Central Economic-Administrative Tribunal

 

FIRST CHAMBER

 

DATE: 23 March 2022

 

PROCEDURE: 00-04377-2018

 

CONCEPT: CORPORATION TAX. I.SDES.

 

NATURE: GENERAL SINGLE INSTANCE CLAIM

 

CLAIMANT: XZ SL - NIF ....

 

REPRESENTATIVE: ... - NIF ...

 

ADDRESS: ... - Spain

 

 

At Madrid, the Court has been convened as indicated above to hear and determine the above-mentioned complaint, which is being dealt with under the general procedure.

 

BACKGROUND FACTS

FIRST.- On 28/08/2018 the present claim, filed on 27/07/2018 against the Settlement Agreement dated 6 July 2018 issued by the Central Delegation of Large Taxpayers of the AEAT (DCGC), relating to CORPORATE INCOME TAX (Consolidated Tax Return System), years 2011 to 2014, was received by this Court.

 

SECOND.- On 7 April 2016, the Central Large Taxpayers Delegation (DCGC) initiated verification and investigation actions on the tax situation of the tax group ..., in general, relating, among other items, to Corporate Income Tax (IS), financial years 2011 to 2014.

 

The notice of initiation was addressed to the entity XZ, S.L. (currently called XZ, S.L.), as the parent company of the tax consolidation group ...

 

As a result of the verification and investigation actions, on 27/04/2018 the following reports were issued:

 

- Record of non-conformity no. ...26, referring to the IS for the financial years 2011 to 2014; it contains the adjustments corresponding to related-party transactions.

 

- Record with Agreement model A11 no. ...44 relating to certain adjustments for related-party transactions.

 

- ...35, relating to income tax for the years 2011 to 2014; it contains all of the regularised items.

 

As a result of the aforementioned non-conformity assessments, the following resolutions were issued on 06-07-2018:

 

1.- Settlement Agreement derived from the non-conformity report no. A02 ...26; it exclusively includes the adjustments for related-party transactions. The taxpayer was notified on 09-07-2018.

 

2.- Provisional Settlement Agreement derived from the non-conformity act nş A02 ...35; includes all the regularised elements. The taxpayer was notified on 09-07-2018.

 

THIRD.- The object of the present file is the Settlement Agreement derived from the non-conformity Act A02 nş ...26, issued by the Deputy Head of the Technical Office of the DCGC on 06-07-2018 and referring to the IS for the financial years 2011 to 2014. The total tax debt amounts to 17,278,933.74 euros (tax liability: 14,760,915.46 euros; late payment interest: 2,518,018.28 euros). The taxpayer was notified on 09-07-2018. The declared data is modified for the following reasons:

 

1) Valuation of the related-party transactions for loans between the entity ... TW BV and the companies W SA and WY SA.

 

2) Valuation of the line of credit granted by the entity ... T NV to W SA

 

3) Valuation of the EUR 4.5 billion loan granted by the entity ... XR NV to W on 23-10-2014.

 

4) Valuation of the loan of EUR 10 billion granted by the entity ... XR NV to XZ SL on 01-12-2009 for the purchase of the W group by the X group.

 

5) Valuation of the financial income and expenses of the current accounts of XZ SL with the entity .... X SPA and with the entity ... XR NV.

 

6) Application of Article 9 of the IDC to the loan and deposit transactions carried out by XZ SL and W SA in connection with the intra-group purchase of shares in GH and XP SA.

 

7) Application of article 119.4 of the LGT in the resulting settlement in relation to the deductions in the tax liability pending application.

 

FOURTH.- Not in agreement, on 27-07-2018, the entity filed an economic-administrative claim RG 4377/18, which is being examined before this Central Economic-Administrative Court, against the settlement agreement described in the previous background.

 

Once the file was made available, allegations were presented on 27 December 2019 in a document in which the following points were developed:

 

1) Previous.- On the object of the present claim.

 

2) On the regularisation of the financial expenses in W for the credit line of 3.5 billion euros.

 

3) The regularisation of financial expenses at W SA for the loan of 4.5 billion euros taken out with XR NV.

 

4) Of the regularisation of financial charges at XZ for the EUR 10 billion loan taken out with XR NV.

 

5) Of the regularisation of financial expenses for the current accounts of XZ with X SPA and with XR NV.

 

6) Of the reclassification of International W BV.

 

7) Non-recognition of the intra-group loan and deposit operation.

 

8) Criteria for the application of pending deductions (article 119.4 LGT).

 

On 25 March 2021, the taxpayer filed a supplementary pleading to which it attached a copy of the Supreme Court ruling of 5 November 2020 (appeal 3000/2018).

 

GROUNDS OF LAW

FIRST.- This Court is competent to rule in accordance with the provisions of Law 58/2003, of 17 December, General Taxation (LGT), as well as the General Regulations for the development of Law 58/2003, of 17 December, General Taxation, in matters of administrative review (RGRVA), approved by Royal Decree 520/2005, of 13 May. None of the grounds of inadmissibility provided for in Article 239.4 of the LGT are present.

 

SECOND.- This Court must rule on the following:

 

- The issues raised based on what was resolved in the settlement agreement and what is set out in the entity's allegations.

 

THIRD.- The first issue raised by the claimant relates to the regularisation of the EUR 3.5 billion credit line granted in favour of W SA by the entity .... XR NV, a financial institution belonging to Group X.

 

In the years under review, the subsidiary, W SA, had entered into agreements with the financial institution ... XR NV (hereinafter, XR) the following financing operations (Diligence A04 extended to W SA on 02-04-2018):

 

- Credit line opened in 2011, with a maximum availability of up to €3.5 billion and a term of 5 years; in 2014 the limit of the credit line is reduced to €1 billion.

 

- 4.5 billion loan, concluded on 23 October 2014, with an interest rate of 3% and a ten-year maturity.

 

With regard to the credit line, it is on record that on 30-11-2011, the entity ... XR opened a credit line in favour of W SA, with a maximum availability amount of 3,500 million euros and a term of 5 years (maturity on 30-11-2016). The agreed interest rate was Euribor plus 240 basis points (2.4%). The Euribor reference period could be 1, 3, 6 or 12 months, depending on the drawdown period. In addition, an availability fee was established on undrawn balances of one third of the margin applied, i.e. 80 basis points over Euribor (0.80%), payable on 31 December of each of the years in which the credit line remained in force and at the time of its cancellation.

 

On 06-06-2014 the limit of the credit line was reduced to EUR 1,000 million while maintaining the rest of the conditions.

 

The credit line is used between 27-07-2012 and 26-03-2013, with short-term credit requests being renewed. The maximum drawn down balance amounts to €1.65 billion between 23-10-2012 and 11-12-2012. From 26-03-2013 and until its modification to 1,000 million euros, no amount is available.

 

It is also recorded in the file that during the period in which the credit line with XR is used, W maintains open credit lines with financial institutions with a joint credit limit of 3,350/3,220 million euros at different maturities with a margin over Euribor of 75 basis points per year and an availability fee of 30 basis points (on average).

 

In the transfer pricing documentation provided by the entity for the inspection, the valuation of this operation is carried out using the comparable free price (CUP) method and as comparable the quotation of the 5-year Credit Default Swaps (CDS) of the bonds of three entities belonging to the electricity sector (Q, UF and W); Q and W with an A- credit rating and UF with a BBB credit rating. The average price of the 5-year CDS yields between 215.5 and 280 basis points per year of spread over Euribor. Regarding the availability fee, the report states that "... the company has internally conducted a market study to analyse the availability fees agreed in the market between independent parties in comparable circumstances. The results of this study show an average availability fee of between 30% and 40% of the agreed margins, understood as the interest rates applicable on drawn balances".

 

In summary, the cost calculated by the taxpayer for the €3.5 billion credit line granted in 2011 is the sum of the following components:

 

1) Interest. Euribor plus a spread of 240 basis points (2.40%); the Euribor reference period is 1, 3, 6 or 12 months, depending on the drawdown period.

 

The spread of 2.40% is calculated by the taxpayer by considering the 5-year bond CDS of three sector entities: W (rated A-), Q (rated A -) and UF (rated BBB). The range is between 215-280 basis points and is set at 240.

 

2) Commission. An availability fee of 80 basis points (0.80%) on the undrawn balance, i.e. one third of the spread of 240 basis points, payable at the end of each year of the loan term.

 

Thus, W pays for drawn amounts, Euribor, at the relevant term, plus a spread of 240 basis points and, for undrawn amounts, a fee of 80 basis points.

 

The inspection considers that the valuation and determination of the expenses accrued for the credit line is not in line with the normal market value; the Inspectorate considers "inappropriate the method used in the transfer pricing documentation, which takes as a reference operations of other entities in the sector, as there is a comparable one from the user of the credit line itself, the default insurance or Credit Default Swaps (CDS) on bonds issued by W, which incorporate the risk of the financed subject, of which the most appropriate is considered the one corresponding to the term of six months, thus resulting in a rate of 1.08976%. The availability commission of one third of this margin is set at a rate of 0.36%. As for the limit of the credit line, it is considered to be oversized, although 1 billion more than the maximum drawn down is allowed, which sets the admissible limit at 2.65 billion euros until 26 March 2013, when the drawn down balance was zero, and 1 billion from that date, when the credit line was not drawn down at all".

 

The inspectorate rejects the deductibility of part of the expense arising from the credit line on the following grounds:

 

1) It questions the 2.40% spread calculated as an average of the five-year CDS of three entities belonging to the electricity sector.

 

The inspectorate considers it more appropriate to use the 6-month CDS of W existing on the day before the operation, which reached 1.08975% (108 basis points); it considers that the spread that should have been applied is 1.08975%, equivalent to the 6-month CDS of W on the day before the operation.

 

The inspectorate does not agree with the criterion of using an average of comparables since "a perfect comparable is available adjusted to the taxpayer's own circumstances and conditions" and adds that the comparables of Q and UF, although "belonging to the same sector, suffer from a lower comparability (for example, UF's credit rating was BBB while W's was A-). Therefore, while in the absence of other better data they might be acceptable, this is not the case here where the taxpayer's own market data is available'.

 

On the other hand, the inspection does not share the taxpayer's criterion of using a 5-year CDS as a comparable because, although the credit line has been granted for a 5-year term, the possibility of drawdown does not exceed 1 year; in the credit line contract itself, when setting the interest rate, it does so by adding a spread linked to the Euribor for a term of 1, 3, 6 or 12 months, depending on the period for which W requests the credit. It does not use any higher maturity benchmark. It is stated in the file that 'W has never drawn down amounts for a duration of 6 months. In fact, most of the requests made by W have been for one month or less, which are renewed and sometimes cancelled early'.

 

The inspectorate therefore considers it more appropriate and more in line with the principle of free competition to use W's 6-month CDS, given that the taxpayer's justification is to meet short-term cash needs.

 

2) Non-disposal fee.

 

The inspectorate accepts the methodology applied for the quantification of the non-disposal fee (1/3 of the spread). However, it reduces it to 36 (0.36%) as the starting point for calculating it should be a spread of 1.08975% instead of 2.40%.

 

3) The amount of the credit line

 

2.65 billion until 26-03-2013 and from that date (the taxpayer has not made use of the credit line) it considers a market amount of 1 billion.

 

The inspection considers that the granted credit of €3.5 billion is oversized; it highlights that the maximum amount used was €1.65 billion for a very short period (from 23/10/2012 to 11/12/2012) and that from 26-03-2013, until its modification to €1 billion, the credit line is not made use of. It also points out that during the period in which it uses the credit line it maintains open credit lines with financial institutions with a combined limit of 3,350/3220 million euros at different terms and a margin over Euribor of 75 basis points.

 

The inspectorate, like the taxpayer, considers it essential to maintain a safety stock of cash in order to be able to meet payments on time. This implies that an independent entrepreneur, acting in free competition, would establish a sufficiently large margin to ensure that no defaults occur. However, the inspectorate considers that this margin should not be such as to tie up a large amount of idle resources. In calculating this margin, the Inspectorate considers that it should be based on the institution's expected needs to meet its payments and the economic environment that could lead to unforeseen payments or expected collections that do not materialise.

 

In order to calculate the amount of the credit line that would have been agreed between independent parties, the audit has taken into account:

 

- That the maximum amount drawn down was €1.65 billion only in a very short period of time compared to the amount of €3.5 billion contracted.

 

- That from 26-03-2013 the taxpayer does not make use of the credit line.

 

- That during the period in which the credit line is used, W maintains open credit lines with financial institutions with a joint limit of 3,350/3,220 million euros at different maturities with a margin of 75 basis points per year, much lower than that applied (240 basis points).

 

- That from the end of 2012 the market stabilises (analyses the functioning of the market).

 

It therefore considers it appropriate:

 

(a) For the period from the concession until March 2013, an amount of EUR 2.65 billion, which means increasing the maximum drawn down by EUR 1 billion. This amount is obtained by drawing on the taxpayer's own amount in its 2014 renegotiation, when the institution was not using the credit line, and is considered adequate as a contingency margin (more than 33% of the amount drawn down).

 

(b) From March 2013 when the taxpayer does not make use of the credit line, it considers a market amount of EUR 1 000 which coincides with the amount applied by the taxpayer in its 2014 negotiation. It recalls that on these dates the taxpayer has not made use of the credit line.

 

The claimant objects to the adjustment made by the inspection on the following grounds:

 

a) The methodology followed to justify the market value of the interest rate set in the transaction was accurate and appropriate.

 

b) The maturity of the financial instrument selected to measure the risk of the credit line coincides with the maturity of the operation and is therefore the appropriate one.

 

c) With regard to the non-drawdown fee, given that the methodology and its quantification has not been the subject of debate, reference is made to the arguments set out in the previous points since, if it were accepted, the specific percentage relating to it would also be confirmed.

 

(c) The amount of the credit line was reasonable and appropriate.

 

The discrepancies are therefore mainly based on the following:

 

1) The comparables used by the entity and the maturity period of the financial instrument.

 

2) The amount of the credit line.

 

FOURTH: Article 16 of Royal Legislative Decree 4/2004, of 5 March, approving the revised text of the Corporate Income Tax Act (TRLIS) states:

 

"1.1 Transactions carried out between related persons or entities shall be valued at their normal market value. Normal market value shall be understood to be that which would have been agreed by independent persons or entities under conditions of free competition.

 

2ş The tax authorities may verify that transactions between related persons or entities have been valued at their fair market value and shall, where appropriate, make any necessary valuation adjustments...;",

 

And paragraph 4 specifies the methods to be followed in order to determine the normal market value.

 

In the present case, the method of the Free Comparable Price (CUP) is not in question. What is at issue is: (i) the comparable selected to justify the market value of the interest rate; (ii) the maturity of the financial instrument selected and; (iii) the amount of the credit line.

 

We first analyse the allegations concerning the comparable selected to justify the market value of the interest rate.

 

It appears from the file that the comparable selected by the entity was the 5-year CDS quotation of W, Q and UF bonds; Q and W with an A- credit rating and UF with a BBB credit rating.

 

However, the inspectorate considers it more appropriate to use the 6-month CDS of W existing on the day before the transaction.

 

The Inspectorate does not agree with the criterion of using an average of comparables mainly because, in the present case, "the taxpayer's own market data is available", i.e. "a perfect comparable adjusted to the taxpayer's own circumstances and conditions is available".

 

For its part, the complainant reiterates in its submission that it acted accurately by selecting W's CDS and, furthermore, in an exercise of prudence, by expanding the sample, for which it selected the CDS of two comparable entities in the electricity sector in order to avoid potential cyclical distortions, a risk to which it is exposed when only one comparable is taken and, specifically, a risk that materialised in W's CDS.

 

It points out that the selection of the CDS of comparable companies makes it possible to remedy the limitations existing in the W CDS and to correct the distortions arising from those limitations by determining an interest rate in line with market circumstances. It relies on the arguments and conclusions set out in two expert reports submitted to the Court, which it endorses.

 

Before analysing the entity's allegations, reference should be made to the provisions of the OECD Transfer Pricing Guidelines, specifically paragraphs 1.33, 3.27 and 3.28 (2010 version) -in similar terms 2017 version-:

 

Paragraph 1.33 included under "D. Guidance on the application of the arm's length principle" provides:

 

"1.33 The application of the arm's length principle is generally based on a comparison of the terms of a controlled transaction with the terms of transactions between independent enterprises. For such comparisons to be useful, the relevant economic characteristics of the situations being compared must be sufficiently comparable....".

 

Paragraphs 3.27 and 3.28 under "A. 4 comparable unrelated transactions provide:

 

"A.4.2 Internal comparables

 

3.27 Step 4 of the "typical" process described in paragraph 3.4 is the review of internal comparables that may exist. Internal comparables may be more directly and closely related to the related party transaction under review than external comparables. The financial analysis is simplified and made more reliable by relying on presumed identical accounting policies and practices for the internal comparables and the related party transaction. Also, reporting on internal comparables may be more complete and less burdensome.

 

3.28 On the other hand, internal comparables are not always more reliable, so any transaction between a taxpayer and an independent party cannot be considered a reliable comparable for related party transactions entered into by that same taxpayer. Internal comparables, where they exist, must satisfy the five comparability factors in the same way as external comparables; see paragraphs 1.38-1.63 (...).

 

Therefore, where internal and external comparables meet the five comparability factors, the internal comparable is a more reliable indicator of the comparable free price of the controlled transaction because it reflects the taxpayer's own circumstances and characteristics, particularly in the case of valuation of financial transactions where the insolvency risk of the borrower of the funds is relevant; internal comparables may be more closely related to the controlled transaction under review than external comparables and, in addition, the information may be more complete and less burdensome (Paragraph 3. 27 of the OECD Guidelines).

 

On the other hand, it should not be forgotten that external comparables are obtained from information sources, such as commercial databases, which are a common source of information and usually have a number of limitations because reporting and filing obligations vary depending on the legal form of the company and whether it is listed or unlisted. Hence, paragraphs 3.31 and 3.32 of the Guidelines provide:

 

3.31 The decision on whether and how to use the databases should be preceded by due caution, as they are developed and presented for purposes other than transfer pricing.

 

3.32 The use of a commercial database may not be necessary when there are other sources of information, e.g. internal comparables.

 

The complainant submits that W's CDS did not adequately reflect the risk that X assumed in financing W because it had certain limitations.

 

It relies on the report and expert opinion submitted to this Court, the former prepared by Financial Analysts (AFI) and the latter by Mr ..., which the company endorses.

 

The question therefore arises whether it is established, as the institution maintains, that W's CDS had certain limitations, that is to say, that it was not a reliable comparable.

 

Firstly, it should be noted that, although it considers that W's CDS had certain limitations which call into question its use as a comparable, the bank itself includes it together with the external comparables to determine the market interest rate.

 

With regard to the expert report provided, the AFI report sets out the reasons why it considers that, in this case, there are circumstances which, in its opinion, make it necessary to use the average cost of issuing comparable companies.

 

It begins by acknowledging that "provided that the borrower's own market indicators exist, the indicator will be considered as the "best possible comparable" as it is representative of market prices obtained by the company itself in transactions with third parties" (last paragraph of page 17).

 

However, it dispenses with its direct use as a measure of the credit risk of transaction X, mainly on the basis of the following arguments (page 18):

 

- The situation of W's CDSs in 2010, 2011 and 2012 was anomalous as they were trading well below their comparables and below the risk that the market was discounting at those times to the Spanish Treasury itself.

 

- The price of CDSs reflects the balance between supply and demand for credit risk hedging. W's low third-party indebtedness explains why the demand for hedging its credit risk was low.

 

The report also states that 'banks offered W a reduced margin on its credit lines based on a perception of low risk in their exposure to W. This perception was consistent due to two factors; (i) W's low bank indebtedness, and (ii) low intrinsic risk of the electricity business'.

 

However, the report does not prove that the price of W's CDS was not a reliable indicator to justify the market value of the interest rate set in the transaction in question, since it merely states that W's CDS is not representative of the risk assumed by X in the financing of W because of W's low indebtedness; nor does it specify or assess the amount at which it could be considered representative of the risk assumed by X in the transaction. Moreover, the fact that W's indebtedness was lower than that of other institutions in the sector does not seem to be sufficient to claim that W's CDS is unreliable, as the institution claims.

 

It is worth noting that section 6.2 of the Conceptual Framework of the 2007 General Accounting Plan, after defining fair value, establishes as the main source for its calculation the so-called 'reliable market value' or 'quoted price in an active market', in which the following requirements are met:

 

(a) The goods or services exchanged in the market are homogeneous;

 

(b) buyers or sellers for a particular good or service can be found at virtually any time; and

 

c) Prices are known and easily accessible to the public. These prices, moreover, reflect real, current and regularly occurring market transactions.

 

Nor does the report prove that the W CDS quotation used by the inspectorate (and by the taxpayer itself, despite the limitations it claims to have) corresponded to an insufficient volume and frequency of transactions.

 

On the other hand, it should be noted that the National Commission for Markets and Competition (CNMC) in its Explanatory Memorandum to the CNMC circular, which establishes the methodology for calculating the financial remuneration rate for the activities of transport and distribution of electricity and regasification, transport and distribution of UF (...), although it refers to the calculation of the financial remuneration rate for the activities of transport and distribution of electricity and regasification, transport and distribution of UF (. ..), although referring to the effects of the aforementioned Circular, when determining the cost of the companies' debt, uses, in the case of W, in relation to the 2012 financial year, its CDS (Table 26; page 73/119), from which it can be deduced that it considered it to be a valid indicator.

 

Lastly, it should be noted that the expert opinion of Mr .... does not prove that the quotation of W's CDS was not reliable for assessing the transaction in question, since it merely states that 'the explanations offered by the taxpayer that the selection of two comparable companies (Q and UF) makes it possible to avoid potential distortions in W's CDS and its reference to point 3.7 of the OECD Guidelines, which clearly supports the reference to competition, seem reasonable to us'.

 

On the other hand, paragraph 3.7 of the OECD Guidelines (2010 version) provides:

 

"The analysis of the set of circumstances is an essential step in the comparability analysis. It can be defined as an analysis of industry, economic, competitive, regulatory and other factors affecting the taxpayer and its environment, without being placed in the limited context of the particular transactions at issue. This step assists in understanding the terms of the taxpayer's related party transaction, as well as those of the unrelated transactions with which it is compared, in particular the economic circumstances of the transaction (see paragraphs 1.55-1.58)".

 

Paragraphs 1.55 to 1.58 elaborate on "economic circumstances"; and the economic circumstances that may be relevant in determining the comparability of markets are: their geographic location, their size, the degree of competition and the relative competitive position of buyers and sellers, the availability of alternative goods and services, etc.. The variables that may affect the value of transactions are described and the way to consider them is not to take the average of the prices of the companies operating in those markets as it seems to be claimed, but to adjust the analysis to the specific conditions of the transaction.

 

Thus, there is no reason to consider that the internal comparable used by the inspectorate (W's CDS) is not a reliable indicator.

 

FIFTH.- It also questions the maturity of the financial instrument selected.

 

As we have pointed out, the comparable selected by the institution was the price of the 5-year CDS; the institution chose a financial instrument with a maturity equal to that of the reference transaction.

 

However, the inspection considers it more appropriate and in line with the arm's length principle to use the 6-month W CDS existing on the day before the transaction, mainly because: (i) although the credit line has been granted for a term of 5 years the possibility of drawdown does not exceed 1 year; (ii) in the credit line contract itself, when setting the interest rate it does so by adding a spread referenced to the Euribor for a term of 1, 3, 6 or 12 months, depending on the period for which W requests the credit; (iii) most of the requests made by W have been for 1 month or less which are being renewed and, on occasions, cancelled early; (iv) the above points indicate that the purpose of the credit lines was to finance transitory short-term liquidity needs; (v) it is justified by various examples provided by the taxpayer itself of credit lines arranged with third parties; (vi) a study has been carried out which corroborates the inspectorate's position of using the 6-month CDS; it is incorporated in Annex I of the settlement agreement; (vii) the taxpayer's credit lines are not used to finance short-term liquidity needs; and (viii) the taxpayer's credit lines have been used to finance short-term liquidity needs.

 

For its part, the complainant points out that in view of the 5-year maturity of the credit line, it was considered appropriate to select the 5-year CDS since the use of a CDS with a shorter maturity would not reflect the market cost to the lender of hedging the risk of the credit line.

 

It stresses that although the drawdowns were made for specific periods of time, information on the duration of such drawdowns was not available to the parties at the time of negotiating the terms of the credit facility.

 

It highlights the conclusions reached in the expert report drawn up by AFI and in the expert opinion of Mr ..., both of which maintain that the benchmarks for comparables should be five years and in no case six months as proposed by the inspectorate because the use of CDS for a term of less than five years would not reflect the market cost of hedging the risk of the credit line.

 

With regard to the use of the six-month CDS instead of the five-year CDS, it should be borne in mind that, although the credit line was concluded for a term of five years, the conditions agreed for determining the spread take as a reference the Euribor at one, three, six or 12 months, which indicates, as the inspectorate points out, that its purpose was to meet short-term cash requirements, so that, in these circumstances, the use of a five-year CDS makes no sense. On the other hand, it should not be forgotten that it is the interest rate stipulated in the contract and the various credit applications that are made that determine the amount of the financial charges that W pays. In this case, the contract itself, when establishing the remuneration of the credit line, refers to different rates depending on the term of the amounts drawn down and not on the duration of the credit line, and according to the file, most of the requests made by W have been for a period of one month or less. The file contains three credit line agreements with three independent banks (BANCO_1, BANCO_2 and BANCO_3) provided by the taxpayer, in which the term of the credit line and the maturity of the amounts drawn differ. In all of them, the period of drawdown does not exceed one year and is even limited to 3 months, while the period of validity of the credit line is different (see details on pages 21 and 22 of the extension report). The aim is to provide a sample of the functioning of the market.

 

The complainant justifies the use of the 5-year term on the grounds that the information on the duration of the drawdowns was not available to the parties at the time of negotiating the conditions of the credit line; however, as we have indicated, the contract does provide for different periods over which to calculate the interest on each drawdown and none of them is longer than 12 months.

 

With regard to the reports provided, it should be pointed out that what must be clarified in this case is the economic relevance of the term of a credit line in which the interest rate agreed is Euribor plus 240 basis points, the reference period being Euribor at 1, 3, 6 or 12 months, depending on the period indicated in the application.

 

Paragraph 1.33 of the OECD Guidelines, reproduced above, states that the application of the arm's length principle is based on a comparison of the terms of a linked transaction with the terms of transactions between independent undertakings.

 

In this respect, it is on record that the Technical Office has conducted a new study with external comparables which corroborates the Inspectorate's position to use 6-month CDS; details of this study with external comparables are incorporated in Annex I to the settlement agreement.

 

The inspection has carried out a corroborative analysis with external comparables which shows that simultaneous credit lines of other companies in the sector agreed with third party entities and with a term of five years present interest rate remunerations substantially lower than those agreed in the intra-group operation under analysis, which determine a range in accordance with the conditions set by the inspection (0.7%-1.3%) and which in relation to the CDS also do not cover the alleged relationship of margin associated with the 5-year CDS.

 

This analysis corroborates the adjustment made by the inspectorate, which is largely confirmed by independent data (6-month CDS) as opposed to what was declared by the taxpayer (5-year CDS).

 

Nothing is said about this analysis in the reports provided or in the statement of allegations, indeed, they do not even mention it.

 

Therefore, as reflected in the corroborative study carried out by the inspection with external comparables in the sector, the details of which are included as Annex I to the Settlement Agreement, which has not been contradicted by the reports provided to this Court (they do not even mention it), it has been sufficiently demonstrated that the financial instrument selected as a comparable by the inspection, the 6-month CDS, was appropriate and in accordance with the arm's length principle.

 

SIXTH.- As for the amount of the credit line, the inspectorate considers that the limit of 3,500 million euros is not in accordance with the principle of free competition as it is oversized.

 

It is recorded in the file that on 30-11-2011, the entity ... XR opened a credit line in favour of W SA, with a maximum availability amount of 3.5 billion euros. The credit line was used between 27-07-2012 and 26-03-2013, with short-term credit requests being renewed and sometimes cancelled early. The maximum balance drawn down amounts to EUR 1.65 billion between 23-10-2012 and 11-12-2012. From 26-03-2013 and until its modification to 1,000 million euros, no amount is available.

 

On 06-06-2014 the limit of the credit line was reduced to 1,000 million euros.

 

In addition, it is recorded in the file that during the period in which the credit line with XR is used, W maintains open credit lines with financial institutions with a joint credit limit of 3,350/3,220 million euros at different terms with a margin over Euribor of 75 basis points per year and an availability commission of 30 basis points (on average).

 

On the basis of the facts and arguments set out in the file, the inspectorate considered the credit line to be oversized and accepted as valid 1 billion more than the amount drawn down, i.e. 2.65 billion until 26 March 2013 (more than 33% of the amount drawn down) and 1 billion euros since it was drawn down.

 

For its part, the complainant considers that the amount of the credit line was reasonable and adequate. The complainant reiterates that it is reasonable that at the time when the operation in question was agreed, the maximum amount of the credit line was set at 3.5 billion euros, given that the financial projections made and the information available at that time were based on a conservative scenario resulting from the recessionary environment and the scarce liquidity. He insists that he does not consider it admissible or technically accurate that the inspectorate determined the amount of the credit line without carrying out an economic analysis of comparability, which demonstrates a lack of technical rigour. It also shows that the inspectorate has not adequately substantiated that the volume of EUR 3.5 billion does not comply with the arm's length principle.

 

He summarises the main arguments contained in the expert reports.

 

Firstly, it should be pointed out that, contrary to the claimant's statement, the inspection has sufficiently reasoned why the amount of the credit line was not in accordance with the arm's length principle as it was oversized (page 63 and following pages of the settlement agreement). On page 63 of the settlement agreement there is a graph showing the total working capital financing (credit lines from financial institutions, promissory notes and line with XR), the credit limit from financial institutions and the joint limit with third parties (limit with financial institutions plus the limit of the programme authorised for the issuance of promissory notes). It can be seen from the graph that the overall available credit limit is not exceeded at any time during the review period and the limit with third party financial institutions is only exceeded between August and November 2012 by a small amount. In view of the line showing the evolution of the group's total debt (including drawdowns on the intra-group credit line), the inspectorate concludes that "it is difficult to argue that it would have been necessary to increase the available intra-group credit by 3.5 billion euros, as was in fact demonstrated, since the credit line was, for most of the contracted period, with minimal or no utilisation".

 

Nothing is said about this graph in the reports provided (they do not even refer to it) and only in the allegations the complainant limits herself to pointing out that it does not allow any obvious conclusions to be drawn from it.

 

Furthermore, the Technical Office carries out a study that confirms the conclusion of the inspection, pages 64 and 65 of the settlement agreement. On page 64 an extract from page 171 of the Group's 2013 annual accounts is reproduced and on page 65 there is a table showing that Group X has almost twice as much liquidity in credit lines as in cash (192.50%) and that W, without taking into account the linked credit line, has slightly more credit lines than cash (115.15%). The inspection notes that "taking into account the 3.5 billion linked credit line, W's ratio of credit line to cash would be 221.21%, almost thirty points higher than that of the group. With the regularisation carried out by the Inspectorate, W would have a ratio (190.91%) almost identical to that of Group X (192.50%) with third parties".

 

The accounts of group X are also analysed, where a tendency is observed to devote one third of its liquidity in the form of cash and the rest to credit lines.

 

Nothing is said about this study in the AFI report, and the other report merely states that the comparison made by the auditors is inappropriate because the situations of X and W are not comparable. In the statement of allegations, the complainant merely points out that the inspectorate is using a ratio (credit line/cash) which, in her opinion, is absurd.

 

In this respect, it is interesting to note that the inspection, based on these calculations, deduces that if W had a liquidity similar to that of X, the credit line should be around 2,500 million euros, which justifies the adjustment made. On the other hand, the entity has not provided any document accrediting what W's financial policy was; we must not forget that W and X belong to the same group, so it seems reasonable to understand that the financial policy of both is similar.

 

It follows from the above that the inspection has sufficiently justified why it considers that the amount of the credit line is overstated.

 

And it also sufficiently reasons why it accepts as valid 1 billion euros more than the maximum amount drawn down, i.e. 2.65 billion euros until March 2013 and 1 billion euros since its drawdown was null and void. Firstly, the inspectorate points out that, like the taxpayer, it considers the maintenance of a cash security stock to be key to meeting payments on time. This implies that an independent businessman, acting in free competition, would establish a sufficiently wide margin to ensure that no defaults occur. However, the Inspectorate considers that this margin should not be such as to tie up a large amount of idle resources. In order to calculate that margin, it says, account must be taken of the institution's expected needs to cover its payments and the economic environment which could give rise to unforeseen payments or estimated collections which ultimately do not materialise. On the calculation of the margin, the settlement agreement states the following (page 64):

 

"..., given the absence of comparables, given the serious difficulties in fixing a single exact amount that could be considered as arm's length, taking into account the seriousness for the company of not being able to have liquidity to meet its short-term payment commitments, the Inspectorate has opted for a very prudent approximation, raising, for the periods in which the credit line had drawdowns, the maximum figure drawn down in the amount of 1 billion euros. In these years the "margin" of safety accepted by the Inspectorate is therefore almost 30% of the total amount. This amount was calculated by the Inspectorate on the basis of the taxpayer's behaviour in the years in which no amount was drawn down from the credit line. To this security margin should be added the possibility of issuing promissory notes, authorised by the board of directors, which was hardly used by the institution".

 

In short, the inspectorate has demonstrated the excess volume of the credit line and has sufficiently reasoned the amount admitted as valid (which allows meeting the foreseen needs and not having idle resources), in short, it has adequately justified why its amount was not in accordance with the principle of free competition.

 

The complainant insists that it was in line with what third parties operating in the same market were doing and as proof of this it again reproduces (page 26) the summary table showing the comparison with other competitors in the market. This summary table was already provided in the statement of objections to the Statement of Objections. It cannot be deduced from that table, as it claims, that the amount of the credit line was in line with the principle of free competition, since it merely reflects percentages without specifying the accounts used (individual or consolidated) or the concepts used to determine them, which led to the figures shown in the table.

 

The AFI report rejects the claim that the credit line is overstretched because W was in a similar position to other competing companies. Data is provided on the ratio of undrawn credit plus cash to operating expenses for the years 2011 to 2014 for W, Q, UF, NN and MM (page 26).

 

The report states that the data are taken from the companies' annual accounts and prepared by the companies themselves without further explanation.

 

The report claims to indicate that the undrawn amount over the total is in line with those of its competitors; however, it does not analyse together with the holding of other liquid instruments and the needs to be met, as the inspectorate has done, so the data provided is partial. On the other hand, it should be noted that nothing is said in this report about the analysis carried out by the inspectorate, which is shown on page 63 of the settlement agreement, nor about the corroborative study carried out by the Technical Office, which is shown on pages 64 and 65 of the settlement agreement.

 

As to whether the economic context of the economic crisis of those years could have influenced the amount of the credit line that was contracted, the report merely states that it "could reasonably condition the cash management decisions of any Spanish company". This is not denied in the file. In the amplifying report it is stated that 'a prudent independent businessman, acting in free competition, would establish a sufficiently wide margin so that non-payments do not occur'. At the same time, it states that "this margin should not be such as to tie up a large amount of idle resources" (page 23 Report).

 

The other report, after making a series of statements, concludes that it does not agree with what was proposed by the inspectorate. However, it does not provide any evidence for its statements.

 

In accordance with the above, in relation to the limit of the credit line, we consider that the limit set by the inspectorate is in line with the principle of free competition.

 

In short, the regularisation carried out by the inspection with regard to the credit line granted by XR to W. It should be noted that the inspection has allowed the deduction of financial expenses and the unavailability commission on a total amount of 2,650 million euros, from 30 November 2011 to March 2013, and on 1,000 million euros from that date, despite the fact that no amount was drawn down.

 

SEVENTH - The next issue raised by the complainant concerns the regularisation of the EUR 4.5 billion loan granted to W SA by the entity .... XR NV.

 

On 23-10-2014 XR grants a loan to W of EUR 4.5 billion with an interest rate of 3% and a term of ten years.

 

In the transfer pricing documentation provided by the entity to the inspection, the valuation of this transaction is made by taking as a reference the average cost of debt issuance by X, certain transactions of other entities in the sector and the price of W's CDS plus a risk-free rate of return, taking into account for these purposes the Euro Swap and adding to the resulting rate a premium for subordination and a premium for the size of the loan.

 

Therefore, to determine the applicable fixed interest rate of 3 per cent, the entity starts from a base price (2.189 per cent) to which it adds a subordination premium (0.49 per cent) and a premium for the size of the issue (0.35 per cent).

 

The bank justifies the base price on the basis of three analyses:

 

1) The first uses X's average cost of debt issuance, using the curves for its euro, dollar and sterling bonds. The base price thus determined would be between 2.16% and 2.26%.

 

2) A second analysis determines the base price from three bond issues in the same year of UF, Q and NN. The base price thus determined would be an average of 2.494%.

 

3) The third analysis determines the base price by adding W's credit insurance quote (W CDS) in October 2014 and a risk-free rate of return using the 10-year euro swap curve, which would yield a base price of 2.11%.

 

The taxpayer justifies the subordination premium on the basis of the insolvency law (article 92 of Law 22/2003), which considers a subordinated loan to be a loan owned by a related person, as in the case of X and W. The taxpayer understands that, given that the subordinated nature would imply being in the last order of priority with respect to other loans with third parties in the event of the company's insolvency, this would imply a higher risk that would justify a higher price. To take account of this, the taxpayer adds a subordination premium of 0,49 % to the base price.

 

This premium is calculated by the taxpayer on the basis of an estimate. In doing so, it assumes that there are two levels of credits (senior and junior) and that the senior debt has a rating rating one notch higher than the subordinated debt. For the calculation it takes the difference between the average cost of two samples of bonds, one with a credit rating of Baa2 and the other Baa3, determining a premium price of 0.49%.

 

The size premium is justified by the taxpayer on the need to compensate the lender given its higher risk exposure by lending amounts of a certain magnitude:

 

- Concentration of resources in a single borrower.

 

- Loss of diversification in its investment portfolio.

 

To calculate it, the taxpayer claims to follow the following methodology: compilation in the market of bonds and loans, with durations between 5 and 15 years that had been formalised in 2013 and 2014, classifying them into two groups, those greater than 1,000 million euros (cluster 1) and those less than 1,000 million euros (cluster 2). The price of the size premium is set by the taxpayer by the difference between the average price set for cluster 1 and that set for cluster 2, resulting in a premium of 0.35%.

 

Compared to the calculations contained in the transfer pricing documentation, the inspectorate considers "that the most appropriate comparable is that resulting from W's CDS, which takes into account the entity's own credit risk (lower than that of Group X), plus a risk-free rate of return, which results in a base rate of 2.1549%. Subordination and size premiums should not be added to this rate".

 

The inspectorate considers that, in the present case, the CDS of W plus a risk-free rate best represents the market value, since it is the one that 'reflects the particular circumstances of W at a similar maturity and is determined by market quotations and therefore by the price that would be set by independent parties'.

 

The inspectorate questions the cost set in the loan granted by X to W in 2014, considering that neither the adjustment for subordination premium nor the adjustment for size was appropriate and setting the interest rate at 2.1549% on the basis of the following:

 

1) It does not agree with the comparable used by the institution to calculate the base price, considering it more appropriate to use W's CDS plus a risk-free rate of return as the comparable because it "takes into account the institution's own credit risk", "takes into account W's particular circumstances", and "is determined by market quotations".

 

The base price taken into account by the inspection is 2.1549% which is calculated on the basis of the sum of W's CDS (1.047%) and the risk-free interest rate (1.170%); on page 69 of the settlement agreement (which reproduces what is stated in the supplementary report) it is stated that "W's 10-year CDS on 22 October (the day immediately after the granting of the loan subject to this verification) was valued at 1.047%. Using the EUR SWAP curve as a risk-free premium, in line with what was done by the taxpayer, would give a value of 1.170% on 22 October 2014. Thus, the base price, determined by the sum of both amounts, would reach 2.1549%".

 

It should be noted that, as pointed out in one of the expert reports submitted to this Court, there is an error as the sum of the CDS of W (1.047%) and the risk-free interest rate (1.170%) gives an interest rate of 2.217% instead of the 2.1549% set by the inspection.

 

2) It rejects the application of the subordination premium (0.49%).

 

The Inspectorate considers that the addition of this premium does not respect the normal market value in accordance with the arm's length principle required by Article 16 of the TRLIS, mainly because:

 

- W's use of a subordinated loan is not justified when there are other options available at a lower cost.

 

- The non-automatic nature of comparability adjustments; only those adjustments that improve comparability should be made, which is not the case here.

 

The amplification report elaborates on these grounds at length, which are reproduced on pages 70 to 72 of the settlement agreement.

 

3) Rejects the application of the size premium (0.35%).

 

The Inspectorate considers that it is not appropriate to make such a size adjustment basically for the following reasons:

 

- The study provided lacks representativeness because the conditions of the comparables used differ from the conditions of the taxpayer, in terms of sector, geographical area, date and quantification; lenders from European countries and Australia and the United States are included, the sample is essentially composed of financial institutions, the issues take place mainly from May to July 2014, the calculation is made based on nominal rates. Page 75 of the settlement agreement, which reproduces the supplementary report, analyses the study carried out by the institution to justify this premium.

 

- The study carried out by the inspectorate concludes that larger amounts can be financed at lower interest rates because the entities issuing them are larger or more solvent and are in a more privileged situation; pages 76 to 78 of the settlement agreement.

 

- The non-automatic nature of the comparability adjustments.

 

The complainant objects to the conclusions of the inspection; it considers that the alignment with the arm's length principle of the interest rate applied in the transaction and, therefore, the market nature of the different components considered in the determination of the transfer pricing policy has been sufficiently verified.

 

The entity considers that the administration's approach in questioning the base price and rejecting its adjustment for the subordination premium and the size premium is erroneous. It considers that the base price is not the market value of the interest rate applicable to the transaction in question and that an adjustment for the subordination premium and size premium is necessary.

 

The discrepancies are therefore essentially based on the following

 

1) the comparable used to determine the base price

 

2) Whether adjustments for: a) subordination premium and; b) size premium are necessary.

 

EIGHTH: Regarding the base price, the claimant considers that the diligence followed in the determination of the base price has been corroborated by the expert reports provided and believes that the Administration's procedure in questioning the base rate is erroneous.

 

To determine the base price, the entity uses the bond curves in euros, dollars and pounds sterling of X. The base price thus determined would be between 2.16% and 2.26%. In addition, and in order to corroborate the results obtained, it carried out two other analyses.

 

In the first, he determined the base price from three bond issues in the same year of UF, Q and NN. The price thus calculated would be an average of 2.494%. The second determined the base price by adding the CDS of W in October 2014 and a rate of return considered risk-free, for which it uses the Euro Swap. This analysis yields a base price of 2.11%.

 

On this basis, the institution establishes a base price of 2.189%.

 

The Inspectorate considers that the analysis that best represents market value was the one that determines the base price by adding a risk-free rate of return to W's CDS (the third analysis performed by the entity); considers that W's CDS of 22 October 2014 (the day immediately prior to the transaction) plus the risk-free interest rate (10-year euro swap curve) is the one that most adequately represents the market value of the remuneration, as it takes into account W's particular circumstances, in a similar term and is determined by market quotations and, therefore, by the price that would be set by independent parties.

 

For its part, the complainant insists that the main analysis, which determines the base price on the basis of X's euro, dollar and sterling bond curves, is the most appropriate.

 

In this respect, it should be noted that XR's loan to W is EUR 4.5 billion, but the analysis that XR considers best represents the market value is the one that uses X's euro, dollar and sterling bond curves, i.e. it incorporates currencies other than the linked transaction. Therefore, this analysis, by including currencies other than that of the transaction in question, is less representative, as it is clear that the currency in which the loan is financed influences the market value of the transaction being valued and, consequently, affects the interest rate, and there is no evidence that the institution has made any adjustment for this reason.

 

With regard to the reports provided, which consider that the entity's own report is more complete as it takes into account comparable companies in the sector, reference should be made to the provisions of paragraph 3.2 of the OECD Guidelines (2010 version):

 

"3.2. As part of the process of selecting the most appropriate transfer pricing method (see paragraph 2.2.) and its application, the purpose of the comparability analysis is always to find the most reliable comparables. Accordingly, where it is possible to determine that an unrelated transaction has a lower degree of comparability than other transactions, it should be eliminated (see also paragraph 3.56.). This does not mean that an exhaustive search of all possible sources of comparables is required, as it is recognised that there are limitations on the availability of information, and the fact that the search for comparables can be very burdensome. ...'.

 

According to this paragraph, transactions with a lower degree of comparability should be eliminated and, in this case, it is clear that the yield estimated on the basis of W's CDS is more specific than that estimated on the basis of other companies.

 

On the other hand, the AFI report itself states that "when determining the benchmark for the cost of issuance, we consider that, provided that the borrower's own market indicators exist, the indicator will be considered as the "best possible comparable" since it is representative of market prices obtained by the company itself in transactions with third parties". And in this case there is such an indicator, W's CDS.

 

Finally, it should be noted that the lack of technical rigour referred to by the complainant has not been observed, since the inspection has analysed the transactions and, taking into account the available market data, has given preference to the specific data of the taxpayer, acting in accordance with paragraph 3.2 of the Guidelines, and has sufficiently justified the application of the principle of free competition to the case.

 

NINTH - In order to determine the price applied to the loan granted by XR to W, the taxpayer adds a subordination premium and a size premium to the base price analysed above.

 

As for the premium for subordination, the entity justifies it in the insolvency law (article 92 of Law 22/2003), which considers subordinated loans to be those whose ownership corresponds to a related person, as is the case of X and W. The taxpayer understands that, given that the subordinated nature would imply being in the last order of priority with respect to other loans with third parties in the event of the company's insolvency, this would imply a greater risk that would justify a higher price.

 

The inspectorate, however, considers that adding this premium does not respect the normal market value in accordance with the arm's length principle required by Article 16 of the TRLIS, mainly for the following reasons:

 

- There is no justification for W to take out a subordinated loan when other options are realistically available at a lower cost.

 

- The non-automatic nature of comparability adjustments. Thus, only those adjustments that improve comparability should be made, which is not the case here.

 

In support of its position, the inspectorate cites, in addition to Article 16 of the TRLIS, paragraphs 1.34, 3.50, 3.51 and 3.53 of the OECD Guidelines (2010 version).

 

The complainant insists on the inspection's lack of technical rigour in rejecting the adjustment for the subordination premium without providing objective market data to justify that this premium does not comply with the arm's length principle.

 

It disagrees with the reasoning followed by the inspectorate and, as evidence that other more advantageous options were not available, it is the analysis made by AFI in its expert report and, along the same lines, the expert opinion of Mr. ..... He adds that AFI's expert report not only assesses the validity of this premium but also carries out an analysis on the basis of which it quantifies the subordination premium it would apply, corroborating that the premium applied is in line with what independent third parties would have agreed.

 

It reiterates that it has sufficiently demonstrated that it has acted in accordance with the precepts of the Guidelines in the process of determining the interest rate applicable to the linked transaction under analysis.

 

First of all, it is important to note that the Inspectorate, like the complainant, takes into account the 2010 version of the OECD Guidelines.

 

The July 2010 OECD Guidelines refer to comparability adjustments in paragraphs 3.47 to 3.54. Of these, the following should be noted:

 

"3.50. Comparability adjustments should be considered if (and only if) they are expected to improve the reliability of the results.

 

3.51. It should be stressed that comparability adjustments are only appropriate if the differences actually affect the comparison. Differences between the taxpayer's related party transactions and those of comparable third parties are unavoidable. The comparison may be correct even if there is an unadjusted difference, provided that the difference does not affect the reliability of the comparison. Conversely, the need for numerous or very large adjustments to key comparability factors may indicate that the transactions of the third party are not sufficiently comparable.

 

3.52. Adjustments are not always justified. For example, an adjustment made to accounts receivable will not be particularly useful when there are substantial differences in accounting policies that cannot be resolved. Similarly, sophisticated adjustments are sometimes made to create the false impression that the result of the search for comparables is 'scientific', reliable and accurate.

 

3.53. It is not appropriate to consider certain comparability adjustments as routine and uncontested, (...;). The only adjustments that should be made are those that are expected to improve comparability.

 

Therefore, the Guidelines allow only adjustments that enhance comparability by stating that the inclusion of 'routine' adjustments is not appropriate and that the only adjustments that should be made are those that 'enhance comparability'.

 

It is also worth noting the provisions of paragraphs 1.6 and 1.34 of the OECD guidelines

 

"1.6 (...). For the purpose of profit adjustment, by reference to the conditions that would have existed between independent enterprises in comparable transactions carried out under comparable conditions (i.e. in a "comparable uncontrolled transaction") the purpose of the arm's length principle is to treat the members of a multinational group as if they were operating as independent enterprises rather than as inseparable parts of a single unified enterprise (...)".

 

"1.34 Independent companies, when assessing the terms of a potential transaction, compare them with other realistically available options and will only enter into it if they do not see a clearly more attractive alternative. For example, it seems unlikely that a company would accept a price offered by an independent company if it knows that other potential customers would be willing to pay more for its product on similar terms. This point is relevant to the issue of comparability because independent firms will normally take into account any economically significant differences between realistically available options (such as differences in the degree of risk or other comparability factors mentioned below) when valuing them. Therefore, when making comparisons under the arm's length principle, tax administrations should also take these differences into account in determining whether comparability exists between the situations being compared and what adjustments may be necessary to achieve comparability.

 

The bank justifies the application of the subordination premium on the basis of the subordinated nature of the loan. In other words, the institution decides to exchange equity for debt, preferring debt with group entities instead of resorting to third-party debt, and intends to charge an additional premium for subordination on the basis of the automatic qualification of the insolvency law. On page 67 of the winding-up agreement it is stated that 'the reason for this loan operation is to optimise the financial structure of W SA which, at that time, was basically financed by its own resources'.

 

The last paragraph on page 45 of the AFI report states the following:

 

"Although, as stated above, W's financing transaction is subordinated in nature, W has a high level of intra-group indebtedness compared with its indebtedness to third parties, so that the level of subordination vis-à-vis third parties is very low, justifying the conservative application of a low subordination premium".

 

Although it is true that according to the Insolvency Act, for the purposes of insolvency proceedings, credits between group companies are subordinated, however, it cannot be concluded from this, as the claimant claims, that any intra-group loan, simply because it is an intra-group loan, incurs a higher risk for the lender and a higher interest rate for the borrower. It is clear that the facts and circumstances of each case will have to be considered.

 

This is not in line with the Guidelines since the only adjustments to be made are those that 'improve comparability', which in this case the taxpayer is not known to have justified.

 

It should be noted that the sum of the premiums to the remuneration required by the market (base price) is exclusively the taxpayer's and, therefore, it is up to the taxpayer to justify that they improve comparability and it is not up to the inspectorate to justify the absence thereof, i.e. the burden of proof falls on the party making the adjustment, as established by the OECD Guidelines; it should be noted that the interest rates of the market comparables (bonds and CDS plus risk-free premium) do not include this premium.

 

On the other hand, it should be recalled that from the borrower's point of view, the borrower (an independent third party) would only accept an increase in the cost of its funding if it were the best available option in view of the facts and circumstances. Regarding the lack of justification that W could have used other available lower-cost alternatives, the inspectorate notes the following:

 

- The inspectorate, as well as the taxpayer, agree on the good and consolidated credit quality of W (even better than X), on the fact that the financial markets had already stabilised and the turbulence had disappeared more than a year before the date of the transaction, and that it was the group's own decision to replace its own financing with external financing (as can be seen from the documentation ...).

 

- If the taxpayer considers that it has not been justified that an independent had granted a loan to W, the question is not whether such a loan should or should not be subordinated, but whether it should or should not exist, which could lead to the absurdity that the loan should be rejected.

 

The bank reiterates that the inspection procedure is flawed because it rejects the subordination premium without carrying out any economic analysis to justify that independent third parties would not have applied the subordination premium, which it says is contrary to paragraph 3.3 of the Guidelines.

 

Paragraph 3.3 of the Guidelines states:

 

"3.3. In order to make the process transparent, it is considered good practice for the taxpayer using comparables to justify its transfer pricing, or tax administrations using comparables to justify a transfer pricing adjustment, to provide the other interested party (i.e. tax inspectorate, taxpayer or foreign competent authority) with supporting information to enable the reliability of the comparables used to be assessed".

 

Well, as we have indicated above, the sum of the remuneration premiums required by the market is exclusively the taxpayer's responsibility and, therefore, it is up to the taxpayer to justify that they improve comparability and not for the inspection to justify the absence of such premiums.

 

Lastly, the AFI report, after analysing W's ability to access other available options, concludes that 'the financing received by X is subordinated' and that 'this financing for a significant amount and under subordination to W's other creditors represents a risk for X that it must charge a premium for subordination'. It then quantifies what the subordination premium could have been.

 

And, in relation to this premium, the expert opinion of D. ... points out the following: "the inspectorate considers the subordination premium as, exclusively, a mere comparability adjustment, when, in our opinion, this is not the case and has much more to do with basic financial principles".

 

As regards the subordinated nature of the loan, we refer to the above. With regard to the quantitative aspects contained in the AFI report (Annex 4), it should be noted that subordinated and senior securities issues and specific issues are shown, but neither the search criteria nor the result of the search are indicated, nor are the basic aspects of the search or how the quantification was carried out.

 

The OECD Guidelines, paragraphs 3.50 to 3.53, reproduced above, require that the comparability adjustment must not only be quantified but that the improvement in comparability achieved with it must be justified, but in this case there is no evidence that this justification has been provided. It should also be remembered that the interest rates of the market comparables (bonds and CDS plus risk-free premium) do not include this premium.

 

In short, we consider that the criterion followed by the inspection is more in line with the guidelines and the purpose sought by the transfer pricing regulations.

 

TENTH - As regards the size premium, in the documentation provided by the entity, it is justified by the need to compensate the lender given its greater risk exposure when lending amounts of a certain magnitude that would entail:

 

- The concentration of resources in a single borrower.

 

- Loss of diversification in its investment portfolio.

 

To calculate the size premium, the taxpayer stated to follow the following methodology: compilation in the market of bonds and loans, with durations between 5 and 15 years that had been formalised in 2013 and 2014, classifying them into two groups, those larger than €1 billion (cluster 1) and those smaller than €1 billion (cluster 2). The price of the size premium is set by the taxpayer by the difference between the average price set for cluster 1 and that set for cluster 2, resulting in a premium of 0.35%.

 

The Inspectorate, however, rejects the size adjustment because according to the OECD Guidelines (2010 version) adjustments to market prices are only admissible if they improve the comparability of the transaction. Furthermore, it considers that the methodology followed by the taxpayer is neither adequate nor rigorous, obtaining conclusions that do not correspond to the market value.

 

According to the inspection, "the adjustment for the loan size premium does not improve comparability but, on the contrary, creates the false impression that the result of the search for comparables is "scientific", reliable and accurate when the reality is different. An apparently logical adjustment is justified, as will be developed below, in a search for non-representative comparables that does not justify such an adjustment.

 

Automatically applying an adjustment because "it is customary in the market" without taking into account the particular circumstances of the case goes against the principle of free competition, since it does not improve comparability but involves a manipulation that is not sufficiently verified with real data. It is an adjustment based on conjecture of the kind rejected by the Guidelines, which accept only well-founded adjustments that improve comparability.

 

The Inspectorate considers that the calculation of the size premium made by the contributor is neither rigorous nor acceptable, essentially because of the following:

 

- It includes issues by borrowers from European countries (Italy, France, ...) as well as from Australia and the United States.

 

- It is essentially composed of financial institutions (it uses mostly financial institutions as comparables).

 

- The issues took place essentially from May to July 2014; only one issue in Australia and one in the United States took place in September; the linked loan is dated 23-10-2014.

 

- The calculation was made on the basis of nominal rates, so that no valuation was made immediately prior to the date on which the loan was granted, but rather on the basis of issues made months earlier.

 

In short, it considers that the study provided lacks representativeness because the conditions of the comparables used differ from the taxpayer's conditions in terms of sector, geographical area, date and quantification.

 

Although the inspectorate does not accept this premium, it has carried out a search in which the taxpayer's terms are reproduced (BBB issue rating) but taking into consideration the taxpayer's sector (electricity) together with the industrial sector (given the proximity between the two) and incorporating the repayment condition (i.e. at maturity). This is set out on pages 76 and 77 of the settlement agreement.

 

The values obtained show, according to the inspectorate, "that searches such as the one carried out by the taxpayer do not allow reliable conclusions to be drawn" and this fact may result from the fact that "the comparability provided does not respect a principle of equivalence when moving from one tranche to another, since issues are taken into consideration .... of a different nature and made by non-equivalent entities'.

 

The bank reiterates that the addition of a size premium based on the size of the loan 'is normal market practice' and that the methodology followed 'for the calculation of that premium follows strict parameters for the search for arm's length value'.

 

It highlights the expert opinion of D. ... that it shares the taxpayer's criteria because "they are based on impeccable financial logic" and that, with regard to the comparables identified, it concludes the following: "we believe that the comparables used are appropriate precisely because of their geographical variety, sectors considered and quantifications".

 

It points out that further evidence that the size premium applied complies with the arm's length principle is to be found in the analysis carried out by AFI in its report to quantify what W's size premium might have been in October 2014.

 

It also defends the appropriateness of using nominal interest rates instead of yield to maturity in the economic analysis carried out.

 

In addition, it points out that the inspection has overlooked the fact that in the arrangement of a comparable loan with third parties an additional cost would have been added, namely the cost of structuring (bank financing or the debt market is associated with additional costs in terms of fees), which would also have increased the applicable interest rate.

 

In relation to the complainant's allegations, it should first of all be noted that, as in the case of the subordination premium, given that the size premium amount is borne exclusively by the taxpayer, it is up to the taxpayer to justify that it improves comparability, as established in the Guidelines. As noted above, any analysis must be based on the specific circumstances of the transaction in question. And it is up to the party defending the size premium adjustment to justify that it improves comparability, a circumstance which, in this case, has not occurred since the taxpayer merely states that it is a fact that the larger the amount to be financed, the higher the interest rate. Such a generic statement is not a universal rule valid under all circumstances.

 

The taxpayer and the reports provided are based on the fact that the larger the amount to be financed, the higher the interest rate; it considers it unquestionable that large transactions such as the related transaction in question entail a higher credit risk and, therefore, require a higher interest rate. However, as the inspectorate points out, this statement is not a universal rule valid under all circumstances since, in addition to the volume of the transaction, other aspects such as the economic sector, backing by private and public institutions, level of leverage, solidity, tradition of profitability, etc. must be taken into account; the volume of the transaction is not the only variable to be taken into account.

 

That the size of the transaction is not the only variable to be taken into account is acknowledged in the AFI Report; after stating that "the size of the debt plays a fundamental role, since the larger the amount, the more difficult it may be to repay it", it states that "the analysis carried out by the inspection concludes that no increase in the interest rate correlated with the amount issued is observed in the market", and then indicates that "we agree with the inspection that there is no evidence in the market of this correlation, since numerous factors other than the amount involved are at work behind each transaction" (page 39).

 

The taxpayer considers that the study carried out is rigorous and complies with the arm's length principle. It defends the adjustment and its quantification using mainly financial borrowers and using nominal rates.

 

The final selection of comparables on the basis of which the taxpayer intends to quantify the size premium includes mostly financial institutions. The selected sample considers issues from Australia and the United States that took place primarily from May to July 2014 (the loan was granted on 23-10-2014) and includes mostly financial institutions as borrowers.

 

Therefore, it has used information on unrelated transactions that occur in a different sector to the one analysed, i.e. it takes issues of a different nature and made by non-equivalent entities.

 

The taxpayer seems to confuse the fact that it is financial institutions that normally lend funds to independent non-financial institutions with the fact that a study in which the borrowers are financial institutions is taken as the basis for quantification, for the purposes of determining an interest rate in a transaction between non-financial institutions.

 

It should be noted that the Bank of Spain differentiates, in its public information, the interest rates on loans to households and non-financial corporations, grouping them together, as opposed to loans to financial institutions.

 

Therefore, the taxpayer's study compares heterogeneous transactions and does not take into account the circumstances of the taxpayer. In this regard, paragraph 1.33 of the 2010 OECD Guidelines states.

 

"For comparisons to be useful the relevant economic characteristics of the situations being compared must be sufficiently comparable".

 

With regard to the preference of the nominal rate over the yield to maturity (YTM), it should be noted that a further elaboration of this can be found on pages 57 and 58 of the extension report.

 

On page 58, in the footnote, the following definition of yield to maturity is given (own translation by the inspectorate):

 

"the percentage rate of return satisfied if the security is held to maturity. The calculation is based on the coupon rate, the duration to maturity and the market price. The coupon in the form of interest paid over the life of the security is presumed to be reinvested at the same rate".

 

The YTM is the concept commonly used to compare the yield of investments in bonds issued on different dates, which seeks to homogenise their yield by referring it to the same date, taking into account the interest still to mature discounted and the market price of the bond, and this with reference to the moment of analysis and not to the future as the taxpayer indicates on the basis of one of the reports.

 

Thus, contrary to what is stated in the report of Mr. ... at no time is it required that future yields are known.

 

Consequently, the yield to maturity of a bond represents the market interest rate or remuneration of a financial transaction for a specific date and term. Therefore, this Court, like the inspectorate, considers that, for the purposes of obtaining adequate comparability, it is more correct to use the yield to maturity (yields on the valuation date) rather than the nominal interest rates agreed on the issue dates.

 

On the other hand, contrary to the claimant's statement in the allegations, the corroborative analysis carried out by the inspectorate is not lacking in technical rigour.

 

First of all, it should be pointed out that the aim of the inspection with this study was to show that it did not consider the quantification provided on the basis of studies such as the one submitted by the taxpayer to be justified.

 

This study is described on pages 75 to 78 of the settlement agreement (it reproduces what was stated in this respect in the extension report); the search criteria and the tool used are defined, the terms used by the taxpayer are reproduced, taking into consideration the taxpayer's sector together with the industrial sector and incorporating the repayment condition, i.e. at maturity, which guarantees homogeneity for the purposes of calculating the interest rate. This is described at length in the file.

 

The Inspectorate carried out a search based on the taxpayer's own sector and geographic scope, expressed in terms of yield to maturity (not nominal). This search determined, on the basis of market data, that 'higher loan amounts did not imply a higher remuneration, but a lower interest rate, contrary to the taxpayer's claim'.

 

Therefore, there is no evidence of the lack of technical rigour to which the claimant refers, nor of any lack of defence on the part of the entity, which, on the other hand, has argued as much as it considered appropriate.

 

Finally, as regards the reports provided, apart from the above, it should be recalled that the OECD Guidelines only allow adjustments that improve comparability, stating that it is not appropriate to include "routine" adjustments and that the only adjustments that should be made are those that "improve comparability".

 

With regard to the quantification of the size premium in the AFI report, it should be noted that in the first analysis they limit themselves to stating the result achieved without providing any details and in the mathematical analysis they refer to a series of generic data.

 

Lastly, it should be noted that the application of the arm's length principle does not automatically lead to the passing on of hypothetical costs that would have been borne by independent third parties in carrying out the transaction. In the case at hand, the loan of 4.5 billion euros was provided by the entity .... XR, and if this entity had incurred costs in obtaining the loaned funds and had not been compensated by other means, it would be appropriate to analyse, after due accreditation, their corresponding transfer in the subsequent mirror financing. However, such circumstances have not been substantiated by the taxpayer.

 

The fact that independent third parties incur costs at the time of granting the financing does not automatically mean that these costs are added in the determination of the arm's length price. Moreover, the taxpayer has not substantiated that a size premium would be payable by an independent third party under the circumstances of the transaction as a whole.

 

Accordingly, the rejection of the application of the size premium is also confirmed.

 

Consequently, the adjustment made by the inspection in relation to the loan of 4,500 million euros is confirmed and the claimant's allegations in this respect are dismissed.

 

The next issue raised by the claimant relates to the adjustment made in relation to the loan of 10,000 million euros granted to XZ SL by .... XR NV.

 

On 01-12-2009 the entity ... XR granted XZ SL (then called XHH SL) a loan of 10 billion euros with a maturity of three years and a fixed rate of 3.2%. Paragraph 17 of the contract states that the purpose of the funds is "...of W ...".

 

On 16-03-2010 the conditions of the loan were modified, extending its amount to 18,000 million euros and establishing a new maturity date, 30-11-2019, and a new interest rate of 4.5%. In 2012 and 2014, some early partial repayments of the loan were made (EUR 3 billion in 2012 and EUR 7,492 million in 2014).

 

In the transfer pricing documentation, the loan granted by XR in 2009 was initially remunerated at a fixed rate of 3.2% calculated as a three-year Euribor swap plus a margin, determined by three elements: risk premium associated with X and W (calculated on the basis of the CDS swaps quoted on the market for these companies), a size premium and a margin of five b.p.. Subsequently, when the conditions of the operation were modified in March 2010, the interest rate on the debt was recalculated, bringing the new interest rate to 4.5%. This rate is the result of adding: a) 3-year Euribor swap; b) risk premium associated with X and W calculated on the basis of these entities' 10-year CDS; c) size premium; d) management premium.

 

The inspection rejects the deductibility of part of the financial expense derived from this loan; the regularisation carried out by the inspection is based on the fact that "given the favourable evolution of the financial markets since 2012" an independent entity would have proceeded to renegotiate the financing conditions. The inspection notes that "although the original terms of the transaction are reasonable, given the contractual and factual situation of this loan (detailed below) and the subsequent evolution of interest rates and financial market conditions, an independent third party would have cancelled the loan and obtained another loan on more advantageous terms in the market or renegotiated the original terms of the loan".

 

The inspection relies primarily on paragraph 1.34 of the Transfer Pricing Guidelines, which states:

 

"Independent companies, when assessing the terms of a potential transaction, compare them with other realistically available options and will only engage in it if they do not see a clearly more attractive alternative ..."

 

The regularisation carried out by the inspectorate is as follows:

 

1) The date it takes into account for the renegotiation of the loan conditions (or, as the case may be, the early cancellation of the loan) is 22-10-2014.

 

The date that the inspection has considered, prudently, it says, to establish the conditions for a renegotiation or replacement of the loan is 22-10-2014 (on 23-10-204 a loan of 4,500 million euros had been granted to W) because "although since 2012 the markets were already sending signals of lower interest rates and stability compared to the previous high interest rates, on that date there is already historical data of almost two years of falling interest rates and stability and good prospects for the financial market on a consolidated basis. Furthermore, the day after that date, W SA obtains the EUR 4,5 billion loan analysed in a previous section of these minutes, which indicates its ability to tap the financial markets and therefore also to renegotiate the terms of its financial situation.

 

It analyses the evolution of the financial markets, highlighting that the taxpayer itself, in its statement of allegations, states the "greater stability and predictability in the financial markets (June 2014)".

 

The result of this analysis is detailed on page 85 of the Settlement Agreement (reproduced in the Supplementary Report).

 

Other circumstances taken into account are:

 

- The maintenance over time of conditions excessively far from market conditions (4.5%) for successive periods of time without any pronouncement by the borrower, who is notoriously prejudiced as a result.

 

- The granting of a new linked loan on 23-10-2014 on more favourable terms.

 

2) It considers, in application of the comparable free price, the market interest rate on 22-10-2014 to be 1.18%.

 

The inspection calculates the market interest rate that would have been applied if the loan had been renegotiated on 22-10-2014. To do so, it carried out three analyses, obtaining as a final result a market interest rate of 1.18% resulting from the use of the Bloomberg tool (XFER) for the bond issues of W and its group with a five-year maturity (period from 2014 to 2019, the maturity date of the loan).

 

In conclusion, it should be noted that "the inspection considers, in application of the comparable free price method, in a prudent manner and favourable to the taxpayer among the various alternatives, the market interest rate as at 22 October 2014 to be 1.18%, which is corroborated by the very close rates of 1.095% and 1.130% determined by the two contrasting methodologies".

 

3) It does not accept that the institution argues that in the case of a renegotiation (early cancellation) of the loan, an early cancellation fee should have been paid.

 

It considers that, in this case, such a fee would not be payable at arm's length for the following reasons:

 

(a) The contract does not provide for an early cancellation fee, whether partial or total.

 

Clause 18) of the Change of Terms and Conditions states: "at any time the lender in order to reflect material changes in market conditions may make such changes

 

market conditions, may make such changes. The borrower (XZ) reserves the right to repay the loan in the event of non-acceptance of such terms".

 

It also contains Prepayment clause 24, according to which, on each interest payment date, the borrower may prepay in part or in full the principal and uncharged interest due by giving 30 days' written notice.

 

The amendment in March 2010 refers to the original 2009 Agreement, and to the resolution of the Board of Directors of 15 March 2010, in the following terms:

 

- Increase of the principal amount up to 18 billion.

 

- Extension of the termination date to 30 November 2019.

 

- Increase of the interest rate from 3.2% to 4.5%.

 

All other clauses of the original contract remain unchanged.

 

In addition, when it has proceeded to early repayment of part of the principal (for example, on 23-10-2012, for 3,000 million euros), it notifies XR in writing, referring to Section 24 of the Contract, indicating date, value, currency and amount, as global information of the Prepayment.

 

b) In the contract the positions of the lender and borrower are balanced.

 

The inspectorate notes that analysing the contract as a whole, it appears to be balanced as "the lender could benefit from situations of rising interest rates in the market, while the borrower could benefit from situations of falling interest rates in the market" and adds that "the taxpayer's claim to include a cancellation fee, in the event of regularisation by the inspectorate based on the fact that the loan had been renegotiated independently, would mean breaking the balance of the contract, since the borrower could not benefit from interest rate falls and the lender could benefit from interest rate rises, in addition to the risk already mentioned that the borrower assumes of not being able to repay the loan or assume the new conditions".

 

c) The entity has made successive repayments of the loan (in 2012, 2014, 2015, 2016, 2017) without having paid a cancellation fee.

 

The claimant rejects the position defended by the inspection; it considers that the conclusions reached by the inspection lack technical rigour as they are based solely on what hypothetically independent third parties would have agreed, without taking into account a real examination of the specific circumstances surrounding the transaction and how the market situation between independent parties could at some point have fitted the related-party transaction. Furthermore, as it had already argued before the inspectorate, it maintains that if the loan had been renegotiated or cancelled early, it would have been subject to the assumption of a cancellation charge.

 

First of all, it should be pointed out that the inspection has sufficiently reasoned the regularisation carried out (it is sufficient to read the contents of the extension report -pages 34 to 39-, reproduced in the settlement agreement -pages 84 to 89- and in the annex to the extension report -pages 64 to 74-). The inspection analyses the situation of the financial markets, using the CDS and risk-free interest rate of the operation in each of the periods (2010 to 2014); the annex to the supplementary report shows the CDS and risk-free interest rate curve for each period. It can be seen that since the beginning of November 2012 the joint rate has been around 2.5% (two points below the agreed rate). It also analyses the documentation provided (contracts, ...) to conclude that although the early repayment clause was not included in the contract, it did carry out early repayments without penalty. The inspection reasons extensively because, in this case, an independent entity, given the situation of the markets, would have renegotiated the conditions of the loan (or, cancelled early) since the contract allowed it, and also reasons extensively because it takes 22-10-2014 as the date of this renegotiation and how, after the analysis carried out, it fixed the interest rate at 1.18%.

 

With regard to the early cancellation fee, the inspection not only does not admit it because it is not provided for in the contract, but also because its inclusion would imply an imbalance between the parties to the contract and because the taxpayer has not applied it in early repayment transactions in the past. All this is explained at length in the file.

 

The file describes the adjustment made and the regulations on which it is based.

 

Therefore, there is no evidence of the lack of technical rigour to which the claimant refers, nor of any lack of defence having been caused to the entity which, on the other hand, has made all the allegations it has considered appropriate and without the allegations made having undermined the exhaustive analysis contained in the settlement agreement.

 

TWELFTH.- The next issue raised relates to the regularisation of XZ's current accounts with X SPA and XR.

 

It is recorded in the file that on 28-02-2007 XZ SL subscribes a current account contract with the parent company .... X SPA, with an initial limit of 10,000 million euros, the purpose of which was to finance the acquisition of W (in 2007 it acquired 67% and in 2009 it reached a 92% shareholding). In accordance with the provisions of the contract, XZ, S.L. may deposit its liquidity surpluses in the current account, notifying this in advance, and may also withdraw funds from the account, subject to prior notification, up to the limit of the funds previously deposited. When the request for funds exceeds the funds previously deposited, (overdrafts on the current account), X SPA may transfer the required funds up to the limit of the credit granted.

 

The initial financial conditions consisted of one-month Euribor with a differential of minus 0.25% for balances in favour of the taxpayer and plus 0.25% for balances in favour of the entity ..., a differential that would be plus 2.16% when the funds drawn down exceeded the limit, as well as a commission of 0.0625% for unused capital. Subsequently, on 29-12-2011, for subsequent years, the differential on the Euribor for balances in favour of the entity ... was set at 1.50%, which would become 4% for amounts exceeding the limit. In turn, the limit was reduced to 5,000 million euros on 08-04-2010 and to 1,500 million euros on 31-12-2012.

 

It is also on record that on 27-12-2011 XZ SL signed a current account contract with the entity .... XR, the purpose of which was for the taxpayer to deposit the surplus liquidity from its daily operations, as well as the possibility of obtaining financing in certain specified cases. The financial conditions consisted of one-week Euribor plus a spread of 1.30% for balances in favour of the taxpayer and the closest Euribor to the level of the funds obtained plus a spread of 2% for balances in favour of the entity ..... Subsequently, for the balances in favour of the taxpayer, on 28-01-2014 it was agreed to take as a reference the Euribor at one week, three months or six months, or another agreed by the parties. For the balances in favour of the entity ..., on 28-05-2013 the differential became 1.60%.

 

The inspectorate believes that "both current accounts correspond to centralised cash management models, usually called "Cash Pooling", common in multinational groups" and "therefore, it is not possible to admit the existence of an asymmetry between the debit and credit rates applied, and furthermore, the company is not a financial institution, the objective of Cash Pooling being the efficient management of the group's cash and, therefore, its functions are management and administration, which are not comparable to those of a credit institution".

 

The inspection considers that the interest rate of 1.5% used by the taxpayer itself in its credit operations with X SPA is applicable to all transactions, both credit and debit, carried out on current accounts with the entity ... and the entity ..... The inspection, based on the provisions of article 16 of the TRLIS, 16 of the RIS and the 2010 OECD Transfer Pricing Guidelines, determines the normal market value; after a thorough examination of the functions (analysing the nature and characteristics of cash pooling), assets and risks, the inspectorate concludes that a banking transaction is not suitable as a comparable of this type of transaction as carried out by the taxpayer and, therefore, the remuneration of the transactions of these entities (deposits and loans) should not be used, in general, to value the internal transactions of the CP. It considers that the asymmetry in the remuneration of the operations of contributing and obtaining funds within the cash pooling of XZ with XR and with X SPA is not acceptable and "applies the rate of 1.5%, used by the taxpayer itself in its credit operations with X Spa, to all operations, both credit and debit, and both with X SPA and with XR, considering this a prudent way of breaking the undue asymmetry of the taxpayer's operations".

 

The complainant insists that the financial transactions carried out are current account operations that should be analysed separately and independently; it considers that they are not part of a common cash pooling agreement. It also insists on the appropriateness of applying different rates to debit and credit balances, since it is common market practice to formalise credit lines and place deposits with different prices for each transaction.

 

THIRTEENTH.- Firstly, the entity maintains that the current account operations under analysis are agreed in an isolated, independent and parallel manner, and that they do not form part of a common cash pooling agreement, as the inspection concludes.

 

In this regard, it should be noted that it is the taxpayer himself, in diligencia no. ..., who expressly acknowledges to the inspectorate that both contracts form part of a cash pooling agreement. Thus, in diligencia no. ... of ... 2018, signed by the inspectorate and the authorised representative of the Group, states the following:

 

"I. Also in relation to the current accounts held with the entity X SPA and XR it is noted:

 

That when the entity was asked about the current account contracts in their credit and debit dimension, entered into between XR and the companies of Group X - ....-, whether they respond to a centralised cash management policy of the group (commonly known as cash-pooling) and their formalisation with other entities, IT IS ANSWERED THAT:

 

"There is indeed a centralisation of the group's cash management. This operation is not only a mechanism foreseen for Spain but also extends to Italy and other areas of Group X such as the United States or Central Europe. It is not expressly called cash-pooling or cash centralisation as such, but it does implicitly operate in this way insofar as any entity deposits its cash surpluses or requests them according to its needs, and up to the limit agreed in the various contracts with each entity.

 

As regards the formalisation of these operations with other group entities, the contracts are very similar to those provided, but with the appropriate differences in terms of currency and prices.

 

It is therefore the institution itself which acknowledges that both operations are part of the group's centralised cash management policy and that, although they are not expressly described as cash-pooling, they do function in that way insofar as any institution deposits its cash surpluses or requests them according to its needs and up to the limit agreed in the contracts. It should be borne in mind that article 107.2 of Law 58/2003 (LGT) stipulates:

 

"The facts contained in the proceedings and accepted by the taxpayer subject to the procedure, as well as their statements, are presumed to be true and may only be rectified by them by proof that they made a factual error".

 

In addition, it is recorded in the file that "in the documentation provided in diligence number 20, dated 6 April 2017, folder "..."-"XR EIA"-"Motivation of the operation", there are various "Power Point" presentations approved on different dates by the Board of Directors, in which the current account with the entity ..." is described as a contract for the placement of surpluses, as well as a contract with the entity ...". as a contract for the placement of surplus cash in Group X, which clearly falls within the scope of the cash management system commonly known as 'cash pooling'. Even in the submission of 17 December 2012, entitled "Approval of the modification of certain conditions of the Intercompany Current Account Credit Agreements signed between X SPA and X HH, S.R.L. and between XR, N.V and XHH, S.R.L. "The relations between the two operations are described, to such an extent that the modifications to both are linked, stating the following common objective: "Therefore, a series of modifications to the X-EEE and XR-EEE intercompany current accounts are proposed in order to adapt the financing structure to the conditions applied by the X Group and to adapt it to the company's expected financial needs".

 

This presentation is reproduced on page 115 of the Settlement Agreement.

 

Moreover, the entity does not dispute the functional analysis in the file. The inspectorate carries out a detailed examination of the functions (the nature and characteristics of cash pooling), assets and risks and, as a conclusion of the functional analysis, stresses that the leading cash pooling entity cannot be considered comparable to a credit institution and, therefore, the remuneration of these operations (deposits and loans) should not be used, in general, to value the internal operations of cash pooling.

 

In short, there are sufficient grounds in the file to conclude that the current accounts under analysis form part of a common cash pooling agreement, as the inspectorate found.

 

The complainant also argues that different interest rates are applied to debit and credit balances in the transactions analysed. It does not understand that the inspectorate intends to apply the same interest rate for debtor and creditor balances, given that it has been demonstrated through the provision during the inspection procedure of an internal comparable (with a credit institution) that it is common practice in the market to formalise credit lines and place deposits with different prices in each operation.

 

The inspectorate considers that both debit and credit balances should be remunerated in the same way; it does not accept the asymmetry applied by the taxpayer in the remuneration of the transactions and considers that the CP's transactions with each other and the CP's transactions with third parties (usually credit institutions) are not comparable, in summary, for the following reasons:

 

1) The lead institution of the CP does not usually have the status of a credit institution. Therefore, it does not meet the special requirements for this type of institution.

 

In addition, our legislation prohibits the taking of deposits to grant loans if the conditions of a credit institution are lacking.

 

2) The functional analysis carried out shows that the functions performed, the assets provided and the risks assumed by the lead institution are not comparable to those of a credit institution.

 

3) In a cash pooling relationship, institutions can change their position from debtor to creditor and vice versa, which differentiates CP contribution transactions from bank deposit transactions.

 

Focusing on the present case, the inspectorate states:

 

"XZ is a participant in a cash pooling arrangement in which it has the possibility to obtain short-term funding when it needs it and to provide short-term funding when it has excess cash. Transactions with group entities, such as XR and X Spa, within this cash pooling agreement are not comparable to those carried out by a company with a bank since, in the first case, the mutual nature of the contributions means that the main risk (default risk) is shared among all the group entities, whereas in the case of a bank loan and credit line the bank assumes this risk. In the case of deposits they are not comparable either, given the different risk assumed by the bank and the non-banks. Given that, ultimately, but not in a simple analysis of the two current account and revolving facility agreements, the ultimate origin and destination of the funds received and provided by XZ cannot be specified in one institution, but rather the origin and destination is the cash pooling itself as a whole, the remuneration for both types of transaction should be the same, as it is motivated by the same risk in both types of transaction. That is to say, as ultimately money is lent to the group and received from the group as a whole, the remuneration should be the same.

 

Therefore, the asymmetry in the remuneration of XZ's CP contribution and fund-raising transactions with XR and X Spa is not acceptable.

 

The Inspectorate therefore applies the rate of 1.5% used by the taxpayer itself in its credit transactions with X Spa to all transactions, both credit and debit, and with both X SPA and XR, considering this a prudent way of breaking the undue asymmetry of the taxpayer's operations".

 

As the inspectorate points out, the asymmetry in the remuneration of the contribution and fund-raising operations within XZ's CP with XR and with X SPA is not acceptable, as the benefits of the operation correspond to all the participants and, consequently, it would not be coherent to assign to the centralised cash management system the functions of a financial institution, nor the benefit that would accrue to it if it demanded higher interest rates than those it pays to the contributors. The centralised system's management company is not a financial institution and, therefore, as the inspectorate points out, the operating principles of such institutions cannot be applied to its operations.

 

In the same sense, this TEAC has pronounced in the resolution of 8 October 2019 (RG 6537-17 and accumulated); in this resolution the following criterion was maintained:

 

"The asymmetry in the treatment given by the taxpayer to credit and debit transactions in cash pooling is not admissible:

 

As this system is configured, both types of transactions should have the same treatment; The analysis of the logic and philosophy that exists in transactions with financial institutions is not transferable to the cash pooling transactions involved here; in this, the transactions that are channelled through the leading entity of the cash pooling, it follows from the functional analysis that it acts as a service provider managing and administering the cash pooling, but not as a credit institution that would assume the consequences of the contributions and drawdowns to/from the cash pool. And all the companies that form part of the cash pooling may be either contributors or receivers of funds, without it being generally known a priori what the debtor or creditor position of each of them will be".

 

In accordance with the above, the regularisation carried out by the inspection is confirmed and the claimant's allegations on this point are dismissed.

 

FOURTEENTH.- The next issue raised relates to the loans granted by the entity .... TW BV to the companies W SA and WY SA.

 

In the financial years audited, the subsidiaries, W SA and WY SA, had taken out loans with the entity ... TW BV, which is wholly owned by W SA.

 

The main activity of the entity ... consists of the issuance of promissory notes and bonds on the debt markets, issues guaranteed by W SA. The funds raised in the market by the entity ... are in turn lent to W SA and WY SA.

 

Furthermore, in the years audited, the entity ... owned 100% of the entity WKK LLC, domiciled in ..., which had issued preference shares guaranteed by W SA, the funds of which were lent to the parent company ..... In turn, these funds obtained by the company ... were also used to finance W SA and WY SA.

 

Consequently, the funds obtained by the company ... from both market transactions and its subsidiary were used to finance W SA and WY SA.

 

In the transfer pricing report they use the comparable free price (CUP) method to value these transactions, carrying out an analysis based on a comparison with syndicated loan transactions involving independent parties; the free price of competition calculated as the entity's remuneration ... is a margin over the lending rate of 6.07 basis points (0.0607%).

 

In December 2009, TW BV entered into an advance pricing agreement (APA) with the government ... for transactions with its group companies, which was renewed in 2013. The Agreement fixes the entity's remuneration ... for each intra-group funds transaction in which it acts as lender at a margin over the lending rate of 6.07 basis points, i.e. 0.0607%. The price assessment is made on the basis of a transfer pricing report dated October 2009 and carried out by ...

 

The tax inspection increases the taxable base of the audited years of the entities W SA and WY SA, and therefore, that of the Group, as a result of the determination of the transfer price of the loan operations agreed between the entity ... and the Spanish entities on the basis of the provisions of article 9 of the DTA with ... and articles 10 and 16 of the TRLIS.

 

The regularisation carried out by the inspection is as follows:

 

1) It classifies the activity of the entity ... as a provider of administrative services and not as a financial intermediary.

 

By analysing the functions, assets and risks of the related parties to the transaction, the inspectorate considers the entity to be a vehicle that performs instrumental functions ... as a vehicle that performs instrumental functions of an administrative nature; it characterises the entity ... as a provider of administrative services in relation to the financial function and rejects the characterisation as a financial intermediary given in the transfer pricing reports.

 

2) Valuation of the services provided.

 

In view of this functional characterisation, the valuation methodology it considers appropriate, based on the information available, is the net margin on total costs of the entity under analysis; it considers the net margin method of the set of operations to be applicable and as a profit indicator it uses total costs.

 

The inspectorate requested the assistance of the National Bureau of International Taxation (ONFI) in preparing the comparability analysis for the purpose of determining the margin applicable to the entity's operating costs .... determining an arm's length price.

 

On 09-03-2018, ONFI has submitted a report which is included in the electronic file. ONFI has selected the application of the net margin method using full costs as a profit indicator. It has located comparable transactions using the ORBIS database. It carried out two search processes. The first one referred to entities classified under the codes "activities auxiliary to financial services". The result of this process gives a total of 9 entities whose range in the financial years 2011 to 2014 is between 2.12% and 24.71% with a median of 13.37%.

 

The second process, of a general nature, on ancillary activities, with the selection criteria identical to the previous one, except, logically, the economic sector of activity. The number of comparables resulting from this process is very high, ranging from -13.10% to 49.44%, with a median of 4.09%.

 

The inspection considers that the first of the search processes, i.e. the one carried out on activities auxiliary to financial services, offers a higher reliability. Accordingly, the value of the indicator of net profit margin over total costs used to determine the market value of the related-party transactions analysed is that corresponding to the first quartile of the aforementioned search process, i.e. 9.45%. It sets the applicable transfer pricing policy at a net margin of 9.45% over operating expenses.

 

The complainant rejects the adjustment in the transfer pricing policy made by the inspectorate because:

 

(a) it considers that there are no objective reasons to justify its characterisation as a service provider of an instrumental nature; it questions the reclassification of the entity ... as a service provider.

 

(b) unjustifiably selects the lower band of the range of the economic analysis instead of positioning itself at the median; challenges ONFI's selection of the first interquartile range of the economic analysis instead of positioning itself at the median of the range of values.

 

(c) it considers that the doctrine of actos propios has been infringed. W was the subject of a tax audit procedure for the financial year 2005, in which the transactions carried out with the entity ... (profit and distribution of dividends).

 

FIFTEENTH.- In relation to the allegations made by the entity, we must first analyse whether it is appropriate to consider the entity ... as a provider of financial auxiliary services or as a financial intermediary.

 

The claimant insists that the classification made by the inspectorate as a service provider is erroneous. It submits that there are no objective reasons to justify its characterisation as a provider of services of an instrumental nature and, consequently, rejects the adjustment made by the inspectorate.

 

On the contrary, after analysing the activities and functions performed by the financial intermediaries, carrying out a thorough examination of the functions, assets and risks of the entity ... and making the comparison, the inspectorate maintains that TW BV (TWBV) should be characterised essentially as a provider of administrative services. The Commission's analysis characterises the entity as an administrative service provider, as a vehicle, with symmetrical assets and liabilities, set up to obtain advantages unrelated to the financial prices it obtains, which are necessarily linked to the guarantee of its parent company, which is the ultimate borrower of the funds. It stresses that the fact that it turns to the capital market to finance itself by issuing debt does not mean that it engages in financial intermediation. The inspectorate considers that its functions are not comparable to those performed by financial intermediaries as it has no autonomy in the activities of raising and using funds and the services it provides are of a purely administrative and support nature; The review of contracts, the keeping of accounts, the completion of contractual formalities, the control of collection and interest payment deadlines, the execution of such payments, the regular provision of information or the filing of tax returns are all tasks that fall within what the OECD calls instrumental functions and which must be distinguished from treasury and other financial functions.

 

For its part, the complainant reiterates that TW BV is a financial intermediary; it points out that the inspection carried out an incomplete functional analysis and incorrectly analysed the risks assumed.

 

However, the inspectorate found that the entity ... operates as an administrative service provider on the basis of the following considerations:

 

A) Assets

 

TW BV's assets consist of the claims arising from the loan contracts it concludes with W and WY (WY). The funds raised are lent to these companies with the same maturities and on the same terms as those laid down in the issue, also incorporating the terms of the hedging swaps where they exist. All financial intermediation costs are passed on to these companies as costs associated with the loans granted.

 

In the lending transactions, W is in some cases a debtor of TW BV, and when it is not a debtor, it guarantees the repayment of the loans concluded between TW BV and WY (internal guarantee), with a risk assumption limit for the company .... of EUR 2 million.

 

The inspectorate notes that 'This way of operating generates a symmetry between the assets and liabilities of its balance sheet which is broken only by the margin agreed with the management ... to remunerate intra-group transactions. The two sides of TW BV's balance sheet are, in practice, symmetrical so that the terms and conditions of assets and liabilities are matched and, in line with its instrumental nature, the company takes no financial risks that would influence the determination of its remuneration'.

 

B) Risks

 

The inspectorate stresses that the symmetry between interest rates, maturities and currencies that exists between the institution's assets (loans to group companies) and its liabilities (funds raised) excludes the incidence of the risks typical of financial institutions.

 

It analyses these risks and the extent to which TW BV assumes them:

 

1) Market risk

 

Market risk essentially includes interest rate risk and exchange rate risk.

 

The inspectorate notes that 'the way in which the transactions are set up by the related entities of the W group has the effect of eliminating these risks. TW BV lends all the funds it raises to entities in its group, W and WY, and since it applies the same conditions (interest rates, terms and currency and, where appropriate, hedging) as those present in its deposit transactions, i.e. it lends at the same terms and interest rates to be paid to third parties (hence the term 'mirror' transactions), TW BV cannot incur market risks.

 

Indeed, the transfer pricing report provided by the taxpayer explicitly acknowledges this reality by stating that 'Since the intercompany loans are entered into on a back-to-back basis, no foreing exchange risk or market interest risk is assumed by TW BV'.

 

2) Liquidity risk

 

Liquidity risk corresponds to the losses that TW BV may incur if it is unable to have access to or dispose of liquid funds in sufficient quantity and at adequate cost to meet its obligations. This risk would materialise only if W and WY are unable to meet their payment commitments and as W unconditionally guarantees all issues instrumented through TW BV, the liquidity risk is not TW BV's risk, but must be assessed at the level of the W group as a whole'.

 

(3) Credit risk

 

The Commission notes that in this case 'this would be the risk that TW BV might incur if its group companies were to default on their obligations to pay the interest or principal on the mirror loans granted to it after raising the funds on the market'. It considers that virtually 'all of TW BV's potential credit risk is materialised with W and WY as it only uses the funds it raises to lend to these companies'.

 

In assessing this risk, the Commission takes into account the fact that W acts as guarantor for TW BV's debts and also guarantees the obligations of other group companies towards TW BV .....

 

Regarding the EUR 2 million risk that TW BV is said to be assuming, the inspectorate notes the following.

 

".... is stated in the documentation of the Preliminary Valuation Agreement provided by the taxpayer: "The guarantees extended by W, S.A. mean that Party A's risk will in no instance be more than EUR 2 million".

 

When assessing this limited credit risk up to EUR 2 million, it has to be borne in mind that the conditions under which it can be realised imply the prior default of TW BV with third party creditors for whatever reason. As a consequence, the creditors of the entity ... would invoke the guarantee that W has given on the issues. In other words, it is ultimately W that can claim up to EUR 2 million from TW BV, in the event that TW BV does not pay its obligations and the parent company of the group has to call on the guarantee for the obligations that TW BV defaults on.

 

But if one takes into account that the loans from TW BV to its group companies are designed as a mirror image (same amounts, same interest rates, same terms and same currencies) of the obligations of TW BV towards third parties, the circumstance in which the claim can occur is certainly peculiar, since only if W defaults on its own obligations towards TW BV .... W can claim the 2 million euros. Indeed, if W fulfils its obligations towards TW BV, it will provide TW BV with all the funds it needs to pay external creditors and there will be no claim and no risk incurred. One might think, purely hypothetically, that once W's (or WY's) funds have been collected, TW BV's administrators can 'make them disappear' and not pay its creditors. But even in this hypothetical scenario, this would be an operational risk of W and not a financial risk of TW BV.

 

Ultimately, therefore, the risk is contractually designed in such a way that only when W stops paying TW BV could W claim the EUR 2 million from TW BV. And such behaviour by W (non-payment by TW BV) would be absurd if one takes into account that W acts as guarantor vis-à-vis third parties for the debt issues, so that it will have to pay in any case.

 

That is, unless one is thinking of a situation in which W is in fact unable to honour either the payment or the guarantee (default of the group's parent company). This circumstance is completely beyond TW BV's control and possibilities of action and would hardly justify the entity .... would hardly justify TW BV having to pay W, as in an arm's length situation no one would take on a risk over which it has no control (OECD Guidelines, paragraph 9.22 et seq.).

 

In short, as has been shown, this risk of TW BV of EUR 2 million, which, moreover, is not justified, is purely nominal or contractual, without any understanding of the circumstances in which it might actually materialise, bearing in mind that W guarantees compliance with the external and internal obligations that have been established'.

 

(C) Role

 

TW BV does not play any relevant role in the debt issues (liabilities on its balance sheet), nor in the loans to W and WY (assets on its balance sheet).

 

With regard to the debt issues (liabilities), the audit notes that 'these issues are part of programmes, private placements and preference share issues, managed and brokered by investment banks, and have been approved by the Board of Directors of W, which unconditionally guarantees them. TW's passive position is reflected in its own description of its functions in the transfer pricing report provided by TW.

 

This report, as stated in the minutes, points out that it is the treasury department of the W group that decides on the viability of all transactions and that it is this department that supports the negotiation, control and management of the cash".

 

Therefore, the inspectorate states that 'the decision regarding the raising of funds, which is the beginning of the "origination" of the issues, i.e. the creation of the financial instrument linking W and TW BV with the lenders (third parties), is in any event the responsibility of the financial department of W. It is this department which has the means and adequate information on the financing of the economic group as a whole to take the decision'.

 

With regard to the origination of the loans to W and WY, the inspectorate notes that 'TW BV's role, according to the transfer pricing report provided, can be summarised as the preparation of the intra-group credit agreements, the booking of the assets and the disbursement of the funds with the assistance of W's treasury department.

 

This preparation relates to the documentation that effectively sets out the terms of the loan which, as we have seen, replicate those of the debt issues made.

 

This is because TW BV cannot decide how to use the funds raised, nor to whom to lend them. Normally, the issues themselves specify the intended use of the funds and limit their use to the perimeter of the group of the company that guarantees them.

 

TW BV therefore also has a passive role in relation to the use to which the funds raised are to be put.

 

The functions relating to the management of the loans attributed to TW BV in the transfer pricing report are purely administrative in nature. We recall that, as stated in the text of the minutes, these are monitoring tasks with regard to the collection and payment of interest, accounting, review of information, reporting process and support tasks'.

 

And after the analysis, the inspection concludes by stating that

 

"the very structure of its balance sheet indicates that it does not fulfil any of the representative functions of financial intermediaries because the two sides of its balance sheet are in practice the same with respect to the terms and conditions of assets and liabilities. There is, of course, no maturity transformation, no liquidity transformation, because the loans to W and WY are a mirror image of the issues made. Nor is there any assumption or transformation of risk because the guarantor of the issues is W itself. TW BV essentially performs routine and low value-added administrative functions.

 

The Commission therefore concludes that TW BV 'must be characterised essentially as a provider of administrative services' since it 'does not perform any significant functions in relation to the creation or "origination" of the loans, either as assets or liabilities, these functions being performed by W or by the financial intermediaries. The functions attributed to it in relation to its management and administration are of a routine or support nature (reviewing contracts, keeping accounts, completing contractual formalities, monitoring the timing of interest collection and payment, enforcing such payments, providing regular information or completing tax returns).

 

Moreover, taking into account the way in which the transactions between TW BV and W and WY are set up, the assumption and exposure of these vehicle entities to financial risks (credit risk, interest rate risk, currency risk and liquidity risk) is nil or, at most, negligible.

 

Finally, this entity does not expose in its related-party transactions assets other than those represented by loans made to related entities. These loans have as their counterpart, practically equivalent, the liabilities represented by the amount of the debentures, bonds or other debt instruments with which the financing is raised on the market. The assets exposed in these transactions are not those of TW BV but those of the group's parent company, which is the guarantor of the issues.

 

In view of the data described above and in line with the reasoning of the inspection, it can be concluded that TW BV should be characterised as a provider of administrative services since, as stated in the Settlement Agreement, in the exercise of its functions (it carries out functions very similar to those carried out by the other comparable wholesale companies included in the sample of comparables), in the use of assets and in the assumption of risks, they correspond to those of a provider of administrative services.

 

SIXTEENTH - Having established that TW BV acts as an administrative service provider rather than as a financial intermediary, the remaining allegations should be analysed.

 

The complainant rejects the adjustment in the transfer pricing policy made by the inspectorate. It does not question the method used or the selection of comparables. It only questions the appropriateness of computing the range corresponding to the first quartile instead of using the median.

 

The inspectorate considers that TW BV does not operate as a financial intermediary but as a provider of administrative services and, in order to determine the market remuneration for these services, it uses the net margin method for all transactions and the total costs as a profit indicator. The result of the study of comparables referring to entities classified in codes of "activities auxiliary to financial services" gives a total of 9 entities whose range in the financial years 2011 to 2014 is between 2.12% and 24.71% with a median of 13.37%. The inspection sets the transfer pricing policy at a net margin of 9.45% on operating expenses, which corresponds to the first quartile.

 

The range of the comparability analysis is:

 

Minimum: 2.12

 

First quartile: 9.45

 

Median: 13.37

 

Third quartile: 22.95

 

Maximum: 24.71

 

The inspectorate, after stressing that according to paragraph 3.62 of the OECD Guidelines, any point in the interquartile range satisfies the arm's length principle, justifies the application of the first quartile on the reliability of the data obtained from the analysis and that the related entity performs fewer functions than all comparables.

 

The complainant points out that the inspectorate has unjustifiably selected the lower band of the interquartile range (the first interquartile) instead of positioning itself at the median of the range of values; considers that it would have been appropriate to position itself at the median because it says that one of the shortcomings of comparability that can be predicted from the comparability analysis is that the identified comparables "do not fully perform the same functions or activities as those performed by TW BV, especially if one takes into account that its principal and the inspectorate do not coincide in the functional characterisation of this entity".

 

Paragraph 3.55 of the OECD Guidelines states that:

 

"In some cases it is possible to apply the arm's length principle to the extent that a single figure (e.g. a price or margin) will be the most reliable benchmark for establishing whether a transaction is at arm's length. However, to the extent that transfer pricing is not an exact science, there will be many occasions where the application of the most appropriate method(s) will lead to a range of figures that are all relatively equally reliable. In such cases, differences between the figures within the range may be due to the fact that, in general, the application of the arm's length principle allows only an approximation of the conditions under which independent companies would have operated. It is also possible that the different points in the range reflect the fact that independent undertakings engaged in comparable transactions in comparable circumstances may not set exactly the same price for the transaction".

 

For the purposes of determining the point in the arm's length range, paragraph 3.62 of the OECD Guidelines recommends the following:

 

"A.7.2 Selection of the most appropriate point in the range...".

 

3.62 In determining this point, where the range comprises highly reliable and relatively equal results, it can be argued that any one of them satisfies the arm's length principle.

 

Where some defects in comparability persist, as discussed in paragraph 3.57, it may be appropriate to use measures of central tendency that allow this point to be determined (for example, the median, mean or weighted mean, depending on the specific characteristics of the data) in order to minimise the risk of error caused by defects in comparability that persist but are not known or cannot be quantified".

 

Firstly, it should be noted that the fact that there is a prior valuation agreement concluded with the administration .... does not allow us to conclude that the transfer pricing policy was appropriate and justified because, as the claimant itself acknowledges, this APA is not binding for the Spanish tax administration; its conclusions cannot be transferred to Spain, as stated in the judgement of the Audiencia Nacional of 25-06-2018, appeal 479/2014) which states "We do not judge the wisdom and validity of the Prior Valuation Agreement existing between the tax administrations of Switzerland and France, as it is not our responsibility, but we consider that its conclusions cannot be transferred to Spain".

 

On the other hand, the tax authorities have justified the application of the first quartile; in this respect, it is stated in the file:

 

"The reliability of the data obtained is derived from the analysis carried out in the ONFI study, to which we refer. It should be noted in this respect that, in a first step, with the criteria used for the selection (active entities, geographical scope, valued activity and sector of activity, independence, size and availability of information), a first sample of 61 companies was obtained, which were subject to a second filtering, and in this process the entities in which the following reasons concurred were eliminated:

 

- Carrying out a different activity from the described activity of intermediation.

 

- Negative operating results for all periods under analysis, in accordance with the provisions of the Transfer Pricing Guidelines, section 1.70.

 

- Absence of available information on activity or on results, as well as inconsistent data making the analysis impossible.

 

The end result was the selection of the nine comparables listed above.

 

As can be seen from the comparability study carried out by ONFI using the ORBIS database, the key characteristic of all the entities resulting from this study is that they are all companies involved in functions ancillary to financial intermediation, whether through advice, transmission of orders, registration or monitoring of investments of independent third parties (NACE codes 6619 and 6499). All these entities differ from the entity under scrutiny, with a NACE Code 6420 (activities of holding companies), and whose activity ascertained by the inspectorate is even lower than those typical of holding companies, being limited to services to group entities. Therefore, given that the related entity performs fewer functions than all the comparables, it has been considered appropriate to use the remuneration corresponding to the first quartile of the sample as it is a better reflection of the remuneration that would have been agreed by an independent".

 

Therefore, contrary to what was stated by the entity, the inspection did justify the application of the first quartile. On the other hand, the institution has not justified the existence of defects in comparability and furthermore has not questioned the entities selected as comparable by the inspection.

 

Therefore, the claimant's allegations are dismissed.

 

SEVENTEENTH.- The claimant then alleges infringement of the doctrine of actos propios by considering that in the verification of the IS for the 2005 tax year, transactions carried out with the entity TW BV were not questioned. It refers to the verification procedure relating to the financial year 2005, the result of which is reflected in the certificate of conformity number ...35 which it attaches to its written pleadings to this Court.

 

With regard to the doctrine of actos propios, the judgment of the Supreme Court of 4 November 2013 (RC 3262/2012 ) states the following:

 

"(...) the Administration may be obliged to observe towards the future the conduct it has followed in previous, unequivocal and definitive acts, creating, defining, establishing, fixing, modifying or extinguishing a certain legal relationship. These acts may be express, by which the will is explicitly manifested, presumed, when the fiction of silence operates in the cases provided for by the legislator, or tacit, in which the declaration of will is implicit in the administrative action in question.

 

The decisive factor lies in the fact that, regardless of the way in which it is externalised, the will appears unequivocal and definitive, so that, given the security that should preside over legal transactions (Article 9.3 of the Constitution) and for the sake of the principle of good faith, aimed at protecting those who acted believing that this was the criterion of the Administration, the latter is constrained to carry out the conduct that those previous acts made foreseeable, not being able to carry out others that contradict, contradict or rectify them.

 

This principle, the principle of good faith, together with the principle of protection of legitimate expectations, constitute guidelines of behaviour to which, in the service of legal certainty, public administrations, all without exception, must adjust their actions [see Article 3. 1, second paragraph, of Law 30/1992, of 26 November 1992, on the legal regime of public administrations and common administrative procedure (BOE of 27 November)], without being able to alter it arbitrarily afterwards, according to section II of the explanatory memorandum of Law 4/1999, of 13 January (BOE of 14 January), by which this second paragraph was added to the initial wording of the precept. We have recently recalled this in the judgement of 22 January 2013 (cassation 470/11, FJ 7ş)".

 

And the Supreme Court ruling of 11-10-2017, appeal no. 1714/2016, states that:

 

"in order for the doctrine of actos propios to be applicable, it is necessary, following a very extensive case law on the matter, on the one hand, that the act in question has created, defined, modified, extinguished or clarified a certain legal situation that affects both its author and the addressee of the act, and, on the other hand, that the addressee has acted in accordance with the law, and, on the other hand, that the addressee has acted in accordance with the law, and that the author of the act has acted in accordance with the law, that the addressee has acted in accordance with the requirements of good faith (which is the principle on which the doctrine rests), and which is nothing other than having complied with what the act in question orders (or, in other words, having respected the legal situation created, defined, modified, extinguished or clarified, thereby causing that situation to be in a state).

 

.....

 

Therefore, in the case at issue in this case, the so-called principle of the Administration's own acts in its acts declaring rights does not apply, as the taxpayer claims, because, as the Supreme Court points out in its Order of 4 December 1998 ".... in order for the doctrine of the administration's own acts to apply, it is fundamentally necessary for a first administrative body to have issued a first act declaring rights and then in the second to revoke the decision taken in the first", and this circumstance does not exist in the present case because the present administrative act of tax assessment does not revoke any decision taken in a previous act relating to the same tax concept, nor is there an express declaratory act which it now modifies".

 

The entity claims that the doctrine of actos propios has been infringed because in the audit for the financial year 2005 the transactions carried out with the entity TW BV were not questioned. It refers to the non-conformity report number ...35 issued on 25-03-2011 to W SA.

 

In its statement of allegations to this Court, it attaches the certificate of conformity number ...35 issued on 25-03-2011 to W SA as representative of the tax group ... Pages 6 to 8 contain the amendments made to the taxable base of the parent entity W SA and none of them refer to the transfer pricing policy. What is more, the minutes do not even state whether in that year it has carried out transactions with TW BV similar to the one under examination here. On the other hand, in its statement of objections, the company merely points out that W SA has been involved with TW BV in transactions identical to those now being regularised 'for many years'.

 

Therefore, there is no record of any analysis or ruling on the transaction being regularised in the present case, nor is there any record of any transactions with TW BV similar to the one being regularised here. The settlement that is the subject of the present case does not revoke any decision taken in a previous act, nor is there an express declaratory act that now modifies it, as indicated in the STS reproduced above.

 

Moreover, the valuation of the related-party transaction that is being regularised here refers to 2009, so it is difficult to argue that the actions relating to the IS for 2005 serve as a precedent.

 

In short, not all the elements are present that allow the application of the doctrine of actos propios in the tax sphere, which has been applied on many occasions by the Courts, and therefore the claimant's allegations in this respect are dismissed.

 

EIGHTEENTH.- The next issue raised relates to the loan and deposit operations carried out by XZ SL and W SA in connection with the intra-group purchase of shares in GH and XP SA.

 

The inspectorate considers that the granting of a loan by the company resident in ... (XR) to XZ SL for the acquisition of GH shares, viewed as a whole and from the point of view of its adoption by an independent company, lacks reasonableness; it considers that it would not have been adopted by an independent company and therefore concludes that it was not made at arm's length and differed from normal market conditions between independent parties. Therefore, and in application of Article 9 of the Dutch-Spanish Double Taxation Convention, it does not allow the deductibility of the financial expenses of the aforementioned loan minus the income from the deposit.

 

The following facts are relevant for the present adjustment and are not disputed:

 

1) The General Meeting of shareholders of W on 21-10-2014 agrees to accept the purchase offer made by XZ, S.L. of the GH shares held directly by W and X P S.A., a company through which W indirectly participated in GH. The purchase was documented in a public deed dated 23-10-2014.

 

On the same date, the payment of an extraordinary dividend was approved for an amount equal to the sale price (EUR 8,253 million) payable on 29-10-2014.

 

2) Previously, on 07-10-2014, the Board of Directors of W, S.A. agreed to distribute an interim dividend against 2014 results (6,352.5 million euros), also payable on 29-10-2014.

 

The Minutes of the Board of Directors expressly refer to the payment date of the ordinary dividend being the same as that of the extraordinary dividend, 29 October.

 

In the same Minutes of the Board of Directors of W, S.A., it is agreed to use the funds received from the sale of the stake in GH (8,253 million euros) to constitute a deposit in the entity .... XR NV (XR) until they are necessary to pay the ordinary and extraordinary dividends.

 

3) In the Minutes of the Board of Directors of XZ, S.L. dated 07-10-2014, it was agreed, subject to the approval of the General Meeting of shareholders of W, S.A., to finance the purchase of the direct and indirect shareholding in GH with a loan of EUR 8.253 million, with the entity ... XR as lender, and apply the amount of the ordinary dividend agreed by the Board of Directors of W, S.A. on the same date and the extraordinary dividend (subject to the approval of the extraordinary shareholders' meeting of W, S.A.) to the cancellation of the loan whose application is approved to finance the purchase.

 

4) The documentation included in the file in respect of the loan arranged between XR and XZ, S.L. and the deposit arranged between W, S.A. and the aforementioned entity .... (XR) shows that XR had made a binding offer with the conditions of both operations on 30-09-2014.

 

The signing date of the contracts is 21-10-2014, the same day as the extraordinary shareholders' meeting, and the value date of both is 23-10-2014. The interest on the deposit is 0.04% per annum, and the interest on the loan is Euribor on 21 October plus 70 basis points (Euribor + 0.7%).

 

Accordingly, XZ, S.L. financed the purchase through an intraday banking transaction (funds flow in and out of the bank accounts by means of accounting entries made simultaneously) reflecting:

 

- A five-day loan obtained by XZ S.L. from the entity .... XR , for an amount equivalent to the purchase price of GH.

 

- A payment by XZ, S.L. to W, S.A. of the amount of the price.

 

- The contracting of a five-day deposit, by W, S.A., with the entity ... XR, for an amount equal to the amount of the sale of GH.

 

5) W, S.A. paid the total dividend on 29 October by crediting accounts held with financial institutions, and with an effective cash outflow only for the part corresponding to the minority shareholders. For the part corresponding to XZ, S.L., the amount of the deposit arranged with the company ... was applied to the payment. XR, which is recovered for accounting purposes (8.253 million euros), and the remainder was financed with new loans, also granted by XR.

 

In turn, XZ, S.L., with the accounting registration of the dividend, cancelled the short-term loan taken out with the entity ... XR to finance the purchase of GH for an amount of 8,253 million euros, and with the remainder it cancelled the loan obtained from the same company in 2009 to finance the acquisition of GH for an amount of 8,253 million euros. ... in 2009 to cover the acquisition of W.

 

Consequently, the payment of the dividend, the deposit and the short-term loan are cancelled by means of an intraday transaction in accounts of financial institutions in the amount of EUR 8.253 million, in the opposite direction to that of the financing of the sale price, ie:

 

- Repayment to W, S.A. of the deposit made by the group's subsidiary .... of the group.

 

- Payment by W, S.A. of the dividend to XZ, S.L.

 

- Repayment by XZ, S.L. of the loan to the entity ....

 

NINETEENTH.- The inspection questions the financial cost assumed by the XZ Group in the purchase of the GH shares from W; this purchase and sale was articulated through the financing of the payment of the shares by means of a five-day loan granted by XR at an interest rate of Euribor plus 0.7% and a five-day deposit of the amount of the sale made by W in the same entity (XR) at an interest rate of 0.04%.

 

It considers that the operation analysed globally does not comply with the arm's length principle as it "lacks rationality" and "would never have been adopted by an independent company"; the inspectorate points out that "the assumption of the financial cost by the XZ group does not imply responsibilities, functions or risks and, consequently, would not have been agreed between independent parties and under free market conditions". In the Settlement Agreement, pages 114 et seq., the inspectorate sets out the reasons that lead it to consider that the operations carried out do not comply with the arm's length principle.

 

The regularisation carried out by the inspectorate is based on the provisions of Article 9 of the Agreement between Spain and .... of 16 June 1971 (BOE of ... of ...) for the avoidance of double taxation in income and wealth taxation (CDI) and the OECD transfer pricing guidelines (2010 version). The Settlement Agreement reproduces the provisions of Article 9 of the DTC and numerous paragraphs of the Guidelines.

 

The complainant disputes the adjustment made by the inspectorate. The complainant insists that the inspectorate has not provided reliable reasons for the entity's wrongdoing and rejects the conclusions reached by the inspectorate. He disagreed with the inspection's conduct in carrying out the adjustment on the basis of Article 9 of the IDC, an issue which is currently controversial and open to debate. He cites the Supreme Court ruling of 31 May 2016. The judgment of the Supreme Court of 5 November 2020 is attached to the supplementary pleadings so that it may be taken into account for the appropriate purposes.

 

Well, in the present case, as the inspectorate points out, what is to be determined is not whether or not the interest is market interest, but whether the transaction has been carried out under conditions of free competition; it is to determine whether the purchase and sale of the GH shares that has given rise to the assumption of a financial cost for the XZ group has been respectful of the "arm's length principle", a principle referred to in Article 9(1) of the Spain-... CDI dedicated to "associated undertakings", which provides:

 

"Article 9. Associated enterprises.

 

When:

 

(a) An Enterprise of a State participates, directly or indirectly, in the management, control or capital of an Enterprise of the other State, or (b) The same persons participate, directly or indirectly, in the management, control or capital of an Enterprise of a State and of an Enterprise of the other State, and In either case, the two Enterprises are, in their commercial or financial relations, are bound together by terms accepted or imposed which differ from those which would be agreed upon by independent Enterprises, the profits which one of the Enterprises would have made in the absence of such terms and which have not in fact arisen by reason of them, may be included in the profits of that Enterprise and taxed accordingly".

 

First of all, it should be noted that the inspectorate has reasoned at length why it considers that the operation, taken as a whole, has not been respectful of the principle of free competition.

 

The inspectorate points out that in this case there is a transaction consisting of a loan from the entity ... (XR) to XZ, XZ (XZ). (XR) to XZ, with which W is paid for the purchase of shares in its subsidiaries and the amount of which W deposits again in the entity .... (XR). At the same time, a dividend distribution is agreed by W, the beneficiary of which is the new acquirer of the shares, XZ. For this payment, W takes the funds from the deposit with ... to make the payment to XZ with which, in turn, XZ will pay off the loan granted to it by .... for the acquisition of the shares in the subsidiaries of W. There is therefore a triangular transaction in two opposite directions, with the particularity that there is no movement of funds but rather accounting entries in the opposite direction, and that all the transactions are agreed at the same time, although the execution takes place with a time lag of less than seven days.

 

Neither at the time the contracts were concluded nor at the time of their termination was there any actual cash movement. Nor was there any change in the Multinational Group's cash position. Although the transactions only generated accounting movements of a circular nature, the involvement of a non-resident multinational Group company in the transaction generated a financial expense in the Spanish tax group, which has been considered deductible in the Spanish corporate income tax return, without producing any other added economic effect. The difference in the interest rates applied to the loan and the deposit is therefore included in the taxable income of the Spanish tax group, reducing it by a net amount of 883,071.67 euros.

 

883,071.67. Therefore, the tax inspectorate has argued at length the reasons that lead it to conclude that the operation carried out is not rational and would not have been agreed between independent parties.

 

On the other hand, the route of Article 9 of the IDC with ... used by the inspectorate to carry out the adjustment is appropriate.

 

As to whether it is possible to directly apply article 9.1 of the IDC without the need to resort to the methods provided for determining the market value in related-party transactions and the procedure established for this purpose in the domestic regulation, the Supreme Court has ruled in its ruling of 5 November 2020, appeal 3000/2018 (reiterating the doctrine contained in the STS of 18-07-2012), to which the claimant refers.

 

The question that presented an objective interest for the formation of case law consisted of:

 

"To determine whether or not it is possible to regularise transactions between Spanish and French companies, directly applying Article 9.1 of the Agreement between Spain and France for the avoidance of double taxation and the prevention of tax evasion and avoidance in respect of income tax and wealth tax, signed in Madrid on 10 October 1995, without the need to resort to the methods provided for determining the market value in related transactions and the procedure established for this purpose in the domestic regulations".

 

In this respect, the Supreme Court declared in the Tenth Ground of Law the following:

 

"That the regularisation of transactions between Spanish and French companies, through the application of Article 9.1 of the Agreement between the Kingdom of Spain and the French Republic for the avoidance of double taxation and the prevention of tax evasion and avoidance in respect of income tax and wealth tax of 10 October 1995, may be carried out without the need to resort to the methods provided for determining the market value of related-party transactions and to the procedure established for that purpose in the internal regulations".

 

It then goes on to state the following (FD Eleventh):

 

"ELEVENTH.- Decision on the claims raised in the appeal.

 

I.- The application of the above criterion to the controversy tried and decided by the judgment under appeal leads to the conclusion that the infringements alleged in the appeal are not to be assessed.

 

This is for the following reasons.

 

The main issue in dispute was not the amount or quantification of the transactions which resulted in the acquisition by the appellant, ....., of shares in SLBA Italia. It was the question whether or not the acquisition of those shares was sufficiently justified to be considered plausible and valid for the purpose of making the allocations which had been deducted for the depreciation of securities of ......

 

The tax authorities and the judgment under appeal, as is clear from the foregoing, took the view that the acquisition lacked justification and was solely for the purpose of tax avoidance, because that was the result of the economic losses that characterised the investee company in the years preceding the acquisition.

 

They invoked Article 9.1 of the IDC to point out that, in those circumstances of economic losses, the parameter of homogeneity with normal or customary transactions between independent companies, which that article establishes in order to accept that a related-party transaction actually existed, could not be assessed in the transactions in question.

 

They concluded that, in those particular circumstances, the appellant company could not be considered to have depreciated its shareholdings to the extent necessary for a deduction to be made on the basis of those shareholdings.

 

II. - The change in case law which the appeal raises in defence of its argument cannot be shared.

 

This must be so because the doctrine contained in the STS of 18 July 2012 (cassation 3779/2009), invoked and transcribed by the lower court judgement that is being appealed in the current cassation, establishes a doctrine that coincides with the interpretative criterion that has been established in the previous legal basis of the current judgement; which is to consider the corresponding adjustment to be appropriate, and thus the annulment of any tax effect that may derive from the transaction in question, when it is clearly inferred from the evidence that the transaction would not have been carried out by independent companies.

 

And because the judgments of 31 May 2016 (rec. 58/2016) and 21 February 2017 (rec. 2970/2015) address different issues from the previous one; as the judgments in those judgments focus on valuation actions and the methods applicable to carry them out".

 

The Supreme Court considers that the regularisation through the application of article 9.1 of the IDC can be carried out without the need to resort to the methods provided for determining the market value in related-party transactions and to the procedure established for this purpose in the domestic regulations. The doctrine contained in the STS of 18 July 2012, appeal number 3779/2009 coincides with the interpretative criterion of this ruling, which is to consider the corresponding adjustment to be appropriate, and with it the annulment of any tax effect that may derive from the transaction in question, when it is clearly inferred from the accredited data that the transaction would not have been carried out by independent companies, which is the case in this instance.

 

In accordance with the foregoing, the inspection's ruling is confirmed and the claimant's allegations are dismissed.

 

VIGESIMO - The last of the issues to be dealt with is that of determining whether or not it was appropriate to comply with the request made by the taxpayer to apply the maximum amount of the deductions pending at the end of each previous year in each of the years subject to inspection, even if they had already been applied in subsequent years, also the subject of the inspection procedure.

 

The Inspectorate considers that what the interested party is seeking is not possible and, in support of its position, refers to the provisions of paragraph 4 of Article 119 of Law 58/2003, General Tax Law, introduced by Law 34/2015, of 21 September, (with entry into force on 12-10-2015, i.e., before the start of the inspection proceedings in question) according to which:

 

"In the settlement resulting from a tax enforcement procedure, the amounts that the taxpayer had pending offset or deduction may be applied, without it being possible for these purposes to modify such pending amounts by filing supplementary returns or requests for rectification after the start of the tax enforcement procedure."

 

It points out that the provisions of that provision prevent an increase, in the inspection procedure - which is a tax application procedure - of the deductions applied in the financial years 2012, 2013 and 2014, with respect to the amounts declared by the taxpayer in their respective self-assessments. It states that the application request made by the taxpayer for the regularisation of the years 2012 to 2015, implies in itself a request for rectification of the tax returns filed in those years, albeit subsumed within the inspection procedure.

 

The claimant, for his part, says that in the corporate income tax returns corresponding to the years 2012 to 2015 he applied the maximum amount of deductions that the regulations allowed him, and it is therefore clear that he wished to apply the maximum possible amount of deductions in each of the aforementioned years. It also states that the Administration must regularise both the aspects that are detrimental and those that benefit the taxpayer, avoiding that the invocation of tax periods or any other reason does not allow some aspects or periods that would have been affected by the verification carried out to be regularised. In this regard, he refers to the SSTS of 05-11-2012 (rec. 4611/2010), 07-10-2015 (rec. 2622/2013), 06-11-2014 (rec. 3110/2012) and 13-10-2014 (rec. 2887/2012). And it states that the regularisation must be complete, for the sake of the principle of legal certainty, recognised by the Supreme Court, among others, in judgments of 25-09-2019 (rec. 4786/2017), 10-10-2019 (rec. 4809/2017 and 4153/2017 and 13-11-2019 (rec. 1675/2018).

 

And he concludes by saying that the provisions of article 119.4 of the LGT have nothing to do with his case as he is not requesting that the deductions declared in the self-assessments filed before the start of the inspection procedure be increased or modified, but rather that those declared be distributed according to the same maximum deduction criteria insofar as the regularisation has led to an increase in the limits of application of the deductions.

 

In the light of the above, the following is set out below:

 

Section 4 of the same article, introduced by Law 34/2015, includes the possibility of applying in a tax enforcement procedure the amounts that the taxpayer had pending offset or deduction, but does not allow those already offset or deducted to be modified by filing supplementary returns or requests for rectification made once a tax enforcement procedure has been initiated.

 

Section II of the Explanatory Memorandum of Law 34/2015 argues the reason for including this paragraph no. 4 to Article 119 of the LGT:

 

"It expressly states the impossibility for taxpayers who, at the start of the verification or investigation procedure, had already applied or offset the amounts they had pending, by means of a supplementary return to leave without effect the offset or application made in another financial year and request the offset or application of those amounts in the financial year checked, which could alter the classification of the infringement possibly committed".

 

However, in drafting the provision, the legislator goes further in that, in order to prevent the declared deductions from being modified, it includes requests for rectification made after the start of the tax application procedure.

 

Well, as indicated in the contested settlement agreement, the request for the application of deductions made by the taxable person for the adjustment of the years 2012 to 2015 implies in itself a request for rectification of the returns filed in those years, albeit subsumed within the inspection procedure, and that, given the wording of Article 119(4) of the LGT, is not possible. It is not appropriate to modify -apply and reapply- the deductions declared by the entity in the years audited.

 

Consequently, in view of the foregoing, and considering that the Inspectorate has carried out a full regularisation (regardless of whether it does not coincide with the claimant's criteria) taking into account all aspects of the same, we also reject the allegations of the interested party on this point, and confirm the contested agreement.

 

This Court ruled in the same sense in its decision of 22 July 2021 (RG 6363-19).

 

 

 

 

In view of the foregoing

 

This Economic-Administrative Tribunal agrees to DISMISS this complaint, confirming the contested act.