Portugal vs “N…S.A.”, March 2023, Tribunal Central Administrativo Sul, Case 762/09.0BESNT

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The tax authorities had issued a notice of assessment which, among other adjustments, disallowed a bad debt loss and certain costs as tax deductible. In addition, royalties paid to the parent company were adjusted on the basis of the arm’s length principle.

N…S.A. appealed to the Administrative Court, which partially annulled the assessment.

Both the tax authorities and N…S.A. then appealed to the Administrative Court of Appeal.

Judgement of the Court

The Administrative Court of Appeal partially upheld the assessment of the tax authorities, but dismissed the appeal in respect of the royalty payments.

According to the Court, a transfer pricing adjustment requires a reference to the terms of the comparable transaction between independent entities and a justification of the comparability factors.

Extracts from the judgement related to the controlled royalty payment. Regarding the correction for ‘transfer pricing’, the applicant submits that the Judgment erred in annulling the correction in question since the defendant calculated the royalty payable to the mother company in a manner that deviated from similar transactions between independent entities. It censures the fact that the rappel discount was not included in the computation of net sales for the purposes of computing the royalty under review. “[S]ince rappel is a discount resulting from the permanent nature of the contractual relationship between the supplier and the customer, (in the case of the Defendant, set at one year) constituting a reduction in the customer’s pecuniary benefit structurally linked to the volume of goods purchased, it can hardly be argued that it has a temporary nature, in the sense of ‘momentary’ or of ‘short duration'”; “(…) by excluding the rappel of rebates deductible from the gross value of sales, for the purposes of determining the net value of sales pursuant to Clause 32 of the Licence Agreement, the Tribunal a quo erred in fact”; “[that] on the transfer pricing regime, the AT demonstrated, by the reasoning of fact and law contained in the final inspection report that the existence of special relations between the Defendant and SPN led to the establishment of different contractual conditions, in the calculation of the royalties payable, had they been established, between independent persons”.

In this regard, it was written in the contested judgment as follows:

“(…) // In fact, the exceptions provided for in clause 32 of the Licence Agreement, which have a broad content, allow the framing of the so-called rappel situations, contracted by the Impugnant with its clients for a determined period of time and subject to periodic review, given their temporary nature. // Which means that, as to the form of calculation of the tax basis of the royalties payable to SPN, no violation of the provisions of the Licence Agreement has occurred. // For this reason, one cannot accept the conclusion of the Tax Authority in the inspection report, that such discounts do not fall within the group of those which, as they have a limited timeframe for their validity, should not be considered as a negative component of the sales for the purposes of calculation of the royalties, in accordance with the contract entered into between the Impugnant and SPN. // In addition, the Tax Authority failed to demonstrate in the inspection report to what extent the conditions practiced in the calculation of the royalties payable by the Impugnant to SPN diverge from the conditions that would be practiced by independent entities, not having been observed the provisions of article 77, no. 3, of the General Tax Law (LGT)”.

Assessment. The grounds for the correction under examination appear in item “III.1.1.6 Transfer prices: € 780,318.77” of the Inspection Report.

The relevant regulatory framework is as follows:

i) “In commercial transactions, including, namely, transactions or series of transactions on goods, rights or services, as well as in financial transactions, carried out between a taxable person and any other entity, subject to IRC or not, with which it is in a situation of special relations, substantially identical terms or conditions must be contracted, accepted and practiced to those that would normally be contracted, accepted and practiced between independent entities in comparable transactions”(12).

(ii) ‘When the Directorate-General for Taxation makes corrections necessary for the determination of the taxable profit by virtue of special relations with another taxpayer subject to corporation tax or personal income tax, in the determination of the taxable profit of the latter the appropriate adjustments reflecting the corrections made in the determination of the taxable profit of the former shall be made’.)

(iii) “The taxable person shall, in determining the terms and conditions that would normally be agreed, accepted or carried out between independent entities, adopt the method or methods that would ensure the highest degree of comparability between his transactions or series of transactions and other transactions that are substantially the same under normal market conditions or in the absence of special relations…”.)

(iv) “The most appropriate method for each transaction or series of transactions is that which is capable of providing the best and most reliable estimate of the terms and conditions that would normally be agreed, accepted or practised at arm’s length, the method which is the most appropriate to achieve the highest degree of comparability between the tied and untied transactions and between the entities selected for the comparison, which has the highest quality and the most extensive amount of information available to justify its adequate justification and application, and which involves the smallest number of adjustments to eliminate differences between comparable facts and situations”.

(v) ‘Two transactions meet the conditions for comparable transactions if they are substantially the same, meaning that their relevant economic and financial characteristics are identical or sufficiently similar, so that the differences between the transactions or between the undertakings involved in them are not such as to significantly affect the terms and conditions which would prevail in a normal market situation, or, if they do, so that the necessary adjustments can be made to eliminate the material effects of the differences found’ (16).

(vi) “In the case of operations or series of operations on goods, rights or services, or of financial operations, carried out between an income taxpayer and any other entity, subject to income tax or not, with which he is in a situation of special relations, and whenever there is non-compliance with any obligation prescribed by law for that situation, the grounds for determining the taxable amount corrected for the effects of the special relations shall comply with the following requirements: // a) Description of the special relations; // b) Indication of the obligations breached by the taxpayer; // c) Application of the methods provided for by law, the Directorate-General for Taxation being able to use any elements at its disposal and its duty to provide reasons for the elements of comparison being considered to be adequately observed even if such elements are purged of data capable of identifying the entities to which they relate; // d) Quantification of the respective effects” (17).

In this regard, settled tax jurisprudence is as follows:

i) ‘For the AT to be able to correct the taxable profit by virtue of special relations between the taxpayer and another entity, it is necessary that different conditions have been established from those which would normally be agreed between independent persons and that the profit ascertained in the accounts is different from that which would be ascertained in the absence of those relations’.

(ii) “The determination of prices in open competition must be made according to a specific methodology, the fundamental criterion of which is comparability, to the greatest extent possible, with substantially similar transactions between independent parties”(19) .

iii) “It falls to the AT to prove the existence of those special relations, as well as the terms under which operations of the same nature between independent persons and under identical circumstances normally take place, and the act must be annulled if such proof is not provided, which means that the correction referred to in Article 58 of the CIRC cannot therefore be based on indications or presumptions, the AT being required to prove the abovementioned legal prerequisites in order to be able to correct the taxpayer’s taxable income under that regime. // If the AT opts for the comparable market price method, it must specify which transaction or transactions between independent entities served as a term of comparison to the one carried out by the taxpayer and, if applicable, which of the most comparable factors of that identical or similar transaction between independent entities were taken into account or taken into consideration, after making the necessary adjustments to ensure the “highest degree of comparability”, as provided for in the aforementioned paragraph 2 of Article 58 of the CIRC”. (20)

The appellant invokes the definition of rappel discount enshrined in the Judgment for Uniformity of Jurisprudence, of the STJ, dated 14/05/2014, P. 86/12.5YQSTR.E1-A.S1 (21).

It should be noted that “[t]he arm’s length principle is compatible with the use of price ranges – or partially inaccurate comparables. This does not mean, however, the acceptance of the perception of reality by approximation, with a margin of error tolerated by law. That is not the justification. The perception of an indeterminate reality consents to a valuation opening. The mark-to-model market price corresponds to a value within an acceptable range. Now, within this range of values, price adjustments cannot be made. The adjustment is only justified if the price charged (or arbitrated by the Tax Administration) departs from that range, as it is based on unfounded and unrealistic reasoning and quantifications in view of the data of the concrete case”(22).

The applicant’s plea focuses on the need to include the value of rappel in the food sector in the basis for calculating net sales for the purposes of determining the percentage of royalties to be paid by the defendant to the parent company.

From the evidence it follows:

i) according to Clause 32 of the Licence Agreement, the concept of net sales shall correspond to “[a]total gross proceeds of sales less: (i) rebates (other than periodical allowances, temporary price promotions, consumer price promotions, trade price promotions and other similar expenses); (ii) returns accepted by licensee on account of spoilages, breakage or other damage rendering the relevant products unmarketable; (iii) any taxes on sales” – (see point “III.1.1.6 Transfer prices: € 780.318,77” of the Audit Report – line R) of the evidence).

ii) The Impugnant clarified with the Tax Authority that “[t]rappel corresponds to temporary discounts granted and contracted annually with the large retailers. These incentives correspond to a consideration paid by the customer. The rappel corresponds to an incentive paid to a client, in accordance with a certain objective agreed in the annual negotiation” – (see point “III.1.1.6 Transfer prices: € 780,318.77” of the Inspection Report – paragraph R) of the evidence).

iii) The Impugnant, under an agreement established with the parent company, makes a 5% royalty payment, on a concept that is called net proceed of sales, which is a concept of net sales, where the incentives with a specific purpose called rappel are not included (paragraph EE) of the evidence).

iv) In June 2009, the appellant and the parent company issued a clarification statement to the General Licence Agreement, which states that the rappel discount is not part of the components to be deducted from the sales amount in order to determine the net sales, the basis for calculating the royalty payable to the parent company (paragraph HH), of the evidence).

In the light of the evidence, it is not apparent that the applicant is able to establish that the principle of comparability of transactions has been infringed in this case. The correction focuses on the concept and scope of the food rappel rebate for the purposes of the interpretation of Clause 32 of the General Licence Agreement. Neither the comparable transaction between independent entities, nor the appropriate calculation procedure, is invoked in these cases and why it should be considered as such. The invocation of a national regime on rappel discounts is not, by itself, sufficient to configure a situation of deviation, due to special relations between the grantors, with surreptitious transfer of profits and tax evasion. The Tax Authorities have not complied with the burden of demonstrating the assumptions of application of the anti-abuse rule in question. The duty to provide reasons for the specific comparable operation (Article 77/3 of the LGT) is also precluded in this case. Reason why the correction cannot be maintained. As decided in the sentence under scrutiny.

The appeal is dismissed in this part.


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Portugal vs N-SA February 2023 Tribunal Central Administrativo Sul Cno 762-09-0BESNT ORG

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