CAAD Ruling on IRC Transfer Pricing Adjustments and Tax Inspection Legality (2010-2011)

The arbitrators Dr. Jorge Lopes de Sousa (chairman arbitrator), Prof. Dr. Maria do Rosário Anjos and Dr. Luís Janeiro, designated by the Ethics Council of the Administrative Arbitration Centre to form the Arbitral Tribunal, constituted on 23-12-2014, hereby agree as follows:

1. Report

A…, S.A., with NIPC …, with registered office at … nos …/…, in …, covered by the Tax Authority … Porto - 2, (hereinafter referred to as "CLAIMANT"), filed a request for constitution of an arbitral tribunal in accordance with the provisions of articles 2 and 10 of Decree-Law no. 10/2011 of 20 January (hereinafter RJAT) and of articles 1 and 2 of Order no. 112-A/2011 of 22 March, in which the Tax and Customs Authority is named as Respondent.

The Claimant requests the annulment of the following corporate income tax assessments numbered 2014 … and 2014 …, both dated 12-05-2014, in the amounts of €454,738.04 and €456,618.10 respectively, as per documents nos. 1 and 2 attached to the arbitral request.

The disputed assessments gave rise to Accounts Reconciliation Statements, in which the amounts to be paid are identified and notified, with reference to the years 2010 and 2011, as appears from documents nos. 3 and 4 attached to the arbitral request.

The disputed assessments resulted from acts of correction and determination of taxable income relating to corporate income tax for the years 2010 and 2011, carried out by the Porto Tax Authority, through decisions dated 30 April 2014 by the Head of Division, by subdelegation of the Deputy Director of Finance, on the basis of the Tax Inspection Report produced on 23/4/2014, attached to the case file as document no. 7 attached to the PI, which carried out "merely arithmetic corrections" that gave rise to the additional assessments hereby disputed.

From the Accounts Reconciliation Statements, the following summary results:

A) Regarding corporate income tax for 2010:

– Document no. 2014 … / Compensation No. 2014 …, of 2014-05-19;

– Taxable Profit Declared in the Year of €356,237.90; Corrections of €1,514,306.06; Taxable Income of €1,870,543.96;

– Additional assessment 2014…, of €408,022.99 plus Late Payment Interest (Assessment no. …) of €19.45 and Compensatory Interest (Assessment no. …) of €46,695.60, in a total, after writebacks/regularizations due, of €454,738.04;

– In accordance with the notification of the "accounts reconciliation" document with the payment deadline of 2014-07-16.

B) Regarding corporate income tax for 2011:

– Document no. 2014 … / Compensation No. 2014…, of 2014-05-26" (Corporate Income Tax 2011 – DOC. NO. 4):

– Taxable Profit Declared in the Year of €616,122.42; Corrections of €1,574,935.47; Taxable Income of €2,191,057.89; Additional assessment No. 2014…, in the amount of €424,431.11 plus Compensatory Interest (Assessment no. …) in the amount of €32,186.99, in a total, after writebacks/regularizations due, of €456,618.10;

– In accordance with the notification of the "accounts reconciliation" document with the payment deadline of 2014-07-23.

The Claimant requests the annulment of these assessments on grounds of illegality, in accordance with article 99 of the CPPT, as they constitute clear violation of law, in particular by violation of the rules established in article 63 of the Corporate Income Tax Code, concerning the so-called "transfer pricing," and its respective regulation set forth in Order no. 1446-C/2001 of 21 December.

In the arbitral request filed, the Claimant invokes as a preliminary issue the illegality of the inspection procedure, insofar as, being a taxpayer covered by the PNAIT, it is unlawful for the motivation justifying its initiation by the Tax Authority, violating the principle of tax legality, which encompasses the rules of the tax inspection procedure – cfr. item e) of no. 2 of article 8 and item h) of no. 1 of article 54 of the LGT; no. 2 of article 44 of the CPPT. It further considers that the inspection procedure is unlawful for not corresponding to any of the legally provided grounds for initiating an inspection, as well as for constituting a serious violation of the minimum status of the Taxpayer that stems from constitutionally protected fundamental rights, insofar as the initiation of the inspection procedure is a consequence of the taxpayer's exercise of a legitimate right to reimbursement of a tax, with the inspection assuming a repressive nature, even sanctionatory, lacking the legal foundation required for any procedural decision, in violation of what is established in no. 1 of article 77 of the LGT. The Claimant alleges that the tax fact that led to the corrections made to the tax result declared in the years 2010 and 2011 is not adequately substantiated, firstly because the alleged special relationships justifying those corrections do not exist, and secondly, because it does not describe the terms in which operations of the same nature normally take place between independent parties in identical circumstances, arguing for the annulment of the disputed tax assessments.

The Claimant further alleges a set of grounds for illegality of the disputed assessments, namely:

a) Illegality resulting from flagrant disregard of the principle of adversarial procedure and the right to prior hearing;

b) Illegality of the additional autonomous taxation assessment (invokes for this purpose the case law of the Decision of 6 July 2012, Proc. no. 281/11, 2nd Section and of the Constitutional Court, in Decision no. 617/2012, of 19 December 2012, Proc. no. 150/12);

c) Illegality of the additional assessment relating to travel expenses not accepted as deductible;

d) Illegality of the acts of additional assessment of corporate income tax for 2010 and 2011 based on the "Transfer Pricing Regime," provided for in article 63 of the Corporate Income Tax Code and Order 1446-C/2001, insofar as the Inspection Report proceeded from the assumption of special relationships which in the claimant's view do not exist.

For this purpose, the Claimant alleges that the provision of item h) of no. 4 of article 63 of the Corporate Income Tax Code – Special relationships by virtue of irrebuttable presumption or legal fiction, is unlawful and unconstitutional. In the case at hand, according to the Claimant, the Tax Authority places in evidence the existence of commercial relationships of the CLAIMANT with an entity subject to a more favorable tax regime, asserting that the hypothesis contained in the cited item h) of no. 4 of article 63 of the CIRC is satisfied. It alleges that, "the Tax Authority takes advantage of the irrebuttable presumption or legal fiction of the existence of special relationships, a solution violating the constitutional principles of Taxpaying Capacity and Proportionality. Insofar as the non-existence, as a matter of fact, real, of special relationships, makes it impossible to comply with the generality of the ancillary obligations that are regulated in terms of information and documentation by Order no. 1446-C/2001, inevitably leading to placing the taxpayer in an indefensible situation. Effectively, it becomes impossible to maintain a record of the criteria justifying the price practiced, once one is faced with a situation of non-existence of a true special relationship, in particular, of any control or dependence, in which the business relationship has a singular nature, that is, when it is a unique contract, in the sense that the taxpayer only entered into "one," with atypical configuration, in a context of lack of public, "market" elements!

It further adds that, by preventing the taxpayer from rebutting the presumption or, with the same result, by not conferring any legal effect to the demonstration it makes regarding the non-existence of special relationships, it exposes the taxpayer, in a particularly burdensome manner, to attack by the Tax Authority via the assertion of violation of the arm's length principle, and to the automatic application of the rules of the regime established for its protection, in terms that, necessarily and inevitably, lead to burdensome taxation via corrections to taxable income. Such irrebuttable presumption or legal fiction is clearly unlawful, insofar as it legitimates the effectuation of corrections that lead to (further) taxation, illegality that results from its absolute character, insofar as it is unconstitutional by violation of the principle of taxpaying capacity, which is therefore shown to be unconstitutional.

The provision of subitem 3 of item g) of no. 4 of article 63 of the CIRC. There never existed any power to exercise influence in decision-making by the A… in the B…. For all these reasons, the assessments suffer from error as to their prerequisites as well as because the Tax Authority, not contenting itself with resort to the irrebuttable presumption, proceeded to attempt to demonstrate the existence of special relationships in accordance with the hypothesis of subitem 3 of item g) of no. 4 of article 63 of the CIRC, i.e., the demonstration of the existence of relationships in which there is a situation of dependence in the exercise of the activity of one of the entities. The Tax Authority decided to declare that "a substantial part of the activity of this entity can only be carried out with the other or depends on decisions of the other," namely, a substantial part of the activity of B… can only be carried out or depends on decisions of the CLAIMANT. It further alleges the illegality of the methods applicable by the Tax Authority, which stem from error as to the prerequisites, namely the comparability method used by the Tax Authority. Beyond all this, the Tax Authority made an erroneous assessment of the management activity developed by the Claimant, disregarding other aspects of differentiation and singularity – atypicality – of the service provided. The terms and conditions contracted by the CLAIMANT with the entity that the Tax Authority considered to be in special relationships are significantly different from the terms and conditions of the services contracted with the entities, clients of the CLAIMANT, which the Tax Authority used to compare those terms and conditions because the services are not comparable. Thus, neither by the nature and characteristics of the service, nor by the nature of the contracting entity, nor by the commercial and legal context, are such situations comparable.

It invokes in support of its thesis the Decision of 2012.10.29, of the Arbitral Tribunal of the CAAD – Proc. 76/2012 - T, whose case law was reiterated, e.g. Decision of Proceedings no. 112/2013.

It concludes, alleging that the tax fact that led to the corrections made to the tax result declared in the years 2010 and 2011 is not adequately substantiated, firstly because the alleged special relationships justifying those corrections do not exist, and secondly, because it does not describe the terms in which operations of the same nature normally take place between independent parties in identical circumstances. Thus, pursuant to article 100 of the Tax Procedure and Procedure Code, "whenever from the evidence produced there results a well-founded doubt about the existence and quantification of the tax fact, the disputed act must be annulled."

The request for constitution of an arbitral tribunal was filed on 15/10/2014 and was accepted by the President of the CAAD and notified to the Tax and Customs Authority on 17-10-2014.

Pursuant to the provision of item a) of no. 2 of article 6 and item b) of no. 1 of article 11 of the RJAT, the Ethics Council designated as arbitrators of the collective arbitral tribunal the signatories, who communicated acceptance of the appointment within the applicable period.

On 05-12-2014 the parties were duly notified of this appointment, and neither party expressed an intention to refuse the appointment of the arbitrators, in accordance with the combined provisions of article 11, no. 1, items a) and b) of the RJAT and articles 6 and 7 of the Ethics Code.

In accordance with the provision of item c) of no. 1 of article 11 of the RJAT, the collective arbitral tribunal was constituted on 23-12-2014.

The Tax and Customs Authority responded on 03/02/2015, defending the dismissal of the request for arbitral ruling and raised the exception of lapse of the right to appeal.

The claimant filed a motion with the case file in which it responded to the exception of lapse of the appeal raised by the Tax Authority, which was admitted and attached to the case file.

On 16-03-2014 the meeting provided for in article 18 of the RJAT took place, intended for the production of testimonial evidence. The parties, Claimant and Respondent, waived the production of testimonial evidence and expressed interest in the presentation of written submissions, whereby the Tribunal fixed for both a period of 15 days to proceed with their presentation. It also set the date for pronouncement of the Decision until 29/05/2015, with notice to the Claimant that within the same period it should proceed with payment of the subsequent arbitral fee.

The Claimant presented its Submissions which are attached to the case file.

The parties have legal personality and capacity, are legitimate and are duly represented (articles 4 and 10, no. 2, of the same instrument and article 1 of Order no. 112-A/2011 of 22 March).

The proceeding is not affected by nullities and no obstacle arises to the consideration of the merits of the case.

1. Facts

2.1. Proven Facts

With relevance to the final decision, the following facts are considered proven:

a) The Claimant B… is a limited company managing assets, whose activity, regulated by law, has as its exclusive purpose the management of client portfolios and advisory services for investments in financial instruments.

b) The Claimant, in developing this asset management activity, undertakes various actions to attract and retain clients;

c) Its activity consists in managing the fortunes or part thereof that its clients entrust to it for management;

d) Although client assets may consist of any property or asset, as a rule clients only place under management part of their more liquid assets, consisting of money or other financial instruments;

e) These types of asset management companies are prohibited (article 7 of Decree-Law no. 163/94) from, in particular, accepting deposits, granting credit, acquiring real property beyond the limit of their own capital, or acquiring for their own account securities except public debt;

f) Practically all profits of the company result from management or advisory commissions charged to clients;

g) In the periodic VAT return for April 2013, the Claimant presents a tax credit of €162,705.28;

h) The Claimant presented itself as a VAT creditor since 2007;

i) Following the Claimant's submission of a request for VAT refund to the Tax Administration, an external audit action was ordered through service orders nos. OI…, OI…, OI… and OI…, sent to the Claimant's address by official letters dated 2013-09-23;

j) Within the scope of the audit action, the Tax and Customs Authority prepared the Report that appears in the administrative file, the contents of which are hereby deemed fully reproduced;

k) The summary of the conclusions of the Inspection Report refers to the following corrections in corporate income tax:

l) With these corrections the taxable profit for the periods in question became:

m) Corrections were made to autonomous taxation resulting from travel expenses, as follows:

n) The set of expenses in question, with respect to travel expenses considered in the autonomous taxation corrections, relates mainly to trips and stays of the Chairman of the Board of Directors of the A… and/or representatives of Institutional clients of the A…, as well as persons who are referenced by these institutional clients for training with the A…;

o) The names of the persons in question and the functions performed are the following:

a. C…, corresponds to C…. (Chairman of the Board of Directors of the A…, for the three-year period of 2009 and 2011); CFR: Docs. Contab._2010 – …, …, …, …, 2011 – …, .;

b. D…, representative of Bank E… (Angolan banking financial institution, client of the A… since 30 July 2007); Docs. Contab._2011 – …, …, …, …, …;

c. F…, representative of Bank M… (currently Bank M…, Angolan banking financial institution, client of the A… since 1 March 2007); Docs. Contab._2011 – …, …;

d. G…, representative of Bank E… (Angolan banking financial institution, client of the A… since 30 July 2007); Doc. Contab._2011 – …;

e. H…, representative of Bank N… (Angolan banking financial institution, client of the A… since 18 November 2009); Doc. Contab._2011 – …;

f. I…, referenced for training by Bank E…; Doc. Contab._2011 – …;

g. J…, O…, P… and Q…, were referenced by Bank E…; Docs. Contab._2011 – …, … and …;

h. K…, representative of Bank N…; Doc. Contab._2011 – 100059;

i. L… (Linked Agent of the A…) – Doc. Contab._2011 – 50080;

p) The fixing of commissions depends on free negotiation between the parties, the level of competition and the increasing sophistication of clients;

q) The high level of competition among similar companies led to the value of commissions becoming increasingly reduced, often assuming the nature of a fee arrangement in which the services are fixed during the management mandate;

r) This situation is internationally recognized in the 2013 report of EFAMA (European Fund and Asset Management Association, www.efama.org) – Cfr. DOC. NO. 8 attached to the PI;

s) The acquisition of investors with high net worth is a difficult task, as they are sophisticated investors, knowledgeable about markets and accustomed to dealing with many financial intermediaries, which implies a continuous effort of client support;

t) Some of the trips and stays in question in the autonomous taxation correction relate to clients of the A...;

u) Some Institutional Clients, which represent high-value assets, are foreign clients who enter Portugal using the city of Lisbon;

v) From the analysis of the Tax Inspection Report relating to the audit action carried out, it concludes that the commercial relationship between the A... and the B... is a relationship between a resident entity (the first) and an entity subject to a clearly more favorable tax regime (the second), insofar as the latter is resident in the Cayman Islands, a territory that appears in Order no. 150/2004, of 13 February, updated by Order no. 292/2011 of 08/11, as having a privileged tax regime;

w) The A... supplies approximately 90% of the total value that makes up the investment fund of the B... and approximately 90% of the management commission that the latter charges to the fund R...is dependent on the decision, or not, of subscription of the latter by the A...;

x) The executive director of the fund R...and its Managing Entity (B...) is S…, who develops activity with Clients, suppliers, shareholders and directors of the A... and other companies in the group T…

y) The Claimant exercised its right to hearing, although it requested an extension of the period for this purpose, from 15 to 25 days, which was denied by the Tax Authority, as appears best from the Final Report which is hereby reproduced for this purpose;

z) The arguments put forward by the Claimant in the hearing were completely disregarded;

aa) The final Report confirmed the elements set forth in the Draft Report previously notified to the Claimant;

bb) From the mentioned fixing of the taxable income of corporate income tax for the years 2010 and 2011, by reason of the mentioned "merely arithmetic corrections" and the consequent additional assessments, resulted, as per the ACCOUNTS RECONCILIATION STATEMENTS, the following values determined and additional tax assessments:

a. Corporate income tax, 2010 – "Doc. no. 2014 …/Nr. Compensation 2014 …, of 2014-05-19", attached to the case file as document No. 3, from which results a Taxable Profit Declared in the Year of €356,237.90; Corrections of €1,514,306.06; Taxable Income of €1,870,543.96 and additional Assessment no. 2014 …, of €408,022.99, Late Payment Interest (Ass. …) of €19.45 and Compensatory Interest (Ass….) of €46,695.60, in a total, after writebacks/regularizations due, of €454,738.04; in accordance with the notification of the "accounts reconciliation" document with the payment deadline of 2014-07-16;

b. Corporate income tax, 2011 – "Doc. no. 2014 …/Nr. Compensation 2014 …, of 2014-05-26", from which results a Taxable Profit Declared in the Year of €616,122.42; Corrections of €1,574,935.47; Taxable Income of €2,191,057.89; Additional assessment (Ass. 2014 …) of €424,431.11, Compensatory Interest (Ass. …) of €32,186.99, in a total, after writebacks/regularizations due, of €456,618.10, with payment deadline of 2014-07-23;

cc) The corporate income tax fixing notes, attached in annex to the Inspection Report, are grounded in the Inspection Report and the authorship of the Head of Division there better identified, referring only to the corrections of "Taxable Income of the General Regime" (as best appears from the analysis of said notes) by reason of transfer pricing;

dd) The corporate income tax fixing notes, having as grounds the Report and the authorship of the Head of Division, only refer to the corrections by reason of transfer pricing;

ee) There is no act of correction of the taxable income of autonomous taxation.

Unproven Facts

There are no unproven facts to register, with relevance to the decision to be rendered in the case.

Basis for the Fixing of the Facts

The fixing of the facts is based on the administrative file and the documents attached with the request for arbitral ruling.

1. Legal Matters

3.1. Preliminary Issue: the Invoked Exception of Lapse of the Right to Appeal

The Tax and Customs Authority raises the issue of lapse of the right to appeal as regards the assessment for the year 2010, on the grounds that the deadline for voluntary payment ended on 16-07-2014, the request for arbitral ruling was filed on 15-10-2014, and the deadline for filing the request for arbitral ruling ended on 14-10-2015, this being a 90-day period, in accordance with articles 10, no. 1, item a), of the RJAT and 102, no. 1, item a), of the CPPT.

The Claimant responded, stating, among other things, that the Tax and Customs Authority misinformed it about the deadline for appeal, by informing it that it could do so within the deadline provided for in article 102 of the CPPT, which is three months.

In fact, in the notification made by the Tax and Customs Authority regarding the assessment for the year 2010, the following was stated:

"You may appeal or challenge in accordance with the terms and deadlines established in articles 137° of the CIRC and 70° and 102° of the CPPT, counted continuously from the date of this notification, which is deemed effected at the moment the recipient accesses the electronic mailbox or, in case of failure to access the same, on the 25th day following its sending."

For a long time courts have adopted the understanding that recipients of acts of the Public Administration should not be prejudiced in the exercise of procedural rights when misled by acts of competent public entities, a rule that has explicit manifestations, for courts, in article 157, no. 6, and article 191, no. 3, of the CPC of 2013 (previous articles 161, no. 1, 198, no. 3) and ( [1] ) and for acts of the administration, in article 7 of the CPA and article 60, no. 4, of the CPTA ( [2] ) ( [3] ).

That is, it has been understood, in summary, insofar as is relevant here, that when an administered party is induced to exercise a facultative power within a certain period by conduct of the Administration, it cannot be prejudiced if the indication of that deadline does not correspond to what should have been indicated.

This is a rule that is a corollary of the constitutional principle of good faith, imposed on the generality of the activity of the Public Administration (article 266, no. 2, of the CRP), and therefore, at least when there is a duty to inform by part of the Administration, assumes greater legal relevance than the rules that provide for periods for the exercise of rights.

Moreover, the situation is perfectly analogous to that provided for in the cited article 191, no. 3, of the CPC, in which it provides that "if the irregularity consists in having indicated for the defense a deadline longer than what the law grants, the defense must be admitted within the deadline indicated, unless the plaintiff has the defendant cited again in proper terms."

In the case at hand, it is unquestionable that the Tax and Customs Authority had the duty to inform the Taxpayer of the deadline it had to react against the notified act (article 36, no. 2, of the CPPT) and did not carry out any notification to the Claimant in which it had been indicated a 90-day period, having made a referral to article 102 of the CPPT, in which a period of three months is provided.

On the other hand, the formula used by the Tax and Customs Authority in the said notification, which was "appeal or challenge," does not contain specific reference to any procedural means, in particular to the judicial appeal process, so it is interpretable as referring to the generality of appealing means, including the tax arbitration process. Thus, one is faced with incorrect information rather than an omission of information.

As regards the alleged violation of the principles of the Rule of Law, in its aspect of protection of legal certainty, and equality, embodied, respectively, in articles 2 and 13 of the Constitution, it is not apparent how they can be placed in question by the possibility of filing the request for arbitral ruling within a period of three months, as the fact that article 102, no. 1, of the CPPT refers to three months as the normal period for judicial appeal, plainly reveals that, before those three months are completed, there is no consolidation of the legal situation created with the assessment, nor is there any reason for the Tax and Customs Authority to be assured that the assessment will not be challenged.

Furthermore, there is also no apparent violation of the principle of equality, as the regime resulting from the indicated rules, applicable whenever the Public Administration provides incorrect information about deadlines for reacting against its acts, is applicable to all situations in which such information errors occur. What would constitute a violation of the principle of equality would be to treat situations in which the Tax and Customs Authority provides incorrect information about the deadline for reaction in the same way as those in which the recipient of the assessment act is provided with correct information.

Thus, it must be concluded that, in this case in which the Tax and Customs Authority did not indicate another deadline in the notification, the applicable period is three months, whereby the filing of the request for arbitral ruling within that period is timely.

Therefore, the exception raised is dismissed.

3.2 Substantive Issue to be Decided

The Claimant raises the issues in a determined order, placing several as "preliminary issues," from which it is inferred that it intends the order of consideration indicated to be followed, with priority consideration of those indicated as "preliminary."

Thus, not being faced with any situation of nullity, in light of what is provided for in article 133 of the Administrative Procedure Code of 1991, the order indicated will be followed, in accordance with the provision at the end of item b) of no. 2 of article 124 of the CPPT, applicable to tax arbitration proceedings by virtue of the provision of article 29, no. 1, item c), of the RJAT.

However, as that rule of the CPPT provides that the aim should be the most stable or effective protection of offended interests, if it is to be judged that the request for arbitral ruling is well-founded for some defect that ensures this protection, the consideration of the remaining matters will be barred, which is a corollary of the principle of prohibition of performance of useless acts, enunciated in article 130 of the CPC subsidiarily applicable by virtue of the provision of article 29, no. 1, item e), of the RJAT.

3.2.1. Issue of Illegality of the Inspection Procedure

The Claimant argues that there is violation of the legal principles applicable to the tax procedure, in particular the principles of legality, impartiality, good faith and participation – cfr. articles 55 to 60 of the LGT, because inspection actions must comply with the National Plan for Tax Inspection Activity (PNAIT), as established in no. 1 of article 23 of the Complementary Tax Inspection Procedure Regime (RCPIT) and the Inspection Report does not identify, in any manner, the terms of its compliance with that plan.

The Tax and Customs Authority responds that article 23, no. 1 and no. 5 establishes that " (…) without prejudice to the possibility of carrying out other inspection actions," the activity of tax inspection complies with the PNAIT, the latter having to provide for part of the resources of tax inspection for inspection actions not expressly provided for therein, and that the inspection action was carried out under Service Order OI… (General/2010 and 2011), by virtue of evidence of the commission of tax violations having been extracted, and that item d) of article 27 of the RCPIT – under the heading "selection" – indicates the verification of significant deviations in the fiscal behavior of taxpayers or other obligated parties against parameters of normalcy that characterize the activity or patrimonial situation or of any acts or omissions that constituted evidence of tax violation.

Article 23 of the RCPIT, in the wording in force when the inspection was carried out, referred, in its no. 1, to the fact that "without prejudice to the possibility of carrying out other inspection actions, the activity of tax inspection complies with the National Plan for Tax Inspection Activities (PNAIT)."

Therefore, it is manifest, from the initial part of this rule, that inspections not included in the PNAIT could be carried out, which is confirmed by no. 5 of the same article in establishing that "the PNAIT must provide for the allocation of part of the resources of tax inspection for inspection actions not expressly provided for therein."

On the other hand, as the Tax and Customs Authority points out, article 27, no. 1, item d), of the RCPIT provides for the possibility of inspections being carried out when there are verified "significant deviations in the fiscal behavior of taxpayers or other obligated parties against parameters of normalcy that characterize the activity or patrimonial situation or of any acts or omissions that constitute evidence of tax violation," and in the case at hand, the Tax and Customs Authority understood that evidence of this type of violation was present.

In the case at hand, the carrying out of the inspection is explained in the Tax Inspection Report in these terms:

II – B) REASON, SCOPE AND TEMPORAL INCIDENCE

II – B.1) REASON FOR ACTION

In the periodic VAT return for April 2013, company A... requested a refund of this tax in the amount of €162,705.28.

This request for VAT refund gave rise to an internal inspection procedure, within which the following facts were ascertained:

– The A... is dedicated to portfolio management, from which result commissions subject and commissions not subject to VAT. The latter case occurs when clients are not resident in Portugal, such as Bank E… SARL and Bank U…

– The company had been in VAT credit position since July 2007, and requested its first VAT refund only in February 2013, in the amount of €30,000.00, despite the accumulated VAT credit reaching €195,390.16

In light of this justification, it must be concluded that the "Reason for action" was the Claimant having submitted a request for VAT refund.

In article 16 of the Response, the Tax and Customs Authority refers to the fact that "with the request for VAT refund resulted evidence, as appears from the justification contained in pages 1 to 5 of the A.F. which led the Inspection Services to change the scope of the inspection action from partial to general."

On those pages 1 to 5 of the administrative file the following is stated, as to grounds of inspection:

On page 1

"1 – AN INTERNAL SERVICE ORDER WAS ISSUED, … FOR ANALYSIS OF THE LEGITIMACY OF THE VAT REFUND REQUEST NO. … RELATING TO PERIOD 2013.04, IN THE AMOUNT OF €162,705.28, SELECTED WITH THE CODES 401 – REFUND SIGNIFICANTLY HIGHER THAN THE PREVIOUS.

2 – THE TAXPAYER WAS REQUESTED, BY OFFICIAL LETTER NO. … OF 2013… FOR VARIOUS ELEMENTS TO ASSESS THE LEGITIMACY OF THE REFUND REQUEST, NAMELY THE DESCRIPTION OF THE ACTIVITY ACTUALLY EXERCISED, TRIAL BALANCE OF THE LEDGER WITH MONTHLY AND ACCUMULATED MOVEMENTS, PHOTOCOPIES OF SOME RELATING TO THE AMOUNTS DECLARED IN FIELDS 3 AND 8 OF TABLE 06 OF THE PERIODIC RETURN FOR THIS PERIOD, ALL CLARIFICATIONS/ELEMENTS HAVING BEEN PROVIDED BY THE TAXPAYER.

3 – BY CONSULTATION TO SIIIT, IT IS FOUND THAT A VERIFICATION WAS CARRIED OUT IN INTERNAL ANALYSIS OF THE REFUND REQUEST NO. … IN THE AMOUNT OF €30,000.00, IN THE UGC – UNIT OF LARGE TAXPAYERS, DIVISION OF INSPECTION OF BANKS AND OTHER FINANCIAL INSTITUTIONS, PERIOD 201303, HAVING BEEN APPROVED IN FULL

4 – HAVING ANALYZED THE ELEMENTS PROVIDED, A PROPOSAL WAS DRAWN UP BY DIVISION II FOR EXTERNAL VERIFICATION OF THE REFUND PERIOD IN QUESTION – 2013.04, AND ALSO PARTIAL ACTION IN VAT AND CORPORATE INCOME TAX FOR THE YEARS 2010 AND 2011 WITH THE FOLLOWING GROUNDS:

a) THE TAXPAYER HAD BEEN IN VAT CREDIT SINCE 200712, HAVING MADE THE FIRST REFUND REQUEST IN 2013.03, IN THE AMOUNT OF €30,000.00 PROBABLY TO CIRCUMVENT THE REQUIREMENT OF A GUARANTEE, GIVEN THAT THE ACCUMULATED CREDIT IN THE PERIOD TOTALED €167,487.02;

b) AT THE DATE OF COMMENCEMENT OF ACTIVITY, THE TAXPAYER DECLARED A PROVISIONAL PRO-RATA OF 84%, MAKING IT NECESSARY TO CONFIRM THE CLASSIFICATION OF THE ACTIVITY EXERCISED AND THE VERIFICATION OF THE CALCULATION OF THE PRO-RATA CURRENTLY UPDATED.

c) INVOICES NOS. 2013… AND 2013… WERE PROVIDED BY THE TAXPAYER, BOTH OF 2013104/30 IN THE AMOUNT OF €167,269.60 AND €441,294.00 AND ISSUED RESPECTIVELY TO BANCO E…, SARL OF LUANDA AND BANCO U… OF LUANDA, IT APPEARS NECESSARY TO PROVE THE MATERIALITY OF THESE AND OTHER OPERATIONS OF THIS TYPE AND THEIR CLASSIFICATION IN VAT, EXTERNAL SERVICE ORDER REQUESTED BY DIVISION II."

Page 2 of the administrative file is blank.

Page 3 of the administrative file, as to possible grounds for inspection, contains:

– a dispatch partially illegible that can be understood to refer to "refund analysis";

A point 3 in which it states: "It is proposed the external analysis of: refund request from 2013.04 and years 2010 and 2011 in accordance with information relating to internal credential …, of which a photocopy is attached."

Page 4 of the administrative file is blank.

Pages 5 and 6 of the administrative file contain information with the following content:

INFORMATION

A. An internal Service Order was issued, OI… for analysis of the legitimacy of the VAT refund request no.…, relating to the period 2013.04, in the amount of 162,705.28€, selected with the codes: 401 – Refund significantly higher than the previous.

B. The taxpayer is registered with CAE …, Fund Management Activities, since 01-03-1991, having been classified in the normal VAT regime, with monthly periodicity. Indeed, the activity exercised, as per the explanation sent by the taxpayer "A A... is an investment company subject to the provisions of the Securities Code and DL 163/194, having as its exclusive purpose the management of portfolios and advisory services, activity from which commission revenues subject and not exempt from VAT (portfolio management and advisory services to resident clients) and commissions not subject to VAT (portfolio management and advisory services to non-resident clients).

C. The taxpayer was requested by official letter no. …/0505 of 12.06.2013 for various elements to assess the legitimacy of the refund request, namely the description of the activity actually exercised, trial balance of the ledger with monthly and accumulated movements, photocopy of some invoices relating to the amounts declared in field 3 and 8 of table 06 of the periodic return of this period. All clarifications/elements having been provided by the taxpayer.

D. By consultation to SIIT, it is found that verification was carried out in internal analysis of the refund request no. …, in the amount of 30,000.00€, in the UGC – Unit of Large Taxpayers, Division of Inspection of Banks and Other Financial Institutions (DIBIF) period 2013.03, having been approved in full.

E. Having analyzed the elements provided, a proposal was drawn up on this date for external verification of the refund request in question. 2013.04, and also partial action in VAT and corporate income tax for the years 2010 and 2011, for the following reasons:

• The taxpayer had been in VAT credit position since 2007.12, having made its first refund request in 2013,03, in the amount of 30,000.00€, probably to circumvent the requirement of a guarantee, given that the accumulated VAT credit in the period totaled 167,487.02€.

"At the date of commencement of activity the taxpayer declared a pro-rata of 84%. making it necessary to confirm the classification of the activity exercised and the verification of the calculation of the pro-rata currently used.

Invoices nos. 2013… and 2013… were provided by the taxpayer, both of 30.04.2013 in the amount of 167,269.60€ and 441,294.00€ and issued respectively, to Bank E…, SARL of Luanda and Bank U… of Luanda. It appears necessary to us to prove the materiality of these and other operations of this type and their classification in VAT

Given the foregoing, it is proposed the closure of this internal credential, …, with no further action.

Neither in the justification indicated in the Tax Inspection Report nor in the pages of the administrative file is there any reference to evidence of violation, it being clear that the sole ground invoked to justify the inspection was the fact that the Claimant submitted a VAT refund request of an amount "significantly higher than the previous."

However, if it is true that this fact justifies inspection in the VAT field, it remains to be clarified what reason was decided for carrying out the inspection as to corporate income tax for the years 2010 and 2011.

Namely, although the Tax and Customs Authority in the transcribed article 16 of the Response refers to the fact that "with the request for VAT refund resulted evidence, as appears from the justification contained in pages 1 to 5 of the A.F. which led the Inspection Services to change the scope of the inspection action from partial to general," in none of those pages is there any allusion to "evidence" nor to tax violation, and, as regards "evidence," only evidence of tax violation could justify inspection in the corporate income tax field, in light of item d) of no. 1 of article 27 of the RCPIT, invoked by the Tax and Customs Authority in article 17 of its Response.

On the other hand, if it is true that article 15, no. 1, of the RCPIT establishes that "the aims, scope and extent of the inspection procedure may be altered during its execution by reasoned dispatch of the entity that ordered it, and must be notified to the entity inspected," it is also true that the justification required, to be relevant, must explain the reason or reasons by which the deciding entity opted to order the extension.

Now, in the case at hand, it is not at all apparent what reason was decided for extending the inspection to corporate income tax and as to the years 2010 and 2011, when it was only necessary to ascertain the regularity of a VAT refund request, whereby the conclusion imposes itself that the dispatch that decided the extension is not justified as to this matter.

On the other hand, the Tax and Customs Authority did not even in the present arbitration proceeding invoke any other ground provided for in article 27 of the RCPIT for selection of the taxpayer to be inspected, other than item d) of no. 1 of article 27.

Being thus, not being able this Arbitral Tribunal to ascertain what reason or reasons were decided for carrying out the inspection in the field of corporate income tax relating to the years 2010 and 2011, it cannot but conclude that the decision to extend the inspection as to this matter was unlawful, which constitutes a defect with repercussion on the assessment act carried out based on the inspection procedure.

3.2.2. Issue of Illegality Due to Disregard of the Principle of Adversarial Procedure and the Right to Prior Hearing

During the inspection procedure, clarifications were requested from the Claimant, which it provided, in the terms that appear in document no. 8 attached with the request for arbitral ruling, the contents of which are hereby reproduced.

Subsequently, the Claimant was notified to exercise the right to hearing, within a period of 15 days, having requested that the period be extended to 25 days, in exercise of the provision of no. 6 of article 60 of the LGT, which was denied on the ground that the inspection procedure has special nature and the maximum 15-day period provided in article 60, no. 2, of the RCPIT, in the wording in force prior to Law no. 75-A/2014 of 30 September, is applicable.

In the request for arbitral ruling the Claimant does not contradict this interpretation of the Tax and Customs Authority regarding the special nature of the RCPIT deadline, coming only in the submissions to defend the unconstitutionality of the rule of article 60, no. 2, of the RCPIT, for reducing guarantees of taxpayers, without doing so through a law in the formal sense, as required by articles 103, no. 2, and 165, no. 1, item i), of the CRP.

But, for the issue of unconstitutionality raised not to be merely abstract (whose consideration is the responsibility only of the Constitutional Court in its own proceeding, in accordance with article 281 of the CRP), it is necessary that its concrete unconstitutionality be demonstrated. Now, in the case at hand, article 60, no. 6, of the LGT, which will have to be applied if the rule of article 60, no. 2, of the RCPIT is considered unconstitutional, also provides for the application of a 15-day period, and therefore only the eventual insufficiency of this period, derived from the "complexity of the matter" (as is referred to in this no. 6), to ensure the right of participation of taxpayers in the formation of the decision can lead to a judgment in the sense of violation of the guarantees of taxpayers.

In the case at hand, although the Claimant refers, in the request for arbitral ruling, to being prevented, by the non-extension of the period it intended, from presenting additional elements and clarifications to those presented during the inspection, it does not even invoke the "complexity of the matter," whereby one would not be faced with a situation in which, applying article 60, no. 6, of the LGT, it would be appropriate to extend the normal 15-day period provided for the exercise of the right to hearing. Moreover, the Claimant does not indicate which additional elements and clarifications it was unable to provide in the 15 days and could obtain or provide in the additional 10 days it intended.

Therefore, there is no reason to make a judgment in the sense of the insufficiency of the 15-day period, particularly in a situation in which the Claimant had previously pronounced on the issues that arose, given that no defect is demonstrated resulting from the non-application of the 25-day period.

In this context, the issue of unconstitutionality raised by the Claimant has no potential to influence the decision of the present proceeding, whereby it is merely abstract, reason for which no consideration is taken thereof.

The Claimant exercised the right to hearing on 21-04-2014, saying, in summary, that it did not agree with the proposed corrections, that the scenario described in the Draft Tax Inspection Report was fanciful and that no significance was given to the facts, situations and interpretations that had been timely presented to the Tax and Customs Authority in the letter it sent dated 19 February 2014, which appears mentioned in item H of part III – 1.1) of the Draft Report (page 32), and whose argumentation the company confirms in exercise of this Right to Hearing.

By way of example of the divergence of understandings, the A... affirms that in the Draft Report the termination of the service provision contract between itself and the B… merited only the assessment that "...it is not understood..." (page 38). The company understands that, "if the scenario built in the Draft Report were plausible, (...) what would be difficult to understand was that such contract existed!"

The Tax and Customs Authority, in the Final Tax Inspection Report understood that the Claimant merely proceeded to make a reference to the elements and justifications already presented, which were already analyzed, and did not present any fact or argument that contradicted the position adopted in the Draft Report, and therefore maintained the proposed corrections.

The Claimant understands that a real right to hearing cannot be satisfied with such acts, of notification and receipt of elements and declaration of the uselessness of the received elements, and that in the case at hand, the Tax and Customs Authority merely transcribed the clarifications provided by the Claimant, without proceeding with their analysis, when it appears to analyze, permits itself to declare "it is not understood," "it is not to be understood." The Claimant affirms that "the crowning expression of the disregard by the Tax Authority of the information and clarifications provided by the CLAIMANT is the issue of the value of the commission for the service provided by the CLAIMANT to the fund manager client. The CLAIMANT justified in meticulous detail, in response to items "1.1, 1.2 and 1.3.", in more than two pages, the criteria and grounds for the value of the fixed quarterly fee of 45,000 Euros, with everything being absolutely disregarded by the Tax Authority without any attempt at serious adversarial procedure."

Following the clarifications provided by the Claimant, the Tax and Customs Authority exposited in detail its position on the existence of special relationships and differences it understood to exist between the prices practiced and those it understood to be appropriate in an arm's length regime, it not being demonstrated that it had not considered the clarifications provided by the Claimant. As the Claimant itself refers, citing RUI DUARTE MORAIS, "the law does not oblige the tax administration to pronounce itself on each and every one of the arguments put forth by the interested parties, but only on those which, objectively, may be relevant to the making of a good decision. This does not mean that it is acceptable for the tax administration not to pronounce on the argumentation put forth by the interested parties on the pretext that, in the context of prior hearing, no new elements were brought forward."

Namely, as to the value of the fee that the Claimant refers to, the Tax and Customs Authority understood in the Tax Inspection Report that "the commission practiced assumed the character of a fee arrangement (fixed value), when management commissions of asset management, as practiced by the A... for its remaining clients, are obtained based on the value of assets under management" (page 52).

Therefore, it is not demonstrated that there has been a defect by the clarifications provided by the Claimant not being considered.

3.2.3. Issue of Illegality of the Additional Assessment of Autonomous Taxation

The Claimant refers, in summary:

– the corporate income tax fixing notes, attached in annex to the Inspection Report, are grounded in the Inspection Report and the authorship of the Head of Division, referring only to the corrections of "Taxable Income of the General Regime" by reason of transfer pricing;

– there is no act of correction of the taxable income of autonomous taxation;

– the tax assessments on account of autonomous taxation in the corporate income tax assessment statements are unlawful due to lack of an act of correction of the value of its respective taxable income with the indispensable justification, as required by no. 1 of article 77 of the LGT;

– autonomous taxation is determined in a totally independent manner from corporate income tax;

– the tax assessments on account of autonomous taxation in the corporate income tax assessment statements are unlawful due to lack of the act.

The Tax and Customs Authority responds that, in accordance with article 16, no. 3, of the CIRC, "the determination of taxable income in the context of direct assessment, when carried out or subject to correction by the services of the Directorate-General of Taxes, is the responsibility of the director of finance of the area of headquarters, effective seat or permanent establishment of the taxpayer, or of the director of the Tax Inspection Services in cases that are subject to corrections carried out by this body in exercise of its functions, or by an official to whom competence by any of them is delegated" and that "as autonomous taxation does not integrate the concept of taxable income defined in article 15 of the CIRC, inserted in its chapter III – Determination of Taxable Income, but rather integrating chapter IV – Tax Rates, its integration in the respective notes is not required."

With regard to autonomous taxation, the CIRC provides only rates, not indicating any separate procedure for determination of autonomous taxable income in relation to that relating to corporate income tax, which is justified by the application of rates being made to the taxable income determined for purposes of corporate income tax.

Thus, in the scope of the determination of taxable income there will only be corrections relating to corporate income tax, with their respective justification, corrections and justification which will also be relevant for purposes of autonomous taxation that has that determination of taxable income as its basis.

Therefore, it is not demonstrated that there is a defect relating to the determination of the taxable income of autonomous taxation and its justification.

3.2.4. Issue of Illegality of the Additional Assessment – Travel Expenses Not Accepted as Deductible

The Claimant challenges the additional assessment insofar as it relates to the non-recognition of expenses relating to travel that it argues are indispensable to the activity of the company and to the formation of its profit with regard to the year 2010.

The set of expenses in question relates mainly to trips and stays of the Chairman of the Board of Directors of the A... and/or representatives of Institutional clients of the A..., as well as persons who are referenced by these institutional clients for training with the A....

The Claimant argues, in summary, that the success of asset management activity depends exclusively on the ability of asset management companies to attract and retain clients willing to entrust part of their fortunes to be managed, and that the acquisition of investors with high net worth is a difficult task, as they are sophisticated investors, knowledgeable about markets and accustomed to dealing with many financial intermediaries. The Claimant affirms that "as A... is an independent asset management company, without connections to financial groups or national banking entities, client acquisition requires substantial investment of its human and material resources. It is a matter of establishing relationships of trust with people representing clients with decision-making authority and demonstrating an in-depth "know-how" of how the international financial sector functions and how business in various international financial centers (London, Paris, Luxembourg, New York, etc.) is conducted. On the other hand, once the relationship of trust with the client is established, one must know how to maintain it and, if possible, increase it. This implies a continuous effort of client support, always seeking to identify the moments and situations in which that support can be materialized. Key examples of such support translate into accompanying people representing them on their professional trips or making available services that facilitate their stay, such as, for example, selection and reservation of hotels. Normally these Institutional clients have diverse commercial interests in various countries and expect their wealth manager to be able to help them resolve the issues they face. This support is, it must be emphasized, a difficult but absolutely essential task for maintaining relationships of trust with clients."

It further states that "the expenses in question are not superfluous or incongruous in the sense that they indicate mere satisfaction of private interests of the representatives of A... clients. On the contrary, they are clearly business-related travel and/or accommodation expenses, particularly of a financial nature. It is further noted that some of the representatives of the clients in question are foreigners, so it is perfectly natural that the entry/exit point to Portugal is preferably from Lisbon" and that "Finally, all the Institutional clients mentioned above represent high-value assets. All are clients that are in the upper quadrant of A... in volume of assets under management, so they are included in what we can call "premium" clients. This means that A... must take special care in the support service to be provided. These are clients who are generally very demanding, in that any inattention or less commitment can have serious negative effects on the conduct of business relationships."

The Tax and Customs Authority argues that "within the scope of the inspection action the Claimant was notified to prove the necessity of these expenses for the realization of its income, having been requested: the identification of the persons in question, indication of the purpose of the trip and supporting documents of whatever might be alleged" and "it happens that, no justification was presented regarding the supporting documents for travel and stays, the Claimant limiting itself, in our opinion, to mere generalities, about the company's activity." The Tax and Customs Authority further argues, in summary, that article 23, no. 1, of the CIRC results in the fact that only expenses that are determining for the realization of profits or gains subject to tax or for the maintenance of the productive source are relevant for tax purposes, requiring proof of their necessity, adequacy, normalcy, or production of the result, and that the lack of these characteristics may give rise to doubts about whether the cause is or is not business-related, with only costs originating in and caused by a business purpose being relevant. It further states that "the Claimant recorded in its accounting account 71120 – Transportation – and 71121 – Accommodation – the invoices, and in the description it is not possible to establish the nexus of causality between the expense incurred and its character of indispensability in the company's activity, namely the necessity of these expenses for the realization of its income, for the identification of the persons in question, indication of the purpose of the trip and evidentiary elements of whatever might be alleged."

Article 23, no. 1, of the CIRC, in the wording in force in 2010-2011, established that "expenses are those that are proven to be indispensable for the realization of income subject to tax or for the maintenance of the productive source."

The interpretation of the concept of indispensability contained in article 23 of the CIRC has, in Portuguese tax law doctrine, authors TOMÁS TAVARES and ANTÓNIO PORTUGAL, authors of seminal works regarding the elucidation of such concept.

For the first of these authors: "The legal notion of indispensability is therefore delineated from an economic-business perspective, by 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 under a profitable profile."

And continues: "(…) Indispensability is subsumed to any act performed in the interest of the company…The legal notion of indispensability thus represses acts that do not conform to the scope of the company, not insertable in the social interest, especially because they do not aim at profit."

The second author, regarding the question of what is the best interpretation of the concept of indispensability, expresses the following position:

"The solution adopted among us (at least in doctrine), following the understandings propounded by Italian doctrine, has been to interpret indispensability in function of the corporate purpose. This position is present from the outset in the writings of Vítor Faveiro, who traces the indispensability of the expense to its assessment as an act of management in function of the concrete corporate purpose, refusing that this indispensability can be assessed freely from any subjective judgment of the law applier."

These works thus support that any economic decline (expense) that has a relationship with the corporate purpose, whether incurred in the context of the activity, or evidences a business purpose, will meet the requirement of indispensability.

Thus, the connection to business activity will be the nuclear element of the interpretive key of the concept of indispensability.

However, as results from the express tenor of the said article 23, no. 1, of the CIRC, it is indispensable, for relevance as expenses, that the connection of the expenses to business activity be proven.

In the case at hand, as the Tax and Customs Authority refers, the elements that appear in the invoices relating to "accommodation" expenses do not allow the ascertainment of the connection of such expenses with the company's activity, and even in the present arbitration proceeding no proof has been produced regarding that connection.

Thus, not having expenses of that type forced connection with the company's activity, and the Claimant limiting itself to making an assertion that it exists, the indispensability of such expenses cannot be considered proven for the purposes provided for in no. 1 of article 23 of the CIRC.

Therefore, the request for arbitral ruling on this ground is dismissed.

3.2.5. Issue of Illegality of the Acts of Additional Assessment of Corporate Income Tax for 2010 and 2011 Based on the "Transfer Pricing Regime"

The Claimant provided services to company B…, during 2010 and 2011, as a result of a contract entered into between them on 22-07-2009 (document no. 9 attached with the request for arbitral ruling, the contents of which are hereby reproduced).

B… has its registered office in the Cayman Islands.

Through this contract, written in English, the Claimant was subcontracted by the A… to provide investment management services ("... to provide investment management services...") of the R… FUND (point 2.1 of the contract).

In this contract a fixed quarterly commission of €45,000.00 was established.

Corrections were made to the taxable profit of the Claimant regarding the years 2010 and 2011, on the ground of the application of the transfer pricing regime, with regard to the provision of services by the Claimant to the B…, within the scope of the referred contract.

The Tax and Customs Authority made corrections to the taxable income of corporate income tax for the years 2010 and 2011, on the basis of the following understanding, in summary:

Given the foregoing, as regards the investment management services provided by the A... to the B…, it is concluded, as previously demonstrated, that terms or conditions were not practiced that are identical to those that would be practiced between independent entities in comparable operations, because, in summary:

– The commission practiced assumed the character of a fee arrangement (fixed value), when asset management commissions, as practiced by the A... for its remaining clients, are obtained based on the value of assets under management;

– The A... practiced a management commission of 0.75%, in 2010 and 2011, on the assets of its largest client, Bank U… – an unrelated entity – with a portfolio with a moderate risk profile, compatible with approximately 66% of the R… Fund, as against a commission invoiced to B… that corresponds to 0.05% of the values managed (14x less).

– Comparing the overall activity of the A..., even including more conservative profiles (for example: fixed-term deposits and treasury bills), which correspond to lower commissions, it is found that management commissions are 0.65% or 0.7% and not 0.05%.

– The value actually charged by B… to the R… fund was essentially 0.5%, which corresponds to approximately ten times more than what was charged by the A....

– B… did not add value to the investment management. Its role is related to legal representation in terms of entering into contracts, possibly with brokerage firms or opening of bank accounts.

In terms of risk, the ultimate responsible parties for management that does not comply with the Fund's policies and restrictions are the Directors of the same and, in case of negligence or intentional error, the responsibility is with the effective investment manager (sub-manager), as per the contract entered into between them.

Therefore, given the facts described, it is found that between the A... and the B… prices of free competition were not practiced, and the latter is exempt from income tax, whereby the results of the B… should be transferred to the A..., on the basis of article 9 of the Model Tax Convention on Income and on Capital of the OECD (a model that defines the guiding principles of national legislation on Transfer Pricing), in accordance with which:

"[When] ... the two associated enterprises, in their business 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 were not obtained because of such conditions, can be included in the profits of that enterprise and taxed accordingly."

III – 1.5) SELECTION OF THE METHOD THAT ALLOWS PROVIDING THE HIGHEST DEGREE OF COMPARABILITY BETWEEN LINKED OPERATIONS AND OTHER NON-LINKED OPERATIONS

The rules for the application of the plurality of methods that article 63 of the corporate income tax code enumerates for the determination of the terms and conditions that would normally be established in arm's length situations are defined in Order 1441-C/01, of 21-12-2001 (hereinafter referred to only as Order).

Normally, the most direct way to determine whether the conditions agreed or imposed between associated enterprises are arm's length conditions is to compare the prices practiced in the context of controlled transactions between these enterprises with the prices practiced in the context of controlled transactions between independent enterprises.

In this context, the Comparable Uncontrolled Price Method (CUPM) is naturally the one that will appear most efficient and rigorous, as it consists in comparing the price of goods or services transferred in a linked transaction ("controlled transaction"), with the price charged in relation to goods or services transferred in the context of a transaction between independent enterprises, in comparable circumstances.

In accordance with article 6 of the Order (Comparable Uncontrolled Price Method – CUPM):

(...)

The CUPM is the most direct way, as any difference between the price practiced in a controlled transaction and the price practiced in a comparable transaction in an open market can be directly attributed, as a rule, to the business and financial relationships agreed or imposed between the enterprises, and arm's length conditions can be determined by directly substituting the price practiced in the controlled transaction with the price practiced in the comparable transaction in an open market (OECD Guidelines).

Taking into account that the linked transaction under analysis relates to services provided by the A... to the B… and it is known the price charged by the latter to the final client, the Resale Price Method could represent an alternative to the CUPM method, as this is based on the price at which a product purchased from an associated enterprise is resold to an independent enterprise. From the resale price the markup on the resale price is deducted. The result obtained after subtracting the gross margin can be considered, after adjustment relating to other costs connected with the purchase of the product (for example, customs duties), an arm's length price of the previous transfer of the good between associated enterprises.

In accordance with article 7 of the Order (Resale Price Method);

(...)

– REGARDING THE RELATIONSHIP BETWEEN B… AND THE R… FUND

An issue that could be raised relates to the fact that the resale price practiced by B… to the R… FUND corresponds to a price agreed between independent entities, as these entities have the same representative: S…. Being that, to densify the relationship between the entities, the subscriber of the participation units is the A..., on account of its clients.

In this context, it is necessary to take into account that the R… FUND is not an entity with legal personality, but rather a Fund composed of the assets of its subscribers.

On the other hand, despite the A... being a subscriber to the Fund, it is not the one that pays, even indirectly, any management commission of the Fund. The economic reality is limited to two participants:

– The one who received the commissions – B…;

– Those who paid the commissions – the actual holders of the participation units [clients of the A... and other Fund clients),

Among these participants there are no special relationships.

Moreover, the management commissions established between the parties form part of the Fund's Prospectus (Private Placement Memorandum) and are itemized in the Fund's Annual and Audit Report, whereby its terms are accessible to investors holding the Fund in their portfolio.

It is further noted that the commissions applied and their calculation are determined by the Fund's depositary entity: Banque V… (Luxembourg).

– SELECTION OF THE METHOD

The verification by the Tax Authority of a linked transaction should be based on the transaction actually occurred between the parties and the manner in which it was structured by them, insofar as it assures the best possible approximation to the functioning of a free market in cases of transfer of goods and services between associated enterprises.

It should reflect the economic reality of the specific situation of the taxpayer that carries out operations within associated enterprises, having as reference point the normal functioning of the market, or adjustments that can be made in a reasonably reliable manner to eliminate the effect

In this context, it is found that:

– The A... develops the activity of asset management, whereby the management of the R… fund assets is comparable with the management it performs with its remaining clients;

– The income from asset management activity results from commissions that are calculated based on the assets managed and their possible returns, as is practiced for all clients;

– This commission may vary depending on the size (assets under management) – the larger the assets, the lower the management commission – and depending on the risk profile – the more aggressive the portfolio, the higher the commission;

– In the activity of asset and fund management developed by competitors of the A..., the income obtained also results from commissions;

– The client that is the holder of assets with a value closest to the R… fund and with an framemarkable risk profile is Bank U…. Being this an independent client, the transactions between this client and the A... present themselves as being the closest to an arm's length situation (Commission of 0.5% to 0.75%).

– The services provided by the A... to the B… were resold by the latter to the R… FUND, knowing the price of this resale (main commission of 0.5%).

Thus, it is considered that the Comparable Uncontrolled Price Method is the one that best adapts to the underlying reality and in relation to which the Tax Authority has better quality and greater quantity of information available for its adequate justification and application and which implies the least number of adjustments for purposes of eliminating the differences existing between the facts and comparable situations (no. 2 of article 4 of the Order)

As set out in the OECD guidelines, the CUPM constitutes the most direct and most reliable means of application of the arm's length principle. Consequently, in this case, preference should be given to this method over all others.

(...)

– CALCULATION OF THE BASE MARKET PRICE

R… Fund – CLASS VALUE

As already mentioned, it is found that the client that is the holder of assets with a value closest to the R… FUND and with a comparable risk profile is Bank U…. Being this an independent client, the transactions between the same and the A... present themselves as being the most comparable, from an arm's length perspective, with those realized between the A... and the B….

The management commissions contracted with Bank U… were 0.76%, in 2010 and 2011, dropping to 0.5%, from 2012 onwards, whereby an interval of commissions between 0.6% and 0.75% is observed.

The risk profile assumed by this client for its portfolio is "moderate," which is equivalent to the VALUE class of the R… Fund, as described in item e) of chapter III – 1.3) of this Report. This VALUE class represents approximately 90% of the total Fund in 2010, and close to 87% in 2011.

On the other hand, there is available information on the value of commissions practiced by B… to the R… FUND, which correspond to 0.5% in the VALUE class of the Fund, these being actually charged and with economic appropriation.

Therefore, starting from the interval of commissions between 0.5% and 0.75% practiced to Bank U… (comparable base price) and given the price actually practiced by B… to the R… FUND (remaining available information to justify the price in question), it would not make sense to define as the arm's length price a commission higher than what was actually charged.

Given the foregoing, it is considered that the arm's length commission referring to the investment management of the VALUE class of the R… FUND will be 0.5% of the average monthly value of the assets under management (as per the Fund's prospectus).

(...)

Given the foregoing, taking into account the market comparables, limited to the price actually charged for investment management, it is found that, by the Comparable Uncontrolled Price Method (CUPM), the free competition price coincides with the value charged by B… to the R… FUND, with the adjustment described in the following paragraphs.

According to the Fund's Management and Audit Report for 2010 and 2011, the amounts charged amounted to:

[Table showing B… charges to R... Fund]

– ACTION OF B…

From the analysis of the transaction in all its phases, it must be taken into account that although B… did not carry out investment management of the Fund, its existence as an offshore intermediary can be justified for other reasons, namely:

– Legal and bureaucratic requirements related to fund management in Portugal;

– Commercial protection of the A... from its clients, as the official investment manager that appears in the Fund prospectus and reports is the B….

Thus, although it is considered that the existence of B… is merely instrumental, it is understood that an adjustment should be made to the arm's length market price, the same being reduced by the expenses with the operationalization and transfer of representation of the Fund's manager to the B….

In this framework, the value of such adjustment should correspond to the expenses of annual maintenance of an offshore company.

Based on research on the Internet, it was found that expenses with creation of a company in the Cayman Islands tend to include legal expenses, appointment of directors, accounting, virtual office, provision of shareholders, mail redirection and representation in legal contracts.

In this context, budgets/estimates on constitution and maintenance of companies were requested from two entities, namely:

– X…, Ltd (company where Y…, AA… and Z… are directors – also directors of B… and R… FUND)

– W… Luxembourg, S. A.

From the elements obtained, it was ascertained that the maintenance expenses of an offshore company include:

– Incorporation Costs: €2,125/4=€531.25 (incorporation costs were distributed over four years);

– Provision of Shareholders, Directors and Secretary (annual): €1,350.00; – Accounting (annual): €1,350.00;

– Agency/Registered Office (annual): €2,100.00;

– Legal Commissions (annual): €2,395.00;

– Other Variable Expenses such as contract signature and opening of bank accounts (assigned the same total as the items above): €7,726.25.

The values described total €15,452.50/year.

It is noted that the A… was notified, on 2014-05-05, to, if it is aware thereof, indicate actions/expenses that may have been the responsibility of the B…, and the same referred to the description made regarding the functions and responsibilities of the Fund.

It is further recalled that the determination of transfer prices is not an exact science and requires a case-by-case assessment by the Tax Administration and the taxpayer.

– QUANTIFICATION OF THE EFFECTS OF THE APPLICATION OF THE COMPARABLE UNCONTROLLED PRICE METHOD

Given the foregoing, it is concluded that the arm's length price that would be established regarding the services provided by the A... to the B… results from the price obtained by the Comparable Uncontrolled Price Method, adjusted by the expenses associated with the creation/maintenance of an entity resident in a fiscally privileged territory.

Thus, the difference between the price practiced by the A... and the arm's length price determined should have been added in field 744 of table 07 of the income tax returns of the Asset Management Company, in the amount of €1,506,922.16, in 2010, and €1,574,935.47, in 2011, as per the following table:

[Table showing A… and B… calculations]

The Claimant understands that the Tax and Customs Authority corrected the value of the remuneration contracted by the CLAIMANT based on terms and conditions that (in its erroneous and not adequately substantiated understanding) would normally be agreed, accepted or practiced between "independent entities" for the provision of said services, through the comparison between manifestly non-comparable realities, because they are not "substantially identical" realities, and through the choice of the incorrect application of the "comparable uncontrolled price method," all with flagrant violation of the prerequisites that legitimize its application.

Article 63 of the CIRC, in the wording in force in 2010-2011, establishes the following, insofar as is relevant here:

Article 63

Transfer Pricing

1 – In commercial operations, including in particular operations or series of operations on goods, rights or services, as well as in financial operations, carried out between a taxpayer and any other entity, whether or not subject to corporate income tax, with which it is in a situation of special relationships, must be contracted, accepted and practiced terms or conditions substantially identical to those that would normally be contracted, accepted and practiced between independent entities in comparable operations.

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 carries out and other substantially identical ones, in normal market situations or in the absence of special relationships, taking into account, in particular, the characteristics of the goods, rights or services, market position, economic and financial situation, business strategy, and other relevant characteristics of the taxpayers involved, the functions performed by them, the assets used and the 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 previous item cannot be applied or, being applicable, do not allow obtaining the most reliable measure of the terms and conditions that independent entities would normally agree, accept or practice.

4 – It is considered that special relationships exist between two entities in situations in which one has the power to exercise, directly or indirectly, significant influence over the management decisions of the other, which is considered verified, in particular, between:

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

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

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

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

e) Entities linked by a contract of subordination, of joint venture or another of equivalent effect;

f) Companies that are in a relationship of control, in the terms in which this is defined in the instruments that establish the obligation to prepare consolidated financial statements;

g) Entities among which, by force of the business, financial, professional or legal relationships between them, directly or indirectly established or practiced, there is a situation of dependence in the exercise of their respective activity, in particular when any of the following situations occurs between them:

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

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

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

4. The right to fix the prices, or conditions of equivalent economic effect, relating to goods or services transacted, provided or acquired by one is, by imposition...

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