Transfer Pricing in Cross-Border Transactions: IRC Tax Arbitration Case 75/2016-T

ARBITRAL AWARD

Applicant: A…, Lda.

Respondent: Tax and Customs Authority

I – Report

1. The contributing company "A…, Lda.", with NIPC … (hereinafter "Applicant"), filed on 9 February 2016 a request for the establishment of a Collective Arbitral Tribunal, in accordance with the combined provisions of articles 2º and 10º of Decree-Law No. 10/2011 of 20 January (Legal Regime for Arbitration in Tax Matters, hereinafter "LRAT"), with the Tax and Customs Authority as Respondent (hereinafter "AT" or "Respondent").

2. The Applicant seeks an arbitral ruling on the illegality of the additional corporate income tax (IRC) assessment No. 2015…, and the corresponding compensatory interest assessment No. 2015…, issued by the Director-General of the Tax and Customs Authority for the tax year 2012, in the total amount of €110,234.74. It calls two witnesses.

3. The request for establishment of the Arbitral Tribunal was accepted by the President of CAAD and automatically served on the AT on 26 February 2016.

4. In accordance with paragraph a) of subsection 2 of article 6º and paragraph b) of subsection 1 of article 11º of the LRAT, as amended by article 228º of Law No. 66-B/2012 of 31 December, the Deontological Council appointed the arbitrators of the Collective Arbitral Tribunal, who communicated acceptance of their appointment within the applicable period, and notified the parties of this appointment on 13 April 2016.

5. The Collective Arbitral Tribunal was constituted on 29 April 2016; it was constituted regularly and is materially competent, in accordance with articles 2º, subsection 1, paragraph a), 5º, 6º, subsection 1, and 11º, subsection 1, of the LRAT (as amended by article 228º of Law No. 66-B/2012 of 31 December).

6. In accordance with subsections 1 and 2 of article 17º of the LRAT, the AT was notified on 29 April 2016 to submit its reply.

7. By Order of the President of the Deontological Council of CAAD dated 27 May 2016, the President Arbitrator was replaced due to the disqualification of the initially appointed President Arbitrator.

8. The AT filed its Reply on 30 May 2016, accompanied by a copy of the Administrative File.

9. In that reply the AT alleges, in summary, the total lack of merit of the Applicant's request, invoking an exception of untimeliness and lapse of the right of action, and objecting to the production of testimonial evidence (while also cautiously entering one witness).

10. By Request dated 9 June 2016 the Applicant made submissions regarding the exception invoked by the AT in its Reply, arguing its lack of merit.

11. The Arbitral Order of 15 June 2016 requested the parties to identify the factual matters on which they wished to examine the witnesses.

12. By Request dated 30 June 2016 the Applicant indicated that it wished to examine the witness entered regarding the facts stated in articles 50º to 60º, 62º to 69º, 89º to 93º, 101º, 116º, 117º, 120º to 133º, 137º and 139º to 142º of the Initial Request.

13. The Arbitral Order of 19 July 2016 designated, in accordance with article 18º of the LRAT, 16 September 2016 for the witness examination meeting, and further requested that the Applicant provide a copy of the contract under which B… pays a licence to C….

14. By Request dated 28 July 2016 the Applicant requested a new start time for the witness examination meeting; indicated its preference for written submissions; and declared that it did not have in its possession the contract referred to in the Arbitral Order of 19 July 2016, although it would endeavour to obtain it.

15. The Arbitral Order of 29 July 2016 fixed a new start time for the witness examination meeting, while establishing that submissions would be made in writing.

16. By Request dated 1 September 2016 the Applicant requested amendment of the witness list previously submitted by it.

17. The Arbitral Order of 1 September 2016 admitted this amendment of the witness list, noting the need to safeguard against language fluency issues arising from the new witness being of foreign nationality.

18. The Arbitral Order of 14 September 2016 determined the postponement of the witness examination meeting due to the sudden unavailability of one of the arbitrators.

19. The Arbitral Order of 22 September 2016 fixed 20 October 2016 as the new date for said meeting.

20. However, by Request dated 29 September 2016 the Applicant requested a new date to be scheduled, which was granted by Arbitral Order of 30 September.

21. On 15 November 2016 the witness examination meeting took place.

22. The witness entered by the Applicant, D…, was examined. From Mr. E… only a party statement was obtained (using simultaneous translation and back-translation), since, in his capacity as Manager of the Applicant, he could not be heard as a witness. The Respondent waived examination of the witness it had entered.

23. At the end of the hearing the Applicant and Respondent were notified to submit written submissions in successive periods of 10 days.

24. The Tribunal set 29 December 2016 as the deadline for rendering the Arbitral Decision.

25. The Applicant submitted its written submissions on 25 November 2016.

26. The Respondent submitted its written submissions on 5 December 2016.

27. The proceedings are not affected by nullities and, once the exceptional matters raised are resolved, there remain no further preliminary or subsequent issues, whether prejudicial or exceptional, that would prevent consideration of the merits of the case, with all conditions being in place for a final decision to be rendered.

28. The AT appointed its representatives in the proceedings and the Applicant filed a power of attorney, with both Parties being duly represented.

29. The Parties have legal personality and capacity and have standing, in accordance with articles 4º and 10º, subsection 2, of the LRAT and article 1º of Ordinance No. 112-A/2011 of 22 March.

II – Findings: Factual Matters

II.A. Facts Considered Proven and Relevant to the Decision

1. The company "A…, Lda." was established on 15 November 1993, and received its current name by amendment of the articles of association in 2011.

2. The company carries on the activity of importing, exporting and marketing graphic products conceived and executed by artists with manual disabilities, and is registered under "Print Preparation and Product Activities" with CAE…, and is subject to corporate income tax under the general taxation regime.

3. The Applicant's activity consists of sending a range of articles, to a group of entities (potential customers, individuals or legal entities), accompanied by an explanatory leaflet presenting the company's objective, which is to promote the sale of articles bearing reproductions of original paintings painted by artists using their mouths or feet. The articles sent by the Applicant to potential customers include calendars, Christmas postcards, gift cards, condolence cards, notepads, diaries, wrapping paper, among others. A leaflet is also sent to potential customers showing, in addition to the prices of the articles sent, the possible payment methods.

4. The individuals or entities receiving the article collections may choose to purchase them or not, and may also place orders for other articles. The article collections are sent to all those in the database that the company has acquired for this purpose.

5. The shareholders of the Applicant were initially "C…" (majority, 99% – hereinafter referred to simply as "C…" or "Parent Company") and E… (minority, 1%, and manager), and on 19 February 2013 "C…" transferred its quota to B…, with registered office in Ireland.

6. In the tax years 2011 and 2012 the Applicant made cross-border payments and transfers to supplier entities based in regions with privileged tax regimes, reported to the AT through model 38 declaration – Declaration of Cross-Border Transfers.

7. Payments were made to supplier B… in Ireland, and it was found that the invoicing did not follow the physical circuit of the goods, which came from Germany, France and Belgium directly to the Applicant.

8. B… is a subsidiary of "C…" with registered office in Liechtenstein (owning 99.99% of the Share Capital).

9. The Applicant places orders with B…, and B… acquires them from German, French and Belgian suppliers, who ship them directly to the Applicant.

10. In 2011 and 2012 B…'s invoicing to the Applicant represented approximately 60% and 67.5% respectively of the total value of the cost of goods sold and materials consumed determined by the Applicant.

11. On 16 October 2014 an inspection action was initiated, under service order No. OI2014…, by the Tax Inspection Services of the Directorate of Services of…, focusing on "Control actions on cross-border transfers", aimed at verifying the justification of operations underlying said cross-border transfers ordered to financial institutions and directed to entities located in countries, territories or regions with privileged tax regimes.

12. Under that inspection action, the Applicant was notified, by official letter No.… of 25 March 2015, to provide proof of the price paid to supplier B… for the goods corresponding to invoices Nos. … to …, issued in 2011 and 2012, in particular for the purpose of classification under article 63º of the Corporate Income Tax Code (CITC) and Ordinance No. 1446-C/2001 of 21 December.

13. The Applicant replied to that request on 24 April 2015.

14. On 11 June 2015 the Applicant was notified of a draft Inspection Report (in the terms contained in the Administrative File, the contents of which are deemed reproduced) and of its right to be heard, which it did not exercise.

15. The inspection action concluded on 2 July 2015.

16. On 7 July 2015, by official letter No.…, the Applicant was notified of the Inspection Report and the Order relating to it.

17. The Inspection Report concludes that some of the adjustments to the determination of taxable income are due to non-compliance with the provision of article 63º of the CITC (and Ordinance No. 1446-C/2001 of 21 December) and the Arm's Length Principle, given the alleged existence of special relationships and the practice of transfer prices, which would lead to partial disallowance as a tax deduction of the amount paid to B… (an alleged inflation of costs resulting in tax "savings", insofar as the goods could have been paid directly to their suppliers at lower prices).

18. The additional corporate income tax assessment No. 2015… and the corresponding compensatory interest assessment No. 2015…, issued by the Director-General of the Tax and Customs Authority for the tax year 2012, were notified to the Applicant on 28 September 2015, with 19 November 2015 set as the deadline for payment of the resulting amount.

19. The Applicant's tax years 2008, 2009 and 2010 had already been subject to inspection actions, as a result of which costs had been disallowed under article 65º of the CITC, and the autonomous taxation regime provided for in article 88º, 8 of the CITC had been applied.

20. On 18 November 2015 the Applicant paid the €110,234.74 assessed.

II.B. Facts Considered Not Proven

Based on the documentary evidence made available in the proceedings and consensually accepted by the parties, and based on the testimonial evidence presented at the hearing, the following facts of interest to the decision of the case remain unproven:

1. That the amounts paid by the Applicant to B… correspond effectively to the value of the rights of use of images and other materials coming from the Parent Company.

2. That there is a cost-sharing agreement between the Applicant, B… and the Parent Company, "C…", and what its contents are. Indeed, at the hearing of 15 November 2016 the Witness entered by the Applicant acknowledged that, notwithstanding being a director of A…, she does not have access to the licence contract concluded between the Applicant and B…, and it is therefore not within her remit to verify whether the unit cost of the collections ordered by the Applicant from B… corresponds or not to an objective assessment of the value of the works composing the collections.

III – Findings: Legal Matters

III.A. Position of the Applicant

a) The Applicant begins by alleging that the filing of the request for arbitral ruling is timely, given that it was filed before 17 February 2016, the date on which the 90-day period established in article 10º, 1, a) of the LRAT would expire (counted from 19 November 2015, the deadline for voluntary payment of tax obligations legally notified to the taxpayer).

b) The Applicant further invokes the lack of substantiation, in fact and in law, direct or by reference, of the assessment acts notified to it, in violation of article 77º, 2 of the General Tax Law (GTL), and even of the regime of article 63º of the Supplementary Regulation of the Tax Inspection Procedure, or article 153º, 1 of the Code of Administrative Procedure, or even articles 103º, 2 and 268º, 3 of the Constitution.

c) From this the Applicant draws the argument that there occurred a breach of an essential legal formality, aggravated by the failure to notify the Applicant to exercise its right to prior hearing, in accordance with article 60º, 1, a) of the GTL.

d) As regards the interpretation adopted by the AT concerning the facts found in the Inspection Report, the Applicant, without contesting those facts, contests it on the grounds that it fails to take into account the impact of the specific nature of the activity carried out by the Applicant in its relationships with B… – rendering direct comparisons with prices practiced in relationships with independent third-party entities illegitimate.

e) The Applicant emphasizes that it is B… that makes available to other companies, such as the Applicant, materials that are supplied to it by the Parent Company, "C…" with registered office in Liechtenstein.

f) Being so, the value paid to B… would correspond to the acquisition of the products marketed by the Applicant, and does not correspond to, nor could it correspond to, the value of the raw materials acquired by B… from German, French or Belgian suppliers, since these are merely engaged in graphic work and production of supports for the creations of B… itself (as a subsidiary of "C…"), which are the works produced by the artists it represents.

g) What was paid to B…, and through it to the Parent Company, are charges such as those incurred on account of:

• Fees, grants and subsidies attributed to the creators of the works;

• Meetings, events and exhibitions of the original works;

• Expenses for transport of those works;

• Insurance of transport and storage of the works;

• Establishment of databases;

• Reproduction of the works;

• Administrative services.

h) The amounts corresponding to the invoicing of German, French and other suppliers do not therefore include the necessary remuneration owed to B… for the use of the images whose reproduction is the subject of the activity of those suppliers, and which the Applicant markets.

i) This is, the Applicant argues, necessarily a subjective value, but centered on the remuneration of the creators of the artworks whose reproduction is in question – and thus operations with B… do not have any abnormal character.

j) On the other hand, the Applicant points out the fact that the COGS (Cost of Goods Sold and Materials Consumed) index decreased in 2011 and 2012 compared to 2010, which in its view would refute the thesis, set forth in the Inspection Report, that this would be an inflation of costs aimed at obtaining tax "savings".

k) The Applicant alleges that the application to this case of the Transfer Pricing regime is not justified, either because there are no direct relationships with any entity based in regions with privileged tax regimes (since the relationships are established with B… and not with the Parent Company, "C…", which is indeed established in Liechtenstein), or because operations with B… do not present any characteristic of abnormality, or even because there are no operations susceptible to comparison with those carried out by the Applicant to determine, for the purposes of article 63º of the CITC, whether conditions different from those that would apply between independent entities were established.

l) In summary, the Applicant, not denying that there are special relationships between it and B…, maintains on the other hand that there were no abnormal conditions in the operations in question, conditions different from those that would be established between independent entities, and that the difference in prices charged by B… and by B…'s suppliers merely reflects the value added by B…, which is essentially the value of the artists' works.

m) Against what is alleged in the Inspection Report, the Applicant dismisses the idea that there was price adjustment with the evasive objective of reducing or eliminating the tax burden, concealing a transfer of profits between entities in special relationship situations so as to place wealth under the jurisdiction of regimes that exempt, in whole or in part, the taxation of such income.

n) In its view, what occurred was the result of mere contractual autonomy, with prices dictated by considerations of an economic nature without evasive or avoidance intent, and thus could not be understood as being in breach of the "Arm's Length Principle" standard – even if the other prerequisites of the Transfer Pricing figure were satisfied.

o) Furthermore, the Applicant emphasizes that it was incumbent on the AT to produce proof of the existence of those abnormal conditions which, if verified, could constitute the practice of Transfer Pricing – but that such proof, imposed by article 63º of the CITC, was not produced within the inspection action, or at its conclusion.

p) Additionally, given that there are no operations susceptible to comparison with those carried out by the Applicant, the choice of methods for determining the price practiced in the free competition market becomes compromised, failing the comparability requirement on which the application of the methodology established in article 4º, 2 of Ordinance No. 1446-C/2001 of 21 December depends and the establishment of "fair market value", whether this coincides with or differs from "arm's length price".

q) Worse, the Applicant alleges, is that, as a result of the inspection action and in consequence of the AT's understanding that article 63º of the CITC applies, the AT resorted to a method different from those provided for in Ordinance No. 1446-C/2001 of 21 December, understanding that the Arm's Length Principle imposed the exclusive consideration, as an allowable cost, of the value invoiced by the suppliers to B… – which the Applicant understands to imply the total disregard of the particular commercial context in which the operations in question developed, a context in which B… adds value to the goods marketed by the Applicant.

r) This value addition, the Applicant alleges, is in no way referable to the role played by independent suppliers, who are mere executors of graphic and commercial tasks, and not responsible for the coordination of the activity of the creators of the works nor the assumption of responsibilities relating to quality control or the conditions for marketing the final product.

s) What, in the Applicant's view, amounts to saying that B… acquires raw materials from those suppliers and transforms them into semi-finished or finished products, incorporating the work of the artists, the costs of transport and distribution, and others. This value addition is, it concludes, incomparable to that corresponding to the intervention of independent suppliers.

t) Being so, the comparison method used by the AT would not justify the adjustments provided for in article 63º of the CITC.

u) The resulting assessment should therefore be annulled for violation of applicable norms and principles, in accordance with the general provisions of article 163º of the Code of Administrative Procedure.

v) The Applicant further requests annulment of the compensatory interest assessment, alleging that there was not even a delay in the assessment of tax owing, and even less a delay that could be attributed to the culpability of the taxpayer (in accordance with article 35º, 1 of the GTL).

w) The Applicant notes not only that it is the settled understanding that mere (non-culpable) divergence of criteria between taxpayer and tax authority does not constitute a delay in assessment that gives rise to compensatory interest; but also that ipso facto the assessment of compensatory interest does not become an automatic consequence of every additional tax assessment.

x) The Applicant observes that the prerequisites for the assessment of compensatory interest were not proven, particularly regarding the facts and culpability – in accordance with the general provisions of article 74º, 1 of the GTL and article 342º, 1 of the Civil Code.

y) It further alleges lack of substantiation of the act of assessment of compensatory interest, in violation of article 77º of the GTL and article 268º, 3 of the Constitution.

z) In return, the Applicant claims, in accordance with article 43º of the GTL, indemnity interest, insofar as it has already paid the entire amount assessed, and in the event that the request for arbitral ruling presented by it is judged to have merit.

aa) In its Request of 9 June 2016, the Applicant made submissions regarding the exception invoked by the AT in its reply, maintaining that the invocation of the exception is based on a manifest error regarding the legal prerequisites, because it apparently disregards the combined application of article 10º of the LRAT with article 102º of the Code of Tax Procedure (CTP), to which the former expressly refers, for the purpose of determining the initial moment of counting the period for the exercise of the right of action.

bb) There would thus occur a confusion between the counting of periods and the establishment of conditions for perfection of service (article 39º of the CTP), contradicting the very document through which the assessment was notified to the Applicant, which itself expressly indicates the regime of article 102º of the CTP.

cc) In the Applicant's view, none of this is changed by its voluntary adhesion to the electronic notification system, since article 39º, 9 and 10 of the CTP refers only to notification and does not interfere with the regime of article 102º of the CTP, the only norm that determines the facts from which counting of the period for the exercise of the right of action begins – and the only one to which article 10º of the LRAT refers. There might still arise some doubt if the period should be counted from the moment of notification – but, the Applicant emphasizes, the norm makes the period for exercise of the right of action start, not from the moment of notification, but from the final moment of the period for voluntary payment, as determined in the notification of the assessment.

dd) In its Submissions, the Applicant, in addition to defending the lack of merit of the exception raised by the Respondent, reiterated, in essence, the arguments previously advanced.

III.B. Position of the Respondent

a) In its Reply, the Respondent maintains the understanding that the assessment in question constitutes a correct application of Law, and is not affected by any formal defect or violation of law due to error regarding the facts or the law.

b) The Respondent begins by invoking an exception of untimeliness of the request and consequent lapse of the right of action.

c) The Respondent understands that, by reason of the Applicant's voluntary adhesion to the electronic notification system (electronic mailbox of ViaCTT), the regime provided for in article 39º, 9 and 10, of the CTP applies to it – and the general regime for notifications does not apply, by force of article 102º, 4, of the CTP.

d) Thus, having the Applicant accessed its electronic mailbox on 24 September 2015, the three-month period was exhausted when, on 9 February 2016, it filed the request for establishment of the present Arbitral Tribunal.

e) The Respondent maintains therefore that the lapse of the right of action is verified, a dilatory exception that results in the dismissal of the instance, in accordance with article 89º of the Code of Administrative Procedure (CAP) and article 278º of the Civil Procedure Code, applicable by force of article 2º of the LRAT.

f) Beyond the exception presented, the Respondent also defends itself by way of substantive reply.

g) It begins by rejecting the allegation of defect of lack of substantiation, noting that all substantiation is contained in the Tax Inspection Report, being therefore contemporary with the assessment – thus evidencing conformity with article 77º of the GTL (in addition to articles 103º, 2 and 268º, 3 of the Constitution).

h) Furthermore, this is the correction of the self-assessment filed by the Applicant, and therefore cannot be unknown to the Applicant or incomprehensible to it. Moreover, the very mechanism provided for in article 60º, 3 of the GTL would indicate, in the Respondent's view, full possibility of substantiation based on the conclusions of an Inspection Report.

i) The Respondent also rejects the allegation of defect of breach of the right to prior hearing, recalling that it was the Applicant itself that waived that right when requested, in the face of the draft Final Inspection Report.

j) As to the alleged violation of law due to error regarding the facts and the law, the Respondent maintains that the Transfer Pricing regime applies, and begins by recalling that in 2012 the Applicant was owned 99% by, and B… was owned 99.9% by, the Parent Company, "C…" with registered office in Liechtenstein, and that B…'s invoicing to the Applicant represented approximately 67.5% of the total value of COGS (cost of goods sold and materials consumed).

k) Being the Applicant and B… held by the same shareholder, forming part of the same international group, there were special relationships between them – which in itself justified an analysis of the operations in light of article 63º of the CITC, Ordinance No. 1446-C/2001 of 21 December, and even article 9º of the Convention for the Avoidance of Double Taxation between Portugal and Ireland, as a means of determining the existence or non-existence of compliance with the Arm's Length Principle.

l) Such analysis was justified, the Respondent emphasizes, regardless of any suspicion or verification of fraudulent intent on the part of the taxpayer, and would continue to be justified even if Liechtenstein were not on the list in Ordinance No. 150/2004 of 13 February.

m) The AT contests that there is justification for the Applicant having omitted the declaration provided for in article 63º, 7 of the CITC, not accepting the application in this case of the exemption provided for in article 13º, 3 of Ordinance No. 1446-C/2001 of 21 December.

n) And it does not accept the argument of alleged "non-comparability", for it would destroy the Arm's Length Principle, preventing any investigation into the existence of Transfer Prices.

o) In practice, the AT maintains that there is nothing singular in the situation: B… merely seeks to pass on in its prices the general expenses of the Parent Company, "C…" – which would be acceptable if proof were made of the methodology used for allocating those expenses of the Parent Company to B… and, through it, to the Applicant.

p) In the absence of such proof, it remains unknown, with a minimum of certainty, what part of the price relates to the passing on of the Parent Company's expenses, and thus conformity with the Arm's Length Principle cannot be verified through any of the methods indicated in article 63º, 3 of the CITC and article 4º, 1 of Ordinance No. 1446-C/2001 of 21 December.

q) For the Respondent, what results from the inspection is that there were, among the parties involved in the transactions, cost-sharing arrangements, such as those characterized in article 11º, 1 of Ordinance No. 1446-C/2001 of 21 December.

r) But, the AT emphasizes, the Applicant proved resistant in minimally evidencing in what terms the costs of the Parent Company are determined and in what terms those costs are divided and allocated to the subsidiary companies, or what profit margin subsists for each of those involved, so that precisely it could be ascertained whether the balance achieved is equivalent to that which would be found between independent entities.

s) In the absence of the Applicant's cooperation in providing information regarding the mode of allocation of costs, and therefore in the absence of justification relating to the application of the Arm's Length Principle, the AT was left with no choice but to disallow those amounts – the only way to ensure that no tax advantage would result from those operations between related entities.

t) The rules on burden of proof required that the Applicant prove the manner of calculation of the "value added" that, attributed to B…, or through it, to the Parent Company, distanced the invoiced values from the only objectively proven value, that of invoicing by the suppliers to B… itself.

u) As to compensatory interest, the Respondent maintains that the mere failure to file a declaration relating to an outstanding tax, as in its view is the case in the present proceedings, does not cease to constitute a failure in diligence in the fulfillment of tax obligations, thus constituting sufficient justification for the recovery of the State through compensatory interest.

v) The Respondent concludes its Reply by pronouncing against the need for testimonial evidence, which it views as incapable of filling the gaps in documentary evidence (although, as a precaution, it also enters a witness).

w) In its submissions, the Respondent maintains and makes explicit the arguments already raised in its Reply, whether on the issue of the exception or regarding the merits of the case.

III.C. Issues to be Decided

III.C.1 – On the Exceptions

1. Defending itself by exception, the Respondent alleges that the request for arbitral ruling is untimely, in that the Applicant accessed its electronic mailbox, where the assessment notice was located, on 24 September 2015.

2. Thus, as the special regime (as opposed to the general regime of article 102º, subsection 1, paragraph a) of the CTP) of article 39º, subsections 9 and 10 of the same statute applied to it, when on 9 February 2016 it requested the establishment of the arbitral tribunal, more than ninety days had already elapsed of which it had to act, as provided in article 10º, subsection 1, paragraph a) of the Legal Regime for Tax Arbitration (LRAT).

3. The Respondent's calculations are correct, but the premise from which it departs is not true.

4. In fact, contrary to what the Respondent argues, the dies a quo is not 24 September 2015.

5. In reality, subsections 9 and 10 of article 39º of the CTP do not contain a norm that stands in a specialized relationship to paragraph a) of subsection 1 of article 102º of the same Code.

6. The latter norm addresses the period for challenging, which it sets at three months counted from the deadline for voluntary payment of tax obligations legally notified to the taxpayer, although subsection 4 permits other special periods.

7. Article 39º of the said Code is not in this case, which establishes the regime for perfection of notifications, with its subsections 9 and 10 telling us when those effected by electronic transmission are considered made.

8. In this manner, the Respondent is correct in pointing to the date of notification of the assessment notice, but its reasoning fails when it places at that moment the dies a quo from which the notified party may challenge, for that day is fixed in paragraph a) of subsection 1 of article 102º.

9. A rule which, moreover, came to be reproduced by the subsequent LRAT, in whose article 10º, subsection 1, paragraph a) the same discipline appears.

10. The dilatory exception of lapse of the right of action invoked by the Respondent therefore lacks merit.

III.C.2 – On the Merits of the Case

a) We believe that the consideration of the merits of the case should result from the separate consideration of two distinct moments: 1- that in which it is a matter of assessing the legitimacy of the correction proposed by the AT to the return filed by the taxpayer, in particular by examining whether the absence of proof regarding the facts we considered unproven is attributable to the Applicant; 2- that in which, having verified the violation of declarative obligations in the return filed by the taxpayer, it is a matter of assessing the adequacy of the correction proposed by the AT to that return.

b) To justify this separate consideration, it suffices to take into account the obvious circumstance that a legitimate intervention is not ipso facto an adequate intervention. Opportunity and legality are not sufficient to ensure the justice of the results.

III.C.2.1. On the Legitimacy of the Correction Proposed by the AT

1. The Applicant, in the course of the inspection, when requested to prove "that the price to be paid to supplier B… IE…U in the invoices issued by it in 2011 and 2012 corresponds to the price that would be accepted and practiced between independent entities in identical operations", in accordance with article 63º of the Corporate Income Tax Code and Ordinance No. 1446-C/2001 of 21 December (hereinafter designated as the Ordinance), informed "that it considers that it is incumbent on the Tax Authority (AT) to prove the existence of special relationships, as well as that the operations were effected under conditions different from those that would be agreed between independent entities".

2. It appears to the Tribunal that there is here a confusion of concepts on the part of the Applicant, with direct impact on the manner in which the inspection subsequently unfolded, and on the consequent conclusions of the AT, which is why it is important to clarify two legal frameworks:

• The fulfillment of the Arm's Length Principle, to which subsection 1 of article 63º of the Corporate Income Tax Code refers, and which must be present in the fixing of the terms and conditions of the commercial and financial operations carried out by corporate income taxpayers with entities considered related, taking into account the definition of subsection 4 of said norm; and

• The accessory obligation of preparation of a tax documentation file regarding Transfer Prices.

1. As to this latter point, subsection 6 of article 63º of the Corporate Income Tax Code provides that "the taxpayer must maintain organized, in accordance with the terms established for the tax documentation file referred to in article 130º, the documentation relating to the policy adopted regarding transfer prices, including the guidelines or instructions relating to its application, the contracts and other legal acts concluded with entities that with it are in a situation of special relationships, with the modifications that occur and with information about the respective compliance, the documentation and information relating to those entities and also to the companies and goods or services used as a basis for comparison, the functional and financial analyses and sector data, and further information and elements that it took 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".

2. This norm should be read in conjunction with subsection 13 of the same article, which provides that "the application of the methods for determining transfer prices, whether to individual operations or to a series of operations, the type, nature and content of the documentation referred to in subsection 6 and the procedures applicable to correlative adjustments are regulated by ordinance of the Minister of Finance", which is currently Ordinance No. 1446-C/2001 of 21 December (the contents of which have remained unchanged since its entry into force).

3. The Ordinance, in the part relating to the tax documentation file of Transfer Prices (article 14º) details the set of information that should be prepared by taxpayers, and the latter must describe and document, in particular:

• Their activity and the activity of the related parties (with express mention of the framework of the special relationship existing, in accordance with subsection 4 of article 63º of the Corporate Income Tax Code) with which they maintained linked operations;

• The detailed identification and quantification of linked operations (of the current year and the two preceding years);

• Their own functional analysis, as well as of the related parties with whom they maintained linked operations;

• Indication and justification of the Transfer Pricing method(s) used for the determination of the arm's length price;

• Information on the comparable data used, evidencing, in the case of recourse to an external entity specialized in market studies, the justification of the selection, where justified, the technical specification of the studies and, as well, an analysis of sensitivity and statistical security or, if the source of the data is internal, the respective technical specification;

• Details of the analyses carried out to assess the degree of comparability between linked operations and non-linked operations and between the companies involved in them, including the functional and financial analyses, and on any adjustments made to eliminate the differences existing.

1. Given the extent and detail of the information required by the Ordinance, it is understandable that the Law would have established an exemption from such a tax documentation regime in favor of certain taxpayers, in particular those of smaller size, to avoid disproportionate costs as against the general interests of taxation.

2. This exemption is contained in subsection 3 of article 13º of the Ordinance, which establishes that "the taxpayer that in the previous year achieved an annual value of net sales and other income below €3,000,000 is exempted from compliance with the provision of subsection 1".

3. It is not a contested fact that in the tax year 2012 the Applicant did not reach the minimum income limit for the preparation of a tax documentation file for Transfer Prices.

4. However, such exemption does not dispense the Applicant from compliance with the Arm's Length Principle in operations that it maintains with related parties, nor is it a contested fact that B… is its related party (specifically, under paragraph b) of subsection 4 of article 63º of the Corporate Income Tax Code).

5. In this context, and notwithstanding the aforementioned exemption, it would have been expected that the Applicant would have, in addition to compliance with accessory obligations regarding Transfer Prices, in particular the completion of Annex H of the Simplified Business Information (SBI) return for the tax year 2012, demonstrated that it complies with the principle referred to in subsection 1 of article 63º of the Corporate Income Tax Code.

6. And it did not do so, stating that, in addition to it not being incumbent on it to make such proof, that proof would be impossible given the specificity of the activity carried out by the Applicant.

7. It is an argument that the Tribunal finds difficulty in understanding.

8. First, because the demonstration of compliance with the Arm's Length Principle is independent of the documentary obligations that rest on taxpayers. Indeed, before the revision of the Corporate Income Tax Code by Decree-Law No. 198/2001 of 3 July, this Code, in its article 57º, already imposed on corporate income taxpayers compliance with the Arm's Length Principle, and it was not with the legislative revision made in 2001, with a greater elaboration of the norm, and with the introduction of the need to justify technically and documentally the terms and conditions fixed in operations with related parties, that this principle began to apply.

9. Furthermore, considering that a Transfer Pricing analysis implies an analysis of the entities involved in the linked operations, it becomes necessary to safeguard the so-called "correlative adjustments", provided for not only in subsections 11 and 12 of article 63º of the Corporate Income Tax Code, but also in the various Conventions for the Avoidance of Double Taxation signed by Portugal. These "correlative adjustments" will have greater impact on Portuguese State revenue in cases where the counterparty to the linked operation is non-resident, in that the adjustment made to a cost recorded by a corporate income taxpayer will not have a "nil" effect (or tending towards "nil") on tax revenue, resulting from the corresponding adjustment, at the level of income.

10. This greater impact on linked operations maintained with non-resident entities is evident in the provision of subsection 8 of article 63º of the Corporate Income Tax Code, which establishes that taxpayers must make the necessary adjustments to their taxable profit in case of non-compliance with the Arm's Length Principle – a duty that is independent of any eventual documentary obligations regarding Transfer Prices.

11. In this manner, having the Applicant made no adjustment to its taxable profit for the tax year 2012 under subsection 8 of article 63º of the Corporate Income Tax Code, and being undisputed the existence (and preponderance) of linked operations with entities not resident in Portuguese territory, strict compliance with such principle is required of the Applicant.

12. Second, the argument regarding the specificity of the Applicant's activity is irrelevant.

13. In reality, it was not its activity in the concrete, or the terms fixed by it, that were subject to scrutiny by the AT, but rather the activity of B… and the pricing policy defined by that entity in the active operations that it maintained with the Applicant.

14. The activity of B… does not present any peculiarity that would prevent its consideration regarding Transfer Prices.

15. Furthermore, the Applicant did not make the necessary demonstrations to justify compliance with the Arm's Length Principle in operations maintained with B…, which has impact on the burden of proof.

16. In accordance with subsection 1 of article 75º of the General Tax Law (GTL), "the declarations of taxpayers presented in accordance with the terms provided for in law are presumed to be true and made in good faith, as well as the data and determinations recorded in their accounts or records, when these are organized in accordance with commercial and tax legislation, without prejudice to the other requirements on which the deductibility of expenses depends".

17. Now, it became evident from the inspection carried out by the AT, not only the existence of omissions by the Applicant in its tax returns, in particular in Annex H of the SBI, but also the expressed conviction of the Applicant regarding not having to provide explanations regarding compliance with the Arm's Length Principle provided for in subsection 1 of article 63º of the Corporate Income Tax Code.

18. With no legitimate reason for refusal to provide information occurring in this case, and with omissions occurring that prevent knowledge of the real taxable matter of the taxpayer, paragraphs a) and b) of subsection 2 of article 75º of the GTL apply, and the Applicant ceases to benefit from the presumption of truthfulness of declarations that results from subsection 1 of article 75º of the GTL.

19. This fully justified the AT's making corrections to the Applicant's taxable profit, in that the absence of the explanations requested of it, which can only be attributed to it, caused the AT not to have sufficient information regarding compliance with the Arm's Length Principle.

III.C.2.2. On the Adequacy of the Correction Proposed by the AT

1. Taking into account the evidentiary elements, including the explanations provided to this Tribunal by the witnesses entered by the Applicant, it is concluded that B…, in the tax year 2012, functioned as an aggregating entity of the supplies necessary for the production of the goods that were sold by the various entities belonging to the Economic Group led by the said Association C…, and these may be aggregated in the following types of inputs:

• Of a material nature, such as the physical media on which such goods are printed or packaged (excluding calendars, envelopes, postcards, etc). These inputs are invoiced to B… by independent suppliers;

• Of an incorporeal nature, fundamentally related to the author's rights of the artists whose works are reproduced and which are supported by Association C…, based in Liechtenstein, which charges a licence to B… in exchange for the rights to reproduce the works.

1. Based on the supplies described above, B… invoices the various entities that, like the Applicant, sell the final product to their customers.

2. The AT did not question the necessity of obtaining these two types of inputs for the Applicant to have the products it markets in proper condition.

3. Additionally, and not insignificantly, there is also to be considered the change that occurred in 2011 in the entities that relate to the Applicant in the supply of the goods that it markets. Indeed, it was from the tax year 2011 that the Applicant started to make its purchases from B…, whereas until that date such purchases were made from Association C….

4. This fact appears to us to be relevant, as the AT's analysis focused on the cost of acquisition of the goods sold by the Applicant, and thus it is important to have in mind the evolution of the Cost of Goods Sold and Materials Consumed (COGS) and its contribution to the total sales recorded by the Applicant during the tax years in which it only related to the said Association, as well as in the tax years in which it began to relate to B…. This relationship is shown in the following table:

1. While it is true that the Applicant's COGS is not constituted solely by invoices from each of these entities, it is a fact that this indicator, relative to the Applicant's sales, registered, on average, an increase from the moment it started to relate to B….

2. In an attempt to better understand the contribution of each of those entities to the Applicant's COGS in each of those years, the following table was prepared, based on information contained in the Tax Inspection Report:

1. That is, it is clear that the remuneration of B… is higher than the remuneration of Association C…. The question thus arises of whether such is justified economically, which should be supported by a functional analysis of B… and Association C… in relation to the Applicant.

2. From what this Tribunal was able to ascertain, there does not clearly result a differentiation that would justify higher remuneration. It is not apparent in what manner B…, from an economic point of view, justifies receiving higher remuneration than Association C…, when the inputs that both provide to the Applicant, in the tax years in which each of them relates to the latter, are substantially identical.

3. However, the correction operated by the AT did not follow this methodology, but rather focused on the comparison between:

• The cost at which the Applicant would incur in acquiring, from independent suppliers, the inputs of a material nature necessary for the production of the goods it markets, such as cards, postcards, window envelopes with letterhead, etc; with

• The cost at which the Applicant incurred with B….

1. Now, this comparison is devoid of sense.

2. And it is devoid of sense because B… did not act, as was proven, as a mere supplier of inputs of a material nature.

3. It became clear that B… bears, from Association C…, costs for licensing relating to the author's rights of the works that it seeks to have reproduced, and thus it is to be expected, from an economic point of view, that B… be compensated for this cost, incorporating it in the invoicing that it issues to the entities of the Group to which it belongs, such as the Applicant, in the course of its activity.

4. The incorporeal element is the essential element of the products sold by the Applicant, and thus it is not understood how the AT could disregard the cost implicit in it in the comparison it made.

5. It would be understandable if the AT, legitimately refusing the Applicant's declaration, had opted for any of the methods for determining transfer prices that are available to it through the combination of article 63º of the Corporate Income Tax Code and Ordinance No. 1446-C/2001 of 21 December.

6. It is not understood how, in the legitimate exercise of its power to correct that declaration, and instead of adequately exploring the methods that are provided for in articles 4º to 10º of that Ordinance, and possibly even overcoming the difficulties raised by issues of alleged incomparability (article 4º, 1, b) of the Ordinance), it made a clean slate of elements that it knew and could not ignore:

• either because they corresponded to a simple intuition based on common rules of experience (who would conceive as normal that B…, or the Applicant, would enrich themselves gratuitously with the author's rights of the creators of the works and with the other incorporeal inputs?);

• or because it had taken them into consideration in the tax assessment for previous tax years of the same Applicant.

1. In summary, the correction proposed by the Respondent, while legitimate, was inadequate.

2. For this reason, the assessment act is illegal, due to erroneous application of article 63º of the Corporate Income Tax Code and articles 4º et seq. of Ordinance No. 1446-C/2001 of 21 December.

III.C.3 – On Indemnity Interest

1. Beyond the declaration of illegality of the assessment, the Applicant also petitions that it be recognized as having a right to indemnity interest, a matter that falls within the scope of the competencies of this Tribunal, as expressly provided for in subsection 5 of article 24º of the LRAT.

2. This is an effect that follows from the acceptance of the request, in that the annulment of the assessment acts renders the prior payment by the Applicant of the entire amount assessed undue.

IV. Decision

In view of all that precedes, it is decided:

a) The request for arbitral ruling is adjudged to have merit, annulling the assessment act in question, with restitution to the Applicant of the tax and compensatory interest paid.

b) The request for payment of indemnity interest is adjudged to have merit, on €110,234.74, from 18 November 2015 until complete restitution, at the legal rate of article 559º of the Civil Code.

V. Value of the Proceedings

The value of the proceedings is fixed at €110,234.74, in accordance with the provision of article 97º-A of the CTP, applicable by force of article 29º, subsection 1, paragraph a), of the LRAT and article 3º, subsection 2, of the Regulation of Costs in Tax Arbitration Proceedings (RCTP).

VI. Costs

Costs are charged to the Respondent, given that the present request was adjudged to have merit, in the amount of €3,060.00, in accordance with Table I of the RCTP, and in compliance with the provisions of articles 12º, subsection 2, and 22º, subsection 4, both of the LRAT.

Lisbon, 7 December 2016

The Arbitrators

José Baeta Queiroz
(President)

Fernando Araújo

Ricardo Gomes Pedro