This case concerned the 2008 tax year, and the tax-payer was a company resident and incorporated in Portugal and a 100 percent subsidiary of a German company. The tax authorities assessed substantial corporate income tax because of a tax audit.
The company claimed that the tax assessment violated the Portuguese transfer pricing regime because the tax authorities assumed that the company had provided a guarantee to its parent company, a related entity. However, according to the company, it could not be said that the subsidiary rendered a guarantee to its parent company under the cash-pooling agreement. The company also argued that the tax authorities were wrong in applying the comparable uncontrolled price method in order to obtain the arm’s-length price under the cash-pooling arrangement.
The tax authorities in their answer stated that the contract between the parent and the subsidiary had clauses that deviated from a cash-pooling contract and they believed it should be deemed a mix of different contracts. According to the tax authorities, the company in addition to providing a guarantee to its parent ended up financing the activity of the parent company in less favorable terms for the company than if it was not in an affiliated relationship.
According to the tax authorities, the company was a company with a budget surplus, which enables it to dispose of funds for financial applications such as savings deposits. The good financial situation of the Portuguese subsidiary contributes to a better credit rating than that of its parent company, and the subsidiary will be able to obtain loans much more easily than its parent company. According to the tax authorities, since the Portuguese subsidiary had excess funds, its account should show zero or a credit balance at all times (debit balances not being allowed).
Inversely, the account of the parent company could have a debit balance (if the overall balance showed at all times zero or a credit balance). This means that the Portuguese subsidiary could not be financed under this agreement. Moreover, since the overall balance had to be positive or zero, the parent company would only obtain financing if the account of the subsidiary had enough balance to cover the needs of the parent company.
The tax authorities further argued that according to clause 7 of the agreement, the Portuguese subsidiary guarantees any eventual liabilities through present or future credits with the bank. The tax authorities consider that according to normal market conditions the bank is protected and guaranteed by the better credit rating of the subsidiary. Without the subsidiary, the parent company would pay a higher interest rate to finance itself. Further, this agreement was only possible because there was a relationship between the parent company and its subsidiary. Otherwise, the subsidiary would never enter into this type of agreement.
The tax authorities believed that those circumstances demonstrated a violation of the arm’s-length principle, since a company without a special relationship would pay a higher interest rate if not for the guarantee of the Portuguese subsidiary. If these types of arrangements were to be legitimized, it would be bad for the economy. Economic groups would end up assuming dominant positions in the market because they would obtain better interest rates for financing their activity, benefiting from the intragroup relationship. The cash-pooling agreement in question showed a guarantee relationship rendering it a mixed contract. Regarding the transfer pricing method, the tax authorities referred to what was decided in a previous case concerning the same taxpayer, except for a past comparable transaction in which the interest rate was different.
After summing up the positions of the parties, the court described the notional cash pooling in which there was no physical movement of the balances between the individual accounts, just a virtual consolidation of the balances for determining the interest rate applicable to all accounts independent of the individual balances. The court explained that the interest rate foreseen in the agreement for credit balances was the base interest rate applied by the bank, and the interest rate that was applied to debit balances was the base interest rate applied by the bank plus 0.5 percent. Ac-cording to the agreement, the credit interest we was to be applied to debit balances if the overall balance of the accounts was positive. Inversely, if the overall balance of the accounts was negative, the interest over credit balances in the accounts would be calculated based on the interest rate applicable to debit balances in the accounts.
According to clause 7 of the agreement, the Portuguese subsidiary and the parent company guarantee any eventual liabilities through present or future credits with the bank, and clause 8.2 states that when the bank wants to receive its guaranteed passive, it should use the credit balances in the accounts guaranteed ac-cording to clause 7.
According to the court, it was not proven that these clauses ever operated during 2008. However, because during the life of the contract the subsidiary always had a credit balance, the tax authorities concluded that the subsidiary’s bank deposits played a guarantee role of the payment of the parent company’s debit be- Moreover, authorities concluded that the bank deposits of the subsidiary could not be openly moved because the parent company was the sole share-holder of the Portuguese subsidiary and therefore could determine the decisions of the subsidiary. The tax authorities further remarked that the subsidiary through its deposits allowed lower interest rates to be applied to the financing obtained by the parent company, concluding that the subsidiary’s bank deposits were in practice guarantees. In light of these facts, the tax authorities considered that the remuneration obtained by the subsidiary in its accounts with the bank was not at arm’s length.
The court concluded that the cash-pooling agreement was more than a virtual merger of balances in order to optimize debit and credit interest, or existing clauses that created a true guarantee rendered by the Portuguese subsidiary to its parent company, the tax authorities argued. Therefore, according to the court, although the agreement was called cash pooling, its true nature was that of an atypical contract of a mixed nature.
The court stated that the guarantee formed by the deposits of the Portuguese subsidiary with the bank was different from the guarantee chosen by the tax authorities to serve as comparable (the guarantee rendered by a Portuguese bank to BEI). In the cash-pooling agreement, the subsidiary did not assume the same position of guarantor since the guarantee function attributed to the funds available in the bank ac-count of the subsidiary only existed if the subsidiary deposited funds in its account and as long as it did not withdraw those funds. On the other hand, in the cash-pooling agreement there was no obstacle to the subsidiary’s withdrawing funds whenever it wanted to. Therefore, the court concluded that the risk assumed by the subsidiary in making available funds in its bank account was inferior to the risk assumed by the Portuguese bank in the comparable situation chosen by the tax authorities.
According to the court, the CUP method can only be adopted if it allows the highest degree of comparability with the uncontrolled transaction, which is not what happened in this case. The court concluded that the method chosen by the tax authorities was inappropriate.
Regarding the use of the application made by the subsidiary in another Portuguese bank as a comparable, the court considered it had to be analyzed in detail.
The Decision of the Court
In the absence of any other comparable cash-pooling agreements, the court concluded that the profit-split method was the only suitable method. The court stated: “in deriving joint interest savings of the pool, it has been assumed that all pool members face identical market rates. However, in a situation in which some members are in a permanent borrowing position in the pool, credit risk may become an issue, which should be reflected in higher debit interest rates for those members.”
In interpreting this sentence, the court concluded that the model proposed in the article would require adaptations if a member of the cash-pooling agreement were in a permanent debit position, as was the case when the parent company was permanently in a debit position while the subsidiary was permanently in a credit position.
According to the court, to follow the tax authorities’ reasoning, special care should be given in addressing the correct comparable. And the court concluded that the comparable chosen by the tax authorities – an application in another Portuguese bank – also does not achieve the highest degree of comparability required by Portuguese law. While the application made with the Portuguese bank was a short-term operation (33 days), the deposits in the bank in the cash-pooling agreement had a long-term perspective (from 2005 to 2008). The court also noted that proof of the highest degree of comparability in order to apply the CUP method to financial transactions should encompass an analysis of the following factors, among others: dead-lines, amounts, risks assumed, guarantees, and positions of the parties in the agreements.
The tax authorities must demonstrate that the factors mentioned above were all taken into consideration and which factors affected the adjustments made.
The court concluded that the tax authorities did not demonstrate, beyond a reasonable doubt, that they considered all the factors as required by law.
P55 T 2012 - 2012-12-24- JURISPRUDENCIA- decisao arbitralF