CAAD Ruling 644/2014-T: Transfer Pricing Adjustments in Corporate Income Tax (IRC) 2008

Case No. 644/2014-T

The Arbitrators, Counselor Jorge Lopes de Sousa (appointed by agreement of the other Arbitrators), Prof. Dr. António Martins and Prof. Dr. Ana Maria Rodrigues, designated, respectively, by the Claimant and the Respondent, to form the Arbitral Tribunal, constituted on 25-11-2014, hereby agree as follows:

1. Report

A…, S.A., legal entity No. …, with registered office at …. – …, …-… …, hereinafter referred to as "A…, SA" or "Claimant", holding company of B..., has, pursuant to the terms and for the purposes of article 2(a), paragraph 1 and articles 10 et seq., all of the Legal Regime of Tax Arbitration ("RJAT"), in conjunction with article 102, paragraph 1 of the Code of Tax Procedure and Process ("CPPT"), applicable by virtue of article 10(a), paragraph 1 of the RJAT, submitted a request for arbitral decision against the Corporate Income Tax ("IRC") assessment notice relating to the year 2008 bearing No. 2011 … and, likewise, against the Compensatory Interest assessment notices No. 2011 … and No. 2011 …, in the total amount of € 1,091,205.49 (one million, ninety-one thousand, two hundred and five euros and forty-nine cents) and, likewise, against the decision dated 02 May 2014 issued by the Deputy Director-General of the Tax and Customs Authority, which only partially upheld the Administrative Appeal filed likewise against those assessment notices, following the dismissal of the administrative reclamation No. …2011….

The TAX AND CUSTOMS AUTHORITY is respondent hereto.

The Claimant proceeded to appoint an arbitrator, Prof. Dr. António Martins, pursuant to article 6, paragraph 2(b) of the RJAT.

Pursuant to article 6, paragraph 2(b) and article 11, paragraph 3 of the RJAT, and within the deadline provided for in article 13, paragraph 1 of the same statute, the highest official of the Tax Administration Service appointed Prof. Dr. Ana Maria Rodrigues as Arbitrator.

The appointed arbitrators designated the third arbitrator, Counselor Jorge Manuel Lopes de Sousa, pursuant to article 11, paragraph 4 of the RJAT.

The undersigned designees to comprise this collective Arbitral Tribunal accepted their appointments in accordance with legal provisions.

Pursuant to article 11, paragraph 7 of the RJAT, the President of CAAD informed the Parties of this appointment on 31-10-2014.

Thus, in compliance with article 11, paragraph 7 of the RJAT, upon the expiration of the deadline provided for in article 13, paragraph 1 of the RJAT, the collective arbitral tribunal was constituted on 25-11-2014.

The Tax and Customs Authority submitted its Response, defending the dismissal of the request for arbitral decision.

On 04-03-2015, evidence was produced through party and witness testimony.

At that meeting, it was decided that the proceedings would continue with written submissions.

The Parties submitted their written arguments.

The arbitral tribunal was duly constituted and is competent.

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

The proceedings are not affected by nullities and no exceptions were raised.

1. Factual Findings

2.1. Proven Facts

Based on the documents contained in the file and in the administrative proceedings attached to the case, the following facts are considered proven:

a) The Claimant is the holding company of "B...", subject to Corporate Income Tax taxation according to the Special Tax Treatment Regime for Groups of Companies, holding the social capital of the following companies with registered offices in Portugal (in addition to others with registered offices abroad, cf. Tax Inspection Report):

b) With reference to the fiscal years 2007 and 2008, inspection actions were carried out on two of the companies in the B...: A... SA and C..., Lda, with Tax Identification Number …), hereinafter referred to as C…;

c) These inspection actions were based on Service Orders Nos. OI… and OI…, regarding A... and Service Orders Nos. OI… and OI…, regarding C…;

d) Following the inspection actions on A..., corrections were made to its taxable profit under IRC as follows:

e) Following the inspection actions on C..., corrections were made to its taxable profit under IRC as follows:

f) As these two

g) companies were covered by the Special Tax Treatment Regime for Groups of Companies (RETGS), the arithmetic corrections made to the individual taxable result of the aforementioned companies were reflected in the group's taxable result, whereby two further inspection actions were carried out on the Claimant, now in its capacity as holding company of B..., in compliance with Service Orders Nos. … and …, inspection procedures for the fiscal years 2007 and 2008, respectively;

h) Service Orders Nos. … and … cover only the imputation to the Claimant, as the taxpayer responsible for determining the group's taxable base, of the corrections made under IRC in companies C... and A…, SA, with no specific corrections to the group's declaration, in order to reflect in the group's taxable result the IRC corrections made to the individual taxable result of the aforementioned companies;

i) Following the inspections of the group of companies, the following corrections were made to the group's taxable base:

j) Following the corrections relating to fiscal year 2008, assessment No. 2011 … and Compensatory Interest assessment notices No. 2011… and No. 2011…, in the total amount of € 1,091,205.49, were issued, with voluntary payment deadline of 20-04-2011;

k) The Claimant, in its capacity as holding company of the group, filed an administrative reclamation of the aforementioned assessments, which was dismissed by decision dated 21-09-2012 (administrative reclamation No. …2011…);

l) On 24-10-2012, the Claimant filed an administrative appeal against the dismissal decision of the administrative reclamation, which was partially upheld by Decision dated 02-05-2014 issued by the Deputy Director-General of the Tax and Customs Authority, issued by sub-delegation of authority, which was notified to the Claimant by Official Letter dated 05-06-2014 (document No. 1 attached to the request for arbitral decision, whose contents are hereby reproduced);

m) In the Tax Inspection Report relating to the inspections referred to in Service Orders OI… and OI…, reference is made, among other matters, to the following:

III.1.1 Arithmetic Corrections pursuant to article 23 of the IRC Code - Non-Tax-Deductible Financial Costs

Documentary analysis of the sub-accounts of the third-party account class made it possible to verify that the company, in addition to the attribution of supplementary allocations to its associates, recorded in fiscal years 2007 and 2008 in the sub-accounts 41 – annex 4, regularly attributes financing, used in the form of current account, which are reflected, respectively, in the current account 2521 -. Group Company - Loan and in the current account 26701 - Finance Group Company / Subs-Correction - annex 5.

Such operations, which increase in fiscal year 2008, result in financial flows that translate in most cases into debtor balances, assuming the form of credit extension to its associates without any remuneration.

On the other hand, there is an increase in the company's obligations to third parties: Debts to credit institutions, suppliers of fixed assets (leasing) and group and associated companies, of which the loans granted by the parent company – D… BV2 stand out, resulting in an increase in financial costs, as evidenced in the Financial Statements for fiscal years 2007 and 2008.

Upon questioning the taxpayer, through its tax advisor, regarding the granting of loans to its associates and the respective interest charging, it was stated by the latter that "(...) interest is only charged to its associates: E... - Tax ID … and F… Tax ID …" - annex 6.

Given the foregoing, it is necessary to determine whether, in light of article 23 of the IRC Code, the totality of financial costs resulting from obligations undertaken by the taxpayer should be considered as tax-relevant when they are not strictly necessary for obtaining its individual gains and profits, it being clear that between the taxpayer and the beneficiary companies there is a relationship of complete control.

The aforementioned rule provides that:

"Costs shall be considered those which are demonstrably indispensable for the realization of income subject to tax or for the maintenance of the income-producing source, namely: (...)

c) Of a financial nature, such as interest on borrowed capital applied in the exploitation (..))"

It immediately follows that these costs do not produce income subject to tax, to the extent that there is no interest charge.

Furthermore, it follows from the aforementioned article that the costs provided for therein cannot fail to respect the company itself.

According to records from the Commercial Registry and those available in the DGCI cadastral system, the subject matter of activity of this company is: "Technical consulting for the plastic material transformation industry". Therefore, the granting of loans to its associates is not directly related to any activity of the taxpayer inscribed in its corporate object, that is to the maintenance of its income-producing source.

We can conclude that the taxpayer, for the exercise of its activity, did not need to resort to credit to the extent that it did, overvaluing the financial costs incurred and consequently contributing to compromise its tax profitability and reducing its contributory capacity.

Thus, according to the foregoing and considering article 23, paragraph 1(c) of the IRC Code, part of the financial costs incurred by the taxpayer are not considered tax-relevant, to the extent that they are not assigned to its activity.

Finally, it is important to observe whether the fact that the taxpayer is in a relationship of complete control over its associates and is covered by RETGS could not determine that a correlative adjustment be made in the sphere of the associates.

Regarding the relationship of control, although the taxpayer may have an interest in the economic development of the activity of its associates, these with distinct legal and tax personality cannot fail to pursue autonomous activities, contributing with the determination of individual results to the group result.

In this sense, there is case law that corroborates that, even with a relationship of complete control, such companies are distinct entities, which have their subject matter of activity, it not being proven that, within the scope of the associates, such amounts contributed directly to the exercise of their activity.

Given the foregoing, it is proposed in accordance with article 23 of the IRC Code to correct the financial costs incurred by the taxpayer in fiscal years 2007 and 2008 according to the following methodology:

– Determination of the implicit interest rate based on the ratio between financial costs related to loans and the total of these obligations contracted with third parties;

– Determination of the average balance of loans granted to its associates;

– Application of the aforementioned interest rate to the monthly average value of loans granted.

(...)

III.1.2. Fiscal Year 2008

1. Implicit Interest Rate

Chart No. 6: Determination of the Implicit Interest Rate

1. Monthly average balance of loans to associates (annex 8)

Chart No. 7: Determination of the monthly average balance of loans to associates

1. Non-tax-deductible costs

Chart No. 8: Determination of Non-tax-deductible Costs

(...)

Chart No. 10: Total Corrections to Fiscal Result-2008

(...)

IX. 2. Prior Hearing

The taxpayer exercised the right to hearing, through one of its managers – G…, through written petition submitted to this Finance Directorate on 24/11/2010 - annex 10.

IX. 3. Allegations presented by the taxpayer and their evaluation

"Allegations"

Within the exercise of the right to hearing, the taxpayer contests the arithmetic corrections proposed under IRC – non-deductible financial costs, pursuant to article 23 of the IRC Code – arising from the regular attribution of financing to its associates, used in the form of current account, not subject to any remuneration.

The taxpayer focuses its defense on the following allegations:

• On the necessity of the funds for the exercise of the activity of its subsidiaries;

• On the maintenance of its income-producing source.

It is recalled that the arithmetic corrections proposed for fiscal years 2007 and 2008, respectively in the amounts of € 280,841.55 and € 349,565.26, arise from the fact that it was detected during the inspection action that the taxpayer, whose activity is "Technical consulting for the plastic material transformation industry", regularly attributes financing to its associates, used by these in the form of current account, obtaining no remuneration from these operations, in order to compensate for the increase in financial costs arising from the increase in obligations undertaken by it with third parties.

Thus, in accordance with article 23 of the IRC Code, it was considered that it was not proven that the totality of financial costs resulting from obligations undertaken by the taxpayer were strictly necessary for obtaining its individual gains and profits.

Given the foregoing, the financial charges resulting from the application of an implicit interest rate supported by the taxpayer to the average balance of loans granted to its associates were not considered as an expense of the taxpayer's activity for the fiscal years under analysis.

"Evaluation"

As already mentioned, without questioning the amounts determined, the taxpayer contests the corrections proposed, arguing with the necessity of funds for the exercise of the activity of its subsidiaries, and on the other hand with the maintenance of its income-producing source.

Let us then proceed to the evaluation of the arguments used by the taxpayer:

On the necessity of funds for the exercise of the activity of its subsidiaries

In point 13.0 of its statement, the taxpayer states that, according to what has been mentioned by the inspection services, there is case law that appears to support that such costs will be deductible, provided that the taxpayer proves that, within the scope of the associates, such amounts contributed directly to the exercise of their activity. On this assertion, it is important to clarify the following:

i. Contrary to what was stated by the taxpayer, it follows from the analysis of various available court decisions that such operating expenses will never be expenses of the taxpayer's activity, to the extent that they did not contribute directly to the exercise of its activity, that is to the maintenance of its income-producing source;

ii. At most, they will be expenses of the activity of its associates, and for this: – They must be reflected in its accounting, which did not occur because these costs were not charged to its associates; and even so

– It is imperative to justify that in fact the amounts granted contributed directly to the exercise of the activity of its associates.

In this context, the taxpayer now submits in the hearing stage exemplary charts of the evolution of the Available Liquidity items for fiscal years 2007 and 2008, as well as the respective MOAFs (Statements of Sources and Uses of Funds) of its subsidiaries.

The taxpayer intends to prove with these elements that "(...) the funds received in the fiscal years under analysis, and regardless of their respective source (e.g. Group companies, financial institutions) were always used by them given that, in the course of fiscal years 2007 and 2008, the amounts in question do not remain in available liquidity (...)".

The taxpayer further considers that such a situation would only occur in a scenario in which the liquidity received from the Parent had remained in available liquidity without any associated return (...)".

First of all, it is important to clarify that, although the taxpayer intends in this procedure to prove the indispensability of the cost for its associates, the taxpayer subject to inspection is company A... SA, and the corrections proposed fall on the individual taxable profit of this company. On the other hand, one cannot speak of the indispensability of a cost that is not reflected in the taxable result of the associates, but rather, incorrectly, only in the taxable profit of the taxpayer.

But even so, regarding the assertions of the taxpayer, it is important to state the following:

i. It is noted that the proposed corrections only affected the current accounts of the subsidiaries in which the average balances at the end of the fiscal years under analysis remained positive, making evident in these situations the financing of the taxpayer to its associates;

ii. The presentation of summary charts of the available liquidity accounts of all subsidiaries (not just those on which the proposed corrections fall) reveal a management of available funds carried out in a group logic, supported by the financial availability generated in the taxpayer, often with recourse to external funds (financial institutions, parent company – D… B.V), which generate costs supported by it and not reflected in its associates;

iii. The situation described thus repeats itself in the available liquidity accounts of all subsidiaries, including those in which no corrections were proposed.

Moreover, the taxpayer intends to demonstrate the effective use of the funds through the presentation of MOAFs of the subsidiary companies. Through the example of company H…, for fiscal year 2007, it tries to justify that "( ) only made financing to subsidiary companies that, in the fiscal years under analysis, presented negative free cash flow".

From the analysis of the MOAFs presented by the taxpayer, the following stands out:

i. The situation presented for company H… (fiscal year 2007) cannot be extrapolated to all subsidiaries, as we find that there are situations where the cash flow (after bank commitments/leasing) is positive and yet capital infusions are made to these companies;

ii. It is further verified that some of the treasury strengthening carried out by the taxpayer are applied in the reimbursement of supplementary allocations;

iii. The opposite also occurs, including H… (fiscal year 2008), the reimbursement of supremes causes the need to reinforce the performance of supplementary allocations;

iv. Even in subsidiary C..., in fiscal year 2007, the balance of the available liquidity account is influenced, not by the operational activity of the company, but rather by the reimbursement of supplementary allocations: the sum of the supremes amounts to € 993,174.46, while the associate reimburses supplementary allocations in the amount of € 1,069,294.52;

Without questioning the occasional treasury needs of its associates, as already stated, the facts presented leave evidence of group treasury management that is reflected, negatively, on the taxable results of the taxpayer, jeopardizing its tax profitability. The corrections proposed are aimed at determining how and how much this policy wrongly influences the results of the taxpayer, so as to restore the measure of financing costs directly related to its activity.

On the maintenance of the income-producing source

Finally, the taxpayer comes forward to argue that, due to the fact that most of its clients are group companies, "(...) it is easily concluded that the maintenance of the income-producing source (...) is conditioned by the economic viability of its subsidiaries, since they are its only clients".

It concludes, considering that its survival depends on financial support to its subsidiaries.

Let us begin by pointing out that we are facing entities which, although they constitute an economic group, are distinct, with capacity to generate funds from their activity. To assume that the survival of its associates depends on the injection of capital by the taxpayer is to assume that these entities do not have capacity to generate wealth, and moreover, that the continuity of the taxpayer may be at risk, according to this logic of fund management, whose financial costs are supported by it.

However, having analyzed the Statement of Results by nature of the entities that motivated the proposed corrections, it is possible to conclude that most of these entities present a negative net result, partly resulting from costs supported with the provision of services charged by the taxpayer. This raises the question whether the treasury difficulties of these companies are not instead due to the costs incurred with these services.

In these terms, it is concluded, highlighting the following:

The elements presented by the taxpayer prove that the existence of group treasury management, ensured by the taxpayer, has negative reflections on its taxable results;

That part of the financial costs supported by the taxpayer are not expenses of its activity, under article 23.0 of the IRC Code; and that

Regardless of whether these could be deductible in the sphere of its associates, it was clearly concluded from the inspection action carried out that these costs, not being charged by the taxpayer, are not reflected in its accounting, whereby the Tax Administration cannot accept its deductibility to the taxable result.

IX. 4. Conclusion

As a result of the evaluation of the elements presented by the taxpayer, it is concluded that the corrections proposed under IRC for fiscal years 2007 and 2008 are upheld:

n) In the Tax Inspection Report relating to the inspections carried out in compliance with Service Orders OI… and OI…, reference is made, among other matters, to the following:

III – DESCRIPTION OF THE FACTS AND GROUNDS OF THE PURELY ARITHMETIC CORRECTIONS TO THE TAXABLE BASE

III. 1 Corrections made to individual taxable result

As already stated, in the fiscal years under analysis, corrections were made to the individual taxable result of two of the companies belonging to the group in Portugal: A... SA, Tax ID … (…) and C... Lda, Tax ID … (OI …), which, in accordance with article 70 of the IRC Code must be reflected in the taxable result of the group. Let us see:

III.1.1. A... SA (OI…)

Financial costs non-deductible under article 23 of the IRC Code:

Documentary analysis of the sub-accounts of the third-party account class made it possible to verify that the company regularly attributes financing, used in the form of current account, which are reflected, respectively, in current account 2521 -. Group Company - Loan and in current account 26701 - Finance Group Company I Subs-Correction, obtaining no remuneration from these operations, in order to compensate for the increase in financial costs arising from the increase in obligations undertaken by it with third parties.

Considering that the activity of the taxpayer is "Technical consulting for the plastic material transformation industry", in accordance with article 23 of the IRC Code, it was considered that it was not proven that the totality of financial costs resulting from obligations undertaken by the taxpayer were strictly necessary for obtaining its individual gains and profits.

Given the foregoing, the financial charges resulting from the application of an implicit interest rate supported by the taxpayer to the average balance of loans granted to its associates were not considered as an expense of the taxpayer's activity for the fiscal years under analysis. Upon expiration of the deadline for exercise of the right to hearing, and not having heeded the claims defended by the taxpayer, a correction to the taxable profit was determined for fiscal year 2007 in the amount of € 280,841.55 and for fiscal year 2008 in the amount of € 349,565.26.

III.1.2. C... Lda (OI…)

Corrections in the scope of the Transfer Pricing issue, under article 63 of the IRC Code:

The analysis of the commercial relations between company C... Lda and company I... Limited (I…) Tax ID … – also belonging to B... -, made it possible to conclude on the existence of special relations, under article 63, paragraphs 3(b), (e), (g) and paragraph 4(h) of the IRC Code.

Thus, company C... Lda, in accordance with paragraph 3 of article 13 of Ordinance 1446/C/2001, was obliged to have information and documentation regarding the policy adopted in determining transfer prices and maintain, in an organized manner, elements capable of proving "arm's length in the terms and conditions agreed, accepted and practiced in the operations carried out with related entities" and the "selection and use of the method or methods most appropriate for determining transfer prices that provide greater approximation to the terms and conditions practiced by independent entities and that ensure the highest degree of comparability of the operations or series of operations carried out with other substantially identical ones realized by independent entities in normal market conditions".

Faced with the non-compliance with this obligation, and with all the legal requirements invoked in paragraph 3 of article 77 of the LGT being proven, to proceed with corrections arising from the application of the transfer pricing issue, the quantification of the effects that the contracting with company I... had on the taxpayer's taxable profit was carried out, in accordance with article 63.0 of the IRC Code and article 9 of the OECD Model Tax Convention, which provides that when "two companies [associated] in their commercial or financial relations are linked by conditions accepted or imposed that differ from those that would have been established between independent companies, the profits which, if such conditions did not exist, would have been obtained by one of the companies, but which were not because of these conditions, may be included in the profits of that company and taxed accordingly".

Given the foregoing, and upon expiration of the deadline for exercise of the right to hearing, without new facts being presented, a correction to the taxable profit was determined for fiscal year 2007 in the amount of € 4,178,458.21 and for fiscal year 2008 in the amount of € 3,864,110.15.

III.2. Specific corrections to the Group Declaration

III.2.1. Aggregated values

The Income Declaration Model 22 of the Group for fiscal years 2007 and 2008 was verified, as well as the aggregated values through the algebraic sum of all items that make up chart 09 (determination of taxable base) and chart 10 (Calculation of tax: amounts withheld at source; payments on account; regional surtax and autonomous taxation) of the IRC Model 22 declarations of each company that constitutes the group.

No corrections were detected from this analysis.

III.3. Corrections to the Group's taxable base

Considering the corrections to the individual taxable result of companies A... SA and C... Lda (point III.1.) the following corrections to the group's taxable base were obtained:

(...)

Chart No. 3: Corrections to the Group's Taxable Base – Fiscal Year 2008

(...)

IX. 2. Prior Hearing

The taxpayer exercised the right to hearing through written petition submitted to this Finance Directorate on 29/12/2010 - Entry Document No. … (Annex 4).

It is important to point out here that the present Service Orders cover only the imputation to the taxpayer responsible for determining the taxable base of the group in accordance with article 64, paragraph 1 and article 1120, paragraph 6(a) of the IRC Code, of the corrections made in the subsidiary companies C..., Lda and A…, SA, with no specific corrections to the group's declaration.

IX. 3. Allegations presented by the taxpayer and their evaluation

Within the exercise of the right to hearing, the taxpayer as holding company analyzes the conclusions in order to demonstrate that the projected decision suffers from errors of fact and law and as such cannot be maintained in the legal order without prejudice to considering that in the individual sphere of each of the companies this was already duly and fully demonstrated.

IX. 3. 1. Regarding company C..., Lda

Allegations

The corrections that the inspection services propose to carry out under article 63. of the IRC Code - Transfer Pricing seems to rest on erroneous prejudgment. (as per § 8º) ... the company cannot fail to reiterate what was already said by C..., Lda, when exercising the right to hearing in the sense that it did not fail to comply with any accounting or tax obligation, namely regarding transfer pricing, given that the relevant information was always available for consultation and analysis and all information and documentation requested was actually delivered. (as per § 10)

... the intervention of I… allowed the company (as a Group) to benefit from various synergies and mitigate the effect of discounts granted to customers in the gross sales margin, even allowing to increase it: 18.5 in 2006; 21.4 in 2007; 19.4 in 2008 and 24% in 2009. (as per § 11º)

... market conditions were not altered by the fact that C..., Lda made purchases of raw materials from I…, thus appearing neither justified nor legal the correction that is now proposed. (as per § 13º)

... the tax profitability of C..., Ida, after the corrections proposed by the Tax Inspection Services, in 2007 and 2008 exceeds, respectively, three times and twice that verified in fiscal years 2004 and 2005, fiscal years in which I… did not exist!".

Notwithstanding what has been stated, sufficient in itself for the non-implementation of the projected correction of the taxable base for the purposes of Corporate Income Tax for fiscal years 2007 and 2008, the Inspection Services should always project forthwith, should they persist in the error in which they incur, the correlative correction at the level of the Irish law company under penalty of an unacceptable double taxation (as per § 18º).

Evaluation

Reiterating what was already referred to in the hearing evaluation chapter of the final report of company C..., Lda, the part considered relevant is hereby transcribed:

.... it is important to point out that the corrections made in this scope are based on non-compliance with the arm's length principle, founded in accordance with article 77 of the LGT, that is:

i) Upon verification of the constitution of the capital of company I… and analysis of the conditions underlying the acquisition of raw materials, both from the commercial and administrative points of view, we conclude that we are facing a situation of special relations between the two entities (the taxpayer and company I…), under article 63, paragraph 4(b), (e), (g) and (h) of the IRC Code; whereby,

ii) The taxpayer was thus, in accordance with paragraph 3 of article 13 of Ordinance 1446-C/2001, obliged to have information and documentation regarding the policy adopted in determining transfer prices and maintain, in an organized manner, elements capable of proving 'arm's length in the terms and conditions agreed, accepted and practiced in the operations carried out with related entities" and the 'selection and use of the method or methods most appropriate for determining transfer prices that provide greater approximation to the terms and conditions practiced by independent entities and that ensure the highest degree of comparability of the operations or series of operations carried out with other substantially identical ones realized by independent entities in normal market conditions".

iii) However, as stated in the Statement of Facts prepared on 09 July, not only was the non-presentation of the Transfer Pricing Dossier assumed, but the only available element would be the raw material supply contracts; In the exercise of the right to hearing both of company C..., Lda and of the company as holding company, nothing was added about the Transfer Pricing Dossier, nor did the taxpayer take the opportunity to present the elements provided for in the aforementioned article, reiterating therefore non-compliance with this obligation;

iv) Given the foregoing, the quantification of the effects that the contracting with company I… had on the taxpayer's taxable profit was carried out, in accordance with article 9 of the OECD Model Tax Convention, which provides that when two companies [associated], in their commercial or financial relations, are linked by conditions accepted or imposed that differ from those that would have been established between independent companies, the profits which, if such conditions did not exist, would have been obtained by one of the companies, but which were not because of these conditions, may be included in the profits of that company and taxed accordingly".

First and foremost, it is emphasized that regarding the requirements that are legally invoked in paragraph 3 of article 77 of the LGT, the taxpayer does not present any new fact in this petition, let us see:

– It does not controvert the existence of special relations, nor even the fact that we are facing a situation of subordination of company I… to the conditions imposed by the taxpayer;

– It does not contradict the fact that the administrative structure, with respect to the selection and contact with suppliers, remains centered on company A… SA.

– Regarding the Transfer Pricing Dossier, article 14 of Ordinance 1446-C/2001 is clear regarding the elements that it must have:

"- Description and characterization of the situation of special relations;

• Characterization of the activity exercised by the taxpayer and by the related entities with which it carries out operations;

• Description of the functions exercised, assets used and risks assumed, both by the taxpayer and by the related entities involved in the linked operations;

• Explanation regarding the choice of the arm's length price determination method;

• Information on the comparable data used",

Moreover, as to the quantification of the effects of non-compliance with the arm's length principle, the taxpayer adds nothing, not presenting any concrete fact that opposes the proposed corrections, the taxpayer intending to justify that these are excessive, arguing that the taxpayer before the incorporation of company I… did not have these levels of profitability.

However, having analyzed the levels of gross margin and tax profitability of C..., Lda before the corrections, these do not express the competitive advantages that the taxpayer shows with the intermediation of I… and the economic reasons that led to its incorporation, quite the opposite, the levels of tax profitability decline to negative values from the contracting with company I…;

Thus, the taxpayer having presented no new facts regarding the non-compliance with its tax obligations on the matter under analysis, nor indeed on the quantification of their respective effects on the fiscal result level, this thereby reinforces the demonstration of the requirements of paragraph 3 of article 77 of the LGT, maintaining the corrections proposed by the Tax Administration in accordance with paragraph 8 of article 63 of the IRC Code and article 9 of the OECD Convention Model;

Finally, it is stressed that the taxpayer in § 17 of its petition comes to request that the correlative adjustment of corrections made in the sphere of company I..., in accordance with paragraph 11 of article 63 of the IRC Code, be carried out, however, as this company is not a corporate income taxpayer in national territory, it is not incumbent on the Portuguese Tax Administration to promote such adjustments.

IX. 3. 2. Regarding company A…, SA

Allegations

Thus, the Tax Administration concludes that, the financial charges resulting from the application of an implicit interest rate supported by the taxpayer to the average balance of loans granted to its associates were not considered as an expense of the taxpayer's activity (...) (as per § 20º)

As the company previously stated when exercising the right to hearing at the individual level, the corrections proposed lack foundation (as per § 21º)

First of all, because the financial costs incurred were, in fact, indispensable for the activity and profits of the associated entities. (as per § 22º)

... the funds made available by the Company, throughout the period under analysis, were actually used in that they did not remain (statically) in available liquidity. (as per § 24º)

Evaluation

Reiterating what was already referred to in the hearing evaluation chapter of the final report of company A…, SA, as a company at the individual level, the part considered relevant is hereby transcribed:

"It is recalled that the arithmetic corrections proposed for fiscal years 2007 and 2008, respectively in the amounts of € 280,841.55 and € 349,565.26, arise from the fact that it was detected during the inspection action that the taxpayer, whose activity is technical consulting for the plastic material transformation industry ", regularly attributes financing to its associates, used by these in the form of current account, obtaining no remuneration from these operations, in order to compensate for the increase in financial costs arising from the increase in obligations undertaken by it with third parties.

Let us begin by pointing out that we are facing entities which, although they constitute an economic group, are distinct, with capacity to generate funds from their activity.

In these terms, the following is concluded:

The elements presented by the taxpayer prove that the existence of group treasury management, ensured by the taxpayer, has negative reflections on its taxable results:

• That part of the financial costs supported by the taxpayer are not expenses of its activity, under article 23 of the IRC Code; and that

• Regardless of whether these could be deductible in the sphere of its associates, it was clearly concluded from the inspection action carried out that these costs, not being charged by the taxpayer, are not reflected in its accounting, whereby the Tax Administration cannot accept its deductibility to the taxable result.

In conclusion

For the loans made, the taxpayer A…, SA as an individual company supported financial costs, but for the loans granted did not receive any amounts as interest, whereby the costs supported with loans obtained to the extent of loans granted to its associates cannot be accepted as a cost in accordance with article 23 of the IRC Code because not necessary for its activity.

A…, SA and its associates pursue autonomous activities, with distinct legal and tax personality and although it has an interest in the economic development of the activity of its associates, it does not have as its activity the granting of loans.

o) The decision of the administrative appeal was based on information contained in the administrative proceedings, whose contents are hereby reproduced, in which reference is made, among other matters, to the following:

In compliance with Service Orders Nos. … and …, with decision dated 08/11/2010, the taxpayer A..., in its capacity as holding company of B..., was subject to an inspection procedure for the period of 2008, in order to reflect in the group's taxable result the IRC corrections made to the individual taxable result of companies A… SA (Tax ID …) and J…, LDA (Tax ID …) in the amount of € 349,565.26, with respect to the first company and in the amount of € 3,864,110.15, with respect to the second company.

xi. In the inspection action, the following facts were ascertained, among others:

• Aspects related to the activity of J…, LDA. (…) (Point II.1.3, page 9 et seq. of the Tax Inspection Report at pages 263 of the administrative reclamation proceedings):

Its sales of goods essentially relate to preforms produced by the company for incorporation in the production process of various companies in the group, both national and located in other countries. Geographically, the sales of goods are distributed, in fiscal years 2007 and 2008, mainly in the domestic market (84% and 71%, respectively)

As for its suppliers, it was verified that from September 2006 onwards, almost all raw materials began to be acquired from company I…, with registered office in Ireland. When the latter acquires a Tax ID in national territory, the J… LDA, which until then made intra-community acquisitions, charging and deducting VAT, begins to make internal acquisitions, with right to deduction, generating substantial refunds.

• Aspects related to the activity of I… (….) (Point II.3, page 9 et seq. of the Tax Inspection Report at pages 263 of the administrative reclamation proceedings):

Company incorporated in August 2006, with 100% ownership by the holding company of B... – D…, BV, with registered office in the Netherlands. Its activity focuses on the sale of goods to companies in B..., with a large part of its sales carried out in Portugal, and more specifically, to J…, LDA.

Upon acquiring a Tax ID (…) in national territory, it begins to make acquisitions mainly in the domestic market, making it possible to fully deduct VAT supported in the acquisition of raw materials.

• Corrections made to the individual result of A…, S.A. (…) (Point III.1.1, page 8 of the Tax Inspection Report at pages 130 of the administrative reclamation proceedings):

Through documentary analysis of the third-party account class sub-accounts, it was verified that the company regularly attributes financing, used in the form of current account, obtaining no remuneration from these operations, in order to compensate for the increase in financial costs. Considering the activity of the taxpayer, in accordance with article 23 of the IRC Code, it cannot be taken as proven that the totality of financial costs resulting from obligations undertaken by the taxpayer were strictly necessary for obtaining its individual gains and profits, which determined a correction to the taxable profit for fiscal year 2008 in the amount of € 349,565.26.

• Corrections made to the individual result of J…, LDA. (…) (Point III.1.2, page 8 of the Tax Inspection Report at pages 130 of the administrative reclamation proceedings):

The analysis of the commercial relations between company J…, LDA. and company I…, also belonging to B..., made it possible to conclude the existence of special relations, under article 63, paragraphs 3(b), (e) and (g) and paragraph 4(h) of the IRC Code. Verification of non-compliance by company J…, LDA., in accordance with paragraph 3 of article 13 of Ordinance 1446/C/2001, with the obligation to have information and documentation regarding the policy adopted in determining transfer prices, determined a correction to the taxable profit for fiscal year 2008 of € 3,864,110.15.

xii. Within the scope of the aforementioned inspection procedure, the following was concluded:

• Verification of the legal presuppositions for, maintaining direct assessment of the taxable base, an increase to this must be made in the global value of € 4,213,675.41 for the period of 2008, which are reflected in the group's taxable result, in accordance with article 70 of the IRC Code.

xiii. After the aforementioned Inspection Report was prepared, the taxpayer was notified, through official letter No. …, dated 13/12/2010, with registration No. RC …PT, to exercise the right to prior hearing on the draft corrections in accordance with article 60(b) of the LGT, within the deadline of 15 days (page 11 of the Inspection Report at pages 133 of the proceedings).

xiv. In the hearing stage, the taxpayer comes forward as holding company to analyze the conclusions in order to demonstrate that the decision suffers from errors of fact and law.

xv. Following the evaluation of the hearing, the final report was then prepared in accordance with article 62 of the RCPIT, maintaining the corrections proposed and notifying the taxpayer through official letter No. …, dated 08/02/2011, as per pages 120 of the administrative reclamation proceedings.

xvi. Consequently, the services proceeded to issue the respective additional assessment No. 2011 …, on 11/03/2011, relating to the period of 2008, which was notified to the taxpayer through registered mail No. RY …PT, dated 15/03/2011.

(...)

With respect to the adjustments regarding transfer pricing, under article 63 of the IRC Code:

(...)

It is our understanding that, in the present case, just as described above, it clearly results from the report of the Tax Inspection Services both the description of the special relations between the recurrent company and company I..., demonstrating the relationship existing between them, as well as explicitly quantifying the amounts that served as the basis for the said corrections.

Let us see.

Paragraph 3 of article 77 of the LGT requires a special duty of reasoning, translated into the following items:

(i) Description of special relations

• The inspection services, in determining the tax implications of the commercial operations verified between I… and J…, LDA, found the existence of special relations between the two companies, since not only are they held, directly in the case of the former, and indirectly in the case of the latter, respectively, 100% by company D… BV (paragraph 4(b) of article 63 of the IRC Code), as demonstrated in the organizational chart in Point B - Description of Facts, but from the analysis of the raw material supply contracts established between I… and J…, LDA, it is evident the subordination of the former to the J… LDA, with the conditions of delivery, the risks assumed, the suppliers and the products established in each of them, which the latter imposes to be acquired from the former (paragraphs 4(e) and (g) of article 63 of the IRC Code), and from September 2006 onwards, J…, LDA began to acquire all of its raw materials from I….

(ii) Indication of the obligations breached by the taxpayer

It was in the context described above that the presentation of the transfer pricing dossier, provided for in article 63, paragraph 6, of the IRC Code, was requested, with the company responding that the same was not duly organized, presenting only the contracts established between the parties for the supply of raw materials from which a clear subordination of I... to the conditions imposed by J..., as described in the previous item, is evident.

The inspection services further verified that the taxpayer, in the taxation period in question, did not file Annex H of the Annual Declaration, provided for in article 113 of the IRC Code, where should appear the nature and amount of operations carried out with related entities, the methods used in determining transfer prices, the value of operations in which the rules provided for in paragraph 1 of article 63 of the IRC Code were not observed and the value of the correction to taxable profit.

(iii) Application of the methods provided for in law

The wording of paragraph 1 of article 63 of the IRC Code requires that the Tax Administration demonstrate that "relations have been established different from those that would normally be agreed between independent persons", attributing to the taxpayer, by paragraph 2 of the same rule and by paragraph 1 of article 4 of Ordinance No. 1446-C/2001, the adoption of the most appropriate method to each operation or series of operations.

Now, for a correct application of the provisions of article 63 of the IRC Code, practical orientation of the arm's length principle should be made, as mentioned in the OECD report, in order to ascertain a reasonable degree of comparability:

"To determine the degree of actual comparability and subsequently make appropriate adjustments to establish the conditions (or a range of conditions) of arm's length, the characteristics of the operations or companies likely to have an impact on the conditions inherent to arm's length operations must be compared. The characteristics that may prove important are those relating to the goods and services transacted, the functions performed by the parties (including the assets used and the risks assumed), the contractual clauses, the economic situation of the parties and their respective business strategies.

In this regard, Maria dos Prazeres Lousa states:

"The application of any of the methods requires the prior determination of the actual degree of comparability of the characteristics of transactions or companies (e.g. characteristics of goods or services transferred; the functions assumed by companies, taking into account the assets used and the risks assumed), which are capable of having an impact on the conditions of transactions in arm's length situations".

Thus, to classify certain transactions as comparable, we must consider various factors

"The characteristics of the goods or services, such as, for example, in the case of provision of services, the nature and volume.

"The functions performed by the parties, both at the structural level and at the organizational level of the group, in order to compare the activities and significant responsibilities on the economic plane exercised by associated companies and by independent companies.

The contractual clauses of the operation in question, insofar as they define the modalities of responsibilities, risks and benefits between the parties.

"The economic framework of the operation in question, it being essential to identify the market(s) in question, to ensure that the realities are comparable and that the respective differences have a materially relevant impact on prices or so that appropriate adjustments can be introduced.

"And to the business strategies of the entities involved.

In these terms, the provision of article 63 of the IRC Code enunciates several methods for determining the terms and conditions that would normally be agreed, accepted and practiced between independent entities.

In the present case, the inspection services, after the enumeration of the various methods capable of being used, opted for the comparable uncontrolled price method (article 6 of the Ordinance) which consists in comparing the price of goods or services transferred in a related party transaction ("controlled transaction") with the price charged with respect to goods or services transferred in the context of an operation between independent companies in comparable circumstances. The inspection services considered that, although the issue is almost exclusive acquisition of raw materials from a related entity, this was the most appropriate method because it constitutes the most direct way to determine whether the conditions agreed between related entities are arm's length conditions.

Furthermore, they opted to reject the so-called non-traditional methods that will only be susceptible of use when traditional methods cannot be applied, following the OECD guidance which argues that:

"traditional methods based on transactions are preferable to methods based on transaction profit when it is intended to determine whether a transfer price is an arm's length price, that is, whether or not there are special conditions affecting the distribution of profits between associated companies. Experience now shows that in most cases it is possible to apply traditional methods based on transactions".

(iv) Quantification of the respective effects

The OECD itself recognizes that, in reality, the existence of exact comparables is rare, suggesting in such cases the application of adjustments, without, however, making any reference to how such adjustments can be made.

In this way, although the comparable uncontrolled price method is considered the most reliable and direct method when there is sufficient information in the market about comparable operations, difficulties may arise in its practical application when related companies carry out operations that they do not carry out with independent companies.

In the words of the OECD Report Guidelines

"(...) the comparable uncontrolled price method compares an operation carried out between related companies with similar operations between independent companies in order to obtain a direct evaluation of the price that the parties would have agreed if they had resorted directly to the market instead of carrying out a controlled transaction. However, this method loses somewhat of its reliability as a substitute for an arm's length negotiation if the characteristics of the operations in the open market with substantial impact on the price practiced between independent companies are not all of them comparable".

This is what occurs in the case subject to analysis, since the acquisition of raw materials by J... is carried out almost exclusively from the related entity (I...), having been demonstrated explicitly in the tax inspection report that, if we were facing independent entities, J…. LDA would not agree to pay more than it would cost him if he acquired the raw materials directly from suppliers, whereby the adjustment in the cost of inventories sold of that company was made, annulling the margin practiced by I... in the sales of raw materials made.

This is because in comparable operations, independent entities define the terms and conditions that consist in the assumption of charges by the entity that would receive the benefit associated with the operations. However, in the case subject to appeal, the inspection services did not provide evidence that company I... added value to the activity of the taxpayer.

Now, however, there is a flaw in the application of the methodology chosen by the inspection services to annul the sales margin applied by company I..., as per pages 28 et seq. of the Inspection Report (…) at pages 272 et seq. of the administrative reclamation proceedings.

That is, given the total cost of inventories sold (CEV) ascertained (€ 38,401,795.94) and the total of sales determined through customer statements, excluding the amount of VAT included (€ 42,482,546.76) it was ascertained that I... practiced a margin of 10.626%. However, in determining the correction to be made to CEV of J..., the inspection services multiplied the CEV by the margin obtained instead of subtracting from that value the markup made by the same, dividing the CEV by the margin and subtracting this value again from CEV, that is, the adjustment to be made for transfer pricing is € 3,492,949.35 and not € 3,864,110.15.

d) Disregard of tax benefits

The recurrent party considers that the assessment subject to appeal is also unlawful because it results in the disregard of tax benefits relating both to the creation of net employment, in virtue of that document indicating the annulment of the assessment in which such benefits were reflected, and to the deduction of SIFIDE.

However, with respect to the tax benefit for the creation of net employment, it is not what is stated in the account reconciliation statement that the recurrent party itself attaches to its petition as document 1. This document merely makes the calculation of the additional assessment No. 2011 … subject to the present appeal with assessment No. 2010 …, which resulted in a refund that became undue in light of the corrections ascertained in the inspection procedure

That is, to the declared taxable profit of € 910,395.50 was added the amount of € 4,213,675.41, referring to the corrections made in the inspection procedure for non-deductible financial costs and transfer pricing, which resulted in a corrected taxable profit of € 5,124,070.91, whereby the tax benefit for creation of net employment was not disregarded in any way.

(...)

V. CONCLUSION

Thus, for the reasons adduced, the present administrative appeal should be partially upheld in the following matters raised by the recurrent:

As to transfer pricing, in the amount of € 371,160.80, maintaining the increase of € 3,492,949.35 to taxable profit;

As well as the portion of the bank guarantee provided in proportion to the granting, provided that it proves the damage caused;

It is further proposed that the request relating to the SIFIDE tax benefit be separated out, to be reviewed as official revision under article 78 of the LGT.

VI. RIGHT TO HEARING

As the decision on the appeal is partly favorable to the recurrent, prior hearing is waived in accordance with paragraph 2 of article 60 of the LGT.

As to the part of the decision that dismisses the appealed decision, given that it is based on facts about which the recurrent was already notified to exercise the right to hearing and having brought no new facts in the administrative appeal, it is to waive new hearing in accordance with paragraph 3 of article 60 of the LGT and items (a) and (c) of paragraph 3, chapter II of Circular No. 13/99.

p) The Tax and Customs Authority calculated the interest it understood to correspond to the financing made by the Claimant to its subsidiaries by applying an implicit interest rate calculated based on total financial costs and debtor balances at the end of each fiscal year;

q) The activity of "B..." corresponds to the production of rigid plastic packaging for large consumption companies, especially in the beverage and food, personal hygiene, home hygiene and oils and lubricants sectors;

r) This same activity is developed under a very specific business model that consists essentially of the production of rigid plastic packaging in integrated production units dedicated to a single customer, in a long-term supply and partnership relationship;

s) In the year 2008, "B..." managed 63 factories in 17 countries: Austria, Brazil, Canada, United States of America, Spain, France, Netherlands, Ireland, Italy, Malaysia, Mexico, Portugal, Czech Republic, United Kingdom, Russia, Ukraine and Vietnam;

t) In 2008, the Claimant held 100% of the capital of C...;

u) Part of B... in 2008 was "I…" (hereinafter, I...), with registered office in Ireland;

v) Until 2006, "B..." had an eminently European character, with a central purchasing office for raw materials in each country;

w) B... understood that centralization was important to strengthen its competitiveness;

x) The strategic decision to create I... was based on the need for "B..." to obtain negotiating conditions even more competitive than its customers, preventing the purchase of raw materials from being transferred to the sphere of decision of the customers themselves;

y) The creation of I... had the advantage of eliminating duplicate administrative structures, generating economies of scale and synergies and provided B... with a more favorable negotiating position for maintaining the raw materials purchasing function within the Group;

z) I... became the unit of the group that conducts the research, identification and selection of independent raw material suppliers and makes the respective purchases, also dedicating itself partially to the logistics and transport of raw materials purchased by it;

aa) The choice of location of I..., headquartered in Ireland, was based on the increasing weight of the United Kingdom market in the Group's activity, which was always greater than the Portuguese market itself, and the opportunities that arose for "B..." in the United States of America (USA) and Canada markets;

bb) I... entered into a contract with C... whereby the former is the entity responsible for identifying and selecting the suppliers that operate in the raw materials market desired, for negotiating the purchase of raw materials from those suppliers and for controlling the compliance with the negotiated conditions in the purchase, for guaranteeing the price and supplying the desired quantities, in addition to supplier evaluation, as well as ensuring that the products are delivered with the specified technical characteristics, as well as assuming responsibility for insurance expenses related to the transport of the products in question, for technical service, and for commercial discussion of complaints, including negotiation of possible indemnities;

cc) I... uses in the activity it performs its knowledge and mastery of the raw materials markets in which it operates and knowledge of the raw material suppliers that the companies in "B..." need;

dd) I... has greater market knowledge and negotiating capacity in the acquisition of raw materials than the other units of B..., which allows it to negotiate lower prices and which would not be within the reach of each of the units of B..., individually considered;

ee) The provision of services to group companies constituted 99.28% of the Claimant's activity in 2008;

ff) The group companies to whom the Claimant made financing in the year 2008 were experiencing financial difficulties;

gg) The Tax and Customs Authority, following the correction to taxable profit arising from the non-consideration of financial costs, did not make corresponding corrections in the taxable profits of the subsidiaries that benefited from the financing;

hh) With reference to fiscal year 2008, the Claimant proceeded to self-assess tax through the filing of the IRC Income Declaration, Model 22, on 29 May 2009, having calculated a taxable base of € 1,114,641.04 and remitted to the State coffers the amount of € 117,391.85;

ii) On 27 May 2010, the Claimant filed a substitute IRC Income Declaration, Model 22 (No. 2010…), in which it calculated a taxable base of € 910,395.50, to which would correspond a tax payable of € 65,415.57 (document No. 16 attached to the request for arbitral decision, whose contents are hereby reproduced);

jj) On 10 August 2010, the Claimant filed a third IRC Income Declaration, Model 22, to which was assigned the identification number 2010-… and which shows a taxable base identical to that contained in the substitute IRC Income Declaration, Model 22, filed on 27 May 2010 (No. …), comprising the inclusion of the tax benefit – SIFIDE, in the amount of € 227,598.88, and from which results the right to a refund of € 162,183.31, having maintained the tax benefit for job creation;

kk) Document No. 2 attached to the request for arbitral decision is hereby reproduced;

ll) The Tax Administration instituted a tax enforcement proceeding, filed under No. …2011…, for compulsory collection of the amounts assessed (document No. 18 attached to the request for arbitral decision, whose contents are hereby reproduced);

mm) On 01-02-2012, the Claimant provided a bank guarantee to suspend the tax enforcement proceeding No. … (document No. 19 attached to the request for arbitral decision, whose contents are hereby reproduced and article 514 of the request for arbitral decision);

nn) On 19-12-2013, the Claimant, under the Exceptional Tax Debt and Social Security Debt Settlement Regime, approved by Decree-Law No. 151-A/2013, of 31 October, paid the sum of € 1,075,156.53, which was being collected in the aforementioned tax enforcement proceeding (document No. 20 attached to the request for arbitral decision, whose contents are hereby reproduced);

oo) On 29-08-2014, the Claimant submitted the request for constitution of the arbitral tribunal that gave rise to the present proceedings.

2.2. Unproven Facts

It was not proven that the Tax and Customs Authority disregarded in the impugned assessment the amount relating to the tax benefit for creation of net employment positions.

In fact, the Claimant does not even assert that the amount relating to this tax benefit was disregarded by the Tax and Customs Authority, following the aforementioned inspections, asserting only that it appears to it that contained in document No. 2 attached to the request for arbitral decision that the annulment of assessment No. 2010 … occurred, from which resulted an amount to be refunded to the Claimant of € 51,976.28.

The Tax and Customs Authority explains in the decision of the administrative appeal that there was no disregard of such tax benefit, as the previously calculated taxable profit was € 910,395.50, it was added the amount of € 4,213,675.41, resulting from the corrections made, whereby the taxable profit became € 5,124,070.91.

This is exactly what is verified in the impugned assessment attached to the request for arbitral decision, in which is indicated the taxable base of € 910,395.50 from the previous assessment and the corrected amount of € 5,124,070.91.

For this reason, no other amount resulting from the previous assessment was disregarded.

2.3. Factual Basis of the Decision

The decision on matters of fact is based essentially on the documents attached to the request for arbitral decision and on the administrative proceedings.

With regard to the factual findings indicated in items p) to ff), it is also based on witness and party testimony, with the Arbitral Tribunal considering that all testified with objectivity and with knowledge of the matters on which their testimony focused.

1. Law

In accordance with article 124 of the CPPT, subsidiarily applicable by virtue of article 29, paragraph 1, of the RJAT, as no defects imputable to the IRC assessment leading to a declaration of non-existence or nullity are alleged, nor is a prioritization indicated, the order of examination of defects should be that which, according to the prudent discretion of the adjudicator, ensures the most stable or effective protection of the injured interests.

Therefore, the formal defects raised by the Claimant shall be examined last, should their examination not be compromised by the solution resulting from the examination of others.

In fact, as is a corollary of the establishment by the aforementioned article 124 of the CPPT of an order of examination of defects, if a defect ensuring effective protection of the rights of the impugners is found to be valid, there will be no need to examine the remainder, for if it were always necessary to examine all defects imputed to the challenged act, the order of their examination would be irrelevant.

3.1. Defect relating to the correction based on the non-deductibility of financial costs supported by the Claimant with the financing granted to its subsidiaries

The Claimant supported financial costs to make financing to its subsidiaries that were in a situation of financial difficulties.

The Tax and Customs Authority understands that "Pursuant to article 23 of the IRC Code, the tax deductibility of interest supported, like any other cost, depends on a judgment regarding its indispensability for the realization of profits or gains subject to tax or for the maintenance of the income-producing source (body of paragraph 1) and it is made explicit in its item (c) of paragraph 1 that such interest on borrowed capital is 'applied in the exploitation'.

The Tax and Customs Authority argues that, first, it becomes necessary to demonstrate the existence of a causal relationship with the company's activity, that is, it becomes necessary to objectively prove that the costs were incurred in the scope of the company's activity and that they are indispensable for obtaining taxable income. And, second, it becomes necessary that the company justify the operation according to normal criteria of economic rationality, that is, the cost incurred must be justified by the taxpayer in light of normal management standards, according to the circumstances of the specific case. In short, the deductibility of costs must depend on a justified relationship with the productive activity of the company, in view of its direct contribution to the maintenance of the income-producing source (articles 130 to 134 of the Response).

The Tax and Customs Authority understands that the activity of the Claimant is "Technical consulting for the plastic material transformation industry", whereby the granting of loans to its associates is not directly related to any activity of the taxpayer inscribed in its corporate object, that is to the maintenance of its income-producing source. For this reason, the Tax and Customs Authority understands that for the exercise of its activity, it did not need to resort to credit to the extent that it did, overvaluing the financial costs incurred and consequently contributing to compromise its tax profitability and reducing its contributory capacity. Thus, according to the foregoing and considering article 23, paragraph 1(c) of the IRC Code, part of the financial costs incurred by the taxpayer are not considered tax-relevant, to the extent that they are not assigned to its activity.

The Tax and Customs Authority further states that "we are facing entities which, although they constitute an economic group, are distinct, with capacity to generate funds from their activity. To assume that the survival of its associates depends on the injection of capital by the taxpayer is to assume that these entities do not have capacity to generate wealth, and moreover, that the continuity of the taxpayer may be at risk according to this logic of fund management, whose financial costs are supported by it." In short, from all the case law cited, from which results a unanimous understanding (cf. the judgment of the Supreme Administrative Court of 2013-01-09), we can draw and reiterate here the conclusion that the superior courts have consistently considered that, pursuant to article 23 of the IRC Code, only costs relating to the activity developed by the taxpayer itself in accordance with its corporate object are deductible (article 152 of the Response).

The requirement of indispensability contained in article 23 of the IRC Code (in the version in force at the date of the facts) should be understood as meaning that costs or expenses must have a relationship with the activity or interest of the company that supports them.

"The legal notion of indispensability is thus defined from an economic-business perspective, by filling, directly or indirectly, the ultimate motivation for obtaining profit. Indispensable costs are equivalent to costs incurred in the interest of the company or, in other words, in all acts abstractly subsuming to a profit profile." (…) "Indispensability subsumes all and any act performed in the interest of the company (…) The legal notion of indispensability thus represses acts inconsistent with the company's purpose, not inserting into the social interest, especially because they do not aim at profit". [1]

The notion of activity or social interest proves to be the defining trait in the fiscal admissibility of costs, when assessed by article 23 of the IRC Code. And in the additional case law cited by the Claimant and the Tax and Customs Authority, the question of linking the fiscal admissibility of financial costs predominates, depending on whether it is considered that the financing entity performs or not, in these operations, its own activity.

Indispensability therefore does not mean a mandatory nexus of causality with revenues/profits, nor that a posteriori the beneficial economic effects necessarily flowing from such costs must be verified or proven. Provided that the costs result from management acts which, based on the information known at the time of their execution, could have as their objective the expected obtaining of revenues or the maintenance of the income-producing source (physical, intangible, financial or other) this should lead to the acceptance of their deductibility.

From the evidence produced, it results that A… SA has not only as its object the provision of consulting services.

It is the head of a group and therefore also has as its object the holding and management of equity stakes in other companies, holding 100% of the share capital of 18 group companies with registered offices in Portugal. For this reason, although it is not formally an investment company, it materializes itself as a company that also manages equity stakes, as the parent company of a group, where it holds almost all of its subsidiaries 100%. And it is this reality that must be considered in assessing the issue of the deductibility of financial charges, mindful of the principle of substance over form, of paramount importance in tax law.

It was within the scope of this real activity of managing equity stakes that the Claimant, A… SA, contracted in the year 2008 bank loans for subsequent granting of non-remunerated financing to its subsidiary companies (subsidiaries in accounting language). The Claimant assumed these bank loans obtained from banking institutions as its own debt in its financial statements, considering as financial costs the expenses supported with this form of financing. Based on these bank loans, it had monetary resources that it subsequently transferred to its subsidiaries, as treasury operations or financing loans. The Claimant invoked as the reason for such gratuitous financing the inability of its subsidiaries to finance themselves directly from banking institutions, or the higher cost associated with such financing if the subsidiaries did it directly, which was corroborated by the evidence produced.

The key argument used by the Tax and Customs Authority of the non-existence of a relationship between the financing (and the financial costs resulting therefrom) and the activity or corporate object of A… is not correct. The witness testimony was illuminating in demonstrating that the subsidiaries needed funds to pursue their businesses and the close relationship of all this with the interest of A… SA.

Such financing, inserted in the management of the equity stakes held by A… SA, have direct and indirect impacts on the activity and the social interest of this entity. Not only do they allow maintaining the financial assets that embody investments in subsidiaries as elements from which they expect income or benefits, but they also allow the operational activity of A… SA to develop more sustainably, as almost all of its activity (100% in 2007 and 99.28% in 2008) translated into the provision of services to group companies, as results from the factual findings established. With these percentages of its activity directed to its subsidiaries, it is clear that the profitability and sustainability of the Claimant depended on the profitability and sustainability of its subsidiaries, since they were practically the only customers to whom this entity provided services.

Thus, from the capacity that the subsidiaries have to purchase services from it results directly an increase in actual revenues of A… SA, as they are its customers. Furthermore, ensuring the subsistence of the subsidiaries means for the Claimant protecting its own assets, constituted by the equity stakes.

In addition to this, the obtaining of profits by the subsidiaries results indirectly in revenues for A… SA, which is the holder of their share capital at 100%, in addition to appreciation of its assets that the equity stakes held comprise.

There is therefore a clear link between the financial costs of A… SA and its activity and its corporate interest, as the subsidiaries were practically its only source of income generation in the year 2008.

Thus, these loans appear as necessary or convenient for the direct pursuit of the purpose of each of the subsidiary companies and directly and indirectly for the pursuit of the purpose of the parent company.

From the foregoing it follows that the correction made relating to the deductibility of financial costs supported by the Claimant in 2008 to finance its subsidiaries violates article 23, paragraph 1, of the IRC Code in the version in force in that year, which constitutes a defect of violation of law justifying the annulment of the assessments in the part corresponding to this correction.

3.2. Defect relating to the application of the transfer pricing regime

3.2.1. Position of the Parties

3.2.1.1 Tax and Customs Authority

For the TA, and through analysis of the participation chain of B..., it is evident that the company "I... Limited" (hereinafter I...) and the company C..., Lda. are held, directly in the case of the former, and indirectly in the case of the latter, respectively, in the percentage of 100%, by company D…, BV. Thus, verification that more than 10% (in this case, 100%) of the capital of both companies is held, directly and indirectly, by the same entity is, by itself, sufficient condition to, pursuant to article 63, paragraph 4, of the IRC Code conclude that special relations exist between I... and C..., Lda.

From the analysis of the raw material supply contracts entered into between C..., Lda., as buyer and I..., as seller, it follows, for the TA, that C..., Lda. selects the suppliers of I.... Suppliers that were, in essence, the same with which this company contracted before the incorporation of I....

The raw material purchase orders are made directly by C..., Lda. to the respective suppliers with indication that the goods are placed directly in the manufacturing unit of that company, with only the invoice being issued by I....

The commercial contacts with suppliers were, in the period in question, established by an employee of C..., Lda., who already performed the same functions before the incorporation of I....

In view of the special relations which, for the Respondent, exist between C..., Lda. and I..., and in addition to the binding to the arm's length principle in the contracting of operations between both, other legally imposed obligations would still fall upon the first entity.

Company C..., Lda. would thus have an obligation to [document truncated]