Transfer Pricing & Autonomous Taxation on Severance Pay: CAAD Ruling 559/2015-T on IRC Additional Assessment

ARBITRAL DECISION

The Arbitrators José Poças Falcão (president), Paulo Lourenço and João Gonçalves da Silva, all designated by the Deontological Council of the Administrative Arbitration Centre to form an Arbitral Tribunal, agree as follows:

1. REPORT

A…, Unipessoal, Lda., with the unique collective person number …, and with registered office at …, no. …, …, … – … … (hereinafter briefly designated as "Claimant"), notified, through official letter no. …/…, dated 28 May 2015, of the decision of partial rejection issued by the Deputy Director of Finance of the Finance Directorate …-… of, within the scope of the gracious complaint procedure no. …2014… (Doc. 1), in which was discussed the illegality of the tax acts of additional assessment of Corporate Income Tax ("CIT") no. 2014…, relating to the fiscal year 2010, of account settlement demonstration no. 2014 … and of compensatory interest assessment no. 2014…, all carried out by the Director-General of the Tax and Customs Authority (cf. Docs. 2 to 4),

came, under the provisions of articles 2, no. 1, letter a), 3-A, no. 2, and 10, no. 1, letters a) and no. 2, of the Legal Framework of Arbitration in Tax Matters, to request the constitution of an arbitral tribunal in tax matters, with a view to obtaining the declaration of illegality of the aforementioned tax acts, maintained in the legal order by the decision of partial rejection of the gracious complaint procedure no. …2014….

It thus bases its petition as follows:

As a consequence of the corrections promoted by the Tax Authority in the aforementioned inspection action, and on 24 January 2014, the Claimant was notified of the act of additional CIT assessment no. 2014…, relating to fiscal year 2010, and respective account settlement demonstrations no. 2014 … and compensatory interest assessment no. 2014 … (cited Docs. 2 to 4).

For its part, the identified account settlement demonstration no. 2014 … determined a balance payable by the Claimant in the total amount of € 279,479.70 (amount which already includes CIT, municipal tax surtax and respective compensatory interest), having established as the deadline for voluntary payment of the aforementioned amount the day 21 March 2014 (cited Doc. 3).

Subsequently, the Claimant was called upon to participate in the fiscal enforcement proceeding no. …2014…, instituted for coercive collection of the total amount of € 280,830.24 (two hundred and eighty thousand, eight hundred and thirty euros and twenty-four cents) (Doc. 7).

In this context, the Claimant filed, on 30 April 2014, a gracious complaint against the aforementioned tax acts (Doc. 8), contesting the legality of the corrections carried out by the Tax Authority to the CIT of fiscal year 2010 and petitioning, consequently, its revocation (the filing of this petition gave rise to the institution of the gracious complaint procedure no. …2014…).

On 13 May 2014, the Claimant provided a bank guarantee in the total amount of € 354,086.50 (three hundred and fifty-four thousand, eighty-six euros and fifty cents), for purposes of suspension of the fiscal enforcement proceeding no. …2014…, in accordance with the provisions of article 169 of the Tax Procedure and Process Code (Doc. 9).

Meanwhile, in the past month of June 2015, the Claimant was notified of the decision of (partial) rejection issued by the Deputy Director of Finance of the Finance Directorate of the … within the scope of the gracious complaint procedure no. …2014…, which is hereby reproduced in its entirety (cited Doc. 1).

Under the terms of the aforementioned decision, the Tax Authority concluded "by the annulment of the tax assessed as autonomous taxation, in the amount of € 145,147.80, and respective compensatory interest, being the petition to be partially granted" (cited Doc. 1).

Nevertheless, the Tax Authority denied the petition for revocation of the tax additionally assessed as a consequence of the increase of the amount of € 5,999,900.00 to the taxable profit of fiscal year 2010 of the Claimant based on the application of the transfer pricing regime established in article 63 of the CIT Code to the operation of disposal of the rights associated with the wine brand B… to company C….

Following this, also in June 2015, the Claimant was notified of the CIT assessment demonstration no. 2015…, the account settlement demonstration no. 2015 … and compensatory interest assessment no. 2015…, all carried out by the Director-General of the Tax and Customs Authority (Docs. 10 to 12).

With the partial annulment of the act of additional assessment of CIT of 2010 – specifically the annulment of the part corresponding to the correction of autonomous taxation and respective compensatory interest, in the amount of € 159,256.96 (one hundred and fifty-nine thousand two hundred and fifty-six euros and ninety-six cents) – the amount of CIT additionally assessed and compensatory interest to be paid was reduced to the sum of € 120,222.74 (one hundred and twenty thousand two hundred and twenty-two euros and seventy-four cents).

Finally, still as a consequence of the aforementioned administrative decision, the Claimant requested from the Head of the Finance Service …–…, through a petition dated 16 July 2015, the reduction of the value of the bank guarantee provided in the above-identified enforcement proceeding (Doc. 13).

In this context, on 6 August 2015, the Claimant was notified that "In accordance with the dispatch issued by the Head of the Service of the …, Deputy, a copy of which is attached, it is communicated that the bank guarantee no. …, issued on 08.05.2014 to guarantee the fiscal enforcement proceeding above identified, should be reduced to the amount of 163,295.49€ (one hundred and sixty-three thousand two hundred and ninety-five euros and forty-nine cents)" (Doc. 14).

The Claimant intends, through the present petition for arbitral pronouncement, to have recognized the illegality of the identified correction to the taxable profit of 2010 – in the amount of € 5,999,900.00 – and, consequently, seeks to obtain the declaration of illegality of the tax acts of additional assessment of CIT, municipal tax surtax and compensatory interest carried out on its basis (which is petitioned at the end).

With the purpose of demonstrating the various errors concerning the assumptions of law suffered by the correction carried out by the Tax Authority to the taxable profit of fiscal year 2010 of the Claimant, it is recalled that the same was based on the application of the transfer pricing regime established in article 63 of the CIT Code to the operation of disposal of the rights associated with the wine brand … B…, carried out between the Claimant and company C…, on 6 October 2010.

Under the terms of the provision of no. 1 of the aforementioned article 63 of the CIT Code, "In commercial operations, including, in particular, operations or series of operations on goods, rights or services, as well as in financial operations, carried out between a taxpayer and any other entity, whether or not subject to CIT, with which it is in a situation of special relations, there must be contracted, accepted and practiced terms or conditions substantially identical to those that would normally be contracted, accepted and practiced between independent entities in comparable operations".

Thus, as observed in the doctrine, "Article 63, no. 1 of the CIT Code makes the application of the legal regime of transfer pricing dependent on the following assumptions: • there has been a commercial operation – or a series of operations; • between a taxpayer and another entity (whether or not subject to CIT); • there are special relations between the two entities" (cf. Diogo Leite de Campos, Susana Soutelinho, Comparable Operations in Transfer Pricing, in Studies in Tribute to Professor Doctor Alberto Xavier, Volume I, Almedina, p. 373).

Consequently, the primary assumption of application of the transfer pricing regime is the existence of special relations between two entities involved in a certain commercial operation (or series of operations).

In fact, only after the subsistence of such special relations is demonstrated does the Tax Authority have the power to scrutinize the conditions of a given operation in light of the arm's length principle, and such analysis may culminate (or not) with the correction of the conditions which are proven to deviate from those which would be contracted, accepted or practiced between independent entities in comparable operations.

The applicative methodology underlying the aforementioned article 63 of the CIT Code may thus be synthesized as follows: "The Tax Administration must begin by proving:

· The existence of special relations;

· That the operations between these entities linked by special relations were carried out in conditions different from those that would be agreed between independent persons;

· That the aforementioned different conditions, established for the operations between the "related entities", had as their cause the existence of those same special relations (…);

· That, due to the special conditions, the tax result assessed was different from what it would be in the absence of those special conditions" (cf. Joaquim António R. Pires, Principal Inspector at the DGCI, Transfer Pricing, Vida Económica, p. 29).

Consequently, following pari passu the applicative process which is thereby outlined, the Claimant will begin by analyzing below the subsistence of special relations between itself and the counterparty of the aforementioned contract for transmission of the rights associated with the wine brand … B….

Without prejudice to anticipating the lack of verification, in the present case, of the first requirement upon which the valid application of that regime depends (i.e., the subsistence of special relations between the aforementioned entities), the Claimant will proceed with the analysis of the method of determining the arm's length principle invoked by the Tax Authority to conduct the correction in question.

In this context, the Claimant will demonstrate the unsuitability of the methodology concretely applied to assess possible deviations in the operation carried out, evidencing the various errors incurred by the Tax Authority in the identification of comparable operations and in the economic analysis of the situation of the Claimant.

Finally, the Claimant will also devote a section to the analysis of the autonomous illegality suffered by the compensatory interest assessment act equally subject to the present petition for arbitral pronouncement, followed by one last respecting the demonstration of the existence of the right to compensation for wrongful provision of guarantee.

The present petition will be concluded with the petition for total annulment of the tax acts above identified based on the illegality of the presumed correction to the taxable profit of fiscal year 2010 of the Claimant.

On the illegality of the correction to the taxable profit of fiscal year 2010 due to improper application of the transfer pricing regime established in article 63 of the CIT Code

I. On the demonstration of the non-existence of special relations in the present case

As mentioned above, it is necessary to begin by analyzing the most elementary of the requirements upon which the applicability of the transfer pricing regime in the present case depends: that of the subsistence, between the Claimant and company C… of special relations in accordance with the terms prefigured in article 63 of the CIT Code.

With this objective, and for ease of exposition, the arguments that, in the Final Tax Inspection Report, founded the verification of special relations between the Claimant and company C… are recalled below (cited Doc. 6):

(i) "(…) on 7 July 2006, A… Lda. acquired from the firm D…, Lda., the rights to the wines … B…, the Old Brandy E… (E…) and F…[and] signed a long-term supply contract with the Group G…, with this being designated with exclusivity, producer, bottler, packager and responsible for the storage of finished products, of the brands B…, Brandy E… and F…, for a period of 20 years";

(ii) in light of the simple statement transcribed in the preceding point, the Tax Authority concluded that "Between the companies "A…, Lda." and the companies of "Group G…", there are the special relations, typified in letter g) of no. 4 of art. 63 of the CIT Code";

(iii) now, "On 06 October 2010, A…, Lda. proceeded to sell for € 100.00, the wine brand … B…, acquired on 07 July 2006 for € 6,000,000.00 to company D…, S.A., now called "C…, Wines, S.A." and whose share capital is held 100% by Group G…, which generated a loss of € 5,999,900 for A…, Lda.";

(iv) whereby, "As already mentioned above, C…, Wines, S.A., is part of Group G… and is held 100% by companies of Group G… (…) Because of this we conclude that this operation carried out between "A…, Lda." and C…, …, S.A., should be properly analyzed based on the legal provisions contained in art. 63 of the CIT Code and in Order 1446-C/2001".

It results from the transcribed excerpts of the Final Tax Inspection Report, in summary, that the Tax Authority understood that special relations subsisted between the Claimant and company C… in the following terms:

(i) in July 2006, the Claimant entered into a contract with company H… under an exclusivity regime for production, bottling and packaging of finished products of the brand B…, Brandy E… and F…;

(ii) by virtue of the execution of the aforementioned supply contract, the Tax Authority understood that between the Claimant and the "Group G… " there was verified a relationship of legal and/or commercial dependence frameable in letter g) of no. 4 of article 63 of the CIT Code;

(iii) the execution, in October 2010, of a contract of disposal of rights between the Claimant and company C…, in the capacity of company integrated in the indicated "Group G…", was subject to the transfer pricing regime established in article 63 of the CIT Code.

This means, therefore, that in the opinion of the Tax Authority the – alleged – subsistence of a special relationship between the Claimant and company H… is communicable to the remaining companies integrated in the "Group G…" [because, supposes the Claimant, between such entities and company H… there subsist special relations frameble in other letters of no. 4 of article 63 of the CIT Code], among which, company C….

In this light, the question which must be answered first is, therefore, whether the Tax Authority could – as it did – apply successively and conjointly the various letters of no. 4 of article 63 of the CIT Code to different entities and operations with the purpose of founding the subsistence of special relations in the present case.

In other words, it must be ascertained whether the circumstance that company C… is held by company H…, entity with which the Claimant entered into in the past a supply contract, is – or is not – capable of meeting the concept of special relations prefigured in letter g) of no. 4 of article 63 of the CIT Code between the Claimant and company C….

Now, the scope of application of the transfer pricing regime is delimited by no. 1 of article 63 of the CIT Code as follows: "In commercial operations (…) between a taxpayer and any other entity, whether or not subject to CIT, with which it is in a situation of special relations, there must be contracted, accepted and practiced terms or conditions substantially identical to those that would normally be contracted, accepted or practiced between independent entities in comparable operations" (the emphasis is the Claimant's).

Further on, no. 4 of the same article 63 of the CIT Code determines "that there are special relations between two entities [i.e., between the aforementioned CIT taxpayer and its counterparty in a certain commercial operation] in situations in which one has the power to exercise, directly or indirectly, significant influence over the management decisions of the other, which is deemed to be verified, in particular, between: (…) g) Entities between which, by force of the commercial, financial, professional or legal relations between them, directly or indirectly established or practiced, there is a situation of dependence in the exercise of their respective activity (…)" (the emphasis is the Claimant's).

From the content of the transcribed nos. 1 and 4 of article 63 of the CIT Code it is possible to infer, with reasonable clarity, that the subsistence of special relations must be ascertained between (i) a CIT taxpayer and (ii) its respective counterparty in a certain commercial operation (or series of operations).

This conclusion is equally confirmed by no. 1 of article 1 of Order 1446-C/2001, of 21 December, where it is clarified that the aforementioned transfer pricing regime is applicable to "operations carried out between a taxpayer subject to IRS or CIT and any other entity, whether or not subject to these taxes, with which it is in a situation of special relations (…)".

Now, from the comparison between the literal element of the various norms which are transcribed results, in objective fashion, that the special relations prefigured by the transfer pricing regime are those which exist (or are verified) between two entities which have carried out a certain commercial operation.

This means, in another perspective – in that of the normative sense binding for the respective interpreter-applier – that the assessment of the subsistence of special relations must be carried out by reference to the relationship established between the parties involved in a given operation.

In this sense work, by the impossibility of assigning them any other textual sense than that which is pointed out to them, the assertions "between a taxpayer and any other entity with which it is in a situation of special relations" (cf. no. 1 of article 63 of the CIT Code), "between two entities" (cf. preamble of no. 4 of the same legal provision) and "in operations carried out between a CIT taxpayer and any other entity with which it is in a situation of special relations" (cf. no. 1 of article 1 of Order 1446-C/2001, of 21 December).

Results from the above, in equally straightforward terms, that the regime flowing from article 63 of the CIT Code does not admit the successive and conjoint application of the various letters of no. 4 of article 63 of the CIT Code to different subjects and to different operations.

Said in another way, the concept of special relations between two entities prefigured in no. 4 of article 63 of the CIT Code, appears not to integrate the relations previously or concomitantly established between one of those two entities and any third parties which have not been party to the commercial operation scrutinized in the transfer pricing context.

This conclusion, based exclusively on the literal element of the norms analyzed, is, in turn, fully confirmed by the rational and systematic interpretative elements underlying the transfer pricing regime.

Regarding the rational element, it is emphasized that the relationship of power or influence presupposed by the transfer pricing regime is based on the knowledge – or, at least, the knowability – of the respective special relations.

Indeed, the knowability of special relations subsisting between the participants in a certain commercial operation constitutes the only way to safeguard that CIT taxpayers are in conditions to comply with the preventive measures provided for in nos. 6 to 13 of article 63 of the CIT Code (where it is required, e.g., the preparation of a transfer pricing file containing all elements relating to the entities with which the taxpayer is in a situation of special relations and to the operations celebrated in such circumstances).

However, while it is clear that it is necessary to impose on CIT taxpayers the duty of exhaustive investigation of the subsistence of such special relations within the scope of a given bilateral commercial relationship (that is, between the party and the counterparty directly related by force of a certain transaction),…

…the fact remains that such investigation becomes increasingly difficult – if not, indeed, impossible – in the hypothesis that such relations must be analyzed by reference to third entities which are not participants in the commercial operation subject to scrutiny under article 63 of the CIT Code.

In this context, if, by hypothesis, the various letters of no. 4 of article 63 of the CIT Code were successively conjoinable in distinct operations and with distinct participants (as the Tax Authority intends), each CIT taxpayer would find itself obliged not only to investigate the subsistence of special relations with its respective counterparty (as results textually from article 63 of the CIT Code)…

…but, further, to scrutinize all special relations (of a group or other type) maintained by such counterparty with other entities with which that same CIT taxpayer could have previously related or could come to relate in the future.

In this hypothesis, and by way of example, the subsistence of a special relationship (e.g. by virtue of letter g) of no. 4 of article 63 of the CIT Code) between a CIT taxpayer and a company integrated in an economic group, more or less vast, would have the effect of dragging within the scope of the transfer pricing regime all operations carried out by that same CIT taxpayer with any one of the remaining entities of such group (or, at the limit, with any entity specially related to that company, albeit not belonging to the same economic group).

Consequently, to anticipate the existence of such special relations (since only upon knowledge of the subsistence of such special relations would the implementation of conditions conforming with the arm's length principle be opposable to the respective participants), the CIT taxpayer would have to know and analyze, in detail, the entire corporate structure, direct and indirect, of the said group (including, in particular, the shareholders natural or legal persons, the members of the corporate bodies of the group companies, etc., as well as all other – and eventual – special relations existing outside the group itself).

However, not only is such information not known or, even – in the majority of cases – knowable, by CIT taxpayers relative to their respective counterparties, but such an interpretation would have the effect of transforming article 63 of the CIT Code into a regime of subjectivist matrix whose main applicative criterion would become the extent of the knowledge of CIT taxpayers regarding the characteristics and corporate and commercial relationships of third entities.

It is concluded, therefore, that such an interpretation would collide frontally with the regime currently established in article 63 of the CIT Code, of overtly objectivist matrix and textually circumscribed to the analysis of the eventual special relations established between two entities participating in a certain commercial operation.

Already in the domain of intra-systemic coherence of the CIT Code, it is important to highlight the regime of non-deductibility of expenses incurred with the transmission of equity interests acquired or transmitted to related entities, contained in nos. 3 and 5 of article 23 of the CIT Code (where situations substantially more promiscuous than those provided for in article 63 of the CIT Code are regulated and which, for that reason, were expressly safeguarded by sectoral anti-abuse norms).

Now, such a non-deductibility regime is applicable when "the equity interests have been acquired from entities with which there are special relations, under the terms of no. 4 of article 63" or upon "the transmission of equity interests (…) to entities with which there are special relations, under the terms of no. 4 of article 63" (cf., respectively, nos. 3 and 5 of article 23 of the CIT Code; the emphasis is the Claimant's).

Results from what is exposed, therefore, that even in cases where a more rigorous and effective action of the tax legislator is invoked in avoiding eventual abuses, the legislator unequivocally clarifies that the assessment of special relations is exhausted in the operation carried out between the participating entities [participations "acquired from" or "transmitted to"], confirming, by clear majority of reasons, the rule which had already been identified in the text of article 63 of the CIT Code.

It is thus allowed to establish as certain that, as textually prescribed by no. 1 of article 63 of the CIT Code, and by no. 1 of article 1 of Order 1446-C/2001, of 21 December, the special relations relevant to the transfer pricing regime are those which are objectively established between the CIT taxpayer and its respective counterparty in a certain commercial operation.

It will be, therefore, between (these) two entities [cf. preamble of no. 4 of article 63 of the CIT Code], and not others, that the fulfillment of any one of the hypotheses prefigured by the legislator as embodying special relations shall be ascertained, in particular that provided for in letter g) of no. 4 of article 63 of the CIT Code.

Given this, it is recalled that the long-term supply contract – capable of, in the opinion of the Tax Authority, meeting the hypothesis outlined by letter g) of no. 4 of article 63 of the CIT Code – was entered into between the Claimant and company H….

This means that when it was concluded, in the Final Tax Inspection Report (cited Doc. 6), that "by virtue of the commercial relations established and practiced, there subsists a situation of dependence of A…, Lda., in relation to "G…", in the exercise of the activity which it develops", the Tax Authority was referring, exclusively, to the relations established between the Claimant and company H…, as its counterparty in the aforementioned supply contract.

However, as is perhaps anticipated, the counterparty of the Claimant in the aforementioned supply contract entered into in July 2006 (company H…) is not the same counterparty of the Claimant in the operation of disposal of the rights associated with the wine brand … B… carried out in October 2010 (company C…).

The same is to say that the Tax Authority invoked, for demonstration of the subsistence of special relations within the scope of an operation carried out between the Claimant and company C…, an operation previously carried out between the Claimant and a third entity (company H…)…

…having, in that context and for that purpose, applied successively and conjointly – in violation of law – the various letters of no. 4 of article 63 of the CIT Code.

It is thus evidenced, without need for further development, the error concerning the assumptions of law into which the Tax Authority incurred in promoting the correction which is analyzed.

Notwithstanding the above, the Tax Authority has now come to maintain, in the context of gracious complaint, that "contrary to what is invoked by the taxpayer, the special relation in the operation of disposal of the wine brand … B… to company C…, …, SA, does not result from the extension of the special relation between the taxpayer and company H…, …, Lda to the counterparty in the disposal of the brand (…) In fact, the special relation invoked in the report is based solely on the application of the provision in letter g) of no. 4 of article 63 of the CIT Code, which provides that the situation of economic dependence must result from "by virtue of the commercial, financial, professional or legal relations between them, directly or indirectly established or practiced", that is, the legislator in the definition of the situation of economic dependence, wished to broaden the scope to cases in which such dependence results from (commercial, financial, professional or legal) relations indirectly established or practiced".

In other terms, the Tax Authority has now come to maintain – in the gracious context – the existence of an indirect relation between the Claimant and company C…, from which resulted the existence of a situation of economic dependence of the first in relation to the second.

More specifically, it is sustained – in the decision of partial rejection – that "what is at issue is the existence of an exclusive supply contract for the products transacted by the taxpayer, resulting directly from such exclusivity the dependence of the latter with respect to H…, …, LDA and, indirectly, with respect to C…, …, SA in the supply of raw materials".

However, it is the case that that – it was not that – the rationale upon which the Tax Administration sought to ground the correction under examination.

As mentioned in the Final Tax Inspection Report, at the time of disposal of the rights of the brand B… the Claimant did not maintain any legal or commercial relationship with company C… nor, even, did it hold any direct or indirect participation in its share capital.

In truth, as flows from the Final Tax Inspection Report, the Tax Authority admits the absence of any type of relationship (commercial, financial, professional or legal) between the Claimant and company C…, in the measure that it refers invariably – by factual impossibility of doing so by direct reference to company C… – to the special relations subsisting between the Claimant and the "Group G…" or "in relation to H…".

This means, therefore, that at the date of the correction sub judice, the Tax Administration did not invoke – nor even leave suggested – the existence of a (commercial, financial, professional or legal) indirect relationship between the Claimant and C… nor did it seek to maintain, in that context, the existence of a situation of economic dependence of the first in relation to the second (the Tax Administration sought to demonstrate, rather, the existence of a situation of dependence of the Claimant in relation to C… arising from the commercial relationship established with H…).

In this context, it is important to clarify that the correction under analysis – as a presupposed act of the act of additional CIT assessment of the year 2010 – could not (cannot) be examined using reasons and grounds different from those contained in the Final Tax Inspection Report, under penalty of subsequent illegality by non-conformity with the preceding acts.

Indeed, the examination of the scrutinized acts must be circumscribed to their respective contextual content, and not, therefore, to a possible admissible content thereof, and must, in such measure, solely and exclusively, take into account the concrete factual and legal situation verified, as indeed was rightly decided in the Judgment of the Supreme Administrative Court, of 5 July 2000, Appeal no. 24632, in the part where it was understood that "(... ) however, in this case, it was not from doubting this indispensability that the tax administration corrected the taxable matter, and so it does not matter to examine here whether or not it is verified".

And in the Judgment of the Supreme Administrative Court, of 22 May 2002, handed down in Appeal no. 0309/02, in which it is emphasized that, "if the act contested in court denied the claim for payment of certain default interest based on grounds which did not include the prescription of the respective right, the legality of the act cannot be examined in light of that prescription".

This means, in summary, that (the)legality of the impugned acts shall be the result of an examination grounded in the motivation of fact and law of those same acts and not in any other which, eventually, could, equally, determine its practice.

Consequently, the (new) ground used by the Tax Administration in the gracious context – albeit, as will be seen, equally unfounded – could never sustain the legality of the impugned acts.

In any event, even if it were admitted that the Tax Administration already left suggested in the Final Tax Inspection Report what is now affirmed in the gracious context – the existence of an indirect relation between the Claimant and C… and, in that context, the existence of a situation of economic dependence of the first in relation to the second – nothing is mentioned regarding the terms and conditions of that supposed relationship, nor in what measure there was verified a situation of dependence of the activity of the Claimant in relation to C….

Indeed, in the decision of partial rejection the Tax Authority limited itself to invoking, as the ground of the subsistence of a special relation between the Claimant and C…, the mere existence of a prior operation carried out between the Claimant and a third entity (company H…).

Consequently, having not been demonstrated, minimally as it may be, that C… had the power to exercise indirectly significant influence over the management decisions of the Claimant – rectius, that the exercise of the activity of the Claimant was dependent on C… as a result of the supply contract entered into between the first and H… – it would always have to be concluded, also here, by the total lack of substantiation of the impugned acts and, consequently, by its illegality.

Finally, the Tax Authority refers in the decision of partial rejection of the gracious complaint that company H… not only "participated in the same contract in which the wine brand … B… was disposed of", but, under the terms of the aforementioned contract, was jointly liable to the Claimant for payment of the price owed by company C…, by virtue of the acquisition of the rights associated with the wine brand … B….

From the aforementioned circumstances and contractual stipulations the Tax Authority drew, in turn, that the eventual special relations subsisting between the Claimant and company H… were communicated to the remaining participants in the respective contract, among which company C….

Now, the contract mentioned by the Tax Authority (i.e., the contract through which the Claimant disposed to company C…, of the rights associated with the wine brand … B…, denominated "…") was provided to that Authority in the course of its respective inspection action (Doc. 15).

As indicated in the Tax Inspection Report, the parties to the aforementioned contract were I… Ltd., J…, Unipessoal Lda. (current Claimant), K... (L...Limited), in the capacity of sellers,…

…and H…, C…, M… Ltd., and N…, Inc., in the capacity of buyers,…

…having been transmitted under such contract, for its part, the library … (acquired by H…), the rights associated with the wine brand … B… (acquired by C…), the physical inventory and all advertising materials located or in transit to the United Kingdom (acquired by M… Ltd.), and, further, the physical inventory and all advertising materials located or in transit to the United States (acquired by N…, Inc.) (cited Doc. 15, Clause 2).

Results from what precedes, therefore, that through the aforementioned contractual instrument various sales and purchase operations were formalized: as many as there are atomistically transmitted objects to each of the participants.

Indeed, such sales and purchase operations could have been formalized separately, taking into account the distinct nature of the elements disposed, the sale price stipulated for each of them and the autonomy of the respective acquirers.

However, for reasons of convenience and simplification, it is common to concentrate several sales and purchase operations in a single contractual instrument jointly executed by the various participants (situation denominated as combination or union of contracts).

In such cases – as in the present – each sale and purchase embodies a legally autonomous contract, albeit combined or united with other contracts of the same nature.

Consequently, transposing the aforementioned contractual formation process to the domain of transfer pricing, it should be concluded that each one of the sales and purchase operations, albeit formalized in the same contractual instrument, will be deserving of an autonomous analysis in the context of transfer pricing, taking into account its legal independence (distinct objects and participants) and economic (distinct contracted conditions).

Indeed, each asset disposed to a specific counterparty for a determined price translates an independent economic operation, susceptible of autonomous evaluation as to its respective conditions (e.g., in the relationship established between the stipulated price and the asset transmitted) and its conformity with the arm's length principle.

This means, therefore, that the transfer pricing regime must be applied, if that be the case, to each one of the sales and purchase operations formalized in the context of a union or combination of contracts, and in each one of them, the subsistence of special relations between the two parties participating (that is, between the disposing party and the acquirer of a certain asset) shall be ascertained.

Transposing this application hypothesis to the present case it will be necessary to conclude, once more, that no special relation subsists between the Claimant and company C…, in the capacity of acquirer of the rights associated with the wine brand … B…,…

…with the consequent non-applicability of article 63 of the CIT Code and, well also, with the inherent illegality of the correction carried out by the Tax Authority by virtue of the vice of violation of law.

Notwithstanding what precedes, if it were to be admitted that the special relations allegedly subsisting between two parties are capable of being extended to the remaining participants in the respective union of contracts, it would always have to be concluded that all operations covered by such contractual instrument constitute a single operation for transfer pricing purposes, taking into account the unsusceptibility of their autonomization as independent operations…

…being forced to recognize, under penalty of there being an insaneable incoherence, that all operations included in the respective contractual instrument constituted after all a single operation, analyzing the aggregate of the operations carried out and the values stipulated for each one of them as if it were a single operation for transfer pricing purposes.

As a consequence, this qualificative hypothesis would imply that the various operations formalized through the contract entered into by the Claimant were jointly analyzed, taking into account the subsistence of special relations between all the participants, it being incumbent upon the Tax Authority to demonstrate that the value globally stipulated was not in conformity with the arm's length principle.

Thus, the Tax Authority should have analyzed in the inspection context the conformity of the price globally agreed as consideration due for the acquisition of the rights associated with the wine brand … B… (which amounted to the amount of € 2,325,000.00, and not solely the value owed by company C…),…

…and, equally, ascertained the conformity of the value paid by H… to the Claimant by virtue of the acquisition of the library … (in the amount of € 1,675,000.00), entities between which the Tax Authority understood to subsist, moreover, a special relation determinative of the application of the transfer pricing regime.

However, it stands out from the Tax Inspection Report that despite sustaining that the contract entered into by the Claimant constituted a single operation for transfer pricing purposes (with the consequent communicability of the special relations established between the various parties), the Tax Authority circumscribed its analysis to the limited and partial examination of only one of the integrative elements of the operation thus carried out.

Indeed, it is verified that in the course of the inspection action carried out the Tax Authority limited itself to scrutinizing the operation carried out between the Claimant and company C… (confirming, in implicit fashion, the autonomy or independence of this operation relative to the remaining ones).

As a consequence, the Tax Authority omitted the analysis of the principal conditions of the operation subject to scrutiny under the transfer pricing regime (such as the price globally owed for the disposal of the rights associated with the wine brand … B…, or the value owed for the disposal of the library…),…

…not analyzing – nor, even, making any reference to – the implications which such conditions would be capable of producing, either in the identification of a comparable operation (in the measure that the comparative analysis required by the transfer pricing regime would come to require the global consideration of the scrutinized operation), or in the subsequent determination of the arm's length price (taking into account that the global value of the operation would amount, in this scenario, to € 4,000,000.00).

This means, therefore, that, in this context, the correction carried out by the Tax Authority would equally be illegal, this time by virtue of suffering from manifest lack of substantiation,…

…since there would have been omitted the analysis of the greater part of the conditions stipulated in the contract entered into by the Claimant, grounding the correction carried out in a merely partial analysis of the operation carried out, which would be manifestly violative of the comparative methodology prescribed by the transfer pricing regime and, for that reason, incapable of grounding the non-conformity of the contract in question with the arm's length principle.

To conclude this point, it remains to be said that the invoked joint liability of company H… for payment of the price owed to the Claimant by company C…, only confirms, contrary to what the Tax Authority maintains, that the various sales and purchase operations formalized through the contract entered into in October 2010 embodied autonomous operations among themselves.

Indeed, in the case where the contract entered into translated a single sales and purchase operation, company H… would be originally liable for payment of the price globally owed to the Claimant, making it useless to stipulate its joint liability for payments owed by the remaining acquirers – in the measure that such clause would embody a mere repetition of the legal regime already applicable to the contract entered into.

In this context, the utility of the stipulation of the joint liability of company H… would only be justified in a scenario of constitution of additional guarantees, that is, in a scenario in which that first company was not, already, liable for payment owed by company C….

Thus, the invoked passive solidarity will have aimed to grant to the Claimant an additional guarantee, identical to a surety without the benefit of prior execution (under the terms of which "The surety guarantees the satisfaction of the credit right, remaining personally obligated to the creditor", cf. article 627 of the Civil Code).

Consequently, and also for this reason, it must be concluded by the manifest illegality of the correction promoted to the taxable profit of the Claimant of fiscal year 2010.

Having arrived here, and without prejudice to having demonstrated that the supply contract celebrated between the Claimant and company H… is not to be considered for purposes of verifying a relationship between the Claimant and company C…, it is noted, in any event, that the Tax Authority did not succeed in demonstrating, even, the subsistence of a special relation between those first entities (the Claimant and company H…).

On this subject, it is necessary to recall that the special relations prefigured in the invoked letter g) of no. 4 of article 63 of the CIT Code were described in the Tax Inspection Report as follows: "When on 7 July 2006, A…, Lda. acquired from the firm D…, Lda., the rights to the wines … B…, the Old Brandy E… (E…) and F…, signed a long-term supply contract with Group G…, with this being designated with exclusivity, producer, bottler, packager and responsible for the storage of finished products, of the brands B…, Brandy E… and F…, for a period of 20 years" (cited Doc. 6).

However, paraphrasing the assumptions outlined by the provision of the invoked letter g) of no. 4 of article 63 of the CIT Code, it is verified that the Tax Authority abstained from demonstrating, by reference to the aforementioned supply contract:

(i) in what measure the exercise of the activity of the Claimant depended substantially on the cession of industrial or intellectual property rights or know-how held by company H…;

(ii) in what measure the supply of raw materials or the access to sales channels of the products by the Claimant depended substantially on company H…;

(iii) in what measure a substantial part of the activity of the Claimant could only be carried out with company H… or depended on its decisions;

(iv) in what measure the right of price fixing, or conditions of equivalent economic effect, was held by H…; or, equally,

(v) in what measure H… could condition the management decisions of the Claimant, based on facts or circumstances alien to the commercial or professional relationship itself.

This means that the Tax Authority limited itself to enunciating, simply and acritically, the legal norm whose assumptions, once fulfilled, could legitimate recourse to the transfer pricing regime.

Moreover, it is the Tax Authority itself which emphasizes in the decision of partial rejection of the gracious complaint procedure that, "in fact, it is not indicated in the final tax inspection report which of the situations provided for in the sub-letters of letter g) of no. 4 of article 63 of the CIT Code" (cited Doc. 1).

What is stated is sufficient to conclude, without more – taking into account that this vice is expressly recognized by the Tax Authority itself – by the manifest lack of substantiation of the correction which is analyzed, with the consequent need for its annulment.

Consolidating what is stated, the Supreme Administrative Court confirms that "the act which leads to these corrections of the taxable matter is not properly substantiated if it does not describe the special relations which justify those alterations" (cf. Judgment of 22-09-2004, handed down in appeal no. 119/04),…

Nevertheless, the Tax Authority came to essay a posteriori the supplementation of that gap in substantiation, alleging, already in the gracious context, that "the reference to the "long-term supply contract with Group G…" clearly indicates that what is at issue is sub-letter 2) of that letter, that is, "the supply of raw materials or the access to sales channels of the products, goods or services of one depends substantially on the other" and that "what is at issue is the existence of an exclusive supply contract for the products transacted by the taxpayer, resulting directly from such exclusivity the dependence of the latter in relation to H…, …, Lda. and, indirectly, in relation to C…, Lda. in the supply of raw materials" (cited Doc. 1).

However, even faced with this subsequent realization, the truth is that the Inspection Report remains totally omissive regarding the effective demonstration of the requirements prescribed by sub-letter 2) of letter g) of no. 4 of article 63 of the CIT Code, not touching upon, minimally as it may be, the terms in which the supply contract entered into by the Claimant with company H… created a relationship of economic dependence relevant for transfer pricing purposes.

Confirming this lack of substantiation, it is further emphasized that the special relations arising from a situation of economic dependence result from the possibility of exploitation, by one company, of the power or ascendancy which it has in relation to another, which finds itself in a state of dependence because it does not have an equivalent alternative for supply of goods or provision of services in question.

As an essential note of this situation the following is emphasized, therefore, that the disadvantaged company will find itself in a state of economic dependence relative to the dominant company, taking into account the non-existence of equivalent alternatives.

In this context, with a view to ascertaining the existence of a situation of economic dependence in the case of the Claimant, the Tax Authority should have ascertained whether, in a moment prior to the execution of the supply contract with H…, the Claimant had the option of negotiating with other wine-producing entities … and, in light of the realistically available options, selected the entity which, at the time, offered it the best commercial conditions and confidence for the exercise of that activity.

Moreover, it is public knowledge that there are other entities in the market with activities and characteristics identical to those of H… (other families with reputation in wine production …), and so there would be no effective impediment for the Claimant to have selected another supplier, on an exclusive basis and for a period of time equally long, at the time when it entered into the aforementioned supply contract.

However, nothing was said on this subject in the Final Tax Inspection Report or, even, in the decision of partial rejection of the gracious complaint.

It is concluded, therefore, by the manifest violation of the duty of substantiation imposed by letter a) of no. 3 of article 77 of the General Tax Law, under the terms of which the Tax Authority should have demonstrated the constitutive requirements of the alleged special relationship subsisting between the Claimant and company H….

In this precise sense has already observed the Central Administrative Court South, that "The burden of proving that the assumptions for application of art. 57 of the CIT [current article 63 of the CIT Code] (…) lies with the Public Treasury, namely by describing, in a clear and objective manner, the type of relationships verified between the taxpayer and the person with whom it is said to have had special relations" (Judgment of 16-01-2007, handed down in appeal no. 1114/03).

In sum, and from what is exposed – whether by being based on error concerning its respective assumptions of law, or by incurring in the vice of lack of substantiation – the correction to the taxable profit of fiscal year 2010 of the Claimant, grounded in the application of article 63 of the CIT Code, is illegal, and should, as such, be annulled.

II. On the unsuitability of the method of determination of transfer prices invoked by the Tax Authority

A) Introductory considerations

Proceeding with the present discussion, it should be noted that even if any special relations subsisted in the present case, there would still be need to scrutinize the conformity of the conditions agreed between the Claimant and company C…, with the arm's length principle and, in case of proven non-conformity, to quantify the respective deviation (as the value of the correction admitted by article 63 of the CIT Code).

It is stated in the Final Tax Inspection Report with regard to the criterion used for this purpose, that "among the methods pointed to in no. 2 of the same art. 63 of the CIT Code, the one which best suits the operation under analysis, is, the Comparable Uncontrolled Price Method, in the measure that, it is possible to determine what the normal market price is for substantially identical operations" (cited Doc. 6) (the emphasis is the Claimant's).

Accordingly, the adoption of the comparable uncontrolled price method invoked by the Tax Authority requires, under the terms of no. 1 of article 6 of Order 1446-C/2001, of 21 December, "the highest degree of comparability with focus both on the object and other terms and conditions of the operation as well as on the functional analysis of the entities involved".

For its part, the comparable uncontrolled price method invoked by the Tax Authority may be used, in accordance with no. 2 of article 6 of Order 1446-C/2011, of 21 December, in the following situations: "a) When the taxpayer or an entity belonging to the same group carries out a transaction of the same nature which has as its object a service or product identical or similar, in quantity or value analogous, and in terms and conditions substantially identical, with an independent entity in the same or in similar markets; b) When an independent entity carries out an operation of the same nature which has as its object a service or a product identical or similar, in quantity or value analogous, and in terms and conditions substantially identical, in the same market or in similar markets".

In this context it would be fitting to presume, therefore, that in the process of identification of comparable operations the Tax Authority had identified the elements and distinctive circumstances of the operation carried out on 6 October 2010 between the Claimant and company C…, in order, in that light, to set the relevant comparability factors, given that the adoption of this method requires, under the terms of no. 1 of article 6 of Order 1446-C/2001, of 21 December, "the highest degree of comparability with focus both on the object and other terms and conditions of the operation as well as on the functional analysis of the entities involved".

Given this, once identified an uncontrolled operation substantially identical to the comparability factors extracted from the operation carried out on 6 October 2010 between the Claimant and company C… – which may be an operation of internal nature (applying the transcribed letter a) of no. 2 of article 6 of Order 1446-C/2011, of 21 December) or of external nature (applying the aforementioned letter b)) – it would still be required of the Tax Authority the comparison between such operations with a view to identifying their respective discrepancies.

However, as will be demonstrated below, the Tax Authority did not attend to the fundamental pillar of the application of the comparable uncontrolled price method (the uncontrolled nature of the comparable operation), violating one of the most elementary principles of the transfer pricing regime, and did not proceed with the prior identification of the relevant comparability factors which would allow to ensure comparability at the highest level in the present case (thereby prejudicing the degree of comparability required by law for determination of transfer prices).

Without prejudice to what precedes, the Claimant will not fail to additionally evidence the errors incurred in the economic analysis carried out by the Tax Authority.

B) On the lack of identification of comparability factors and the consequent violation of the degree of comparability at the highest level

Cutting short the present analysis, it is recalled that the comparable uncontrolled price method invoked by the Tax Authority "requires the highest degree of comparability with focus both on the object and other terms and conditions of the operation as well as on the functional analysis of the entities involved", under the terms of article 6 of Order no. 1446-C/2001, of 21 December.

For this purpose, the Tax Authority should have preliminarily set the relevant comparability factors for the identification of the respective comparable operation,…

…in particular, the "specific characteristics of the goods, rights or services; the functions performed by the entities participating in the operations; the contractual terms and conditions; the economic circumstances prevailing in the market; the strategy of the companies; and other characteristics relevant to the operation in question or to the companies involved" (cf. article 5 of Order no. 1446-C/2001, of 21 December).

Indeed, the understanding of the Arbitral Tribunal regarding the necessity of fixing and careful weighing of the comparability factors used as the criterion of base for the tax adjustment has been lapidary: "As results from the text of this norm, it is only legal to use this method when there exists the highest degree of comparability and this must focus cumulatively on the object, terms and conditions of the operation, in addition to the functional analysis of the entities involved. Indeed, that word "both" [included in the aforementioned no. 1 of article 6] evidences that one is not facing an alternative listing of requirements, but rather a cumulative one." (cf. Proceedings no. 55/2012-T, no. 145/2013-T and no. 160/2013-T);…

…adding the same Tribunal, in another decision, that "From this there derives that the CUP [Comparable Uncontrolled Price], elected as the most reliable method as a basis for eventual adjustments, requires quite demanding conditions for its application. It is understood that it be so. For such method to constitute the basis of the adjustments, the operations in question (controlled and uncontrolled) must possess a high degree of comparability. If not, the CUP will not serve as a criterion of base for the tax adjustment." (cf. Proceeding no. 91/2012-T; it should be noted that all Proceedings identified in this article and the previous one have in common the declaration of illegality of corrections in transfer pricing by violation of the norms which define the application of the comparable uncontrolled price method).

In the present case, however, it is verified that the Tax Authority limited itself to identifying as a comparable operation, for purposes of quantification of the adjustment to be made to the taxable profit of the Claimant of fiscal year 2010, the operation of acquisition of the rights associated with the wine brand … B… carried out on 7 July 2006 between the Claimant (then denominated O…– …, Unipessoal, Lda.) and company D…, S.A.,…

…sustaining itself for this purpose in the generic analysis of some economic indicators with the intent to establish – through market share, positive operating margins and absence of impairment losses – that the sale price of the brand in 2010 would be identical to the price paid by the Claimant at the time of its acquisition in 2006,…

…and concluding, on this subject, that "Everything points to that the market price of brand B… in 2010 would be identical to the market price obtained in 2006 given that there has been no deterioration up to 2010 of the conditions of market underlying the formation of the purchase price" (cited Doc. 6).

In the same sense, the Tax Authority reiterated in the decision of partial rejection of the gracious complaint that between the controlled operation and the comparable operation there exists perfect identity, both in the object (the wine brand … B…), as in the entities involved (reversing only the positions of buyer and seller), considering thus assured the highest degree of comparability required by no. 1 of article 6 Order no. 1446-C/2001, of 21 December.

It is emphasized, however, that the Tax Authority contradicts itself when concluding that "The only situation which distinguishes the controlled operation (carried out in 2010) with the comparable operation (carried out in 2006) is really the fact that they were carried out in distinct periods." (cited Doc. 1, point 29 of p. 10) when, in the preceding point, it acknowledges that the contractual and commercial positions of the entities involved were reversed,…

…adding nothing further regarding this reversal, as if the position of the parties – of buyer or seller in a controlled operation – embodied an irrelevant aspect in the matter of comparability.

On this matter, it is important to note that in paragraph 1.55 of the OECD Transfer Pricing Guidelines (2010 version) it is expressly referred to the necessity of consideration, in the comparative analysis to be carried out, of all relevant economic circumstances in this domain, among which are "the relative competitive positions of buyers and sellers".

In other words, it is recognized by the guiding principles of the OECD – in which, for its part, the Portuguese transfer pricing regime is based – that the relative competitive position of the buyer or the seller influences the arm's length price.

Consequently, by not fixing the comparability factors prescribed by Order no. 1446-C/2001, of 21 December, the Tax Authority prejudiced the identification of a comparable operation which would properly safeguard the reversal of roles of seller to buyer and, therefore, the competitive and negotiating position of the Claimant.

Equally, the Tax Authority did not safeguard the comparability of the economic circumstances prevailing in the market in 2010, since it limited itself to invoking a comparable operation carried out in 2006 without taking care to prove (by fixing the proper comparability factors) that the market conditions remained identical notwithstanding the time lapse which elapsed between the date of the comparable operation (2006) and the date of the compared operation (2010).

Results from what precedes, therefore, that the lack of fixing of the comparability factors by reference to the present case led to the Tax Authority ignoring elements as relevant as the time elapsed between the operations analyzed and the relative position of the parties involved, irreparably prejudicing the highest degree of comparability required by no. 1 of article 6 Order no. 1446-C/2001, of 21 December, and wounding the correction carried out with the vice of illegality by violation of law.

C) On the controlled – and, therefore, inadmissible – nature of the comparable operation used by the Tax Authority to quantify the adjustment carried out

Proceeding with the present analysis, it is highlighted, as already amply referred to, that under the terms of no. 1 of article 63 of the CIT Code the comparable operation for purposes of application of the transfer pricing regime should embody an operation carried out in "terms or conditions substantially identical to those that would normally be contracted, accepted and practiced between independent entities in comparable operations" (the emphasis is the Claimant's).

It was equally possible to verify above that the Tax Authority elected as a comparable operation, for purposes of quantification of the adjustment to be made to the taxable profit of the Claimant of fiscal year 2010, the operation of acquisition of the rights associated with the wine brand … B… carried out on 7 July 2006 between the Claimant (then denominated O…– …, Unipessoal, Lda.) and company D..., S.A..

However, as the Tax Authority should not be unaware – taking into account the factual finding carried out in the inspection context and the additional elements requested of the Claimant – the aforementioned comparable operation does not translate an operation carried out between independent entities, but rather a controlled operation carried out between entities relative to which special relations subsisted.

In this sense, it is referred in the point "II.3 – Brief characterization of the taxpayer" of the Tax Inspection Report (cited Doc. 6) that:

(i) The Claimant "was incorporated on 06 July 2006, with share capital of € 5,000.00, under the designation O…– …, Unipessoal, Lda., having as sole shareholder the firm P…, S.L., with registered office in Madrid – Spain";

(ii) On 7 July 2006, the brand B… was acquired by the Claimant from company D..., S.A.;

(iii) Subsequently, on 25 July 2006, "the entirety of the share capital of D…, Lda., was acquired by group G…, with the firm H…, Lda., NPC … acquiring 71% of the share capital and the firm Q…– …, S.A., NPC … acquiring the remaining 29%";

(iv) Finally, "On 09 November 2006, D…, Lda., was transformed into a joint-stock company becoming designated C…, …, S.A.".

Now, as the Tax Authority highlights, company D…, S.A. (subsequently redenominated to C…), only integrated Group G… on day 25 July 2006, the date on which its share capital was wholly acquired by companies H… and Q…– Wines, S.A..

Until day 25 July 2006, the aforementioned company D…, S.A., was wholly held by entities R… B.V. and S… (UK) Limited (in 71.43% and 28.57%, respectively), both companies integrated in Group T…, as is expressly referred in the Asset Sale and Purchase Agreement provided to the Tax Authority in the course of the inspection action (cited Doc. 15, Recital C).

This means, therefore, that on 7 July 2006 (date of acquisition of brand B… by the Claimant), both the Claimant (buyer) and D…, S.A. (seller), belonged to Group T…, subsisting between them a situation of special relations under the terms prefigured in letter b) of no. 4 of article 63 of the CIT Code.

In other words: the values which were used by the Tax Authority as arm's length values for purposes of correction to the taxable profit of the Claimant, constituted, after all, values of an operation carried out between two specially related entities – the Claimant and company D…, S.A., both companies integrated in Group T….

As a consequence, the values of the operation of acquisition of brand B… carried out on 7 July 2006 by the Claimant could not have been used by the Tax Authority as referents for the assessment of the arm's length price in a comparable operation, for the simple – but definitive – reason that they do not translate a price agreed between independent entities,…

…and the correction carried out based on such values, for this reason, illegal, in the measure that it frontally violates the regime prescribed by article 63 of the CIT Code.

D) On the errors incurred by the Tax Authority in the analysis of some economic indicators

Already regarding the analysis of some economic indicators (analysis which was carried out with the intent of maintaining that the sale price of the brand in 2010 would be identical to the price paid by the Claimant at the time of its acquisition in 2006), it is stated in the Tax Inspection Report (cited Doc. 6) that:

(i) In relation to operating results, "the contribution of brand B… was always positive. In the last 4 fiscal years, it was even superior to the contribution given by brands E… and F…" [however, taking into account the evolution of this indicator (30.25% in 2007, 86.93% in 2008, ‑50.81% in 2009 and ‑46.21% in 2010), it is easily understood that, starting from 2009, the wine … business gave signs of strong weakening, especially when compared with the brandy business (‑26.97% in 2007, 10.39% in 2008, ‑1.08% in 2009 and 11.47% in 2010)];

(ii) that "in all fiscal years the operating margin [of brand B…] was positive" [even though the margins verified in the wine … segment are effectively positive, the Claimant cannot fail to draw attention to the decrease in the same in recent years of activity (‑41.82% in 2009 and ‑34.80% in 2010)];

(iii) that "the demand for this type of product [wine …] only decreased, between 2006 and 2010, about 6%, whether in quantities or in volume of business" [however, it remains to be seen whether, contrary to the negative evolution of the worldwide wine … market which the Tax Authority considers to constitute a not very significant reduction, the evolution of the brandy market would not have been better, a situation which would justify the interest of the Claimant in distancing itself from the wine … business to devote itself to the core business of Group T…, through brands E… and F…];

(iv) and that the market share of brand B… "remained stable in the period between 2006 and 2010, even considering that 2006 and 2010 do not correspond to complete years, having even increased slightly in 2007 and 2008" [on this point, the Claimant cannot agree with the advanced conclusion, since, as can be verified, the market share of B… registered increasingly smaller growth (27.1% in 2007 and 17.8% in 2008), until registering, indeed, a contraction in 2009 and in 2010 (-9.7% and ‑21.6%, respectively)].

Summarizing what is stated, the Claimant cannot conform to the analysis carried out by the Tax Authority regarding the stability of market share, the maintenance of positive operating margins and the absence of impairment losses invoked with the purpose of demonstrating the impossibility of devaluation of brand B…, in the measure that:

(i) on one hand, and as above evidenced, the market share of the Claimant suffered a contraction in 2009 and in 2010, of -9.7% and -21.6%, respectively, values completely incompatible with a situation of stability (the Tax Authority will have, apparently, focused its analysis on absolute values, examining the market share of the Claimant in a reductive way, without contemplating and evaluating its evolution, a good indicator of the growth and sustainability of the business); and

(ii) on the other hand, even though the operating margins remained positive, a notable decline is evident in the periods of 2009 and 2010, especially when compared with the operating margins recorded in the brandy business segment, for which reason it would never be obvious and "expected that such situation [the maintenance of positive operating margins] would be maintained", because successive declines in the operating margin could, over time, result in negative margins;

Already in the gracious context, the Tax Authority observed that the starting point of the analysis carried out was to "ascertain what the criteria were which underlaid the formation of the purchase prices (in 2006) and sale (in 2010) of the wine brand … B…" (cited Doc. 1, p. 11)…

…and, based on some of the elements provided (with a different purpose) by the representative of the Claimant, determine the allocation of the price among the entities which participated in the purchase of the rights associated with brand B… (i.e., the Claimant and I…), with the Tax Authority concluding that "the sale price should have been at least €365,178.53" (cited Doc. 1), to which corresponds an allocation of 16% of the transaction price.

However, that was not the approach adopted by the Tax Authority to determine the correction effected to the sale price of brand B… by the Claimant to C….

In this sense, notwithstanding not questioning the global price paid by C…, in the amount of € 2,325,000.00 (having questioned only its distribution between the Claimant and I… in the Final Tax Inspection Report) the Tax Authority ended up determining the value of the correction carried out disregarding completely that global price or its conformity with the arm's length principle.

As a consequence, and by virtue of the – incorrect – application of the comparable uncontrolled price method, the Tax Authority ended up correcting the transaction price attributed to the Claimant to a value even superior to the price globally owed, without establishing, minimally as it may be, the departure from that value (that is, without demonstrating its non-conformity with the arm's length principle, which once more demonstrates the commission of the vice of lack of substantiation).

Finally, the analysis carried out by the Tax Authority of the argumentation presented by the Claimant in the context of gracious complaint raises the following additional observations:

(i) The Tax Authority understands that, even though the monthly operating margin recorded by the Claimant presents a very disparate behavior in the years analyzed, "it remains to be demonstrated that "starting from 2009, the wine … business gave signs of strong weakening", since, in 2008, the value of the monthly margin was not very different from what was determined in 2009". Now, taking into account the evolution of this indicator, calculated monthly (-34.88% in 2007, 86.93% in 2008, 50.81% in 2009 and -28.29% in 2010), the conclusion remains that, starting from 2009, the wine … business gave signs of strong weakening, especially when compared with the brandy business (-63.48% in 2007, 10.39% in 2008, -1.08% in 2009 and 48.63% in 2010). Indeed, the statement of the Tax Authority regarding the variation of the margin recorded between 2008 and 2009 is not comprehensible, since what is at issue is a decline to half the value.

(ii) The Tax Authority further adds that "the market share in the year 2009 is only inferior to that observed in the immediately preceding year and the market share of 2010 is superior to that observed in 2006, in the year in which the taxpayer acquired the wine brand … B…, whereby it is concluded that there is no the deterioration invoked by the taxpayer". On this point, the Claimant does not understand how the Tax Authority can ignore the record of successive retractions in 2009 and in 2010, respectively of 9.7% and -21.6%.

…imposing itself, by all that is exposed, the annulment of the correction embodied in the increase of the amount of € 5,999,900.00 to the taxable profit of the fiscal year 2010 of the now Claimant.

Autonomous illegality of the compensatory interest assessment

On the absolute lack of substantiation regarding the demonstration of the requisiteness of compensatory interest

Together with the additional CIT assessment, the Claimant was notified of the compensatory interest assessment demonstration, in the amount of € 24,760.13 (cited Docs. 2 to 4).

This act of compensatory interest assessment was not, however, accompanied by any substantiation demonstrative of the verification of the assumptions, of fact and of law, upon which its requisiteness depends.

On this subject, article 35, no. 1, of the General Tax Law provides, following moreover what was already established in the previous article 83 of the Tax Procedure Code, that only "(...) compensatory interest is due when, by fact attributable to the taxpayer, the assessment of part or all of the tax owed or the delivery of tax to be paid in advance, or withheld or to be withheld in the context of tax substitution is delayed".

Attentive to the most recognized doctrine and the jurisprudence which has been settling, compensatory interest will only be assessed in the case of there being prejudice to the Tax Authority by fact attributable – on the grounds of fault, therefore – to the taxpayer; in other words, in the words of the Supreme Administrative Court, "(...) compensatory interest arising from the delay in the assessment of the respective tax (...) presuppose the existence of fault (intent or negligence) of the taxpayer for the delay or failure of the assessment" (cf. Judgment of the Supreme Administrative Court, of 23 October 2002, Proceeding no. 1145/02).

There is required, therefore, a voluntary action, aimed at undue exploitation and known, or knowable, by the taxpayer, relative to the legitimate revenues of the State.

And, on this particular point, taking into account the provisions of articles 74, no. 1, of the General Tax Law and 342, no. 1, of the Civil Code, it incumbent (fell to) the Tax Authority to demonstrate and prove such constitutive facts of the right to compensatory interest assessment (namely, the fault of the taxpayer in the eventual delay or retardation of the tax assessment),…

…that is, to demonstrate the assumption of the compensatory interest assessment which translates into the "(...) existence of a nexus of causality between the action of the taxpayer and the retardation of the assessment and, equally, a judgment of censure, on the grounds of intent or negligence, assessed in abstract, according to the diligence of the "bonus pater familias"" (cf. Judgment of the Supreme Administrative Court, of 17 October 2001, Proceeding no. 25.803),...

...being certain that the jurisprudence has maintained that the requisite imputability required by law is not verified in the case where the "(...) retardation of the assessment (...) [results] from a simple, non-culpable, divergence of criteria" between the taxpayer and the Tax Administration" (cf. Judgments of the Supreme Administrative Court, of 18 February 1998, Proceeding no. 22.325, and of 23 October 2002, Proceeding no. 1145/02).

Moreover: in the same decision it was further sustained that the imputability referred to in the law is not satisfied by "(...) the mere objective link of the fact to the taxpayer (...) also having a subjective judgment consisting in the attribution or imputation of the failure to comply to the will of the agent, so as to be able to formulate regarding its conduct, a judgment of censure, in a word, the fault" (Judgment of the Supreme Administrative Court, of 18 February 1998, Proceeding no. 22.325).

Now, this fault must be appreciated or, at least, be the object of consideration – albeit perfunctory – by the Tax Authority, externalized in the respective Report.

And this because the assessment of compensatory interest is not an immediate and automatic consequence – as the Tax Authority appears to intend – of any additional tax assessment, and can only correspond, rather, to the final result of all the cognitive and evaluative process where the aforementioned nexus of causality is established and a judgment of censure is formulated regarding the action of the taxpayer (cf. Judgment of the Supreme Administrative Court, of 3 October 2001, Proceeding no. 25.034).

That, however, is not what the Tax Authority did, limiting itself to requiring, in automatic fashion, the aforementioned amount of € 24,760.13 as compensatory interest, exceeding the legal formalities established for the respective assessment and thereby impregnating the respective assessment act with the vice of form due to lack of substantiation, under the provisions of article 35, no. 1, of the General Tax Law.

On the pretermission of essential legal formality

Additionally there is to be added to what is exposed that, under the terms of article 60, no. 1, letters a) and e), of the General Tax Law – which makes concrete the constitutional principle of participation of citizens in the formation of decisions by the Public Administration (article 267, no. 5, of the Constitution of the Portuguese Republic) – taxpayers must be notified to, if they wish, exercise the right of prior hearing on the report of conclusions of any inspection action and respective – and consequent – assessment acts,…

…establishing itself further on, no. 3 of the same legal provision, that "(...) having the taxpayer been previously heard at any of the phases of the procedure to which letters b) to e) of no. 1 refer, its hearing is dispensed with before the assessment, except in case of invocation of new facts on which it has not yet pronounced itself".

Well now, the Claimant was notified to exercise the right of prior hearing, but only regarding the conclusions of the inspection action carried out in fiscal year 2010, where the matter of compensatory interest is not, minimally as it may be, addressed.

For this reason, and taking into account the wording of no. 3 of article 60 of the General Tax Law, the Claimant should have been notified to pronounce itself on such assessment, either at the moment foreseen in letter e) of no. 1 of the same provision, or before the assessment, that is, at the moment foreseen in letter a) of no. 1 of article 60 of the General Tax Law.

What matters is that, independent of the moment at which such notification for prior hearing should have occurred, the Claimant would have to have been expressly notified to, if it wished, pronounce itself on the intention to proceed with the compensatory interest assessment.

Having said this, the act of compensatory interest assessment above identified is equally illegal due to pretermission of the essential legal formality provided for in article 60, no. 1, letter a), of the General Tax Law.