IRC Payments to Privileged Tax Regime Entities – CAAD Arbitration 86/2018-T Decision

ARBITRAL DECISION

The Arbitrators José Pedro Carvalho (Presiding Arbitrator), Adelaide Moura and Diogo Leite de Campos, appointed by the Deontological Council of the Centre for Administrative Arbitration to form an Arbitral Tribunal, hereby decide as follows:

I – REPORT

On 6 March 2018, A..., Lda, NIPC ..., with registered address at Rua ..., Industrial Zone of ..., ...-... ... ..., ..., filed a request for the constitution of an arbitral tribunal, pursuant to the combined provisions of Articles 2 and 10 of Decree-Law No. 10/2011, of 20 January, which approved the Legal Framework for Arbitration in Tax Matters, as amended by Article 228 of Law No. 66-B/2012, of 31 December (hereinafter abbreviated as RJAT), seeking the declaration of illegality of the Corporate Income Tax (IRC) assessment notice No. 2017 ... of 2017-10-25, relating to the fiscal year 2013, in the amount of €571,111.33.

To substantiate its request, the Applicant alleges, in summary:

• Violation of legally prescribed procedures by notifying the Applicant to justify operations that did not fall within the scope of Article 65 of the Corporate Income Tax Code (CIRC);

• Error of law regarding facts, as proof was presented that the operations subject to correction were effective, had a normal character and their amount was not exaggerated;

• Formal defect due to lack of proper substantiation embodied in its contradiction and obscurity;

• Material substantiation defect embodied in erroneous interpretation of the substantive rule – Article 65 of the General Tax Law (LGT);

• Unconstitutionality of the interpretation given to Article 65 of the CIRC due to violation of Article 104(2) of the CIRC;

• Unconstitutionality of the interpretation given to Article 65 of the CIRC due to violation of Article 204(2) of the CIRC, specifically regarding WTO/GATT agreements and the Tax Treaty with Hong Kong;

• Defect of content regarding bound acts as the act was given content (Article 65 of the CIRC) distinct from what the law requires (Article 63 of the CIRC).

Subsidiarily:

• Error of fact (error in qualification of facts) in proceeding with the correction of expenses that did not contribute to the formation of taxable profit for the year 2013 (violation of the principle of periodization of fiscal years);

• Expiration of the right to assess autonomous taxation.

On 07-03-2018, the request for constitution of the arbitral tribunal was accepted and automatically notified to the Tax Authority.

The Applicant did not appoint an arbitrator, whereby, pursuant to Article 6(2)(a) and Article 11(1)(a) of the RJAT, the President of the Deontological Council of CAAD appointed the undersigned as arbitrators of the collective arbitral tribunal, who communicated acceptance of their appointment within the applicable timeframe.

On 27-04-2018, the parties were notified of these appointments, and neither party expressed any intention to challenge any of them.

In accordance with Article 11(1)(c) of the RJAT, the collective Arbitral Tribunal was constituted on 17-05-2018.

On 21-06-2018, the Respondent, duly notified for such purpose, submitted its response in defense by way of counterclaim.

On 11-09-2018, the hearing referred to in Article 18 of the RJAT took place, where witnesses presented by the parties were examined.

Having been granted a deadline for submission of written arguments, the same were presented by the parties, commenting on the evidence produced and reiterating and developing their respective legal positions.

It was indicated that the final decision would be notified by the deadline set in Article 21(1) of the RJAT, which deadline was extended by two months, pursuant to Article 21(2) thereof, by order of 12-11-2018.

The Arbitral Tribunal is materially competent and is properly constituted, pursuant to Articles 2(1)(a), 5 and 6(2)(b) of the RJAT.

The parties have legal personality and capacity, are legitimate and are legally represented, pursuant to Articles 4 and 10 of the RJAT and Article 1 of Ordinance No. 112-A/2011, of 22 March.

The proceedings do not suffer from any nullities.

Thus, there is no obstacle to the consideration of the case.

Having considered everything, it is necessary to render the following decision:

II. DECISION

A. FACTUAL MATTERS

A.1. Facts Established as Proved

• The Applicant has been registered since 01-01-1989 for the activity of "Wholesale trade in hides and skins" (CAE 46240) and "Other wholesale trade in consumer goods, n.e.c." (CAE 46494), and is classified under the general IRC taxation regime.

• The Applicant was subject to a partial inspection action in IRC for the fiscal year 2013, conducted by the Finance Directorate of ..., pursuant to service order No. OI2017..., with the objective of verifying compliance with fiscal obligations relating to bank transfers to countries, territories or regions qualified as "tax havens" or subject to privileged taxation regimes.

• As a result of the inspection action, the amount of €819,041.81 was added to the taxable result for IRC purposes, pursuant to Article 65(1) of the CIRC, and autonomous taxation was assessed in the amount of €286,664.63, which resulted in the issuance of IRC assessment notice No. 2017... and account reconciliation statement No. 2017..., determining tax payable in the amount of €571,111.33.

• The External Service Order No. OI2017... was signed on 04-04-2017.

• The Applicant made various fund transfers during the fiscal year 2013 with destination to Hong Kong, set out in the table below, which were not declared in Annex H of the Annual Statement of Accounting and Tax Information (IES):

[Table of transfers]

• The Tax Inspection (IT) notified the Applicant to present documentary proof of compliance with the requirements of this legal provision, relating to the materiality of the operations and the absence of abnormal character and exaggerated amount.

• The said notification covered B... LIMITED and other suppliers based in the People's Republic of China, C... LIMITED and D... LIMITED.

• The import operations relating to the said 3 suppliers totaled 23 operations, of which 17 related to B... LIMITED.

• The Applicant requested and obtained an extension of the deadline for response to the said notification, from 30 to 60 days.

• Following the notification, made pursuant to Article 65(4) of the CIRC and carried out in the person of the Certified Accountant and dependent worker of the Applicant E..., documentation was attached, with the IT limiting its analysis to the operations referenced in the table below, relating to supplier B..., an entity domiciled in Hong Kong:

[Table of operations]

• From the invoices that document the operations in question, as well as from the respective maritime bills of lading, it follows that the goods acquired by the Applicant originate from three distinct locations – Vietnam, Thailand and China, with the loading of the ship effected by three entities – F... (Vietnam), G... Ltd (Thailand) and H... Ltd. (China).

• The bills of lading from Thailand, whose goods were loaded aboard by G... Ltd, always contain the indication of an invoice number that coincides with the invoice number used by B....

• The remaining bills of lading make no mention of invoice numbers.

• B... uses three distinct invoice numbering systems, depending on one of the three aforementioned suppliers.

• Payment of all invoices was made to the banking entity I..., located in Shanghai, People's Republic of China.

• In the Inspection Report (RIT), it was considered that "With respect to proof of the existence of imports of goods from the Far East, the documentation presented meets this requirement."

• Regarding the abnormal character of expenses, the RIT states:

"With respect to proof that the amounts paid or due to B... do not have an abnormal character, A... merely asserts that since the goods transacted are 'hides', which are related to the company's social and economic scope, the normal character of the operations is demonstrated (Annex 5, page 4, § 23).

The question that arises is far broader than the simple argument presented. Indeed, it is questionable whether it is normal to have interposed an entity resident in a tax haven when A... purchased entire containers and, according to email messages presented, sometimes could not even import all the merchandise it desired (Annex 8, extracted from CD-ROM, file Pdf 23-24.12).

Especially because B... intermediated the import of goods with origins in three distinct territories from each other (Vietnam, Thailand and China) and distinct from the territory of residence (Hong Kong), without it being minimally demonstrated that such intermediation was essential.

And this procedure, of intermediation by an entity distinct from the entity that appears as "consignor" in the bill of lading, is not verified in practically all other imports of goods, such as those from the following suppliers:

• D… (China) Annex 9;
• J… (China) Annex 10;
• K… (China) Annex 11;
• L… (China) Annex 12;
• M… (Taiwan) Annex 13;
• N… (Philippines) Annex 14;
• O… (India) Annex 15;
• P… (India) Annex 16;
• Q… (India) Annex 17.

The normality of the operations is likewise questionable when it is verified that payments are made via China, which is completely incoherent with the issuance of invoices from Hong Kong. Indeed, Hong Kong may be attributed the title of financial center, whereby the passage through this territory of financial flows related to acquisitions in other locations might even be qualified as normal. Payment via China, as is the case with B..., is what departs from normality.

On this point, the evidence presented is insufficient."

• Regarding the exaggerated amount of expenses, the RIT states:

"With respect to the proof required by Article 65(1) and Article 88(8), both of the IRC Code, regarding the demonstration that the operations are not of exaggerated amount, it is verified that such proof is manifestly insufficient or does not allow a conclusion that rules out tax disregard and autonomous taxation of the operations effected with B....

A... sought to carry out a comparison with its peers, invoking companies that it qualifies as direct competitors. When the figures invoked by A... itself regarding those competitors were analyzed, it is verified that A... presents a performance in terms of gross margin on sales that is inferior to the majority of these competitors.

On the other hand, when this same performance is compared with the ratios of the business unit ..., it is likewise verified that its performance is aligned with the median statistical measure. The facts and indications found point to substantially superior performance, probably close to the 3rd quartile statistical measure, whose direct and exact verification was not possible due to lack of cooperation from A....

If A...'s allegations pointed to performance superior to its competitors, the facts and indications verified suggest that A... will be aligned with the 3rd quartile, which, prima facie, seems to be favorable to A...'s claims. However, this analysis, in isolation, proves nothing.

Even if A... may be, in terms of gross commercialization margin, aligned with the median of the business unit (in terms of declared values), or even aligned with the 3rd quartile of that same business unit (as is likely), any such alignment does not ipso facto mean that the operations carried out with B... cannot be of exaggerated amount. (...)

Also for purposes of proof, A... sought to carry out a comparison of prices practiced by B... with selling prices practiced by other operators from whom it purchases merchandise in comparable situations, but restricted this attempt at proof only to Anilines.

Notwithstanding the foregoing, the comparison contains some errors in mixing and swapping references and/or original invoices, whereby the Tax Inspection carried out exhaustive and complete work of comparing acquisition prices.

From this work it was possible to conclude that some merchandise acquired from B... had a price that could be considered acceptable, as it fell within the price range verified in relation to all acquisitions of comparable merchandise and in minimally comparable situations (even though this intermediate price was sometimes related to the timing of the acquisition).

Even in cases where comparability is questionable, such as when the origin of the goods is different (which may entail different transport costs), the analysis relegated this question to the background, not interfering with the conclusions.

This work was carried out not only for all types of Anilines, in order to correct some shortcomings in A...'s presentation, but also for all Cruets, notwithstanding that A... presented nothing for these items.

A... also expressed intentions to present proof in terms of gross commercialization margins, but did so only in relation to one purchase invoice and without specifying how it reached the values it presented. This attempted proof covers only a small part of the acquisitions made from B....

Notwithstanding also in this case the lack of proof, and without prejudice to A...'s lack of cooperation in explaining the costing formula and in presenting, on verifiable media, all inventory movements including Opening Inventory and Closing Inventory, the Tax Inspection carried out analysis (conditioned by the limitations exposed) of the gross commercialization margins of all references acquired from B....

For purposes of the conclusion on whether acquisitions from B... are or are not overpriced, the two most recent analyses will be taken into account, namely: the comparison of acquisition prices and the gross commercialization margin.

In the case of comparison of acquisition prices, the conclusion is quite straightforward and is set out throughout point III.1.4.3.2 of this report.

As regards the analysis of the gross commercialization margin, given the limitations in analyzing the gross margin actually practiced by A..., and the limitations in determining the gross margin of each of the references acquired from B..., and as a matter of safety and certainty in assessment, only references presenting a margin lower than the margin declared by A... (18.74%) will be considered as not making proof in terms of compared gross margin.

As a matter of safety and certainty in assessment, only references that do not pass the sieve of both analyses (acquisition price higher than comparables and gross commercialization margin lower than declared), will be deemed as not making proof that they are not of exaggerated amount."

• The RIT further states:

"As provided in Articles 65(1) and 65(4) of the IRC Code, A... was notified to present proof that the amounts paid or due, by any title, to entities resident outside Portuguese territory and there subject to a clearly more favorable tax regime, correspond to operations effectively carried out and do not have an abnormal character or exaggerated amount, such proof being equally relevant for purposes of Article 88(8) of that legal instrument.

With respect to proof that such expenses relate to operations effectively carried out, proof was made that imports of merchandise with origin in the Far East occurred.

However, the proof presented raises doubts regarding the persons contacted at B..., and likewise raises doubts upon verification that some bills of lading indicate an invoice number, this numbering being identical to the numbering affixed to invoices from B....

If B... is an intermediary, what is the reason for placing (only sometimes) the numbering of invoices issued by this intermediary?

If the entities belong to the same economic group (producer/shipper and intermediary), and knowing the tax contingency of Articles 65 and 88 of the IRC Code, what is the reason for the merchandise being invoiced by the intermediary resident outside Portuguese territory and there subject to a clearly more favorable tax regime?

As to proof that the expenses derived from invoices issued by B... do not have an abnormal character, no proof was presented other than the simple assertion that such operations fall within the company's social and economic scope.

As explained, it does not seem normal for an intermediary entity resident outside Portuguese territory and there subject to a clearly more favorable tax regime to be interposed in shipments of merchandise originating from three distinct territories, each with a distinct consignor.

Why not carry out acquisitions directly from these consignors as was verified in practically all other imports?

Also, the reality of payments, not to Hong Kong, as would be expected, but to China, does not allow for the conclusion that the operations do not have an abnormal character.

With respect to proof that the operations in question do not have an exaggerated amount, in point III.1.4.3.4 of this report a summary of the scant proof presented, analysis of that same proof presented, and supplementary analyses carried out by the Tax Inspection have already been presented, making it quite clear that, with respect to some acquisitions, it was in no way demonstrated that such operations are not overpriced, quite the contrary.

As a matter of certainty and safety, only acquisitions were flagged that simultaneously presented an acquisition price higher than other acquisitions of identical merchandise and presented a commercialization margin lower than declared by A... (whereby it is presumed that the commercialization margin of those specific merchandise would present a margin well below A...'s actual commercialization margin).

In these terms, with the limitations of proof regarding effectiveness (in the context presented), with limitations of proof regarding character, with manifest limitations in proof regarding amount, and with the supplementary analyses carried out, it should be concluded that, at least with respect to operations flagged as having acquisition price higher than competitors and presenting commercialization margin lower than declared by A..., the tax disregard mechanism provided for in Article 65(1), first part of the IRC Code should apply, as should such operations be subject to the autonomous taxation referred to in Article 88(8) of the IRC Code."

• The receipt confirmation of the registered letter corresponding to registration RH0...PT, which conveyed notification of the final inspection report, was signed on 23-10-2017.

• A..., LDA is a company of markedly commercial character that exercises as its sole activity "Wholesale trade in hides and skins", CAE 46240.

• The Applicant was founded in 1984 and has since dedicated itself to the commercialization of hides and synthetic articles destined for a broad range of industrial activities, with emphasis on the footwear sector.

• Following the evolution and development of the characteristics of this sector, the Applicant focused on presenting and combining new materials and on establishing a close relationship with design.

• The range of products commercialized by the Applicant, as of the date of the facts subject to inspection, encompassed natural hides of cow, buffalo, goat, sheep and pig and also synthetic articles, such as PU and/or PVC, this offer being complemented by textile products, such as fur and non-woven fabrics.

• An important and essential component of footwear is linings, which in a good part of the Applicant's customers are manufactured in natural hide.

• A good hide for linings requires specific qualities such as reduced thickness, ductility, resilience and resistance to shock.

• The raw material that best suits these characteristics is pig hide, originating from the Far East and which is not produced in any other geographic zone.

• In order to mitigate quality problems, especially in natural products, the Applicant works with the same suppliers for several years.

• It is important in business relations of supply contracts in other zones of the globe to have mutual knowledge and confidence acquired and established over the years, for which it is fundamental, among other things, timely payment and payment in the conditions dictated by the supplier.

• Although the commercial name or legal personality of the supplier entities has varied over the years, the Applicant has been negotiating with the same Asian businessmen for several years, among whom is included the R... family.

• B..., an entity based in Hong Kong since 2007, is held by promoters originating from the People's Republic of China, from the city of ..., and who under other corporate names have been suppliers of A... since the beginning of its activity.

• The reliability of this supplier and the timeliness of its supplies were the reasons why it became the main supplier among A...'s suppliers of pig hide (aniline and cruet).

• The prices practiced by B... were negotiated by the Applicant, with cancellation of orders occurring because the prices proposed by that supplier were considered by the Applicant to be too high.

• Invoice No. 13/554, of 18-02-2013, relates to a purchase from N..., a Philippine supplier contacted at a Hong Kong fair, from which was acquired only one item of a single reference (1PO1T009XNS).

• This article was proposed to A... as a business opportunity, since it had been produced for a Mexican customer who subsequently withdrew the order, being a stock/lot for which the price A... was able to negotiate a considerable discount.

• The Applicant never made another order from this supplier, as the quality of the product fell far short of expectations, resulting in difficulty in its sale, with difficulty in selling it, as only in 2017 the article had significant sales, due to market scarcity, with about 80 feet remaining in inventory.

• The referencing of merchandise by A..., regarding the purchases in question was made in the following manner:

[Table of product codes and references]

• The variables relevant to the determination of prices for products referable to the references in question, as of the relevant date, were:

• The type of hide (aniline or cruet) - 4th digit;

• The finish – 5th digit;

• The hide being of pig or sow (given the quality, pig hide is superior to sow) – 6th digit;

• Fourth, the quality of the product.

• The time factor embodied in the cyclical conditions of supply and demand;

• The exchange rate of the US dollar against the Chinese currency, the "yuan/renminbi".

• The Color Code (columns 7 to 9), within each of the patterns and finish, was not reflected from the point of view of price setting.

A.2. Facts Established as Not Proved

With relevance to the decision, there are no facts that should be considered as not proved.

A.3. Substantiation of Proved and Not Proved Factual Matters

Regarding the factual matters, the Tribunal does not have to rule on everything alleged by the parties; rather, it has a duty to select the facts that matter for the decision and to distinguish between proved and not proved matters (cf. Article 123(2) of the Code of Tax Procedure and Process (CPPT) and Article 607(3) of the Code of Civil Procedure (CPC), applicable by virtue of Article 29(1)(a) and (e) of the RJAT).

Thus, the facts pertinent to the adjudication of the case are chosen and delimited according to their legal relevance, which is established in light of the various plausible solutions to the question(s) of law (cf. former Article 511(1) of the CPC, corresponding to current Article 596, applicable by virtue of Article 29(1)(e) of the RJAT).

Thus, having regard to the positions taken by the parties, in light of Article 110(7) of the CPPT, the documentary evidence and the Procedural Record attached to the case, as well as the testimonial evidence and party statements produced, the facts listed above were considered proved, with relevance to the decision, taking into account that, as stated in the Judgment of the Court of Administrative Appeals (TCA-Sul) of 26-06-2014, rendered in case 07148/13, "the evidentiary value of the tax inspection report (...) may have probative force if the assertions contained therein are not contested."

The facts contained in points 23 to 32, 37 to 39 were based on the testimonial evidence presented by the Applicant and on party statements produced, whereby the testimony of the witness presented by the Tax Authority, as having no direct knowledge of the same, was not capable of, in that part, undermining the remaining evidence produced.

In particular, points 38 and 39 gave special consideration to party statements, as well as the testimony of witness S..., who demonstrated direct and precise knowledge of the facts, showing objectivity and impartiality on the matter, and whose testimonies were consistent with the available documentary evidence.

No consideration was given to allegations made by the parties, presented as facts, consisting of strictly conclusive statements, incapable of proof, and whose truthfulness must be determined in relation to the concrete factual matters consolidated above.

B. LAW

As previously stated, the Applicant begins by alleging violation by the Tax Authority of the legally prescribed procedure, by notifying the Applicant in the person of its certified Accountant, pursuant to Article 65(4) of the CIRC, to justify operations that did not fall within the scope of such provision.

For the Applicant, "in substance it is not the same thing to carry out verification in two months (one month contained in the notification plus another from the Applicant's request – request of 2017-05-05 approved by the Finance Directorate of ...) that purchases from suppliers C... and D... LIMITED based in the People's Republic of China and B... LIMITED, based in Hong Kong (23 import processes) were effective, did not have abnormal character or exaggerated amount or only of the 17 import processes relating to B...", ultimately having been required "justifications/verifications in excess of what the legal norm provides."

The Applicant furthermore maintains that the tax inspector did not engage "with the company in a manner to present its ideas on the form of verification and the use to be made of general means of proof, as the collaboration principle to which it is subject imposes."

The Applicant concludes that there was a violation of the principles of proportionality and good faith.

With due respect, the allegation now made by the Applicant cannot be accepted in any way.

Thus, first and foremost, the concretization of none of the principles invoked, absent any norm that specifies them, descends to the level of detail sought by the Applicant.

That is: it would not, as a rule, be sustainable that, by application of a mere principle, the Tax Authority be legally censured for potential errors – which are not even indicated as intentional – for which the law itself provides no sanction.

Moreover, in the present case, the factual substratum itself invoked by the Applicant does not point toward any dysfunction.

Thus, as regards the fact that notification was made in the person of the Certified Accountant, the Applicant does not allege violation of any norm, nor indicate any prejudice resulting therefrom.

On the other hand, as regards the "excessive" notification, it cannot be overlooked that the Applicant was afforded the maximum legal deadline provided, when it is certain that, at the abstract level, an infinite number of situations substantially more complex than that of the Applicant can be configured, and which must be handled, at most, within the same deadline that was granted to the Applicant.

As to the circumstance that the notification in question included matters that, subsequently, were considered as not falling within the scope of the legal purpose of Article 65(4) of the CIRC, no concrete reason for complaint on the part of the Applicant can be discerned.

Indeed, one of two things must be true:

• Either it was manifest that the matter in question went beyond the scope of the legal purpose of the notification carried out, and the Applicant did not need to waste more time than necessary to say precisely that;

• Or it was not manifest that this was so, which may justify an increase in the evidential burden on the Applicant but, necessarily, justifies at the same time and to the same extent that, precisely because it was not manifest that the matter in question went beyond the scope of the legal purpose of the notification carried out, such matter was included in it.

Thus, if there was any "excess," it would more likely be at the level of the deadline granted to the Applicant, rather than at the level of the content of the notification directed to it.

Thus, in light of the foregoing, the arbitral request should fail in this regard.

The Applicant proceeds further, raising the occurrence of error of law regarding facts, as it considers that proof was made that the operations subject to correction were effective, had normal character and their amount was not exaggerated.

At issue in this part is, therefore, the application of Articles 65 of the CIRC, in the version of Law No. 64-B/2011, of 30 December (in force in 2013), and 88(8) of the same Code, which establish the following, insofar as the case is concerned:

"Article 65

Payments to Non-Resident Entities Subject to Privileged Tax Regime

1 – Amounts paid or due, by any title, to natural or legal persons resident outside Portuguese territory and there subject to a clearly more favorable tax regime shall not be deductible for purposes of determining taxable profit, unless the taxpayer is able to prove that such expenses correspond to operations effectively carried out and do not have an abnormal character or exaggerated amount.

2 – A natural or legal person is considered to be subject to a clearly more favorable tax regime when the territory of residence of same appears on the list approved by ordinance of the Minister of Finance or when such person is not taxed therein on an income tax identical or analogous to IRS or IRC, or when, regarding the amounts paid or due mentioned in the preceding number, the amount of tax paid is equal to or less than 60% of the tax that would be due if the said entity were considered resident in Portuguese territory.

3 – For purposes of the provision in the preceding number, taxpayers must possess and, when requested by the Directorate-General of Taxes, provide the corroborating elements of the tax paid by the non-resident entity and of the calculations made for determining the tax that would be due if the entity were resident in Portuguese territory, in cases where the territory of residence of same does not appear on the list approved by ordinance of the Minister of Finance.

4 – The proof referred to in number 1 must take place following notification of the taxpayer, made with minimum notice of 30 days."

"Article 88

Autonomous Taxation Rates

(...)

8 - Expenses corresponding to amounts paid or due, by any title, to natural or legal persons resident outside Portuguese territory and there subject to a clearly more favorable tax regime, as defined by the Code, shall be subject to the regime of number 1 or number 2, as appropriate, with the applicable rates being respectively 35% or 55%, unless the taxpayer is able to prove that they correspond to operations effectively carried out and do not have an abnormal character or exaggerated amount. (...)"

The territory of Hong Kong was included in 2013 on the "list of countries, territories and regions with privileged taxation regimes, clearly more favorable," as set forth in Ordinance No. 292/2011, of 8 November, which amended Ordinance No. 150/2004, of 13 February.

At issue in the case sub judice is the proof, imposed by both of the above-cited norms, regarding the effectiveness of the operations and the normal or not exaggerated character of the operations, proof for which, pursuant to the applicable norms regarding burden of proof, rests with the Applicant.

As stated in the Judgment of the Court of Administrative Appeals (TCA-Sul) of 05-11-2015, rendered in case 07022/13, we are dealing with the "application of the rule of non-acceptance of deductible expenses when payments made to natural persons or companies established in tax havens are involved, unless the taxpayer proves the above-identified vectors:

a- We are dealing with operations effectively carried out;

b- That do not have an abnormal character or that the amount involved is not exaggerated."

More can be read in the same judgment:

"More should be mentioned that the law requires no formalism in these proofs, thus applying to them the system of free proof and whereby the taxpayer can avail itself of all means of proof permitted by law (cf. e.g. Articles 352 et seq. of the Civil Code). With respect to proof of the truthfulness of the operation, the mere presentation of written documents, namely contracts entered into between the parties, will not suffice, as these are presumed to be simulated, nor will demonstration of payment of the price, as such is not called into question. What should be subject to proof is rather the effective provision of services, (...) that is, the commercial fact that was at the origin of payment of the same price that appears as a cost to be deducted in IRC. As to proof of the absence of abnormal or exaggerated character of expenses, this should pass through demonstration that the contract, whose truthfulness has been proved, presents itself as balanced. To this end, the taxpayer should demonstrate the real importance of the advantages gained from the contract in question, such as to make proof that the expenses established constitute fair remuneration for those advantages, particularly by comparison with the costs of similar services on the market."

It shall be, therefore, in light of the criterion indicated and having regard to the concrete grounds imprinted by the Tax Authority on the tax act sub judice that its legality must be assessed.

Let us proceed, then.

As results from the norms in question, and from the judicial interpretation made thereof, which has previously been set out, it is necessary to ascertain whether proof has been made that:

• We are dealing with operations effectively carried out; and that

• The same do not have an abnormal character or that the amount involved is not exaggerated.

Before proceeding, it should be noted from the outset that, as expressly results from the Inspection Report, it is not disputed that the operations in question were not effectively carried out, the only reservation raised therein, related to the use of an email "chinafareast", being duly clarified in light of the factual matters established as proved.

In this framework, it is only necessary to assess whether the operations in question do not have an abnormal character or whether the amount involved is not exaggerated, in light of the jurisprudential understanding, referenced above, according to which "the taxpayer should demonstrate the real importance of the advantages gained from the contract in question, such as to make proof that the expenses established constitute fair remuneration for those advantages, particularly by comparison with the costs of similar services on the market."

With respect to the verification, or not, of operations with an abnormal character, it was stated, in summary, in the Inspection Report that:

• "it is questionable whether it is normal to have interposed an entity resident in a tax haven", "without it being minimally demonstrated that such intermediation was essential," and that "this procedure, of intermediation by an entity distinct from the entity that appears as 'consignor' in the bill of lading, is not verified in practically all other imports of goods";

• "The normality of the operations is likewise questionable when it is verified that payments are made via China, which is completely incoherent with the issuance of invoices from Hong Kong. Indeed, Hong Kong may be attributed the title of financial center, whereby the passage through this territory of financial flows related to acquisitions in other locations might even be qualified as normal. Payment via China, as is the case with B..., is what departs from normality."

Regarding the first of the aspects focused upon, the evidence produced and the factual matters established as proved demonstrate that this is a long-standing supplier of the Applicant, of a specific material (Asian pig hide), of great importance for the activity of the latter, and which reorganized its corporate structure, centering it in Hong Kong.

Thus, any "strangeness" that was justified in the Inspection Report is hereby deemed duly dissipated.

As to the second of the aspects focused upon above, it should be made clear, following the jurisprudence previously emphasized, that the judgment of normality in question is restricted to a purely economic perspective, that is, it should be demonstrated that the operations in question do not have an abnormal character, within the framework of the economic activity (generating income subject to tax) of the taxpayer who was party to them.

This means, first and foremost, that it is not any deviation from procedures, practices or habits that will obstruct the normality of the operations. Thus, and at the limit, for example, it would not be normal that invoices be issued in shocking pink ink. Nevertheless, such fact would not be apt to rule out the normality of the operations underlying such invoices, in the terms and for the purposes of the norms with which we are now concerned.

Having said this, in the circumstance that payments are invoiced in Hong Kong but made to China, one cannot fail to take into account that that territory, without prejudice to its particularities, is an Administrative Region of the P.R. of China.

Moreover, contrary to what is assumed in the Inspection Report, it is a matter of public knowledge that payments are not always made directly to the creditor, it being legal and admissible that they be made to third parties, at the instruction of the latter, on the one hand, or that they be made to the creditor but in a jurisdiction different from its seat, a typical case in our country being payments made in Portugal for services rendered in Angola.

Finally, and also in counterpoint to what was considered in the Inspection Report, from the point of view of normality of fraudulent or evasive activity, the usual would be to make payments owed to non-resident entities in tax havens, at banking entities based in these. Such a procedure is what complicates the action of tax authorities, given the characteristic hermeticity of territories qualified as having privileged taxation.

The contrary, which is what happens in the case, when payment to an entity based in territories qualified as having privileged taxation is made outside these, comprises a circumstance that, per se, though not demonstrating it, corroborates other indications of the normality of the operation, by showing that no effort is being made to obscure the payments, when this could easily be done.

Thus, and for example, if a payment to an entity based in Andorra is made in Portugal, the national authorities will have, taking into account the obligations of cooperation that rest with banking entities and the inspection powers available to them, all the conditions to investigate or collaborate in the investigation of any irregularity that has been perpetrated.

Thus, taking into account that the operations now in question were effectively carried out, that their object relates directly to the activity of the Applicant, exercised for several years, that the intermediation of the entity based in Hong Kong concerns merchandise very specific and which are part of the normal trade of the Applicant for several years, that such entity is successor to others, based in the P.R. of China, with whom the Applicant has also been transacting for several years, and that it is not evident that advantage was sought to be taken of all the advantages that the territory of seat could provide, from a perspective of fraud or abuse, one cannot conclude otherwise than that, in the present case, it has been demonstrated, beyond reasonable doubt, that the operations in question do not have an abnormal character.

Having reached this point, it is now necessary to address the assessment of whether the amount involved in the operations in question is exaggerated or not.

On this matter, the Applicant began by alleging, already during the inspection procedure, that its economic performance, by comparison of gross margins obtained with other companies which are its competitors, "still remains at perfectly normal values for the sector."

On this matter, the Inspection Report concluded after extensive analysis that "In summary, it is not possible to validate A...'s assertion that it is aligned with the operators it qualifies as its competitors, it being even possible to suppose that its commercialization margin is above those listed competitors, and coherent with the value of the 3rd quartile of the business unit ..."

That is, it was not invalidated in the Inspection Report that the economic performance of the Applicant, by comparison of gross margins obtained with other companies which are its competitors, "still remains at perfectly normal values for the sector," the possibility even being admitted that such performance may be at a considerably higher level than the sector normal.

Nevertheless, here, as in the Inspection Report, it is concluded that this element, per se, comprises merely an abstract given that, though capable, when combined with others of a concrete nature, of pointing toward the non-exaggeration of the amounts involved in the operations in question, by itself does not permit establishing, necessarily and beyond any reasonable doubt, that such is the case.

Subsequently, the Applicant presented a case-by-case analysis of purchase prices, carried out in two ways:

• Comparison of B...'s purchase prices with other operators; and

• Comparisons of gross commercialization margins.

The said method was likewise accepted by the Tax Authority, which proceeded to its analysis by the two ways proposed, analysis that will now be assessed, whereby, in the scope in question, the following items/references were analyzed by the Tax Inspection:

Pig Anilines:

• Cognac;
• Brown Nutmeg;
• White;
• Soft Cognac;
• Dark Brown;
• Beige;
• Navajo Beige;
• Fjord Blue;
• Mel Rajah;
• Black;
• Anthracite Gray;
• Colonial Beige;
• Orange.

Pig Cruets:

• Beige;
• Beige Burlywood;
• Naples Beige;
• Burgundy Brown;
• Anthracite Gray;
• PAARL Cognac;
• Chrome;
• Lacquered Blue;
• Lacquered Beige;
• Lacquered Beige Burlywood;
• Lacquered Beige Corn;
• Lacquered Naples Beige;
• Lacquered White;
• Lacquered Burgundy Brown;
• Lacquered Cabul Brown;
• Lacquered Anthracite Gray;
• Lacquered Medium Gray;
• Lacquered Honey;
• Lacquered Honey Melon;
• Lacquered Honey Sienna;
• Lacquered Black;
• Honey Sienna;
• Black.

From the items mentioned, the Tax Inspection ultimately considered proof of non-exaggeration of the amount of operations realized with respect to the following:

Pig Anilines:

• White (1 ref);
• Soft Cognac;
• Dark Brown;
• Beige (2 refs);
• Fjord Blue;
• Mel Rajah;
• Anthracite Gray;
• Colonial Beige;
• Orange.

Pig Cruets:

• Beige Burlywood;
• Naples Beige;
• Burgundy Brown;
• Lacquered Naples Beige;
• Lacquered Burgundy Brown;
• Lacquered Honey Sienna;
• Black.

And concluded that such proof was not verified with respect to the following items:

Pig Anilines:

• Cognac;
• Brown Nutmeg;
• White (ref. 1PO1SG020GZ);
• Beige (ref. 1PO1SG120GZ);
• Navajo Beige;
• Black.

Pig Cruets:

• Beige;
• Anthracite Gray;
• PAARL Cognac;
• Chrome;
• Lacquered Blue;
• Lacquered Beige;
• Lacquered Beige Burlywood;
• Lacquered Beige Corn;
• Lacquered White;
• Lacquered Cabul Brown;
• Lacquered Anthracite Gray;
• Lacquered Medium Gray;
• Lacquered Honey;
• Lacquered Honey Melon;
• Lacquered Black;
• Honey Sienna.

It was with respect to operations concerning these last items that the respective costs were disregarded and autonomous taxation was levied, at issue in the present arbitral process, and on which this Arbitral Tribunal must rule, noting that operations subject to correction by the Tax Authority correspond to orders of references that failed both of the tests referred to above.

Upon review of the Inspection Report, it is verified, from the outset, the occurrence of two methodological errors, which emerge from the factual matters established as proved, and which are as follows:

• The Tax Authority assumed that the 6th digit of the Applicant's references designates "large" or "small" hides, when, as was ascertained, it refers to pig "hide" (more expensive, ref. "O") or "sow hide" (cheaper, ref. "G");

• That the 7th, 8th and 9th digits of those references (color code) are relevant to the acquisition price, which, as was also ascertained, will not be the case.

Beyond what has been pointed out, it should be noted that the criterion for assessing the non-exaggeration of the value of operations practiced can never be based on considerations of the sort "Naturally, in an entity aiming at profit, any acquisition of goods or services that is carried out at a price higher than the lowest possible price, with other business conditions being identical, must be considered exaggerated." (p. 69 of the Inspection Report).

Indeed, and as stated in the Judgment of the Court of Administrative Appeals cited above, the criterion is that of "the real importance of the advantages gained from the contract in question", and that "the expenses established constitute fair remuneration for those advantages, particularly by comparison with the costs of similar services on the market."

Naturally, such comparison must be made from a perspective of normality, applied to the specific case, which encompasses a series of contingencies, such as the time when the transactions occurred, the need, at that time, for the acquisition in question, the context and trust relationships between the parties involved, the relevance of quality (or other subjective elements) of the goods or services in the business sector in question, and even the possibility of the existence of a less accurate business decision.

What will be at issue will therefore be whether the operations in question have, beyond any reasonable doubt, the capacity to generate advantages for the entity involved, and that the cost of those advantages is fair, reasonable, proportional to such advantages, in the context of the market in which the agent operates, which obviously does not boil down to an obligation that operations with entities resident in territories subject to more favorable tax regime must be, in order to be accepted, carried out at the lowest possible cost, or even that they be at a cost lower than all or some others practiced on the market, but that they be under conditions and for values that, from the perspective of the concrete market in question, do not present themselves, insofar as the case now matters, as exaggerated.

Having verified the operations underlying the corrections made by the Tax Authority, now in issue, it is noted, from the outset, that a high number of them reconduce to situations which, from the perspective of the Tax Authority, it was not possible, from among the data made available by the Applicant, to obtain acceptable references that would permit, in at least one of the two ways of analysis undertaken, carrying out valid comparisons.

On this matter, and having regard to the fact that, as previously stated, the Inspection Report suffers from error of fact in considering incomparable references in which only the color code (digit 7 to 9) varied, it is then necessary to ascertain whether, in fact, for the operations in question it is or is not possible to obtain comparison terms, within the methodologies followed in the Inspection Report itself.

Thus, in light of the verified irrelevance of the color code (digit 7 to 9), the Pig Anilines Cognac, Brown Nutmeg, and Black, acquired from B... and whose acquisition operations underlie the corrections made by the Tax Authority, and now in issue, will be comparable to all remaining acquisitions of dyed anilines (reference "T" in the 5th digit), of pig hide (reference "O" in the 6th digit).

Having enlarged the comparison base in this manner, we have that, for the first method of analysis, suggested by the Applicant and accepted by the Tax Authority, taking into account the data of the Inspection Report itself, the following maximum values (in USD/unit) of comparable operations are verified:

Pig Anilines Dyed Pig Hide:

• Cognac: 0.870
• Brown Nutmeg: 0.880
• Soft Cognac: 0.900
• Dark Brown: 0.920
• Fjord Blue: 0.890
• Mel Rajah: 0.850
• Black: 0.880
• Anthracite Gray: 0.920
• Orange: 0.890

Now, from the references indicated, it should be noted from the outset that the Tax Authority accepted as non-exaggerated amount those referring to colors Soft Cognac, Dark Brown, Fjord Blue, Anthracite Gray and Orange, where operations were carried out at values higher than the acquisition of Pig Anilines Cognac, Brown Nutmeg, and Black, now in question, some of which with B... itself. Thus, and in light of the fact proved that color included in digits 6 to 9 of the Applicant's references does not contend with the prices of the operations, it must necessarily be concluded that the operations relating to the acquisition of Pig Anilines Cognac, Brown Nutmeg, and Black from B... must likewise be deemed as having non-exaggerated amount.

In light of the same principles, acquisitions of Pig Anilines White (ref. 1PO1SG020GZ) Beige (ref. 1PO1SG120GZ), and one of the acquisitions of Navajo Beige (ref. 1PO1SG115GZ), acquired from B... and whose acquisition operations underlie the corrections made by the Tax Authority, and now in issue, will be comparable to all remaining acquisitions of simple anilines (reference "S" in the 5th digit), of sow hide (reference "G" in the 6th digit).

Having enlarged the comparison base in this manner, we have that, for the first method of analysis, suggested by the Applicant and accepted by the Tax Authority, taking into account the data of the Inspection Report itself, the following maximum values (in USD/unit) of comparable operations are verified:

Simple Pig Anilines Sow Hide:

• White: 0.780
• Beige: 0.780
• Navajo Beige: 0.780

All these values relate to acquisitions from B..., it being the case that remaining acquisitions of the same materials varied in price between 0.620 and 0.745, with likewise values of 0.690 and 0.720.

Notwithstanding, the deviation verified will not, given the criteria previously set forth, be sufficient for it to be adjudged that non-exaggeration of the values in question is not verified.

Indeed, within the universe of comparison above pointed out, we have the following operations:

Simple Pig Anilines White Sow Hide:

[Table with price comparisons]

Simple Pig Anilines Beige Sow Hide:

[Table with price comparisons]

Simple Pig Anilines Navajo Beige Sow Hide:

[Table with price comparisons]

From the foregoing it results that, excluding the highest value operations with B..., a variation of values between 0.620 and 0.745 is verified, that is, of 0.125, the value of the operations with B... being situated 0.035 above the aforementioned highest value, that is, less than 5% above.

On the other hand, looking at all the operations as a whole, it is verified that D... is, as a rule, the cheapest supplier of the Applicant, with respect to the raw materials in question.

Thus, and for example, in Simple Pig Anilines White Sow Hide, the difference between the maximum price of D... (0.800) and the maximum price verified (0.870, from M...), is 8.75%.

In another example, in acquisitions of Fjord Blue Pig Anilines, accepted by the Tax Authority as non-exaggerated value, the difference between the price practiced by D... (0.715) and by B... (0.890) – which, it is repeated, was considered non-exaggerated – was 0.175, corresponding to almost 25%!

Thus, globally considering the factual situation, of being at issue a traditional supplier of the Applicant, with consequent indices of reciprocal satisfaction, the reduced scope of the sample that was possible to formulate, the circumstance that there are no doubts whatsoever that these were effective operations, relating to merchandise that falls within the core of the Applicant's productive activity, the fact that this is a very extensive commercial relationship without any relevant abnormalities being detected, as well as all operations having resulted in profit (greater or lesser) for the Applicant, and properly weighed in its context, the deviation in question, a judgment of non-abnormality of the prices in question is formulated with the necessary certainty and without any reasonable doubt.

Finally, the operation relating to the acquisition of Pig Anilines Navajo Beige, with ref. 1PO1SO115GZ, will, in light of what has been set forth, be comparable to all remaining acquisitions of simple anilines (reference "S" in the 5th digit), of pig hide (reference "O" in the 6th digit).

Having enlarged the comparison base in this manner, we have that, for the first method of analysis, suggested by the Applicant and accepted by the Tax Authority, taking into account the data of the Inspection Report itself, the following maximum values (in USD/unit) of comparable operations are verified:

Simple Pig Anilines Pig Hide:

• White: 0.870
• Beige: 0.890
• Navajo Beige: 0.850

It is thus verified that the acquisition of Pig Anilines Navajo Beige, with ref. 1PO1SO115GZ, was at a price below the highest acquisition price of anilines of the same species (simple, of pig hide) of white and beige colors, it being that such values were practiced by other entities than B... (M...).

In this context, it also cannot be considered that it is not demonstrated, beyond reasonable doubt, the non-exaggerated character of the amount of the operation relating to the acquisition from B... of Pig Anilines Navajo Beige, with ref. 1PO1SO115GZ.

With respect to Cruets, we have from among the products relating to operations identified, that all of them were considered as having no comparable term, reason for which they failed the first of the tests regarding the non-exaggerated character of the amount of their respective operations, carried out by the Tax Authority.

However, in light of what has been previously set forth, we have that the Pig Cruets in question can be reconduce to the following types:

• Simple Sow Hide (5th and 6th digit of the reference, respectively "S" and "G"): Beige; Chrome;
• Dyed Sow Hide (5th and 6th digit of the reference, respectively "T" and "G"): Anthracite Gray; PAARL Cognac and Honey Sienna;
• Lacquered Sow Hide (5th and 6th digit of the reference, respectively "L" and "G"): Lacquered Blue; Lacquered Beige; Lacquered Beige Burlywood; Lacquered Beige Corn; Lacquered White; Lacquered Cabul Brown; Lacquered Anthracite Gray; Lacquered Medium Gray; Lacquered Honey; Lacquered Honey Melon; Lacquered Black.

With respect to the first of the referred groups, and in the same terms already previously set forth for anilines, we have the following maximum values (in USD/unit) of comparable operations:

Simple Pig Cruets Sow Hide:

• Beige: 0.280
• Beige Burlywood: 0.320
• Naples Beige: 0.320
• Chrome: 0.325

From the references indicated, the Tax Authority accepted as non-exaggerated amount those referring to colors Beige Burlywood and Naples, where operations were carried out at values higher than the acquisition of Simple Pig Cruets Beige, now in question, some of which with B... itself. Thus, and in light of the fact proved that color included in digits 6 to 9 of the Applicant's references does not contend with the prices of the operations, it must necessarily be concluded that the operations relating to the acquisition of Simple Pig Cruets (sow hide) Beige from B... must likewise be deemed as having non-exaggerated amount.

As to the acquisition of Simple Pig Cruets (sow hide) Chrome from B..., it is verified that the same is situated only half a cent of a dollar, per unit, above the maximum value practiced in comparable operations, in the terms previously set forth, whereby this operation also should not be deemed as exaggerated amount.

With respect to the second of the referred groups, always in the same terms, we have the following maximum values (in USD/unit) of comparable operations:

Dyed Pig Cruets Sow Hide:

• Burgundy Brown: 0.340
• Anthracite Gray: 0.320
• PAARL Cognac: 0.310
• Honey Sienna: 0.335
• Black: 0.300

From the references indicated, the Tax Authority accepted as non-exaggerated amount those referring to color Burgundy Brown, where an operation was carried out at values higher than the acquisition of Dyed Pig Cruets Anthracite Gray, PAARL Cognac and Honey Sienna, now in question, to an entity other than B... (M...). Thus, and in light of the fact proved that color included in digits 6 to 9 of the Applicant's references does not contend with the prices of the operations, it must necessarily be concluded that the operations relating to the acquisition of Dyed Pig Cruets (sow hide) Anthracite Gray, PAARL Cognac and Honey Sienna from B... must likewise be deemed as having non-exaggerated amount.

With respect to the third of the referred groups, always in the same terms, we have the following maximum values (in USD/unit) of comparable operations:

Lacquered Pig Cruets Sow Hide:

• Lacquered Blue: 0.385
• Lacquered Beige: 0.370
• Lacquered Beige Burlywood: 0.350
• Lacquered Beige Corn: 0.340
• Lacquered Naples Beige: 0.370
• Lacquered White: 0.340
• Lacquered Burgundy Brown: 0.400
• Lacquered Cabul Brown: 0.360
• Lacquered Anthracite Gray: 0.360
• Lacquered Medium Gray: 0.350
• Lacquered Honey: 0.370
• Lacquered Honey Melon: 0.360
• Lacquered Honey Sienna: 0.400
• Lacquered Black: 0.360

That is: it is verified here that acquisitions of Lacquered Pig Cruets Sow Hide of color Lacquered Honey Sienna and Lacquered Burgundy Brown, which were accepted as non-exaggerated amount by the Tax Authority, had an amount higher than the remaining acquisitions which were by the same considered as having not demonstrated that non-exaggerated character.

However, and following what was previously set forth, those operations will be considered as comparable, whereby all will have to be had as having non-exaggerated amount.

In light of all the foregoing, it is adjudged that the demonstration has been made, presupposed by Articles 65 and 88(8) of the applicable CIRC, that the operations sub judice correspond to effective operations of normal character and non-exaggerated amount.

Thus, attentive to errors of fact, and consequent errors of law, the tax act subject to the present arbitral action must be annulled, the arbitral request being consequently procedural, and knowledge of the remaining questions raised by the Applicant being prejudiced.

C. DECISION

To this effect, this Arbitral Tribunal decides to wholly uphold the arbitral request formulated and, in consequence:

• Annuls the Corporate Income Tax (IRC) assessment notice No. 2017... of 2017-10-25, relating to the fiscal year 2013;

• Condemns the Respondent in the costs of the process, as set forth below.

D. Value of Proceedings

The value of the proceedings is set at €571,111.33, pursuant to Article 97-A(1)(a) of the Code of Tax Procedure and Process, applicable by virtue of Article 29(1)(a) and (b) of the RJAT and Article 3(2) of the Regulation of Costs in Tax Arbitration Proceedings.

E. Costs

The arbitration fee is set at €8,568.00, pursuant to Table I of the Regulation of Costs in Tax Arbitration Proceedings, to be paid by the Respondent, since the request was wholly upheld, pursuant to Articles 12(2) and 22(4), both of the RJAT, and Article 4(4) of the aforementioned Regulation.

Notify accordingly.

Lisbon, 17 January 2019

The Presiding Arbitrator

(José Pedro Carvalho)

The Arbitrator Vogal

(Adelaide Moura)

The Arbitrator Vogal

(Diogo Leite de Campos)