If the characteristics of the transaction that are economically relevant are inconsistent with the written contract between the associated enterprises, the actual transaction should generally be delineated for purposes of the transfer pricing analysis in accordance with the characteristics of the transaction reflected in the conduct of the parties ...

“Tobacco S.A.” is the parent company of a group active in the tobacco industry. C. SA is a subsidiary of the group and operates as a toll manufacturer (Toller) on behalf of another subsidiary, B S.A. For the manufacturing services provided C S.A receives a “toll fee” from B S.A. According to the manufacturing service agreement the toll fee is calculated, based on Toller’s production costs plus and the capital invested by Toller in the production. Following an audit the tax authorities issued an additional assessment of corporate income tax and compensatory interest, relating to FY 2009, in the amount of EUR 1,395,039.79. The tax authorities considered that i) to correct the value of the production costs of the year 2009, in the amount corresponding to the deduction of the income with the “Write Off” of several credit balances of third parties over the company, since these deductions were not provided for in the contract; ii) to correct the value of the return on invested capital [which in the contract and also in the sentence is designated by the acronym ROCE] because the rules of the contract for its determination were not respected, which resulted in a lower remuneration by C. S.A. and in a cost saving by its contractual counterpart, leading to a result that is not compatible with the arm’s length principle. An appeal was filed against the assessment, but the tax tribunal of Lisbon dismissed the appeal and upheld the assessment. An appeal was then filed with the Supreme Administrative Court. Tobacco S.A. claimed that it did not in any way breach the contract for the provision of production services as it applied the POC rules when calculating the toll fee. Thus, it must be concluded that the correction made by the Tax Authority and confirmed by the Court of Appeal and which is claimed to be exclusively based on the incorrect interpretation of the contract by the Appellant is illegal due to the violation of the law. Moreover, according to Tobacco S.A, the tax authorities made an error on the assumptions, since it corrected the calculation of the value of the return on invested capital based on different rules from those which, in its interpretation, result from the contract. The appellant had made the calculations according to the statutory accounts (POC accounts), in compliance with the provisions of Annex B to the contract, and the Tax Authorities decided to correct those values by applying the values contained in Annexes C and D (US GAAP accounting classifications), which, according to the appellant, have the sole function of “allowing uniform intra-group reporting, essentially of a management nature”. “(…) as to the corrections to the ROCE, in the amount of €2,965,761.08, the appellant claims that, by disregarding the POC accounts and considering the US GAAP accounts, the Tax Authorities followed an understanding that does not prove to be correct and is distant from that provided for in the agreements entered into. Judgement of the Supreme Administrative Court The Supreme Administrative Court dismissed the case, as it considered to lack jurisdiction in regards to a judgment on the factual matter. The case was therefore officially transferred to the South Administrative Central Court. Excerpt “… Therefore, the Supreme Administrative Court is reserved the role of a review court, with intervention only in cases where the matter of fact in dispute in the case is stabilised and only the law remains under discussion. In order to assess the competence of the Supreme Administrative Court on the grounds of hierarchy, it is necessary to consider, in principle, only the content of the conclusions of the appeal statements (since these define the object and delimit the scope of the appeal – cf. It is necessary, in principle, to look only at the content of the conclusions of the appeal statement (since the object and scope of the appeal are defined by those conclusions – see Article 635 of the CPC) and check whether, in the light of those conclusions, the questions in dispute are resolved exclusively by applying and interpreting legal norms or whether, on the contrary, consideration of them implies the need to settle questions of fact (either because the appellant maintains that the facts presented as proved in the judgment have not been proved, or because he disagrees with the conclusions of fact to be drawn from them, or, still, because he invokes facts which have not been presented as proved and which are not, in the abstract, irrelevant for the judgment of the case). But not only this, it may also be necessary to compare the conclusions with the very substance of the allegations in the appeal, in particular to check whether they expressly contradict the facts on which the decision is based. And if the appellant raises any issue of fact, the appeal will no longer be based exclusively on points of law, and the competence of the Central Administrative Court will be defined from the outset, regardless of the possibility that this Court may eventually conclude that the disagreement on the factual issue is irrelevant for the decision of the appeal. However, the problem, in this case, of the correct interpretation of the contractual clauses on the basis of which the accounts (the accounting system) that are to serve as the basis for the calculation of the taxable amount are defined, is still a matter of fact. Although it is accepted that it may be qualified as a mixed matter (of fact and law), as it involves, on the one hand, the interpretation of the will of the contractual parties in determining the accounts that they intended to use in the calculation of the taxable amount for the purposes of taxation in Portugal of C……… (factual judgment) and, on the other hand, the normative interpretation of the contractual and legal clauses that define the arm’s length principle in the scope of legal transactions between persons that are in a special relationship with each other (transfer pricing), the truth is ...

Cadence Design System Srl received a sales commission of 29% under a written agreement dated 1999 with a related party in Ireland. However, in 2003 the commission rate was changed to only 20%. The change was communicated to Cadence Design System Srl by e-mail from the Irish company dated 6/08/2002. Following an audit, the tax authorities issued an assessment where the taxable income was calculated on the basis of the commission rate originally agreed by the parties. A complaint was filed by Cadence and in 2010 the regional tax court (CTR) issued a decision where the commission rate was set to 22.38% for FY 2003 based on a transfer pricing study provided in the case. Not satisfied with the decision an appeal was filed with the Supreme Court. Judgement of the Supreme Court The Supreme Court dismissed the appeal and upheld the decision of the regional tax court. Excerpts “The ruling in question, in fact, inferred the existence of greater revenues from the clause in the (written) commission agreement between the sister companies, under which the consideration due to the taxpayer by the Irish company was set at 29% of the revenues. In compliance with the evidentiary mechanism of Article 39(1)(d), the CTR, therefore, by an assessment of merit that cannot be reviewed by the court of legitimacy, ruled out that the factual elements relied on by the appellant to demonstrate the reduction of the commission from the amount originally provided for, were capable of eliminating the probative effectiveness of the relevant contractual clause.” “The appellant complains that the CTR applied the erroneous regula iuris according to which, in the absence of contrary proof on the part of the taxpayer, the taxpayer’s claim, assisted by a presumption iuris tantum of foundation, should be upheld. It points out that the appellate court: “should have ascertained whether documentation existed, i.e. positive proof of the office’s claim and, in the absence of any proof of the Treasury’s assumption, should have allowed the taxpayer’s appeal.” (See p. 94 of the appeal). He submits that, in so doing, the appellate court failed to notice that the percentage provided for in the contract had then been modified by the parties, as attested by the e-mail of 6/08/2002, addressed by the Irish sister company to the Italian taxpayer, which indicated the new commission percentage of 20%. According to the defence, the CTR, by disregarding this element of knowledge, also infringed Article 11 of the Vienna Convention, which recognises that a contract of sale between intra-group companies, belonging to different States, does not need to be in writing, ad substantiam or ad probationem, and indeed is not subject to any formal requirement. “The CTR, on the contrary, presumed the existence of greater revenues on the basis of the negotiation clause referred to several times above, and, subsequently (with a judgement on the merits, unquestionable in the court of legitimacy), did not find that the taxpayer had provided evidence of the reduction of the percentage of 29%, denying, inter alia, that the e-mail from the Irish company, addressed to the appellant, communicating the reduction of the commission percentage from 29% to 20%, was capable of: “invalidate the very different conclusion of the written contract” (see page 5 of the contested judgment).” “In the present case, it is clear that the judgment of appeal is not criticised for a motivational defect concerning a historical fact that is controversial and decisive for the judgement, but rather, in an inadmissible manner, for the relevance that it attributed to certain concrete elements of the case (starting with the written contract that provided for a commission percentage of 29%), to the detriment of others, deemed irrelevant (for example: the e-mail of 6/08/2002), in order to recognise and affirm the validity of the tax assessment.” Click here for English translation Click here for other translation Cass 27-12-2018 no 33406 ...

If the characteristics of the transaction that are economically relevant are inconsistent with the written contract between the associated enterprises, the actual transaction should generally be delineated for purposes of the transfer pricing analysis in accordance with the characteristics of the transaction reflected in the conduct of the parties ...