CAAD Ruling on IRC Taxable Profit Corrections and Transfer Pricing – Process 660/2014-T

Case No. 660/2014-T

The Arbitrators Counsellor Jorge Lopes de Sousa (designated by agreement of the other Arbitrators), Prof. Doctor António Martins and Prof. Doctor 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", parent company of the A... Group, presented, pursuant to and for the purposes of the provision in paragraph a) of number 1 of article 2 and articles 10 and following, all of the Legal Framework of Tax Arbitration ("RJAT"), in conjunction with number 1 of article 102 of the Code of Tax Procedure and Process ("CPPT"), applicable by virtue of the provision in paragraph a) of number 1 of article 10 of the RJAT, a request for arbitral pronouncement against the assessment act of Corporate Income Tax ("IRC") for the year 2007 with number 2011 … and, likewise, against the assessment acts of Compensatory Interest number 2011… and number 2011…, in the total amount of € 1,243,135.05, and, likewise, against the order, of 02 May 2014, of the Sub-Director General of the Tax and Customs Authority, which granted only partial relief of the Hierarchical Appeal filed also against those acts, following the dismissal of the administrative reclamation no. …2011….

The TAX AND CUSTOMS AUTHORITY is the Respondent.

The Claimant proceeded to designate an arbitrator, Prof. Doctor António Martins, pursuant to the provision in article 6, no. 2, paragraph b) of the RJAT.

Pursuant to the provision in paragraph b) of no. 2 of article 6 and no. 3 of article 11 of the RJAT and within the period set forth in no. 1 of article 13 of the same statute, the highest official of the Tax Administration service designated as Arbitrator Prof. Doctor Ana Maria Rodrigues.

The designated arbitrators designated the third arbitrator, Counsellor Jorge Manuel Lopes de Sousa, pursuant to article 11, no. 4 of the RJAT.

The signatories designated to constitute this collective Arbitral Tribunal accepted their designations, pursuant to legally established provisions.

Pursuant to and for the purposes of the provision in no. 7 of article 11 of the RJAT, the President of CAAD informed the Parties of such designation on 31-10-2014.

Thus, in conformity with the provision in no. 7 article 11 of the RJAT, upon the expiration of the period set forth in no. 1 of article 13 of the RJAT, the collective arbitral tribunal was constituted on 25-11-2014.

The Tax and Customs Authority submitted a Response, defending the inadmissibility of the request for arbitral pronouncement.

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

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

The Parties presented arguments.

The arbitral tribunal was regularly constituted and is competent.

The parties have legal personality and capacity and are entitled to bring proceedings (articles 4 and 10, no. 2, of the same statute and article 1 of Order no. 112-A/2011, of 22 March).

The proceedings do not suffer from nullities and no exceptions were raised.

1. Matter of Fact

2.1. Proven Facts

Based on the elements contained in the proceedings and in the administrative proceedings attached to the record, the following facts are considered proven:

a) The Claimant is the parent company of the "A... Group", taxed, under Corporate Income Tax, according to the Special Regime for Taxation of Groups of Companies, holding equity capital of the following companies with registered office in Portugal (in addition to others with registered office abroad, cf. Tax Inspection Report):

b) With reference to the years 2007 and 2008, inspection actions were taken on two of the companies of the A... Group, A... SA and A...1, Lda, with taxpayer number …), hereinafter referred to as A...1;

c) These inspection actions were based on Service Orders nos. OI… and OI…, regarding A... S.A. and Service Orders nos. OI… and OI…, regarding A...1;

d) As a result of the inspection actions of A... S.A., corrections were made to its taxable profit under IRC as follows:

e) As a result of the inspection actions of A...1, corrections were made to its taxable profit under IRC as follows:

f) Since these two companies were covered by the Special Regime for Taxation of the Group of Companies (RETGS), the arithmetic corrections made to the individual taxable result of the aforementioned companies were reflected in the taxable result of the group, whereby two more inspection actions were carried out on the Claimant, now in the capacity of parent company of the A... group, in compliance with Service Orders nos. … and …, inspection procedures for the years 2007 and 2008, respectively;

g) Service Orders nos. … and … cover only the imputation to the Claimant, as the taxpayer responsible for determining the taxable matter of the group, of the corrections under IRC made in companies A...1, and A..., SA, there being no specific corrections to the group's return, in order to reflect in the taxable result of the group the corrections under IRC made to the individual taxable result of said companies;

h) As a result of the inspections of the group of companies, the following corrections were made to the taxable matter of the group:

i) As a result of the corrections relating to the year 2007, the assessment no. 2011 … and the acts of assessment of compensatory interest nos. 2011 … and 2011 …, in the total amount of € 1,243,135.05, were issued, with a voluntary payment deadline of 18-04-2011;

j) The Claimant, in its capacity as parent company of the group, filed an administrative reclamation against the aforementioned assessments, which was dismissed by order of 31-07-2012 (administrative reclamation no. …2011…);

k) On 04-09-2012, the Claimant filed a Hierarchical Appeal against the order dismissing the administrative reclamation, the appeal being partially granted by Order of 02-05-2014, of the Sub-Director General of the Tax and Customs Authority, issued by subdelegation of powers, which was notified to the Claimant by Official Letter dated 05-06-2014 (document no. 1 attached with the request for arbitral pronouncement, the contents of which are hereby reproduced);

l) In the Tax Inspection Report relating to the inspections referred to by Service Orders OI… and OI… it is stated, among other things, the following:

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

The documentary analysis of the subcategories of the third-party class accounts made it possible to verify that the company, in addition to the allocation of supplementary contributions to its associates, recorded in years 2007 and 2008, in subcategories 41 – annex 4, regularly grants loans, used in the form of current account, which are reflected, respectively, in current account 2521 - Group Co. - Loan and in current account 26701 - Fin Gr Co. / Subs-Corr - annex 5.

Such operations, which increase in the year 2008, result in financial flows that translate in most situations into debit balances, taking 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 companies and associates, of which the loans granted by the parent company stand out – M...BV2, which result in an increase in financial costs, as evidenced in the Financial Statements for the years 2007 and 2008.

When questioned the taxpayer, through its Tax Advisor, about the granting of loans to its associates and the respective charge of interest, it was stated by this that "(. ..) interest is only charged to its associates: B... - Financial Services Company taxpayer no. … and L... Financial Management Consultancy taxpayer no. …" - annex 6.

Given the foregoing, it is important to know whether, in light of article 23 of the IRC Code, the entirety of the financial costs resulting from the obligations incurred by the taxpayer should be considered as fiscally relevant, when they are not strictly necessary to obtain its individual gains and profits, it being certain that between the taxpayer and the beneficiary companies there is a relationship of total domination.

The aforementioned provision provides that:

"Expenses are those which are demonstrably indispensable for the realization of income subject to taxes or for the maintenance of the productive source, namely: (.. .)

c) Of a financial nature, such as interest on foreign capital used in operations (. ..)"

It is immediately concluded that these expenses do not generate income subject to taxes, in that there is no charge of interest.

On the other hand, it follows from the aforementioned provision that the expenses therein provided cannot fail to respect the company itself.

According to the elements of the Commercial Registry and those available in the DGCI cadastral system, the activity of this company is: "Technical consultancy for the plastic material processing industry". Therefore, the granting of loans to its associates is not directly related to any activity of the taxpayer inscribed in its corporate purpose, or with the maintenance of its productive source.

We can conclude that the taxpayer, to exercise its activity, did not need to resort to credit in the manner it did, overvaluing the financial costs incurred and consequently contributing to compromising its tax profitability and diminishing its tax capacity.

Thus, according to the foregoing and considering article 23, no. 1 al. c) of the IRC Code, part of the financial costs incurred by the taxpayer are not considered as fiscally relevant, in the proportion that they are not allocated to its activity.

Finally, it is important to observe whether the fact that the taxpayer is in a relationship of total domination with its associates and is part of the RETGS could not determine that a correlative adjustment be made in the sphere of the associates.

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

In this sense there is jurisprudence that corroborates that, even with the existence of a relationship of total domination, such companies are distinct entities, which have their own activity, and it has not been proven that in the context of the associates such amounts contributed directly to the exercise of their activity.

Given the foregoing, it is proposed pursuant to article 23 of the IRC Code, the correction of the financial costs incurred by the taxpayer in the 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 incurred with third parties;

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

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

III.1.1. Year 2007

1. Implicit interest rate

Chart no. 3: Determination of the implicit interest rate

1. Average monthly balance of loans to associates (annex 7)

Chart no. 4: Determination of the average monthly balance of loans to associates

1. Non-deductible costs

Chart no. 5: Determination of non-deductible costs

(...)

Chart no. 9: Total Corrections to Fiscal Result - 2007

(...)

IX.2. Prior Hearing

The taxpayer exercised the right to hearing, through one of its managers - C..., by written petition, submitted to this Finance Office on 24/11/2010 - annex 10.

IX.3. Arguments presented by the taxpayer and their assessment

"Arguments"

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 – resulting from the regular allocation of financing to its associates, used in the form of current account, not subject to any remuneration.

The taxpayer concentrates its defense on the following arguments:

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

• The maintenance of its productive source.

It is recalled that the arithmetic corrections proposed, for the years 2007 and 2008, respectively in the amounts of € 280,841.55 and € 349,565.26, result from the fact that it was detected during the inspection action that the taxpayer, whose activity is "Technical consultancy for the plastic material processing industry", regularly grants 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 expenses, resulting from the increase in obligations assumed by it with third parties.

Thus, according to the provision in article 23 of the IRC Code, it was considered that it was not proven that the entirety of the financial costs resulting from the obligations incurred by the taxpayer were strictly necessary to obtain its individual gains and profits.

Given the foregoing, it was not considered as an expense of the activity of the taxpayer, for the years in question, the financial charges that result from the application of an implicit interest rate borne by the taxpayer to the average balance of loans granted to its associates.

"Assessment"

As already referred to, without putting into question the amounts determined, the taxpayer contests the corrections proposed, arguing the necessity of funds for the exercise of the activity of its subsidiaries, and on the other hand with the maintenance of its productive source.

Let us then proceed to assess 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 submission, the taxpayer states that according to what was mentioned by the inspection services, there is jurisprudence that seems to support that such costs will be deductible, provided that the taxpayer proves that in the context 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 judgments available that such operating expenses will never be expenses of the activity of the taxpayer, in that they did not contribute directly to the exercise of its activity, that is, to the maintenance of its productive source;

ii. At best they will be expenses of the activity of its associates, and for such: – They must be reflected in their accounting, which did not occur because these expenses 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, in the exercise of the right to hearing, submits example charts of the evolution of the items of Cash and Cash Equivalents, for the years 2007 and 2008, as well as the respective Statements of Changes in Financial Position (MOAFs) of its subsidiaries.

The taxpayer intends to prove with these elements that "(. ..)the funds received in the years in question, and regardless of their respective source (e.g. Group companies, financial institutions) were always used by these, in that, during the years 2007 and 2008, the amounts in question do not remain in cash and equivalents (. ..)"

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

First and foremost, it is important to clarify that, although the taxpayer intends at this stage to prove the indispensability of the expense for its associates, the taxpayer subject to inspection is 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 an expense 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 statements of the taxpayer, it is important to note the following:

i. First, it should be noted that the corrections proposed only covered current accounts of the subsidiaries in which the average balances at the end of the years in question remained positive, making it evident in these situations the financing of the taxpayer to its associates;

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

iii. The situation described is thus repeated in the cash and equivalents accounts of all subsidiaries, including those on which no corrections were proposed.

On the other hand, the taxpayer intends to demonstrate the effective use of funds through the presentation of the Statements of Changes in Financial Position of the companies with equity interests. Through the example of company A...2, for the year 2007, it attempts to justify that "( ) only made financing to the companies with equity interests that, in the years in question, presented negative free cash flow".

From the analysis of the Statements of Changes in Financial Position submitted by the taxpayer, the following should be noted:

i. The situation presented for company A... 2 (year 2007) cannot be extrapolated to all subsidiaries, as we find that there are situations in which cash flow (after bank commitments/leasing) is positive and yet funds are transferred to these companies;

ii. It is also verified that some of the cash injections made by the taxpayer are applied in the reimbursement of supplementary contributions;

iii. The opposite is also true, including in company 2 (year 2008), the reimbursement of shareholder advances causes the need to increase supplementary contributions;

iv. Even in the associate A...1, in the year 2007, the balance of the cash and equivalents account is influenced not by the operational activity of the company but by the reimbursement of supplementary contributions: the sum of shareholder advances amounts to € 993,174.46, when the associate reimburses supplementary contributions in the amount of € 1,069,294.52;

Without putting into question the occasional cash requirements of its associates, as already mentioned, the facts presented leave evidence of a group cash management that is reflected negatively in the taxable results of the taxpayer, putting into question its tax profitability. The corrections proposed aim to determine how and how much this policy wrongly influences the results of the taxpayer, in order to restore the measure of financing costs directly related to its activity.

On the maintenance of the productive source

Finally, the taxpayer comes to defend that due to the fact that a large part of its clients are companies of the group, "(.. .) it is easily concluded that the maintenance of the productive source (...)is conditioned by the economic viability of its subsidiaries, given that they are its only clients".

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

Let us first emphasize that we are dealing with entities that, although they constitute an economic group, are distinct, with the 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 the capacity to generate wealth, and more, that the continuity of the taxpayer could be at risk, according to this logic of fund management, whose financial expenses are borne by it.

However, having analyzed the Statement of Results by nature of the entities that gave rise to the proposed corrections, it is possible to conclude that most of these entities present a negative net result, in part resulting from the expenses incurred with the provision of services charged by the taxpayer. Thus the doubt arises whether the cash difficulties of these companies are not rather due to the costs incurred with these services.

In these terms it is concluded, noting the following:

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

That part of the financial expenses borne 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 expenses, not being charged by the taxpayer, are not reflected in the accounting of these, so the Tax Administration cannot accept their deductibility to the taxable result.

IX.4. Conclusion

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

m) In the Tax Inspection Report relating to the inspections carried out in compliance with Service Orders OI… and OI… it is stated, among other things, the following:

III – DESCRIPTION OF FACTS AND GROUNDS FOR MERELY ARITHMETIC CORRECTIONS TO TAXABLE MATTER

III.1 Corrections made to individual taxable results

As already mentioned, in the years in question, corrections were made to the individual taxable results of two of the companies belonging to the group in Portugal: A...SA, taxpayer no. … and A...1 Lda, taxpayer no. … (OI …), which, according to article 70 of the IRC Code should be reflected in the taxable result of the group. Let us see:

III.1.1. A...SA (OI…)

Non-deductible financial expenses under article 23 of the IRC Code:

The documentary analysis of the subcategories of the third-party class accounts made it possible to verify that the company regularly grants financing, used in the form of current account, which are reflected, respectively, in current account 2521 - Group Co. - Loan and in current account 26701 - Fin Gr Co / Subs-Corr, obtaining no remuneration from these operations, in order to compensate for the increase in financial expenses, resulting from the increase in obligations assumed by it with third parties.

Considering that the activity of the taxpayer is "Technical consultancy for the plastic material processing industry", according to the provision in article 23 of the IRC Code, it was considered that it was not proven that the entirety of the financial costs resulting from the obligations incurred by the taxpayer were strictly necessary to obtain its individual gains and profits.

Given the foregoing, it was not considered as an expense of the activity of the taxpayer, for the years in question, the financial charges that result from the application of an implicit interest rate borne by the taxpayer to the average balance of loans granted to its associates. Upon the expiration of the period for exercise of the right to hearing, and the taxpayer's claims not being addressed, a correction to the taxable profit was determined for the year 2007 in the amount of € 280,841.55 and for the year 2008 in the amount of € 349,565.26.

III.1.2. A...1 Lda (OI…)

Corrections in the context of Transfer Pricing matters, pursuant to article 63 of the IRC Code:

The analysis of the commercial relationships between the company A...1 Lda and the company U... (U...) taxpayer no. … – also belonging to the A... Group -, made it possible to conclude on the existence of special relationships, under paragraphs b), e), g) of no. 3 and h) of no. 4 of article 63 of the IRC Code.

The company A...1 Lda was thus, according to what is provided in no. 3 of article 13 of Order 1446/C/2001, obligated to have available information and documentation relating to the policy adopted in determining transfer prices and to maintain, in an organized manner, elements capable of proving the "arm's length conditions in the terms and conditions agreed, accepted and practiced in operations carried out with related entities" and the "selection and use of the method or methods most appropriate for determining transfer prices that provide a greater approximation to the terms and conditions practiced by independent entities and that ensure the highest degree of comparability of operations or series of operations carried out with others substantially identical realized by independent entities in normal market conditions".

Faced with the breach of this obligation, and all legally invoked requirements being proven in no. 3 of article 77 of the General Tax Law, for corrections arising from the application of transfer pricing matters to proceed, the quantification of the effects that the contractualization with the company U... had on the taxable profit of the taxpayer was carried out, in accordance with the provision in article 63 of the IRC Code and article 9 of the OECD Model Tax Convention, which determines when "two enterprises [associates] in their commercial or financial relationships 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 which were not because of such conditions, may be included in the profits of that enterprise and taxed accordingly".

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

III.2. Specific corrections to the Group Declaration

III.2.1. Aggregated values

The Annual Income Declaration Model 22 of the Group for the years 2007 and 2008 was verified, as well as the values aggregated through the algebraic sum of all items that make up chart 09 (determination of taxable matter) and chart 10 (Calculation of tax: withholdings; payments on account; local surtax and autonomous taxation) of the IRC Model 22 declarations of each of the companies that make up the group.

From this analysis, no corrections were detected.

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

Considering the corrections to the individual taxable results of companies A...SA and A...1 Lda (point III.1.) the following corrections to the taxable matter of the group were obtained:

Chart no. 2: Corrections to the Taxable Matter of the Group - Year 2007

(...)

IX.2. Prior Hearing

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

It is important to note here that the present Service Orders cover only the imputation to the taxpayer responsible for determining the taxable matter of the group under article 64 no. 1 and paragraph a) of no. 6 of article 112 of the IRC Code of the corrections made in the dominated companies A...1, Lda and A..., SA, with no specific corrections to the group's declaration.

IX.3. Arguments presented by the taxpayer and their assessment

As part of the exercise of the right to hearing, the taxpayer, as parent company, comes to analyze the conclusions in order to demonstrate that the projected decision is flawed by errors of fact and law and, as such, cannot be maintained in the legal order without prejudice to it being considered that in the individual sphere of each of the companies such has already been duly and fully demonstrated.

IX.3.1. Regarding the company A...1, Lda

Arguments

The corrections that the inspection services propose to implement under article 63 of the IRC Code - Transfer Pricing appear to be based on an incorrect prejudgment. (as per § 8) ... the parent cannot but reiterate what was already said by A...1, Lda, when exercising the right to hearing in the sense that it did not breach any accounting or tax obligation, namely in terms of transfer pricing, and that the relevant information was always available for consultation and analysis and all information and documentation requested was indeed delivered. (as per § 10)

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

... the market conditions were not altered by the fact that A...1, Lda makes purchases of raw materials from U..., thus not appearing to be either justified or legal the correction that is now proposed. (as per § 13)

... the tax profitability of A...1, Ida, after the corrections proposed by the Tax Inspection Services, in 2007 and 2008 exceeds, respectively, three times and double that verified in the years 2004 and 2005, years in which U... did not exist!".

Notwithstanding what is hereby stated, by itself sufficient for the non-implementation of the projected correction to the matter for purposes of Corporate Income Tax for the years 2007 and 2008, the Tax Inspection Services must always project, should it persist in the error it commits, the correlative correction at the level of the company of Irish law under penalty of an unacceptable double taxation (as per § 18).

Assessment

Reiterating what was already mentioned in the chapter assessing the right to hearing of the final report of company A...1, Lda, the part considered relevant is hereby reproduced:

.... it is important to emphasize that the corrections made in this context are based on the non-observance of the arm's length principle, grounded under article 77 of the General Tax Law, that is:

i) Upon verification of the constitution of the capital of company U... and having analyzed the conditions underlying the acquisition of raw materials, from both a commercial and administrative perspective, we conclude that we are in a situation of special relationships between the two entities (the taxpayer and company U...), under paragraphs b), e), g) no. 3 and h) no. 4 of article 63 of the IRC Code; therefore,

ii) The taxpayer was thus, according to what is provided in no. 3 of article 13 of Order 1446-C/2001, obligated to have available information and documentation relating to the policy adopted in determining transfer prices and to maintain, in an organized manner, elements capable of proving the 'arm's length conditions in the terms and conditions agreed, accepted and practiced in operations carried out with related entities" and the 'selection and use of the method or methods most appropriate for determining transfer prices that provide a greater approximation to the terms and conditions practiced by independent entities and that ensure the highest degree of comparability of operations or series of operations carried out with others substantially identical realized by independent entities in normal market conditions".

iii) However, as evidenced by the Statement of Declarations drawn up on 09 July, not only was it acknowledged that the Transfer Pricing Dossier was not presented, but that the only available element would be the raw material supply contracts; When exercising the right to hearing both of company A...1, Lda and of the parent as parent company, nothing was added concerning the Transfer Pricing Dossier, nor did the taxpayer take the opportunity to present the elements provided for in the aforementioned provision, thus reiterating the breach of this obligation;

iv) Given the foregoing, the effects that the contractualization with company U... had on the taxable profit of the taxpayer were quantified, in accordance with the provision in article 9 of the OECD Model Tax Convention, which determines when two enterprises [associates], in their commercial or financial relationships 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 which were not because of such conditions, may be included in the profits of that enterprise and taxed accordingly".

First and foremost, it should be emphasized that regarding the requirements that are legally invoked in no. 3 of article 77 of the General Tax Law, the taxpayer does not present any new fact in this petition, let us see:

– It does not contradict the existence of special relationships, nor even the fact that we are in a situation of subordination of company U... to the conditions imposed by the taxpayer;

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

– As regards the Transfer Pricing Dossier, article 14 of Order 1446-C/2001 is clear regarding the elements it must have:

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

• Characterization of the activity exercised by the taxpayer and by the entities related 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 of the choice of the method for determining the arm's length price;

• Information about the comparable data used",

Moreover, as to the quantification of the effects on the non-observance of the arm's length principle, the taxpayer adds nothing, presenting no concrete fact that contradicts the corrections proposed, with the taxpayer intending to justify that these are excessive, arguing that the taxpayer before the constitution of company U... did not have these levels of profitability.

However, having analyzed the levels of gross margin and tax profitability of A...1, Lda before the corrections, these do not express the competitive advantages that the taxpayer displays with the intermediation of U... and the economic reasons that led to its constitution, rather the opposite, the levels of tax profitability decline to negative values from the time of the contractualization with company U...;

Thus, having the taxpayer presented no new facts regarding the breach of its obligations regarding the matter in question, nor as to the quantification of the respective effects at the level of the tax result, this thus reinforces the demonstration of the requirements of no. 3 of article 77 of the General Tax Law, maintaining the corrections proposed by the Tax Administration, under no. 8 of article 63 of the IRC Code and article 9 of the OECD Model Convention;

Finally, it is emphasized that the taxpayer in § 17 of its petition comes to request that the correlative adjustment of the corrections made in the sphere of company U... be effected, pursuant to no. 11 of article 63 of the IRC Code, however, since this company is not a taxpayer of IRC in national territory, it does not fall to the Portuguese Tax Administration to promote such adjustments.

IX.3.2. Regarding the company A..., SA

Arguments

Thus, concludes the Tax Administration that, it was not considered as an expense of the activity of the taxpayer, (...), the financial charges that result from the application of an implicit interest rate borne by the taxpayer to the average balance of loans granted to its associates. (as per § 20)

As the parent stated when exercising the right to hearing on an individual basis, the proposed corrections lack foundation (as per § 21)

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

... the funds made available by the Parent, throughout the period in question, were effectively used in that they did not remain (statically) in cash and equivalents. (as per § 24)

Assessment

Reiterating what was already mentioned in the chapter assessing the right to hearing of the final report of the company A..., SA, as a company on an individual basis, the part considered relevant is hereby reproduced:

"It is recalled that the arithmetic corrections proposed, for the years 2007 and 2008, respectively in the amounts of €280,841.55 and €349,565.26, result from the fact that it was detected during the inspection action that the taxpayer, whose activity is "technical consultancy for the plastic material processing industry", regularly grants 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 expenses, resulting from the increase in obligations assumed by it with third parties.

Let us first emphasize that we are dealing with entities that, although they constitute an economic group, are distinct, with the 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 cash management, ensured by the taxpayer, has negative effects on its taxable results:

• That part of the financial expenses borne 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 expenses, not being charged by the taxpayer, are not reflected in the accounting of these, so the Tax Administration cannot accept their deductibility to the taxable result.

In conclusion

For the loans made, the taxpayer A..., SA, while an individual company, bore financial charges, but for the loans granted did not receive any amounts by way of interest, so the costs borne with loans obtained to the extent of the loans granted to its associates cannot be accepted as a cost under article 23 of the IRC Code as not necessary to its activity.

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

n) The decision on the Hierarchical Appeal was based on information contained in the administrative proceedings, the contents of which are hereby reproduced, in which the following is stated, among other things:

(...) in compliance with Service Orders nos. … and …, with order of 08/11/2010, the taxpayer A..., S.A., in its capacity as parent company of the A... group, was subject to an inspection procedure for the period 2007, with a view to reflecting in the taxable result of the group the corrections under IRC made to the individual taxable result of companies A... SA (taxpayer no. …) and D..., LDA (taxpayer no. …) in the amount of € 280,841.55, regarding the first company and in the amount of € 4,178,458.21, regarding the second company.

1. In the various inspection procedures, the following facts were among others found:

• Aspects relating to the activity of D..., LDA. (…) (Point II.1.3, p. 9 et seq. of the RIT at fls. 263 of the administrative reclamation proceedings):

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

As for its suppliers, it was verified that from September 2006, almost all raw materials started to be purchased from company U..., with registered office in Ireland. When the latter acquires, in national territory, a taxpayer number, D... LDA, which until then carried out intra-community acquisitions, collecting and deducting VAT, starts to make internal acquisitions, with the right to deduction, generating substantial refunds.

• Aspects relating to the activity of U... (…) (Point II.3, p. 9 et seq. of the RIT at fls. 263 of the administrative reclamation proceedings):

Company incorporated in August 2006, being 100% owned by the parent company of the A... group - M..., BV, with registered office in the Netherlands. Its activity focuses on the sale of goods to companies of the A... group, a large part of its sales being made in Portugal, and more specifically, to D..., LDA.

Upon acquiring a taxpayer number (…) in national territory, it starts to make especially acquisitions in the national market, making it possible for it to obtain full VAT deduction on the VAT incurred in the acquisition of raw materials.

• Corrections made to the individual result of A..., S.A. (…) (Point III.1.1, p. 8 of the RIT at fls. 130 of the administrative reclamation proceedings):

Through the documentary analysis of the subcategories of the third-party class accounts, it was verified that the company regularly grants financing, used in the form of current account, obtaining no remuneration from these operations, in order to compensate for the increase in financial expenses. Considering the activity of the taxpayer, according to article 23 of the IRC Code, it cannot be given as proven that the entirety of the financial costs resulting from the obligations incurred by the taxpayer were strictly necessary to obtain its individual gains and profits, which determined a correction to the taxable profit for the year 2007 in the amount of € 280,841.55.

• Corrections made to the individual result of D..., LDA. (…) (Point III.1.2, p. 8 of the RIT at fls. 130 of the administrative reclamation proceedings):

The analysis of the commercial relationships between the company D..., LDA. and the company U..., also belonging to the A... group, made it possible to conclude the existence of special relationships, under paragraphs b), e) and g) of no. 3 and paragraph h) of no. 4 of article 63 of the IRC Code. Verifying the breach by the company D..., LDA., according to what is provided in no. 3 of article 13 of Order 1446/C/2001, of the obligation to have information and documentation relating to the policy adopted in determining transfer prices, a correction to the taxable profit for the year 2007 of € 4,178,458.21 was determined.

1. In the context of the inspection procedure referred to above, it was concluded that it should proceed to increase the taxable matter by the total amount of € 4,459,299.76 for the period 2007, which is reflected in the taxable result of the group, according to article 70 of the IRC Code.

2. After the respective Inspection Report mentioned above was prepared, the taxpayer was notified, through official letter no. …, of 13/12/2010, with registration no. RC …PT, to exercise the right to prior hearing, on the draft corrections, as provided for in paragraph b) of article 60 of the General Tax Law, within 15 days (p. 11 of the RIT attached at fls. 133 of the proceedings).

xiv. As part of the right to hearing, the taxpayer comes forward as parent company to analyze the conclusions in order to demonstrate that the decision is flawed by errors of fact and law.

xv. Next, and after analysis of the right to hearing, the final report was prepared, under article 62 of the RCPIT, maintaining the corrections proposed and notifying the taxpayer through official letter no. …, dated 08/02/2011, as per fls. 116 of the administrative reclamation proceedings.

xvi. Consequently, the services proceeded to issue the respective additional assessment no. 2011…, on 10/03/2011, for the period 2007, which was notified to the taxpayer through CTT registration no. RY …PT, dated 15/03/2011.

(...)

With regard to adjustments in terms of transfer pricing, under article 63 of the IRC Code:

(...)

It is our understanding that, in the case sub judice, as described above, it clearly results from the report of the Tax Inspection Services both the description of the special relationships between the respondent company and company U..., demonstrating the relationship existing between them, as well as making explicit and quantifying the amounts that served as the basis for the aforementioned corrections.

No. 3 of article 77 of the General Tax Law requires a special duty of substantiation, translated into the following paragraphs:

Description of special relationships

1. The inspection services, in determining the tax implications of the commercial operations verified between U... and D..., LDA, found verified the existence of special relationships between the two companies, since not only are they owned, directly, in the case of the first, and indirectly, in the case of the second, respectively, 100% by company M...BV (paragraph b) of no. 4 of article 63 of the IRC Code), as demonstrated in the organization chart present in Point B - Description of Facts, as from the analysis of the raw material supply contracts provided by U..., it is evident the subordination of the latter to D... LDA, with each of them establishing the delivery conditions, the risks assumed, the suppliers and the products that the latter imposes be purchased from the former company (paragraph e) and g) of no. 4 of article 63 of the IRC Code), with from September 2006, D..., LDA starting to purchase all of its raw materials from U....

Indication of obligations not fulfilled by the taxpayer

1. It was in the context described above that the presentation of the transfer pricing dossier, provided for in article 63, no. 6, of the IRC Code, was requested, to which it responded that the same was not duly organized, presenting only the contracts established between the parties of raw material supply from which a clear subordination of U... to the conditions imposed by D..., LDA is extracted, as described in the previous paragraph.

2. The inspection services also 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 have been included 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 no. 1 of article 63 of the IRC Code were not observed, and the value of the correction to the taxable profit.

Application of the methods provided for in law

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

2. Now, for a correct application of the provision in the aforementioned article 63 of the IRC Code, a practical guidance of the arm's length principle must be made, as referred to in the OECD report, in order to ascertain a reasonable degree of comparability:

"To determine the degree of effective comparability and then to make the appropriate adjustments to establish the conditions (or a range of conditions) of arm's length, it is necessary to compare the characteristics of the operations or companies susceptible to having an impact on the conditions inherent in arm's length operations. The characteristics that may prove important are those relating to the goods and services transacted, the functions exercised by the parties (including the assets used and the risks assumed), the contractual clauses, the economic situation of the parties and their negotiating strategies.

1. In this sense, Maria dos Prazeres Lousa states:

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

1. Thus, in order to classify certain transactions as comparable, we must consider various factors:

• To the characteristics of the goods or services, such as, for example, in the case of the provision of services, the nature and volume;

• To the functions exercised by the parties, both at the level of structure and at the level of organization of the group, so as to compare the activities and significant responsibilities at the economic level that are exercised by the associated enterprises and by independent enterprises;

• To the contractual clauses of the operation in question, in the part where the modalities of responsibilities, risks and benefits between the parties are defined;

• To 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 do not have a materially relevant impact on prices or that appropriate adjustments can be introduced;

• And to the business strategies of the entities involved.

1. In these terms, the provision in article 63 of the IRC Code comes to enumerate various methods for determining the terms and conditions that would be normally agreed, accepted and practiced between independent entities.

2. In the case sub judice, the inspection services, after the enumeration of the various methods capable of use, opted for the comparable uncontrolled price method (article 6 of the Order) which consists in comparing the price of goods or services transferred in a related party operation ("controlled operation") with the price charged with regard to goods or services transferred in the context of an operation between independent enterprises in comparable circumstances. The inspection services considered that, despite the almost exclusive acquisition of raw materials being at issue from an associated entity, this was the most appropriate method because it constitutes the most direct way of determining whether the conditions agreed between related entities are arm's length conditions.

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

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

Quantification of the respective effects

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

2. 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 associated enterprises carry out operations that they do not carry out with independent enterprises.

3. In the words of the OECD Report Guidelines

"(. ..) the comparable uncontrolled price method compares an operation carried out between associated enterprises with similar operations between independent enterprises in order to obtain a direct assessment of the price that the parties would have agreed if they had resorted directly to the market instead of carrying out a controlled operation. However, this method loses some 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 enterprises are not all of them comparable".

1. This is what occurs in the case subject to analysis, since the acquisition of raw materials by D..., LDA is carried out almost exclusively from the associated entity (U...), and it has been demonstrated, explicitly, in the tax inspection report, that, if we were dealing with independent entities, D.... LDA would not accept to pay more than it would cost if it purchased raw materials directly from suppliers, therefore an adjustment was made to the cost of goods sold of that company, eliminating the margin practiced by U... in the sales of raw materials made.

2. This is because in comparable operations, independent entities define the terms and conditions which 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 give as proven that company U... added value to the activity of the taxpayer.

3. However, there is a flaw to be pointed out in the application of the methodology chosen by the inspection services for the elimination of the margin on sales applied by company U..., as per pages 28 and following of the RIT (…) attached at fls. 272 et seq. of the administrative reclamation proceedings.

4. That is, given the total cost of goods sold (CEV) determined (€ 37,993,069.81) and the total sales, determined through customer statements, excluding the VAT amount included (€ 42,335,343.76) it was found that U... was practicing a margin of 11.429%. However, in determining the correction to be made to the CEV of D..., LDA the services multiplied the CEV by the margin obtained instead of removing from such value the inflation effected by the same, dividing the CEV by the margin and subtracting this value again from the CEV, that is, the adjustment to be made by way of transfer pricing is € 3,749,883.93 and not € 4,178,458.21.

(...)

IV. CONCLUSION

1. For the reasons adduced, the present Hierarchical Appeal should be partially granted on the following questions raised by the respondent:

• As regards transfer pricing, in the amount of € 428,574.28, maintaining the increase of € 3,749,883.93 to the taxable profit;

• As well as, the part of the bank guarantee provided in the proportion of the granting, provided it proves the damage caused;

V. RIGHT TO HEARING

Since the decision on the appeal is partially favorable to the respondent, prior hearing is dispensed with, under no. 2 of article 60 of the General Tax Law.

As for the part of the decision that dismisses the appealed order, given that it is based on facts with respect to which the respondent has already been notified to exercise the right to hearing and has not brought new facts before the Hierarchical Appeal, it is dispensed with new hearing, in accordance with no. 3 of article 60 of the General Tax Law and paragraphs a) and c) of no. 3, chapter II of Circular no. 13/99.

o) The Tax and Customs Authority calculated the interest which it considers corresponds to the financing made by the Claimant to its subsidiaries by applying an implicit interest rate calculated on the basis of total financial charges and debit balances at the end of each year;

p) The activity of the "A... Group" corresponds to the production of rigid plastic packaging for large-scale consumer companies, especially in the sectors of beverages and food, personal hygiene, household hygiene, and oils and lubricants;

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

r) In the year 2007, the "A... Group" managed 63 factories in 17 countries: Austria, Brazil, Canada, United States of America, Spain, France, the Netherlands, Ireland, Italy, Malaysia, Mexico, Portugal, Czech Republic, United Kingdom, Russia, Ukraine, and Vietnam;

s) In 2007, the Claimant held 100% of the capital of A...1;

t) Part of the A... group in 2007 was "U…" (hereinafter, U...), with registered office in Ireland;

u) Until 2006, the "A... Group" had an eminently European character, with each country having a central purchasing office for raw materials;

v) The A... Group understood that centralization was important to strengthen its competitiveness;

w) The strategic decision to create U... was based on the need for the "A... Group" to obtain negotiating conditions even more competitive than those of its clients, preventing the purchase of raw materials from being transferred to the decision-making sphere of the clients themselves;

x) The creation of U... had the advantage of eliminating duplicated administrative structures, generating economies of scale and synergies and provided the A... Group with a more favorable negotiating position for maintaining the raw materials procurement function within the Group;

y) U... became the unit of the group that conducts research, identifies and selects independent suppliers of raw materials and makes the respective purchases, also dedicating itself, partially, to logistics and transport of raw materials purchased by it;

z) The choice of the location of U..., headquartered in Ireland, was based on the increasing weight of the United Kingdom market in the activity of the Group, which has always been greater than that of the Portuguese market itself, and the opportunities that emerged for the "A... Group" in the market of the United States of America (USA) and Canada;

aa) U... entered into a contract with A...1 whereby the latter is the entity responsible for identifying and selecting suppliers that operate in the market of desired raw materials, for negotiating the purchase of raw materials from those suppliers and for monitoring compliance with the negotiated purchase conditions, for guaranteeing the price and for supplying the desired quantities, in addition to supplier evaluation, as well as ensuring that products are delivered with the specified technical characteristics, as well as assuming responsibility for insurance expenses related to the transportation of the products in question, for technical service, and for commercial discussion of complaints, including negotiation of possible indemnities;

bb) U... uses, in the activity it performs, its knowledge and mastery of the raw materials markets in which it operates and the knowledge of raw material suppliers that the companies of the "A... Group" require;

cc) U... has greater knowledge of the market and negotiating capacity in the acquisition of raw materials than the other units of the Group, which allow it to negotiate lower prices that would not be within the reach of each of the units of the "A... Group", considered individually;

dd) The provision of services to group companies constituted 100% of the activity of the Claimant in 2007;

ee) The companies of the Group to which the Claimant made financing in the year 2007 were in financial difficulties;

ff) The Tax and Customs Authority, as a result of the correction to the taxable profit derived from the non-consideration of financial costs, did not make corresponding corrections in the taxable profits of the subsidiaries that benefited from the financing;

gg) The Tax Administration initiated a tax enforcement proceeding, filed with number …, for coercive collection of the sums assessed (document no. 15 attached with the request for arbitral pronouncement, the contents of which are hereby reproduced);

hh) To suspend the aforementioned tax enforcement proceeding, the Claimant provided a bank guarantee, amended on 03-02-2012, following notification by the enforcement officer for that purpose, it being provided in the amount of € 1,580,280.55 (Document no. 16 attached with the request for arbitral pronouncement, the contents of which are hereby reproduced);

ii) On 19-12-2013, the Claimant, under the Exceptional Regime for the Regularization of Tax and Social Security Debts, approved by Decree-Law no. 151-A/2013, of 31 October, paid the sum of € 1,143,091.13, which was being collected in the tax enforcement proceeding referred to in the previous paragraph (document no. 17 attached with the request for arbitral pronouncement, the contents of which are hereby reproduced and article 497 of the request for arbitral pronouncement, not contested);

jj) On 03-09-2014, the Claimant submitted the request for constitution of the arbitral tribunal which gave rise to the present proceeding.

2.2. Facts not proven

There are no facts relevant to the decision of the case that have not been proven.

2.3. Substantiation of the decision on matters of fact

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

As regards the matters of fact indicated in paragraphs p) to ff), it is also based on witness examination and party testimony, the Arbitral Tribunal understanding that all testified with impartiality and with knowledge of the matters on which their testimony was given.

1. Matters of Law

In accordance with the provision in article 124 of the CPPT, subsidiarily applicable by virtue of the provision in article 29, no. 1, of the RJAT, in so far as no vices attributable to the IRC assessment that lead to a declaration of non-existence or nullity are imputed thereto, nor is a relationship of subsidiarity indicated, the order of assessment of vices should be that which, according to the prudent discretion of the judge, ensures more stable or effective protection of the interests offended.

For that reason, the formal vices raised by the Claimant will be assessed in last place, if its assessment does not prejudice the solution resulting from the assessment of others.

In truth, as is a corollary of the establishment by the aforementioned article 124 of the CPPT of an order of assessment of vices, if a vice is judged to be upheld that ensures effective protection of the rights of the challengers, it will not be necessary to assess the remainder, as, if it were always necessary to assess all vices imputed to the impugned act, the order of its assessment would be indifferent.

a. Vice relating to the correction based on the non-deductibility of the financial charges borne by the Claimant with the financing granted to its subsidiaries

The Claimant bore financial charges to make financing to its subsidiaries that were in situations of financial difficulties.

The Tax and Customs Authority understands that "Pursuant to article 23 of the IRC Code, the tax deductibility of interest borne, like any other expense, depends on a determination as to its indispensability for the realization of income subject to tax or for the maintenance of the productive source (body of no. 1) and is made explicit in the respective paragraph c) of no. 1 that such interest on foreign capital is 'used in operations'.

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

The Tax and Customs Authority understands that the activity of the Claimant is "Technical consultancy for the plastic material processing industry", therefore the granting of loans to its associates is not directly related to any activity of the taxpayer inscribed in its corporate purpose, or with the maintenance of its productive source. For that reason, the Tax and Customs Authority understands that, for the exercise of its activity, it did not need to resort to credit in the manner it did, overvaluing the financial costs incurred and, consequently, contributing to compromising its tax profitability and diminishing its tax capacity. Thus, according to the foregoing and considering article 23, no. 1, al. c) of the IRC Code, part of the financial costs incurred by the taxpayer are not considered as fiscally relevant, in the proportion that they are not allocated to its activity.

The Tax and Customs Authority further states that "we are dealing with entities that, although they constitute an economic group, are distinct, with the 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 the capacity to generate wealth, and more, that the continuity of the taxpayer could be at risk, in accordance with this logic of fund management, whose financial expenses are borne by it. "In short, from all the case law cited, from which results a unanimous understanding (cf. the Supreme Administrative Court judgment of 2013-01-09), we can withdraw and reiterate here the conclusion that the superior courts have consistently considered that, pursuant to article 23 of the IRC Code, only costs that relate to the activity developed by the taxpayer itself according to its corporate purpose are deductible" (article 152 of the Response).

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

"The legal notion of indispensability is shaped, therefore, by an economic-business perspective, through the fulfillment, direct or indirect, of the ultimate motivation for obtaining profit. Indispensable costs are equivalent to expenses incurred in the interest of the company or, in other words, in all acts abstractly subsumed in a lucrative profile." (…) "Indispensability is subsumed to any act performed in the interest of the company (…) The legal notion of indispensability thus represses acts that are non-conformant with the scope of the company, not insertable in 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 tax admissibility of expenses, 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 predominates, as was to be expected, of the link between the tax admissibility of financial expenses in terms of whether it is considered that the financing entity performs or does not perform its own activity in such operations.

Indispensability therefore does not mean an obligatory nexus of causality with income, nor that, a posteriori, economic effects lucrative necessarily must be verified or proven as resulting from such expenses. Provided that the expenses 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 income or the maintenance of the productive source (physical, intangible, financial or other), such should lead to the acceptance of their deductibility.

From the evidence produced, it results that A... SA does not have only the provision of consultancy services as its purpose.

It is the head of a group and, therefore, also has the holding and management of interests in other companies as its purpose, holding 100% of the equity capital of 18 group companies with registered office in Portugal. For that reason, even though it is not formally a management and holdings company, it assumes itself materially as a company that also manages equity interests, as the parent company of a group, where it holds almost all of its subsidiaries at 100%. And it is this reality that must be taken into account when assessing the question of the deductibility of financial charges, having regard to the principle of the prevalence of substance over form, of paramount importance in tax law.

It was within the scope of this real activity of management of equity interests that the Claimant, A... SA, incurred, in the year 2007, bank loans for subsequent granting of non-remunerated financing to its subsidiary companies (subsidiary companies, in accounting language). The Claimant assumed these bank loans obtained from the Bank as its own debt in its financial statements, considering as financial charges the expenses borne with this form of financing. Based on these bank loans, it had monetary resources which it subsequently transferred to its subsidiaries, as treasury operations or financing loans. The Claimant invoked as the reason for this non-remunerated financing the inability of its subsidiaries to finance themselves directly from the Bank, or the greater expense associated with such financing if the subsidiaries did so directly, which was corroborated by the evidence produced.

The pivotal argument used by the Tax and Customs Authority of the non-existence of a relationship between the financing (and the financial charges resulting from them) and the activity or corporate purpose of A... is not correct. The witness testimony was elucidatory to the effect that the subsidiaries needed funds to pursue their businesses and the close relationship of all of this with the interest of A... SA.

Such financing, inserted in the management of the interests held by A... SA, has direct and indirect effects on the activity and the social interest of this entity. Not only do they make it possible to maintain the financial assets that embody the investments in the subsidiaries as elements from which they expect income or benefits, but also make it possible for the operational activity of A... SA to develop more sustainably, as almost all of its activity (100% in 2007 and 99.28% in 2008) resulted in the provision of services to group companies, as results from the matters of fact established. With these percentages of its activity directed to its subsidiaries, it is manifest that the profitability and sustainability of the Claimant was dependent on the profitability and sustainability of its subsidiaries, as they were practically the only clients to whom this entity provided services.

Thus, from the capacity that the subsidiaries have to purchase services from it results directly the increase of the effective income of A... SA, as they are its clients. Furthermore, ensuring the subsistence of the subsidiaries means for the Claimant protecting its own assets, constituted by the interests.

To this is added that from the obtaining of profits by the subsidiaries result indirectly income for A... SA, which is the owner of their capital at 100%, in addition to appreciation of its assets which the equity interests held integrate.

There is therefore a clear link between the financial charges of A... SA and its activity and its corporate interest, as the subsidiaries were practically its only productive source of income in the year 2007.

Thus, such loans appear to be necessary or convenient to the direct pursuit of the purpose of each of the subsidiary companies and directly and indirectly to the direct pursuit of the purpose of the parent company.

From the foregoing it follows that the correction made relating to the deductibility of the financial charges borne by the Claimant in 2007 to finance its subsidiaries violates article 23, no. 1, of the IRC Code, in the version in effect in that year, which constitutes a vice of violation of law, which justifies the annulment of the assessments, in the part corresponding to that correction.

3.2. Vice 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 the analysis of the chain of participations of the A... group, it is evident that the company "U..." (hereinafter U…) and the company A...1, Lda. are held, directly in the case of the first, and indirectly in the case of the second, respectively, in the percentage of 100%, by the company M…, BV. Thus, the 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, a sufficient condition to, pursuant to article 63, no. 4, of the IRC Code conclude that there are special relationships between U... and A...1, Lda.

From the analysis of the raw material supply contracts entered into between A...1, Lda., in the capacity of buyer and U..., in the capacity of seller, it results, for the TA, that A...1, Lda. selects the suppliers of U.... Suppliers which were, in essence, the same with whom this company contracted before the constitution of U....

The purchase orders for raw materials are made directly by A...1, Lda. to the respective suppliers, indicating that the goods are placed directly in the manufacturing unit of that company, with only the invoicing being issued by U....

Commercial contacts with suppliers were, in the period in question, established by an employee of A...1, Lda., who was already performing the same functions before the constitution of U....

In view of the special relationships which, for the Respondent, exist between A...1, Lda. and U..., and in addition to the binding to the arm's length principle in the contracting of operations between both, the first entity would still have other legally imposed obligations.

The company A...1, Lda. would thus have an obligation of specific documentation as to transfer pricing, pursuant to no. 6 of article 63 of the IRC Code, and what is established in articles 13 to 15 of Order no. 1446-C/2001, of 21 December.

This translates, namely, in the organization of a dossier that comprises the documentation justifying the policy adopted as to transfer pricing by the entity in question. But, according to the TA, the company A...1, Lda. did not fulfill the obligations incumbent upon it, as when asked to present the transfer pricing dossier it informed that the same was not organized.

In the view of the TA, the prices practiced in the purchases of raw materials made by U... from national and foreign suppliers are arm's length prices. That is, they would be the prices that, in normal market terms, should have been practiced in the acquisitions of raw materials made by A...1, Lda from U....

This conclusion of the inspection report entails the elimination of any remuneration to the latter entity, by way of its alleged intermediation function between A...1 and raw material suppliers, on the grounds that independent entities would not alter their commercial supply structure in the terms and conditions that were established between those related entities.

It can be stated, within the framework of reasonableness in which the determination of transfer prices occurs, that the degree of comparability of the operations selected by the TA is high, so they can serve as support for the determination of the arm's length price in accordance with the comparable uncontrolled price method (CUPM), provided for in paragraph a) of no. 3 of article 63 of the IRC Code.

For the operations of acquisition of raw materials made by A...1 Lda. from U..., the available information allows the identification of comparable operations, within the meaning of no. 3 of article 4 of Order no. 1446-C/2001, of 21 December, within the group. That is, there would be internal comparables, which correspond precisely to acquisitions of identical raw materials made by U... from independent suppliers.

For the TA, the Claimant failed to demonstrate what the added value consisted of that the interposition of U... between A...1, Lda. and its suppliers came to introduce in the procurement of raw materials. On the other hand, the functional organizational chart of A...1, Lda. did not undergo changes with the introduction of U... in the raw material acquisition circuit.

From this it results that the administrative structure that supported the raw materials procurement function did not undergo changes, as A...1, Lda. continued to ensure the selection and contacts with suppliers, the issuance of purchase orders, the processing of such orders, the indication of the specifications of the products to be purchased, and the making of payments of invoices issued by suppliers, with the physical flow of products also undergoing no alteration.

It would not be sufficient for the Claimant to allege that U... has a physical structure and human resources in Ireland, with real allocation to the procurement of raw materials and to the development of the alleged functions of procurement and sourcing of raw materials to A...1, Lda. On this matter, the TA alleges that no facts were presented showing [... truncated ...]