Process: 711/2014-T

Date: May 8, 2015

Tax Type: Valor do pedido:

Source: Original CAAD Decision

Summary

In Process 711/2014-T, A... S.A. challenged a Corporate Income Tax (IRC) assessment for the 2010 tax year, contesting a €2,927,752.32 correction to taxable income related to financial charges deemed non-deductible by the Portuguese Tax and Customs Authority. The case centered on an intercompany loan agreement between the Portuguese subsidiary and its French parent company, B... S.A.S., which had acquired 100% of the claimant's share capital in 2004. The loan, initially contracted for €47.3 million to repay a bank loan, was subsequently amended multiple times, ultimately establishing a principal of €40.7 million with an 8.62% annual interest rate for 2010. The Tax Authority applied Article 63 of the Corporate Income Tax Code (CIRC), which governs transfer pricing adjustments, arguing that the financial charges failed to meet legal requirements for tax deductibility due to their nature and quantification. A critical aspect of the case involved the loan's structure: a 2009 amendment stipulated that accrued interest would be capitalized and paid only at maturity in 2013 along with the principal, creating a compound interest effect. By year-end 2009, unpaid interest totaled €20,227,179.99, which was then included in the base for calculating 2010 interest charges of €4,764,133.40. The claimant sought annulment of the assessment totaling €15,583.57 resulting from this correction and requested a refund with compensatory and default interest. The case proceeded to the Administrative Arbitration Centre (CAAD) under the Legal Framework for Tax Arbitration, with the respondent Tax Authority initially requesting reduction of the claim's scope since the assessment also included other unchallenged corrections. The claimant agreed to limit the challenge to the specific financial charges correction, and the tribunal was constituted with a sole arbitrator to decide whether the transfer pricing adjustment was legally justified.

Full Decision

Arbitral Decision

I. Report

  1. A…, S.A., tax identification number …, with registered office at Street … no. …, …, … (hereinafter abbreviated as "Claimant") came, pursuant to the combined provisions of Articles 2, no. 1, subparagraph a), and 10, no. 1, subparagraph a), of the Legal Framework for Tax Arbitration, approved by Decree-Law no. 10/2011, of 20 January (RJAT) and 102, no. 1, subparagraph a), of the Code of Tax Procedure and Process (CPPT), to request the constitution of an arbitral tribunal for the issuance of a decision annulling the tax assessment identified below.

  2. The Respondent is the Tax and Customs Authority.

  3. The Claimant seeks the arbitral tribunal's decision to:

3.1. annul the correction to taxable income in the amount of €2,927,752.32 and the consequent annulment of the Corporate Income Tax (CIT) assessment no. 2014 …, referring to the tax year 2010, in the total amount of €15,583.57, which resulted from that correction, and which was executed by the Director-General of the Tax and Customs Authority; and

3.2. condemn the Tax and Customs Authority to refund that amount (€15,583.57) unduly paid with respect to the contested assessment, plus compensatory interest and default interest if applicable.

  1. The Claimant opted not to designate an arbitrator.

  2. Pursuant to the provisions of subparagraph a) of no. 2 of Article 6 and subparagraph b) of no. 1 of Article 11 of the RJAT, as amended by Article 228 of Law no. 66-B/2012, of 31 December, the Ethics Council designated the arbitrator of the arbitral tribunal, who communicated acceptance of the designation within the applicable period.

  3. The parties were notified of that designation and did not express their will to challenge the arbitrator's designation, pursuant to the combined provisions of Article 11, no. 1, subparagraphs a) and b) of the RJAT and Articles 6 and 7 of the Ethics Code of CAAD.

  4. Thus, in accordance with the provisions of subparagraph c) of no. 1 of Article 11 of the RJAT, as amended by Article 228 of Law no. 66-B/2012, of 31 December, the sole arbitral tribunal was constituted on 24-12-2014.

  5. The Tax and Customs Authority submitted its response, in which it defends the dismissal of the arbitral decision request.

  6. In its response, the Tax and Customs Authority raised a preliminary objection concerning the correction of the request, on the ground that the Claimant contests only the correction to taxable income of €2,927,752.32, relating to "improper accounting as operating expenses, relating to financial charges, in the amount of €2,927,752.32, which, given its nature and quantification, do not meet the legal requirements for them to be tax-deductible, as they violate the provisions of Article 63 of the CIT Code".

  7. According to the Tax and Customs Authority, the assessment indicated as the subject matter of the request is also determined by another correction, which the Claimant does not contest, so that it is "incorrect, as it does not accord with the grounds of the challenge, the arbitral request formulated, where the total annulment of the aforementioned additional assessment is requested", wherefore the Tax and Customs Authority came to request the reduction of the request accordingly.

  8. The meeting provided for in Article 18 of the RJAT took place on 04-03-2014. When asked about the request for reduction of the request presented by the Respondent, the Claimant did not object to it, wherefore the request for total annulment was reduced to a request for partial annulment of the identified tax assessment.

  9. The Arbitral Tribunal was duly constituted.

  10. The parties submitted written submissions.

  11. The parties possess judicial personality and capacity, are entitled to sue and are duly represented (Articles 4 and 10, no. 2, of the RJAT and Article 1 of Ordinance no. 112-A/2011, of 22 March).

  12. The proceedings do not suffer from any defects and there is no obstacle to the consideration of the merits of the case.

II. Factual Matters

a. Established Facts

  1. The following facts are considered established:

16.1. The Claimant is a resident legal entity with commercial activity focused on the following business areas: (i) decorative paints; (ii) thermal insulation; and (iii) Automotive Repainting.

16.2. In 2004, the Claimant's share capital was fully acquired by a French law company, B… S.A.S. (at the time, C… S.A.S.), with registered office at … Avenue …, ……, France (hereinafter abbreviated as "B…").

16.3. B…, like the Claimant, are part of an international economic group specializing in various business areas, notably in the paints sector, which encompasses the Claimant's activity (hereinafter, "B Group").

16.4. On 29-10-2004, and to amortize a loan it had contracted with Bank Espírito Santo Investimento, B…, in the capacity of lender, and the Claimant, in the capacity of borrower, executed an onerous loan contract – the "Intercompany Loan Agreement" – in the initial amount of €47,308,663.30 – hereinafter "Loan".

16.5. Semi-annual capital repayments were fixed in the contract, until 06-11-2012, thus providing for a maturity of 8 years for the loan.

16.6. With respect to interest, its accrual and payment were provided for with monthly, quarterly, or semi-annual periodicity, as notified by the lender.

16.7. For this purpose, an annual rate of 7.98% was applied.

16.8. That contract was amended with effect from 27-04-2006.

16.9. In accordance with the version of the contract that, from that date, governed the relationship between the companies, the borrowed capital was €40,700,000.00.

16.10. The repayment of the borrowed capital was to be made in full on 06-11-2012.

16.11. With respect to interest, the rate of 7.98% per annum was maintained.

16.12. As regards its accrual, it was agreed that interest would accrue with monthly, quarterly, semi-annual or nine-month periodicity, as notified by the lender entity.

16.13. It was further established that on the last day of each interest period the accrued interest would be paid.

16.14. On 22-12-2009 the terms of the contract were amended again.

16.15. The amount indicated in the contract as borrowed capital continued to be €40,700,000.00.

16.16. The date set for the repayment of that amount – borrowed capital – became 27-04-2013 (that is, eight and a half years from the start of the loan).

16.17. With respect to interest, it was now determined that accrued interest would be paid on the date of payment of capital (27-04-2013).

16.18. The interest rate was also regulated, fixing, in the respective Annex I, an annual rate for the years 2009 to 2013.

16.19. The interest rate applied, with respect to the tax year in question, was 8.62%.

16.20. In this amendment to the contract, unlike what occurred in the previous versions, no reference was made to the interest accrual period.

16.21. This is the version of the contract in effect in the year 2010, subject matter of the present proceedings.

16.22. On 31-01-2010 the capital owing was €34,330,663.30 and the value of interest calculated until 31-12-2009 amounted to €20,227,179.99, from which it follows that the amount to be considered for the calculation of interest (at the aforementioned rate of 8.62%) was, on that date, €54,557,843.29.

16.23. On 14-12-2010 a partial repayment of the borrowed capital was made, in the amount of €1,000,000.00, the capital owing becoming €33,330,663.30 and the amount for the calculation of interest (which includes the value of interest calculated until 31-12-2009) amounting to €53,557,843.29.

16.24. Interest charges in 2010 amounted to €4,764,133.40.

16.25. In 2013, the remaining capital was amortized and all interest on the Loan was paid, which only accrued on that date (the date of capital payment in 2013).

16.26. On 27 August 2013, pursuant to Service Order no. OI2013…, an external inspection procedure was initiated against the Claimant, with reference to the tax year 2010, initially of partial scope and later expanded.

16.27. Following the AT's request for clarification regarding the interest rate applied in the financing operation, the Claimant herein sent, on 7 March 2014, a report prepared by D…, which concludes that, during the fiscal year 2010, "the terms and conditions agreed and practiced in the medium and long-term financing operation with fixed interest rate carried out between B… and A…, comply with the arm's length principle, as stipulated by the Portuguese transfer pricing regime" (p. 19 of the Report).

16.28. D… prepared that report in order to assist the Claimant herein "in the preparation of transfer pricing documentation referring to the economic analysis of the financial nature operation established within the B Group, with reference to the fiscal year 2010".

16.29. In that report, the comparable uncontrolled price method was adopted.

16.30. For this purpose, comparable external information was searched in the Thomson Reuters Eikon database.

16.31. After analyzing the D… report, the tax inspection concluded – without questioning the appropriateness of the choice, in the situation sub judice, for the adoption of the comparable uncontrolled price method – that we are not in the presence of comparable operations.

16.32. The Tax Inspection, in determining the transfer prices of the operation under analysis, considered the external comparable configured in the monthly interest rates published by the ECB – MFI Interest Rates, with the following rationale: "having regard to the nature of the operation in question (loan) and its objective (to amortize the pre-existing bank loan with a Portuguese banking institution), it was considered appropriate to use these rates for the purposes of validating the compliance of the related operation under appraisal with the Arm's Length Principle, as they meet, in particular, the comparability criteria (nature and extent) and independence".

16.33. On 26-03-2014, the Claimant was notified of the Draft Tax Inspection Report ("PRIT"), through Official Letter no. …, of 20-03-2014, pursuant to the provisions and for the purposes provided in Articles 60 of the General Tax Law ("LGT") and 60 of the Supplementary Regime of Tax Inspection Procedure ("RCPIT"), pursuant to which the AT proposed the following corrections to that tax year relevant to the decision of the present case:

(i). Correction relating to financial charges:

Correction in the amount of €2,927,752.32, concerning the interest recorded by the Claimant as operating expenses for the period relating to the Loan, which were considered excessive and, therefore, not deductible under the transfer pricing regime (cf. Article 63, no. 1 of the CIT Code); and

(ii). Withholding Tax on CIT:

Failure to withhold CIT in the amount of €384,594.29, resulting from the AT's position that interest relating to the Loans accrues at the end of each fiscal year.

Since it understands and contends that the interest calculated with reference to the fiscal year 2010, in the amount of €4,764,133.40, accrued in that fiscal year, the AT proposed the corresponding withholding (applying the rate of 5%, established in Article 87, no. 4, subparagraph g) of the Personal Income Tax Code ("IRS"), to interest which it considered deductible for tax purposes, and the rate of 10% provided for in the Agreement to Avoid Double Taxation between Portugal and France ("ADT") to interest which it considered as not deductible.

16.34. The other corrections proposed were not questioned by the Claimant as they resulted from mere clerical errors which the latter acknowledged and therefore did not contest.

16.35. However, the Claimant did not accept the PRIT in the part relating to the aforementioned corrections, having exercised its right to prior hearing.

16.36. On 30 April 2014, the Claimant herein was notified of the respective RF, through Official Letter no. …, of 29 April 2014, pursuant to which the Claimant was informed that the AT maintained, in full, the two corrections previously proposed in the PRIT and questioned by the Claimant.

16.37. The Claimant requested a new study, now from E…, in which it is stated that "[b]ased on this market benchmark [constructed through the addition of the additional country risk premium to the market spreads obtained from the search for comparables performed in the Web DealScan database and to the market benchmark for the indexing reference calculated based on swap rates] it was possible to conclude that the arm's length principle was not compromised, insofar as the interest rate agreed in the operation under analysis of 8.62%, falls within the respective interquartile range, between the first quartile and the median".

16.38. The AT, by understanding that the interest rate practiced in the interest calculated in 2010 with reference to the Loan was higher than that which would be practiced in a similar operation that took place between independent entities, disregarded that rate and replaced the practiced rate and the recorded values by the 3-month euribor rate plus a spread of 2.5%, which it considered to be the interest rate that would be practiced between independent entities in normal market conditions.

16.39. At the rate considered by the AT as arm's length (Euribor 3m + 2.5%), the interest calculated in 2010 would amount to €1,836,381.08, wherefore the AT disregards and adds to the taxable profit of the Claimant the amount of €2,927,752.32 (corresponding to the difference between the amount of interest recorded - €4,764,133.40 - and the amount of interest accepted at the rate proposed by the AT).

16.40. Following the aforementioned transfer pricing corrections made pursuant to Article 63 of the CIT Code, the Claimant was notified, on 21 May 2014, of the CIT assessment and compensatory interest which is now contested, from which resulted an amount payable of €15,583.57, with the term for voluntary payment being 16 July 2014.

16.41. The Claimant proceeded to make voluntary payment of the assessed amount.

b. Unestablished Facts

  1. Of the facts with interest for the decision of the case, those not contained in the factuality described above were not established.

c. Reasoning for the Decision on Factual Matters

  1. The facts were established based on the documents attached to the proceedings.

III. Matters of Law

A. Summary of the Parties' Arguments

  1. The grounds for the Claimant's claim are summarized in the conclusions of the written submissions presented, which are as follows:

"A. The transfer pricing regime does not provide for the possibility of resorting to an internal comparable operation for the purposes of transfer pricing corrections.

B. In the case sub judice the AT did not apply an external comparable operation, and the comparable operation used cannot serve as the basis for the comparison of the conditions (interest rates) practiced between related entities, on the one hand, and between independent entities, on the other hand.

C. Even if the possibility of resorting to such an (in)comparable operation were admitted – which is not admitted due to lack of adherence to the legal norms that govern this transfer pricing matter – the comparable used by the AT could never be accepted, particularly taking into account the obligation to apply the highest degree of comparability, as the two related operations have substantially different maturity periods and values, one having a fixed rate and the other a variable rate.

D. The contested tax assessment should therefore be annulled for violating the norms defining the use of the comparable uncontrolled price method for determining transfer prices, namely Articles 63, no. 3, subparagraph a), of the CIT Code and Articles 4, subparagraph a), and 6, no. 1, of Ordinance no. 1446-C/2001.

E. The AT failed to fulfill the duty to provide reasons for the tax acts, in its material aspect, thus violating the provisions of Articles 268, no. 3, of the Constitution, 125, no. 2, of the Code of Administrative Procedure, and 77, nos. 1 and 3 of the LGT, failing at the same time the burden of proof of the facts constitutive of the right to assessment which it was bound to by Article 74, no. 1, of the LGT.

F. It is concluded, therefore, that the CIT assessment and respective compensatory interest which is now contested should be annulled for violation of law, namely, pursuant to the provisions of Articles 100, no. 1, of the CPPT and 135 of the Code of Administrative Procedure."

  1. The AT concludes its counter-submissions as follows:

"Having regard to the fact that the use of the comparable uncontrolled price method to determine whether the interest rate applied in the financing operation under analysis complied with the arm's length principle did not generate controversy, it remains to ascertain the merit and reliability of the comparable data used.

However, both in the collection of data and in their processing, so as to make the closest possible approximation to the specific characteristics of the concrete related operation under analysis, only the AT was able to obtain an adequation to the context of the financing operations market carried out in the Portuguese market and to the context of the entities involved.

Contrary to what is affirmed and repeatedly stated in the Claimant's submissions, the AT did not resort to an internal comparable consisting of a related operation, it based itself instead, to support the validity of the terms that would be fixed in a similar operation between independent entities, on a process of calculating interest rates that the creditor itself – B… – accepted in financing obtained from a banking institution and which resulted in another financing granted to A….

However, the results obtained with the adoption of that calculation process were indeed constrained by the monthly average interest rates published by the ECB applied to loans in the Portuguese market, in 2010, concluding that the upper limit did not exceed the one provided by the ECB statistics.

There are therefore no doubts as to compliance with the duty to provide reasons for the corrections made to interest expenses under the transfer pricing rules, especially of no. 1 of Article 63 of the CIT Code.

What does not find justification or reasoning is the divergence existing between the rate used in the operation subject to the present proceedings (rate of 8.62% of the 2004 financing), with respect to the rates published by the ECB, as the difference exceeds 5 percentage points and the claimant failed to demonstrate that the rate used in the remuneration of the financing is identical to the one that would be contracted, accepted and practiced between independent entities in similar operations."

B. Applicable Legal Framework

  1. The general transfer pricing regime is provided for in Article 63 of the CIT Code, which, in 2010, had the following wording:

"Article 63

Transfer Pricing

1 — In commercial operations, including, in particular, operations or series of operations concerning goods, rights or services, as well as in financial operations, carried out between a taxpayer and any other entity, subject or not to CIT, with which the taxpayer is in a situation of related party relationships, terms or conditions substantially identical to those normally would be contracted, accepted and practiced between independent entities in comparable operations must be contracted, accepted and practiced.

2 — The taxpayer must adopt, for the determination of the terms and conditions that would normally be agreed, accepted or practiced between independent entities, the method or methods capable of ensuring the highest degree of comparability between the operations or series of operations it performs and others substantially identical, in normal market situations or in the absence of related party relationships, taking into account, in particular, the characteristics of the goods, rights or services, the market position, the economic and financial situation, the business strategy, and other relevant characteristics of the taxpayers involved, the functions performed by them, the assets used and the distribution of risk.

3 — The methods used must be:

a) The comparable uncontrolled price method, the resale price method or the cost plus method;

b) The profit split method, the transactional net margin method or another, when the methods referred to in the preceding subparagraph cannot be applied or, even if they can be, do not allow obtaining the most reliable measure of the terms and conditions that independent entities would normally agree, accept or practice.

4 — Related party relationships are considered to exist between two entities in situations where one has the power to exercise, directly or indirectly, a significant influence on the management decisions of the other, which is considered verified, in particular, between:

a) An entity and the owners of its capital, or the spouses, ascendants or descendants thereof, who hold, directly or indirectly, a participation of not less than 10% of the capital or voting rights;

b) Entities in which the same capital owners, their respective spouses, ascendants or descendants hold, directly or indirectly, a participation of not less than 10% of the capital or voting rights;

c) An entity and the members of its governing bodies, or any administration, management or supervisory bodies, and their respective spouses, ascendants and descendants;

d) Entities in which the majority of the members of the governing bodies, or the members of any administration, management or supervisory bodies, are the same persons or, being different persons, are linked to each other by marriage, legally recognized de facto union or kinship in the direct line;

e) Entities linked by a subordination contract, a parity group contract or other contract of equivalent effect;

f) Companies that are in a relationship of control, as this is defined in the legal instruments establishing the obligation to prepare consolidated financial statements;

g) Entities between which, by virtue of the commercial, financial, professional or legal relationships between them, directly or indirectly established or practiced, a situation of dependence exists in the performance of their respective activity, in particular when the following situations occur between them:

  1. The performance of the activity of one substantially depends on the transfer of industrial property rights or intellectual property or know-how held by the other;

  2. The supply of raw materials or access to sales channels for products, merchandise or services by one substantially depends on the other;

  3. A substantial part of the activity of one can only be carried out with the other or depends on decisions thereof;

  4. The right to fix prices, or conditions of equivalent economic effect, relating to goods or services transacted, provided or acquired by one is, by constant imposition of a legal act, in the ownership of the other;

  5. By the terms and conditions of its commercial or legal relationship, one may condition the management decisions of the other, depending on facts or circumstances unrelated to the commercial or professional relationship itself.

h) An entity resident or non-resident with a permanent establishment situated in Portuguese territory and an entity subject to a clearly more favorable tax regime resident in a country, territory or region on the list approved by ministerial ordinance.

5 — For the purposes of calculating the percentage level of indirect participation in capital or voting rights referred to in the preceding number, where no special rules are defined, the criteria provided in no. 2 of Article 483 of the Commercial Companies Code apply.

6 — The taxpayer must maintain organized, pursuant to the provisions established for the tax documentation process referred to in Article 130, the documentation relating to the policy adopted regarding transfer pricing, including the guidelines or instructions relating to its implementation, the contracts and other legal acts executed with entities with which the taxpayer is in a situation of related party relationships, with the modifications that occur and with information on their compliance, the documentation and information relating to those entities and also to the companies and goods or services used as a comparison term, the functional and financial analyses and the sectoral data, and any other information and elements taken into consideration for the determination of the terms and conditions normally agreed, accepted or practiced between independent entities and for the selection of the method or methods used.

7 — The taxpayer must indicate, in the annual statement of accounting and tax information referred to in Article 121, the existence or non-existence, in the taxation period to which it relates, of operations with entities with which the taxpayer is in a situation of related party relationships, and further, in the case of declaring its existence:

a) Identify the entities in question;

b) Identify and declare the amount of operations carried out with each one;

c) Declare whether the documentation relating to the transfer pricing practiced was organized, at the time when the operations took place, and is maintained.

8 — Whenever the rules set out in no. 1 are not observed, with respect to operations with non-resident entities, the taxpayer must make, in the statement referred to in Article 120, the necessary positive corrections in the determination of taxable profit, by the amount corresponding to the tax effects attributable to such non-observance.

9 — In operations carried out between a non-resident entity and its permanent establishment situated in Portuguese territory, or between this and other permanent establishments of that entity situated outside this territory, the rules contained in the preceding numbers apply.

10 — The provisions of the preceding numbers apply equally to persons who simultaneously engage in activities subject and not subject to the general CIT regime.

11 — When the Directorate-General for Taxation makes corrections necessary for the determination of taxable profit by virtue of related party relationships with another taxpayer of CIT or IRS, in the determination of taxable profit of the latter, appropriate adjustments must be made that reflect the corrections made in the determination of taxable profit of the first.

12 — The Directorate-General for Taxation may also proceed to the correlative adjustment referred to in the preceding number when such results from international conventions executed by Portugal and under the terms and conditions provided therein.

13 — The application of transfer pricing determination methods, either to individualized operations or to series of operations, the type, nature and content of the documentation referred to in no. 6 and the procedures applicable to correlative adjustments are regulated by ministerial ordinance."

  1. Pursuant to no. 13 of Article 63 of the CIT Code, Ordinance no. 1446-C/2001, of 21 December, was approved, which provides, in particular, the following:

"Article 4

Determination of the Most Appropriate Method

1 - The taxpayer must adopt, for determination of the terms and conditions that would normally be agreed, accepted or practiced between independent entities, the most appropriate method for each operation or series of operations, taking into account the following:

a) The comparable uncontrolled price method, the resale price method or the cost plus method;

b) The profit split method, the transactional net margin method or another method appropriate to the facts and specific circumstances of each operation that satisfies the principle set out in no. 1 of Article 1 of this ordinance, when the methods referred to in the preceding subparagraph cannot be applied or, even if they can be, do not allow obtaining the most reliable measure of the terms and conditions that independent entities would normally agree, accept or practice.

2 - The most appropriate method for each operation or series of operations is considered to be the one that is capable of providing the best and most reliable estimate of the terms and conditions that would normally be agreed, accepted or practiced in an arm's length situation, and the choice should be made for the method most capable of providing the highest degree of comparability between the related operations and other unrelated operations and between the entities selected for comparison, which has the best quality and greatest amount of information available for its adequate justification and application and which involves the least number of adjustments for the purpose of eliminating the differences existing between the facts and the comparable situations.

3 - Two operations meet the conditions to be considered comparable if they are substantially identical, which means that their relevant economic and financial characteristics are analogous or sufficiently similar, so that the differences existing between the operations or between the companies involved in them are not capable of significantly affecting the terms and conditions that would be practiced in a normal market situation or, if they are, it is possible to make the necessary adjustments that eliminate the relevant effects caused by the differences verified.

4 - Whenever there are well-founded doubts about the reliability of the values that would be obtained with the application of a given method, the taxpayer must attempt to confirm such values by applying other methods, either individually or in combination.

5 - If, within the scope of application of a method, the use of two or more unrelated comparable operations or the application of more than one method considered equally appropriate results in a range of values that ensures a reasonable degree of comparability, it is not necessary to make any correction, provided that the relevant conditions of the related operation, in particular the price or profit margin, fall within that range.

Article 5

Comparability Factors

For the purposes of the preceding article, the degree of comparability between a related operation and an unrelated operation must be assessed, taking into account, in particular, the following factors:

a) The specific characteristics of the goods, rights or services that, being the object of each operation, are capable of influencing the price of the operations, particularly the physical characteristics, quality, quantity, reliability, availability and supply volume of the goods, the bargaining form, the type, duration, degree of protection and anticipated benefits from the use of the right and the nature and scope of the services;

b) The functions performed by the entities involved in the operations, taking into account the assets used and the risks assumed;

c) The contractual terms and conditions that define, explicitly or implicitly, how the responsibilities, risks and profits are divided among the parties involved in the operation;

d) The economic circumstances prevailing in the markets in which the respective parties operate, including their geographic location and size, the cost of labor and capital in the markets, the competitive position of buyers and sellers, the phase of the commercialization circuit, the existence of substitute goods and services, the level of supply and demand and the degree of general development of the markets;

e) The strategy of the companies, contemplating, among the aspects capable of influencing its operation and normal conduct, the pursuit of research and development activities for new products, the degree of diversification of activity, risk control, market penetration schemes or maintenance or strengthening of market share and also the life cycles of products or rights;

f) Other relevant characteristics regarding the operation in question or the companies involved.

Article 6

Comparable Uncontrolled Price Method

1 - The adoption of the comparable uncontrolled price method requires the highest degree of comparability with emphasis on both the object and other terms and conditions of the operation as well as on the functional analysis of the entities involved.

2 - This method may be used, in particular, in the following situations:

a) When the taxpayer or an entity belonging to the same group carries out a transaction of the same nature concerning a service or identical or similar product, in quantity or value analogous, and in substantially identical terms and conditions, with an independent entity in the same or similar markets;

b) When an independent entity carries out an operation of the same nature concerning a service or an identical or similar product, in quantity or value analogous, and in substantially identical terms and conditions, in the same market or in similar markets.

3 - Whenever a related operation and an unrelated operation are not substantially comparable, the taxpayer must identify and quantify the effects caused by the differences existing in transfer prices, which must be of a secondary nature, proceeding with the necessary adjustments to eliminate them, so as to determine an adjusted price corresponding to that of a comparable unrelated operation."

C. Assessment

  1. From the interpretation of Article 63 of the CIT Code, in accordance with the constitutional principles of legality and tax capacity, it follows that the corrections to taxable profit made by the AT must cumulatively observe the following requirements:

i) The existence of related party relationships between the taxpayer and another person;

ii) The practice, between both, of conditions different from those normally would be agreed between independent entities;

iii) That the related party relationships are an adequate cause of such conditions;

iv) That those conditions have led to a profit determined that is different from that which would be determined in their absence[1].

  1. Both parties acknowledge the existence of relationships between B… and A…, in light of the provisions of no. 4 of Article 63 of the CIT Code.

  2. As to the conditions practiced, the Claimant, based on the reports of D… and E…, argues that "the interest rate established in the financial operation now under discussion complied with the arm's length principle, falling within the range of rates that would be applicable in a context of absence of related party relationships".

  3. The AT contends, in the opposite sense, and transcribing part of the Inspection Report, that:

"In light of the above, it is concluded that we are not in the presence of comparable operations, either as to their nature or as to their territorial extent, that would permit validating the rates practiced between related entities, so the comparability criterion essential for the evaluation of compliance with the provisions of no. 1 of Article 63 of the CIT Code is not met.

In fact, the operation in question here consists of a loan of money made by the shareholder and whose purpose was to amortize another existing loan at the time (2004), between A… and a Portuguese Bank. It thus appears that the analysis performed by the taxpayer, with the aim of determining a market interest rate comparable to that applied to the financings, does not prove to be comparable, given the variety and complexity of debt securities covered by the sample as well as the markets in which they are traded, which makes the terms and conditions practiced in those transactions quite different from those practiced in the operation under analysis.

Qualifying the aforementioned entities, as already explained, as related entities, the search presented by A… as a comparable operation for the assessment of the Arm's Length Principle in the granting of financings made by B…, does not meet the comparability criterion required for this purpose, so the analysis exhibited by the taxpayer cannot be considered".

  1. The AT adopted the external comparable configured in the monthly interest rates published by the ECB – MFI Interest Rates, with the following rationale: "having regard to the nature of the operation in question (loan) and its objective (to amortize the pre-existing bank loan with a Portuguese banking institution), it was considered appropriate to use these rates for the purposes of validating the compliance of the related operation under appraisal with the Arm's Length Principle, as they meet, in particular, the comparability criteria (nature and extent) and independence" (§ 116 of the Response).

  2. From this resulted the AT's consideration of the 3-month euribor rate plus a spread of 2.5% as the interest rate that would be practiced between independent entities in normal market conditions.

  3. That is, the choice of comparable was made based on i) the operation configures a loan and ii) its objective being the amortization of another loan (banking).

  4. Now, for the AT to use the 3-month euribor rate plus a spread of 2.5%, it would have to prove that this is the best comparable price, taking into account the factors listed in Article 5 of Ordinance no. 1446-C/2001, of 21 December.

  5. According to the AT, the operation in question had the exclusive purpose of replacing the banking loan existing at the time, and it is based on the idea of "specific purpose" of the operation that it develops its argument.

  6. However, it is not enough to invoke that "specific purpose", together with the nature of the operation – "a loan" – to justify the choice of comparable.

  7. It should be noted that the correction to taxable profit cannot be based on mere indicia or presumptions, under penalty of violating the principle of legality, requiring the AT to prove the verification of the respective normative requirements.

  8. It should further be noted that, pursuant to Article 6 of Ordinance no. 1446-C/2001, "the adoption of the comparable uncontrolled price method requires the highest degree of comparability with emphasis on both the object and other terms and conditions of the operation as well as on the functional analysis of the entities involved".

  9. As stated in the Arbitral Decision of 24-12-2012, issued in the context of Case no. 55/2012-T, "(...) the use of this method is only legal when there exists the highest degree of comparability and this must focus cumulatively on the object, terms and conditions of the operation, in addition to the functional analysis of the entities involved. In fact, the word «both» makes clear that we are not dealing with an alternative list of requirements, but rather a cumulative one".

  10. It happens that the financing operations in question (the operation that the AT chose as comparable and the related operation) have distinct characteristics that result in a deficient degree of comparability, given the degree of comparability required by law.

  11. In the first place, in the case of the internal comparable operation, a maturation period of 3 years is involved, while in the related operation the maturation period is 9 years.

  12. In the second place, the borrowed amounts to be considered are significantly different in the related operation and in the "comparable operation" given that in the related operation the borrowed amount is manifestly superior to that of the comparable operation (€5,300,000.00).

  13. In this way, it is concluded that the AT fails to prove the practice, in the related operation, of conditions different from those normally would be agreed between independent entities.

  14. On the other hand, the AT's rejection of the conclusions of the D… Report is based on the fact that it was based on a "set of 291 observations generically comparable", without taking into account (by allegedly D… having "committed an error") the specific purpose of the operation, which is considered to be manifestly insufficient to prove the inappropriateness of the comparable selected by that entity.

  15. Indeed, the AT argues that: "The justification presented by the taxpayer [regarding the interest rate applied in the financing operation now in dispute] was extracted from a database that aggregates information relating to the interest rates used in the remuneration of various debt securities, issued in markets worldwide, throughout the year 2010." (p. 10/28 of the RF).

  16. And concludes "we are not in the presence of comparable operations, either as to their nature or as to their territorial extent, that would permit validating the rates practiced between related entities (...)" (p. 10/28 of the RF).

  17. The AT does not explain, however, the reasons why it understands that the operations in the sample considered in the D… Report are not comparable to the related operation under test, not justifying what the different nature is between the Loan and a bond financing that would make them incomparable or what territorial extent would be acceptable.

  18. Recall that it was incumbent upon the AT to prove the verification of the requirements for the corrections provided for in Article 63 of the CIT Code[2]. However, it does not do so.

  19. Thus, and in conclusion, the correction made by the AT is deemed to be illegal, for improper application of the norms relating to transfer pricing.

  20. The tax assessment that was based on the aforementioned fixing of taxable income suffers, therefore, from the vice of error as to the legal requirements, which justifies its annulment, pursuant to Article 163 of the Code of Administrative Procedure, applicable pursuant to the provisions of Article 29, subparagraph c), of the RJAT.

  21. Concluding on the illegality of the contested tax assessment, the Tribunal must decide a second issue, which concerns whether or not compensatory interest is owed to the Claimant.

  22. Article 43, no. 1 of the General Tax Law provides that:

"Compensatory interest is owed when it is determined, in gracious reclamation or judicial challenge, that there was an error attributable to the services that results in payment of the tax debt in an amount greater than the legally due amount".

  1. It is considered that "[t]he error attributable to the services that operated the assessment is demonstrated when they proceed to gracious reclamation or challenge of that same assessment and the error is not attributable to the taxpayer" (DIOGO LEITE DE CAMPOS, BENJAMIM SILVA RODRIGUES, JORGE LOPES DE SOUSA, General Tax Law. Annotated and Commented, 4th ed., Lisbon, 2012, p. 342).

  2. The law further provides, in Article 100 of the General Tax Law, that:

"The tax administration is obliged, in the event of total or partial success of claims or administrative appeals, or of judicial proceedings in favor of the taxpayer, to immediately and fully restore the situation that would have existed if the illegality had not been committed, including the payment of compensatory interest, pursuant to the terms and conditions provided by law."

  1. As stated in the Decision of the Supreme Administrative Court of 11/02/2009, Case no. 1003/08,

"Having the legislator adopted compensation in the form of compensatory interest, following a decision annulling a tax assessment, presuming the patrimonial injury resulting from the deprivation of the amount paid as a result of a decision annulling an illegal assessment, the interpretation of Article 100 of the LGT in accordance with the Constitution is that it recognizes the right to compensatory interest from the date on which the deprivation of the amount illegally assessed occurred and not only from the end of the deadline for execution of the decision annulling the assessment."

  1. In the present proceedings, we are faced with an assessment based on legal error attributable to the services, from which resulted the unduly payment of tax liability by the Claimant, wherefore the right of the Claimant to the refund of the unduly paid amount and to compensatory interest is recognized.

  2. Pursuant to no. 1 of Article 61 of the Code of Tax Procedure and Process (CPPT), "[i]nterest is counted from the date of unduly paid tax until the date of processing of the respective credit note, in which they are included".

IV. Decision

Accordingly, and with the grounds set out above, the Arbitral Tribunal decides:

a) To uphold the request for arbitral decision and, consequently, to annul the contested assessment, with all legal effects;

b) To uphold the request for condemnation of the Respondent to payment of compensatory interest, at the legal rate, pursuant to the provisions of Articles 43 of the General Tax Law and 61 of the Code of Tax Procedure and Process.

V. Value of the Case

The value of the case is fixed at €15,583.57, pursuant to the provisions of Article 97-A, no. 1, subparagraph a), of the Code of Tax Procedure and Process and Article 3, no. 2, of the Regulation of Costs in Tax Arbitration Proceedings.

VI. Costs

In accordance with the provisions of Article 22, no. 4, of the RJAT, the amount of costs is fixed at €918.00, pursuant to Table I attached to the Regulation of Costs in Tax Arbitration Proceedings, to be borne by the Respondent.

Lisbon, 08 May 2015

The Arbitrator,

Paulo Nogueira da Costa

[1] In this sense, see Decision of the Central Administrative Court South of 09-04-2002, Case 1573/98.

[2] See, among others, Decision of the Central Administrative Court South, of 18 December 2008, issued in the context of Case no. 02515/08.

Frequently Asked Questions

Automatically Created

What are non-deductible financial charges under Portuguese IRC rules?
Non-deductible financial charges under Portuguese IRC rules are interest expenses and other financial costs that fail to meet specific legal requirements for tax deductibility. Under Article 23 of the CIRC, financial charges must be incurred for business purposes, properly documented, and commercially justified. Article 63 of the CIRC specifically addresses transfer pricing aspects, requiring that intercompany financial transactions between related entities comply with the arm's length principle. Financial charges may be deemed non-deductible when: (1) interest rates exceed market conditions for similar transactions between independent parties; (2) the debt-to-equity ratio is considered excessive (thin capitalization rules apply); (3) the loan serves no valid business purpose beyond tax avoidance; (4) proper transfer pricing documentation is lacking; or (5) the charges relate to capitalized interest on previously unpaid interest (compound interest) that doesn't reflect arm's length conditions. The Tax Authority may also disallow deductions for financial charges related to transactions that lack economic substance or where the terms significantly deviate from what would be agreed between unrelated parties under comparable circumstances.
How does Article 63 of the CIRC regulate transfer pricing for financial expenses?
Article 63 of the CIRC establishes the transfer pricing framework for financial expenses between related entities, requiring that intercompany financial transactions, including loans and interest charges, comply with the arm's length principle as defined by OECD guidelines. This article mandates that the terms and conditions of financial arrangements between associated enterprises (companies under common control or ownership) must reflect what independent parties would agree under comparable circumstances. For financial charges, this means examining: (1) the interest rate applied compared to market rates for similar risk profiles and loan terms; (2) whether the borrowing company could have obtained similar financing from independent lenders; (3) the business justification for the loan structure and amount; (4) whether the lender would have provided similar terms to an unrelated party; and (5) compliance with documentation requirements under Portaria 1446-C/2001 for transfer pricing documentation. Article 63 empowers the Tax Authority to adjust declared taxable income when financial charges don't meet arm's length standards, recalculating deductible interest based on comparable market conditions. The burden of proof regarding arm's length compliance generally falls on the taxpayer, who must demonstrate through contemporaneous documentation that the financial terms are consistent with independent party transactions.
Can a company challenge an IRC tax assessment on financial charges at CAAD arbitration?
Yes, companies can challenge IRC tax assessments on financial charges through CAAD (Centro de Arbitragem Administrativa) arbitration under the Legal Framework for Tax Arbitration (RJAT - Regime Jurídico da Arbitragem em Matéria Tributária), approved by Decree-Law 10/2011 of January 20. Article 2(1)(a) of the RJAT grants taxpayers the right to submit disputes concerning the legality of tax acts to arbitration, including challenges to IRC assessments resulting from corrections to financial charges and transfer pricing adjustments. The arbitration process provides an alternative to judicial courts for resolving tax disputes, offering advantages such as faster resolution (typically within 6 months), specialized arbitrators with tax expertise, and lower costs. To initiate arbitration at CAAD for financial charges disputes, the taxpayer must: (1) file a request within the legal deadline (generally 90 days from notification of the final administrative decision); (2) specify the contested tax assessment and the legal grounds for challenge; (3) pay the required arbitration fee; and (4) comply with procedural requirements under the RJAT and CPPT (Tax Procedure Code). The arbitral tribunal has full jurisdiction to review both the factual and legal basis of the Tax Authority's corrections, including whether financial charges meet deductibility requirements under Article 23 and transfer pricing rules under Article 63 of the CIRC, and can annul or modify the assessment accordingly.
What are the legal requirements for financial charges to be fiscally deductible in Portugal?
For financial charges to be fiscally deductible in Portugal under IRC rules, they must satisfy several cumulative legal requirements established primarily in Articles 23 and 63 of the CIRC. First, the charges must comply with the general deductibility criteria under Article 23: (1) they must be costs incurred in the taxpayer's interest and for business purposes (indispensability test); (2) they must be properly documented with supporting contracts, invoices, and payment evidence; (3) they must be recorded in accordance with accounting standards and reflected in the fiscal year's accounts; and (4) they cannot be excluded by specific provisions of the CIRC. Second, for intercompany financial charges between related entities, Article 63 requires arm's length compliance - the interest rate, loan amount, terms, and conditions must reflect what would be agreed between independent parties under comparable circumstances. Third, thin capitalization rules may limit deductibility when debt levels are excessive relative to equity, though Portugal has adopted the OECD BEPS approach limiting interest deductibility based on EBITDA rather than traditional debt-to-equity ratios. Fourth, proper transfer pricing documentation must be maintained contemporaneously, demonstrating the business rationale and market conformity of the financial arrangement. Fifth, the charges must relate to loans used for business purposes rather than non-deductible applications. Failure to meet any of these requirements may result in partial or total disallowance of the financial charge deductions by the Tax Authority during inspections.
How does the Portuguese Tax Authority assess transfer pricing adjustments on intercompany financial charges?
The Portuguese Tax Authority assesses transfer pricing adjustments on intercompany financial charges through a systematic inspection process combining documentary review, comparative analysis, and economic substance evaluation. The assessment methodology typically involves: (1) Reviewing the intercompany loan agreement and related documentation to understand terms, conditions, interest rates, repayment schedules, and amendments; (2) Examining the taxpayer's transfer pricing documentation file (required under Portaria 1446-C/2001) to verify whether contemporaneous analysis supports arm's length compliance; (3) Conducting comparability analysis using databases (such as Bloomberg, Amadeus, or local market data) to identify interest rates for comparable transactions between independent parties, considering factors like loan amount, duration, currency, borrower's credit rating, existence of guarantees, and economic conditions; (4) Applying functional analysis to determine whether the lender performs functions and assumes risks justifying the return (interest rate); (5) Evaluating economic substance - whether the borrowing served a valid business purpose beyond tax optimization, and whether the borrower could have obtained similar financing from independent lenders (debt capacity analysis); (6) Identifying red flags such as capitalization of interest (compound interest arrangements), rates significantly above market, loans coinciding with equity transactions, or circular financing structures within the group. When the Tax Authority determines non-compliance, it issues corrections adjusting taxable income to reflect arm's length conditions, typically recalculating deductible interest using comparable market rates and may disallow amounts exceeding this benchmark. Taxpayers receive notification of proposed corrections and can present defense arguments before final assessment issuance.