Furniture S.A is engaged in the production and sale of furniture and had established a US subsidiary to market and sell furniture overseas. The pricing of the controlled transactions with the US subsidiary had been based on a resale price method, which resulted in prices amounting to 70% of the list price for the products.
The Portuguese tax authority issued an assessment for FY 2015 and 2016, where the pricing of the controlled transaction had been adjusted in accordance with the price list resulting in additional taxable profits.
Result reached in the arbitration tribunal.
The Tribunal set aside the additional assessment of income in respect of the transfer pricing adjustment.
“…In the contract concluded with E… the Claimant safeguarded direct sales to large customers (with volume to fill a given number of containers). In practice, despite this safeguard, it is apparent from the evidence produced that the only major customer in the US since then has been E… and, in particular, no business was conducted with any major US customer in the years 2015 and 2016.
Therefore, it is not possible to identify, as there is no internal comparable in the transactions carried out by the Claimant with unrelated entities in the US market.
In fact, the comparable used by the Tax and Customs Authority are the list prices of direct (end) customers of the Claimant, in relation to which the comparability factors required for the application of the transfer pricing regime are not demonstrated, namely the comparable market price method used by the Tax and Customs Authority.
In fact, to compare commercial transactions carried out with wholesalers (on the one hand) with transactions carried out with retailers and direct addressees (on the other hand), is to compare substantially different realities, since the intervention of wholesalers in the marketing circuit necessarily implies that prices are charged that ensure them a profit margin, which does not occur in sales made directly to retailers. Indeed, it is unsustainable, from an economic point of view, that, in purchases from the Plaintiff for subsequent resale to retailers, an independent wholesale intermediary would accept a price that would not allow it to remunerate itself with a margin (aimed at covering its costs plus a remuneration).
Therefore, it cannot be considered proven that the price that would be charged between the Claimant and E…, if the latter were an independent wholesaler, would be the price charged by the Claimant with retailers.
On the other hand, the quantities sold by the Claimant to E… are different (much higher) than those sold to other direct customers of the Claimant in the US market and the quantity of goods sold is one of the factors “likely to influence the price of the transactions” expressly provided for in paragraph a) of no. 5 of Ordinance no. 1446-C/2001.
Furthermore, the conditions under which marketing is carried out are also different, as none of the operations carried out with direct retail customers were subject to the conditions agreed in the contract entered into between the Claimant and E… and “the contractual terms and conditions that define, explicitly or implicitly, the manner in which responsibilities, risks and profits are shared between the parties involved in the operation”, are comparability factors that sub-paragraph b) of article 5 of Ordinance 1446-C/2001 requires to be weighed. In this context, it must be taken into account that the deferral of payment allowed to a wholly owned entity does not imply bearing an economic risk similar to that inherent to transactions with independent entities.
In this context, as there are unique characteristics in the transactions of the Claimant with E…, the lack of adequacy of the comparable market price method is evident, as it “requires the highest degree of comparability with incidence both on the object and other terms and conditions of the transaction and on the functional analysis of the intervening entities” (article 6, no. 1, of Ministerial Order no. 1446-C/2001).
This lack of appropriateness of the comparable market price method is confirmed by paragraph a) of no. 2 of the same article 6 of Ministerial Order 1446-C/2001, from which it follows that, as regards the use of internal comparables, this method cannot be used when there is no “transaction of the same nature having as its object an identical or similar service or product, in like quantity or value, and under substantially identical terms and conditions, with an independent entity in the same or similar markets”.
Lastly, it should be emphasised that, as tax arbitration proceedings are an alternative to judicial review proceedings (Article 124(2) of Law 3-B/2010 of 28 April 2010), they are, like the latter, a procedural means of mere legality which aims to eliminate the effects produced by illegal acts, annulling them or declaring their nullity or non-existence [Articles 2 of the RJAT and 99 of the RJAT]. Therefore, the acts must be assessed as they were performed. Therefore, it is not in question to assess whether the application by the Claimant of the transfer pricing regime (for example, in relation to the use of the Minimum Resale Price Method provided for in article 7 of Ministerial Order no. 1446-C/2001) was correct or not, but to determine whether the corrections made by the Tax and Customs Authority have legal support.
In the case at issue, the corrections are illegal due to an error in the choice of the comparable market price method and its application to a situation in which the legal requirements for its application are not met.
Therefore, it must be concluded that the corrections made by the Portuguese Tax and Customs Authority based on the transfer pricing system are vitiated by error on the assumptions of law.
This error justifies the annulment of the corrections, under the terms of article 163, no. 1, of the Administrative Procedure Code, applicable subsidiarily under the terms of article 2, paragraph c), of the LGT.
The request for arbitral award regarding these corrections being granted, the knowledge of the remaining defects imputed to them by the Claimant is prejudiced, as it is useless (articles 130 and 608, no. 2, of the CPC). In fact, article 124 of the CPPT, applicable subsidiarily by virtue of the provisions of article 29, no. 1, of the RJAT, by establishing an order of acknowledgment of defects, presupposes that, once a defect that assures the effective protection of the impugned act’s rights is judged valid, it is not necessary to acknowledge the remaining defects, since, if it were always necessary to assess all defects imputed to the impugned act, the order of acknowledgment would not matter.
For the foregoing reasons, there is no need to consider the remaining defects imputed by the Claimant to the corrections based on the transfer pricing regime.