IRC Tax Assessment Annulled: Specialization Principle & Transfer Pricing Rules (CAAD 609/2015-T)

ARBITRAL AWARD

The arbitrators Counselor José Baeta Queiroz (arbitrator-president), Dr. Rui Ferreira Rodrigues and Professor Doctor João Ricardo Catarino, adjunct arbitrators, appointed by the Deontological Council of the Administrative Arbitration Center to form the Arbitral Court, constituted on 02 February 2015, hereby agree as follows:

I. Report

1. "A…, Portugal SA", collective entity no. …, with registered office at Rua …, no. …, …, municipality of Santa Maria da Feira, (hereinafter "Claimant"), submitted, on 21 September 2015, a request for the constitution of a collective arbitral tribunal, pursuant to the combined provisions of articles 95 of the General Tax Law (LGT), 99, paragraph a) of the Code of Tax Procedure and Process (CPPT), 137, no. 1, of the Corporate Income Tax Code (CIRC), 2 and 10, no. 2, of Decree-Law no. 10/2011, of 20 January (Legal Regime of Arbitration in Tax Matters, hereinafter referred to only as «RJAT») and of articles 1 and 2 of Administrative Order no. 112-A/2011, of 22 March, in which the Tax and Customs Authority (AT) is the Respondent.

2. The claim subject of the request for arbitral pronouncement consists of the assessment of the legality of the additional assessment of corporate income tax (IRC) no. 2015…, of 23 April 2015, for the year 2010, in the total amount of 4,766.28 €, corresponding to 4,052.79 € in IRC and 713.49 € in compensatory interest, from which arises a tax debt in the total amount of 5,804.42 €, contained in the statement of account correction to which the adjustment no. 2015… of 24 April 2015 refers (documents nos. 1 and 2 attached to the request for arbitral pronouncement).

3. The Claimant petitions that the IRC correction, determined following the internal tax inspection no. O12014…, in the amount of 339,394.93 €, be declared illegal, and as a result of the claim being granted:

   i) The annulment of the aforementioned assessment, given the illegality of the aforementioned arithmetic corrections;

   ii) The annulment of the assessment of compensatory interest due to failure to meet the legal requirements provided for in article 35 of the LGT;

   iii) The restitution of the amount wrongfully paid in the amount of 5,804.15 €;

   iv) The payment of indemnificatory interest, pursuant to article 43 of the LGT; and

   v) The condemnation of the AT to pay the costs of the arbitral proceedings.

4. The request for arbitral pronouncement was accompanied by nineteen documents, numbered 1 to 3 and 265 to 280.

5. The Claimant protested to attach 216 documents with nos. 4 to 264, cf. article 9 of the request for arbitral pronouncement, which was not done, up to this moment, despite stating in its final pleadings that it had attached them to the initial petition, cf. paragraph v) of part II, page 3.

6. The request for the constitution of a collective arbitral tribunal was accepted by the President of CAAD and automatically notified to the AT on 01 October 2015.

7. The Claimant did not proceed with the appointment of an arbitrator, wherefore, pursuant to paragraph a) of no. 2 of article 6 and paragraph b) of no. 1 of article 11 of the RJAT, the President of the Deontological Council appointed the undersigned as arbitrators of the collective arbitral tribunal, who communicated acceptance of the appointment within the deadline.

8. On 17 November 2015, the Parties were notified of this appointment, having raised no objection, pursuant to the combined articles 11, no. 1, paragraphs a) and b) of the RJAT and articles 6 and 7 of the CAAD Code of Deontology.

9. Thus, in accordance with the provision of paragraph c), no. 1, article 11 of the RJAT, the collective arbitral tribunal was constituted on 02 December 2015.

10. The Respondent was notified, by arbitral order of 02 December 2015, to, pursuant to article 17, no. 1, of the RJAT and within a period of 30 days, submit a response and, if desired, request the production of additional evidence.

11. On 19 January 2016, the Respondent attached to the case a copy of the administrative file referred to in no. 2 of article 17 of the RJAT and no. 1 of article 111 of the CPPT, constituted by pages numbered 1 to 326.

12. On 20 January 2016, the Respondent submitted a response in which it defended itself by way of opposition, arguing for the dismissal of the request for arbitral pronouncement.

13. It further requested the dispensation of the meeting referred to in article 18 of the RJAT.

14. In light of the principles of autonomy in the conduct of proceedings, celerity, simplification and procedural informality, inherent in no. 2 of articles 19 and 29 of the RJAT, and considering that the Parties did not request the production of any evidence, the aforementioned meeting was dispensed with, the proceedings continuing with optional written pleadings, in successive form for the Respondent.

15. On 03 February 2016, the Parties were notified to, within a period of twenty days, submit final written pleadings.

16. Which the Claimant did on 26-02-2016.

17. And the Respondent on 29-03-2016.

18. The date of 03 June 2016 was also set for the pronouncement of the respective final arbitral award.

19. The Parties were notified of this order on 08 April 2016.

II. Purging of Defects

1. The Parties have legal personality and capacity, are entitled to be parties (articles 4 and 10, no. 2 of the RJAT and article 1 of Administrative Order no. 112-A/2011, of 22 March) and are duly represented.

2. The Arbitral Court is regularly constituted and is materially competent to hear and decide the claim, cf. article 2, no. 1, paragraph a) of the RJAT.

3. The proceedings do not suffer from any nullities.

III. Position of the Parties

Non-Compliance with the Principle of Exercise Specialization

Claimant's Position:

• As stated in the Report of the Tax Inspection, the Tax Administration determined a correction in the amount of 1,900.46 € to the taxable profit for the year 2010 calculated by the Claimant, based on non-compliance with the principle of exercise specialization.

• Such correction relates to transport costs incurred in connection with the return of merchandise documented by credit note no. …/…, of 26 February 2010, and motivated by failures in quality control tests carried out in the United States of America.

• On 26 February 2010, in the context of the commercial relationship maintained with B…, the Claimant proceeded to issue the aforementioned credit note, in the amount of 168,295.00 €, relating to merchandise that failed quality control tests carried out in the United States of America by C… USA INC and were consequently subject to returns by the latter.

• Such merchandise had been sold by the Claimant to B… and to D…, LTD. (subsequently merged into E…) in the years 2008 and 2009, being destined for the North American market.

• The aforementioned merchandise, subject to credit note no. …/…, was grouped in a single container and returned from the United States of America to Portugal, being shipped, on 21 October 2009, by sea from Houston, Texas, to the port of Leixões, from where it was subsequently transported by road to the Claimant's facilities in …, where it arrived on 24 November 2009.

• The costs incurred with the transport inherent to the aforementioned physical return of merchandise, in the amount of 1,900.46 €, were being debited to the Claimant by its Customers, so that it would bear them, as the failures in the corresponding quality control tests occurred, without prejudice to the physical return having occurred only, as stated above, in late 2009 and in a single containerized transport.

• Only after the reception and examination of the returned merchandise did the Claimant assume the respective transport costs and issue the corresponding credit note no. …/…, on 26 February 2010, recording such costs in the accounting records also only at that moment.

• While the Claimant acknowledges having recorded the transport costs inherent to the return of merchandise by reference to the moment of issue of the corresponding credit note (early 2010) and not to the moment of reception of the returned merchandise (late 2009) –, the principle of exercise specialization cannot fail to be qualified by the principle of justice – with constitutional and legal recognition, respectively in article 266, no. 2, of the CRP and in article 55 of the LGT.

• Indeed, the principle of exercise specialization does not have an absolute and total rigidity, in such a way as to lead to the penalization of taxpayers who caused no injury to the public treasury and who, on the contrary, calculated and paid IRC on revenues anticipatedly and erroneously – unduly benefiting the State's coffers.

• It is noted, however, that, in the situation which is the origin of the correction in question, such transport expenses were not recorded by the Claimant as a tax expense in the same year in which the return took place (2009), but only in the year of issue of the credit note which documented the cancellation of the underlying merchandise sale (2010).

• This means that, in the calculation of the taxable profit for IRC purposes for the year 2010, 1,900.46 € were recorded as an expense which, properly speaking, should instead have been considered in the calculation of the taxable profit for IRC purposes for the year 2009.

• However, such observation also implies the conclusion that the taxable profit for the year 2009 remained artificially elevated, to the exact extent of the reduction in the result of 2010 caused by the expense which the Tax Administration seeks to correct.

• In other words, as invoked by the Claimant in the prior hearing, its untimely recording of expenses in no way injured the Public Treasury, on the contrary: it resulted in the calculation of taxable matter for 2009 in excess – a situation whose late remedy, only in 2010, only harmed the Claimant patrimonially –, which is why the Tax Administration should have refrained from making the projected correction, under pain of creating a manifestly unjust situation, of double patrimonial penalization of the Claimant.

• Now, given the situation in question, faced with the finding of the untimely consideration of expenses in 2010, either the Tax Administration should have also corrected, correspondingly, while still within the deadline, the year 2009, or it should have refrained from promoting any correction to the year 2010, for being unjust.

• What the Tax Administration cannot pretend is to simply disregard, pure and simply, the negative component of the taxable profit of the year 2010, keeping untouched the taxation in 2009, when, from the outset, faced with the documentation presented in the prior hearing but also in light of the content of the Final Report of the Tax Inspection, there is no doubt whatsoever as to the occurrence and justification of the expenses in question.

• In this way, by proceeding with the correction of the aforementioned amount of 1,900.46 €, the Tax Administration violated the provision of article 55 of the LGT and, above all, article 266, no. 2, of the CRP, pursuant to which:

"the organs and agents of the administration are subject to the Constitution and the law and must act, in the exercise of their functions, with respect for the principles of equality, proportionality, justice, impartiality and good faith."

• The principle of justice thus requires that the Tax Administration not disregard the practical consequences that may result from its own actions, and must refrain from the performance of acts which result in the violation of constitutionally protected principles.

• Contrary to the understanding expressly assumed in the Report of the Tax Inspection, it is evident that the Tax Administration is bound by those constitutional imperatives and not only by the strict formal legality arising from ordinary legislation.

• This position is, moreover, a consequence of the case law of the Supreme Administrative Court, pursuant to which the principle of specialization should, in exceptional situations, such as the present one, yield to the principle of justice.

• As stated in the Award of the Supreme Administrative Court no. 291/08, of 25 June 2008, regarding the rigidity of the principle of specialization: "the aforementioned rigidity must also be attenuated through other means. This has had resonance both in doctrine and in case law and, even in tax administration itself [...].

Thus, without questioning the fiscal relevance of the principle of exercise specialization, it is permitted to allocate costs to prior exercises, when it has not resulted from voluntary and intentional omissions, with a view to operating a transfer of results between exercises [...].

All the more so because, in principle, the deferment of the accounting of costs only resulted in losses for the taxpayer, as the taxable profit was only relieved of such costs at a later time than when this should have occurred."

• In the same sense, it is important to note the Award of the Supreme Administrative Court no. 1648/02, of 2 May 2003:

"In truth, account must be taken of the principle of justice, with constitutional and legal conformity (see articles 266, no. 2, of the CRP and 55 of the LGT).

[...]

On the other hand, it is also evident that the State was not harmed by the activity of the appellant, since what happened is that it accounted for vacations as expenses, only it did not do so correctly. That is, the amounts – certain though they were – were not allocated to the corresponding exercises.

But from that, as has been said, no loss to the State results.

Now, and following the understanding endorsed by the Administration which received the assent of the Honorable Judge, it would be intolerably harmed that would be the administered, because of this it could not now account as expenses, what it actually bore.

And, as we have seen, the FA limited itself to correcting the error relating to the exercise in question here, withdrawing the expenses, but not adding the actually borne, thus not correcting the exercises affected by the correction, if taken to their ultimate consequences.

Now, it is manifestly not just to benefit the administration and harm the administered."

• The aforementioned case law finds support in doctrine long defended, namely, by LEITE DE CAMPOS, SILVA RODRIGUES and LOPES DE SOUSA, according to which:

"This is a situation in which the exercise of a tied power (correction of the taxable matter in the face of violation of the principle of exercise specialization) leads to a flagrantly unjust situation and in which, for this reason, the question arises of operating the 'principle of justice', enshrined in articles 266, no. 2 of the C.R.P. and 50 of the L.G.T., to prevent the possibility of making the said correction.

There are, in this situation, two duties to be weighed, both with legal support: one is to restore the truth about the determination of the taxable matter for the exercises referred to, giving effect to the principle of specialization, a restoration that the tax administration must make even if it brings it no advantage; another is to prevent administrative activity from resulting in the creation of a situation of injustice.

Among those two values, namely in cases where the tax administration suffered no harm from the error committed by the taxpayer, the option should be made not to make the correction, limiting that duty of correction by force of the principle of justice.

On the other hand, it is to be noted that in a situation of this type there is not even any public interest in the action of the tax administration, since what is at issue is not the obtaining of a tax that is owed, wherefore, having all administrative activity to be guided by the pursuit of this interest, the administration should refrain from acting.

Consequently, acts correcting the taxable matter which lead to situations of injustice of this type are to be considered voidable, due to defect of violation of law.

[...]

The principle of exercise specialization is an instrument to achieve just taxation, which cannot be transformed into a trap that enables the tax administration to collect taxes that are not owed," cf. LEITE DE CAMPOS, SILVA RODRIGUES and LOPES DE SOUSA, "Lei Geral Tributária Comentada e Anotada", Lisbon, 2012, Encontro da Escrita, pages 453 and 454.

• In summary, in light of the foregoing and on the basis of the violation of the principle of justice enshrined in articles 266, no. 2, of the CRP and 55 of the LGT, the aforementioned correction must be considered illegal, which is invoked for the due legal effects.

In the pleadings submitted on 26-02-2016, it formulates its conclusions, arguing for the full granting of the request for arbitral pronouncement.

Respondent's Position:

• The positive correction made to taxable profit, in the amount of 1,900.46 €, respects the transport costs incurred in connection with the return of merchandise referenced in credit note no. …/…, of 26.02, has as its legal basis no. 1 of article 18 of the CIRC.

• The merchandise covered by credit note no. …/… was returned to the claimant's facilities in …, where it arrived on 24.11.2009, and only after the reception and examination of the returned merchandise were the transport costs assumed and the corresponding credit note issued.

• The Claimant acknowledges that the lack of accounting recognition resulted from an error, as the expense was borne in 2009 – the year of reception of the returned merchandise – but, invokes in its defense, that the principle of exercise specialization must be tempered with the principle of justice.

• It is true that the principle of exercise specialization is already viewed by the legislator with some degree of flexibility, reflected in no. 2 of article 18, which admits that expenses (and other negative components) relating to prior exercises may be accepted in the exercise in which they are accounted, when on the date of closure of the accounts of the one to which they should be imputed they were unforeseeable or manifestly unknown.

• And, in truth, such conditions are not met, allowing it to be concluded that the error, intentional or not, translated itself in the non-observance of the principle of exercise specialization, which could have been corrected by the initiative of the claimant and was not, all the more so because by the date of closure of the accounts of 2009, it had certainly already issued the aforementioned credit note.

• As for the invocation of the principle of justice and its projection in the application of the principle of exercise specialization, it should be noted that the cited case law – Award of the STA, of 25.06.2008, case no. 291/08, resumes the administrative understanding contained in circular letter C-1/84, of 18 June, created still in the domain of Industrial Contribution, when there was no provision in law whatsoever on the treatment to be given to costs and revenues of prior exercises.

• Now, the AT, by virtue of the provision of article 55 of the LGT, in the exercise of its functions, is bound by respect for the principle of justice but, first and foremost, by the principle of legality, that is, must guide its actions by strict compliance with its legal determinations, in this case, of no. 2 of article 18 of the CIRC and it was in that sense that it oriented its conduct by proceeding with the correction of taxable profit.

On 29-03-2016, it submitted its pleadings arguing for the dismissal of the request for arbitral pronouncement.

Non-Compliance with the Transfer Pricing Regime

Claimant's Position:

• On 18 December 2014, and in the context of external tax inspection, the Claimant was notified through office no. …, of 15 December 2014, of the Finance Directorate of …, for the presentation of an additional set of accounting elements and, as well, to, regarding the transfer pricing study presented, explain why it concluded there that the terms and conditions practiced by the Claimant with its Customer B… (related party) in the year 2010 fell within the market reference interval.

• On 26 March 2015, through Office no. …, of 23 March 2015, of the Tax Inspection Services of the Finance Directorate of …, sent by registered mail, the Claimant became aware of a Draft Report of the Tax Inspection regarding its year 2010.

• From the content of the aforementioned draft report, corrections to the taxable profit collectible by the Claimant were stated, relating to IRC for the year 2010, in the total amount of EUR 339,394.93, itemized as follows:

a) EUR 337,493.97, on account of non-compliance with the transfer pricing regime;

b) EUR 1,900.46, on account of non-compliance with the principle of exercise specialization;

Total: EUR 339,394.43

• As well as a set of points that reproduced the content of the Final Report of the Tax Inspection carried out under the service order no. OI2012… and which had as its object the year 2009 – cf. essentially Points II.3.10.1, II.3.10.2, II.3.10.5 and II.3.10.6 of the Draft notified – and which intended to demonstrate the alleged instrumentalization of B… to divert profits from Portugal to Ireland, concluding the Tax Administration that:

"It was thus proven that this entity [B…] does not possess economic substance nor commercial justification, having been used solely for purposes of a fiscal nature, without any effective intervention in the transactions that occur between the taxpayer and the companies of the Group that it supplies, C… USA, F… Australia and G… South Africa"

• In the exercise of its prior hearing right, regarding the alleged non-compliance with the transfer pricing regime in the sales it made to B…, the Claimant emphatically rejected the understanding of the Tax Administration, explaining in summary that, as duly set out in the study presented, the analysis of transfer prices contained in its tax file was based on a careful and considered selection of companies comparable in terms of size and activity to the Claimant, without operations with related parties.

• For that reason, the entire universe of 17 companies identified for comparison reflects the conduct of activity by comparable companies in conditions of full competition, and should be considered for the definition of the market interval (between +9.48% and -2.19%) – as provided for in article 4, no. 5, of Administrative Order no. 1446-C/2001, of 21 December –, there being no legal basis or rational justification for concluding that only the median of the interval (5.76%) "constitutes full competition."

• As for the considerations made regarding the alleged instrumentalization and lack of economic substance of B…, the Claimant invoked from the outset the absence of concrete demonstration by the Tax Administration of the statements contained in the Draft Report of the Tax Inspection relating to the commercial relationship between B… and C… USA INC and to the marketing margin allegedly achieved by the former in sales to the latter, as well as to the allegedly zero added value contributed by B….

• As stated in the Report of the Tax Inspection, the Tax Administration determined a correction in the amount of EUR 337,493.97 to the taxable profit calculated by the Claimant for the year 2010, invoking that the Claimant, in the sales of merchandise to its customer B… – related party –, practiced prices lower than those that would exist if these were similar operations carried out between parties not linked by special relationships.

• As to the legal basis, the Tax Administration invokes the provision of article 63, no. 1, of the CIRC, pursuant to which:

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

• However, the scope of the transfer pricing regime is not to legitimize any correction given the existence of special relationships between two entities, but solely to determine adjustments when the conditions practiced between such entities differ from those that would exist if no such relationships existed (and only to the extent of that difference).

• That is, faced with the finding of the existence of special relationships between two entities, the Tax Administration cannot simply form an a priori and deeply rooted conviction that the conditions practiced are different from those that would exist between unrelated parties, evading a careful and neutral factual analysis of the situation to conclude whether or not one is faced with the establishment of conditions different from the conditions that would normally be agreed.

• The Claimant, complying with the ancillary obligation incumbent upon it according to article 63, no. 6, of the CIRC and, as well, with articles 13 and following of Administrative Order no. 1446-C/2001, of 21 December, of the Ministry of Finance, proceeded to carry out an analysis of transfer prices – materialized in a Transfer Pricing Report – which covered, among others, its commercial relationships with B…, clearly pointing this analysis to the conclusion that the conditions practiced by the Claimant with that Customer did not differ from those that would exist between unrelated entities.

• As explained from the outset in the prior hearing, the analysis contained in the Transfer Pricing Report aimed at the definition of a market interval – as provided for in article 4, no. 5, of the aforementioned Administrative Order no. 1446-C/2001, of 21 December –, based on a selection of companies comparable to the Claimant with similar commercial relationships but maintained with unrelated parties.

• Specifically, by search in the "SABI – BUREAU VAN DIJK" business information database, 6 national companies engaged in the same activity pursued by the Claimant were selected, without operations with related parties and with annual revenues exceeding EUR 3,000,000.00.

• In parallel, by consultation of the Yearbook of the Portuguese Cork Association ("APCOR"), 18 additional companies were selected, thus stabilizing a set of 24 companies comparable to the Claimant.

• Subsequently, from the aforementioned universe of 24 companies, 3 companies were excluded for not having financial data available in their respective commercial register and still another 4 companies with results considered statistically disparate and as such capable of diminishing the reliability of the sample, thus a final sample of 17 comparable companies to the Claimant was defined, as follows:

• Regarding this universe of 17 companies, the net margin of the operation of each one was calculated for the last three years prior to 2010 – 2007, 2008 and 2009 –, and the corresponding average, as follows:

• The final result of the search carried out was the definition of a market reference for net operation margin between -2.19% and 9.48%, as the average net operational margin of the years 2007 and 2009:

• In the year 2010, the net operation margin of the Claimant in sales made to B… was 2.91% – a value that falls within the identified reference interval –, which is why it was concluded in the Transfer Pricing Report that in the sales in question the principle of full competition was respected.

• In this respect, it is also important to additionally state that, as noted in the Transfer Pricing Report, the average profitability margin of the Claimant recorded a decline in 2010 compared to the previous years – to which the comparables used in the Transfer Pricing Report refer for being the available ones at that date –, influenced above all by the adverse national and international macroeconomic framework that dictated a generalized increase in the cost of raw materials.

• The existence of this decline – given its cause, with high probability of having also occurred in the operational margins of companies taken as comparable for defining the market interval – is nonetheless relevant to adequately frame the comparison of the Claimant's margin in 2010 with the average margin of comparable companies in the three prior years (2007, 2008 and 2009), offering a simple explanation for why the Claimant's 2010 margin has a value that falls within the lower half of the market interval defined for comparison – but yet, note, perfectly within it.

• As results from the Final Report of the Inspection, the Tax Administration understood not to develop any own analysis of transfer prices, agreeing (i) with the method adopted by the Claimant, (ii) with the universe of comparable companies identified and even (iii) with the reference interval resulting from the analysis developed by the Claimant.

• Indeed, the Tax Administration bases the correction in question on its interpretation that only the median of 5.76% corresponds to a market operating margin, which is why it determined the adjustment of the value of sales made by the Claimant to B… in the year 2010 – from 2.91% to the said value of 5.76%.

• This interpretation of the Tax Administration is unacceptable and technically incorrect, falling into a clear misunderstanding: the analysis developed aimed at defining a reference market interval and not the determination of a specific value of operational margin – which is well understood, since unrelated companies, operating freely in the market, would only by manifest chance have identical net operational margins.

• Thus, contrary to what was considered by the Tax Administration – and as results from careful reading of the Transfer Pricing Report with whose content it agrees –, the entire universe identified of 17 companies reflects the conduct of activity by companies comparable to the Claimant in conditions of full competition.

• It is important to note that the definition of a market interval within which full competition is considered to have been respected is perfectly consistent with the existing international guidelines on the subject, on which the Administrative Order no. 1446-C/2001, of 21 December, was actually based:

"In some cases it will be possible to apply the arm's length principle to arrive at an exact value (e.g. price or margin) which is the most reliable for determining whether the terms of a transaction met the arm's length principle.

However, because transfer prices are not an exact science, there will also be many occasions when the application of the most appropriate method or methods will produce a range of values all equally reliable. In these cases, the differences in the values that make up the range may be caused by the fact that, in general, the application of the arm's length principle will only produce an approximation of the conditions that would exist between independent parties. It is also possible that the different points in the range are due to the fact that independent enterprises in similar transactions and in comparable circumstances may not establish exactly the same price for the transaction.

[...]

If the relevant value of the related party transaction (e.g. price or margin) is within the arm's length range, no adjustment should be made.

If the relevant value of the related party transaction (e.g. price or margin) falls outside the arm's length range defined by the tax authorities, the taxpayer should have the opportunity to present arguments to the effect that the related party transaction satisfies the arm's length principle, and that the related party transaction falls within the arm's length range (i.e. that the arm's length range is different from that defined by the tax authorities). If the taxpayer is unable to demonstrate that fact, the tax authorities will have to determine a point within the arm's length range to which they will make the adjustment of the related party transaction.

In determining this point, when the range contains results of equal reliability, it is reasonable to argue that any point in the range satisfies the arm's length principle"

[translation of ours from the original English language; underlining ours] – cf. Organization for Economic Cooperation and Development, "OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations", Paris, 2010, OECD PUBLISHING, pages 123 to 125.

• In other words, the entire statistically defined interval between +9.48% and -2.19% identified in the Transfer Pricing Report must be considered as reflecting a market relationship between operating costs and operating results in the years in question, there being no legal basis or rational justification for concluding as the Tax Administration that only the median of the interval (5.76%) "constitutes full competition."

• The Claimant had the opportunity to emphasize precisely that in the prior hearing and, even before that, on 8 January 2015, through clarifications provided in the course of the inspection action and through the delivery of an explanatory note addressing precisely that point and intended to clarify it – cf. document no. 272 –, clearly pointing article 4, no. 5, of Administrative Order no. 1446-C/2001, of 21 December, to the definition of reference market intervals and not to the fixation of a specific value that translates full competition.

• In this respect, the Tax Administration in the Final Inspection Report expressly admits the lack of legal basis that determines the intended adjustment to the median, invoking only "statistical rules" and asserting that from these necessarily results convergence to the interquartile interval and specifically to the median.

• The generic reference to such supposed statistical rules is nothing more than a sham argument, it being important to emphasize that the analysis legally required in transfer pricing – and developed by the Claimant – is satisfied with the definition of a market interval through the identification of at least two market comparables (minimum and maximum), which in the specific case was done respectively with the identification of the average net operational margins of companies L…, LDA. and T…, S.A., with the concepts of median and 1st and 3rd quartiles translating merely intermediate points of that interval, as best illustrated below:

• The table contained in the previous article is also striking for clearly showing that what the Tax Administration intends, after all, is to make the net operational margin of the Claimant for the year 2010 coincide with the average of that same margin recorded in the years 2007 to 2009 by company H…, LDA., ignoring that all the other 16 companies referred to also operated in a situation of full competition and that, therefore, the use of the entire universe of companies identified for defining the market reference interval not only necessarily provides a more reliable view of market reality, but constitutes the only approach consistent with the provision of article 4, no. 5, of Administrative Order no. 1446-C/2001, of 21 December.

• In light of the foregoing, there will be no doubt that the Tax Administration did not minimally satisfy the burden incumbent upon it of demonstrating that, contrary to what was concluded in the Transfer Pricing Report of the Claimant, commercial conditions comparable to those that would exist if these were unrelated entities were not observed in the year 2010 with B….

• That is, the correction in question boils down to the illegal resort by the Tax Administration to the prerogative that is available to it in light of article 3, no. 2, of Administrative Order no. 1446-C/2001, of 21 December, due to failure to meet the legal requirements thereof.

• Without prejudice to this conclusion, it is equally important to highlight the irrelevance of the considerations made by the Tax Administration around the "Fiscal Profitability of Sales" of the Claimant – cf. page 9 of document no. 3 –, whether due to the manifest lack of reasoning of what is stated in this respect in the Final Inspection Report, whether due to the total unsuitability of such a criterion for promoting any correction in transfer pricing matters.

• Indeed, regarding the aforementioned concept of "Fiscal Profitability of Sales" the requirements of legal reasoning are minimally satisfied, as there is no indication of the value of such profitability for the years in question (or justification of its form of obtaining), with only mention being made of "data contained in the AT database."

• With the scant reasoning presented, the Claimant is, not only impossible to know the specific value of "Fiscal Profitability of Sales" in question, but it even finds itself in a position of being unable to audit the correctness of the conclusion drawn by the Tax Administration, for lack of knowledge of the exact terms of its calculation and, as well, of the specific universe of companies whose data will have been used to provide the Tax Administration's database, which is sufficient to conclude that there is a manifest lack of legally required reasoning and is invoked for the due legal effects.

• Similarly, the considerations made by the Tax Administration regarding the activity of B…, the allegedly zero added value generated by it and the relationships maintained with C… USA INC present themselves as irrelevant – and to a large extent factually wrong.

• The Tax Administration alleges that the sale price to C… USA INC practiced by B… of the products acquired from the Claimant is quite higher than the sale price practiced by it in sales to B… and, as well, that the marketing margin of B… is 12.4%.

• Notwithstanding that such considerations are stressed as being irrelevant for purposes of supporting by the Tax Administration of the correction specifically promoted based on the transfer pricing regime, the Claimant cannot simply let pass unchallenged the same.

• First of all, it is noted that the understanding of the Tax Administration is based on the consideration that B… is a company without economic substance or commercial justification, yet accepting as valid the information obtained through exchange of information with the Irish Tax Authorities that it is a regularly constituted company and compliant with its obligations – notably of a fiscal nature; cf. pages 20 to 23 of the Tax Inspection Report (document no. 3) –, and refraining from questioning such authorities about the effective activity of the company, instead opting to make vague considerations about the tax system of the Republic of Ireland in support of the correction determined to the Claimant's taxable profit – cf. pages 28 and 29 of the Tax Inspection Report (document no. 3), without any indication of the source used.

• Additionally, already within the scope of the tax inspection to which it was subject regarding the year 2009 and in the subsequent litigation, the Claimant attached various pieces of evidence, of the most varied nature, evidencing that B… is a real company, with real existence and activity, highlighting in this respect, not only the purchase orders and invoices issued by the parties for documentation of their transactions, but also evidence of the contacts (telephonic and in-person) maintained in the year 2009 and, as well, elements sent by B… from Ireland demonstrating the existence of its facilities and personnel at its service.

• As to the value supposedly zero added value contributed by B…, it is important to note that the function performed by it for its Customers is not limited to a mere indiscriminate buying and selling of merchandise.

• Indeed, as invoked at length by the Claimant to the Tax Administration, B… is aware of the needs and stock levels of merchandise of its Customers, ensuring the satisfaction of those efficiently, namely having due regard to the times of transport (by sea or air) necessary for delivery of the products acquired – an aspect of good management essential for the activity of such Customers to proceed in a balanced manner: without interruptions due to lack of stock but with minimum storage costs –, a function that in no way is performed by the Claimant.

• In other words, if an excessive remuneration of B… were to exist, it could be explained by the valuation assigned to the function of assistance in managing stock levels performed by the said company to the benefit of its Customers C… USA INC, to F… AUSTRALIA and to G… SOUTH AFRICA, which however does not amount to any alleged diversion of profits from Portugal to Ireland but rather to an analysis of the fiscal acceptance of costs respectively in the United States of America, in Australia and in South Africa.

• Additionally, it is important to emphasize that, as B… is a separate entity from the Claimant, it is unaware (and has no obligation to know) which revenues are realized by it in the sales of merchandise to C… USA INC in the year 2010, nor is the Final Inspection Report notified accompanied by any documentary evidence that may constitute proof of such values.

• Specifically, it is false that this information results from any documents annexed to the Final Inspection Report – the information obtained from the North American Tax Authorities regarding the value and quantity of the supposed supplies made to C… USA INC by B… has no probative value since it is limited to listings (moreover partially illegible) of invoice and credit note values, unaccompanied by any copies of the respective supporting documents and without even containing a minimal specification of the specific merchandise to which they would refer.

• Not knowing the Claimant whatsoever – without obligation to know – the data relating to the acquisitions of merchandise made by C… USA, INC to B… in the year 2010, the analysis of the supporting documents based on which such listings will have been prepared would be essential to audit their accuracy and, specifically, to determine whether the entirety of the values referred to in fact refers to merchandise sold by it to B… in the year in question.

• Indeed, unaccompanied by copies of their respective supporting documents, the listings in question are nothing more than tables, apparently prepared in a spreadsheet, without express authorship or any text or legend of framing of the data presented, and any minimally rigorous analysis aimed at identifying why B… will have sold to C… USA, INC part of the merchandise acquired from the Claimant in the year 2010 would have to pass through the actual confrontation of the invoices issued by the Claimant to that Customer with the invoices issued by it to C… USA, INC in the same period – an exercise that the Tax Administration unacceptably refrained from.

• Faced with the express invocation by the Claimant, in the prior hearing, of the lack of concrete demonstration of the considerations made by the Tax Administration, it unacceptably chose to ignore the participation of the Claimant in the decision, obstinately maintaining its position alluding merely to the existence of special relationships between entities:

Finally, regarding the considerations made on the commercial relationships with B…, marketing margins and added value generated, contrary to what is asserted, they are not devoid of meaning, nor decontextualized nor misdirected, as all of us know the control relationships between companies A…, B… and C… USA.

• In summary, the Tax Administration ends up intending to base the correction in question merely on a subjective judgment as to the absence of economic substance and commercial justification of B… and the added value generated by it, which cannot in any way be admitted as a basis for any transfer pricing adjustment.

• In light of the foregoing and all things considered, there is no doubt about the illegality of the correction in question, whether due to lack of reasoning, or due to error in its respective factual and legal requirements and, to that extent, of the IRC assessment no. 2015…, which is invoked for the due legal effects.

In the pleadings submitted on 26-02-2016, the Claimant formulates the following conclusions, arguing for the full granting of the request for arbitral pronouncement.

• The correction determined for non-compliance with the transfer pricing regime is illegal, whether due to lack of reasoning, or due to error in its respective factual and legal requirements, and to that extent the IRC assessment no. 2015… must be annulled;

• The Claimant fulfilled the obligation incumbent upon it to carry out an analysis of transfer prices that covered its commercial relationships with B…, adopting the "net operation margin method" to assess whether the conditions practiced in those operations in 2010 were comparable to those that would have been adopted in operations between unrelated entities;

• The final result of the search carried out was the definition of a market reference for net operation margin between -2.91% and 9.49%, as the average net operational margin of the years 2007 to 2009;

• The net operation margin of the Claimant in sales made to B… in 2010 amounted to 2.91%, falling within the reference interval of values recorded in operations between unrelated parties;

• The Tax Administration agreed (i) with the "net operation margin method" adopted by the Claimant, (ii) with the universe of comparable companies identified and (iii) with the reference interval resulting from the analysis contained in the Transfer Pricing Report of the Claimant;

• The related operations with B… in 2010 respected the principle of arm's length in so far as the net operation margin of the Claimant falls within the reference interval identified in the respective transfer pricing study;

• The Tax Administration sustains the correction of the Claimant's taxable profit under the transfer pricing regime on the basis (i) of the statistical rules which allegedly require the conclusion that only the median reveals a statistically reliable result for determining the market net margin from the comparison of the universe of unrelated entities selected by the Claimant, (ii) of the assertion that B… lacks economic substance, having been used solely for purposes of a fiscal nature and (iii) of the assertion that the sale price practiced by B… in its sales to C… USA INC is higher than that practiced by the Claimant notwithstanding the added value contributed by the Irish Company being zero whereas by contrast to the added value generated by the Claimant;

• The grounds invoked by the Tax Administration aside from being wrong cannot be admitted for the transfer pricing adjustment in question, maintaining full validity the analysis contained in the Transfer Pricing Report prepared by the Claimant;

• If it intended to consider only the value of the median as that which indicates market conditions, the Tax Administration had the burden of expressly identifying (i) which the circumstances and particularities of the market operations selected for sampling in the Claimant's study that would imply distortions in their degree of comparability with the related operations and (ii) which the specificities of the Claimant's operations that would prejudice their comparability with the selected sample;

• The Tax Administration did not meet that burden of reasoning either in the Tax Inspection Report or, a posteriori, in the present case, and it is in any case to be noted that the reasoning contained in points 16, 17, 18, 19, 20 and 22 of the Response of the Honorable Representatives of the Tax and Customs Authority to the Claimant's request for arbitral pronouncement has an innovative character and is therefore inadmissible;

• Be that as it may, the facts invoked in points 16, 18 and 22 of the Response of the Honorable Representatives of the Tax and Customs Authority are false and in any case do not specifically identify which circumstances diminish the comparability of the result of operations between unrelated parties contained in the sample collected in the transfer pricing study prepared by the Claimant.

Respondent's Position (contained in the response to the request for arbitral pronouncement):

• In the year 2010, the operations carried out between A… and B… (company registered in Ireland with VAT number … T) translated into a total billing volume of 11,825,592.89€.

• B… operates as an exclusive distributor of A…'s products for the markets of the USA, Australia and South Africa.

• The operations between the Claimant and B… capable of being subsumed under the transfer pricing regime provided for in article 63 of the CIRC.

• Through the analysis carried out by the Claimant and contained in the transfer pricing file, the following market reference resulted:

• The successive elimination of the maximum and minimum values causes the sampling to converge to the median, which translates the conditions of full competition, this being the value used to make the correction between the "net cost plus" registered by CSP of 2.91%, and the full competition value of 5.76%.

• Whereby the Inspection Services understood that the price practiced departs from the price compared by the observed entities, as it departs significantly from the median of the sample which this yes better configures the full competition, the sale price for C… practiced by B…, is quite higher than the sale price practiced by A…, considering that the added value contributed by B… is zero.

• Being A… the main generator of added value, it is not justified that it obtain a margin on operating costs of 2.91%, while B… obtains a marketing margin of 12.4%.

• In this manner and because it was concluded by non-compliance with the principle of full competition, adjustments were made in light of the transfer pricing regime, in the following terms:

• The Arm's Length Principle has its genesis in the provisions contained in no. 1 of article 9 of the OECD Model Tax Convention which determines the following: "Where… the two enterprises [associated], in their commercial or financial relations, are linked by conditions accepted or imposed that differ from those that would be established between independent enterprises, the profits which, if such conditions did not exist, would have been obtained by one of the enterprises, but were not obtained because of such conditions, may be included in the profits of that enterprise and taxed accordingly."

• In the Portuguese legal order, the Arm's Length Principle is enshrined in article 63, no. 1 of the CIRC4 which establishes the following: "In commercial operations, including, namely, operations or series of operations on goods, rights or services, as well as in financial operations, carried out between a taxpayer and any other entity, whether or not subject to IRC, with which it is in a situation of special relationships, terms or conditions substantially identical to those that would normally be contracted, accepted and practiced between independent entities in comparable operations must be contracted, accepted and practiced."

• Having to contract, accept and practice in the commercial operations carried out between them terms and conditions substantially identical to those that would be contracted, accepted and practiced between independent entities, in comparable circumstances, in obedience to the Arm's Length Principle set out in no. 1 of article 63 of the CIRC.

• Pursuant to the provision of no. 2 of article 63 of the CIRC, as well as in article 4 of Administrative Order no. 1446-C/2001, of 21 December, the taxpayer must adopt, for the determination of the terms and conditions that would normally be agreed, accepted or practiced between independent entities, the method or methods capable of ensuring the highest degree of comparability between the operations or series of operations it carries out and others substantially identical, in normal market situations or in the absence of special relationships, taking into account, namely, the characteristics of the goods, rights or services, market position, economic and financial situation, business strategy, and other relevant characteristics of the taxpayers involved, the functions performed by them, the assets used and the allocation of risk.

• Article 4, no. 2 of the aforementioned Administrative Order considers as "(...) most appropriate method for each operation or series of operations that which is capable of providing the best and most reliable estimate of the terms and conditions that would normally be contracted, accepted and practiced in a situation of arm's length, the choice being made for the method most apt to provide the highest degree of comparability between the related operations and other non-related operations and between the entities selected for comparison, which has the best quality greater amount of information available for its adequate justification and application and which involves the least number of adjustments for purposes of eliminating the differences existing between the facts and comparable situations."

• With respect to the methods to be used, no. 3 of article 63 of the CIRC and no. 1 of article 4 of Administrative Order no. 1446-C/2001 enshrine two typologies:

A) Methods based on Operations:

i) Comparable uncontrolled price method;

ii) Resale price method;

iii) Cost plus method.

B) Methods based on Profit of Operations:

i) Profit split method;

ii) Net margin method.

iii) Another method, appropriate to the facts and specific circumstances of each operation that satisfies the principle set out in no. 1 of article 1 of this ordinance, when the methods referred to in the previous subparagraph cannot be applied or, being applicable, do not allow obtaining the most reliable measure of the terms and conditions that independent entities would normally agree, accept or practice.

• Based on the most recent OECD Guidance (§2.1.e et seq. of the Guidelines) the selection of one of these methods for assessing the compliance of a related operation with the Arm's Length Principle aims to find the most appropriate method for the specific case.

In this sense, and in accordance with what is provided in §2.3. of those Guidelines, methods based on operations are considered the most direct methods of establishing whether the conditions practiced in the context of a related operation are Arm's Length.

• Thus the correction concerned the sales made to B…, qualified as "related operations" in light of the definition given by paragraph b) of no. 3 of article 1 of Administrative Order no. 1446-C/2001, of 21.12, and translated into an increase in taxable profit of 337,493.97 €.

• In the choice of the most appropriate method (pursuant to article 4 of the Administrative Order) for the determination of transfer prices in compliance with the arm's length principle, the Claimant's choice fell on the net operating margin method, designated by "net cost plus" which indicates that the indicator "net margin" is calculated with reference to operating costs (cf. article 10 of the aforementioned Administrative Order), an option that received acceptance from the AT.

• Equally the comparability study and the selection of the sample (constituted by 21 companies), from data extracted from SABI and APCOR databases did not raise objections, (cf., acknowledged in point 60 of the PI) the same being able to be affirmed regarding the interval of values for the indicator 'average net margin' between 2007 and 2009 (see table below) taken as comparable data, which means that the disagreement existing centers, solely, on the choice of the most representative value of the arm's length indicator.

• The Claimant calculated, in 2010, a net operating margin of 2.91%, a value that falls within the 1st Quartile interval, having concluded from this that it respected the principle of full competition set out in no. 1 of article 63 of the Corporate Income Tax Code.

• It should be recalled that, notwithstanding the indication provided by the provision of no. 5 of article 4 of Administrative Order no. 1446-C/2001, according to which "If, within the scope of application of a method, the use of two or more comparable non-controlled operations or the application of more than one method considered equally appropriate leads to an interval of values that assure a reasonable degree of comparability, it becomes unnecessary to proceed with any correction, if the relevant conditions of the related operation, namely the price or profit margin, fall within that interval," it is important to have regard to the facts and specific circumstances surrounding the related operations under analysis and, in light of what article 10, no. 3 of the same instrument provides, reflect its effect on the choice of the net margin value taken as the best comparable in the specific case.

• As is noted in point 64 of the PI and, also, in the preamble of Administrative Order no. 1446-C/2001, "the rules on transfer prices do not allow acting with the rigor and precision proper to an exact science" and must ensure that the allocation of profits between related companies that participate in the operations is aligned with the creation of value, that is, profits must be allocated to companies that develop economic activities that contribute to their generation.

• It is against this background and having further regard to the fact that the activity developed by the Claimant makes it the main generator of added value, that it can be concluded that the allocation of the profits of the related operations should reflect that fact, to the detriment of B…, whose contribution to the generation of results is not such as to justify the application of a marketing margin calculated at 12.4%.

• In order to correct the detected distortion and achieve the value most approximating to what would occur in normal market conditions, between independent entities, the AT considered, in a context of reasonableness and in light of the available data, that the most representative value of the arm's length margin would correspond to the value of the median [5.76%].

• And among the facts and particular circumstances surrounding the related operations under analysis, which argue for the provision of no. 5 of article 4 of Administrative Order no. 1446-C/2001 not to be followed, those worthy of emphasis are those relating to the fact that the risks of the operations intermediated by B… are borne by the Claimant, whether the risks of storage, shipment, transport, return or collection, that is, commercial and financial, since, as far as is revealed by the facts described (cf., points 10 to 12 of the PI), the Irish company, in the exercise of its trading functions, limits itself to issuing and sending purchase orders, receiving the invoices issued by the Claimant and re-invoicing the customers.

• Regarding the transport of the products transacted with B… and dispatched to C…, F… or G…, it was ascertained that it is always carried out in the name and at the account of A…, with no reference whatsoever, of any kind, in the transport documents, to B… and likewise, the expenses with customs clearances are also borne by the Claimant.

• Whereby the greater the risks assumed the greater the remuneration obtained must be.

• To corroborate this action is also worthy of highlighting the information provided by the competent tax authorities of Ireland, within the scope of international administrative cooperation, established under article 26 of the Convention concluded between Portugal and Ireland to avoid double taxation and prevent tax evasion in matters of income taxes, evidencing that at the time it did not have a material and human structure that would support the exercise of an effective economic activity, as evidenced by the fact that B…:

· does not own facilities, is seated at …, Dublin …, within the scope of a virtual office rental service acquisition contract with company Y…;

· The operational personnel of B… consists of the manager and support personnel available within the scope of the office rental service acquisition contract concluded with Y…, mentioned above;

· The purchase orders of products are received by B… from its customers, which it satisfies with the products it acquires from its suppliers, and which are sent, under its supervision, directly from its suppliers to its customers;

· Its only product supplier in the years 2010, 2011 and 2012 was A… and its only customers were C…, F… and G…, to whom all of its billing was destined; and

· The payments made to the Claimant by B… are ordered from the USA and stem from a bank account opened in the name of that company in the same American bank with which C… works;

• The correction to taxable profit, resulting from the consideration of the median of the arm's length interval as the most appropriate comparable value to the particular circumstances in which the related operations are carried out, is that which best reflects the contribution of the activity actually developed by the interveners – the Claimant and B… – in the generation of the overall result of production and sale of the manufactured products.

• The Claimant asserts that, and concludes that, by the fact that the company presents a value of the net operating margin between the minimum and the maximum (9.48%) by itself assures that the sales were practiced respecting the arm's length principle.

• The Claimant refers to an excerpt of the Administrative Order embodied in the OECD Guidelines, which concludes generically that "when the range contains results of equal reliability, it is reasonable to argue that any point in the range satisfies the arm's length principle."

• Below the 1st quartile and above the 3rd quartile are companies that depart from centrality (from the median), not presenting results of equal reliability to those found in the inter-quartile interval, which is why we understand that reliable results are found in this interval, and consequently in full competition.

• In truth, the median is a moment that assures the value of the indicator that divides the number of observations in half, assuming both the 1st and 3rd quartile moments, deviations from the average of the indicator verified, which in an extreme and irregular situation could be assumed, which we understand does not occur, which is why the most precise indicator was assumed in Statistics, the median, as the value of the observation of the sample that presents a central value.

• As the median is the statistically mathematically considered most reliable moment, and any of the values in the range could be used, it was this, the median, taken into consideration for purposes of correction and not the greater or lesser point of the range.

The median is a measure of location of the center of distribution of data. After the ordering of the elements of the data sample, the median is the value (belonging or not to the sample) that divides it in half, that is, 50% of the elements of the sample are less than or equal to the median and the other 50% are greater than or equal to the median.

• In Statistics, a central tendency is a central value or typical value for a probability distribution. The most common measures of central tendency are the arithmetic mean, the median and the mode.

Usually authors use central tendency (or centrality) meaning "the tendency of quantitative data to cluster around a central value." The median is of central importance in robust statistics, as it is the most resistant statistic, having a breakdown point of 50%, as long as not more than half of the data is contaminated, the median will not give an arbitrarily large result.

• The median is defined only in one-dimensional ordered data and is independent of any metric distance. Indeed, it is an indicator with greater reliability relative to the mean, as this is greatly influenced by outlying values (outliers), that is, values very large or very small that are distinct from most of the data, which motivated the choice of the AT.

On 29-03-2016, it submitted its pleadings arguing for the dismissal of the request for arbitral pronouncement.

IV – Subject Matter of the Dispute

The question that constitutes the thema decidenduum consists of assessing the legality of the arithmetic corrections to the IRC taxable matter, determined by the Tax Authority in the tax inspection of the year 2010, regarding the alleged non-compliance:

• with the principle of exercise specialization (article 18 of the CIRC); and

• with the transfer pricing regime (article 63 of the CIRC).

V – MERITS

Factual Matters

A) Proven Facts

With relevance to the assessment and decision of the questions raised, the following facts are given as settled and proven:

1. The Claimant (A… Portugal, SA) was established on 09-01-1995 and engages in the activity of production and commercialization of natural cork stoppers (CAE…), also commercializing technical stoppers and stoppers…, the latter produced by third parties, and integrates a group of companies at the worldwide level, all operating in the sector of closures for the wine industry.

2. It operates in two industrial units located in the municipality of Vila Nova da Feira:

   – A… 1 (main unit) functions in the facilities located at Rua …, no. …, and in Rua…, no. …, in …, which constitutes the headquarters of the company and of the "Group AA…" in Portugal, and comprises an industrial pavilion with several buildings and a construction site area that cover more than 14,000 m2, where the productive part, the offices, the laboratory and the warehouses of raw materials and finished products are located.

   This property, built in 2007, corresponds to article matrix no. … of the parish …, and is rented to the Claimant by Z… Real Estate Company, SA, NIPC…, the owner entity thereof.

   – A… 2 functions in the facilities located in …, Rua…, no. …, in …, where the unit for finishing stoppers intended for European markets is installed.

   This property corresponds to article matrix no. … of the parish of …, and is rented to the Claimant by BB…, NIF…, owner thereof.

3. The Group AA… integrates 12 entities, with at its top as parent company E… company registered in Luxembourg.

   The structure of GROUP AA… is as follows:

   [Organizational chart showing group structure]

4. The Claimant is indirectly held by the parent company (in 36.5%) and by C…, Inc, a company registered in the State of California, in the USA (in 54.5%), in virtue of these companies being the holders of all the capital of CC… SGPS, Ltd., NIPC… (in the said percentages), which, in turn, holds all the capital of the Claimant.

   • The parent company holds directly all the capital of the Portuguese companies DD…, SA, NIPC… and EE… Portugal, SGPS, Ltd., NIPC…, and also of the company registered in Ireland B…, Ltd, with VAT number IE…T and of the company FF…, SA.

   • EE… Portugal, SGPS, Ltd. is in turn the holder of 100% of the capital of the Portuguese companies GG… International, Ltd., NIPC… and HH…, Raw Materials, Single-member Ltd., NIPC….

   • Finally, and already at the base of Group AA…, we have II… France, SARL and JJ… Spain, SL, both held entirely by the Portuguese company GG… International, Ltd.

Main abbreviations of companies:

1. The Claimant controls all vertically integrated operations of the production process, which can be summarized as follows:

· - cork is acquired, selected and traced by its exclusive supplier, HH…, which has its registered office at the same location as the Claimant and production facilities that were expanded and rebuilt in 2008, in … (and include a cork stabilization park, a warehouse of pallets of prepared cork and a high-efficiency boiler in stainless steel);

· - weekly, cork is transported in pallets that contain approximately 750 kg each, from HH… to the Claimant's facilities in …;

· - in the main industrial unit of the company, in …, cork is transformed into stoppers, with all operations of the production process being carried out there until obtaining the finished product: stripping, manual and automatic drilling, drying, rectification, electronic and manual selection, washing and pre-drying, TCA bacteria control through the patented innocork system (exclusive to Group AA…), drying and coating;

· - when destined for the market of third countries, namely the American market (United States and Argentina), the stoppers are dispatched from A… 1, with the finishing operations being carried out in the group companies that exist in those countries;

· - when destined for the intra-community market, namely Spain and France, the stoppers go to the unit in … (A… 2) for the performance of finishes (such as: humidification and treatment), which are carried out according to the requests and specifications of customers, and only then are they dispatched to intra-community customers;

· - this happens because Group AA… in European countries has only commercial agents, entities to whom they pay commissions on sales intermediated, while in the United States of America, Australia and South Africa and Argentina it has group distributor companies, with capacity for the finishing of stoppers before being delivered to final customers;

· - in Portugal, the Claimant has only one salesman, given the reduced size of this market in the company's volume of business.

1. Pursuant to paragraph l), no. 3, of article 59 of the LGT and article 49 of the Supplementary Regime of Tax and Customs Inspection Procedures (RCPITA), the Claimant was notified by the AT, according to office no. … of the Tax Inspection Services of the Finance Directorate of …, of 17-10-2014, that, in the short term, an inspection action of the books would be initiated, with the indication of its scope (partial-IRC) and its extension (year/year 2010), (document no. 269 attached to the p.i.).

2. The inspection procedure commenced on 29-10-2014 (notification of Service Order no. O12014…) and ended on 17-03-2015 (notification of the diligence note referred to in no. 1 of article 62 of the RCPITA);

3. In the Draft Tax Inspection Report (PRIT), prepared on 17-03-2015, and with agreement memorandum of 20-03-2015, the following is stated, with interest for the present case (document no. 273 attached to the p.i.):

a) Regarding IRC, the Claimant declared a very high accounting and tax loss in the year 2008, and since then, has been deducting it from the taxable profits calculated in the following years (page 4);

b) Regarding the year 2010, the model 22 declaration is summarized in the following table (page 5):

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