A LRD Sociedade Unipessoal Limitada (“A…”) is a Portuguese single-member limited company acting as a routine distributor, performing local sales and marketing support functions and bearing only market and customer relationship risks. Its UK-based related party, B… UK, assumed the principal risks including supplier relationship, delivery, inventory, credit, foreign exchange, and product liability risks. For the 2020 financial year, A… applied the transactional net margin method (TNMM) using return on sales (ROS) as a profit level indicator. Before calculating the interquartile range, A… made working capital adjustments to the financial data of the 15 independent comparable companies identified in its benchmark study. These adjustments aimed to neutralise differences in accounts receivable, accounts payable and inventory financing costs between the comparables and the tested party, following the methodology described in the Annex to Chapter III of the OECD Transfer Pricing Guidelines (paragraphs 3.47 and 3.54). The adjusted interquartile range ran from 0.66% to 2.32%, and A… reported an operating margin of 0.98%, falling within the first quartile.
Following an internal audit, the Portuguese Tax Authority accepted the sample of 15 comparables and the TNMM/ROS methodology but rejected the working capital adjustments. The Tax Authority considered that A… had not demonstrated that the adjustments increased the reliability and comparability of the sample, noting an absence of tests and insufficient evidence regarding the materiality of comparable entities’ transactions. Without the working capital adjustments, the SIT recalculated the arm’s length range using the weighted average operating margin and arrived at a median of 1.97%. This led to an upward adjustment of the taxable profit and an additional corporate income tax assessment of €59,654.04 for 2020. A… challenged the assessment before CAAD.
Judgment
The Tribunal ruled in favour of A… and annulled the additional corporate income tax assessment.
The Tribunal found that A…’s reported margin of 0.98% fell within the interquartile range of 0.66% to 2.32% determined in the comparability study. Since the taxpayer’s result was within the arm’s length range, the Tribunal held it was not legally permissible for the tax authority to substitute that result with a different point (1.97%) within the same range. The Tribunal noted that the Tax Authority had tacitly accepted the validity of A…’s benchmark study by using the same sample of comparables, yet had merely disregarded the working capital adjustment and applied a different calculation method (weighted average operating margin) without providing sufficient technical or legal justification. The Tribunal concluded that the tax authority had breached its enhanced duty to state reasons under Article 77(3) of the General Tax Law and had failed to discharge its burden of proof under Article 74 of the General Tax Law. The corrections were found to be vitiated by errors in factual assumptions and a breach of Article 63(1) of the Portuguese Corporate Income Tax Code. The Tribunal also ordered the tax authority to refund the unduly paid tax together with compensatory interest.
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