Portugal - Intra-group management charges and loans, thin capitalization issues 

Background

The tax authorities made adjustments concerning the following items.

• Management services provided by group companies - The tax authorities (1) did not find that certain categories of intra-group management services were “indispensible” to the generation of income or to the maintenance of the productive source of income; and (2) asserted that the taxpayer was not able to demonstrate the arm’s length nature of these intra-group charges.
• Loan granted to a group company - The tax authorities considered that the interest rate charged by the taxpayer was not at arm’s length because the taxpayer was paying a higher rate of interest on loans borrowed from a third-party bank. However, the tax authorities made a “positive” correction, selecting the comparable uncontrolled price (CUP) method as the most appropriate method. The interest rate on the third-party borrowing was used to benchmark the intra-group loan transaction.
• Thin capitalization based on a presumption of “special relations” because of related-party guarantees - The tax authorities considered that the amount of borrowing from a U.S. third-party bank, guaranteed by a related party, was “excessive.” The Portuguese thin capitalization rule takes into account certain “special relations”—i.e., when guarantees have been provided by other companies having special relations with the taxpayer. The interest considered to be “excessive” was not accepted for tax purposes by the tax authorities.

The taxpayer did not agree with these tax adjustments, and filed a tax claim (reclamação graciosa) and, when that claim was rejected, filed a tax appeal (recurso hierárquico) which because there was no response from the authorities was deemed to have been refused.

Hence, the taxpayer initiated this action before the court (Tribunal Arbitral).

Court decision

The court held for the taxpayer regarding all the items at issue.

Note that the court decision is not yet final, and is subject to appeal by the tax authorities.

• Intra-group management charges - The court did not agree with the position of the tax authorities, and concluded that the tax adjustment was based on incorrect assumptions.
• Intra-group loan - The court concluded that the tax adjustment “infringed” on the rules underlying the use of the CUP method for Portuguese transfer pricing purposes. In particular, the court found that the comparable uncontrolled transaction used by the tax authorities was not “reliable” because the selected transaction did not provide for the highest degree of comparability (in relation to the relevant comparability factors) as required under the CUP method.
• Thin capitalization - The court noted that the Portuguese thin capitalization rule would apply as a consequence of the existence of guarantees provided by group companies with respect to the loan from the U.S. third-party bank, even though the group companies were EU-based companies. Notwithstanding this finding, because of an incompatibility with other regulations (having greater importance under Portuguese law), the court in this proceeding looked to the Portugal-United States income tax treaty and concluded that a correction for “excessive interest” could be only allowed in situations of “special relations” between the taxpayer (and its group companies) and the bank—which were not present in this case. Therefore, the court rejected the tax correction based on application of the thin capitalization rule by the tax authorities.

KPMG observation

Tax professionals in Portugal look to this decision as yet offering more support for the proposition that taxpayers need to prepare and maintain contemporaneous and robust transfer pricing analyses, using the most appropriate methodologies that demonstrate the arm’s length nature of their related-party transactions.

For more information, contact a tax professional with KPMG in Portugal:

Luis Magalhães

+ 351 210 110 087

Catarina Breia

+ 351 220 102 353

Or contact a tax professional with KPMG's Global Transfer Pricing Services.