematic assumption of expenses, determined by the subordination of the sister companies' activity to the Claimant's interest (cf. wording of the RA and G) of the established facts), is associated systematic growth of the Claimant's income, accepted in the Decision.

And that such continued assumption permitted the expansion of the sister companies' activity with the consequent impact on the evolution of actual and expected income of the claimant (sales to the sisters) and on its potential for profitability, through such sales and the specific effects of the financial mechanics of the RA, shown in the economically more representative sister company. In sum, the said continued assumption of expenses has, for the Claimant, a business purpose; as the occasional assumption had it in the Hummel case.

5- Conclusion

The expenses resulting from the Retail Agreement (RA) constitute a price, or consideration, that the Claimant pays to sister companies so that these, on an exclusive basis, under its strategic guidance and commercial directives, allocating assets to the pursuit of the Claimant's interests, sell the products thereof. Independent entities, upon which the Claimant based identical international expansion of sales, demanded equal average compensation. The OECD Guidelines on operations between related parties and their prices contain abundant examples of strategies similar to the RA, showing the normality and interest of such management acts for entities – such as the Claimant – that practice them. (What will need to be assessed is whether, in a perspective of potentially evasive fiscal management, they respect or not the rules of arm's length principle).

The RA is potentially associated (and even proven) with an increase in the Claimant's sales and thus of income subject to tax (cf. article 20, no. 1, of the Corporate Income Tax Code). Associated with the RA, in light of its wording and the financial conditions in which it operates, is further associated (and proven) a potential of, by itself alone, in addition to income resulting from sales to sister companies, generating income (cf. also article 20, no. 1, of the Corporate Income Tax Code); and being even plausible that, by itself, it can generate net profit (which article 23 of the Corporate Income Tax Code does not require).

The expenses derived from the RA are thus related to the Claimant's commercial interest. The Decision, in deciding that they constitute always and solely mere transfer of expenses, wholly foreign to the Claimant's interest, goes in a direction which I do not follow, in light of what is established in article 23 of the Corporate Income Tax Code and its interpretation followed in the Decision, of the evidence elements in the records on the business motivation, the economic rationality of the RA and its impact on the Claimant's income, of the doctrine, and of the case law on the assumption of expenses of third parties, provided it is made in the interest or purpose of the company that assumes them, as is the case of the records.

António Martins