The arbitration administrative court in Portugal recently ruled in favour of the taxpayer in a dispute with the Portuguese Tax Authorities (TA) in respect to the application of the arm’s length principle to inter-company loan and management fee transactions for fiscal years (FY) 2007 and 2008.
The dispute was about an additional assessment issued by the TA to the taxpayer.
Background
The taxpayer was a Portuguese manufacturing subsidiary of a multinational group headquarters in the USA, which exported the manufactured goods essentially to the UK, Spain and Germany, and also performed relevant sales to France, Turkey and the Czech Republic.
The taxpayer borrowed from an independent third party bank (the Bank) a long-term loan allocated to an investment plan of the taxpayer, in Fiscal Year 2006, which had fixed maturity and reimbursement dates with quarterly interest at a rate corresponding to the quarterly Libor and Euribor plus a 4.5% spread. The taxpayer granted a loan to the Headquarters with no fixed maturity, which was remunerated at a fixed interest rate of 4%, in Fiscal Year 2007 and 2008.
After analyzing the loans granted to the taxpayer by the Bank, the TA concluded that an effective interest rate between 7.03% and 11.36% had been borne.
The TA concluded that a taxpayer dealing at arm’s length would not choose to bear costs in connection to a loan, if the interest rate received from allocation of the cash surplus was inferior to the interest rate borne on the loan. Based on this rationale the TA applied the comparable uncontrolled price method (CUPM) to compute an additional tax assessment, and adjusted the taxpayer’s taxable income, in respect to the remuneration of the loan granted to the Headquarters, to the differential between the interest rate borne in the loan borrowed from the Bank and the interest rate charged to the Headquarters in the application of cash surpluses.
In respect to the management charges borne by the taxpayer, the TA concluded that neither the transfer pricing documentation process nor the invoices clearly identified and detailed the services provided, since they merely presented an allocation of costs. The TA disregarded the management fees charges for the purposes of determining the taxpayer’s taxable income, by concluding that no services had been provided.
The taxpayer argued that the comparable transaction used by the TA to price the loan was not in fact comparable in view of the CUPM requirements under Portuguese law. Additionally, the taxpayer rejected the TA’s claim that no independent entity would choose to maintain a loan with a higher interest rate if the interest rate received in the application of surplus funds was inferior, since these two different transactions have different purposes and a different impact on the financial structure of a company.
Court decision
The Court decided both queries under analysis in favour of the taxpayer. The Court decided that not all the comparability factors that are required by the Portuguese law to apply the CUPM had been fulfilled by the TA. The TA’s arguments with regard to their decision to disregard the charges relating to management fees were also rejected by the Court.
