In 2012, the Luxembourg tax authorities issued a tax ruling in favour of Fiat Chrysler Finance Europe (‘FFT’), an undertaking in the Fiat group that provided treasury and financing services to the group companies established in Europe. The tax ruling at issue endorsed a method for determining FFT’s remuneration for these services, which enabled FFT to determine its taxable profit on a yearly basis for corporate income tax in Luxembourg. In October 2015, the Commission concluded that the tax ruling constituted State aid under Article 107 TFEU and that it was operating aid that was incompatible with the internal market. The Commission found that the Grand Duchy of Luxembourg was required to recover the unlawful and incompatible aid from FFT. FFT brought an action before the General Court for annulment of the Commission’s decision. In it’s Judgement of September 2019, the General Court dismissed the actions brought by FFT and confirmed the validity of the Commission’s decision. This decision was then appealed to the European Court of Justice by FFT. In December 2021 the Advocate General Opinion was published. The AG opined that the decisions of the General Court should be set aside because the arm’s length principle had been used incorrectly as the benchmark for “normal” taxation in Luxembourg at that time. Judgement of the Court of Justice of the European Union The Court set aside the judgment delivered by the General Court on 24 September 2019 in the case Luxembourg and Fiat Chrysler Finance Europe v Commission (Joined Cases T-755/15 and T-759/15) and annuls the decision of the Commission of 21 October 2015 on the State aid granted by Luxembourg to FFT. The Court holds that the General Court was wrong to confirm the reference framework used by the Commission to apply the arm’s length principle to integrated companies in Luxembourg, in failing to take into account the specific rules implementing that principle in that Member State As a preliminary point, the Court recalls that action by Member States in areas that are not subject to harmonisation by EU law is not excluded from the scope of the provisions of the FEU Treaty on monitoring State aid. It next recalls that the classification of a national measure as ‘State aid’ requires four conditions to be fulfilled. First, there must be an intervention by the State or through State resources. Second, the intervention must be liable to affect trade between the Member States. Third, it must confer a selective advantage on the beneficiary. Fourth, it must distort or threaten to distort competition. As part of the analysis of tax measures, from the perspective of EU State aid law, the examination of the condition relating to selective advantage involves, as a first step, identifying the reference system, that is the ‘normal’ tax system applicable in the Member State concerned, then demonstrating, as a second step, that the tax measure at issue is a derogation from that reference system, in so far as it differentiates between operators who, in the light of the objective pursued by that system, are in a comparable factual and legal situation, without finding any justification with regard to the nature or scheme of the system in question. For the purposes of assessing the selective nature of a tax measure, it is, therefore, necessary that the common tax regime or the reference system applicable in the Member State concerned be correctly identified in the Commission decision and examined by the court hearing a dispute concerning that identification. In that regard, the Court concludes that, in so far as, outside the spheres in which EU tax law has been harmonised, it is the Member State concerned which determines, by exercising its own competence in the matter of direct taxation and with due regard for its fiscal autonomy, the characteristics constituting the tax, only the national law applicable in the Member State concerned must be taken into account in order to identify the reference system for direct taxation, that identification being itself an essential prerequisite for assessing not only the existence of an advantage, but also whether it is selective in nature. According to the Court of Justice, the General Court committed an error of law in the application of Article 107(1) TFEU by failing to take account of the requirement arising from the case-law, according to which, in order to determine whether a tax measure has conferred a selective advantage on an undertaking, it is for the Commission to carry out a comparison with the tax system normally applicable in the Member State concerned, following an objective examination of the content, interaction and concrete effects of the rules applicable under the national law of that State. The General Court was wrong to endorse the approach consisting in applying an arm’s length principle different from that defined by Luxembourg law, confining itself to identifying the abstract expression of that principle in the objective pursued by the general corporate income tax in Luxembourg and to examining the tax ruling at issue without taking into account the way in which the said principle has actually been incorporated into that law with regard to integrated companies in particular. In addition, by accepting that the Commission may rely on rules which were not part of Luxembourg law, even though it recalled that that institution did not, at that stage of development of EU law, have the power autonomously to define the ‘normal’ taxation of an integrated company, disregarding national tax rules, the General Court infringed the provisions of the FEU Treaty relating to the adoption by the European Union of measures for the approximation of Member State legislation relating to direct taxation. The Court concludes that the grounds of the judgment under appeal relating to the examination of the Commission’s principal line of reasoning, according to which the tax ruling at issue derogated from the general Luxembourg corporate income tax system, are vitiated by an error of law in that the General Court validated the Commission’s approach. More specifically, that error consisted, in ...

In determining the true taxable income of a controlled taxpayer, the standard to be applied in every case is that of a taxpayer dealing at arm’s length with an uncontrolled taxpayer. A controlled transaction meets the arm’s length standard if the results of the transaction are consistent with the results that would have been realized if uncontrolled taxpayers had engaged in the same transaction under the same circumstances (arm’s length result). However, because identical transactions can rarely be located, whether a transaction produces an arm’s length result generally will be determined by reference to the results of comparable transactions under comparable circumstances. See § 1.482-1(d)(2) (Standard of comparability). Evaluation of whether a controlled transaction produces an arm’s length result is made pursuant to a method selected under the best method rule described in § 1.482-1(c) ...

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When transfer pricing does not reflect market forces and the arm’s length principle, the tax liabilities of the associated enterprises and the tax revenues of the host countries could be distorted. Therefore, OECD member countries have agreed that for tax purposes the profits of associated enterprises may be adjusted as necessary to correct any such distortions and thereby ensure that the arm’s length principle is satisfied. OECD member countries consider that an appropriate adjustment is achieved by establishing the conditions of the commercial and financial relations that they would expect to find between independent enterprises in comparable transactions under comparable circumstances ...

This Chapter provides a background discussion of the arm’s length principle, which is the international transfer pricing standard that OECD member countries have agreed should be used for tax purposes by MNE groups and tax administrations. The Chapter discusses the arm’s length principle, reaffirms its status as the international standard, and sets forth guidelines for its application ...

OECD member countries continue to endorse the arm’s length principle as embodied in the OECD Model Tax Convention (and in the bilateral conventions that legally bind treaty partners in this respect) and in the 1979 Report. These Guidelines focus on the application of the arm’s length principle to evaluate the transfer pricing of associated enterprises. The Guidelines are intended to help tax administrations (of both OECD member countries and non-member countries) and MNEs by indicating ways to find mutually satisfactory solutions to transfer pricing cases, thereby minimising conflict among tax administrations and between tax administrations and MNEs and avoiding costly litigation. The Guidelines analyse the methods for evaluating whether the conditions of commercial and financial relations within an MNE satisfy the arm’s length principle and discuss the practical application of those methods. They also include a discussion of global formulary apportionment ...

At issue in this case is whether the arm’s length principle as described in the OECD Transfer Pricing Guidelines can be applied by the EU in determining if state aid had been granted. In 2012, the Luxembourg tax authorities issued a tax ruling in favour of Fiat Chrysler Finance Europe (‘FFT’), an undertaking in the Fiat group that provided treasury and financing services to the group companies established in Europe. The tax ruling at issue endorsed a method for determining FFT’s remuneration for these services, which enabled FFT to determine its taxable profit on a yearly basis for corporate income tax in the Grand Duchy of Luxembourg. In 2015, the Commission concluded that the tax ruling constituted State aid under Article 107 TFEU and that it was operating aid that was incompatible with the internal market. The Commission found that the Grand Duchy of Luxembourg was required to recover the unlawful and incompatible aid from FFT. FFT brought an action before the General Court for annulment of the Commission’s decision. In it’s Judgement of September 2019 Union , the General Court dismissed the actions brought by FFT and confirmed the validity of the Commission’s decision. This decision was then appealed to the European Court of Justice by FFT. At the same time, Ireland filed an appeal in regards of application of the arm’s length principle in state aid cases. According to Ireland, applying the arm’s length principle in these cases was in breach of the principle of legal certainty. AG Opinion from the European Court of Justice The Advocate General proposes that the Court dismiss the appeal brought by Ireland in its entirety. The Advocate General considers in particular that the General Court correctly held that the Commission was not required to take account of the intra-group and cross-border dimension of the effects of the tax ruling at issue when determining whether that ruling conferred an economic advantage, and that the three errors made, according to the Commission, in the calculation of the remuneration of the treasury and financing services provided by FFT prevented an arm’s length outcome from being obtained and could therefore form the basis for a finding of economic advantage. Excerpt “178. The principle of legal certainty, which is a general principle of EU law and thus applies to the acts of the institutions, bodies, offices and agencies of the European Union, requires, according to settled case-law, that rules of law must be clear and precise and that they must be foreseeable. (81) More specifically, that principle requires an assessment of whether an EU legal act enables those concerned to know precisely and unequivocally the extent of their rights and obligations and to take steps accordingly. (82) This requirement must be observed all the more strictly in the case of an act liable to have financial consequences. (83) 179. It is apparent from the case-law of the Court of Justice that the principle of legal certainty is intrinsically linked to the development of legal standards by the European Union, and by national authorities when they implement EU law, and that it permits judicial review of flaws liable to result in unpredictable application of the legal act in question. (84) 180. The principle of legal certainty is narrower in scope with regard to an administrative decision, as is apparent from the case-law on State aid. In that area, the Court of Justice has found the principle of legal certainty to have been infringed only where the conduct in question had been engaged in by the Commission before or during the procedure leading to the adoption of a decision to recover State aid. (85) 181. In the present case, the principle of legal certainty is relied on in opposition to the use, for the purposes of determining whether the requirement for an advantage was fulfilled, of the arm’s length principle, on the ground that the scope of that principle was not defined. In other words, what is challenged is the substantive validity of an assessment made by the Commission in relation to the characterisation of a State measure as State aid. However, the substantive validity of such an assessment cannot be challenged on the basis of conformity with the principle of legal certainty. To hold otherwise would be to prohibit the Commission from conceiving new approaches in the application of rules of law, leaving it frozen in its current position. In particular, such an interpretation would mean that the Commission is prevented from using any novel benchmark to guide its assessment of whether there is an advantage for the purposes of Article 107(1) TFEU. 182. Having regard to the case-law referred to above and to the fact that FFT’s criticism relates, ultimately, to the finding of advantage made for the purposes of characterising the tax ruling at issue as State aid, I must conclude that the principle of legal certainty cannot be legitimately relied on in the present case. Thus, no error of law can be attributed to the General Court on the basis that it did not disapprove the characterisation of the scope of the arm’s length principle which emerges from the decision at issue. I therefore consider that the first part of the third ground of appeal must be rejected. 183. In any event, the General Court was right to hold, in response to the arguments advanced respectively by FFT and the Grand Duchy of Luxembourg and set out in paragraphs 155 and 176 of the judgment under appeal, that the Commission had sufficiently defined the scope and content of the arm’s length principle applied in the decision at issue, and that that definition was thus not open to criticism on the basis that the discretion left to the Commission in applying that principle was overly broad. I am thinking particularly of the General Court’s observations that the arm’s length principle is ‘a tool for checking that intra-group transactions are remunerated as though they had been negotiated between independent undertakings’ and that the examination in the light ...

In 2012, the Luxembourg tax authorities issued a tax ruling in favour of Fiat Chrysler Finance Europe (‘FFT’), an undertaking in the Fiat group that provided treasury and financing services to the group companies established in Europe. The tax ruling at issue endorsed a method for determining FFT’s remuneration for these services, which enabled FFT to determine its taxable profit on a yearly basis for corporate income tax in the Grand Duchy of Luxembourg. In 2015, the Commission concluded that the tax ruling constituted State aid under Article 107 TFEU and that it was operating aid that was incompatible with the internal market. The Commission found that the Grand Duchy of Luxembourg was required to recover the unlawful and incompatible aid from FFT. FFT brought an action before the General Court for annulment of the Commission’s decision. In it’s Judgement of September 2019 Union , the General Court dismissed the actions brought by FFT and confirmed the validity of the Commission’s decision. This decision was then appealed to the European Court of Justice by FFT. AG Opinion from the European Court of Justice The Advocate General opined that the decisions of the General Court should be set aside because the arm’s length principle had been used incorrectly as the benchmark for “normal” taxation in Luxembourg at that time. Excerpts “…I share Ireland’s view that the approach adopted by the Commission in the decision at issue and endorsed by the General Court in the judgment under appeal ultimately amounts to introducing into the national tax system constituting ‘normal’ taxation a rule, namely the arm’s length principle, which is extraneous to that system. For the reasons set out inter alia in the preceding point, the reference to the purported objective pursued by the national legislature is not capable of justifying the arm’s length principle’s belonging to the said system.” “110. It has not escaped my attention that, if the arm’s length principle were incorporated into the national legal order, the number of national tax authorities whose tax rulings might be subject to Commission scrutiny from a State aid perspective would be reduced and the OECD guidelines would become de facto binding by restricting the Commission’s discretion in examining those rulings. Nevertheless, this is, in my view, the only reasoning that the General Court can regard as legally correct, since it respects the exclusive competence of the Member States in matters of direct taxation. 111. By contrast, the legal reasoning followed by the Commission, principally, and endorsed by the General Court in the judgment under appeal defines the reference framework constituting ‘normal’ taxation by relying on a version of the arm’s length principle based on an uncodified element such as the (purported) objective of Luxembourg tax law. Is this not precisely the undue interference in the Member States’ tax autonomy which the Court has always carefully condemned until now? I think that it is.” ” It follows from the reasoning set out in points 101 to 113 and points 167 to 174 of this Opinion that the General Court committed an error of law, in the judgment under appeal, in approving the examination of the existence of an economic advantage on the basis of a reference framework comprising an arm’s length principle which does not derive from national tax law and thereby also infringed the provisions governing the division of competences between the European Union and its Member States.” Click here for English Version of the Opinion ...

A transfer pricing method is applied for the purpose of determining the price of a controlled transaction. Methods acknowledge by the OECD The five methods approved by the OECD are the comparable uncontrolled price (CUP) method, resale price method (RPM), cost plus method (CPM), transactional net margin method (TNMM) and the transactional profit split method (TPSM). OECD also acknowledge use of methods applying techniques used by independent parties for price setting (e.g. valuation techniques for pricing transfers of business assets and credit ratings for determining interest payment). Under narrowly defined circumstances special transfer pricing methods can be applied for simplification purposes according to the OECD Transfer Pricing Guidelines (e.g. the simplified method for LVAS and bilaterally agreed Safe Harbors). At the outer boundary of the arm’s length principle, transfer pricing methods are applied to minimise tax avoidance. This includes the HTVI guidance, the so called sixth method used for commodity transactions, and the group rating approach for setting interest rates on inter-company loans. Pricing methods outside the arm’s length principle include formulary apportionment, industry averages and use of rules of thumb. The Process of Pricing Controlled Transactions Consider the materiality of the transaction vs. the administrative burden and the purpose for pricing the transaction – pricing at the time of the transaction, retrospective price testing, tax assessment, MAP/APA or risk assessment purposes. This is relevant for the overall approach and thoroughness of the pricing exercise. Read the terms and conditions of the agreement and then make an effort to get a full understanding of the true nature/substance of the transaction (or the combined/aggregated transactions), the parties to the transaction and the circumstances under which the transaction has been agreed . Then read the terms of the written agreement again and compare – delineation (what is the real deal). Is remuneration of the transaction included in other transactions. Are there tax incentives for mis-characterizing and/or -pricing the transaction (e.g. low tax jurisdictions) Search for pricing data on comparable transactions – internal, external, historical and other useful information related to pricing of similar transactions. Consider if segregation or aggregation of transactions is needed. Select the most appropriate transfer pricing method – choice of tested party, profit level indicator, use of more than one  method for complex transactions Find the information needed to apply the chosen transfer pricing method – benchmark study, comparability adjustments, financial data, cost base, relevant profit, splitting factor, cash flow, credit rating etc. If the method is based on comparable transactions diagnostic ratios (e.g. turnover compared to costs, profit per employee) may need to be checked? Determine the price of the transaction. Verifying Compliance with the Arm’s Length Principle The last step in the process of pricing a transaction is testing that the price arrived at is in accordance with the arm’s length principle. How is the combined profit from the transaction ultimately shared between the parties and does it reasonably reflect the functions, assets and risk of the parties in relation to the transaction? Will the parties each have a separate benefit from the transaction – are both parties better of by engaging in the transaction taking into account their options realistically available? Is the transaction commercially rational for both parties? If the answer to any of those three questions is – NO – the pricing exercise will have to be revisited. Illustration of Transfer Pricing Methods ...

A significant volume of global trade consists of international transfers of goods and services, capital and intangibles within MNE groups and thus between related parties. Transactions between related parties are referred to as “controlled” transactions, as distinct from “uncontrolled” transactions between independent companies. The forces that regulate pricing of transactions between independent parties are known as “marked forces”. Independent parties can be assumed to operate in their own self-interest (“on an arm’s length basis”) in negotiating terms and conditions for transactions. Put in simple terms an independent seller would want to sell at the highest price and an independent buyer would want to buy at the lowest price – and the price agreed between the two independent parties would be determined in an equilibrium of these two opposite forces. Absent regulation, pricing of controlled transactions within MNE Groups would be determined by forces that differs from those that govern pricing between independent parties – e.g. the overall group profit and taxation. This would result in (1) obstructions to world trade as competition between MNE groups and local businesses would not be at equal footing, and (2) erosion of taxing right in souvereign contries due to MNEs reallocating  profits and tax bases in group companies operating in high tax counties to low tax countries.  For these reasons regulation is needed. “Transfer pricing” is the general term used for regulation of pricing and terms in controlled transactions. In most countries transfer pricing is governed by the Arm’s length principle. Transfer pricing regulations would allow for an adjustment  in the example above. The price of 90 set in the controlled transaction between related parties would be reduced to 80 based on the price agreed between independent parties under comparable circumstances. The authoritative statement of the arm’s length principle is found in paragraph 1 of Article 9 of the OECD Model Tax Convention, which forms the basis of bilateral tax treaties involving OECD member countries and an increasing number of non-member countries and on which most countries internal regulations are based. Article 9 provides: [Where] conditions are made or imposed between the two [associated] enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which would, but for those conditions, have accrued to one of the enterprises, but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly. By seeking to adjust profits in MNEs by reference to the conditions which would have obtained between independent enterprises in comparable transactions and comparable circumstances, the arm’s length principle follows the approach of treating the members of an MNE group as if they were operating as separate entities rather than as inseparable parts of a single unified group. Transfer pricing does not necessarily involve tax avoidance, as the need to set such prices is a normal aspect of how MNEs must operate. Where the pricing does not accord with internationally applicable norms or with the arm’s length principle under domestic law, the tax administration may consider this to be “mis-pricing”, “incorrect pricing”, “unjustified pricing” or non-arm’s length pricing, and issues of tax avoidance and evasion may potentially arise ...

The Swiss company X SA (hereinafter: the Company or the Appellant), is part of the multinational pharmaceutical group X, whose parent holding is X BV (hereinafter referred to as the parent company) in Netherlands, which company owns ten subsidiaries, including the Company and company X France SAS (hereinafter: the French company). According to the appendices to the accounts, the parent company did not employ any employees in 2006 or in 2007, on the basis of a full-time employment contract. In 2010 and 2011, an average of three employees worked for this company. By agreement of July 5, 2006, the French company undertook to carry out all the works and studies requested by the parent company for a fee calculated on the basis of their cost, plus a margin of 15%. The French company had to communicate to the parent company any discoveries or results relating to the work entrusted to it. It should also keep the parent company informed of the progress of the transactions, directly or through the Company. The results of all studies became the property of the parent company. By an agreement of February 19, 2008, the parent company granted the Swiss Company access to the research and development activities carried out by the French company, in exchange for paying the parent company a royalty of 2.5% of all revenues generated on the products or registered by the parent company through the French company. In 2013, the Swiss Tax Administration informed the Company of the initiation of a tax assessment for the years 2008 to 2010, as well as a tax evasion attempt procedure for the year 2011. These proceedings resulted from a communication from the Federal Tax Administration that mentioned the existence of charges not justified by commercial use during the years in question. Later the same year the Tax Administration informed the Company that the proceedings were extended to the years 2003 to 2007. In 2014 a tax assessment was issued for the tax years 2003 and 2005 to 2010. The Tax Administration estimated that the Company had paid royalties to the parent company for the use of research and development of certain molecules. However, the latter company had no substance or technical expertise to carry out this activity. In practice, the research and development of the X group was led by the Swiss Company, which subcontracted some of the tasks to the French company. The amount of royalties paid by the Swiss Company to the parent company, after deduction of the costs actually borne by the company for subcontracting, constituted unjustified expenses on a commercial basis. The Swiss company stated that the parent company assumes important financial, regulatory and operational risks, for which it should be compensated. The Supreme Court concluded that the parent company was a mere shell company, and as a result, disregarded the transaction. The court found that the parent did not hold the required substance to be entitle to any royalty payments. The parent was not involved in the group’s R&D activity and had no/very few employees. It was not even the legal owner because the patents were registered in the Swiss company’s name. The Swiss company had 60 employees and made all the strategic decisions over the R&D functions. The Federal Tribunal ruled in favor of the Swiss Tax Administration. The Court found the transactions and payments to be a hidden distribution of profit leading to tax evasion. Click here for translation ...

Eastern Produce Ltd is part of Camellia Plc Group, and is is engaged in the growing, production and processing of tea in Malawi. The Malawi tax administration conducted a tax audit and found that transfer prices for intergroup service transactions had not been at arm’s length. However, in the notifications to Eastern Produce Ltd. no reference was made to the local arm’s length regulations – only the OECD Transfer Pricing Guidelines. Eastern Produce Limited complained to the High Court and argued that: “The decision and proceeding by MRA to use OECD (Organisation for Economic Cooperation and Development) guidelines whilst performing transfer pricing analysis and as a basis for effecting amendments to tax assessments was illegal. CONSIDERATIONS OF THE COURT, EXCERPS “With regard to transfer pricing in 2014, the law was contained in Section 127A. Section 127A provides as follows:“where a person who is not resident in Malawi carries on business with a person resident in Malawi and the course of such business is so arranged that it produces to the person residentin Malawi either no profits or less than profits which might be expected from that he had been no such relationship, then the profits of that resident person from that business shall be deemed to be the amount that might have been expected to accrue if the course of that business had been conducted by independent persons“. “Section 127A of the Taxation Act is not a stand-alone provision. The Taxation (Transfer Pricing) Regulations, 2009 guide the application of Section 127A of the Taxation Act on transfer pricing issues in Malawi.” “The methods shall be applied in determining the price payable for goods and services in transactions between related enterprises for the purposes of Section 127A of the Act; and A person shall apply the method most appropriate for his enterprise, having regard to the nature of the transaction, or class of transaction, or class of related persons or function performed by such persons in relation to the transaction.” “…there is no dispute between the applicant and the respondent that the law on transfer pricing issues in Malawi was governed by Section 127A and the Taxation (Transfer Pricing) Regulations, 2009, as cited above. This legal position was even accepted and confirmed by the deponent in crossexamination. What this means is that any transfer pricing issues arising from controlled transactions between related enterprises, as is the case at hand, was to be resolved by the Act and the Regulations, and not OECD Guidelines.” “In its Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (July 2010 edition, page 206), the OECD states that there are two main issues in the analysis of transfer pricing for intra group services (which the Agreement purports)….’ The deponent in cross-examination admitted that Section 127A has to be applied together with the 2009 Regulations. The deponent admitted that the Guidelines are sometimes used as an interpretation tool/aid.” “I have to mention that, looking at ET 2, ET4 and ET6, it is very clear that the respondent did not make any reference to the Transfer Pricing Regulations, 2009. Instead, the respondent placed much emphasis on the OECD Guidelines as cited above. I am even at pains to note that the respondent did not even use the OECD Guidelines as an interpretation tool to the local Transfer Pricing Regulations. ET2, ET4 and ET6 are not showing that the OECD Guidelines were only used as an interpretation aid. Any person reading these exhibits will definitely conclude that the respondent applied the law contained in the OECD Guidelines.” “The use of these Guidelines at the expense of the Transfer Pricing Regulations, 2009 is illegal.” “The other issuel have to resolve is the rejection and its aftermath of the method used by the applicant. There is no dispute that the transaction involved herein is a controlled transaction. There is therefore no dispute that it involves transfer pricing issues. Definitely, the transfer price that was to be set between the applicant and its parent company was to be based on the arm’s length principle as per Section 127A of the Taxation Act read together with Taxation (Transfer Pricing) Regulations, 2009.” “Section 6(2) of the Transfer Pricing Regulations, 2009 have placed the burden of choosing a Transfer Pricing method on the taxpayer. In the present case, that burden was with the applicant. Again, Section 7 of the Regulations provides for documentation that may be required by the Commissioner General where a taxpayer has applied a transfer price. In the present case, it was submitted by the deponent that they rejected the transfer price set by the applicant and disallowed the commission on humanitarian grounds. In the first place, let me state that enterprises are under an obligation to keep documentation that assist them in arriving at appropriate transfer price basing on the arm’s length principle. This information may as well be requested by the Commissioner General to assist in assessing whether the correct analysis was done before arriving at an appropriate transfer price as provided for in Section 7 of the Transfer Pricing Regulations, 2009. I am of the considered view that where a taxpayer fails to provide such information, the Commissioner General is indeed at liberty to reject the transfer price or method used by the taxpayer. It is my humble view that though the Regulations places the burden on the taxpayer to choose a method, after the Commissioner General has rejected the method, the Commissioner General has to arrive at an appropriate method to be used.” THE JUDGEMENT The court ordered the applicant [company] within the next 14 days, to submit to the respondent all the necessary documentation pursuant to Section 7 of the Regulations, 2009 for the respondent [tax administration] to undertake a comprehensive analysis of the transfer pricing issues and arrive at an appropriate transfer price method. The respondent to communicate its decision after 21 days of its receipt of such documentation. Thereafter, the respondent to communicate the correct tax payable by the applicant. An order similar to certiorari quashing the notice of amended assessment for ...

Corrugados del Guarco S.A. had declared losses on controlled transactions for FY 2003, 2004 and 2005 as export prices for these transactions had been set below cost and without profit margin, and also different from the price charged for that product to other independent or unrelated companies, in favour of its related company Envases Nicaragüenses S.A. According to the Corrugados del Guarco S.A. the reason why the prices of these controlled transactions had been set low was that unfair competition had made it necessary to use a commercial strategy of selling at preferential prices to the group company in Nicaragua. The tax authorities issued an assessment whereby the prices of the controlled transactions were adjusted in accordance with the arm’s length principle. Furthermore a fine was issued to the company for gross negligence. Judgement of the Supreme Court The Court dismissed the appeal of Corrugados del Guarco S.A. Excerpts from the Judgement “…Finally, and in relation to transfer pricing, on which the plaintiff argues reservation of law, it is necessary to indicate that guideline 20-03, called “Fiscal Treatment of Transfer Pricing, according to Normal Market Value”, issued by the Director General of Taxation on June 10, 2003, refers to the rules of the Organisation for Economic Co-operation and Development (hereinafter OECD), for the setting of prices between related companies. This international organisation is dedicated to contributing to the peaceful and harmonious development of relations between peoples, with an emphasis on collaboration in the global economy. In this regard, the Constitutional Chamber explained the content of the aforementioned body of norms as follows: “The guideline in question is based on the assumption that if these operations have some kind of artificial manipulation, and this is detrimental to the tax authorities, it allows the application of articles 8 and 12 of the Code of Tax Rules and Procedures to establish that certain transactions correspond to a market value as if they had been established between independent persons or entities that compete freely. Although there are different methodologies, to conclude that a price corresponds to a certain reality or not, the problem before the Chamber is an issue closely linked to one that arises for any operator of law that must apply rules that seek to compensate forms of abuse of law or that do not correspond to an economic reality to avoid tax liabilities” (Ruling 2012-4940 of 15 hours 37 minutes of 18 April 2012). The aforementioned court also added, on the constitutionality of the rule “our country does not need to be a member of that body to make use of certain rules or practices that contain a high degree of consensus, especially if, as in the case at hand, articles 15 and 16 of the General Law on Public Administration establish the limits to discretion, even in the absence of a law, which is precisely what is happening in the present case. This Court agrees with the Attorney General’s Office and the Minister of Finance that these are rules with a high degree of subjection to science and technique, as in the case of the general principles of accounting, where a law would not be necessary to reach a technical consensus. In this sense, those methods or techniques make it possible to arrive at a result that is as close to reality as possible, without it being necessary for them to be formally incorporated into the legal system” (ibidem). The above shows that the principle of legal reservation is not violated in the application of OECD transfer pricing methods, such as those analysed here. V.- As a second allegation, it was argued that the financial penalty was imposed without previously following a sanctioning procedure, since it only faced a determinative one.“ ” In the opinion of this Court, the arguments of the appellant also fail to break this aspect of the judgement. The court took for granted that with intent, the plaintiff sold at prices below cost and that she used an agreement with another private individual to defraud the tax authorities, therefore it cannot be indicated in this court that she did not qualify the conduct, establishing that even article 71 of the Code of Tax Rules and Procedures, allows the sanction when it has acted with intent or mere negligence, that is to say, by negligence. The law seeks to ensure that the self-assessments, on which the country’s entire tax system is based, are made seriously and carefully, and therefore penalises fraud and negligence in the self-assessment with 25 percent of what has not been paid to the Treasury. This procedure is necessarily linked to the assessment procedure, where it is defined whether what was declared and paid by the taxpayer is in accordance with the legal system and this is clearly stated by the sentencing body, which also refers that the sanctioning procedure was carried out in the terms established by the said numeral 150 CNPT and that the right of defence was guaranteed by giving the taxpayer a hearing and resolving his appeals.” Click here for English translation Click here for other translation ...

ARTICLE 9 ASSOCIATED ENTERPRISES 1. Where an enterprise of a Contracting State participates directly or indirectly in the management, control or capital of an enterprise of the other Contracting State, or the same persons participate directly or indirectly in the management, control or capital of an enterprise of a Contracting State and an enterprise of the other Contracting State, and in either case conditions are made or imposed between the two enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which would, but for those conditions, have accrued to one of the enterprises, but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly. 2. Where a Contracting State includes in the profits of an enterprise of that State – and taxes accordingly – profits on which an enterprise of the other Contracting State has been charged to tax in that other State and the profits so included are profits which would have accrued to the enterprise of the first mentioned State if the conditions made between the two enterprises had been those which would have been made between independent enterprises, then that other State shall make an appropriate adjustment to the amount of the tax charged therein on those profits. In determining such adjustment, due regard shall be had to the other provisions of this Convention and the competent authorities of the Contracting States shall if necessary, consult each other. COMMENTARY ON ARTICLE 9 CONCERNING THE TAXATION OF ASSOCIATED ENTERPRISES 1. This Article deals with adjustments to profits that may be made for tax purposes where transactions have been entered into between associated enterprises (parent and subsidiary companies and companies under common control) on other than arm’s length terms. The Committee has spent considerable time and effort (and continues to do so) examining the conditions for the application of this Article, its consequences and the various methodologies which may be applied to adjust profits where transactions have been entered into on other than arm’s length terms. Its conclusions are set out in the report entitled Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations,’ which is periodically updated to reflect the progress of the work of the Committee in this area. That report represents internationally agreed principles and provides guidelines for the application of the arm’s length principle of which the Article is the authoritative statement. Paragraph 1 2. This paragraph provides that the taxation authorities of a Contracting State may, for the purpose of calculating tax liabilities of associated enterprises, re-write the accounts of the enterprises if, as a result of the special relations between the enterprises, the accounts do not show the true taxable profits arising in that State. It is evidently appropriate that adjustment should be sanctioned in such circumstances. The provisions of this paragraph apply only if special conditions have been made or imposed between the two enterprises. No re-writing of the accounts of associated enterprises is authorised if the transactions between such enterprises have taken place on normal open market commercial terms (on an arm’s length basis). 3. As discussed in the Committee on Fiscal Affairs’ Report on “Thin Capitalisation” there is an interplay between tax treaties and domestic rules on thin capitalisation relevant to the scope of the Article. The Committee considers that: a) the Article does not prevent the application of national rules on thin capitalisation insofar as their effect is to assimilate the profits of the borrower to an amount corresponding to the profits which would have accrued in an arm’s length situation; b) the Article is relevant not only in determining whether the rate of interest provided for in a loan contract is an arm’s length rate, but also whether a prima facie loan can be regarded as a loan or should be regarded as some other kind of payment, in particular a contribution to equity capital; c) the application of rules designed to deal with thin capitalisation should normally not have the effect of increasing the taxable profits of the relevant domestic enterprise to more than the arm’s length profit, and that this principle should be followed in applying existing tax treaties. 4. The question arises as to whether special procedural rules which some countries have adopted for dealing with transactions between related parties are consistent with the Convention. For instance, it maybe asked whether the reversal of the burden of proof or presumptions of any kind which are sometimes found in domestic laws are consistent with the arm’s length principle. A number of countries interpret the Article in such a way that it by no means bars the adjustment of profits under national law under conditions that differ from those of the Article and that it has the function of raising the arm’s length principle at treaty level. Also, almost all member countries consider that additional information requirements which would be more stringent than the normal requirements, or even a reversal of the burden of proof, would not constitute discrimination within the meaning of Article 24. However, in some cases the application of the national law of some countries may result in adjustments to profits at variance with the principles of the Article. Contracting States are enabled by the Article to deal with such situations by means of corresponding adjustments (see below) and under mutual agreement procedures. Paragraph 2 5. The re-writing of transactions bet ween associated enterprises in the situation envisaged in paragraph 1 may give rise to economic double taxation (taxation of the same income in the hands of different persons), in so far as an enterprise of State A whose profits are revised upwards will be liable to tax on an amount of profit which has already been taxed in the hands of its associated enterprise in State B. Paragraph 2 provides that in these circumstances, State B shall make an appropriate adjustment so as to relieve the double taxation. 6. It ...

When transfer pricing does not reflect market forces and the arm’s length principle, the tax liabilities of the associated enterprises and the tax revenues of the host countries could be distorted. Therefore, OECD member countries have agreed that for tax purposes the profits of associated enterprises may be adjusted as necessary to correct any such distortions and thereby ensure that the arm’s length principle is satisfied. OECD member countries consider that an appropriate adjustment is achieved by establishing the conditions of the commercial and financial relations that they would expect to find between independent enterprises in comparable transactions under comparable circumstances ...

This Chapter provides a background discussion of the arm’s length principle, which is the international transfer pricing standard that OECD member countries have agreed should be used for tax purposes by MNE groups and tax administrations. The Chapter discusses the arm’s length principle, reaffirms its status as the international standard, and sets forth guidelines for its application ...

OECD member countries continue to endorse the arm’s length principle as embodied in the OECD Model Tax Convention (and in the bilateral conventions that legally bind treaty partners in this respect) and in the 1979 Report. These Guidelines focus on the application of the arm’s length principle to evaluate the transfer pricing of associated enterprises. The Guidelines are intended to help tax administrations (of both OECD member countries and non-member countries) and MNEs by indicating ways to find mutually satisfactory solutions to transfer pricing cases, thereby minimising conflict among tax administrations and between tax administrations and MNEs and avoiding costly litigation. The Guidelines analyse the methods for evaluating whether the conditions of commercial and financial relations within an MNE satisfy the arm’s length principle and discuss the practical application of those methods. They also include a discussion of global formulary apportionment ...

In this case, the Swiss Court elaborates on application of the arm’s length principel, transfer pricing methods, OECD TPG, and the burden of proof in Switzerland. Excerp in English (unofficial translation) “5.1. The question of whether there is a disproportion between the service provided by the company and the compensation it provides is determined by comparison with what has been agreed between independent persons (“Drittvergleich”): the question is whether the benefit would have been granted, to the same extent, to a third party outside the company, or to check whether the “arm’s length” was respected. This method makes it possible to identify the market value of the property transferred or the service rendered, with which the counter-benefit actually required must be compared. 5.2. Where there is a free market, the prices charged therein are decisive and allow an effective comparison with those applied in the transaction examined. If there is no free market, but transactions with the same characteristics have been concluded with a third party or between third parties, the price at issue must be compared with that which has been carried out in those transactions. This method corresponds to the comparable free market price method as set out in the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (July 2010 edition, see especially § 2.13). ss, hereinafter: Principles). In order for this method to be applicable, the transaction with a third party or between third parties must be similar to the transaction examined (Locher, op.cit., 103 ad art 58 DBG), that is to say having been concluded in circumstances comparable to this one. The concept of ” comparable transaction ” is not easy to define. The relevance of the comparison with transactions concluded with third parties assumes that the relevant economic circumstances of these transactions are similar to those of the transaction examined. The comparability of the transactions is determined by their nature and the totality of the circumstances of the case. If the relevant economic conditions differ from those of the transaction under review, adjustments must be made to erase the effects of these differences. However, it can not be ruled out that a comparable transaction was not concluded at market price. The formation of the price can indeed be influenced by several elements, such as market conditions, contractual conditions (for example, the existence of secondary benefits, the quantity of goods sold, terms of payment), the commercial strategy pursued by this third party purchaser or the economic functions of the parties. Nevertheless, the price charged in a comparable transaction is presumed to correspond to the market price; in case of dispute, proof to the contrary lies with the company. In the absence of a comparable transaction, the examination of the arm’s length principle is then based on a hypothetical value determined by other methods, such as the cost-plus method or, in the context of transactions such as the distribution of goods, the resale price.” Click here for translation ...

Nestlé de Costa Rica S.A. had been issued a tax assessment in which the taxable income for FY 2005 and 2006 was adjusted with an additional amount of ¢60,609,096.00 and ¢75,663,084.00. According to the tax authorities, the sales made by Nestlé to its related companies located in Chile, Switzerland and Puerto Rico had a profit margin different from those made to third parties. The margin on the unrelated transactions was 88% whereas the margins on comparable related party transactions was only 7%. The adjustments was determined based on internal CUPs. Judgement of the Court The Court dismissed the appeal of Nestlé. Excerpts “This Chamber agrees with the Tribunal, in the sense that the expert witness Luna Ramírez, during her testimony, does not manage to disprove the system applied by the Tax Administration, since she rejects the method used, however, she also states that it is difficult to resort to any other method. What is clear from this testimony is that in this process the plaintiff could not substantiate or justify the reason why it sold the same product at a lower price to its related companies.” “According to the study made by the Tax Administration, which again was not contested by the plaintiff, the average profit on the standard cost of the products sold to independent companies was 87.87%, while with the related companies it was 7.17% for the tax periods at issue here. The difference is so large that it is not possible to explain reliably the reason for this disparity.” “Therefore, this Chamber endorses the Court’s position of upholding the criterion issued by the Tax Administration and collecting the differences due to the total non-payment of the tax.” Click here for English translation Click here for other translation ...

Polymer S.A. had been issued an assessment of taxable income based on the arm’s length principle. In the assessment the tax authorities had based the adjustment on the guidance provided in the OECD TPG. Polymer S.A. was of the opinion that this was unconstitutional since the OECD TPG had not been implemented by law and Costa Rica was not an OECD member country. Judgement of the Supreme Court The Court dismissed the appeal of Polymer S.A. Excerpts from the Judgement “The contested Guideline does not establish or impose a single method of transfer pricing analysis, so that, in the absence of a law, the autonomy of tax law allows for the determination of the tax payable to resort to the provisions of Articles 8 and 12 of the Code of Tax Rules and Procedures, without prejudice to the possibility that other – better – techniques may be admitted. What is important is that the contested Interpretative Guideline does not aim to eliminate multiple other scenarios arising from different forms of business organisation, but is directed at transfer pricing between related companies. Even if the legislator may adopt a certain technique or several techniques to regulate a certain behaviour of companies, or recognise legal practices to reduce taxes, it is possible to admit that if there are clashes with tax law and reality, in the absence of a law, it is ultimately up to the judge to decide on the correct application of the technical rules. Thus, in the absence of any particular legislation, this fact does not prevent the parties in conflict from presenting their arguments, producing evidence and demonstrating the need to apply other criteria that allow for the non-application of the technical rule that adopts the guideline in question, or of another possible method, a situation that evidently makes the discussion a matter of ordinary legality. For all of the above reasons, the action must be dismissed, as indeed it is. A., the contested Guideline interprets Articles 8 and 12 of the Code of Tax Rules and Procedures, disregarding the legal forms to assess the true economic intention of the parties. It allows to assess transactions between related entities, where transfer prices exist, and to make the respective income tax adjustments. It does not aim to eliminate other multiple scenarios arising from different forms of business organisation, but rather targets transfer pricing between related companies. Moreover, our country does not need to be a member of the Organisation for Economic Co-operation and Development (OECD) to make use of certain rules or practices that contain a high degree of consensus, under the provisions of articles 15 and 16 of the General Law of Public Administration that establish the limits to discretion, even in the absence of law. By virtue of the foregoing, and there being no reasons to justify a change of criterion, it is considered that the contested Directive does not infringe the principles of the reservation of law, regulatory power and legal certainty, and therefore the action is rejected on the merits.“ Click here for English translation Click here for other translation ...

In an appeal to the Supreme Court in Costa Rica, Nestlé claimed that the basis for an arm’s length adjustment was unconstitutional, since the arms length principle as described in the OECD transfer pricing guidelines had not been incorporated into the laws of Costa Rica. Judgement of the Supreme Court The Court dismissed the appeal of Nestlé. “The contested Guideline does not establish or impose a single method of transfer pricing analysis, so that, in the absence of a law, the autonomy of tax law allows for the determination of the tax payable to resort to the provisions of Articles 8 and 12 of the Code of Tax Rules and Procedures, without prejudice to the possibility of admitting “other -better- techniques”. What is important is that the contested Interpretative Guideline does not aim to eliminate other multiple scenarios arising from different forms of company organisation, but is directed at transfer pricing between related companies. Even if the legislator may adopt a certain technique or several techniques to regulate a certain behaviour of companies, or recognise legal practices to reduce taxes, it is possible to admit that if there are clashes with tax legislation and with reality, in the absence of a law, it is ultimately up to the judge to decide on the correct application of the technical rules. Thus, in the absence of any particular legislation, this fact does not prevent the parties in conflict from presenting their arguments, producing evidence and demonstrating the need to apply other criteria that allow for the non-application of the technical rule that adopts the guideline in question, or of another possible method, a situation that evidently makes the discussion a matter of ordinary legality. For all of the above reasons, the action should be dismissed, as it is in fact being dismissed.” Click here for English translation Click here for other translation ...

It should not be assumed that the conditions established in the commercial and financial relations between associated enterprises will invariably deviate from what the open market would demand. Associated enterprises in MNEs sometimes have a considerable amount of autonomy and can often bargain with each other as though they were independent enterprises. Enterprises respond to economic situations arising from market conditions, in their relations with both third parties and associated enterprises. For example, local managers may be interested in establishing good profit records and therefore would not want to establish prices that would reduce the profits of their own companies. Tax administrations should keep these considerations in mind to facilitate efficient allocation of their resources in selecting and conducting transfer pricing examinations. Sometimes, it may occur that the relationship between the associated enterprises may influence the outcome of the bargaining. Therefore, evidence of hard bargaining alone is not sufficient to establish that the transactions are at arm’s length ...

Factors other than tax considerations may distort the conditions of commercial and financial relations established between associated enterprises. For example, such enterprises may be subject to conflicting governmental pressures (in the domestic as well as foreign country) relating to customs valuations, anti-dumping duties, and exchange or price controls. In addition, transfer price distortions may be caused by the cash flow requirements of enterprises within an MNE group. An MNE group that is publicly held may feel pressure from shareholders to show high profitability at the parent company level, particularly if shareholder reporting is not undertaken on a consolidated basis. All of these factors may affect transfer prices and the amount of profits accruing to associated enterprises within an MNE group ...

When transfer pricing does not reflect market forces and the arm’s length principle, the tax liabilities of the associated enterprises and the tax revenues of the host countries could be distorted. Therefore, OECD member countries have agreed that for tax purposes the profits of associated enterprises may be adjusted as necessary to correct any such distortions and thereby ensure that the arm’s length principle is satisfied. OECD member countries consider that an appropriate adjustment is achieved by establishing the conditions of the commercial and financial relations that they would expect to find between independent enterprises in comparable transactions under comparable circumstances ...

When independent enterprises transact with each other, the conditions of their commercial and financial relations (e.g. the price of goods transferred or services provided and the conditions of the transfer or provision) ordinarily are determined by market forces. When associated enterprises transact with each other, their commercial and financial relations may not be directly affected by external market forces in the same way, although associated enterprises often seek to replicate the dynamics of market forces in their transactions with each other, as discussed in paragraph 1.5 below. Tax administrations should not automatically assume that associated enterprises have sought to manipulate their profits. There may be a genuine difficulty in accurately determining a market price in the absence of market forces or when adopting a particular commercial strategy. It is important to bear in mind that the need to make adjustments to approximate arm’s length transactions arises irrespective of any contractual obligation undertaken by the parties to pay a particular price or of any intention of the parties to minimize tax. Thus, a tax adjustment under the arm’s length principle would not affect the underlying contractual obligations for non-tax purposes between the associated enterprises, and may be appropriate even where there is no intent to minimize or avoid tax. The consideration of transfer pricing should not be confused with the consideration of problems of tax fraud or tax avoidance, even though transfer pricing policies may be used for such purposes ...

This Chapter provides a background discussion of the arm’s length principle, which is the international transfer pricing standard that OECD member countries have agreed should be used for tax purposes by MNE groups and tax administrations. The Chapter discusses the arm’s length principle, reaffirms its status as the international standard, and sets forth guidelines for its application ...

OECD member countries continue to endorse the arm’s length principle as embodied in the OECD Model Tax Convention (and in the bilateral conventions that legally bind treaty partners in this respect) and in the 1979 Report. These Guidelines focus on the application of the arm’s length principle to evaluate the transfer pricing of associated enterprises. The Guidelines are intended to help tax administrations (of both OECD member countries and non-member countries) and MNEs by indicating ways to find mutually satisfactory solutions to transfer pricing cases, thereby minimising conflict among tax administrations and between tax administrations and MNEs and avoiding costly litigation. The Guidelines analyse the methods for evaluating whether the conditions of commercial and financial relations within an MNE satisfy the arm’s length principle and discuss the practical application of those methods. They also include a discussion of global formulary apportionment ...

A Const S.A. filed an appeal with the Central Administrative Court against a corrections made by the Tax Administration for FY 1990 under application of the arm’s length principle (contained in article 57 of the CIRC in Portugal). The Central Administrative Court dismissed the appeal. An appeal was then filed against this decision to the Supreme Administrative Court. By Judgment of 4 February 2004, the appeal was also dismissed at this instance. Dissatisfied with that decision A Const S.A. filed an appeal with the Constitutional Court. Grounds for the appeal was stated as follows “In compliance with the provisions of nº 2 of art. 75-A of the LTC it is moreover expressly stated that the present appeal is based on the concrete review of the constitutionality of art. 57 of the CIRC (in the wording in force on the date of the facts of the case, applicable in casu) taking into account its applicability in the contested decision: a. either because it is a blank provision, containing vague and imprecise concepts, without any definition of criteria of positive law for its concretisation, its application being based on the arbitrary filling by the Tax Authorities of indeterminate general clauses, which violates the constitutional principles and rules of tax legality (art. 106, no. 2, CRP, in the wording in force at the time of the facts of the case, applicable in casu), certainty, legal security and confidence (art. 2 of the CRP); b. because the contested decision, in its interpretation and application of the aforementioned rule (Article 57 of the CIRC) violated the constitutional principles of certainty, legal security, confidence, good faith, equality and impartiality enshrined in Articles 2, 13, 266(1) and (2) of the Constitution.” Decision of Constitutional Court The Court dismissed the appeal of “A Const S.A.” and concluded that the rule contained in no. 1 of article 57 of the Corporate Tax Code, in the original wording, in force at the time of the facts of the case, was not unconstitutional. Excerpts “… In fact, although the delimitation of the assumptions for the application of that regulation depends on a judgment of interpretation and valuation of elements of a technical nature – existence of “special relationships” and a deviation from “normal” prices – and the use of maximum of experience, it does not appear that, as stated in the aforementioned judgment n.º 233/94, “from the constitutional imposition contained in the principle of tax legality, it follows that such presuppositions for the application of the contested regulations legally established are shown to be insufficiently densified, taking into account the specificities of the tax field, where often, and in the exercise of control powers, if will have to resort to indeterminate legal concepts and the contribution of elements of a technical nature to base the decisions of the Administration in the pursuit of the public interest expressed in the correct taxation of economic agents ”. In fact, in this case, the individual knows, in view of the normative postulate, that not every situation will justify the realization of the necessary corrections to determine the taxable profit: this will only happen when we are faced with situations that, terms of the law, whether arising from the existence of special relationships of dependence , causing distortion in relation to market prices and having a direct influence on the determination of that profit. Furthermore, since the criterion adopted by the legislator is objectively related to the market, the administration is left tax, which is responsible for determining the taxable amount under the terms of article 57 of the CIRC, linked to the establishment of the arm’s length price, and this criterion does not include subjective assessments. And if it is true that the questioned rule, similarly to what also happens in other legal systems, does not materialize the valuation criterion that will govern the determination of the arm’s length price, the fact is that the reference to the prices established between independent entities it ends up establishing the objective limits within which such a criterion can be set. In fact, this is what the new transfer pricing regulation – Article 58 of the CIRC- came to clarify, bringing a greater degree of certainty, security and, above all, greater efficiency to the action of the tax administration. However, this does not imply that, previously, article 57, no. 1, of the CIRC did not have sufficient density for taxable persons to determine the presuppositions for the performance of the Administration and for the Courts to proceed with the control of the adequacy and proportionality of the administrative activity. Therefore, it must be concluded that the questioned rule allows the taxable person to fully know and control which quantitative expression of the tax fact is taken into account. It contains a sufficient normative density that conditions administrative activity and binds the administration to the verification of its application assumptions, allowing that the courts can syndicate the administrative decision that this norm makes application. In addition, article 80 of the Tax Procedure Code in force at the time of the facts of the case, which already contained additional requirements for reasons (currently included in article 77, paragraph 3, of the General Tax Law) for cases in which the Administration proceeds to carry out corrections motivated by the existence of special relationships, ends up reinforcing the guarantees that the principle of legality, namely in its dimension of tax typicality, postulates. … Pursued from the knowledge of the appeal, by a decision passed in the meantime, the assessment of the unconstitutionality of the contested decision, for violation of the ” constitutional principles, certainty, legal certainty, trust, good faith, equality and impartiality, enshrined in arts. 2, 13, 266, nº 1, nº 2, of the Constitution”, the appellant, who, in the application for filing an appeal to this Court, had invoked the violation, by the questioned rule – art. 57, no. 1, of the CIRC , in the wording in force at the time of the facts of the case -, of the principles of certainty, legal certainty and trust (art. to this same rule the violation of “constitutional principles of taxation of real income, ...

ALP S.A. filed an appeal with the Central Administrative Court against a corrections made by the Tax Administration for FY 1992 under application of the arm’s length principle (contained in article 57 of the CIRC in Portugal). The Central Administrative Court dismissed the appeal. An appeal was then filed against this decision to the Supreme Administrative Court. By Judgment of 6 June 2001, the appeal was also dismissed at this instance. Dissatisfied with that decision ALP S.A. filed an appeal with the Constitutional Court. ALP S.A grounds for the appeal was: By virtue of the Principle of Tax Legality, the rules of incidence must be predetermined in their content, and the elements that comprise it must be formulated in a precise and determined manner. Determining the content of the levy tax rule excludes the use of undetermined concepts, as well as certain normative concepts, whose application to the specific case is based on subjective or personal assessment of the enforcement body, under penalty of postponing legal certainty. According to Nuno Sá Gomes, in Manual of Tax Law, Vol. II, 2000, p. 39, “… In turn, it is said that we are facing an absolute reservation of the law when it is established, as among us, that the formal law must contain not only the foundation of the administration’s conduct, but also the criteria for decisions in concrete cases. , not giving rise to any discretion or availability of a tax type by the tax administration ”. In the specific case, the corrections made result from the application of art. 57.º, no. 1, of the CIRC and the understanding by the tax administration agent of the existence of special relationships between the taxpayer and another person as a result of that legal precept. However, “special relationships” and “relationships that establish conditions different from those agreed between different persons” are vague, undetermined concepts that give the tax administration discretionary powers to correct the taxable amount. However, this is not a matter of technical discretion, as the law does not call for its application to non-legal or artistic or professional scientific knowledge, but to the appreciation of established relationships, whether the profit presented is different from normal and how the actual amount on which the correction was based is quantified. It is the ordinary law – art. 103, nos. 2 and 3, and art. 268 of the CRP – which must establish the parameters in which this activity is regulated under penalty of unconstitutionality. And these criteria do not exist nor are they established by law, so the great breadth and indeterminacy of the content of those concepts allow the enforcement agency to include any and all gains in the norm, thus sacrificing legal certainty!!! Thus, the rule of art. 57.º, no. 1, of the CIRC, being formulated in vague and imprecise terms, using pure normative concepts, without any concreteness and determination, it is a materially unconstitutional norm for breach of the principle of legality and tax typicality. According to Nuno Sá Gomes, ob. cit., p. 193 “…the aforementioned art. 57.º does not clarify what is to be understood by special relationships, only touching on the criterion of dependence, therefore, it seems that there are special relationships whenever the entities in question are dependent on each other”. Hence, from the outset, a broad indeterminacy that amounts to attributing to the tax administration the discretionary power to decide when there is a special relationship of dependence, which, as we said, is unconstitutional. The fact that the tax law does not define what is to be understood by SPECIAL RELATIONS and the vague, elastic nature of this concept leads us to conclude that the formula used, right there, violates art. 106, no. 2 of the CRP, which requires that “the law determines… the incidence”. Thus, while the tax legislation does not set out the following criteria, it must be considered that art. 57 of the CIRC is unconstitutional, as it gives the Tax Administration discretionary powers to correct the taxable matter. Therefore, the norm of paragraph 1 of art. 57 of the CIRC be declared unconstitutional!” Decision of Constitutional Court The Court dismissed the appeal of ALP S.A. Following a thorough description of the provisions forming the basis for application of the arm’s length principle in other countries, the Court concluded that the  “arm’s length principle” as implemented in Portugal in art. 57 of the CIRC was not unconstitutional. Excerpts “… Thus, in the specific case, taking into account the above considerations, it will have to be concluded that the union norm not only presents a sufficient normative density – in terms of containing, in its formulation, a sufficient significant aptitude, capable of cutting a framework of administrative action legally presupposed and conditioned -, as it allows the courts to syndicate the goodness and correctness of administrative judgment. In other words, it can be said that the legally outlined framework does not allow the determination of the practical-normative meaning of the precept, materialized in its application, as a result of the consideration of the problem, to be carried out outside the legal command set out in the norm, as a result , therefore, of a freedom of administrative action that is judicially indiscriminate. On the contrary, the rule does not reflect any juridical-political option of the legislator for the granting of discretionary powers, it also refers the administrative decision to the (linked) verification of the application assumptions from the consideration of the concrete legal problems, being able, therefore, in this measure, the tax courts assess the verification of the assumptions of administrative action and determine, in the face of a specific problem, We can thus conclude, in summary, that we are dealing, in this case, with undetermined concepts whose content does not demand the attribution of any constitutive power to the tax administration in terms of determining the taxable amount, since only that objective meaning that results from directly from tax law. This, contrary to what happened in the rule indicated by Judgment no. of taxation. On the other hand, the tax administration is now only recognized with a competence of ...